I have thought up a simple concept that could really reduce investors tax bill.
It would involve starting with the total market index, and effectively dividing it into two separate indices. You could call them Harvest Index A and Harvest Index B.
Sampling would have to be done that would control for market cap, value/growth characteristics, and sector weightings. The idea is to make the two indices act as close to identical as possible in all of the aforementioned characteristics. However, the two indices must not hold any two of the same equities. There must be no overlap in the holdings.
If the two indices track each other with a high degree of precision, an investor could swap ETFS with confidence. As far as the investor is concerned, they give the same exposure. However, because they do not hold any equities that are identical, the IRS cannot question that they are effectively different securities.
Right now, some investors swap VTI, with SPY because they track different indices. I see this as kind of dangerous because they do hold some of the same stocks; there is overlap. You could make an argument that the wash sale rule is being broken.
However, with these custom tailored harvesting pairs there would be no overlap. Controlling for market cap, value/growth, and sectors would be critical to maximizing correlations between the pairs.
What do you guys think?
Product Idea: Equity Harvesting Pairs
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Product Idea: Equity Harvesting Pairs
Last edited by melveyr on Tue Aug 23, 2011 1:57 am, edited 1 time in total.
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Re: Product Idea: Equity Harvesting Pairs
Not sure about SPY and VTI, but I've heard of people using SPY and something like VTWO, which tracks the Russell 4000. I know there is some stock overlap, but I think you can argue that they track different indices.melveyr wrote:
Right now, some investors swap VTI, with SPY because they track different indices. I see this as kind of dangerous because they do hold some of the same stocks; there is overlap. You could make an argument that the wash sale rule is being broken.
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Re: Product Idea: Equity Harvesting Pairs
I do tax loss harvests when I can.
My pairs are:
Stock VTI and VOO
Bond TLT with half EDV and VGLT
Gold GTU and GLD
In the past when I could have sold GTU for GLD I choose not to do it because at the time I felt the long term capital gain advantage from GTU was worth it and did not want to start over or get stuck holding GLD and paying collectable gains.
My pairs are:
Stock VTI and VOO
Bond TLT with half EDV and VGLT
Gold GTU and GLD
In the past when I could have sold GTU for GLD I choose not to do it because at the time I felt the long term capital gain advantage from GTU was worth it and did not want to start over or get stuck holding GLD and paying collectable gains.
Re: Product Idea: Equity Harvesting Pairs
Melveyr,
Have you read/seen anything that leads you to believe a violation of the wash-sale rule would result from a VTI-to-VOO move?
I thought it was pretty well settled, or at least not sufficiently challenged yet, that this type of activity did not violate the wash-sale rule.
To me, this is one of those things that may be "up for interpretation" but I always "err on the side of me" when it comes to taxes... even though I'm an accountant, and there may be some risk to that.
Have you read/seen anything that leads you to believe a violation of the wash-sale rule would result from a VTI-to-VOO move?
I thought it was pretty well settled, or at least not sufficiently challenged yet, that this type of activity did not violate the wash-sale rule.
To me, this is one of those things that may be "up for interpretation" but I always "err on the side of me" when it comes to taxes... even though I'm an accountant, and there may be some risk to that.
"Men did not make the earth. It is the value of the improvements only, and not the earth itself, that is individual property. Every proprietor owes to the community a ground rent for the land which he holds."
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dualstow
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Re: Product Idea: Equity Harvesting Pairs
It's in interesting idea, but I wouldn't want to be stuck with the half that doesn't own, say, Apple or Google.
I'd rather just deal with the taxes.
EDIT: Well, I guess you could own plenty of both and do a small TLH, a block for a block.
I'd rather just deal with the taxes.
EDIT: Well, I guess you could own plenty of both and do a small TLH, a block for a block.
Last edited by dualstow on Tue Aug 23, 2011 8:44 am, edited 1 time in total.
