You may be surprised to learn that even if the value of your portfolio has decreased, you can still benefit and lower your tax burden through a strategy known as tax-loss harvesting. If you have decided to open an account at a Robo-advisor to benefit from the various advantages they offer, you might want to check if they provide tax-loss harvesting too.
Continue reading this article to discover more about tax-loss harvesting, how Robo-advisors make it automated, and which Robo-advisors have this feature. We will be covering:
What is tax-loss harvesting?
Do Robo-advisors offer tax-loss harvesting?
How Robo-Advisor Tax-Loss Harvesting Work?
Which Robo-Advisors Offer Tax-Loss Harvesting?
Is tax-loss harvesting worth it?
The bottom line
What is tax-loss harvesting?
Tax-loss harvesting is a method used by investors to reduce their tax bills. It is accomplished by selling investments that are at a loss in your portfolio and offsetting some or all of the realized capital gains on other investments (sold during the same year). For example, if you close a position with a capital loss of $1,000, it will offset a $1,000 capital gain on another security. So you will not be liable for any tax in this case as gains and losses were offset.
In summary, you sell at a loss, reduce or even eliminate your tax on capital gains accumulated throughout the year, and then buy a similar asset again, allowing you to keep the same exposure, asset allocation, and target risk of your portfolio.
Do Robo-advisors offer tax-loss harvesting?
Yes, some Robo-advisors provide automated tax-loss harvesting, which helps you reduce your tax burden. But keep in mind that not all Robo-advisors offer tax-loss harvesting techniques, or specific criteria must be met to benefit from automated tax-loss harvesting, such as your portfolio should be above a certain amount, or the loss should be beyond a pre-specified level.
How Robo-advisor tax-loss harvesting work?
Robo-advisors use an algorithm to build portfolios, perform rebalancing, and check for tax-loss harvesting opportunities within each portfolio. Their programs can easily identify which assets have unrealized losses and determine similar assets that can be purchased simultaneously without affecting the overall optimal asset allocation.
We analyzed Betterment's tax-loss harvesting strategy known as "Betterment's Tax Loss Harvesting+™." It is a fully automated harvesting strategy for Betterment's customers, where they regularly check for loss opportunities that can create value for clients. They define for each asset class in the portfolio a primary security and an alternate one. Both securities are highly correlated and are expected to produce nearly identical returns. That way, once the primary security is replaced with the alternative one, the portfolio will have the same risk exposure and expected return.
Below is an extraction of some primary and alternate securities used by Betterment’s Tax Loss Harvesting+™. As shown, both ETFs have the same exposure but are provided by different ETF providers.
Betterment Portfolio Primary and Alternate Instruments
Once the harvest of the loss is executed, Robo-advisors use the proceeds of the sale to rebalance the entire portfolio, and adjust the portfolio allocation to the target weights.
Are there any restrictions on tax-loss harvesting?
Depending on the country where you file your taxes, there might be some restrictions on how you apply tax-loss harvesting techniques. For example, in the US, the "wash-sale" rule prohibits the sale of a security at a loss and replacing it with the same or an identical investment 30 days before or after the sale. While the UK and the US have this rule, other countries do not have a wash-sale period. But do not worry, you don't need to be concerned about similar restrictions as the algorithms of Robo-advisors have rules in place to avoid triggering the wash-sale rule or other trading restrictions.
Which Robo-advisors offer tax-loss harvesting?
Various Robo-advisors offer tax-loss harvesting for their clients. We will list some of them in the below section.
As mentioned earlier, Betterment, a US Robo-advisor developed a strategy called “Betterment’s Tax Loss Harvesting+™”. The feature is available to all Betterment clients at no additional cost.
Betterment has no minimum balance to open an account and helps you manage your money through various automatically managed portfolios with socially responsible investing options. They also offer cash management services and financial planning tools. It has two offerings:
Betterment Digital, where you can start investing with a low management fee of 0.25% annually. They also give you access to financial advisors for an additional cost.
Betterment Premium: In addition to the features of Betterment Digital, you get full access to certified financial advisors and can add banking features to your account for free. To qualify, you must still have a minimum balance of $100,000, and the annual fee is increased to 0.40 %.
Wealthfront is a US-based Robo-advisor that recommends an automatically managed portfolio based on your risk profile and financial goals. They offer tax-loss harvesting on any taxable accounts.
The minimum balance to open an account is $500, and their fees are 0.25% per year. Wealthfront provides borrowing, cash management services, financial planning tools and offers automated tax-loss harvesting for its clients.
Schwab Intelligent Portfolios is another US Robo-advisor that offers automated tax-loss harvesting, but you should have invested assets in your portfolio greater than $50,000 (the minimum to open an account is $5,000). Schwab’s algorithm automatically monitors, on a daily basis, tax-loss harvesting opportunities and works on rebalancing the portfolios. You can open a traditional or retirement account, and they will invest your funds in ETFs that span more than 20 asset classes; the allocation depends on your investment strategy and risk profile. Schwab Intelligent Portfolios are among the cheapest Robo-advisors in the US as they do not charge any annual fees.
SoFi Automated Investing is a Robo-advisor offering tax-loss harvesting for the portfolios they manage. Like other Robo-advisors, SoFi recommends a portfolio containing between four and nine ETFs based on your risk profile. SoFi gives you access to several other products besides the Robo-advisory service, such as credit cards, insurance, loans, and crypto. The minimum amount to start investing is $1, and they offer their Robo-advisory services for free.
Axos Invest is a Robo-advisor by Axos Bank offering low-cost, automatically managed portfolios with a very high degree of customization. They also offer automated tax-loss harvesting and automatic portfolio rebalancing, keeping your portfolio holdings near their optimal levels. You should have more than $500 to start investing at Axos, and they charge an annual fee of 0.24% to manage your portfolio.
A Spanish Robo-advisor accessible to European and international investors. They offer a wide range of automatically managed portfolios, including socially responsible portfolios with a high degree of customization. InbestMe uses up to 3 equivalent ETFs for each position in your portfolio, so that their tax-loss harvesting procedure runs smoothly. The minimum amount to open an account at inbestMe is €1,000 for Spanish investors (€250 for pensions), and $/€5,000 for international investors, and their fees range between 0.15% and 0.50% per year. You can read our inbestMe review for further insights.
Questwealth is a Canadian Robo-advisor offering automatically managed pre-built portfolios. You can start investing with $1,000, and their fees are relatively low, ranging between 0.20% and 0.25% per year. They offer tax-loss harvesting that can be useful for money invested outside a Registered Retirement Savings Plan account (RRSP) or a tax-free savings account (TFSA).
Questwealth Homepage
Comparing Robo-advisors with tax-loss harvesting
Robo-advisors with Tax-Loss Harvesting
Is tax-loss harvesting worth it?
Yes, tax-loss harvesting is worth it. Although it can be an excellent technique to reduce your taxes, it is not for everyone and is not suitable for all accounts. Additionally, you should be aware of some restrictions like the “wash-sale” rule in the US, for example.
The bottom line
In conclusion, automated tax-loss harvesting is a feature offered by many Robo-advisors. It is often considered an advantage when comparing the services offered by different platforms. It follows the same logic as ordinary tax-loss harvesting executed by financial advisors, but the process is more automated and executed more frequently. Since most Robo-advisors use algorithms, they can easily identify assets with unrealized losses, harvest the loss by selling the assets, and replace them with other similar investments. Then the losses can be used to offset the taxable gains and reduce overall tax payments.
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