Equities have felt the effects of inflation this year, with the major equity indexes dropping for much of 2022 and even entering into bear market territory. It provides advisors and investors with the possibility of tax loss harvesting mid-year and moving to an alternative fund type that might be better suited to mitigate some volatility within equities while providing income opportunities.
The two main reports that the Federal Reserve relies upon to determine its monetary policy came in higher than expected for August, with August’s broad CPI climbing 0.1% month-over-month and a stronger-than-expected jobs report reflecting a slowing but underlying strength within the jobs market. Fed tightening is likely to remain aggressive in the latter half of 2022 unless clear and consistent indicators of inflation reduction and a slowing job market are present
As long as inflation persists at high levels, it can continue to erode the buying power of consumers, impacting a broad range of equities and having far-reaching effects across supply chains and more as higher costs eat into margins.
The Dow Jones Industrial Average, an index that tracks 30 blue-chip companies, is down 15.72% year-to-date as of September 16, while the broader S&P 500, which tracks the 500 top U.S.-listed companies, is down 19.72% over the same period. There is a tax loss harvesting potential in capturing losses in the S&P 500 and shifting to blue-chip companies that typically perform more reliably over long time horizons, including in market downturns, or also moving from a general investment in the Dow Jones Industrial to a risk-managed investment within the same index.
Losses within equities this year could be captured via tax loss harvesting, a practice whereby the investment is sold off at a loss, and those losses can then be applied to taxes owed on investments making a profit. In other words, capital losses can offset capital gains, though tax loss harvesting is a tax deferral, not a cancellation.
Advisors and investors selling an investment for tax loss harvesting purposes but still wishing to maintain their exposure need to be aware of the wash-sale rule, which prevents repurchasing of the identical security or investment sold for 60 days around the sale (30 days before and 30 days after), or else the capital loss will not be applicable towards offsetting capital gains. The way around this is to purchase a like fund that still provides the desired exposure but is different enough to avoid triggering the wash-sale rule.
In the case of the Dow Jones Industrial Average, if an investor had an allocation to a broad-based ETF that covered the Dow Jones and they wished to capture those capital losses to offset any gains they might have this year, they could sell the broad-based ETF at a loss and move into a fund that offered potentially better volatility mitigation within the Dow Jones for the current market of uncertainty while also providing monthly income opportunities.
Various ETFs are available that work to mitigate volatility within equities or seek high current income, but few funds combine the two using a collar strategy. A collar strategy entails holding shares of an underlying security while simultaneously buying protective put options and writing calls for the same security and seeks to reduce volatility, generate income, and provide a measure of downside protection.
A put option gives its owner the right, but not the obligation, to sell the underlying asset at a specific price on a specific day. In contrast, a call option gives its owner the right but not the obligation to buy the asset instead.
Nationwide offers a variety of actively managed ETFs that utilize a collar strategy within equities, including the Nationwide Dow Jones® Risk-Managed Income ETF (NDJI), an ETF that invests in a portfolio of securities included in the Dow Jones Industrial Average, and a fund that could be used to tax loss harvest into this year.
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