Inside Robo Advisor Tax Loss Harvesting

September 09, 2014

Nobody’s an average Joe when it comes to taxes.

This is the sixth blog in a multiple-blog series by ETF.com’s Director of Research Elisabeth Kashner on the new “robo advisory” industry. The previous five, in the order in which they appeared, are as follows:

“I rarely use oxygen myself, sir. It promotes rust.”

—Robby the Robot (Forbidden Planet)

Wealthfront, Betterment and FutureAdvisor trumpet their tax-loss harvesting and rebalancing services, claiming that their automated systems deliver hefty, seemingly risk-free returns.

If this is so, I’ll recommend one of them for managing my teenage son’s bar mitzvah money, or at least put a memo on my calendar for nine years from now, when, please God, he’ll begin paying taxes. But as always, I’ll have to make sure I understand the ins and outs, so that I can back up my recommendations with solid analysis.

So I invite you, taxpayer and investor, to come along with me on a deep dive into tax-loss harvesting.

We’ll survey estimates of tax-loss harvesting’s value, and then walk through a sample tax-loss trade. We’ll see how many variables are at play, so you can decide if harvesting would help you, with your current tax bracket, future earnings expectations, capital markets expectations and estate plans, if any.

How Much Is Tax-Loss Harvesting Worth?

Wealthfront’s home page claims 1 percentage point of annual tax-loss harvesting returns, plus 0.40 percentage points per year for rebalancing.

But Betterment goes even further.

Jon Stein, Betterment’s chief executive officer, told me that “Betterment’s aggressive tax-loss harvesting can be worth 2 percentage points per year, and that tax-aware rebalancing is worth as much as tax-loss harvesting in certain markets.”

FutureAdvisor provides a chart showing 3.03 percentage points year of tax savings, from single-stock switches around the S&P 500 Index, which is not the same as the firm’s ETF-switching service.

These are some big numbers—big enough to convince would-be robo-investors to demand tax-loss harvesting and rebalancing services, and to build a huge competitive advantage for the firms that do it well. Of the six robo-advisors who offer all-ETF portfolios, three don’t currently have tax-loss harvesting programs.

Should they?

 

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