Wealthfront's tax lost harvesting claims not quite accurate

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
User avatar
Topic Author
neurosphere
Posts: 5205
Joined: Sun Jan 17, 2010 12:55 pm

Wealthfront's tax lost harvesting claims not quite accurate

Post by neurosphere »

Hi all, Wealthfront has been brought up around here several times. Micheal Kitces has a post on his blog which evaluates their claim that their TLH methods can add up to 1%. Basically (surprise) he finds their claims overblown:

http://www.kitces.com/blog/wealthfront- ... #more-3021

I've been skeptical of their claims, and have warned colleagues about it when they asked for my opinion about Wealthfront. Michael's analysis expresses my skepticism quite well.

It's a long post, but here is a part of the summary paragraph:
Yet at the same time, this entire exercise illustrates perhaps the greatest weakness of Wealthfront: that developing broad-based algorithms for investment purposes can miss out on the nuances of individual tax planning - an entirely different core competency that must be integrated into the picture, as advisors routinely do and "robo-advisors" are still struggling to do. The situation is especially true given that Wealthfront will harvest losses for all clients on an ongoing basis, regardless of the fact that for some doing so will eventually drive them into a higher tax bracket and destroy wealth, while for others it should not be done at all because they're young and in the lower tax brackets and eligible for 0% capital gains rates and consequently harvesting gains is the best strategy for them.
I agree with Micheal here, that TLH is not beneficial, or can actually hurt, if it's not done with one's specific situation in mind. Note, Kitces income is based on RIAs and other investment advisors, many of who are competing for the same clients as Wealthfront. So he may not be the most unbiased source, because any growth in "robo-investing" may be perceived as a threat to a traditional investment manager.

Wealthfront charges 0.25% on an AUM basis. If someone absolutely wants to have their investments selected and managed for them, they can hire an advisor for 0.5% who can ensure that any transactions are indeed beneficial to the client.

Neurosphere
User avatar
zed
Posts: 336
Joined: Wed Jan 07, 2009 2:01 pm
Location: A river runs thru it

Wealthfront Tax Loss Harvesting White Paper

Post by zed »

[Thread merged into here, see below. --admin LadyGeek]

Michael Kitces hits one out of the park in his blog post on "how not to calculate tax alpha".
The benefits of reducing current tax liabilities through tax loss harvesting are widely acknowledged - so much, that the IRS developed the 30-day "wash sale" rules to prevent taxpayers from abusing the strategy. Yet less widely understood is that there's one crucial caveat to tax loss harvesting - that taking advantage of the loss also reduces the cost basis of the investment, potentially exposing the taxpayer to a gain in the future that can wipe out some, most, or all of the tax benefit, and in the extreme with today's four capital gains tax brackets actually drive up future tax rates and leave the investor worse off than having done nothing at all.

Notwithstanding these issues, many investors and advisors continue to overstate the benefits of tax loss harvesting, and now "robo-advisor" Wealthfront is doing so as well, with its "Tax-Loss Harvesting White Paper" that purports Wealthfront can increase an investor's wealth by an extra 1%/year, annualized, indefinitely, through its daily tax loss harvesting strategy. Unfortunately, though, the reality is that in a review of its strategy, Wealthfront - like so many others - is confusing tax savings with tax deferral, and in the process may be drastically overstating its benefits by a factor of 10:1, and for its typical investor the true annual benefit may be a mere 1/25th of what their "white paper" claims purport.
http://www.kitces.com/blog/wealthfront- ... #more-3021



Allan Roth appears to arrive at a similar conclusion in his blog post:

http://www.cbsnews.com/news/a-tax-frien ... -indexing/



Perhaps a cautionary note for all of us as stated by Michael in an earlier blog post:
However, while tax loss harvesting remains a viable strategy, it is often greatly overvalued, as the true benefit is not the tax savings from harvesting a loss but merely the benefit of deferring those gains. In the meantime, the strategy has a non-trivial exposure to several risks, including the potential for the alternative investment held during the 30-day wash rule period underperforming the original investment, the possibility of negative tax arbitrage if the investment rebounds in the near term, and the danger that harvesting losses too effectively over time will drive the client's future capital gains into a higher tax bracket! In addition, the fact remains that capital loss harvesting produces no benefits for clients who are eligible for 0% capital gains tax rates, and in fact potentially harms them; in such scenarios, clients should actually be harvesting gains, not losses!

Ultimately, this doesn't mean that harvesting capital losses is a bad strategy, but it is a strategy where the risks must be carefully considered, as they can easily outweigh the relatively modest benefits!
http://www.kitces.com/blog/is-capital-l ... vervalued/
Last edited by zed on Fri Feb 07, 2014 4:36 pm, edited 1 time in total.
livesoft
Posts: 86075
Joined: Thu Mar 01, 2007 7:00 pm

Re: Wealthfront Tax Loss Harvesting White Paper

Post by livesoft »

Thanks for drawing this to my attention.

