Wealthfront’s Tax-Loss Harvesting: 2023 Results

Wealthfront’s Tax-Loss Harvesting is designed to assist decrease your tax invoice with none additional effort and at no further price. The technique is so highly effective that Wealthfront’s Chief Funding Officer Burton Malkiel known as it “the one dependable method for traders to outperform the market, because it permits you to take action on an after-tax foundation.” 

Tax-Loss Harvesting, which is on the market to all Wealthfront purchasers with taxable Automated Investing Accounts, generated vital potential financial savings for purchasers in 2023:

Estimated tax financial savings in 2023: Final yr alone, our software program harvested $256 million in complete losses to assist decrease purchasers’ taxes (with $2.7 billion harvested during the last 5 years and $3.4 billion during the last decade). Based mostly on our purchasers’ present self-reported earnings, state of residence, and tax-filing standing (e.g., single, married submitting collectively) we infer a mixed federal and state tax price for every shopper. We then multiply every shopper’s price by their losses, which provides as much as a complete estimated tax good thing about $83.4 million in 2023.
Estimated after-tax profit during the last decade: Utilizing the identical methodology described above to deduce purchasers’ tax charges, we calculate each day tax profit as a proportion of complete account worth for every cohort after which add up and annualize the each day values over time. We discover that for purchasers who use Tax-Loss Harvesting in a Basic portfolio, our software program has harvested sufficient losses to generate a median annual estimated tax profit price 1.63% of their portfolio worth during the last decade. This interprets to a median annual after-tax profit price 6.5 occasions our 0.25% annual advisory charge. 

Shoppers we estimate have had their charges completely coated by Tax-Loss Harvesting: After we use every shopper’s inferred tax price to estimate their profit from Tax-Loss Harvesting and examine that profit to the precise quantity they paid in advisory charges, the result’s that for over 97% of taking part purchasers who’ve used Tax-Loss Harvesting for not less than a yr, the estimated tax profit exceeds charges paid.

Transparency is necessary to us at Wealthfront, and that’s why we constantly publish the outcomes of our Tax-Loss Harvesting service so you possibly can clearly see the profit it gives. So far as we all know, we’re the one robo-advisor to do that. You shouldn’t essentially assume different tax-loss harvesting companies will supply the identical profit as ours—not all tax-loss harvesting software program is similar, and we’ve labored onerous to construct what we imagine is one of the best obtainable. 

On this put up, we’ll assessment the fundamentals of tax-loss harvesting and take a extra detailed take a look at how Wealthfront’s Tax-Loss Harvesting carried out by the tip of 2023.

The fundamentals of tax-loss harvesting

Tax-loss harvesting is a tax deferral and tax-minimization technique the place you promote investments which have declined under their buy worth after which substitute them with comparable investments. Doing this implies your portfolio retains the identical basic threat and return traits, however you get to “harvest” a loss. And once you file your tax return, you should utilize harvested losses to offset capital good points and, you probably have any left over, as much as $3,000 of peculiar earnings for the yr. Extra unused losses could be rolled over to future years.

How does tax-loss harvesting prevent cash?

Tax-loss harvesting saves you cash in two methods:

Tax minimization: Tax-loss harvesting could be a tax-minimization technique within the type of tax-rate arbitrage. That’s as a result of tax-loss harvesting can mean you can offset short-term capital good points (that are sometimes taxed as peculiar earnings, that are at present taxed at as much as 37% on the federal stage) right this moment and pay long-term capital good points charges (which at present high out at 20% on the federal stage) once you finally promote your investments sooner or later, offered you maintain them for not less than a yr. Needless to say your capability to do that is dependent upon your future tax charges and once you resolve to promote your investments.

Tax deferral: Tax-loss harvesting may show you how to push paying your taxes into the longer term. That is priceless due to the time worth of cash. Think about that cash you save by not paying taxes right this moment could be invested, that means it has the potential to be price extra sooner or later once you do finally pay taxes. Have in mind, nevertheless, that there’s a possible threat that your tax price will go up in that point and your eventual tax price may exceed the profit you obtained from reinvestment.

Wealthfront’s 2023 Tax-Loss Harvesting outcomes

At Wealthfront, we use “harvesting yield” to measure the good thing about our Tax-Loss Harvesting. To calculate it, we take the each day quantity of harvested losses and divide by each day AUM. Then we calculate the common of these values and multiply it by the entire variety of buying and selling days in a yr to get annualized harvesting yield. When harvesting yield is excessive, meaning our software program discovered and took benefit of extra alternatives to reap losses.

The desk under reveals dollar-weighted common annual harvesting yield for purchasers with a Basic portfolio with a threat rating of 8 (the danger rating extra generally chosen by purchasers utilizing Tax-Loss Harvesting), sorted by the yr they first began utilizing Tax-Loss Harvesting (we name this the “shopper classic”).

Common annual harvesting yield for Basic portfolios with a threat rating of 8 by 2023

The desk above focuses on threat rating 8 portfolios as a result of they’re the commonest amongst Wealthfront purchasers utilizing Tax-Loss Harvesting. However you must know that our software program has harvested vital losses for purchasers with different threat scores, too. The dollar-weighted common annual harvesting yield for purchasers utilizing Tax-Loss Harvesting in a Basic portfolio throughout all vintages and threat scores is 5.44% during the last decade (5.11% during the last 5 years, and 1.23% during the last yr). 

