If someone is pitching you a long/short strategy primarily as a way to generate tax losses, stop and ask a different question first: do you actually believe this manager can pick stocks?
That question matters more than any tax benefit they’re about to describe. And it’s the one that most of the marketing materials gloss over.
Below is a straightforward look at how these strategies work, who they’re actually a fit for, and what can go wrong if you skip that first question. If you’re currently in one of these strategies, or being pitched one, and want a second opinion, email me directly at [email protected] with the details and I’ll tell you plainly whether it looks like a fit for you. As a fee only fiduciary, I don’t sell any products or strategies. I only work for you, not for a fund manager or a custodian, and I work with investors across Colorado and nationally.
One more reason to act on this now rather than later: Schwab just raised the minimum for its standard long/short SMAs to $10 million, up from $1 million, effective September 16, 2026, and it’s no longer accepting new enrollments or fresh capital into its higher-leverage portfolio margin accounts at all. That’s the third time this year Schwab has tightened access to this strategy. If you’re below that new threshold, or your current provider is scrambling to figure out where you land under the new rules, that’s worth a conversation.
My Quick Take
Personally, I’d look at a customized tax-managed portfolio available to firms like mine before jumping into a tax-aware long-short strategy.
With a large appreciated position, you can build a portfolio around the stock you already own while gradually reducing it and systematically harvesting losses elsewhere. The strategy can be customized around how much of the position you want to transition, how much tax loss you want to target each year, individual security restrictions, and other portfolio preferences. You can also model different transition scenarios beforehand to see the expected tracking error and tax consequences.
Tax-aware long-short strategies can generate significant tax losses, but they’re considerably more complicated. You’re combining long positions, short positions, tax-loss harvesting, active trading and the need to generate enough alpha to overcome fees, shorting costs and other friction. That can look great in a bull market, but the investment strategy still has to deliver.
Then there’s the question of getting out. Over time, you can build substantial deferred gains, while short positions don’t receive the same step-up-in-basis treatment that long positions generally can at death.
I’ve also seen firsthand why I’m cautious about this approach: years ago, a market-neutral tax-loss strategy from a major quantitative manager was marketed around its ability to generate substantial tax losses and positive returns in different market environments, yet it experienced a significant loss in its first year while the broader market was up.
I usually tell clients: don’t let the tax tail wag the investment dog.
Tax savings are valuable, but they shouldn’t be the reason you own an investment strategy that otherwise doesn’t make sense.
What Is a Tax-Aware Long/Short Strategy?
The mechanics are simpler than the name suggests.
In a traditional portfolio, you invest your capital into a diversified set of long positions, meaning stocks you expect to rise. A long/short extension strategy does something different.
Take a 130/30 portfolio as an example. The manager invests your $100 of capital into stocks they believe will outperform. Then they borrow an additional $30 using margin and put that into more long positions. At the same time, they sell $30 worth of stocks short, meaning they borrow shares and sell them, betting those companies will underperform.
The result: $130 in long positions and $30 in short positions, with roughly $100 of net market exposure. The long and short positions largely offset each other, so your overall equity exposure stays close to a traditional portfolio’s level. You’re not making a leveraged bet on the market going up. You’re making a bet that the manager can identify winners and losers better than the market can.
A 200/100 portfolio uses the same structure on a larger scale: $200 in long positions, $100 in short positions, still roughly 100% net equity exposure.
These are sometimes called extension strategies or long/short SMAs (separately managed accounts). They’re typically implemented in a taxable brokerage account, not a hedge fund structure.
This Is Active Stock Picking. Full Stop.
Here’s where the conversation has to start: long/short strategies are, above all else, active investment management.
The manager is making two sets of decisions constantly. Which stocks to own and which stocks to short. That’s twice the surface area for getting it right or getting it spectacularly wrong. The tax component doesn’t change that calculus at all.
