I’m curious if others are using stop-loss orders for tax-loss harvesting in their portfolios. I run a value-based investment strategy with a typical holding period of over 200 days. Recently, I added a 20% stop-loss rule to my approach. Backtesting showed that this rule neither significantly improved nor hurt performance, but it opens the door to potential tax alpha by selling stocks at a loss and replacing them with the next highest-ranked stock in my strategy.
For those managing taxable accounts, are you using a similar approach to capture tax benefits? What’s your experience been like?
I don't use stop loss orders but the way you are using them kinda works like a common alternative.
I usually let the broker handle lot selection to maximize tax losses, works fairly well. But I'd much rather prefer to see a tax loss harvesting feature here that factors in things like selling losers before the 1-year mark (for short-term loss benefits) and holding winners past a year. Ideally, it would also swap out losers with similarly ranked alternatives. Parametric does (did?) this for retail banking clients, like Goldman, etc., and was eventually bought by Eaton Vance. I think you are approximating this which should validate your idea.
The bottom line, imo, is that saving on taxes is pure alpha and by far easier to capture than trading/investing edge. If you have a way to do it, definitely do it.
Speaking of taxes, taxes are one of the reasons why a long-short strategy could be a good thing: the short side can contribute so much losses that not only do you not have to pay any capital gains taxes if you wouldn't liquidate your portfolio, but you can also offset many other capital gains.
The downside is that you need an account that can utilize higher leverage.
If you have a cash account and an IRA account and you increase and decrease position sizes, then the way to minimize your taxes is as follows. If you're selling a portion of your position in a stock and you've lost money on the stock, sell it in your cash account; if you've made money on it, sell it in your IRA. Keep doing that and you'll end up with a cash-account loss and an IRA gain. I did this for a couple of years and it worked wonders for my taxes, and I'll do it again if I get more cash to invest (right now I'm only investing in IRAs).
The other thing to do is this: if you're donating stock from a cash account to a charity or foundation, always donate the stock that has appreciated the most. Your cost basis will limit your deduction, but it'll be far easier to avoid capital gains, and in the end those count for more since the standard deduction is already sizable.