Tax Loss Harvesting: what is it and how large is the expected benefit?

Tax Loss Harvesting is the rage now. Robo-advisers do it for you, and every DIY saver should seriously consider the benefits. Let’s look at what Tax Loss Harvesting is, how and why it works and how large (or small) the expected benefits can be.

What is Tax Loss Harvesting?

Tax loss harvesting involves these four simple steps:

  1. Continuously monitor the taxable portfolio for tax lots that are underwater, i.e., have a cost basis above today’s value. Otherwise known as a capital loss. This can be a short-term or long-term loss.
  2. Sell those tax lots and immediately buy a similar asset (though not identical to avoid the IRS wash sale rule). One might also do the regular portfolio rebalancing at the same time.
  3. Up to $3,000 p.a. in such losses can be used to offset ordinary income and lower the tax burden. Any excess over the $3,000 can be carried forward and written off in future years.
  4. Reinvest the tax savings from step 3 and watch your portfolio grow even faster! Note: the benefit is not $3,000, but $3,000 times the marginal tax on ordinary income!

For more details on the implementation please refer to our DIY guide on how to be your own DIY Robo-adviser.

How and why does Tax Loss Harvesting work?

TLH Explained 1
Tax Loss Harvesting Mechanics
The TLH excess return consists of three components and we can later see how much each one of them is really worth:

  1. Time value of money: you get a tax benefit today but may pay higher taxes later when you eventually liquidate the position in retirement. Even if the tax rate were to be the same in retirement (or even slightly higher) you stand to gain from TLH because the government gives you an interesting-free loan to invest the TLH proceeds over potentially many years. You increase your future tax liability by exactly what you harvest in benefit today. See the red bar in middle column vs. blue bar on the left in the figure above. But getting the benefit today is still valuable! The green bar in the middle column is the gain from TLH in that case, which is equal to the capital gains from investing the date 0 tax savings net of the capital gains tax on those additional capital gains (orange bar).
  2. Tax rate arbitrage 1: between ordinary income and long-term gains. If you do the TLH right, your future capital gains are taxed at the lower long-term capital gains rate, while the benefit from the tax write off today comes from the higher ordinary income marginal rate. You squeeze the orange and red tax liabilities and get to keep more for yourself, see right column in the chart above.
  3. Tax rate arbitrage 2: between currently high marginal rates and (hopefully) lower rates in retirement. Chances are that during your working years you have higher taxable income putting you into a higher tax bracket both on your federal and state tax return. Moreover, you might move from a high tax state (NY, CA) to a low or no-income-tax state (FL, NV). In the chart above, tax rate arbitrage squeezes the red and orange tax liability boxes even more and leaves more pure after-tax gain (green bar, right column) for you to keep. In the best possible case the future taxes are zero and you get to keep the entire loot! Woo-hoo!
TLH Explained 2
Two Components of Tax Rate Arbitrage

Tax Loss Harvesting: Numerical Examples

Let’s look at some numerical examples to see how much we can expect to make from harvesting tax losses! The assumptions used in the calculations are:

  • The investor starts out on December 31 of year 0 with a given portfolio value and a given harvestable loss.
  • The all-equity portfolio generates a certain capital gains return and dividend yield each year. The dividends net of taxes are reinvested in the portfolio every year.
  • Without TLH the investor simply keeps the money invested for a number of years then retires on December 31 of year N and liquidates the portfolio on January 1 of year N+1.
  • With TLH we assume the investor realizes the entire loss on December 31 of year 0 and invests the proceeds as well as the TLH tax savings in a very similar (but not identical) equity fund to avoid the wash sale rule. Any tax losses beyond the $3,000 maximum are carried forward and invested in future years. Upon retirement, any leftover losses will be used to offset long-term capital gains during retirement.
  • In both cases we assume that the investor realizes no other capital gains along the way. He/she will of course earn capital gains, but just not realize them in a taxable account until after retirement (using tax rate arbitrage 2, see above).

What’s the most you can expect in extra annualized % return?

