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Introducing Tax Loss Harvesting+

Our service is twice as effective as other TLH strategies.

Articles by Dan Egan
By Dan Egan VP of Behavioral Finance & Investing, Betterment Published Jun. 18, 2014
Published Jun. 18, 2014
5 min read
  • Tax loss harvesting can reduce your taxes.

  • Our service is twice as effective as other TLH strategies.

  • Betterment's best-in-class system avoids common pitfalls found in other tax loss harvesting strategies in order to help your portfolio grow faster.

There are many ways to get your investments to work harder for you—better diversification, downside risk management, and the right mix of asset classes for your risk level. We do all of that automatically for you at Betterment through our portfolio of low-cost index-tracking ETFs.

But there is another way to get even more out of your portfolio—capitalizing on investment losses to improve your after-tax returns with a method called tax loss harvesting.

Now, investors can do that seamlessly with Betterment’s new Tax Loss Harvesting+™ (TLH+™): a sophisticated, fully automated service for Betterment customers. Over the last 13 years, we looked at what TLH+ would have added to a portfolio for a single resident living in California and earning $100,000 in annual salary.¹ The result was +0.77% in additional returns. This extra portfolio growth comes at no extra downside risk, and no additional cost. It’s just smart investing.

In other scenarios, TLH+ would have provided as much as +1.4% in additional returns in the same time period.²


Additional returns with tax loss harvesting chart


The story doesn’t end there. When we did an apples-to-apples comparison, we also found that Betterment’s mean annual tax offset was 2x greater than the competition.


average annual tax offset by strategy chart


Read about the detailed methodology in our Tax Loss Harvesting+ white paper.

What is tax loss harvesting?

Tax loss harvesting is the practice of selling a security that has experienced a loss—and then buying a similar one to replace it. The replacement does two things: it allows the investor to “harvest”, or realize, a capital loss on his or her tax return, all while maintaining desired exposure to the asset class. The only way to realize a loss is to sell the depreciated asset.

It is a relatively simple concept that is hard to do right when you have many asset classes and even more tax lots in your portfolio.

Betterment’s TLH+ uses sophisticated software engineering to handle this complexity, scanning portfolios daily for losses (temporary dips that result from volatility), that can be harvested. Traditionally, a service like this was only available to high net worth investors—but we are now making it  more widely available than it ever has been before. Sophisticated DIY investors are also familiar with this practice, typically harvesting once a year, but daily harvesting, which is more effective, is virtually impossible to implement manually.

Betterment TLH+ strategy and benefits

We have built our best-in-class system from the ground up with the expertise of our investment team, tax experts, and software engineers. At the heart of TLH+ is a powerful algorithmic system for robust tax lot and wash sale management via our innovative Parallel Position Management (PPM) system. Our PPM system allows a single asset class to be comprised of two closely correlated securities indefinitely.

This dual-ticker system eliminates the limitations of existing tax loss harvesting strategies–including inadvertently triggering short-term capital gains (and potentially leaving you owing more tax), cash drag, interference between your taxable and IRA accounts, and throwing off your asset allocation.

Benefits you can expect:

  • You will never be exposed to short-term capital gains as a result of an attempt to harvest losses. Through our proprietary Parallel Position Management system, a dual-security asset class approach which enforces preference for one security, we never trigger short-term capital gains in an attempt to harvest losses.
  • You have zero cash drag at all times. With fractional shares, and seamless handling of all inflows during wash sale windows, every dollar is always invested at the desired allocation risk level.
  • Your harvests also serve as an opportunity to rebalance across all asset classes, rather than re-invest solely within the same asset class. This further reduces the need to rebalance during volatile stretches, which means fewer realized gains, and better after-tax returns.
  • You will never experience a disallowed loss through overlap with your IRA. We use a tertiary ticker system, eliminating the possibility of permanently disallowed losses due to subsequent IRA activity. This makes our TLH+ ideal for those who invest in both taxable and tax-advantaged accounts.

Should you use it?

Tax loss harvesting is beneficial for the majority of investors—when you can write off losses against capital gains, and/or up to $3,000 of ordinary income. Any losses not used to offset gains or ordinary income can be carried forward indefinitely until used up. The earlier you start tax loss harvesting—and the higher your current tax bracket—the more beneficial it can be over time.

However, harvesting lowers your cost basis, which can mean more taxes in the future—unless you don’t plan to liquidate your investments. That makes harvesting an especially beneficial strategy if you plan to donate some, or all of your assets to charity, or pass them down to your heirs, who will get a stepped-up basis.

However, there are some specific instances when you should not use TLH+, or should proceed with caution. Harvesting losses is not appropriate if you are in a low enough tax bracket to realize capital gains tax free. More generally, TLH+ primarily adds value through tax deferral, which is undesirable if your future tax bracket will be higher than your current. If you expect to achieve (or return to) substantially higher income in the future, tax loss harvesting may be exactly the wrong strategy—it may, in fact, make sense to harvest gains, not losses.

For married couples, TLH+ is designed to prevent inadvertent wash sales (where securities are sold and repurchased shortly thereafter) between two separate accounts or one joint account, and it allows the IRS to consider Betterment joint account activity as one.

When you enable TLH+ on your Betterment account, you’ll be asked for your spouse’s Betterment account information so that we can help optimize your investments across your accounts and help prevent wash sales

More tax optimization services

Tax Loss Harvesting+ is only one piece of the suite of tax optimization services we offer to all customers. Other tax benefits we include:

TaxMin lot selling: Every customer benefits from our TaxMin cost basis accounting method, where we sell lots with losses before gains, and lots with long term gains before short term gains. It is a more efficient way to handle accounting, that can save thousands in taxes.

Smart rebalancing: We use all cash flows and dividends as an opportunity to rebalance your portfolio. This reduces the need for selling to rebalance, which should lower your capital gains liability over time. Our intelligent algorithms will never trigger short-term capital gains to rebalance.

Tax-efficient securities: Our portfolio is built with tax-efficient exchange traded funds (ETFs), which can provide an estimated 0.7% in tax savings per year.

Tax-Coordinated Portfolio™: If you have long-term investments in multiple accounts, Tax-Coordinated Portfolio can apply an asset location strategy to help boost your after-tax returns. Our research estimates an additional benefit of 0.48% each year on average. Over 30 years, that’s an extra 15% in your pocket.

Read a detailed methodology in our Tax Loss Harvesting+ white paper and learn more about our tax optimization.

¹Additional key assumptions is liquidating 50% of the portfolio at the end of the period. More details are discussed in detail in our white paper and disclosure.

² Additional scenarios are discussed in detail in our white paper and disclosure.

Determination of most-trusted automated investment service reflects Betterment LLC’s distinction of having the most customers in the industry, made in reliance on customer counts, self-reported pursuant to SEC rules, across all online-only registered investment advisors.


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Original content by Betterment

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