Schwab Intelligent Portfolios March 13, 2020

    When market volatility inevitably ramps up from time to time, riding that roller coaster can sometimes leave you feeling a bit queasy. But that doesn't mean the only thing you can do is close your eyes and hang on until the ride ends. For savvy investors, volatility can actually provide opportunities for agile trading that can be used to their advantage.

    For instance, tax-loss harvesting is a powerful tool that may help reduce current tax liabilities for taxable accounts and potentially leave you more to invest over time, but it's a complicated and time-consuming process for individual investors to manage. For many years, this type of sophisticated service was only available to the wealthiest investors. But now, Schwab Intelligent Portfolios® is able to use the power of technology to automate this complex process for you. For a more in-depth look at how tax-loss harvesting works, the tax implications and the IRS "wash sale" rule, please visit this white paper.

    Tax-loss harvesting trades increased during market volatility

    While tax-loss harvesting trades have occurred every month since the March 2015 launch of Schwab Intelligent Portfolios, periods of elevated market volatility highlight the potential benefit of the tax-loss harvesting feature. The number of tax-loss harvesting trades across Schwab Intelligent Portfolios accounts that are enrolled in the service have historically surged when markets turn turbulent.

    The market correction during Q4 2018 and subsequent rebound in Q1 2019 help illustrate the power of tax-loss harvesting. As Figure 1 shows, the total number of tax-loss harvesting trades across Schwab Intelligent Portfolios rose sharply along with market volatility in Q4 2018 as the U.S. stock market tumbled. Clients enrolled in tax-loss harvesting were able to capture the losses for tax purposes by selling the ETFs in their portfolio that had declined enough below their purchase price. Additionally, because the tax-loss harvesting feature simultaneously reinvests the proceeds of the sale into an alternate ETF in the same asset class to keep clients invested according to their targeted asset allocation, those clients stayed invested and benefited from the market rebound in Q1 2019.

    Figure 1: Tax-loss harvesting trades have increased when markets turned turbulent

    A bar chart showing the number of tax-loss trades across Schwab Intelligent Portfolios with a line overlay of the S&P 500 Index. The number of tax-loss harvesting trades in Q3 2019 when the S&P 500 index was trending upwards, was roughly 60,000. Then the number of trades rose sharply in Q4 2018 to roughly 324,000 when the S&P Index dropped and then decreased to roughly 3,500 in Q1 2019 and roughly 8,000 in Q2 2019 when the S&P 500 Index was rising.

    Sources: Charles Schwab Investment Advisory and Morningstar Direct, 7/1/2018 – 6/30/2019

    A tax-loss harvesting case study

    To further illustrate how tax-loss harvesting works, we examined the tax-loss harvesting trades that occurred in a Schwab Intelligent Portfolios account that most closely mirrors the model portfolio during December 2018, the most turbulent month during the Q4 volatility. The representative account had a balance of approximately $100,000 and was invested in a globally diversified total return strategy based on a moderate growth risk profile consisting of 61% stocks, 26.5% fixed income, 2% commodities and 10.5% cash.

    As shown in Figure 2, the account saw 11 tax-loss harvesting trades in December 2018. Total losses harvested during the month came to approximately $3,608. While not listed in this example, the account experienced tax-loss harvesting trades in other months of the year as well. These captured losses accrue over the course of the year and may potentially be used to help offset realized capital gains when filing year-end tax returns and up to $3,000 in ordinary income to the extent that captured losses exceed an investor’s capital gains for the year.

    While tax-loss harvesting does not eliminate tax liabilities (future taxes would need to be paid based on the cost basis of the replacement security whenever it is sold at a later date), it defers taxes and can help to potentially reduce current tax liabilities.

    This is just an example for illustrative purposes, and the tax-loss harvesting activity within your account depends on market conditions, when you opened your account, subsequent deposits/withdrawals, whether you switched to a different portfolio after opening the account, and other factors.

    Figure 2: Tax-loss harvesting trades have increased when markets turned turbulent

    Schwab Intelligent Portfolios includes primary and secondary ETFs in each asset class in order to be able to capture losses when the market presents these opportunities while also maintaining your strategic allocation by reinvesting into the alternate ETF in that asset class.