That harvesting yield can translate into actual profit for our purchasers. As we described above, we estimate the common annual after-tax profit for all purchasers utilizing Tax-Loss Harvesting in a Basic portfolio of any shopper classic and threat rating during the last decade is 1.63%, which is over 6.5 occasions Wealthfront’s annual advisory charge. Briefly, Tax-Loss Harvesting generates potential after-tax profit that may considerably outweigh the price of our service. Put one other method, you’re prone to come out forward on price utilizing Wealthfront’s Tax-Loss Harvesting in comparison with managing your personal portfolio for no advisory charge.

The evaluation above solely contains our Basic portfolios (our hottest portfolio) however it’s additionally necessary to notice that our Socially Accountable portfolio, which we launched in late 2021, has had comparable Tax-Loss Harvesting outcomes over the identical time interval.

The typical annual harvesting yield for our all Socially Accountable portfolios throughout threat scores and shopper vintages in 2023 was 3.00% (vs. 3.07% for our Basic portfolio).

The typical annual harvesting yield for all Socially Accountable portfolios throughout threat scores and shopper vintages for the reason that portfolios’ inception in late 2021 was 11.56% (vs 10.63% for Basic portfolios over the identical interval).

For those who had a personalized portfolio at Wealthfront (we launched these in mid 2021) you additionally continued to profit from Tax-Loss Harvesting in 2023:

The typical annual harvesting yield for all personalized portfolios at Wealthfront throughout all shopper vintages in 2023 was 3.66%.

The typical annual harvesting yield for all personalized portfolios at Wealthfront throughout shopper vintages for the reason that inception of customized portfolios at Wealthfront in mid 2021 was 10.38%.

As a result of our Automated Bond Portfolios are so new (launched in mid 2023), we didn’t embrace them in our evaluation for this put up. To study extra concerning the efficiency of our US Direct Indexing portfolios (which characteristic a extra superior type of Tax-Loss Harvesting), take a look at our US Direct Indexing white paper.

Why not simply harvest losses on the finish of the yr?

You would possibly consider tax-loss harvesting as a technique to make use of on the finish of the yr in a last-ditch effort to decrease your tax invoice, however it’s much more highly effective once you search for alternatives to reap losses all yr lengthy like Wealthfront’s software program does. Fewer than half of the losses Wealthfront harvested in unmodified Basic and Socially Accountable portfolios in 2023 (41.7%) have been harvested within the remaining quarter of the yr, the time of yr that many individuals who manually conduct tax-loss harvesting are inclined to take action (with 22.9% harvested in This autumn during the last 5 years and 29.2% in This autumn during the last decade). In different phrases, in case you waited till the tip of the yr to manually harvest losses as a substitute of automating it year-round with Wealthfront, you seemingly missed out.

How a lot profit will you get from Tax-Loss Harvesting?

Your state of affairs is exclusive, so the precise profit you personally obtain from Tax-Loss Harvesting will seemingly be larger or decrease than the common figures offered on this put up. Some elements that have an effect on the profit you’ll obtain from Tax-Loss Harvesting are:

The riskiness of your portfolio. Riskier portfolios are typically extra risky, and extra volatility often means extra alternatives to reap losses.

While you make deposits. For those who make one massive deposit and by no means add extra, it will get more durable to reap losses over time. Frequent add-on deposits, nevertheless, imply you’ll have extra tax tons in your portfolio and it’s extra seemingly our software program will have the ability to harvest losses.

Your marginal tax price. The upper your marginal tax price, the extra you’ll save once you use losses to offset taxable good points. For those who reside in a excessive tax state and have a excessive earnings, you’re prone to get extra profit than somebody in a decrease tax bracket in a decrease tax state.

Your capability to make use of losses. It’s doable that you simply received’t notice sufficient capital good points annually to make use of your entire harvested losses. You would possibly even have unused losses after offsetting as much as $3,000 of peculiar earnings. That’s okay—you should utilize leftover losses in future years.

Wash gross sales. Often, some profit from Tax-Loss Harvesting could be misplaced to clean gross sales. Wash gross sales are comparatively uncommon at Wealthfront (they have an effect on lower than 0.01% of the common each day {dollars} traded, excluding withdrawals) as a result of our software program is designed to keep away from them throughout your entire Automated Investing accounts with us. When a wash sale does happen, it’s not a giant drawback—you simply have to attend a yr to comprehend the loss related to that transaction.

Appropriate alternates. Some investments supplied at Wealthfront aren’t eligible for Tax-Loss Harvesting as a result of we don’t have appropriate alternate ETFs obtainable for them. This may decrease your harvesting yield. You may at all times test to see if an ETF obtainable at Wealthfront has a Tax-Loss Harvesting alternate by looking for particular investments right here.

A strong tax-minimization technique in all market situations

At Wealthfront, we imagine what units us aside is our give attention to enhancing your after-tax returns. We wish to maximize your after-tax returns whether or not the market is up (because it typically was final yr) or down, and, though efficiency is dependent upon market situations, our Tax-Loss Harvesting service has a demonstrated monitor report of producing potential tax financial savings for purchasers in each situations. We’re delighted to supply it to you at no further price.