An Empirical Evaluation of Tax-Loss Harvesting Alpha

14 Pages Posted: 3 Apr 2019 Last revised: 27 May 2019

See all articles by Shomesh Chaudhuri

Shomesh Chaudhuri

Massachusetts Institute of Technology

Terence Burnham

Chapman University - Department of Business and Economics; Chapman University The George L. Argyros School of Business & Economics

Andrew W. Lo

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER); Massachusetts Institute of Technology (MIT) - Computer Science and Artificial Intelligence Laboratory (CSAIL)

Date Written: March 5, 2019

Abstract

Advances in financial technology have made tax-loss harvesting strategies potentially more feasible for retail investors. We evaluate the magnitude of this "tax alpha" using historical data from the Center for Research in Securities Prices monthly database for the 500 securities with the largest market capitalization from 1926 to 2018. Given long- and short-term capital gains tax rates of 15% and 35%, respectively, and assuming investors have short-term gains or ordinary income to offset short-term losses, we find that a tax-loss harvesting strategy yields a geometric average of 1.10% per year from 1926 to 2018. However, this tax alpha is highly variable: over four successive 23-year periods, the tax alpha ranged from 0.57% to 2.29% per year, increasing in periods with higher volatility, higher dispersion of the individual returns, and lower overall return for the market. Although tax alphas are mostly positive, the largest magnitudes occur in years when investors are least likely to be able to make use of them immediately, i.e., when most equity investments are down. Since investors seldom have enough short-term gains to offset short-term losses and there are often limits to the amount of loss that can be carried forward or deducted against ordinary income, the tax alpha should be discounted accordingly. Indeed, with a constant marginal tax rate of 35% applied to all gains, the tax alpha across the entire historical sample decreases from 1.10% per year to 0.51% per year.

Keywords: Tax-Loss Harvesting; Tax Optimization; Tax Alpha; Tax-Aware Investing

JEL Classification: G11, G12, H26

Suggested Citation

Chaudhuri, Shomesh and Burnham, Terence C. and Lo, Andrew W., An Empirical Evaluation of Tax-Loss Harvesting Alpha (March 5, 2019). Available at SSRN: https://ssrn.com/abstract=3351382 or http://dx.doi.org/10.2139/ssrn.3351382

Shomesh Chaudhuri

Massachusetts Institute of Technology ( email )

77 Massachusetts Avenue
50 Memorial Drive
Cambridge, MA 02139-4307
United States

Terence C. Burnham

Chapman University - Department of Business and Economics ( email )

Orange, CA
United States

Chapman University The George L. Argyros School of Business & Economics ( email )

333 N. Glassell
Orange, CA 92866
United States

Andrew W. Lo (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-618
Cambridge, MA 02142
United States
617-253-0920 (Phone)
781 891-9783 (Fax)

HOME PAGE: http://web.mit.edu/alo/www

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Massachusetts Institute of Technology (MIT) - Computer Science and Artificial Intelligence Laboratory (CSAIL)

Stata Center
Cambridge, MA 02142
United States

Register to save articles to
your library

Register

Paper statistics

Downloads
321
Abstract Views
1,886
rank
93,709
PlumX Metrics