As long as the 0% and 15% long-term cap gains tax brackets exist, I am sure I will benefit from TLHing. I can't worry about the uber-wealthy and their problems.
Wiki This signature message sponsored by sscritic: Learn to fish.
User avatar
Topic Author
neurosphere
Posts: 5205
Joined: Sun Jan 17, 2010 12:55 pm

Re: Wealthfront Tax Loss Harvesting White Paper

Post by neurosphere »

User avatar
zed
Posts: 336
Joined: Wed Jan 07, 2009 2:01 pm
Location: A river runs thru it

Re: Wealthfront Tax Loss Harvesting White Paper

Post by zed »

livesoft,

Perhaps my last edit and your first post crossed in the ether. I'm not concerned with the uber-wealthy either.

I am however revisited my TLH strategy in light of the fact that since I'm now semi-retired and thus have a lot of tax-free LTCG headroom in my 15% tax bracket, TGH makes more sense than TLH.
User avatar
zed
Posts: 336
Joined: Wed Jan 07, 2009 2:01 pm
Location: A river runs thru it

Re: Wealthfront Tax Loss Harvesting White Paper

Post by zed »

neurosphere ,

You beat me to the punch! :beer
livesoft
Posts: 86075
Joined: Thu Mar 01, 2007 7:00 pm

Re: Wealthfront Tax Loss Harvesting White Paper

Post by livesoft »

I think someone should try to write an article where tax-loss harvesting really has much higher benefit than anyone would expect. Let me outline a couple of things here:

Suppose I pay a marginal income tax rate of 48% even though I am in the 25% marginal income tax bracket. This happens because of loss of tax credits and other odd things. If I get to deduct $3,000 from my ordinary income, I save about $1440 on taxes. Yes, my basis in the investments is reduced by $3K, so I will need to factor in the taxes on that $3K in the future.

But in the future, there can be many years between stopping work and withdrawing from tax-deferred investments like a 401(k) or traditional IRA. And more years until receiving SS benefits. In those years, one has to pay expenses somehow, but there is conveniently that taxable account that created all those tax-loss harvesting opportunities in the past. If one chooses which investments to sell judiciously, one will have return of capital which is not taxed at all and some long-term capital gains. Those gains can be offset by carryover losses, so are not taxed. But more importantly, with return of capital and offset gains, one has no income and an AGI close to zero. Yet before one is that huge 0% tax bracket that could be filled up with LT cap gains or Roth conversions. This is the true benefit of tax-loss harvesting for me.

Of course, if one keeps working until age 70 or later or if one has pension income to fill up the lower tax brackets, the above scenario does not apply. Or if one needs $200,000 a year to meet expenses, it won't apply either. But if it does apply, one's earlier TLH moves could save one quite a lot of taxes. But how to quantitate that savings for the likes of Kitces?
Wiki This signature message sponsored by sscritic: Learn to fish.
mnvalue
Posts: 1107
Joined: Sun May 05, 2013 2:22 pm

Re: Wealthfront's tax lost harvesting claims not quite accur

Post by mnvalue »

Unless I missed it, doesn't Wealthfront's analysis (as well as the one in that blog) fail to account for the fact that state tax is deductible on the Federal return? That is, the "23.8% (Federal) + 13.3% (state) = 37.1%" math from the blog is incorrect; it's actually 23.8% + 13.3% * (1-23.8%) = 33.3361%. This reduces the potential gains from TLH a touch more. On the other side of the argument, how much you donate to charity is an important fact, as you can avoid ever paying the tax on some of your money that way.
gkaplan
Posts: 7034
Joined: Sat Mar 03, 2007 7:34 pm
Location: Portland, Oregon

Re: Wealthfront's tax lost harvesting claims not quite accur

Post by gkaplan »

Gordon
User avatar
LadyGeek
Site Admin
Posts: 95686
Joined: Sat Dec 20, 2008 4:34 pm
Location: Philadelphia
Contact:

Re: Wealthfront's tax lost harvesting claims not quite accur

Post by LadyGeek »

FYI - Neurosphere's post was first, so I merged zed's thread into here. Everyone's opinions should now be together.
Wiki To some, the glass is half full. To others, the glass is half empty. To an engineer, it's twice the size it needs to be.
Wagnerjb
Posts: 7213
Joined: Mon Feb 19, 2007 7:44 pm
Location: Houston, Texas

Re: Wealthfront's tax lost harvesting claims not quite accur

Post by Wagnerjb »

We discussed the Wealthfront claims a few months ago, and here is what I said at that time:
I have been tax loss harvesting for almost 30 years in my taxable account, almost exclusively with individual stocks. I doubt that 1% is realistic. I am a big proponent of tax loss harvesting, and the benefits are very real but I just think 1% is exaggerated. I have seen a different study - using individual stocks - that shows an average annual benefit of 0.6%. Since individual stocks are more volatile than index ETFs, I cannot see how one can get to 0.6% with ETFs, much less the 1% level.

I suspect the 1% comes from two assumptions. First is a constant and substantial flow of "new money" into the account every year. This allows more different tax lots to be purchased, and new money is more likely to be a loss harvesting candidate. Second, they likely assumed capital gains being generated by the funds, and the TLH served to offset those gains. I believe a tax efficient portfolio will generate virtually zero in capital gains, so that assumption is also a bit questionable.

I do agree wth those who feel that 0.25% is a very modest fee for a) advice and b) loss harvesting.
Best wishes
Andy
Post Reply