A Tax-Loss Harvesting Horserace: Direct Indexing vs. ETFs

Abstract

This paper proposes and analyzes an enhanced, but easily implemented, heuristic for tax-loss harvesting within a portfolio of stocks. Because stock returns are correlated within and across sectors, harvesting opportunities may simultaneously arise across many stocks that also concentrate in individual sectors, and the active risk of undertaking all available harvests may become undesirable. Our algorithm balances harvesting yield, active risk, portfolio rebalancing, and turnover. We evaluate the performance of our heuristic using Monte Carlo simulations across time and within different market environments. We show that harvesting yield for a portfolio of stocks is superior to market ETFs.

Keywords: Direct Indexing; Loss Harvesting; Tax Loss Harvesting; Tax Alpha; Tax Efficiency; Tax Optimization; Tax-Aware Investing

JEL Classification: D14, G11, H21, H24