"Tax Loss Harvesting" in a Financial Advisor pitch: help me understand

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gruesome
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"Tax Loss Harvesting" in a Financial Advisor pitch: help me understand

Post by gruesome »

Hi,

I got pitched by a Financial Advisor last week.

They charge an Assets Under Management (AUM) fee (First $1M, 1.0%, next $2M, 0.8%, next $2M, .75%...) and then sub-contract the management of the money to another firm (who charge their own fees).

Part of their pitch was "tax loss harvesting" advantages.

After reading https://www.bogleheads.org/wiki/Tax_loss_harvesting I'd like to know "in practice, how much does TLH tend to improve returns?"

Here's information from the chart on their pitch deck related to "tax loss harvesting" -- if you could help me understand it, I'd appreciate it.

I understand the "S&P 500 Pre-Tax" column below -- these percentages align with "VII" returns -- and their returns consistently trail VII -- which aligns with my understanding that "active managers rarely beat the market":

"S&P 500 Strategy - Net Bundled Fee % - Maximum Federal and State Returns":

Code: Select all

Year   S&P 500 Pre-Tax     Strategy Pre-Tax        Pre-Tax Difference
2020   18.40               15.00                   -3.40
2019   31.49               27.88                   -3.61
2018   -4.38               -5.05                   -0.66
2017   21.83               20.08                   -1.75
2016   11.96               8.22                    -3.74
2015   1.38                -0.39                   -1.77
But the chart continues (and these are the columns they focus on) -- showing "after tax" returns where their numbers "look better":

Code: Select all

Year  S&P 500 After-Tax    Strategy After-Tax      After-Tax Difference    Tax Alpha
2020  16.57                21.74                   5.18                    8.57
2019  29.46                27.41                   -2.05                   1.55
2018  -5.77                -2.06                   2.72                    4.38
2017  20.33                19.73                   -0.60                   1.15
2016  10.62                8.30                    -2.33                   1.42
2015  0.19                 2.95                    2.76                    4.53
I don't understand what "S&P 500 After-Tax" means here -- if I owned VII, are these my "after tax rate of return" after accounting for taxes on dividend payments (when I'm in a high tax bracket)?

What does "Tax Alpha" mean?

Given 2020 rows - for the "pre-tax", the strategy trailed S&P 500 by 3.40% (18.40->15.00). But after "Tax Loss Harvesting" they
Beat the S&P by 5.18%? 5.18+3.40=8.58 (I guess that's where "Tax Alpha" comes from). That seems like a big savings!

Does tax loss harvesting really "save" that much money?

One important note: I don't know if this chart "Net Bundled Fee %" includes the "Financial Advisors" AUM Fee (and just accounts for the sub-contractors fees). If these are not, is it accurate to "subtract that percent from the After tax numbers?"

Is there anything else I should ask to confirm it makes sense to pass on this offer? Thanks!
Last edited by gruesome on Mon Jun 14, 2021 11:24 am, edited 2 times in total.
wetgear
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Re: "Tax Loss Harvesting" in a Financial Advisor pitch: help me understand

Post by wetgear »

TLH saves some money, what that works out to depends on individual and market circumstances but it won't be anywhere near these numbers:
gruesome wrote: Mon Jun 14, 2021 10:54 am Assets Under Management (AUM) fee (First $1M, 1.0%, next $2M, 0.8%, next $2M, .75%...)
You will end up paying them way over any savings they provide you.
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neurosphere
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Re: "Tax Loss Harvesting" in a Financial Advisor pitch: help me understand

Post by neurosphere »

gruesome wrote: Mon Jun 14, 2021 10:54 am After reading https://www.bogleheads.org/wiki/Tax_loss_harvesting I'd like to know "in practice, how much does TLH tend to improve returns?"
That's the wrong question. The question is, suppose there is indeed a benefit to TLH...is this something I can do myself or should I pay someone else to do it for me? Then, you can decide whether the benefit of TLH is something you want to spend your time on. :D
If you have to ask "Is a Target Date fund right for me?", the answer is "Yes".
dbr
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Re: "Tax Loss Harvesting" in a Financial Advisor pitch: help me understand

Post by dbr »

A different point of view is that return from TLH is highly risky in the sense that the result is highly variable depending on market and individual circumstances. The costs to the account are risk free in the sense of being certain and constant. To pay a risk free penalty for a risky benefit the benefit has to have a hefty risk premium. I don't believe that exists here.
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neurosphere
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Re: "Tax Loss Harvesting" in a Financial Advisor pitch: help me understand

Post by neurosphere »

One has to make a lot of assumptions to quantify the benefits of TLH. One would have to look at all the underlying assumptions made by the advisor in order to determine whether they are reasonable. I suspect the assumptions are cherry picked to provide the maximum TLH benefit.

