Now is a good time to sell your long-term Treasurys.
That’s not because interest rates might be heading back up and thereby producing losses for these bonds, though of course that’s entirely possible.
The reason to instead consider selling your long-term Treasurys is to harvest a tax loss that you can use to offset any capital gains on which you would otherwise have to pay tax next April.
This strategy only works in a taxable account, of course. But if you own Treasurys in a taxable account, you could very well be leaving money on the table if you don’t follow this strategy between now and the end of the year.
To illustrate, imagine that in August 2019 you invested $100,000 in the SPDR Long-Term Treasury ETF
(I picked that month because that was when long-term Treasurys hit their peak.) If you sold your SPTL position today you’d net about $64,000, which translates to a long-term capital loss of around $36,000. If your marginal tax rate is 30%, and you also have at least that many capital gains to offset, then you can reduce your tax bill by as much as $11,000 by selling your SPTL position.
What if you want to maintain your exposure to long-term Treasurys and therefore don’t want to sell? That in theory could be a problem, since the IRS’s wash sale rule prevents you from using a loss to offset a capital gain if you repurchase within 30 days of selling. But that doesn’t have to be a big problem in practice, since there are other long-term Treasury ETFs besides SPTL.
You must exercise some care in picking a substitute long-term Treasury ETF to hold during this 30-day-wash-sale period, however. That’s because the IRS says that your substitute cannot be “substantially identical” to what you sold, and it’s not always clear what satisfies that criterion. For example, you most likely would violate the wash sale rule if your substitute for SPTL were the Vanguard Long-Term Treasury Index ETF
since both ETFs are benchmarked to the same index—the Bloomberg U.S. Long Treasury Bond Index.
There are other long-term U.S. Treasury ETFs that are not benchmarked to this specific index, however, and they are more likely to pass muster. I’m not a tax attorney, and by no means should you consider this column to be tax advice. But an ETF that most likely would not violate the wash sale rule is the iShares 20+ Year Treasury Bond ETF
which is benchmarked to a different index—the IDC US Treasury 20+ Year Index. Not surprisingly, the TLT’s performance hasn’t been identical to SPTL’s, which is a virtue when it comes to satisfying the IRS’ wash sale rule. But the TLT’s performance nevertheless has been close.
Since the August 2019 peak of the long-term Treasury market, for example, the SPTL ETF has produced a 10.1% annualized loss while VGLT’s loss has been 10.9% annualized. The correlation coefficient between their monthly returns over the last 10 years is a very high 99.8%.
Searching for correlations
This discussion illustrates what you should be looking for when wanting to harvest a tax loss while also maintaining your portfolio exposure: You want to find a substitute asset that is similar but not identical.
ETFs is one arena in which you are likely to find a substitute that satisfies these competing imperatives. One helpful tool in this regard is the Correlation Tracker maintained by the SPDR group of ETFs, which allows you to find the Select Sector SPDR ETF that is most highly correlated with any given stock.
To illustrate, consider Bank of America
which is down nearly 20% over the last 12 months. Based on returns over the last year there’s a 90.1% correlation coefficient between it and the Financial Select Sector SPDR
Assuming the future is like the past, therefore, you could harvest tax losses while giving up little upside potential by selling BAC and buying XLF with the proceeds—and then reversing the transaction after the 30-day wash sale rule has expired.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at email@example.com.