In a Sept. 28 NPR podcast, Bloomberg reporter Loukia Gyftopoulou described Asness as “a mad genius in a way, who’s now found this way to help rich people slash their tax bills, potentially, to the extreme.”
Asness’ strategy uses thousands of long and short positions, with his fund buying some investments while betting against others. As individual positions fall, AQR can sell or close them to lock in losses for tax purposes, while gains elsewhere in the portfolio keep the overall strategy profitable.
The numbers help explain the appeal. In one hypothetical scenario presented to potential investors, AQR showed how a $100 million investment could grow to $300 million over 10 years while generating $600 million in realized losses. The investor hasn’t actually lost $600 million overall; the figure represents cumulative losses realized on individual positions along the way, which can then offset taxable gains elsewhere.
Most investors don’t have $100 million, or even the $1 million minimum AQR initially required to participate in the strategy. But the tax principle behind it isn’t reserved for the ultrawealthy. Ordinary investors can use a much simpler version, known as tax-loss harvesting, to offset capital gains and potentially reduce their tax bill.
The more accessible tax-loss harvesting
Asness’ approach may involve much larger figures and far more complexity, but tax-loss harvesting itself is an established way for investors to legally reduce what they owe in taxes.
The tax benefit is spelled out by the IRS, which says capital losses can offset capital gains. If losses exceed gains, taxpayers can use up to $3,000 of the remaining losses to reduce their taxable income each year, while carrying additional losses into future years.
Tax-loss harvesting is common enough that major asset managers recommend it to clients. Vanguard senior financial advisor Scott Walker describes it simply as intentionally selling investments at a loss to lower taxes. As such, Vanguard offers automated tax-loss harvesting for investors who don’t want to manage the process themselves.
Meanwhile, Fidelity notes that investors don’t necessarily need capital gains today to benefit from harvesting losses, since those losses “can be used to offset income or future gains.” Investors with professionally managed portfolios may already be benefiting from the strategy, since portfolio managers often harvest losses to reduce taxes.
Christopher Fuse, an asset allocation portfolio manager at Fidelity, says tax-loss harvesting “can help a client reach their goals faster” because less money goes toward taxes and more remains invested.
However, these potential tax savings come with important caveats.
