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Is tax-loss harvesting right for all investors?

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The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Eaton Vance disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Eaton Vance are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Eaton Vance fund. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Past performance is no guarantee of future results.

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      By Brian Langstraat, CFAChief Executive Officer, Parametric

      Seattle - Back in the 1980s, the first mobile phones were clunky devices that weighed as much as bricks and looked like them, too. Owned only by the very few, all these phones did was make calls — with no texting, no web browsing and certainly no playing Fortnite. Nowadays, according to 2018 data from the Pew Research Center, 95% of the U.S. population owns some sort of mobile phone, and 77% owns a smartphone.

      These ubiquitous devices aren't the only invention from the previous millennium that was once tailored to a very small subset of the population and now appears to be undergoing something of a democratization.

      Back in the early 1990s, Parametric helped pioneer tax-loss harvesting — selling a basket of securities at a loss and simultaneously replacing it with a different basket of securities — to help clients reduce their tax risk while maintaining their market exposure. That strategy has begun to migrate from the realm of specialty practice to the broader world of investment advisory. More and more retail firms are touting its benefits to more and more clients. After all, if tax-loss harvesting is good for some investors, it must be good for all investors, right?

      Well, frankly, maybe not. As with early mobile phones, we may have a classic case of a bad connection here.

      Tax-loss harvesting isn't for every investor

      Like everything else in the finance universe, tax-managed investing isn't a free lunch. At heart, tax-loss harvesting is a trade-off between risk and return. In this respect it's no different from any other investment decision, and investors must evaluate tax-loss harvesting accordingly.

      For example, are you comfortable vacating a position to harvest a loss, or is there risk in being out of a position that potentially exceeds the tax benefit? If so, how might you mitigate that risk? If you sell out of multiple positions to harvest losses, are you comfortable with the effect that might have on the portfolio's overall tracking error?1

      The answers may be different for every investor, and in our experience the risk-return trade-off ends up favoring certain types of investors. To the extent that the average investor is being told to harvest losses in knee-jerk fashion, they're being done a disservice.

      Once again, tax-loss harvesting feels like the shiny new thing in the industry — even though it really isn't. And like many shiny new things, it's both benefiting and suffering from all the hype. We say hold the phone. Tax-loss harvesting can be a powerful tool that helps advisors provide more value to their clients, but it's not a one-size-fits-all solution. It's not even a many-sizes-fit-all solution. Instead it's more accurate to think of it as a many-sizes-fit-most approach.

      Bottom line: Advisors may have some clients who will benefit greatly from tax-loss harvesting. They may have other clients who will see only modest, but significant, benefits. And they may have still others who will see no benefit at all. Overpromising what tax-loss harvesting offers doesn't do those clients any favors.