    Date Asset Class Tax Loss Harvesting Activity Harvested Loss*
    12/6/2018 International Developed Market Large Company Stocks – Fundamental
    • Shares of primary ETF (FNDF) sold
    • Shares of secondary ETF (PXF) bought
    $331.21
    12/14/2018 US Small Company Stocks
    • Shares of primary ETF (SCHA) sold
    • Shares of secondary ETF (VB) bought
    $320.81
    12/14/2018 International Developed Market Small Cap Stocks – Fundamental
    • Shares of primary ETF (FNDC) sold
    • Shares of secondary ETF (PDN) bought
    $270.00
    12/17/2018 U.S. Large Company Stocks
    • Shares of primary ETF (SCHX) sold
    • Shares of secondary ETF (VOO) bought
    $318.75
    12/17/2018 U.S. Large Company Stocks – Fundamental
    • Shares of secondary ETF (PRF) sold**
    • Shares of primary ETF (FNDX) bought
    $279.36
    12/21/2018 International Developed Market Small Company Stocks
    • Shares of secondary ETF (VSS) sold**
    • Shares of primary ETF (SCHC) bought
    $266.99
    12/21/2018 U.S. Small Company Stocks – Fundamental
    • Shares of secondary ETF (PRFZ) sold**
    • Shares of primary ETF (FNDA) bought
    $771.14
    12/21/2018 High-Yield Bonds
    • Shares of primary ETF (HYLB) sold
    • Shares of secondary ETF (USHY) bought
    $269.07
    12/24/2018 U.S. Real Estate Investment Trusts (REITs)
    • Shares of primary ETF (SCHH) sold
    • Shares of secondary ETF (USRT) bought
    $354.29
    12/26/2018 Emerging Markets Stocks – Fundamental
    • Shares of secondary ETF (PXH) sold**
    • Shares of primary ETF (FNDE) bought
    $202.02
    12/26/2018 Emerging Markets Stocks
    • Shares of secondary ETF (IEMG) sold**
    • Shares of primary ETF (SCHE) bought
    $223.66
    Total $3,607.93

    This example should be interpreted as illustrative only and not representative of an actual client's experience.

    *Harvested losses take into account the purchase price (cost basis) of the security sold in calculating the amount of the loss harvested for tax purposes.

    **Note that the secondary ETF was sold and the primary ETF was purchased in these tax-loss harvesting trades because of previous trades in which the primary ETF had been sold and the secondary ETF purchased.
     
    Source: Charles Schwab Investment Advisory, Inc.

    How volatility can work for you

    While financial markets are volatile by nature, prepared investors can take action to help make these inevitable fluctuations work for them. Sophisticated portfolio management services such as tax-loss harvesting may help reduce investment taxes and can leave you more money that can be reinvested with the potential to grow over time. With Schwab Intelligent Portfolios, automated tax-loss harvesting is available for accounts with at least $50,000 in investable assets.

    By David Koenig, CFA, FRM, Chief Investment Strategist, Schwab Intelligent Portfolios

    Tax‐loss harvesting is available for clients with invested assets of $50,000 or more in their account. Clients must choose to activate this feature. The tax‐loss harvesting feature that is available with Schwab Intelligent Portfolios Solutions™ is subject to significant limitations which are described on the Schwab Intelligent Portfolios Solutions website and mobile application (collectively, the "Website") as well as in the Schwab Intelligent Portfolios Solutions™ disclosure brochures (the "Brochures"), and the IRS website at www.irs.gov. You should consider whether to activate the tax‐loss harvesting feature based on your particular circumstances and the potential impact tax‐loss harvesting may have on your tax situation. You should read the tax‐loss harvesting disclosures on the Website and in the Brochures before choosing the tax‐loss harvesting feature. Neither the tax‐loss harvesting strategy nor any discussion herein is intended as tax advice, and neither Charles Schwab & Co., Inc. nor its affiliates, including but not limited to Charles Schwab Investment Advisory, Inc., represents that any particular tax consequences will be obtained.

    Schwab Intelligent Portfolios® and Schwab Intelligent Portfolios Premium™ are designed to monitor portfolios on a daily basis and will also automatically rebalance as needed to keep the portfolio consistent with the client's selected risk profile. Trading may not take place daily.

    Please read the Schwab Intelligent Portfolios Solutions™ disclosure brochures for important information, pricing, and disclosures related to the Schwab Intelligent Portfolios and Schwab Intelligent Portfolios Premium programs.

    Schwab Intelligent Portfolios® and Schwab Intelligent Portfolios Premium™ are made available through Charles Schwab & Co. Inc. ("Schwab"), a dually registered investment advisor and broker dealer. Portfolio management services are provided by Charles Schwab Investment Advisory, Inc. ("CSIA"). Schwab and CSIA are subsidiaries of The Charles Schwab Corporation.

    Nothing in these materials represents a recommendation of a particular ETF.

    (0220-0E42)


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