The time value of money means that a dollar available today is generally worth more than a dollar received later because today’s dollar can be invested and grow. The advantage is not guaranteed when invested in risky assets; it is closest to a free lunch when funds earn a effectively riskless return, such as in an FDIC-insured savings account or appropriately matched government bonds. section 14.1.1
Tax-loss harvesting applies the same logic to taxes: a dollar of tax paid tomorrow is preferable to a dollar paid today, because the retained cash can remain invested until the liability comes due. The eventual benefit depends on tax rates, investment returns, trading costs, opportunity costs, and rules such as the wash-sale rule. section 14.1.1 section 14.5
Deferring a $1,000 tax bill
Suppose an investor owes $1,000 in tax and has $1,000 in cash ready to pay it. Selling an ETF bought for $100,000 that is now worth $95,000 realizes a $5,000 loss; at a 20% tax rate, that loss produces a $1,000 tax benefit. The investor can defer the payment and keep the $1,000 invested, while using the $95,000 sale proceeds to buy a similar ETF and preserve broadly similar portfolio exposure. section 14.1.1
Applying the principle requires comparing benefits with limitations:
- Prefer delayed taxes when retained cash can earn a return before the liability is due. section 14.1.1
- Account for future tax liabilities and differences between short-term and long-term capital-gains rates. section 14.5
- Proceed only when expected tax benefits exceed trading and opportunity costs; estimate value through backtesting. section 14.5
