Tax loss harvesting in a practice that indirectly increases your investment returns by reducing taxation on your investment income.
How does tax loss harvesting work?
The way it works is that you sell a security that has experienced a loss. By realizing, or “harvesting” this loss, you are able to offset taxes on both gains and income. You then replace the sold security with a similar security, maintaining optimal asset allocation and expected returns.
Tax loss harvesting is offered by several online wealth management companies, such as Betterment in the US, who will prove this service for you in a fully automated fashion.
Alternatively, you could conduct it yourself if you are managing your own investment portfolio.
While transaction costs have to be taken into consideration, it is a clever way to add that little extra to your investment returns by reducing the impact of taxation. it is particularly effective if you are in a high tax bracket.