Let’s pick assumptions that would generate a large TLH benefit, so as to give TLH the best possible chance to succeed:

We call this person Mr. A:

  • Portfolio value of $10,000 and a harvestable loss of $3,000 (thus, initial cost basis $13,000)
  • Very high current marginal taxes: 49.6% for ordinary income (39.6% federal plus 10% state), 33.8% for dividends (20% federal, 10% state, 3.8% ACA). The tax rate on long-term capital gains in retirement is 0% for the maximum tax rate arbitrage.
  • Time horizon is 10 years.
  • The expected equity return is 7% nominal, 5% from capital gains and 2% from the dividend yield.
  • Results, see table below: Almost 1.5% extra return annualized, and over $2,700 of extra after-tax portfolio value in ten years. That’s a lot of dough for two trades, taking probably no more than a few minutes of your time!
  • The 1.49% annual tax benefit is significantly better than the 0.77% Betterment calculated.
  • Of course, we could have stretched the assumptions much more to make the TLH even more attractive, say, by lowering the current portfolio value to $3,000 while keeping the tax loss at $3,000 as well. The annualized TLH benefit would have been more than 4%. That would have been a bit unrealistic, though; someone earning a high six figure income, who owns only a few thousand dollars and generated tax losses of 50%.

TLH Results 1
Tax Loss Harvesting Estimated Gain: Mr. A
Most of the gain came from the tax rate arbitrage, especially the zero future tax rate (Tax Arbitrage 2), see chart below. But nevertheless, even in the absence of any tax arbitrage, there is money to be made from TLH. Almost $700 are simply due to the time value of investing the TLH proceeds over ten years. Thus, TLH is worthwhile even if the tax in the future were to jump up all the way to an insane 49.6%, equal to today’s high marginal rate. If in addition the future LT Capital gains tax were to stay at today’s Dividend/LT Cap Gains tax rate of 33.8% we gain another $700, with the remaining $1,350 coming from reducing the LT Capital Gains tax rate all the way to 0%.

TLH Results 2
Components of Mr. A’s Tax Loss Harvesting Gain

How much do we diminish the Tax Loss Harvesting benefit when we use consecutively less extreme assumptions?

Mr. A has a pretty impressive excess return from Tax Loss Harvesting. But his case is not typical at all. Very few people are in such a high tax bracket, and in addition Mr. A also had a very tiny investment portfolio and a large pile of tax losses relative to the portfolio value. This means the benefits of a $3,000 write-off are applied to a relatively small base, hence, the impressive increase in the % return.

Let’s see how that annual percentage tax alpha diminishes as we make the assumptions less and less beneficial for TLH.

TLH Results 3
Tax Loss Harvesting Gains Comparison for Mr./Mrs. A through H

Mrs. B: same as Mr. A but twice the portfolio value and twice the harvestable loss.

  • $20,000 initial portfolio value, $6,000 harvestable loss
  • Why should this make a difference? Mrs. B can only write off $3,000 from her taxable income in a year and has to wait until next year for the remaining $3,000. The dollar benefit increases, though by less than a factor of two. The tax alpha suffers a tiny bit due to this but is still very, very impressive! 1.44% p.a.!

Mr. C: Five times the portfolio value and five times the harvestable loss as Mrs. B

  • $100,000 initial portfolio value, $30,000 in harvestable loss
  • The dollar value of TLH goes up, but by a little bit less than a factor of five and we experience another deterioration in the percent alpha because it take 10 years to work off the pile of tax losses, $3,000 per year. This diminishes the time value gain of TLH, but the total alpha is still north of 1%! 1.16%!

Mrs. D: double the portfolio size and tax loss of Mr. C

  • $200,000 initial portfolio value, $60,000 in harvestable losses
  • Now there are more tax losses than we can write off in the remaining 11 years of high marginal tax rates (it’s 11 years, because we assume that we use the tax write-off in calendar years zero through ten). The remaining tax losses will now offset the capital gains during retirement. Then the TLH will have zero benefit because LT gains are already taxed at a zero marginal rate.
  • The result is a significant deterioration in the tax alpha down to 0.64%, but still a good boost in returns and an impressive $22,000 in extra final portfolio value.

Mr. E: Lower Tax loss available

  • Same as Mrs. D, but instead of $60K in tax losses, he is only able to scoop together $20K. That doesn’t sound like very much. True, the losses would only be about 10% of today’s portfolio value, but keep in mind that the initial portfolio value could the product of many years (even decades) of saving and reinvesting dividends. A large share of the tax lots in your account may have a low tax basis so that even a significant drop of 20 or 30% will not produce much of a harvestable loss.
  • The tax benefit drops to now 0.44% p.a. and a total of about $15,500. Sounds attractive, but the Betterment and Wealthfront fees of 0.15-0.25% already eat up a big chunk of it.

Mrs. F: Lower current tax rates

  • Same assumptions as Mr. E, but more middle-class tax rates: 30% for ordinary income (e.g. 25% federal, 5% state), lower taxes on dividends (15% federal, 5% state), but keep the zero tax rate in retirement.
  • Another deterioration in the tax benefit. Only about $9,500 in extra portfolio value after ten years, or about. 0.27% in extra return. That’s still worth the “hassle” of a few trades today but may not justify hiring a Rob-adviser who charges 0.15%-0.25%.

