How I Brofited from the Brexit

Set For Life

The sky wasn’t falling. The end wasn’t near. But you wouldn’t know it if you had access to a computer, television, or radio recently.

The overreaction wasn’t limited to major new outlets, although they were all over it. Even a couple of my favorite financial companies got in on the act. When I logged in a full week after the vote to Brexit, both Personal Capital and Vanguard had Brexit pop-ups (Brop-ups?).

We in the blogosphere gave our perspectives, which tended to be more sensible. Recommendations to ignore the news, stay the course, and don’t believe the hype were standard issue.

 

 

 

PersonalCapitalBrexit

 

 

VanguardBrexit

The first two trading days after the United Kingdom voted to pursue negotiating an exit from the European Union were not pretty. Equity prices sunk worldwide, on the order of about 5% to 10% depending on the market.

When a small drop like this occurs, and they occur quite often (this is the third time in about 9 months we’ve had such a drop), you have options. You can:

Option number two isn’t bad advice, but I went with the third option.

 

Tax Loss Harvesting and Rebalancing

 

My taxable account holds two asset classes, US stocks and International stocks. I will typically hold from two to four funds. At the time of the Brexit vote, I held three funds, VFIAX (S&P 500), VTSAX (Total US Stock Market), and VFWAX (International Stock).

I had some recent lots of VFWAX purchased June 17th that had capital losses of about $740 and another $220 loss from shares purchases on St. Patrick’s Day. Bad luck of the Irish?

I also held shares of VTSAX purchased mid-March through early May that had losses of about $2,200. The percentage drops weren’t huge, but it added up to over $3,000 in potential losses. Time to harvest those losers!

Here is the peri-Brexit performance of the two funds that presented tax loss harvesting opportunities.

BrexitExcel

 

After two trading days, the international fund was down 9.1% and the US fund was down 5.6%. Before the closing bell on Monday, June 27th, I exchanged from VFWAX to VTMGX (Developed International Markets). These are not substantially indentical; in fact, the fund I traded into does not hold emerging markets, which the old fund did. This move actually brought my portfolio better in line with my desired allocation of equal developed and emerging market holdings within the international stock category.

In the same session, I exchanged from VTSAX into both VFIAX and VTMGX. Since the international stocks had taken a larger hit with the Brexit vote, redistributing a bit from US to International stocks also brought my current allocation a bit closer to my desired allocation. With the click of a button, I had accomplished both tax loss harvesting, and rebalancing.

To avoid a wash sale, which could cancel at least a portion of your losses, you must not purchase replacement funds of the same or substantially identical fund within 30 days before and after you sell at a loss. This does not mean you can’t sell a lot purchased within the last 30 days, but if you do, be sure to sell all lots purchased within the last 30 days, and don’t buy again for another 30 days.

 

Benefit of Tax Loss Harvesting

 

So how exactly did I “Brofit“?

Each year, the IRS allows you to deduct up to $3,000 in capital losses from your gross income. With a marginal state and federal income tax of about 45%, a $3,000 deduction this year will save me over $1,300 on my tax bills.

Additional losses can be carried over to future years, and can be applied against capital gains. Do I have additional capital losses harvested? You’d better believe it.

In January, I harvested over $40,000 in losses. In 2015, I harvested nearly $30,000, about $10,000 of which was used to offset gains I took when I sold the last of my T. Rowe Price actively managed funds to go all-in with lower cost Vanguard Index funds.

With around $60,000 in losses left to carry over, I’ll be able to take a $3,000 deduction every year for the next twenty years. I can also access money invested in funds with significant gains without taking a tax hit, if the need were to arise in an emergency.

Since I’ve set my cost basis lower, it could be argued that I’ll end up paying more in capital gains tax later. I can present several counter arguments:

  • I’d rather pay a tax later than pay a tax now.
  • I’m avoiding high income tax to potentially pay the lower capital gains tax.
  • It’s quite possible to pay zero capital gains tax in early retirement.
  • Cost basis is reset when donated or passed along to heirs.
OLYMPUS DIGITAL CAMERA

the heirs apperent

 

I’m no market timer, but I’m always timing the market.

 

Tax loss harvesting requires making a decision to sell. Buying into a similar fund prevents you from missing out on rebound gains (or realizing further losses). Ideally, you will sell at a trough, but those are only evident in hindsight. Nothing prevents you from selling again a few days or weeks after exchanging into a fund, but you will have to find a third not-substantially-identical fund in which to exchange.