Re: Product Idea: Equity Harvesting Pairs
As far as I know, no one has gotten burned for the overlap in other ETFs. But honestly, doing those pairs is a clear violation. You are essentially selling some securities and buying them back instantly and claiming that you didn't. Just because no one has gotten in trouble before doesn't make it safe IMO. I wouldn't want to be the first. AFAIK nothing about it is settled. Whenever I look it up I see people say "do it at your own risk."
Also, when I was reading about bonds I am pretty sure that simply moving around on the yield curve is not okay. You can't sell a 10 year bond and buy back a 9 year treasury. You could sell a 10 year treasury, and then buy back a 9 year Coca Cola bond though. I am pretty sure that you have to change the issuer. I looked this up because I considered the prospect of selling TLT and going 50% IEF for the harvest.
However, if anyone has some definitive information about the overlap I would love to hear it. The overlap just really makes it seem like a clear violation of the law to me.
Also, when I was reading about bonds I am pretty sure that simply moving around on the yield curve is not okay. You can't sell a 10 year bond and buy back a 9 year treasury. You could sell a 10 year treasury, and then buy back a 9 year Coca Cola bond though. I am pretty sure that you have to change the issuer. I looked this up because I considered the prospect of selling TLT and going 50% IEF for the harvest.
However, if anyone has some definitive information about the overlap I would love to hear it. The overlap just really makes it seem like a clear violation of the law to me.
everything comes from somewhere and everything goes somewhere
Re: Product Idea: Equity Harvesting Pairs
Maybe VTI -> VOO is too close.
What about going from VTI to a small cap fund, but making the purchase within your 401(k) or IRA to avoid the tax-ineffeciency hit in years-to-come with high turnover. There'd be very little overlap, and you can just trade some "cash" in your IRA for Cash in your taxable accounts for 30 days, and vise versa with the (substantially different) stock funds.
After the month goes by, if you want, you could take your cash from the VTI sale and rebuy, and sell the small-cap fund in your IRA to put back in cash, or you could continue to keep it as-is.
Fortunately, when stocks drop enough to harvest, rates are often at their lowest, and therefore the tax-efficiency of cash isn't such an issue... it's when rates rise (usually post-recovery) that you reall want to get your cash out of your taxable space.
What about going from VTI to a small cap fund, but making the purchase within your 401(k) or IRA to avoid the tax-ineffeciency hit in years-to-come with high turnover. There'd be very little overlap, and you can just trade some "cash" in your IRA for Cash in your taxable accounts for 30 days, and vise versa with the (substantially different) stock funds.
After the month goes by, if you want, you could take your cash from the VTI sale and rebuy, and sell the small-cap fund in your IRA to put back in cash, or you could continue to keep it as-is.
Fortunately, when stocks drop enough to harvest, rates are often at their lowest, and therefore the tax-efficiency of cash isn't such an issue... it's when rates rise (usually post-recovery) that you reall want to get your cash out of your taxable space.
"Men did not make the earth. It is the value of the improvements only, and not the earth itself, that is individual property. Every proprietor owes to the community a ground rent for the land which he holds."
- Thomas Paine
- Thomas Paine
Re: Product Idea: Equity Harvesting Pairs
Well, I do think there is going to be some overlap between VTI and small cap because VTI does hold small caps that are likely in the small cap index. Maybe I am being fanatical, but I want zero overlap.
I have been doing some thinking, and have constructed a Frankenstein version of what I was talking about in the OP. This Frankenstein creation is totally do-able today too.
Harvest Index A: 50% Large Cap Growth, 50% Small Cap Value
Harvest Index B: 50% Large Cap Value, 50% Small Cap Growth
There is zero overlap between these pairs because a stock is either a value stock or a growth stock. If you stick with the same fund provider for all of your ETFs, you can be pretty confident about this.
One would simply start out with A for example, wait until a harvest event occurs and switch to B, and then wait for a harvesting event to occur and switch back to A. Neither one is the "default" holding. You only switch when you have a loss that you want to realize.