Mr. G: Half-million dollar taxable portfolio with $25K in tax losses

  • Now we get into FI (Financial Independence) territory. Again, this kind of portfolio value was not invested as one large lump-sum just a few weeks ago, but is the product of many years worth of saving. Hence, a sizable tax loss is not that easy to generate given that many tax lots are going to be from the early to mid 2000s, not to mention early 2009.
  • Tas Loss Harvesting is still going to generate a lot of extra after-tax return, but as a percentage of the principal it’s only 0.11% p.a. If you hire a Robo-adviser the 0.15%-0.25% annual fees will eat up the entire tax advantage and more.

Mrs. H: Same as Mr. G, but low current tax rate

  • Now the current ordinary income tax is only 15% (no state tax, 15% federal) and the existing dividend and LT capital gains tax is already 0%. It will also stay 0% in retirement.
  • The Tax Loss Harvesting gain is now under $5,000, and only worth 5 basis points per year. Hiring a Robo-adviser in this situation would be a major waste of money.

If anybody has ideas for other robustness checks (Mr./Mrs. I,J,K,L,M,…) for us to check out please let me know. We might be able to reach Mr. T (see below, right) before Physician on FIRE reaches Dr. J (see below, left) in his Four (or Five?) Physician study.


The TLH benefits can be larger or smaller depending on several other factors, especially unrelated capital gains. If you have large additional short-term capital gains from other unrelated investments early on, you might do significantly better than we calculated, because you don’t have to wait to write off $3,000 every calendar year, but instead get the entire benefit upfront and thus a higher time value of money effect (higher Time Value of Money effect). But nobody in their right mind would voluntarily realize short-term gains when they face high marginal taxes, so unless there are circumstances where someone faces forced short-term gains this situation can’t be too common.

If you have large additional long-term gains from unrelated investments, you might do worse than we calculated. That’s because first you have to net your harvested capital losses against capital gains. Even the short-term losses are netted against long-term gains before they can be used to lower your taxable income! In the extreme case where long-term gains are already taxed at zero percent (Mrs. H in the example above) your entire tax losses might be wiped out for no gain at all. Thus, unrelated capital gains will inadvertently eliminate the Tax Rate Arbitrage 1 Effect between ordinary income and long-term capital gains.

Moreover, caution with average vs. marginal benefits. The benefit from TLH of the marginal dollar invested is most likely below the average benefit. Let’s take the comparison between a Roth IRA vs. a taxable account (see our comparison calculations here): normally a Roth IRA would easily beat a taxable account without TLH because dividends and capital gains are taxed in the taxable account. But the difference in returns could be small if capital gains are realized in retirement at 0%. TLH could make the taxable account more attractive or the marginal benefit could be so small to keep the Roth IRA ahead. Whether to put those additional $5,500 into a Roth IRA or taxable account crucially depends on the individual circumstances and the marginal benefit, not the average over the whole portfolio!


  • Tax loss harvesting is a useful tool when saving in a taxable account. Unfortunately, TLH cannot be scaled arbitrarily. Hence, the tax alpha estimates quoted by the Robo-advisers are not that easy to generalize.
  • Depending on the tax rate assumptions and the size of the harvestable loss in relation to both the $3,000 annual tax write off and the initial portfolio value, the tax alpha can range from several basis points (hundredth of a percent) to north of one percent per year. For most investors, however, the promise of 0.77% extra return p.a. from TLH (Betterment estimate) is unrealistic. The Wealthfront estimate of upto 2% p.a. is borderline preposterous. We have written earlier on how the two Robo-advisers exaggerate their estimates and depending on where you fall in the spectrum of Mr. A through Mrs. H, you may have a very different experience from what the Robo-advisers advertise.
  • For current early retirees in low tax brackets and low (or no) state taxes, the expected extra return from newly generated tax losses is minimal, likely below 0.10%. That’s still a lot of money, considering the large sums involved. But it would likely not justify hiring a Robo-adviser just for the Tax Loss Harvesting.

36 thoughts on “Tax Loss Harvesting: what is it and how large is the expected benefit?

  1. Great write-up and analysis, ERN. The Bogleheads wiki talks about the option of letting your money sit on the sidelines for 31 days before back into the same fund. I think that’s a bad move, as the market can move a whole lot in a month, potentially negating the monetary benefit of the TLH or making the whole set of transactions a losing proposition. So I wholeheartedly agree with you leaving that out. It’s best to exchange directly into a similar fund.