When choosing a partner fund, it’s best to choose a fund you would be willing to own forever. If more than 30 days have passed, you can exchange back into the original fund. I would only do so if the recently acquired fund had further losses (or perhaps very minimal gains).

I got lucky on this round, as the funds I sold had gained back most of their 2-day losses in a 3-day rebound. It remains to be seen if the rally will last.

I’ll be ignoring the noise, but tracking my balances.

 

VanguardTaxableBrexit

 

 

This screen capture, showing the fluctuation within my taxable account over the last 30 days looks pretty flat. If I had done nothing with the Brexit, I would have been just fine. By doing something, I did better than fine.

How did you Brofit from the Brexit?

*If you sign up for Personal Capital via any of the links on these pages, which I strongly encourage you to do for obvious reasons, this site will be awarded $100, and half of site profits will be donated to charity. I have been using Personal Capital’s free service far longer than I’ve had a site, and I was recommending it to friends before I had any way to benefit from it.

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29 comments

  • Nicely done! I usually try to take advantage of big drops in the market with some tax-loss harvesting and/or buying more stock. I did happen to buy a few more broad market ETF shares on Monday, near the lows of the month, and they’ve increased in value nicely. That’s mostly just good luck, but I say always bet against catastrophe!

    • Thank you, Matt. You never know if it’s going to drop further, but you know you’re getting a better deal on those shares compared to the price 2 days earlier. In 2008 / 2009, I was buying on the way down and the way back up without much worry about the direction of the markets It all worked out quite well in the end.

      Best,
      -PoF

  • The Green Swan

    Nice work PoF. Curious when you sell one fund for another similar fund, do you have to sell and then wait a day or two for the funds to settle before buying the new fund? Thanks!

    • I believe that may be an issue with ETFs and it may depend on the brokerage firm. I’m 100% in mutual funds, so it’s a simple “Exchange” from one fund to another, which happens at the end-of-day price for both funds. If you wait to make the trades close to the 4 pm EST deadline, you have a good idea of what those prices will be.

  • This is really interesting for me. I am trying to learn more about Tax Loss Harvesting. We are in a very different situation where we will be in a higher tax bracket after retirement (due to pensions) – so I always have to consider that too. We just held tight this month since just reaching FI. No need to create undue stress!

    • Thank you, Vicki. The tax situation you will be facing is the opposite of most physicians or others with high salaries in the earning years. Although your income tax may be higher with the pension, your long-term capital gains rate may be unaffected. If you’ve got a sizable taxable account, TLH will actually be more advantageous when you are collecting the pension.

      Best,
      -PoF

  • Nice work! My taxable account is just starting to get big enough where TLH would be a worthwhile adventure. I’ve been reading up on good exchange partners such as VFIAX for VTSAX and VFWAX for VTIAX.

    • You can also use VLCAX (Vanguard Large Cap) as a third partner for the US Stocks. ER is a little higher, but still quite low at 0.08%.

      I’ve gotten pretty creative with the international funds. In the past, I have exchanged from Total International into two funds (Developed and Emerging), then further exchanged Developed into European and Pacific, then eventually exchanged European, Pacific, and Emerging back into Total International.

      Best of luck with your future TLH,
      -PoF

  • thejollyledger

    I am always interested in reading more about how tax loss harvesting works. Thanks for sharing your experience of selling low for TLH purposes but also buying low for to rebalance. Seems sensible considering your tax situation.

    • I’m happy to share my adventures, and I may write a more complete how-to guide at some point. I’ll have to learn more about the intricacies of ETFs as I don’t have experience with them, but I know it’s not necessarily as straightforward.

      If you want to learn more, head to Bogleheads and search through livesoft’s old posts. You may have to be logged in to do so. Also, he’s posted nearly 50,000 times, so it may take awhile. 🙂

      Cheers!
      -PoF

  • Seems like you made a good move. I ended up deciding to do nothing. The market is down again today, so I wonder if my choice might end up being a good one too!

    I guess we’ll find out!

    • I was surprised I was able to capture another $3,000 in TLH. I wouldn’t have bothered if the amount was much less. If the market drops significantly below last week’s lows, I can look for a third TLH partner or see where we’re at 31 days from last week’s trades.

