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How tax-loss harvesting and direct indexing turned market volatility into tax savings in 2025

Markets are unpredictable—but your tax strategy doesn’t have to be. highlights two increasingly popular wealth management strategies, and , which have proven particularly effective in capturing tax benefits during volatile market conditions.

Why 2025 Was Exceptional for Tax-Loss Harvesting

The year’s heightened market volatility—with several S&P 500 sectors experiencing swings exceeding 20%—created significantly more opportunities than typical market years.

Industry research indicates that tax-loss harvesting through direct indexing in 2025 was more than double the long-term average for index portfolios, with annual loss capture rates ranging from 5% to 20% of portfolio value for diversified strategies. For a $2 million portfolio, this could translate to harvested tax losses ranging from $100,000 to $400,000, depending on the harvesting approach used.

What is Tax Loss Harvesting?

is the practice of selling securities at a loss to offset capital gains and reduce tax liability, while maintaining market exposure to potential gains. While the concept is straightforward, its execution—particularly when automated—can deliver substantial benefits.

How Automated Tax-Loss Harvesting Works

Modern automated tax-loss harvesting platforms operate continuously.

1. Continuous Portfolio Monitoring 
Systems track all portfolio positions in real time, identifying securities trading below their purchase price.

2. Strategic Loss Harvesting 
When favorable conditions arise, the system sells securities at a loss to realize tax deductions that can offset gains or ordinary income.

3. Immediate Reinvestment for Maintained Market Exposure 
Proceeds are reinvested in similar securities with nearly identical risk and return characteristics, maintaining market exposure.

4. IRS Wash Sale Rule Compliance 
Advanced algorithms ensure all trades comply with , which prohibit buying “substantially identical” securities within 30 days before or after a sale.

This automation allows for frequent, emotion-free harvesting based on preset rules, greatly increasing realized losses versus manual approaches.

Tax-Loss Harvesting Benefits: Multiple Layers of Tax Relief

Tax-loss harvesting provides .

Offsetting Capital Gains Tax
Harvested losses directly reduce taxable capital gains. If you realized $10,000 in capital gains but harvested $5,000 in losses, you’ll only owe taxes on $5,000 of gains.

Prioritizing High-Tax-Rate Gains
Short-term capital gains (on investments held less than a year) are taxed at ordinary income rates, which can be significantly higher than long-term capital gains rates. The IRS allows you to match short-term losses against short-term gains first, minimizing the amount taxed at these higher rates.

Reducing Ordinary Income Tax
If your losses exceed your capital gains, you can apply up to $3,000 of the excess against your ordinary income each year. For someone in the 37% tax bracket, this deduction alone could save approximately $1,110 in taxes.

Carrying Losses Forward
Unused losses can be carried forward indefinitely. If you harvested $10,000 in losses but only had $3,000 in gains this year, you could offset those gains: Deduct $3,000 from ordinary income, and carry the remaining $4,000 forward to future tax years.

Direct Indexing: Maximizing Tax-Loss Harvesting Opportunities

takes tax-loss harvesting to another level. Instead of owning an index fund like VOO (which tracks the S&P 500), investors own the individual securities that comprise the index.

Direct Indexing vs. Traditional Index Funds

Traditional Index Fund Approach 
A $2 million position in VOO only provides tax-loss harvesting opportunities during significant market downturns. In 2025, the S&P 500 declined by approximately 5.75% in March, which meant a maximum potential harvest of about $115,000—and only if shares were sold at the market trough before recovery.

Direct Indexing Approach 
By owning individual stocks that make up an index, investors can harvest losses at the security level throughout the year—even when the index as a whole rebounds. According to industry analysis, this approach could have captured $100,000 to $400,000 in harvested losses for a $2 million portfolio in 2025, depending on the aggressiveness of the harvesting strategy.

Direct Indexing Adoption Is Growing

A 2022 Cerulli Associates projected that direct indexing would expand at an annual rate exceeding 12% through the next five years, with assets anticipated to exceed $800 billion by 2026.

The appeal extends beyond tax benefits. Direct indexing allows for customization options, including ESG preferences, sector tilts, and risk controls—all while maintaining the ability to harvest losses continuously at the individual stock level.

Tax Alpha: Quantifying the Advantage

Industry studies measure the additional after-tax return from strategic loss harvesting as . According to institutional research, direct indexing’s tax alpha ranges from 1% to 2% annually for many investors.

Systematic approaches and automation enable monthly or more frequent harvesting, significantly increasing cumulative loss capture compared to manual or quarterly approaches.

For a $2 million portfolio, 1.5% annual tax alpha could represent $30,000 in additional after-tax returns each year—value that would otherwise be lost to taxes.

Conclusion: Strategic Tax Planning for Volatile Markets

While investors can’t control market volatility, they can control their response to it. The combination of automated tax-loss harvesting and direct indexing has allowed wealth management firms to transform market downturns from purely negative events into opportunities for tax optimization. As 2025 demonstrated, systematic approaches to capturing tax losses—particularly through direct indexing—can generate meaningful tax savings that compound over time, especially during volatile market periods. For high-net-worth investors in taxable accounts, these strategies have become increasingly central to comprehensive wealth management.

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