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Written by: Jack Manley
A week into the fourth quarter, many investors are looking ahead to the end of 2025 and bracing for this year’s annual capital gains distributions. Estimates will be announced starting this month, and by mid-December, most gains will have been paid out. Capital gains season is generally dreaded: investors, even those who did not sell any assets, see their tax bills increase, eroding portfolio performance.
However, by being tax-conscious in asset allocation and portfolio construction, investors can minimize a portfolio’s tax burden and maximize after-tax outcomes. This can be accomplished in two main ways:
- Tax alpha harvesting: In periods of market stress, investors can capitalize on negative performance by realizing a loss in a position, deducting that loss from the year’s tax bill and reinvesting the proceeds into a security or basket of securities with similar characteristics. Market volatility can be transformed into tax savings without deviating from long-term allocation goals or moving into cash.
Recent market performance has warranted a closer look at this strategy. Despite closing up 23% in 2024, 133 companies within the S&P 500 ended the year down 5% or more, with 356 companies experiencing a 5% pullback at some point. So far in 2025, 407 names have sold off by 5% or more through September 30. With volatility likely to persist due to policy uncertainty and structural factors like increased market efficiency and greater investor access to data, tax alpha harvesting should remain a fruitful strategy.
- Investing in more efficient vehicles: Depending on the investment vehicle (ETFs or mutual funds), annual capital gains distributions can vary significantly. ETFs typically pay out much lower capital gains than mutual funds. In 2024, for example, active mutual funds paid out capital gains roughly 4.5 times the amount of their ETF counterparts, while passive mutual funds paid out at a ratio of 3:1.
This is because ETFs use an in-kind redemption mechanism that allows them to deliver underlying shares to investors who wish to redeem, avoiding the need to sell securities and trigger capital gains for the entire fund. In contrast, mutual funds must sell assets to meet redemptions, creating taxable events shared by all investors, making them structurally less tax-efficient. For investors focused on after-tax outcomes, this built-in advantage gives ETFs, particularly active ones, a compelling edge. It has also helped drive growth in active ETFs that is three times that of the broader ETF market.
As the fourth quarter unfolds, investors face both the uncertainty of markets and the certainty of taxes. With headline gains again driven by a handful of names, the potential for profit-taking and rebalancing increases, raising the risk of redemption-driven tax consequences. For this reason, tax-aware investing, be it through a "tax alpha harvesting" strategy or an ETF investment vehicle, matters now more than ever.
Number of S&P 500 stocks with a drawdown of 5% or more
Despite positive index returns in 22 of 30 years, roughly 75% of stocks experienced a drawdown of 5% or more in any given year
Source: FactSet, Standard & Poor’s, J.P. Morgan Asset Management.
A 5% drawdown is calculated from each stock’s start-of-year price. If a stock declines by 5% or more at any point during the year, it is counted exactly once – even if it later recovers and declines by 5% again. Data for 2025 are year-to-date as of the latest completed month.
Guide to the Markets – U.S. Data are as of October 7, 2025.
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