Financial Analysts Journal 30 June 2020 Volume 76 Issue 3
An Empirical Evaluation of Tax-Loss-Harvesting Alpha
This article quantifies how much alpha is available from tax-loss harvesting and in which market environments these strategies are most effective.
Advances in financial technology have made tax-loss harvesting more feasible for retail investors than such strategies were in the past. We evaluated the magnitude of this “tax alpha” with the use of historical data from the CRSP monthly database for the 500 securities with the largest market capitalizations from 1926 to 2018. Given long-term and short-term capital gains tax rates of 15% and 35%, respectively, we found that a tax-loss-harvesting strategy yielded a before-transaction-cost tax alpha of 1.08% per year for our sample period. When the strategy was constrained by the “wash sale rule,” the tax alpha decreased from 1.08% per year to 0.82% per year.
About the Authors
Shomesh E. Chaudhuri is chief technology officer of QLS Advisors, Cambridge, Massachusetts.
Terence C. Burnham is associate professor of finance at Chapman University Argyros School of Business and Economics, Orange, California.
Andrew W. Lo is Charles E. and Susan T. Harris Professor of Finance at the MIT Sloan School of Management and the director of MIT’s Laboratory for Financial Engineering. He focuses his research on the fundamental aspects of investments and financial markets, including the measurement of illiquidity risk in hedge fund returns, the growth of systemic risk in the hedge fund industry, and most recently, evolutionary and neurobiological models of individual risk preferences and financial markets. Before joining MIT’s finance faculty, Mr. Lo taught at the University of Pennsylvania’s Wharton School. He has published numerous articles and books on finance and economics. Mr. Lo received his PhD in economics from Harvard University.