When doing a backtest of the two portfolios, there is some tracking error between the two so these Frankenstein harvesting pairs are not perfect. Perhaps it could be worth it for increased tax efficiency. We all know that taxes can play a big role. Besides, we are in the PP. We embrace "tracking error" compared to traditional portfolios
Does this seem like an okay idea for a taxable account? I know that in isolation the growth/value and large/small cap indices are less tax efficient than VTI... Perhaps the harvesting could more than make up for this?
I have been doing some thinking, and have constructed a Frankenstein version of what I was talking about in the OP. This Frankenstein creation is totally do-able today too.
Harvest Index A: 50% Large Cap Growth, 50% Small Cap Value
Harvest Index B: 50% Large Cap Value, 50% Small Cap Growth
There is zero overlap between these pairs because a stock is either a value stock or a growth stock. If you stick with the same fund provider for all of your ETFs, you can be pretty confident about this.
One would simply start out with A for example, wait until a harvest event occurs and switch to B, and then wait for a harvesting event to occur and switch back to A. Neither one is the "default" holding. You only switch when you have a loss that you want to realize.
When doing a backtest of the two portfolios, there is some tracking error between the two so these Frankenstein harvesting pairs are not perfect. Perhaps it could be worth it for increased tax efficiency. We all know that taxes can play a big role. Besides, we are in the PP. We embrace "tracking error" compared to traditional portfolios
Does this seem like an okay idea for a taxable account? I know that in isolation the growth/value and large/small cap indices are less tax efficient than VTI... Perhaps the harvesting could more than make up for this?
everything comes from somewhere and everything goes somewhere
Re: Product Idea: Equity Harvesting Pairs
It seems like the Frankenstein approach would work OK.
Another approach would be to pair a dividend-oriented fund with a no-dividend fund.
Though, playing devil's advocate, I wonder if the tax-loss harvesting benefits outweigh the expenses incurred by using multiple semi-obscure ETFs instead of one heavily-traded ETF.
I think you're really fishing for a pair of ETFs that both track the total market but are explicitly constituted to have no overlap. For example, one ETF tracks all stocks whose ticker starts with A-M, the other N-Z. Even better would be to flip a coin for each company, and have a separate heads ETF and tails ETF. Due to reversion to the mean, both would track the total market well.
Another approach would be to pair a dividend-oriented fund with a no-dividend fund.
Though, playing devil's advocate, I wonder if the tax-loss harvesting benefits outweigh the expenses incurred by using multiple semi-obscure ETFs instead of one heavily-traded ETF.
I think you're really fishing for a pair of ETFs that both track the total market but are explicitly constituted to have no overlap. For example, one ETF tracks all stocks whose ticker starts with A-M, the other N-Z. Even better would be to flip a coin for each company, and have a separate heads ETF and tails ETF. Due to reversion to the mean, both would track the total market well.
Re: Product Idea: Equity Harvesting Pairs
Yes, I thought about the coin flip idea. You understand what I am going afterKevinW wrote: I think you're really fishing for a pair of ETFs that both track the total market but are explicitly constituted to have no overlap. For example, one ETF tracks all stocks whose ticker starts with A-M, the other N-Z. Even better would be to flip a coin for each company, and have a separate heads ETF and tails ETF. Due to reversion to the mean, both would track the total market well.
everything comes from somewhere and everything goes somewhere
Re: Product Idea: Equity Harvesting Pairs
My question would be why does Vanguard sell Both VTI and VOO if they are the same?
VTI tries to tracks the total US market index VOO tries to tracks the S&P 500 index. Both VTI and VOO have different expense ratios and different characteristics. These are two different investment products that track different indexes and are not the same in my opinion.
Everything has overlap but it does not make it the same or substantially similar for example a Chimpanzee and a Human have close to the same DNA but you can see a difference even though they may behave the same.
VTI tries to tracks the total US market index VOO tries to tracks the S&P 500 index. Both VTI and VOO have different expense ratios and different characteristics. These are two different investment products that track different indexes and are not the same in my opinion.
Everything has overlap but it does not make it the same or substantially similar for example a Chimpanzee and a Human have close to the same DNA but you can see a difference even though they may behave the same.