    In the last year alone, I’ve done enough TLH to offset $3,000 in ordinary income for the next 20 years. I would be perfectly content if we never see another good opportunity, but of course, I know we will.

    Thanks for the mention!

    1. Thanks PoF!
      Yes, I never understood the approach that some on Bogleheads follow with the 31 days of money sitting on the sideline. They are implicitly following a momentum strategy, which may have worked in 2008/9, and would not have worked in August 2016 or February 2016 with the rapid recoveries. Very odd to see this implicit market timing through momentum from the bogleheads, who strike me as mostly passive investors with a value tilt.

      Yes, I recall your experience with the tax losses from last year. Great for you! $3,000 write off per year could be worth almost $1,500 in tax savings every year. A lot of money for very little work, but when you divide it by your total taxable portfolio value it’s probably less than the 0.77% benefit that some Robo-advisers quote.

      Also your situation poses a unique challenge: what if you have losses left over when you retire in a few years? You will be in a lower bracket, so the benefit will be a bit smaller in retirement. In addition, if you realize LT capital gains in retirement your carry-over losses will first be netted against those gains. But if the gains are in the first two federal brackets, there is zero benefit. Very tough problem: delay the capital gains until the carry over tax losses are all gone? Or at least minimize the LT gains by selling off mostly the high cost basis lots early in retirement to squeeze out the maximum from the carry over losses? Very tough problem! The whole TLH is such a messy topic, I have the feeling that even after such a long post I only scratched the surface!

      1. Yes, it is true that in my working years, at a high marginal tax rate in a high income tax state, I will save roughly $1400 per year, or about 0.14% and shrinking as time goes on. That’s nowhere near 0.77% or 2%, but it’s still $1400 for 14 minutes of effort.

        In RE, I’ll have to take a close look at the tax situation from year to year. I won’t have income from work, but I expect to have some halfway decent blog income by then, which could completely thwart my plans to pay no federal income tax. It’s a good problem to have, though.

        Regardless of what I do, there will be qualified dividends realized in the taxable account every year. It would be nice to remain in the 15% bracket to avoid paying taxes on those, assuming tax laws are largely the same.


  2. This has really helped me get a better understanding of TLH.

    Regarding the wash sale rule, how is a similar fund defined? For example, let’s say you had invested in funds like VTSAX or VDIGX. Does Vanguard offer you guidance on that stuff?

    1. Thanks! And thanks for that great question!
      I doubt Vanguard wants to be too explicit in giving guidance but switching back and forth between those two equity funds should be 100% safe in avoiding wash sales. That’s because VTSAX has the CRSP US Total Stock Market index as benchmark and the VDIGX has a completely different index (NASDAQ US Dividend Achievers Select) as its benchmark. Hence, no wash sale.
      The Robo-advisers are actually a lot more blatant in their wash sale avoidance. For example the two ETFs they use for US Total market are VTI (Vanguard) and SCHB (Schwab) and even they appear safe from a wash sale perspective because they track very slightly different benchmarks, despite being 99.9% correlated.

      We put together a list of ETFs and Mutual Funds with their respective benchmarks:
      Sometimes there are 3 or 4 different options even within the major themes, like US large cap or US total market. Or you can switch between the majors (say, between IVV and VTI or the two Vanguard funds you mentioned) for even more options to avoid wash sales.

  3. That’s great work, ERN! This is the first time I ever see a detailed expose of TLH and the range of possible % benefits. Also: Will the $3000 tax write-off per year ever be inflation adjusted? If not, the tax benefit will evaporate over time with inflation, right?

    1. Thanks for stopping by! The $3,000 upper limit per year hasn’t been inflation-adjusted for as long as I can remember. Who knows, maybe the Robo-advisers will hire lobbyists and try to change that!

  4. Great article. Really informative. I have to say, I was only vaguely familiar with the concept of tax loss harvesting before reading this article. I knew it was something that was available, but I didn’t realize it was so widely applicable. Excited to add it to my financial toolbox. Keep up the great work!

    1. Thanks. That’s a nice comment! Of course, now the stock market is close to the all time high, but check your tax lots next time if there’s a drawdown and see if you can generate some tax losses. Cheers!

  5. Any experience with tax harvesting when your main non-qualified asset is holding individual stocks rather then MFs or ETFs?

