Tax-Loss Harvesting (and Where Direct Indexing Fits)
March 16, 2026 - At its core, tax-loss harvesting is a tax management technique: when part of a taxable portfolio is down, you may be able to sell at a loss, reinvest promptly, and potentially use that loss to reduce taxes. Done well, it can improve after-tax outcomes over time. Done poorly, it becomes an expensive “feature,” or worse, an unintended drift into market timing.
Tax-loss harvesting is a two-step process (and some forget step two)
Most investors understand step one: sell at a loss to capture the tax loss.
The forgotten step is step two: reinvest in a way that keeps the portfolio’s intended risk level intact.
If you sell an investment at a loss and do not replace it with something meaningfully similar, you did not just harvest a tax loss. You changed your portfolio unintentionally.
We sometimes see a version of this when an investor sells at a loss, sits in cash “until things feel better,” and plans to get back in later. That is not tax-loss harvesting - that is market timing, and it can go poorly because recoveries don’t tend to announce themselves in advance.
A disciplined process keeps you invested. The objective is to capture a tax benefit without changing the portfolio.
The question when comparing SMA direct indexing vs. a broader approach
When someone is comparing a direct indexing SMA to other approaches, a simple question helps clarify the decision:
Do you want part of your portfolio to be managed tax efficiently, or all of it?
The instinctive answer is “all of it.” That is usually the more logical goal because taxes do not care which product wrapper you used. Taxes care about what happened across the household’s taxable investments.
This is where strategy matters more than packaging. We believe tax-loss harvesting tends to be most effective when it is coordinated across:
Multiple taxable positions
Multiple asset classes
The household’s overall allocation and cash flow plan
If tax management is siloed inside a single sleeve, you may be improving one corner of the portfolio while missing opportunities elsewhere.
What tax-loss harvesting does (and what it does not)
Tax-loss harvesting does not create market returns. Markets are uncertain, and return projections should be treated with skepticism. What tax-loss harvesting can do is improve after-tax efficiency by generating losses that can typically be used to:
Offset future capital gains
If losses exceed gains, offset up to $3,000 per year of ordinary income (with remaining losses generally carried forward indefinitely)
The value is often meaningful in volatile markets. It is not guaranteed. It depends on your tax bracket, future gains, time horizon, and how your plan integrates charitable giving and estate considerations.
What a “best practice” approach looks like
Our view is that the best version of tax-loss harvesting has a few consistent characteristics:
Broad diversification. A portfolio that is diversified across multiple asset classes, and parts of asset classes, tends to create more natural “winners and losers” at any given time, which can create more harvesting opportunities without distorting the plan. Because returns are random, and because asset classes perform differently in different economic conditions, being tax sensitive across all asset classes may get a better result. Harvesting inside of one asset class may provide some value, but, for example, US large cap stocks tend to move together, when there are other asset classes that may not be correlating at the same time.
Low friction. The less you give up in fees, trading costs, and complexity, the more of the potential benefit you keep.
Immediate reinvestment. The process should be designed to capture losses while maintaining comparable exposure, so you are not inadvertently taking a market bet by going to cash or changing the portfolio’s risk profile.
Household coordination. We believe tax strategy tends to work better when it is managed across the household rather than inside isolated product silos.
Integration with charitable and estate planning. For many families, tax efficiency is not just harvesting losses; it is coordinating gains, gifting appreciated investments when appropriate, and aligning decisions with long-term intentions. It is often possible—never promised, never guaranteed—for disciplined tax management plus charitable planning to materially reduce lifetime capital gains taxes, and in some cases eliminate them altogether.
That is the framework we think investors should use when evaluating any tax-managed offering, including direct indexing.
Where direct indexing and SMAs can make sense
Direct indexing (often delivered through a separately managed account, or SMA) replaces ETFs with a basket of individual stocks that resembles an index. With more individual positions, there may be more harvesting “surface area.” In some situations, that can be beneficial.
We do not view this as inherently good or bad. It is a tool.
The question is whether the tool is the best tool to get the overall outcome the investor seeks.
The tradeoffs to understand before you buy the wrapper
1) Fees can consume the benefit
We have seen SMA management fees quoted as high as 1.50%. At that level, it is possible for the fee to absorb much of the tax advantage, especially over long holding periods. Lower-fee alternatives exist, sometimes closer to 0.50%. If an SMA is being used primarily for tax-loss harvesting, the fee is not a footnote. It can be the main risk.
2) The “step two” problem is harder with individual stocks
With broad market exposure, replacing exposure after harvesting can be relatively clean: you are trying to maintain the same general risk characteristics.
With individual stocks, replacements can be less precise. Selling one company and buying a different company is not the same exposure. Over time, this can create unintended drift unless the process is exceptionally disciplined.
3) Charitable gifting can be limited or impractical
Many charitably inclined families prefer donating appreciated investments rather than cash. In some SMA programs, donating specific appreciated positions is either not allowed or becomes impractical. If charitable planning is part of your tax strategy, ask how this works before committing.
4) Step-up in basis may reduce the value for some families
If someone is later in life and expects to hold taxable assets until death, current law often provides a step-up in cost basis for heirs. In that scenario, paying an ongoing fee purely for harvesting losses may have limited payoff. Tax law can change, so this should not be the only factor, but it belongs in the analysis.
A clean way to evaluate the pitch
If you are considering an SMA/direct indexing proposal, ask:
Is this designed to tax-loss harvest one sleeve or coordinate across the full household portfolio?
What is the all-in fee, and what must be true for the tax benefit to exceed that fee? Is it possible to get the value of tax loss harvesting without paying this additional fee?
Does the process reliably complete both steps—harvesting losses and maintaining intended risk exposure?
Does it integrate cleanly with charitable giving and estate intentions?
Am I relying on rosy return “expectations” that are not realistic?
If you want a second set of eyes
This is general information, not tax advice. Tax rules are complex and personal, and you should coordinate what you do with your overall tax plan. If you are evaluating a direct indexing SMA and want a plain-English view of whether it is likely to add value in your situation, schedule a call. We can help you pressure-test the fee, the constraints, and whether the approach is built to tax-loss harvest a slice of your portfolio—or coordinate the full plan.
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Information presented is for educational purposes only and is not personalized investment, financial, legal, tax, or accounting advice. Nothing on this website should be interpreted to state or imply that past performance is an indication of future performance. All investments involve risk and unless otherwise stated are not guaranteed. Be sure to consult with tax, legal, accounting, and financial professionals about your specific situation before implementing any planning strategies. Investment Advisory Services offered through Timberchase Financial, LLC, a Registered Investment Adviser with the U.S. Securities & Exchange Commission. Registration does not imply a certain level of skill or training.