But I do feel that there is rarely a situation where one gets NO benefit from TLH. It's form of tax-deferral and in general that's helpful. But no way is it worth 1% AUM fee when it's other wise easy for you to do it yourself.
If you have to ask "Is a Target Date fund right for me?", the answer is "Yes".
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neurosphere
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Re: "Tax Loss Harvesting" in a Financial Advisor pitch: help me understand

Post by neurosphere »

dbr wrote: Mon Jun 14, 2021 11:45 am A different point of view is that return from TLH is highly risky in the sense that the result is highly variable depending on market and individual circumstances. The costs to the account are risk free in the sense of being certain and constant. To pay a risk free penalty for a risky benefit the benefit has to have a hefty risk premium. I don't believe that exists here.
This a very eloquent way to explain it. Thanks.
If you have to ask "Is a Target Date fund right for me?", the answer is "Yes".
retiringwhen
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Re: "Tax Loss Harvesting" in a Financial Advisor pitch: help me understand

Post by retiringwhen »

As stated by others, TLH improvement is not the real question. Instead, what is the "Strategy" they are employing?

It looks like a direct indexing approach with TLH to improve returns. This is an interesting idea, but fraught with problems. Rick Ferri and others have looked at this in detail and their biggest problem is it creates massively complex portfolios that require a lot of attention. This is great for the advisor, terrible for the investor as they get locked in. Also, the TLH benefits decline over time and you are just left with a terribly complex portfolio with not marginal benefit

The advisor you reference has very hefty fees and they have to come up with a reason/justification for them. Direct Indexing is one way to do that.

A judicious use of a half-dozen ETFs by market Cap and growth/value that can be rotated among different providers (Vanguard to iShares to Schwab, etc.) could most likely capture much of the same Tax Loss Harvesting benefits and not require an advisor or a tremendous amount of effort.
carne_asada
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Re: "Tax Loss Harvesting" in a Financial Advisor pitch: help me understand

Post by carne_asada »

The sales pitch is usually that the fund emits losses so that you can TLH them but its never enough to cover the AUM. If you go with a large ETF you almost never have anything emitted(gains or loss) as they are very tax efficient. I got pitched the same sort of thing: advisors like to use a cherry picked "lost decade" as a reason why you should avoid the S&P ETFs - my response is always - show me how your fund performed over the exact same time period and that usually shuts them up.
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Re: "Tax Loss Harvesting" in a Financial Advisor pitch: help me understand

Post by Jack FFR1846 »

So you pay them 1% for them to throw the ball over the wall to a subcontractor who charges....I don't know....1% to do the actual work. Besides TLH, what else do they do? Do they choose funds that return kick backs to them and charge you 1%? Do they create a sea of funds to show you how smart they are to understand all of this?

On tax loss harvesting. I don't really understand them well enough to quite get it. But I doubt you'll make up the charges these clowns are proposing.
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Re: "Tax Loss Harvesting" in a Financial Advisor pitch: help me understand

Post by bertilak »

I don't see TLH as a way to improve returns but as the silver lining in a bad situation -- a big drop in market.

If your portfolio loses value -- which will happen from time to time -- one can at least take advantage of that loss at tax time. Realize the loss by selling and then, at the same time, remain fully invested by buying back into a different fund with same asset class. For example, trade Total Stock Market for S&P500, which very closely tracks Total Stock Market. The down side is that you have just lowered your cost basis so future sales will have a bigger tax implications. But that's a future concern that may never materialize. You save taxes now but potentially pay that back in the future.

I would never pay a financial advisor to tell me when to do this. The concept is simple enough.
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gruesome
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Re: "Tax Loss Harvesting" in a Financial Advisor pitch: help me understand

Post by gruesome »

Thanks for comments, I'm learning!
retiringwhen wrote: Mon Jun 14, 2021 11:55 am It looks like a direct indexing approach with TLH to improve returns. This is an interesting idea, but fraught with problems. Rick Ferri and others have looked at this in detail and their biggest problem is it creates massively complex portfolios that require a lot of attention.
It looks like they pick a percentage of S&P -- is that "direct indexing"? It definitely complicates things!

In the pitch deck the portfolio they recommend has ~200 individual equities in it (all S&P 500 as far as I could tell).

