Several factors can shape the tax loss harvesting opportunity in a direct indexing account. The five below are especially important when setting expectations with investors.
1. How the account was funded
The starting point matters. Investors who fund a direct indexing account with cash start with a fresh cost basis across the portfolio, creating maximum flexibility for future harvesting opportunities. As positions decline from their cost basis, losses can be harvested and replacement stocks can be purchased with the proceeds.
Accounts funded with appreciated securities have less flexibility to harvest losses unless there is a drawdown or capital gains budget.
For example, if 25% of a portfolio is funded with a low-basis concentrated stock and 75% with cash, one-quarter of the portfolio may be locked up and unavailable for loss harvesting. Losses from stocks purchased with the cash can be used to offset the concentrated position and bring the portfolio closer to the index.
2. The cost basis of existing holdings
Cost basis is one of the main drivers of harvesting opportunities. Tax lots with a higher cost basis have more room to generate losses if prices decline. For short-term holdings, which are held for one year or less, positions are typically harvested when the unrealized loss exceeds 4%.
Tax lots with a low cost basis, or substantial embedded gains, may offer limited harvesting potential unless a company-specific event causes a sharp sell-off. Over time, the opportunity set naturally shrinks as equity markets generally rise and fewer positions trade below their cost basis. Tax loss harvesting also reduces the portfolio’s overall cost basis as proceeds are reinvested.
As portfolios mature, losses become harder to find. Adding new cash can refresh the cost basis and extend the harvesting opportunity set.
3. When the account was opened
Harvesting opportunities are often influenced by when an account is opened and invested. Market conditions during the first few quarters of a new account can have a meaningful impact on the availability of losses.
Accounts opened shortly before the tariff-driven volatility of 2025 experienced significant harvesting opportunities as the S&P 500® drew down 18.9%. By year-end, the S&P 500® returned 17.9%, showing why year-round tax loss harvesting can matter when volatility pops up.
A portfolio established during a steadily rising market may have fewer immediate opportunities. This timing effect is largely outside the investor’s control, but it underscores why loss harvesting potential can vary by account.
4. Amount of market volatility
Volatility is the engine that powers tax loss harvesting in direct indexing portfolios. Periods of market stress, sector rotations, and company-specific price declines can create opportunities to realize losses while maintaining market exposure.
Losses don’t require a broad market downturn. Even in positive years, many individual stocks decline and create harvesting opportunities. Figure 1 shows that even in strong calendar years (positive green dot), a significant percentage of S&P 500® stocks still lost money (blue bars).
In 2025, for example, the S&P 500® returned 17.9%, but 36% of index constituents, or 180 stocks, were down for the year. A portfolio can show positive returns overall while still generating losses for tax purposes.
Extended periods of low volatility and strong market performance may reduce available losses, particularly in mature portfolios that have already harvested significant losses. These portfolios can become “ossified,” meaning fewer positions remain below cost basis and new harvesting opportunities become harder to find.
