Robo-advisers such as Wealthfront and Betterment tout daily tax-loss harvesting as a way to hike your returns. But independent research suggests the technique has less effect than claimed.
Tax-loss harvesting is a legal technique for reducing your tax liability. If you have sold an investment at a loss this year, you can use that to offset capital gains elsewhere in your portfolio. Or, if you didn't book any gains, you can use the loss to offset your ordinary income — declaring the maximum-allowed capital loss of $3,000 could mean a savings of several hundred dollars on your taxes.
But an investor who harvests a loss today might be raising her taxes in the future. Because loss harvesting only defers taxes — it doesn't eliminate them.
While most loss harvesting is done by hand once a year, robo-advisers harvest losses automatically, perhaps daily. Robo-advisers tout significant benefits. Wealthfront figured that it increased annual performance between 0.73 and 2.6 percent from 2012 to 2017, while Betterment estimates that it can deliver a 0.77 percent increase. But those figures are vastly overstated, said one critic of the robo-advisers.
Michael Edesess, chief investment strategist at Compendium Finance, an investment adviser, said Wealthfront fails to note that taxes must be paid later and that the one-year maximum write off is $3,000. Betterment's number is better, he says, but still exaggerated. He puts the real effect at between 0.15 percent and 0.25 percent annually.
Asked for comment, Wealthfront pointed to in-house data to reiterate its claims. Betterment cited other peer-reviewed studies estimating the value of harvesting at 0.37 and 0.50 percent, well above the critic's model.
All these figures could move downward based on changes to future capital gains tax rates. Higher future rates make loss harvesting less valuable, while lower future rates allow an investor to repay this "loan" at a lower cost.
Where tax rates go is anyone's guess, but the numbers touted by leading robo-advisers are not even close. "They're nothing more than a marketing gimmick," says Edesess.