I was told the reason its not "500" individual equities is so they can do TLH without wash sales (Eg, if they sell Pepsi, they buy Coke).

I've been migrating from individual equities (I still have ~20 individual equities) to a 3-ETF portfolio -- so this is going "the wrong way" for me if there are no strong benefits. In my ideal scenario, I never sell the ETFs and just retire on the generated dividends.
Jack FFR1846 wrote: Besides TLH, what else do they do?
A lot of tax planning stuff -- setting up trusts, wills, etc. Not something I'd want to pay an AUM fee for. One thing they talked about that was new to me was setting up a Charitable Remainder Trust -- but, again, I think I could get advice without an AUM on that.
Exchme
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Re: "Tax Loss Harvesting" in a Financial Advisor pitch: help me understand

Post by Exchme »

There is often a lot of deception in the numbers from advisors. My former advisor would always show the S&P index, ignoring dividends - I showed him the Yahoo S&P Total Return index and he insisted he'd never seen that before and didn't know what it meant. Next time we talked, he was showing his same deceptive numbers. Meanwhile, for their funds, the advisor happily included dividends and ignored some of the layers of fees, trying to focus your attention only on the advisor fees, not the fees to run the funds, which were actually larger. So I would never believe numbers provided by them, it's just a game as to where they've hidden the fees, but rest assured, they are targeting taking 2-3% of your money each year.

The math of fees over long periods is shocking. I ran an example for my mid 30's daughter - if you have an investment in stocks earning their historical average of 10%/year and decide to pay an advisor 2.2% and wait 35 years, who has the bigger pile, you or the advisor? If you assume the advisor invests what he collects from you in the same market at the same 10% return but is smart enough not to pay advisory fees, the answer is your advisor has more than you. At 3% fees, the advisor will have taken 62% of the total. This explains all those expensive buildings on Wall Street and high salaries.

So - Run Away! Advisors are snake oil salesmen trying to get rich off your money. You can get better advice here for free.
retiringwhen
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Re: "Tax Loss Harvesting" in a Financial Advisor pitch: help me understand

Post by retiringwhen »

gruesome wrote: Mon Jun 14, 2021 12:22 pm Thanks for comments, I'm learning!
retiringwhen wrote: Mon Jun 14, 2021 11:55 am It looks like a direct indexing approach with TLH to improve returns. This is an interesting idea, but fraught with problems. Rick Ferri and others have looked at this in detail and their biggest problem is it creates massively complex portfolios that require a lot of attention.
It looks like they pick a percentage of S&P -- is that "direct indexing"? It definitely complicates things!

In the pitch deck the portfolio they recommend has ~200 individual equities in it (all S&P 500 as far as I could tell).

I was told the reason its not "500" individual equities is so they can do TLH without wash sales (Eg, if they sell Pepsi, they buy Coke).
Sounds like they are making things fuzzy, but yes that sounds like direct indexing. Overall, the pitch looks like they are selling complexity to justify their fee with little real alpha to be found.

My wife and I got that pitch once, we just laughed it off and said, broad-based index funds were just fine with us.

I TLH my index funds when advantageous, 2018 and 2020 were bonanzas! Unless we have a VERY big market crash again, my days of TLH'ing are done for a while.
Chip
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Re: "Tax Loss Harvesting" in a Financial Advisor pitch: help me understand

Post by Chip »

This sounds similar to something that was pitched to another Boglehead a while back, especially since the term "tax alpha" was used. Thread here: viewtopic.php?f=1&t=279488

I had some rather uncharitable things to say about the way that particular advisor chose to calculate "tax alpha". I'm not saying the pitch you received is using the same calculations, but the numbers are suspiciously high.
MrJones
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Re: "Tax Loss Harvesting" in a Financial Advisor pitch: help me understand

Post by MrJones »

Chip wrote: Mon Jun 14, 2021 12:32 pm This sounds similar to something that was pitched to another Boglehead a while back, especially since the term "tax alpha" was used. Thread here: viewtopic.php?f=1&t=279488

I had some rather uncharitable things to say about the way that particular advisor chose to calculate "tax alpha". I'm not saying the pitch you received is using the same calculations, but the numbers are suspiciously high.
Great breakdown in your linked post.

OP, the numbers are way too high to make any sense. TLH opportunities are rare. Any robot advisor like Wealth front does it for 0.3% or less. Even that won't likely offset it, taken over a few decades.