      I’d just as soon not have any further opportunities, but I’ll take what the market gives us.

      Best,
      -PoF

  • Thanks for sharing your strategy and experience post-Brexit. I don’t profess to know the ins and outs of tax loss harvesting, so this was a great read for me.

    • Once you understand the rationale, the execution is actually pretty simple, particularly if you’re invested in mutual funds. I’ve got some reading to do to more fully understand how it might be different with ETFs.

      The community is always pushing me to learn more, which is great!

      Best,
      -PoF

  • JK

    Great post. A few quick questions:
    -Why VWFAX over VTIAX? Quick bogleheads search seemed to favor VTIAX, which is what I use.
    -As a resident, I’ve never yet had the opportunity for TLH (all in tax advantaged accounts). How do you “selectively” choose which lots of purchases to sell. I’m sure that you have lots of Vanguard money that you can’t tax loss harvest, so how to you actually preferentially sell one of the newer “lots” as opposed to prior lots.

    As always, love the blog. Thanks for posting!

    • Glad to hear from you, JK. I can definitely address those questions. I used to have shares of VTIAX, but harvested losses from them, getting into VFWAX. I’ve gone around the horn a few times, particularly with the international funds. The ER for VFWAX is 0.13% versus 0.12% for VTIAX, which is a difference of $10 per $100,000 per year.

      To specify which lots to sell (and yes, most of my lots have gains), be sure to have your cost basis set to Specific ID. Vanguard is required to track since 2011. For some odd reason, the default setting for cost basis seems to be average cost, which complicates TLH. I believe if you make the change, Vanguard can make it retroactive, at least for funds purchased since 2011. When you want to sell / exchange, you’ll be presented with every purchase as a separate lot, and a unique loss or gain. Sell the reds, keep the greens, and you’ve locked in your paper loss.

      Best,
      -PoF

  • Congratulations on the “Brofit” (great use of the word). I did option 2 and did absolutely nothing and love that the market is near all time highs now. I’m also slowly getting accustomed to learning what Tax Loss Harvesting is..

    • I imagine most people did nothing, which is a good course of non-action. Politically, the Brexit is a big deal, but at least in the short term, it has proven to be a non-issue for our portfolios, with major indexes once again approaching all-time highs.

  • As

    Thanks for sharing your strategy. It is really helpful. I am just started my journey for FI and recently using vanguard. I have two questions for you if you could answer. This is more on how to use Vanguard then more on strategy.

    1. How can you decide which “lot” to sell on vanguard? I mean in order to do this right way you need to make sure you are selling the lot which is under loss and not the one with profit.

    2. I assume you don’t have automatic reinvestment of dividends selected for your vanguard account. Do you actually reinvest your dividends by yourself?

    • Good questions. Answers:

      1. Be sure you have “Specific ID” set as your cost basis. If not, it can be change. The default, I believe, is average cost. You don’t want that.

      2. You are correct. I have dividends diverted to a money market fund within Vanguard. From there, I choose which fund to invest in. Thank you for the reminder! Dividends were posted 12/19 and 12/21.

      Cheers!
      -PoF

  • Matthew

    Hi PoF,

    Thanks for the great post. I’m still learning how to do TLH. So far we have a VTIAX and a VTSAX in our taxable account. But I also have, VITPX in my Roth 401k, VTSAX on my Backdoor Roth IRAs, and VINIX on both my 403b and 457b. So my question is, can we still do TLH for VTSAX in our taxable account even though we have identical/similar funds in our tax-advantaged accounts?
    Thanks!

    -Matt

    • Any “substantially identical” purchase in the Roth (VITPX is essentially the same as VTSAX) within 30 days before or after selling VTSAX will negate a portion of the loss you take by selling VTSAX in taxable. But only equal to the value of the purchase in the Roth. Assuming you sell into VFIAX (Admiral Fund S&P 500), then you’ve got issues with purchases of VINIX in the 403b & 457b if you TLH out of VFIAX in taxable at a future date.

      I have eliminated the possibility by owning mid caps and small caps in my Roth and tax deferred accounts, and holding VTSAX / VFIAX in taxable. It switches up your allocation a bit, but it’s worthwhile once you have a sizable taxable account. In 2016, a year in which the S&P 500 gained over 11% (dividends reinvested), I took paper losses of over $45,000. That will come in handy for years.

