Tax loss harvesting strategies that could up your portfolio’s growth potential

Highlights Oct.01,2022 21:53

Tax loss harvesting can both unlock and free up dollars to invest in more compelling opportunities. Growth-focused investments are particularly ripe for harvesting this year, as Fed tightening and the rotation from growth to value has impacted tech-focused benchmark funds, FAANG stocks, and innovation themes.

Investors looking to maintain and potentially enhance their growth exposures can employ tax loss harvesting strategies as a way to pivot into long-term, thematic growth investments. Growth investments have broadly struggled in 2022 due to the shifting macro environment with the Federal Reserve’s aggressive interest rate hikes intended to curb inflationary pressures. Its impact on markets has been significant, with the S&P 500 down -16.14% on the year through August 31 — the worst start in nearly 50 years.1 But growth-focused investments such as the technology sector have been hit even harder: Through the first nine months of the year, the Nasdaq 100 Index was down -24.38%, while the S&P Technology Select Sector Index was down -21.80%).2

While this year is proving challenging for investors, the market sell-off may provide a silver lining: It opens the door for tax loss harvesting, which can both unlock potential tax benefits as well as offer an opportunity to reevaluate one’s portfolio amid the rising rate environment.

We believe there are three ways investors can seek to capture losses and reallocate to other potential growth opportunities.

SHARPEN GROWTH EXPOSURES: TARGET PRECISE GROWTH OPPORTUNITIES AMID THE REGIME SHIFT

What worked in the past may no longer suffice in this new regime. In 2021, the Fed’s dovish monetary policies benefited virtually all asset classes, with many growth stocks and funds among the biggest winners. Yet in the current environment of rising rates and a shakier economic outlook, stocks in growth sectors like technology have not enjoyed the same tailwind. Approximately 45 names in the Nasdaq 100 Index were down more than 25% year-to-date, through the end of August.3 iShares recently posted a relevant article, A Masterclass in Diversification, which underscores why diversification matters — especially in volatile markets.

# of Nasdaq 100 constituents by YTD performance bucket

Source: FactSet, BlackRock, September 2022. Performance calculated as year-to-date total return through 8/31/22.

Note: Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.

Chart description: Column chart showing the number of Nasdaq 100 constituents across four year-to-date performance buckets: positive returns, down 0-10%, down 10-25%, and down more than 25%. The chart shows how many large cap companies within the index have had negative performance so far this year.

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As a result, investors looking for continued growth exposure may need to seek out more targeted opportunities which, despite broader economic headwinds, could still benefit from long-term structural shifts in technology, demographics, and other areas. Megatrend investing seeks to identify specific segments of the market which may be poised for potential long-term structural growth opportunities irrespective of sector, country, or size. As an illustrative example, the Morningstar Exponential Technologies index “is designed to deliver diversified exposure to companies poised to benefit from innovative technologies with exponential growth potential.”4 The index targets several innovations propelled by long-term structural forces, including big data & analytics, cloud computing, energy transition technologies, fintech, health care devices and therapies, connectivity, nanotechnology, transportation, and robotics.

In today’s environment, a potential strategy to gain access to such an exposure includes harvesting losses in negatively performing growth-tilting funds and swapping them with more targeted megatrend strategies.

SPREAD OUT THE RISK: AVOID OVERLY CONCENTRATED BETS BY SHIFTING FROM INDIVIDUAL STOCKS TO DIVERSIFIED INVESTMENTS

Tumultuous markets also have a way of humbling individual stock selections. This year is no exception. Many names that were lauded for their stellar performance over the past two years — particularly large cap growth companies — have seen their fortunes reverse.

Some investors buy individual stocks with the intent of gaining exposure to a broader theme rather than the prospects of an individual company. Investment in a fast-growing electric vehicle stock for instance, can often be rooted in broader excitement around paradigm-shifting changes like the shift from gas to electric transportation.

Yet, investing in a single stock to capture a theme could present potentially avoidable risks. Attempting to pick the top future beneficiary of transformational changes can prove difficult and may miss a wider opportunity set. For example, within the EV theme, not only are there several auto manufacturers who could benefit from rising EV adoption, but also there several other areas of the EV value chain from battery producers, battery material suppliers, and technology developers that could benefit as well.

Diversified investment vehicles like ETFs can offer a means of reducing these potential risks and pain points. A potential strategy investors may want to consider for pivoting into such investments: selling individual stock positions with unrealized losses and swapping them with megatrends ETFs that provide more diversified exposure to the investment theme (please note wash sale exceptions).5 The iShares Product Screener can help investors by identifying ETFs that have exposure to a particular stock, among several other positions for improved diversification.

MAINTAIN EXPOSURE: HARVEST LOSSES, WHILE STAYING INVESTED IN HIGH CONVICTION THEMES

Investors may have experienced recent underperformance across existing thematic exposures. For example, indexes tracking the robotics, genomics and blockchain themes performed negatively through the first 8 months of the year.6 Although near term performance has suffered, the downturn affords an opportunity for investors to capture losses and fine-tune their exposures.

While some thematic strategies can be too highly concentrated and volatile and others can be too dilutive and duplicative. Investors may want to consider megatrend ETFs with four principles in mind:

Precision: Built to capture the pure-play names driving cutting-edge themes to new frontiers

Diversity: Intended to capture niche players across a theme’s full value-chain across the globe

Agility: Designed to evolve as a theme advances and key players change Affordability: Priced at the low end of the range for comparable options in the market today

CONCLUSION

With growth investments broadly performing negatively thus far this year, investors may want to consider harvesting losses and allocating to positions which may be better suited for the new market regime. We’ve identified three potential tax loss harvesting strategies:

Sharpen growth exposures: Consider swapping under-performing growth investments with exposures that zero-in on high growth potential themes dictated by structural shifts in technology, demographics, and more

Spread out the risk: Investing in a single stock to capture a theme could present potentially avoidable risks. Megatrend ETFs can address this pain point by investing in dozens of pure-play stocks across a theme’s value chain, providing the access to narrow investment themes offered by single stock investment, but with the potential benefits of diversification

Maintain exposure: Consider investments that will maintain portfolio allocation to individual sectors or themes, while increasing exposure to areas of high growth potential However one plans to approach tax loss harvesting season, iShares offers potential solutions in line with these strategies. Our breadth of megatrend ETFs provide targeted exposure to high growth themes across breakthrough technologies, climate, demographics, global wealth, and urbanization.