Is tax-loss harvesting valuable after the first few years?
Dimensional shows factor rebalancing persists harvesting opportunities
Okay, so, you fund a new portfolio with cash, because you’re all jazzed about this direct indexing stuff you’ve heard about.
Then, 5 years pass, and you have index-like exposure, but your manager isn’t tax-loss harvesting as much because your portfolio has grown meaningfully above its cost basis. Here’s a video explainer…
We sometimes call this “ossification,” though I drink from the well of tax management and think of it more like “dessication.”
In other words, we’ve wrung all the tax alpha out of an account, and there’s not much more we can do… except that Dimensional Fund Advisers has a different take.
Dimensional’s paper, A Historical Perspective on Multifaceted Tax Management, shows that, even without adding additional cash, tax-loss harvesting potential can extend well past 5 (or so) years, pushing ossification/dessication 10 years out or more.
They call their approach “Multifaceted Tax Management.”
DFA does all the normal things (like keeping dividends qualified, managing wash sales, etc.), but they go beyond the naive direct indexing mandate of harvesting a bunch of tax losses while keeping tracking error in check.
Two things Dimensional emphasizes:
Factor rebalancing resets cost basis more consistently than naive indexing
Selecting rebalancing replacements specifically to keep capturing premiums
Factor investing and tax management appear to create tasty affinities. Like 🥜 🧈 & 🍓.
Most folks assume regular cash injections and unlimited external short-term capital gains in their research, but Dimensional shows there’s value in tax management without new cash or external gains (panel C below).
I’ll have more to say about DFA’s approach soon…
In honor of the King of the Hill reboot
Bobby is older.
I am older.
You are older.
It's fine.