+1. OP, when anyone starts making up terms like "tax alpha", run!
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Re: "Tax Loss Harvesting" in a Financial Advisor pitch: help me understand

Post by Northern Flicker »

gruesome wrote: I got pitched by a Financial Advisor last week.

They charge an Assets Under Management (AUM) fee (First $1M, 1.0%, next $2M, 0.8%, next $2M, .75%...) and then sub-contract the management of the money to another firm (who charge their own fees).

Part of their pitch was "tax loss harvesting" advantages.

After reading https://www.bogleheads.org/wiki/Tax_loss_harvesting I'd like to know "in practice, how much does TLH tend to improve returns?"
I don't think you can discuss TLH in a generic manner with respect to improving returns. The benefit depends not just on the asset, but also the tax situation of the investor.

What can be quantified is the cost of getting an advisor that does TLH, and 1% AUM is unlikely to be very competitive. Would Betterment or Vanguard PAS deliver that more cheaply?
Last edited by Northern Flicker on Tue Jun 15, 2021 2:07 pm, edited 2 times in total.
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afan
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Re: "Tax Loss Harvesting" in a Financial Advisor pitch: help me understand

Post by afan »

I think you have your answers. The adviser would not do anything for which you would pay an AUM fee, so there is no reason to pay them an AUM fee. If you wanted a TLH service, you can get one from a robo at far lower cost. But TLH is not that complicated and you can do it yourself for free.

It IS a lot of hassle if you want to harvest every single down tick but this would be a foolish thing to do. There was a poster at WCI who engaged one of these robos and at the end of the year received an 89 page 1099. Apparently many for the transactions had losses of less than a dollar. From a tax perspective it accomplished nothing but it did require checking all those pages to eliminate the wash sales.

If you have money in index funds, you don't have this endless stream of gains and losses in individual securities. Whether they can run a portfolio that matches the broad market, captures all the losses at the individual stock level and do it for a fee that puts you ahead is an open question.

Note that one of the big robos got caught flat out lying about its TLH service. It claimed that it took account of assets held outside the robo, such as retirement funds. Although it made a show of collecting information on what was held and regular purchases in these accounts, it proceeded to ignore this completely. Customers were stuck with many wash sales that they had to sort out before filing their taxes.

I would not pay someone to TLH for me.
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anil686
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Re: "Tax Loss Harvesting" in a Financial Advisor pitch: help me understand

Post by anil686 »

Northern Flicker wrote: Mon Jun 14, 2021 12:56 pm
gruesome wrote: I got pitched by a Financial Advisor last week.

They charge an Assets Under Management (AUM) fee (First $1M, 1.0%, next $2M, 0.8%, next $2M, .75%...) and then sub-contract the management of the money to another firm (who charge their own fees).

Part of their pitch was "tax loss harvesting" advantages.

After reading https://www.bogleheads.org/wiki/Tax_loss_harvesting I'd like to know "in practice, how much does TLH tend to improve returns?"
I don't think you can discuss TLH in a generic manner with respect to improving returns. The benefit depends not just on the asset, but akso the tax situation of the investors.

What can be quantified is the cost of getting an advisor that does TLH, and 1% AUM is unlikely to be very competitive. Would Betterment or Vanguard PAS deliver that more cheaply?
I agree with this. Frankly, I don’t think TLH (esp TLH alpha) is very transparent nor is very easy to do. Basically, it assumes you take your tax savings at the time they happen and re-invest those savings at the same time and let those savings grow in a projection. But since most of us do not recognize our tax savings until doing our taxes (duh), we cannot add extra money to the account that we do not recognize as a savings yet. Furthermore, if you owe 4K in taxes and have 3 K in TLH so your total tax liability is 1K, you still need to put 3 K in your investment account to realize the TLH alpha - otherwise it is just tax savings now and higher taxes (possibly) later when you sell due to a lowered cost basis.

Hope that helps…
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Re: "Tax Loss Harvesting" in a Financial Advisor pitch: help me understand

Post by grabiner »

gruesome wrote: Mon Jun 14, 2021 10:54 am But the chart continues (and these are the columns they focus on) -- showing "after tax" returns where their numbers "look better":

