Tax-loss harvesting helps investors limit taxes they would pay on capital gains. The strategy works by selling a security currently losing money. While this may seem counterintuitive, it serves a purpose. By selling or “harvesting” this loss, investors can claim the loss to offset taxes they would pay on capital gains. The security sold is ideally replaced by a similar one, keeping the portfolio at its optimal allocation level.
Example: You made $1000 in capital gains this year and are facing paying tax on the full amount. Now, say you own an ETF and are down $500 on your investment. If you sell the ETF for the $500 loss, you can claim this loss on your taxes and only have $500 in capital gains taxed (instead of $1000). You would then take the remaining money and invest it in a similar ETF, one that will keep your portfolio allocated properly.