Making Lemonade Out of Lemons: Tax-Loss Harvesting and Swapping from Mutual Funds to ETFs

Chief Investment Officer, Model Portfolios

We have witnessed an almost unprecedented four to five weeks of market disruption, and many investors are wondering what they can do to stem the tide.

We can’t predict what markets will do from here, but what we do know is that the market declines have generated unrealized tax losses in many individual positions.

Tax loss harvesting is a tangible way of adding value for investors by, possibly, putting money in their pockets in the form of tax savings. Investors can swap out of existing positions and into comparable strategies, thereby realizing tax losses while remaining fully invested. Those losses can then be used to offset realized gains elsewhere in the portfolio.

After a 30-day holding period to satisfy the wash-sale rules, investors can then swap back to the original position if they so choose. Please note, however, that there are tax rules regarding which losses need to be matched to which gains, and investors should seek appropriate tax advice before initiating these transactions.

This exercise might be especially useful for investors considering a swap out of active managers, for two reasons:

  1. For many investors, the default tax loss swap might be to a market cap-weighted beta ETF. But by deploying a WisdomTree strategy instead, the investor can maintain a more similar factor tilt to the active manager and, therefore, potentially a more consistent portfolio performance.
  2. Swapping out of a mutual fund and into an ETF strategy with similar active tilts makes sense from a structural perspective. With ETFs, investors get a more transparent, tax-effective and potentially much lower cost investment vehicle compared to mutual funds.

Many investors have refrained from making the advantageous structural move to ETFs because of unrealized embedded capital gains in historical mutual fund positions. But if the recent market declines have altered that situation, investors should seriously consider “making lemonade out of lemons” by harvesting tax losses and migrating to a new investment vehicle (the ETF) while still maintaining their active management factor tilts.

We think this idea is one excellent way to “lean into” these disruptive markets and add tangible and proactive value to investor portfolios.

Important Risks Related to this Article

Neither WisdomTree Investments, Inc., nor its affiliates, nor Foreside Fund Services, LLC, or its affiliates provide tax advice. All references to tax matters or information provided on this site are for illustrative purposes only and should not be considered tax advice and cannot be used for the purpose of avoiding tax penalties. Investors seeking tax advice should consult an independent tax advisor.

Investing involves risk, including possible loss of principal.

Investors should carefully consider the investment objectives, risks, charges and expenses of the Funds before investing. U.S. investors only: To obtain a prospectus containing this and other important information, please call 866.909.9473 or go to Read the prospectus carefully before you invest.

WisdomTree Funds are distributed by Foreside Fund Services, LLC, in the U.S. only.

For more investing insights, check out our Economic & Market Outlook


About the Contributor
Chief Investment Officer, Model Portfolios
Scott Welch is the Chief Investment Officer of Model Portfolios at WisdomTree, a provider of factor-based ETFs, differentiated model portfolios, and digital asset solutions. In his role as CIO, he oversees the construction and ongoing management of the WisdomTree model portfolio solution set. He chairs the WisdomTree Model Portfolio Investment Committee and is an active member of the WisdomTree Asset Allocation team. Prior to joining WisdomTree, Scott was the Chief Investment Officer of Dynasty Financial Partners, a provider of outsourced investment research, portfolio management, technology, and practice management solutions to RIAs and advisory teams making the move to independence. Prior to Dynasty, Scott was a Co-Founder and the Chief Investment Officer of Fortigent, LLC, a provider of outsourced investment research, technology, and practice management solutions to RIAs and banks that targeted high net worth investors. Scott holds the Certified Investment Management Analyst (CIMA®) designation, and he sits on the Board of Directors of the Investments & Wealth Institute (IWI, formerly known as IMCA) and is an outside member of several RIA Investment Committees. Scott earned a Bachelor of Science in Mathematics from the University of California at Irvine and an MBA with a concentration in Finance from the University of Massachusetts at Amherst.