      Best,
      -PoF

  • Matthew

    Thank you for replying PoF! I really appreciate it.

    The way we are investing in the 403b, 457b and HSA is by approximating the total stock by having VINIX, VMCIX, VSCIX (81%/4%/15%) in the 403b/457b and VIIIX and VEMPX (81%/19%) in the HSA. To make TLH easier you recommend me switching all my VINIX to VMCIX and VSCIX in my 403b/457b, all my VIIIX to VEMPX in my HSA and all my VITPX to a mid/small cap fund in my Roth 401k? This is still ok even with the slight change in asset allocation right? What percentage do you recommend that my new VMCIX and VSCIX be in the 403b/457b? Also in my Roth 401k with VITPX to what fund should I switch to given the following fund options below. We currently have 600k in taxable, 245k in Roth 401k, 25k in HSA, 55k in Backdoor, 230k in 403b/457b. (I apologize in advance for asking too many questions)

    Roth 401k funds:
    Glazier Fixed Fund View prospectuses, reports or fact sheets
    Real Asset Fund View prospectuses, reports or fact sheets
    Target Retire Inc Tr II View prospectuses, reports or fact sheets
    Target Retire 2015 Tr II View prospectuses, reports or fact sheets
    Target Retire 2020 Tr II View prospectuses, reports or fact sheets
    Target Retire 2025 Tr II View prospectuses, reports or fact sheets
    Target Retire 2030 Tr II View prospectuses, reports or fact sheets
    Target Retire 2035 Tr II View prospectuses, reports or fact sheets
    Target Retire 2040 Tr II View prospectuses, reports or fact sheets
    Target Retire 2045 Tr II View prospectuses, reports or fact sheets
    Target Retire 2050 Tr II View prospectuses, reports or fact sheets
    Target Retire 2055 Tr II View prospectuses, reports or fact sheets
    Target Retire 2060 Tr II View prospectuses, reports or fact sheets
    Target Retire 2065 Tr II View prospectuses, reports or fact sheets
    Vanguard Dividend Growth Fund View prospectuses, reports or fact sheets
    Vanguard Equity Income Fund Adm View prospectuses, reports or fact sheets
    Vanguard Explorer Fund Admiral View prospectuses, reports or fact sheets
    Vanguard Inflation-Protect Sec Adm View prospectuses, reports or fact sheets
    Vanguard International Growth Adm View prospectuses, reports or fact sheets
    Vanguard Internatl Explorer Fund View prospectuses, reports or fact sheets
    Vanguard Ist Tt St Mk Idx Ist Plus View prospectuses, reports or fact sheets
    Vanguard Mid-Cap Growth Fund View prospectuses, reports or fact sheets
    Vanguard Prime Money Mkt Fund View prospectuses, reports or fact sheets
    Vanguard Retire Savings Trust III View prospectuses, reports or fact sheets
    Vanguard Selected Value Fund View prospectuses, reports or fact sheets
    Vanguard Tot Intl Stock Ix Inst View prospectuses, reports or fact sheets
    Vanguard Total Bond Mkt Ix Ist Pls View prospectuses, reports or fact sheets
    Vanguard Wellington Fund Admiral View prospectuses, reports or fact sheets

    • I don’t want to get too specific with advice, but you’ve got the right idea. As long as you’ve avoided duplication of funds between tax advantaged and the taxable account, you’ll be in good shape. You’ve got lots of great options, and the fine details aren’t going to make or break you.

      With volatility having fallen off so much lately, there hasn’t been much in the way of TLH opportunity this year. For better or worse.

      Cheers!
      -PoF

  • DrJayzzz

    Did you ever write a how to on TLH? If not could you point me where to learn how to do this? Thanks PoF!

    • I haven’t written my ultimate guide — I keep waiting for a good opportunity to TLH, but one has not presented itself in recent months.

      I recommend the Bogleheads wiki and forum — it comes up quite often. I believe it talks about returning to your original position after 31 days, but I personally wouldn’t recommend it unless the new fund has no gains in the month after you TLH out of the original fund. I hope that makes sense.