    1. Thanks for stopping by! Great question!
      With single name stocks you have the issue of the wash sale rule. You’d have to wait 31 days to buy back that stock. What to do for 31 days? Sit on your hands? The stock might recover and you’d buy back the same stock at a higher price and invalidate the entire TLH advantage.
      You could buy back a similar stock (same sector/industry, same characteristics, such as P/B, P/E, etc.). But that’s not so trivial. The correlation between individual stocks is much lower than between the different ETFs with similar (though not identical) benchmarks. If you sell XOM and buy back CVX there is still some mis-tracking between the two. During the 31 days this could go in your favor or against you. Even worse, for stocks like GOOG, AMZN, AAPL there aren’t that many close substitutes at all.
      So, one method that might be workable is to sell the losing lots, buy an index fund to “park” the money for 31 days, then buy back the original stocks. If you have a large enough portfolio of stocks (10-20 at least) you will have some mis-tracking between the index and the individual stocks. Sometimes it goes against you, sometimes in your favor, but over many instances the plus and minus will average out.

  6. Oh wow, great article. I don’t use TLH much these days because everything is up. I only have a few investments that are down. I usually use loss sale to offset gains. You’re right about individual stocks. It’s hard to replace the one you sell.

    1. Hi Joe! Thanks for stopping by. Yes, recently there hasn’t been much of an opportunity to harvest losses. The Brexit drop was too short for most people to move. So February 11 this year was the last really good opportunity to bank some tax losses.
      But it’s good to know about TLH because the next drawdown will happen for sure. When nobody expects it. 🙂

    1. I hear you! I wish the Robo-advisers could lobby in congress to increase the $3,000.
      Of course if you have other capital gains that are forced (say you invest in real estate through private equity and they realize capital gains without you having any control) then you can deduct $3,000 plus whatever those other cap gains were. But that’s probably rare.

  7. ERN, this is a great post and a great explanation. It can make a huge difference to people’s taxes (think about Bill Gates & WB!). At the moment we don’t have to worry about losses as all our gains are tax free. Eventually they may be and we could use this (we’ll have to do our research about Australia).


    1. Oh, great, thanks! Glad you liked it. I claim no expertise in the Australian tax system though, haha.
      Also rich folks use this all the time, you’re right. Maybe not the plain and simple TLH because the $3,000 is too low to make a difference for them. But they would invest in business ventures with large initial write-offs to capture the time-value effect and/or shift income between high and low marginal tax rate years. Good point!!!

  8. Have you considered tax gain harvesting?

    Example: You exchange fund A for fund B, realizing a loss of $1000.
    At the same time, you sell enough of fund C to realize a gain of $1000,
    and exchange that into similar fund D.

    The net gain is zero, so no immediate tax benefit. However, you have just
    shielded a $1000 gain from taxes.

    In practice, it’s hard to line your ducks up in a row, but the Bogleheads do it.

  9. ERN- Can’t believe I didn’t know about this earlier, I have lost a decade of TLH :(. As a data point – we had not done our taxes for 2018 and so I tested the impacts of this on our taxes. We would have save over $700 had we implemented TLH in 2018 (and we had plenty of positions to do that with given Octobers mess).
    TD Ameritrade makes TLH pretty easy and we just executed three trades for 2 years’ worth of TLH offsets.

  10. What is the simplest example which demonstrates the “Time Value Effect” without any “Tax Rate Arbitrage”?

    Suppose you invest $100 in a stock whose price subsequently halves and after that quadruples. If you merely buy and hold, and then liquidate, you owe $300*CGT (where “CGT” is your capital gains tax rate). If instead you sell after the stock halves and repurchase it (ignoring wash sale rules for the moment), then you generate a loss of $50 and lower your cost basis to $50; so after the stock quadruples and you sell it for $400, you must pay ($350 (the gain) minus $50 (the loss you generated))*CGT, i.e., you must still pay $300*CGT. Where does the time value of money figure in?

    1. Good question.
      Take your example and use a 50% marginal tax (for simplicity).

      Prices of the stock in periods 0,1,2 = 100,50,200.

      Buy and Hold: Cash flows in periods 0,1,2: -100,0,+150 You get only 150 after tax 200-(200-100)x0.5

      Tax loss harvesting: you harvest the $50 in losses and get a $25 in tax relief in year 1. But in year 2 you have to tax $150 in gains and thus get only $125 after tax.

      Your cash flows are now: -100,+25,+125.

      Notice that both cash flow streams have the same SUM (because there is no tax RATE arbitrage yet). But the TLH realizes the income a little bit earlier. That’s better from a time value of money aspect.

      You can also calculate the IRR: +22.5 in buy and hold, 25.0% with TLH. The TLH IRR has to be higher due to the earlier repayment.

  11. Do you have a spreadsheet/tool that can estimate the benefit of Tax Loss Harvesting for different tax rate and allocation assumptions?

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