Tax Loss Harvesting 101

As robo advisors and other automated investing tools increase in popularity, more and more competitive features become available to help manage and optimize your investment portfolio. One of the more popular (and beneficial) features that many robo advisors offer is tax loss harvesting – an automated strategy to help decrease your tax liability.

Want to know how this feature will help you manage your taxable accounts and keep more money in your pocket? Read on where we discuss:

  • What is tax loss harvesting?
  • Which robo advisors offer the service?
  • How widely available is it?

What is Tax Loss Harvesting?

Tax loss harvesting is the process of selling a security at a loss in order to offset a capital gains tax liability. This liability is usually associated with a different security (that has increased in value), producing a short-term capital gain (which is taxed at a higher federal tax rate than long-term gains).

Watch the video below to get a better idea of what this process is all about:

In the world of Robo Advisors, the service recognizes the best time to sell your investment (that has decreased in value) in order to offset the tax liability of a different investment (which has risen in value).

Once the investment is sold, it is automatically replaced by a similar investment to harvest the tax loss, while still retaining the original asset allocation of your investment account. This allocation was previously calculated by the Robo Advisor to determine the most profitable route.

Tax Loss Harvesting example

The Best Robo Advisors for Tax Loss Harvesting

Although tax loss harvesting is a common feature among Robo Advisors, the following are two examples that make the service readily available to most investors:

Wealthfront

Wealthfront includes tax loss harvesting as part of its service for all accounts that meet the minimum balance of $500. The service also offers a more optimized version of this called ‘Direct Indexing’, which is offered to accounts that are worth more than $100,000. This feature lets Wealthfront buy and sell individual securities (rather than indexes) in order to further optimize the tax efficiency of your investments.

FutureAdvisor

FutureAdvisor offers a free service (for investors with balances of any size) and a more comprehensive premium service if your balance is over $10,000. If you opt for the FutureAdvisor Premium service, you will get to enjoy tax loss harvesting as a standard feature. Although some investors might find the $10,000 threshold to be quite steep, it is important to note that this is considerably lower than some other Robo Advisors.

How Widely Available is Tax Loss Harvesting?

Tax Loss HarvestingAlthough there are a lot of discussions on the benefits of tax loss harvesting, we believe that this service makes a real difference to the majority of investors.

This is why it is offered by many Robo Advisors on the market. But keep in mind that you may need to be over a certain investment threshold for the feature to activate on your account.

In many cases, the tax planning feature of the Robo Advisor will only come into action for balances that reach a certain threshold. This particular threshold will differ from one service to the next. Other robo advisors may activate it only on paid accounts, if they otherwise offer a free service.

We don’t generally see a problem with this, since low balances aren’t going to benefit from it as much as accounts with larger balances.

The service is impressive, but you should keep in mind that tax loss harvesting is only beneficial to investors with taxable accounts and not IRAs or other tax-exempt investments.