Harvest Tax-Loss Like a Pro with A Robo-Advisor
Tax-Loss Harvesting is a powerful yet complicated tool that you can use to your advantage. When you have an investment with an unrealized loss, you can sell that asset and then replace it with a similar security.
The S&P 500 index is was down over 17% in 2022. If you have a taxable investment account, there is no doubt that you had some unrealized losses in your portfolio.
Navigating the rules and documentation required for Tax-Loss Harvesting is complicated. However, there are several Robo-Advisor investment products that automatically take care of the process in the background.
What is Tax-Loss Harvesting?
When you have an unrealized loss, you can sell the equity, turning the loss into a realized loss. You can use the loss to offset capital gains.
Once you sell the equity, you replace it by purchasing another security. You cannot repurchase the same security you just sold within 30 days, or you will trigger the wash-sale rule. A wash-sale will wipe your loss from the books, and you will not be able to use it to offset capital gains.
You can avoid the wash-sale rule by selling one ETF for a different ETF that covers the same segment. You realize the loss and retain similar diversity in your portfolio by doing so.
Tax-Loss Harvesting is only applicable in taxable investment accounts. The tactic does not apply to 401K, IRA, or any other tax-advantaged account.
The IRS limits the amount of capital gains you can offset per year. The limit is $3,000 for an individual taxpayer. If your loss is on a long-term holding (more than 12 months), you can carry the loss forward to use in future years.
Tracking your assets and identifying opportunities for Tax-Loss Harvesting can be challenging. The process is pretty complicated and time-consuming. You also need to provide detailed documentation when filing your federal tax return.
Enter the Robo-Advisor
One of the early Robo-Advisors was Betterment. Today, there are many Robo-Advisors available. These investment platforms provide low-cost advisory services, including rebalancing and Tax-Loss Harvesting.
One advantage of a Robo-Advisor over a traditional human-managed account is that the Robo-Advisor is always looking at your account and identifying opportunities.
I try not to stare at the market, especially when it’s tanking. However, I know the market is making a big move south when I get an email from Betterment:
The Robo-Advisor has been rebalancing my portfolio and finding Tax-Loss Harvesting opportunities for the last five years. In that time, the robot has turned losses into opportunities to the tune of more than $46,000.
At the end of each year, Betterment provides me with all the documentation necessary to file my taxes. The robots do the heavy lifting.
There are many Robo-Advisors available now that provide Tax-Loss Harvesting. Some examples include Wealthfront, Schwab Intelligent Portfolios, Axos Invest, Future Advisor, and Betterment.
Who benefits from Tax-Loss Harvesting?
If you are in a drawdown phase in your financial journey, Tax-Loss Harvesting can help offset capital gains. You can use long-term losses that have been rolled from previous years to offset gains (up to $3,000 per year).
These losses can also be beneficial if you have individual stocks in your portfolio and want to sell to purchase a diverse product, like an ETF.
Gains from portfolio rebalancing can also be offset by losses that have been harvested.
Summarizing Robotic Tax-Loss Harvesting
Robots can simplify the management of your portfolio. You need to evaluate management fees before choosing the Robo-Advisor path. While most are low-cost, they are still significantly more expensive than a self-managed investment with Vanguard.
In my case, I have tax-advantaged accounts in very low-cost products like VTSAX from Vanguard. These retirement accounts do not benefit from Tax-Loss Harvesting, and I found no reason to pay for a service that provides no value.
A Robo-Advisor can bring value to your taxable investment accounts. Of course, you need to research based on your needs.
In my case, the robots bring enough value to justify the cost. And they make me feel like a pro when it comes to Tax-Loss Harvesting.
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