Opinion: Selling stocks at a loss now is a smart tax move. Buying them back before January is even smarter.

You only have a few more days to take advantage of two different ways of tax loss selling.

I am referring to the sale of stocks that you hold at a loss in order to offset the capital gains that you have previously made so far this year, and on which you will otherwise have to pay tax next April.

The second opportunity for profit is due to the tendency of stocks sold in December to rebound in the new year. So you might want to get back into the stocks you sold by the end of the year.

Many are unaware of this rebounding trend and therefore miss the second half of this two-pronged year-end strategy. But it’s pretty steep, as you can see from the chart below, which reports the average monthly returns in December and January of the worst and best performing stocks in the past year. To put the rebound in losing stocks into context, consider that on an annualized basis, they produced the equivalent of a 55% gain in January.

There’s a catch: The IRS rejects your tax losses if, within 30 days, you redeem the stocks you sold. It’s because of this so-called wash-sell rule that you don’t have much time this year to sell the stocks you hold at a loss and buy them back by the end of December. If you instead wait until mid-December or late December to reap your tax losses, you may be missing out on most of the potential rebound in your stocks in January.

What if you don’t want to spend the shares in December that you would otherwise consider selling for tax loss purposes? The only solution I know of is to find other titles that are strongly correlated with them, and substitute these new ones during the 30 days of wash-sale. As long as your surrogates perform as well as your original holdings, you won’t miss out on any gains while still being able to reap tax losses.

To illustrate, consider Exxon Mobil XOM,
+ 0.56%,
who was one of the biggest losers of 2020 and therefore in the crosshairs of investors looking for losses to reap for tax purposes. A good substitute would have been the Energy Select Sector SPDR XLE,
+ 0.58%,
since, as the graph below shows, the two titles are highly correlated. To quantify their close correlation, consider that the correlation coefficient of their weekly changes over the past five years is 0.93 – quite close to the coefficient of 1.0 which would indicate a perfect correlation.

You won’t always be able to find a stock as strongly correlated as Energy Select Sector SPDR is at Exxon Mobil, but your goal should be to find one with a correlation coefficient of 0.7 or higher. From a statistical standpoint, that means you find a security whose gyrations can explain or predict at least half of your candidate’s moves at a loss.

Several online tools locate alternate titles that are highly correlated with your tax loss sellers. For the visual spirits of you, navigate to the “Advanced Chart” tab which is provided on the MarketWatch website for any stock. By entering another ticker in the “Compare” box, you can see a price chart of the two stocks and their degree of correlation.

Most statisticians among you can use tools such as the “Correlation trackingAvailable on the Select Sector SPDR website and “Assets Correlation” tool on the Portfolio Visualizer website.

But go ahead. You don’t have a moment to waste.

Mark Hulbert is a regular contributor to MarketWatch. Its Hulbert Ratings tracks investment newsletters that pay a fixed fee to be audited. He can be contacted at [email protected]

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