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Lately, with the year 2020, having had a lot of ups and downs and wiggles in it in categories doing better in categories doing worse. I've had a lot of people asking me about tax loss, harvesting, what is it? Is it right for them now? Right. For them, it's always about them and different than the thing itself.
But tax loss harvesting is when you're a taxable entity, as opposed to a tax-free or a text for an entity, like a pension plan or something, or a 401k I'm looking at unrealized losses that you have and selling them. So you've got that as a capital loss, which you can use to offset against capital gains in the past or in the future to reduce your tax bill while replacing them with something that effectively has been down as much and acts the same.
So that if let's say you bought stock X, you bought it at a hundred, it felt a 60, you got a 40% loss. Uh, it's a fair amount of money to you. And you could sell that now lock in that capital loss, which you could use to offset other gains you might have in the past this year, or we'll forward into future years called a tax loss carry forward.
But to do that, if you still liked that stock, when it was down at 60 and thought it would go back up, you better buy a stock that replaces it, which would act exactly as well as it. That's not always so easy to do. Sometimes you can do it. Sometimes you can't. There's a traditional notion in all kinds of things that you can use correlation, coefficients to measure how closely two things move together.
And what you want. If you're selling this stock is to have another stock, probably have a very similar category like to chemical stocks or to technology stocks that correlate very highly. But beyond that correlation, doesn't tell you causality correlation, just tell you what's happened in the past. And so you want to actually understand why they wiggle together and that they then therefore will wiggle together in the future.
So this other one, the one you would buy after you'd sold stock X, maybe we call it stock. Y will behave like stock X would have. So you get the upside that you expected. Otherwise, if you were to sell it, you just sell it and be gone. So the real concept is to look at the stocks that are down a fair amount when you're in a taxable entity, like a normal person, and figure out if you can sell them to lock in the loss and replace them with a stock that acts similarly, the problem that you have is that pretty often, everyone else is playing the same game at the same time, particularly right around year end, which is what we're coming up on.
And right around December 31st or the last couple of weeks of December, people say, Oh my gosh, I ought to be doing this now. And as they do this now at the end of the year, they often pound those stocks down that were already down even more because they're all trying to get out at the same time. And to do that, you have to buy another stock.
Similarly down often people don't do that because those stocks scare them because they've been down so much. And if you don't do that correctly, you're likely to get whipsawed by having the stock that you buy do worse than the stock that you sold. The other thing that people often do wrong is they sell the stock and then they wait to buy it back later.
And often, particularly if they do it at year end, they find it. The stock is bounced back. Once you get past the end of the taxable reporting season at the end of the year and in January, before they can buy it back, 30 days later has gone through the roof and their net behind as a general rule in my thinking, you want to take your tax loss harvesting to the extent that you do it before you ever get to December and optimally, maybe you do it in September or October before anybody's thinking about tax loss harvesting.
So you don't get all the noise of having to do this against the backdrop of everyone else doing it at the same time. So real answer is, is this right for you? Depends on what your circumstances are, which is what you can say about so many other things in investing, . Your videos.
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