Practical Applications of A Tax-Loss Harvesting Horse Race: Direct Indexing vs. ETFs

In A Tax-Loss Harvesting Horse Race: Direct Indexing vs. ETFs, from the Fall 2023 issue of The Journal of Beta Investment Strategies, authors Roni Israelov of NDVR and Jason Lu of the International Monetary Fund propose a tax-loss harvesting (TLH) strategy for direct indexing portfolios. Their strategy is practical to implement and produces substantial TLH returns, based on Monte Carlo simulation analysis. Trading monthly, it seeks to harvest tax losses on securities that have declined in value by 10% or more—but it includes trading limits to avoid creating excessive over- and underweight conditions in individual stocks and industry sectors. The authors assert their strategy produces an average annualized benefit of roughly 1.2%, with about a third of the losses harvested over a 20-year period occurring in the first 2.5 years. They also find that TLH opportunities are roughly three times greater in direct indexing portfolios than in ETF investments, because TLH trades can be executed on individual stocks in the former but not the latter.