Tax loss harvesting is selling a security that has experienced a loss—and then buying a similar asset to replace it. The switch does two things: it allows the investor to realize, or “harvest”, a valuable loss while keeping the portfolio balanced at the desired allocation.

Capital losses can lower your tax bill by offsetting other gains or ordinary income up to certain levels.  But the only way to realize a loss is to sell the asset that has experienced a loss. However, in a well-allocated portfolio, each asset plays an essential role in providing a piece of total market exposure. For that reason, an investor should not want to give up the expected returns associated with each asset just to realize a loss.