"Trumping the Superficial Loss Rule is like eating your cake and keeping it"
Portfolio Diagnostics is more than a powerful portfolio building tool. It's a tax management tool. By using it to identify similar funds, you can trump the "superficial tax rule", thus selling your investment and keeping it at the same time. Who said there is no such thing as a free lunch?
The bear market has produced once-in-a-decade tax opportunities. If you have some funds that have lost money since the date of purchase, you can crystallize your loss by selling those funds before year end. By doing that, you can realize a capital loss that you can offset against your capital gains of the same year, or if you have none, against past years'. This can reduce your tax bill or even get you a small tax refund. However, should you get rid of a good investment for the sake of earning a small tax break?
Absolutely not. As we all know, we cannot even sell a fund today and buy it back tomorrow. The taxman is well aware of this trick and has a ready rule to stop it: "the superficial loss rule". That rule stipulates that, if you sell an investment and buy it back within a month, any realized capital loss on your investment sale is deemed to be a "superficial loss" and is simply denied.
One way to work around the superficial loss rule is to sell your fund and buy a very similar one that invests in the same assets. This is very easy to do with index funds. If you have an Altamira or CIBC Canadian equity index fund, you can replace it with a Scotia or Royal Bank Canadian equity index fund. Because you are dealing with two different securities, the superficial loss rule does not apply Yet, for all intents and purposes, you are dealing with two funds that have nearly identical portfolios. Watch out for the trading costs, though, i.e. make sure the cost of replacing your fund with another does not outweigh the tax advantage.
But what if you have only actively managed funds? Here is where Portfolio Diagnostics comes into play. There is no such thing as the best fund in any category. In every category, there is a handful of good funds. Most of the good funds have two or three similar funds, either within the same family or in other families. They may not be totally identical, but they may be very similar. Using the Similarity Analysis tool, you can check your fund against as many as 30 other funds within the same category. Do that and find out which funds have the highest coefficient of correlation with yours. Then, look at the holdings and see which funds have similar holdings. You may be surprized by the degree of similarity. By selling your fund and buying a similar one, you can realize your tax loss without foregoing a good investment.