Re: Product Idea: Equity Harvesting Pairs
Why does vanguard create VT if it is simply total international and total domestic? Because different people want different ways of organizing their trades.
With VTI and VOO there is some serious overlap. If the IRS wanted to enforce the rule as written, you could be prosecuted. You are simply using a different vehicle to buy a lot of the same investments. A large portion of your trade would be violating the rule.
You probably won't be prosecuted, but I am trying to construct something that is totally legal.
With VTI and VOO there is some serious overlap. If the IRS wanted to enforce the rule as written, you could be prosecuted. You are simply using a different vehicle to buy a lot of the same investments. A large portion of your trade would be violating the rule.
You probably won't be prosecuted, but I am trying to construct something that is totally legal.
Last edited by melveyr on Tue Aug 23, 2011 3:30 pm, edited 1 time in total.
everything comes from somewhere and everything goes somewhere
Re: Product Idea: Equity Harvesting Pairs
I disagree with the premise. The IRS is not going to say that a wash sale is taking place if you exchange VTI with SPY.
In fact, one could go so far as to exchange TSM with appropriate amounts of SP500 and Extended Market index, and hold 99.99% the same stocks, and it wouldn't be a wash sale because it's two separate index funds. Money is fungible. In essence, in order to do the above trade, one would be selling $1 worth of TSM and buying $1 worth of Extended Market. Then selling $5 worth of TSM and buying $5 worth of SP500.
Just because the overall final composition is the same as the beginning, doesn't mean it's a wash sale, because the individual parts sold, and bought are not identical.
This idea is extremely complex and is a solution in search of a problem.
It would be like trying to sell a Shotgun that had a diamond coated barrel, so that the ATF couldn't rule the hacksaw in my toolbox plus my shotgun = constructive possession of a short-barrel shotgun. The ATF isn't looking to arrest me for that, and if they did they would have to arrest 10+ Million Americans who own both a shotgun and a hacksaw.
The IRS doesn't have the man power and the judicial system doesnt have the judges to decide on a case-by-case basis what a substantially similar sale is.
In fact, the IRS has no idea what stocks you repurchased with your sold profits. Even if it was an actual wash sale where you rebought the exact same stock in another brokerage, the IRS wouldn't know unless they did a thorough audit.
In my ideal libertarian fantasy land, there would be no taxes on capital gains because the underlying holdings already paid corporate taxes. In essence, the stockholder already paid taxes in the fact that their stocks are worth less than they would be, had the company that the stock represented ownership didn't pay corporate taxes.
In fact, one could go so far as to exchange TSM with appropriate amounts of SP500 and Extended Market index, and hold 99.99% the same stocks, and it wouldn't be a wash sale because it's two separate index funds. Money is fungible. In essence, in order to do the above trade, one would be selling $1 worth of TSM and buying $1 worth of Extended Market. Then selling $5 worth of TSM and buying $5 worth of SP500.
Just because the overall final composition is the same as the beginning, doesn't mean it's a wash sale, because the individual parts sold, and bought are not identical.
This idea is extremely complex and is a solution in search of a problem.
It would be like trying to sell a Shotgun that had a diamond coated barrel, so that the ATF couldn't rule the hacksaw in my toolbox plus my shotgun = constructive possession of a short-barrel shotgun. The ATF isn't looking to arrest me for that, and if they did they would have to arrest 10+ Million Americans who own both a shotgun and a hacksaw.
The IRS doesn't have the man power and the judicial system doesnt have the judges to decide on a case-by-case basis what a substantially similar sale is.
In fact, the IRS has no idea what stocks you repurchased with your sold profits. Even if it was an actual wash sale where you rebought the exact same stock in another brokerage, the IRS wouldn't know unless they did a thorough audit.
In my ideal libertarian fantasy land, there would be no taxes on capital gains because the underlying holdings already paid corporate taxes. In essence, the stockholder already paid taxes in the fact that their stocks are worth less than they would be, had the company that the stock represented ownership didn't pay corporate taxes.