alex_686 wrote: ↑
Sat Nov 09, 2019 11:47 am
nedsaid wrote: ↑
Sat Nov 09, 2019 11:06 am
I wonder if there are any academic studies regarding aggressive tax loss harvesting and investment returns. This strategy involves lots of turnover to generate the tax losses and I am wondering if this is creating a friction with bid/ask spreads and incorrect sell/buy decisions.
This strategy should be "passively trading", and not doing "information trading". In theory you can make money this way. In reality, a 200% to 300% turnover would generate a drag of about 10 to 20 bps.
nedsaid wrote: ↑
Sat Nov 09, 2019 11:06 am
In other words, I am wondering if the "Nedsaid effect", the ratio of incorrect sell/buy decisions being 2:1 or even 3:1 to correct sell/buy decisions. In other words, what you sell tends to do better than what you buy to replace, this is a big problem for amateur stock pickers and less so for investment professionals. I do know that this effect hits the professionals too. I am wondering if the algorithms and Artificial Intelligence have overcome this problem. This is one big reason that I warn against trading your portfolio a lot. Any research on this?
I think we have danced this dance before? I said your concerns were based on Fear, Uncertain, and Doubt. You said no. Could you please be specific on what type of incorrect sell/buy decisions you are talking about. This is a index strategy.
Let me be specific. The manager has no opinion on the direction of the market, of any individual security, and is trying to match the market's return. No position can be under/over weighted by 10%. So a index position of 1% could be no more than 1.1% to 09% This off-weighting would last 31 days and then may well be inverse. The portfolio is neutrally loaded on factors such as size, sector, value etc. The portfolio also has a tracking error of under 150 bps, which includes the bid/ask drag from the frequent trading. There is just not a lot of room for decisions here.
There has been plenty of academic studies on this. Most of the foundational stuff was written 30 years ago. Like I said in a earlier comment, I really wish I had a good non-proprietary source.
The thing is, if you are maintaining an index and selling the losers within that index for tax loss harvesting, it seems that you have to replace the losers with SOMETHING. The algorithms can work around the wash sale rules no problem, you can sell the losers and buy them back in 30 days. But what do you do in the interim? This isn't fear, uncertainty, and doubt. Just wondering what they do. I suppose they do something like sell Exxon and buy Chevron. It seems you would have friction from bid/ask spreads probably not a huge deal, as someone else said, maybe 10 to 20 basis points. You could use sampling to mostly replicate index performance, I suppose you could replicate the S&P 500 with 200 stocks. The thing is the trading must create some tracking error because the performance of what you sell isn't going to be exactly the performance of what you buy to replace. I don't think that what I am saying is illogical at all. You could get a slight performance benefit from the trading or a slight drag. My guess based upon experience is that over time it would be a drag.
The strategy as explained above is to sell losers to offset winners and over time get the tax basis in the portfolio higher and higher. The big savings are when the investors sells out because the stocks at that point should have relatively high basis. I get that.
If you are getting portfolio drag of under 150 basis points, that is still close to 1 1/2 percent a year. That is not indexing if you have that much drag. I think I read somewhere that the tax drag on the S&P 500 or the US Total Stock Market Index is 0.50% a year.
One reason that I am skeptical about this is that I owned two Quantitative Funds for years that were supposed to "improve" on the S&P 500. They were American Century Equity Growth, which tried to be a bit growthier than the Index and American Century Income and Growth, which tried to generate a dividend yield higher than the Index. Both funds kept the same sector weights as the index and both sampled with about 200 stocks and often with lower market caps than the Index. At one time, they were trying to capitalize a bit on the Size factor. I noticed that they now are doing this with fewer stocks 109 for Income and Growth and 123 for Equity Growth. For years, these funds did well, reliable outperforming the benchmark by about 1% a year. The last decade has been tough on these funds and they both have been trailing the S&P 500. They did this at 0.67% fees. The Vanguard S&P 500 Admiral Shares have returned 13.51% a year vs. 11.96% for Income and Growth vs. 12.42% annually for Equity Growth.
Granted, American Century was trying to beat the index and they were not investing for tax efficiency. Their failure to meet the benchmarks was probably due to factors, their fees, and increasing efficiency of the markets. It was hard enough to beat the index with quantitative strategies. You can see my skepticism over a higher turnover tax loss harvesting/offsetting realized capital gains from winners. The more trading, the more friction costs and those add up over time.
For the tax managed strategy to work, the benefit from realized capital losses and the resulting tax savings has to outweigh the management fee and the performance drag from all the trading.
Of course, the lower the fees to do this, the better. The robots charge 0.25% and in another thread someone was hiring a firm that was charging 0.70%. I would go for the robots. I also know that Vanguard used to have tax managed products but they are managed for all the investors in the fund and not for just one individual.
I saw an article in Advisor Perspectives that explains this. The question is how has this worked in actual practice? The article said that tax drag can be 1% to 3% a year. On an unmanaged index it is probably about 0.58% a year ((2% dividend yield x (.20 Capital Gains + .05 State Income Tax + .038 Net Investment Income Tax)) for wealthy individuals.
https://www.advisorperspectives.com/com ... d-indexing
A fool and his money are good for business.