Code: Select all

Year  S&P 500 After-Tax    Strategy After-Tax      After-Tax Difference    Tax Alpha
2020  16.57                21.74                   5.18                    8.57
2019  29.46                27.41                   -2.05                   1.55
2018  -5.77                -2.06                   2.72                    4.38
2017  20.33                19.73                   -0.60                   1.15
2016  10.62                8.30                    -2.33                   1.42
2015  0.19                 2.95                    2.76                    4.53
I don't understand what "S&P 500 After-Tax" means here -- if I owned VII, are these my "after tax rate of return" after accounting for taxes on dividend payments (when I'm in a high tax bracket)?
I expect that the Tax Alpha (the savings caused by their tax strategy) are computed by an oversimplified formula. If you harvest your capital losses, you can deduct them from your taxes, but the benefit of the deduction may not be at your full tax rate. If you are in a 32% tax bracket and you harvested $1000 in losses in 2020, with no long-term capital gains that year), you got a $320 tax benefit. But if you harvested $100K in losses, you did not get a $32K tax benefit (unless you also had $100K in short-term capital gains). You took $3000 of your ordinary income for a $960 tax benefit in 2020, but any further benefit was delayed to later years, reduced in value if it offset long-term capital gains or if you sold the replacement shares, and of no value if the loss offset capital gains on the replacement shares.

If you never sell anything and your investments don't generate capital gains, the maximum possible benefit of tax loss harvesting is a $3000 income reduction every year, for a $960 tax savings in a 32% bracket. In practice, you may also get some other benefits. For example, I harvested losses in 2008-2009, and hadn't used those up in 2013 when I sold stock for a home down payment; the carryover losses offset the capital gain I would have otherwise had on the stock sale. (With additional harvesting, I still haven't used up all my capital losses.)
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Re: "Tax Loss Harvesting" in a Financial Advisor pitch: help me understand

Post by PowderDay9 »

Agree with grabiner.

In summary, the value of TLH depends on your tax situation but for most investors the value of TLH is very small. I wouldn't pay much for the service.

Since there is the $3k limit of losses per year, you can save up to around $1k per year on taxes. The hope is that your marginal tax rate will be lower when you eventually sell the lower basis TLH shares.

I TLH myself. It's extremely easy if you have a simple portfolio. Good luck!
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Re: "Tax Loss Harvesting" in a Financial Advisor pitch: help me understand

Post by Dottie57 »

[note that tax loss harvesting pertains to taxable accounts only. You would get no benefit from doing so in an IRA or 401k.
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Re: "Tax Loss Harvesting" in a Financial Advisor pitch: help me understand

Post by Strifey »

Those fees are way too high.

I have a taxable account with Fidelity and they cold-called me about their SMA (Separately Managed Account) options which is basically the same thing. Their annual fees range from .2% - .65% though depending on how much you have invested ($100K minimum). They specifically wanted to get me into the Tax-Managed U.S. Equity Index Strategy which seeks index-like returns with enhanced after-tax returns primarily through investing in S&P 500 companies.

I think a lot of companies offer something similar and you could do better than 1% AUM.

As people have said it's not whether TLH is beneficial because it is, it's just how much benefit they bring + the AUM vs doing it yourself.

I mentioned I already TLH with ETFs when the Fidelity rep called me and his main argument for the benefit of a SMA is that they could offer more opportunities to TLH than an ETF... which I think is valid.

For example, Coke could have a downturn and they TLH into Pepsi.. but the rest of the market is up so you normally couldn't TLH something like VTI.

I ultimately don't really want to pay higher fees and complicate my portfolio to do this though, assuming similar returns as an index strategy you're basically giving up control of a simple portfolio and paying higher fees to get a bigger benefit on the backend through TLH. In the end I prefer a simpler portfolio and TLH myself on bigger market corrections... As people mentioned, if you're not actively selling constantly and having capital gains the only benefit you gain is $3K/yr anyways.
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Re: "Tax Loss Harvesting" in a Financial Advisor pitch: help me understand

Post by retiringwhen »

Strifey wrote: Mon Jun 14, 2021 10:22 pm For example, Coke could have a downturn and they TLH into Pepsi.. but the rest of the market is up so you normally couldn't TLH something like VTI.
You could use Vanguard market segment ETFs like VTV/VUG/VBR/VBK (Large Cap Value and Growth, and Small Cap Value and Growth) for US and VEU/VSS (Total International plus Small Cap Completion Index) or VWO/VEA (Emerging and Developed Markets) and get lots of opportunities to tax loss harvest among them over their initial growth years.

As with all these strategies (including the single stock version from the OP), once the market makes a long-term move up, you will have little opportunity to tax-loss harvest going forward. Even with the single stock versions, after 4 or 5 years, you will likely only get one or two opportunities a year to harvest losses and the relative value of the strategy will be gone, while the management fees continue to be charged. Excellent plan for the the asset manager, not so much for the investor.
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