Think about what you’re actually agreeing to when you invest in one of these strategies:
You’re hiring a manager to identify stocks that will outperform. You’re also hiring that same manager to identify stocks that will underperform and short them using borrowed money. If they’re wrong on the longs, you underperform. If they’re wrong on the shorts, you can lose significantly more than you would in a plain index fund. And if they’re wrong on both at the same time, which has happened, the tax losses you harvested won’t save you.
The Schwab Center for Financial Research laid this out clearly in their February 2026 paper. In their example, a manager who generates pre-tax stock alpha of 1.6% combined with tax alpha of 5.8% can deliver after-tax alpha of 7.4%. But a manager who produces negative pre-tax alpha of -6.9% through bad stock picks on both the long and short sides still captures that same 5.8% in tax benefits. The after-tax alpha in that scenario? Negative 1.1%. The tax benefits didn’t save the investor. They just made a bad situation slightly less bad.
The lesson from Schwab’s own research: investors shouldn’t focus on tax alpha in isolation, but should also assess the manager’s underlying stock-selection capability.
That’s the crux. The tax planning benefits can be real and substantial. But they’re layered on top of the investment strategy, not underneath it.
If you don’t believe the manager is a skilled stock picker, you shouldn’t be in the strategy at all. The tax benefits aren’t worth sacrificing pre-tax returns.
What Can Go Wrong: The Risks You Need to Understand
Short Squeezes
This one deserves special attention because most investors underestimate it.
When a manager shorts a stock, they borrow shares and sell them, expecting the price to fall. If instead the price rises sharply, short sellers face mounting losses and often rush to buy shares back to cover their positions. That buying pressure pushes the price even higher, which forces more shorts to cover, which drives the price higher still. That spiral is a short squeeze.
Short squeezes can be fast and brutal. There’s theoretically no ceiling on how high a stock can go, which means there’s theoretically no limit on losses from a short position. During the 2021 GameStop episode, hedge funds with short positions reportedly lost more than $10 billion. Hertz surged over 56% in a single day in April 2025 after an unexpected investor disclosure triggered a squeeze in a heavily shorted stock.
A long/short manager doesn’t need to be shorting meme stocks to face this risk. Any crowded short position in a rising market, or a position where shares become scarce and borrowing costs spike, can create the same problem. The Schwab paper describes this scenario explicitly: when shorts rise significantly more than the index during a market rally (a junk rally or short squeeze), negative pre-tax alpha can completely offset whatever tax alpha the strategy was generating.
Leverage and Volatility Risk
More gross exposure means more sensitivity to market moves in both directions. A 200/100 strategy with 300% gross exposure isn’t just twice as volatile as a passive index fund. It’s leveraged in ways that can amplify drawdowns significantly in stressed markets.
During the 2008 financial crisis, 130/30 strategies fell an average of 43.1% during the bear market, compared to 40.9% for long-only funds. Many strategies that had been pitched as sophisticated closed because they failed to deliver on their promises. A subsequent study found the surviving long/short strategies also lagged the S&P 500 during the recovery. The leverage that amplifies your ability to generate tax losses also amplifies your exposure when markets move against you.
The Tax Deferral (Not Elimination) Reality
Something managers often underemphasize: tax losses harvested today don’t disappear. They lower your cost basis. If the strategy eventually gets unwound, or if positions rebound and are later sold at a gain, those gains become taxable in future years. You’ve deferred the tax bill, not eliminated it.
The Schwab paper is direct about this: tax costs on capital gains are deferred, not eliminated.
Additionally, gains from short positions are generally taxed as short-term capital gains regardless of how long the position was held. That’s a headwind in any year where the strategy generates net gains on short positions.
Manager Complexity and Operational Risk
Running a long/short book is operationally demanding. Sourcing shares to borrow isn’t always easy. Borrow availability can be limited, costs can spike, and positions can be forced closed at disadvantageous prices. As Brent Sullivan, who runs the Tax Alpha Insider blog, put it, sourcing shorts in practice is more fragmented and harder to manage than most people initially expect.