      Best,
      -PoF

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  • Gasem

    I consider tax loss harvesting a separate asset class. I’ve harvested for a couple decades and when I FIRE’d I had about $500K harvested. I especially made hay back in the early 90’s, 2000-2003, and of course 2007 to 2011. I was dutifully sticking away everything I could in pretax accounts (standard fare advice) and then I learned about RMD at age 70. I see this as a government trap, so I greatly reduced my pretax investment limiting it to the matched portion of a 401K and started investing in post tax equities, with efficient tax drag , ie no dividends etc.

    My pre to post ratio was about 1:3, a much larger stake in post than pre, very un-recommended, HOWEVER I have my cap loss asset class to play against my post tax money. My capital appreciation was about 1.3 million above my basis at FIRE, so I definitely have plenty of gain to offset. Below is an example of the advantage of cap gain v cap loss.

    In early retirement you want to be hedged toward the bond side of things, maybe 50:50 for 5-10 years. It has been studied and this mix shows best probability of portfolio success over the long term. Bengen the author of the 4% withdrawal rule studied it and found any mix from 55:45 to 45:55 bonds to stocks was an efficient choice for the 4% rule to succeed especially in early retirement. The 4% rule looks at how many times since 1926 was a portfolio overwhelmed by a singularly bad choice in withdrawal vs a singularly bad year to start withdrawing , in other words 4% was the boundary % withdrawal where no matter when you started you withdrawal the portfolio didn’t fail.

    Since it’s earliest in retirement. The bet is: will your investing mistake cause your portfolio to fail before your heart disease causes you to fail. 5 years in you have less time for an investing mistake to run you out of money before you run out of beats. 10 years in even less time to worry about failure etc. In each succeeding 5 year epoch you can become a little more aggressive in the stock:bond mix.

    It is actually suggested for best safety you start the mix transition from stock aggressive (accumulation phase) to bond aggressive 5 years before retirement and 5 years after ( I call this 10 years transition phase) and then start moving back to a more aggressive stock allocation once you hit the end of transition.

    I read that paper AFTER I fired so the first 5 years of transition were spent at 75:25 stocks: bonds+cash+REIT+GLD. (Here’s the TLH part) I decided to create a “home brew annuity” to live on for 5 years while I did some back door Roth conversion till RMD kicked in. So the annuity gave me tax free money to live on while I was pulling out IRA contributions to the limit of 15% taxes and stuffing them into a Roth. To do that I need to make no “income”. I chose $10K a month as my “home brew” payout. I already had $200K in cash and I wanted a little “fudge just in case” factor of $50K for non budgeted splurges ,like my wife and daughter are going to Rome for Christmas. My daughter is in a choral group which will be performing at a dozen venues in Italy then. I needed therefore $450K + my $200K to live on for 60 months so I sold $450K post tax stock with a $110K net cap gain, paired it with $110K of cap loss from my TLH stash and I still have $390Kof TLH left, and I can look for opportunities to increase that as circumstances permit. My tax bill for creating my annuity was $0. The money is in VWSUX (gotta love the name) a short term muni bond fund.

    Here is what that maneuver did. I moved me much closer to 55:45 stocks to bonds. Every month I withdraw I slowly move back to a more aggressive stock allocation automatically, and after 5 years I will be back to 70:30 or so depending on what I put in the Roths. (I did another maneuver to make my portfolio more conservative, bought some LTIPS which are an inflation hedge so the ratios are not purely from creating the annuity. )

    I won’t address my mix again till this 5 year epoch is complete and at that time SS and RMD kicks in so I will need far less assistance from my post tax account to stabilize my income. I’m assured 10K per month for 5 years and I’m earning a little over 1% tax free in VWSUX. I chose this fund because the paper is shorter term which is another inflation hedge. So between bonds, reits, muni s,tips, and gld I have excellent inflation protection and I still have plenty of equities for capital appreciation.

    It’s a little bit complicated, BUT I just saved $110K in taxes for free and that ain’t chicken feed. That is the power of tax loss harvestring

    • I don’t know how many investors were taking advantage of TLH opportunities, but the last couple decades have given plenty of opportunity. I managed to harvest about $46,000 last year (2016), a year in which the stock market gained > 10%. The best use of those will be to offset $3,000 of ordinary income per year, but I may cease earning income before I use it all up. In that case, I’ll use the harvested losses to avoid taking capital gains in my retirement years. In the meantime, I’ll be watching for opportunities to add to the paper losses.

      Cheers!
      -PoF

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