I Brofited from the Brexit. Here's How.

Doing nothing in a market downturn is sage advice. Taking advantage and profiting is even better.

The sky wasn’t falling. The end wasn’t near. But you wouldn’t know it if you had access to a computer, television, or radio recently.

The overreaction wasn’t limited to major new outlets, although they were all over it. Even a couple of my favorite financial companies got in on the act. When I logged in a full week after the vote to Brexit, both Personal Capital and Vanguard had Brexit pop-ups (Brop-ups?).

We in the blogosphere gave our perspectives, which tended to be more sensible. Recommendations to ignore the news, stay the course, and

were standard issue.

don’t believe the hype

The first two trading days after the United Kingdom voted to pursue negotiating an exit from the European Union were not pretty. Equity prices sunk worldwide, on the order of about 5% to 10% depending on the market.

When a small drop like this occurs--and they occur quite often (this is the third time in about nine months we’ve had such a drop)--you have options. You can:

Freak out and sell before the bottom drops out completely. Please don’t.

Don’t just do something. Stand there!

• Take advantage of what will hopefully be a short-lived drop before the rebound.

Option number two isn’t bad advice, but I went with the third option.

Tax Loss Harvesting and Rebalancing

My taxable account holds two asset classes, US stocks and International stocks. I will typically hold from two to four funds. At the time of the Brexit vote, I held three funds, VFIAX (S&P 500), VTSAX (Total US Stock Market), and VFWAX (International Stock).

I had some recent lots of VFWAX purchased June 17th that had capital losses of about $740 and another $220 loss from shares purchases on St. Patrick’s Day. Bad luck of the Irish?

I also held shares of VTSAX purchased mid-March through early May that had losses of about $2,200. The percentage drops weren’t huge, but it added up to over $3,000 in potential losses. Time to harvest those losers!

Here is the peri-Brexit performance of the two funds that presented tax loss harvesting opportunities.

After two trading days, the international fund was down 9.1% and the US fund was down 5.6%. Before the closing bell on Tuesday, June 27th, I exchanged from VFWAX to VTMGX (Developed International Markets). These are not substantially indentical; in fact, the fund I traded into does not hold emerging markets, which the old fund did. This move actually brought my portfolio better in line with my desired allocation of equal developed and emerging market holdings within the international stock category.

In the same session, I exchanged from VTSAX into both VFIAX and VTMGX. Since the international stocks had taken a larger hit with the Brexit vote, redistributing a bit from US to International stocks also brought my current allocation a bit closer to my desired allocation. With the click of a button, I had accomplished both tax loss harvesting, and rebalancing.

To avoid a wash sale, which could cancel at least a portion of your losses, you must not purchase replacement funds of the same or substantially identical fund within 30 days before and after you sell at a loss. This does not mean you can’t sell a lot purchased within the last 30 days, but if you do, be sure to sell all lots purchased within the last 30 days, and don’t buy again for another 30 days.

Benefit of Tax Loss Harvesting

So how exactly did I “

t”?

Brofi

Each year, the IRS allows you to deduct up to $3,000 in capital losses from your gross income. With a marginal state and federal income tax of about 45%, a $3,000 deduction this year will save me over $1,300 on my tax bills.

Additional losses can be carried over to future years, and can be applied against capital gains. Do I have additional capital losses harvested? You’d better believe it.

In January, I harvested over $40,000 in losses. In 2015, I harvested nearly $30,000, about $10,000 of which was used to offset gains I took when I sold the last of my T. Rowe Price actively managed funds to go all-in with lower cost Vanguard Index funds.

With around $60,000 in losses left to carry over, I’ll be able to take a $3,000 deduction every year for the next twenty years. I can also access money invested in funds with significant gains without taking a tax hit, if the need were to arise in an emergency.

Since I’ve set my cost basis lower, it could be argued that I’ll end up paying more in capital gains tax later. I can present several counter arguments:

• I’d rather pay a tax later than pay a tax now.

• I’m avoiding high income tax to potentially pay the lower capital gains tax.

• It’s quite possible to pay zero capital gains tax in early retirement.

• Cost basis is reset when donated or passed along to heirs.

The heirs apparent.

I’m no market timer, but I’m always timing the market.

Tax loss harvesting requires making a decision to sell. Buying into a similar fund prevents you from missing out on rebound gains (or realizing further losses). Ideally, you will sell at a trough, but those are only evident in hindsight. Nothing prevents you from selling again a few days or weeks after exchanging into a fund, but you will have to find a third not-substantially-identical fund in which to exchange.

When choosing a partner fund, it’s best to choose a fund you would be willing to own forever. If more than 30 days have passed, you can exchange back into the original fund. I would only do so if the recently acquired fund had further losses (or perhaps very minimal gains).

I got lucky on this round, as the funds I sold had gained back most of their two-day losses in a three-day rebound. It remains to be seen if the rally will last.

I’ll be ignoring the noise, but tracking my balances.

This screen capture, showing the fluctuation within my taxable account over the last 30 days looks pretty flat. If I had done nothing with the Brexit, I would have been just fine. By doing something, I did better than fine.

How did you Brofit from the Brexit?