What the Schwab and Fidelity Restrictions Tell You (Updated September 2026)
This is a fast-moving development, and it matters for anyone considering one of these strategies right now.
In April 2026, Charles Schwab, which custodies the majority of RIA-managed assets, rolled out its first round of meaningful restrictions on long/short separately managed accounts. The new rules capped how much of an RIA’s total Schwab custody assets could go into long/short SMAs at 30%. Minimum account sizes were set at $1 million for standard Reg T margin accounts (typically used for 130/30 and 145/45 strategies) and $3 million for portfolio margin accounts used for higher-leverage structures like 200/100. Leverage was also capped at 200% of principal for long positions and 100% for short positions.
Then, in September 2026, Schwab tightened access again, its third such move this year. Effective September 16, 2026, the minimum for standard long/short SMAs jumped from $1 million to $10 million. At the same time, Schwab stopped accepting new enrollments or fresh capital into portfolio margin accounts entirely, closing off the higher-leverage versions of the strategy to anyone not already using one.
Fidelity moved even earlier. It stopped opening new long/short accounts in December 2025 and, as of May 2026, began charging higher fees to some existing long/short SMA holders.
What does this signal? Custodians are managing risk, and they’re doing it in stages. Schwab had $21.3 billion of its total $126.7 billion margin loan balance tied to RIA long/short strategies as of March 2026, a real concentration of leverage and operational complexity on their platform. Raising the bar to $10 million and pulling back from portfolio margin accounts altogether suggests that concentration hasn’t eased.
For investors, the takeaway is straightforward. Even the major custodians view these strategies as needing tighter guardrails than they did a year ago. They aren’t products that every investor with a taxable account should be running, and the list of investors who even qualify to try one is getting shorter.
Who This Strategy Is For and Who It Isn’t
Who it may fit well
These strategies tend to make the most sense for investors who:
- Have a large taxable gain they need to offset, whether from a concentrated stock position, a business sale, real estate, or a significant liquidity event
- Have substantial taxable assets. Schwab’s new minimum sets the eligibility floor at $10 million for standard long/short accounts, and portfolio margin versions of the strategy are no longer open to new investors at all. Even before this latest change, most advisors found the fees, complexity, and risks hard to justify below $5 million in taxable assets. That gap between the old practical minimum and the new formal one tells you something about where this strategy is heading
- Are already in the highest tax brackets and expect to remain there
- Genuinely believe in the specific manager’s ability to pick stocks and manage short exposure, not just the tax benefit narrative
- Are comfortable with active management, leverage, margin, and performance that may differ materially from a broad index
- Have a long enough time horizon to ride out drawdowns that can emerge from short squeezes or market dislocations
Research from the Journal of Asset Management (Goldberg, Cai, and Schneider, 2024) found that 130/30 portfolios generate roughly 2.7 times more capital losses than long-only portfolios over the first 10 years. For investors with a sufficient and ongoing supply of gains to offset, that can translate to pre-liquidation tax alpha of around 4.4% per year. But the same research found that if the investor lacks short-term capital gains to offset, or if the strategy is liquidated early, that tax advantage shrinks substantially.
Who it’s probably not right for
These strategies are less likely to be appropriate for investors whose primary goal is generating tax losses without genuine conviction in the manager’s stock-picking ability, people who prefer low-cost passive investing and aren’t comfortable with active management, investors with most of their wealth in tax-deferred accounts where the tax benefits have no application, anyone with a shorter time horizon who might need to exit during a drawdown, and investors who are sensitive to performance that looks very different from the S&P 500.
The Tax Benefits, Explained
When a manager’s short position loses money (meaning the stock they shorted went up), that realized loss can be used to offset capital gains elsewhere in your portfolio, whether from other securities, real estate sales, or business proceeds.
Long positions that are sold at a loss work the same way.
The advantage of the long/short structure is that it creates more opportunities to harvest losses than a traditional long-only portfolio, because both sides of the trade can generate them. In a rising market, your short positions tend to lose money. In a falling market, your long positions tend to lose money. That continuous loss-harvesting capacity is the genuine tax benefit.
