THE HOLIDAYS are a time to celebrate. For mutual fund investors, however, this end-of-year period should also serve as the time to reap losses, gather tax benefits and consider reconstructing an investment portfolio.

But reaping the benefits of your losers is not as simple as dumping any fund with recent losses. It involves restructuring your portfolio to position it for the future.

"It's a mistake to let the tax issue affect where your portfolio ends up, yet that's what people do," says Phil Holthouse, of the accounting firm Holthouse, Carlin and Van Trigt in Los Angeles. "They're so anxious to take the loss and get something out of their misery that they wind up hurting their investment portfolio.

"People really need to make the portfolio decisions - 'Where should I put my money and how should I allocate it?' - ahead of the tax decision."

When mutual fund shares are sold, any loss can be used to offset capital gains earned on other investments. If the losses exceed all gains earned, the remainder can be used to reduce up to $3,000 of ordinary income per year. Any losses beyond that can be used in future years.

As a general rule, investors looking to harvest losses fall into two camps: those who are satisfied with their asset allocation and simply want the tax benefits, or those who want to rejigger the portfolio into a new position.

The harvesting process starts the same way for both groups. First, identify losses, which can sometimes be tricky when a fund has been held for a long time.

For example, a fund may have a positive 10-year record, but big losses over the past three years. Many fund firms include on their statements the average cost per share for the fund, which can convince long-term holders that they have no losses to reap.

Instead of looking at average share price, examine your investment history with the fund; shares that were purchased at a price above where the fund stands today can be sold at a loss. This requires "specific selection," where shareholders notify the fund firm in writing (and before making the trade) that they want to redeem only those shares purchased on or after certain dates. Doing this allows an investor to eliminate the shares that are down, while leaving shares with long-term gains undisturbed.

Specific selection can only be used, however, if the investor has never sold shares using the "average-cost method" for calculating profits or losses. Once an investor sells shares using the average cost per share to determine profits or losses, they must use that method for as long as they own the fund.

Finally, consider the potential tax benefits, the hassle factor of accounting for the change and the potential costs and transaction fees that might be incurred by a change.

If the tax benefits are negligible, stand pat.

But if losses are substantial enough to warrant a move, there are two preferred outcomes.

The investor who is satisfied with his asset allocation should invest the proceeds from the sale of losers into funds that are similar to what he just sold, thereby keeping the spread of assets unchanged.

The new funds can resemble the old ones - same asset category and investment style - but not be identical. Repurchasing the old fund before 30 days have elapsed - or buying a fund that is essentially identical within a month of the sale - is considered a "wash sale," where the sale and the purchase of the same security wipes out the tax benefits.

Investors looking to reconstruct their portfolio should decide first on their new strategy, determining what percentage of holdings they want in any asset category going forward.

The proceeds from the sales of their losers should then be moved into funds that put the new plan into play.

Rande Spiegelman, vice president for the Schwab Center for Investment Research in San Francisco, worries that investors will "max out" their tax-loss selling, and pursue hot investments rather than long-term strategy. "Harvesting losses is a bad idea if it leaves your portfolio a mess," Spiegelman says.

The revamped portfolio is a big part of the "replacement risk" associated with harvesting losses. If the new investment portfolio is not equal or superior to the old, the tax benefits probably aren't worth the effort.

"Most people don't want to throw out their portfolio wherever losses exist and start over, because that usually doesn't make things better," Spiegelman says. "But if you can pick your spots, harvest some losses and change your portfolio for the better, then you've made the most of your opportunity."

Charles A. Jaffe is mutual funds columnist at The Boston Globe. He can be reached by e-mail at jaffe@globe.com or at The Boston Globe, Box 2378, Boston, Mass. 02107-2378.