But here’s the key thing to hold onto: those tax losses lower your cost basis in the portfolio. When you eventually exit the strategy, you’ll likely owe taxes on gains that reflect the accumulated basis reduction. The tax benefit is real, but it’s a deferral. In high-leverage strategies that get unwound suddenly, the tax bill at the end can be significant.
A Structural Tool, Not a Silver Bullet
Used correctly, long/short strategies can complement a broader planning approach for the right investor. They can help a tech executive with $5 million of concentrated RSUs diversify more quickly. They can help a business owner who just sold their company deploy capital efficiently while offsetting the sale gain. They can serve as a meaningful component of a multi-year tax management plan when coordinated with charitable giving, asset location, and estate planning.
But they work in that context because the underlying investment strategy is sound. The tax benefits amplify good outcomes. They don’t rescue poor ones.
The question to ask before committing isn’t “how many losses can this generate?” It’s: do you genuinely believe this manager can pick longs and shorts better than the market, over time, net of their fees, the cost of borrowing, and the operational complexity?
If the answer is yes, and the tax benefits align with your planning needs, this tool may be worth exploring.
If the answer is uncertain, or if the pitch is leading with tax benefits rather than investment merit, that’s your signal to slow down.
A Lower-Stress Alternative: Direct Indexing Through Dimensional SMAs
If you read the sections above and landed in the second group, without genuine conviction that a manager can out-pick the market on both the long and short side, that doesn’t mean you’re stuck choosing between a full tax bill today and staying concentrated. There’s another route worth understanding: direct indexing through a Dimensional separately managed account (SMA), available through approved advisors (Inclinevest is an approved advisor).
The mechanics are more straightforward, and for many investors, easier to hold onto through a volatile year. Instead of hiring a manager to bet on which specific stocks will rise and which will fall using borrowed shares, a Dimensional SMA has you directly own a broad basket of individual stocks. Dimensional’s strategies hold up to roughly 1,400 names, compared to the roughly 400 names many direct indexing competitors typically hold, according to the firm. That larger holding count creates more opportunities to harvest losses and more flexibility to manage short-term gains during rebalancing, all without requiring anyone to correctly predict which individual companies will underperform.
The account is monitored daily rather than weekly, monthly, or quarterly, and it can be customized around your specific concentration. That includes excluding your employer’s stock or sector so you’re not rebuilding the same concentration risk you’re trying to diversify away from, screening out holdings for values-based reasons, and choosing a tax management level that matches how tax-sensitive you actually are. Dimensional also excludes REITs from these strategies, since REIT dividends are largely taxed as ordinary income rather than at the lower qualified dividend rate.
On cost, the direct SMA management fee is 0.29%. Layered with an advisor’s own fee, the total all-in cost typically lands somewhere between 1.00% and 1.50%, including my fee as your advisor. That’s frequently less expensive than the combined cost of an actively managed long/short strategy once you account for its significantly higher management fees, financing costs on the short positions, and operational overhead.
On performance, this isn’t a strategy built around beating the market through stock selection the way a long/short overlay is. It’s a systematic approach to broad diversification with active tax management layered on top. Dimensional reports that its SMA accounts funded with cash outperformed their benchmarks by an average of about 3%, net of fees, in 2022. That single year was unusually favorable for tax-loss harvesting given the market’s volatility, and past results never guarantee what happens in any future year, so this figure should be read as context rather than an expectation.
The practical difference between the two approaches comes down to what keeps you up at night. A long/short strategy asks you to trust an active manager’s stock-picking, on both sides of the trade, indefinitely. A direct indexing SMA asks you to trust a systematic, rules-based process for harvesting losses across a broad, diversified basket you actually own. For investors managing a large concentrated position over many years, not just one tax year, that second option is often the one that lets you actually stay invested in the plan.
If you have a concentrated position and want to know whether a direct indexing SMA, a tax-aware long/short strategy, or some combination of the two fits your situation, email me directly at [email protected] with the details, or schedule a conversation and we’ll work through it together.
Where This Leaves You Right Now
Schwab’s restrictions, now three rounds deep in a single year, and Fidelity’s earlier pause on new accounts reflect a broader maturation in how the industry is thinking about these strategies. They became popular rapidly, and in some cases were marketed aggressively to investors who may not have fully understood what they were buying. The custodian-level guardrails are a healthy correction.
For advisors and investors, this means account minimums have moved from $1 million to $10 million in under six months, leverage in the most aggressive structures is constrained, and portfolio margin versions of the strategy are closed to new money entirely. Investors entering now should factor that into their planning, including the possibility that exiting a strategy or switching managers might trigger a taxable event from position unwinding.
If you’re weighing a long/short strategy, already in one, or wondering whether the new $10 million minimum affects a strategy you’re currently using, email me directly at [email protected] with the details of your situation. I’ll give you a straight, fiduciary read on whether it fits, with no product to sell you either way. You can also see how I work and what I charge on the services and fees page, or schedule a conversation directly.
Key Takeaways
- A tax-aware long/short strategy is active stock picking on both the long and short side, not a tax product. The tax benefits sit on top of that active bet, not underneath it
- Tax losses harvested through these strategies lower your cost basis. The tax bill is deferred, not eliminated
- Short squeezes and leverage can produce losses that outweigh any tax benefit, especially in a rising or volatile market
- Schwab raised its standard long/short SMA minimum from $1 million to $10 million effective September 16, 2026, and closed portfolio margin accounts to new enrollments entirely, its third tightening of the year
- These strategies tend to fit investors with a large taxable gain to offset, substantial taxable assets, genuine conviction in the manager’s stock-picking ability, and a long time horizon
- If the pitch leads with tax benefits rather than investment merit, that’s a signal to slow down and get a second opinion
- For investors without conviction in a manager’s stock-picking ability, direct indexing through a Dimensional SMA offers broad diversification and active tax management without betting on any individual manager’s calls, typically for an all-in cost of 1.00% to 1.50%
About the Author
Gabriel Motta, CFP®, MBA, is the founder and principal of Inclinevest LLC, a fee-only fiduciary retirement financial advisor and financial planner based in Greenwood Village, Colorado. He works with high-net-worth pre-retirees and retirees throughout south Denver, across Colorado, and nationally, including clients in Washington, California, Florida, Texas, and New York. As a retirement planner and wealth manager, Gabriel helps clients navigate retirement income planning, Social Security strategy, tax-efficient withdrawals, and equity compensation. Gabriel is a NAPFA and XY Planning Network member. Learn more about Gabriel and Inclinevest or schedule a conversation.
Sources
- Long-Short Strategies for Concentrated Position Management – Schwab Center for Financial Research, February 2026
- Schwab Tightens Tax-Aware Long-Short Account Rules Yet Again – InvestmentNews, September 3, 2026
- Schwab Imposes Stricter Limits on Tax-Aware Long-Short Accounts – WealthManagement.com, September 2026
- Schwab Imposes New Limits on RIAs Using Long-Short Strategies – AdvisorHub, April 2026
- Schwab Imposes New Account Curbs as Tax-Aware Strategies Boom – Bloomberg, April 23, 2026
- A Guide to 130/30 Loss Harvesting – Goldberg, Cai & Schneider, Journal of Asset Management, 2024
- Diversify Concentrated Stock with Long/Short – BlackRock/Aperio, 2024
- What’s a Short Squeeze and Why Does It Happen? – Charles Schwab
This article is for general informational and educational purposes only. It isn’t personalized investment, tax, or legal advice, and it shouldn’t be relied on as a substitute for guidance specific to your situation. Inclinevest LLC is a registered investment adviser. Registration doesn’t imply any level of skill or training. Please consult a qualified professional before making decisions about your own financial circumstances.s.
