The Money Mustache Community
Learning, Sharing, and Teaching => Investor Alley => Topic started by: jeromedawg on December 04, 2014, 11:30:17 AM
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Hey guys,
I started reading up a little more on how some are using Betterment for their safety nets. It seems this is kind of a controversial topic where the naysayers wouldn't advise *investing* your savings money whereas proponents advise that it's only as risky as you want (or can tolerate) and in the end shouldn't leave you worrying a whole lot. So what's the consensus? I'm assuming it comes down to how comfortable you are with the risk of "investing emergency money" so maybe I'm just answering my own question.
Any pointers on why I should or shouldn't consider this though? I read somewhere that one person stated (or maybe it was based off of advice from Betterment) he would only go this route if he had $12k in SAVINGS, and anything in excess would be the "safety net" - does that make sense? I'm in a position where I think I could maintain a true savings and put down probably around $50k for a 'safety net' investment. I have much more stashed away in other taxable investments with Fidelity in addition to my non-taxable/retirement funds, so it's not like this is the last leg or anything. The reason Betterment is appealing is because there are fewer restrictions on withdrawals and thus easier access to that money in case it becomes "need it now" or "need it soon" money. As far as the fees go, it seems reasonable to pay the .25% when it seems like they take care of A LOT of things that you'd otherwise be worrying about managing yourself. At this point, I think I'd rather prefer to have a "set and forget" it type of investment in Betterment with this shorter-to-mid term money. In fact, as much as I'd like to call it a "safety net" or "rainy day" funds, I'd probably just leave it open and flexible to even become a home down-payment or car fund. Digression: besides Betterment are there other/better of these "robo" management tools out there? Wealthfront? Learnvest? etc? There's so many of these guys that it's hard keeping up with what it is they are or are even offering!
All that said, if it sounds like stashing this $50k in Betterment might be a good idea, what would you suggest my target allocation be?
Thoughts?
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Betterment suggests a 40/60 allocation: https://www.betterment.com/resources/personal-finance/safety-net-funds-why-traditional-advice-is-wrong/
A place you can do this for free is Wisebanyan.com. You have to refer 5 people to sign up (I referred myself 5 times) or wait until they invite you. However, Wisebanyan doesn't have muni bonds so their account is not as tax efficient as Betterment.
I actually invest my emergency fund at 40% stock and 60% bonds at TD Ameritrade in commission-free ETFs. The 40% stock allocation matches my 100% stock (for retirement) allocation. My retirement allocation is in my signature. Then for the bond portion, I'm 50% SHM and 50% ITM. Because I'm managing this myself, there's a little more work involved. It also takes longer to withdraw money because I have to wait for it to settle. Betterment is great because you can get your money on the 2nd business day as long as the request is made when the market is open. It also makes it incredibly easy because they do all of the rebalancing for you.
My actual emergency fund plan is 1 month's expenses in an online savings account and 3 month's expenses at TD Ameritrade. I keep debating on going with Betterment or Wisebanyan for this to make it simpler. If I did that, I'd just do 100% invested and not worry about the cash (since it'd be just as easy to withdraw money from Wisebanyan or Betterment as it is to get money from an online savings).
My favorite part of investing the emergency fund is that the money is still working for you and you shouldn't have to add money to it as your lifestyle grows. I'm all for investing my emergency fund, but most out there are not.
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I don't agree with investing in Betterment, but I DO support investing your emergency fund beyond a few thousand cash in the bank. Once you have enough money in the market, even if the market goes down 75%, you're still covered. And in the meantime, your money is working for you. Yes, you'll could possibly end up selling low, but that's better than letting your money sit stagnant (and you could also end up selling high).
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Thanks guys! Beric01, if not Betterment, where might you suggest investing an emergency fund as you were describing? And why are you opposed to Betterment? Is it mostly the fees?
Logan T, I did sign up for Wisebanyan but am on the waiting list. I may consider referring to speed things up. I do agree with the part about making my money continue working and growing but am trying to figure out the best vehicle at this time for it.
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This will be worth watching out for when it launches: https://intelligent.schwab.com/
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This will be worth watching out for when it launches: https://intelligent.schwab.com/
Nice! I recently just opened checking and investment accounts with Schwab (mostly so that I would have access to that ATM/Debit card with no foreign transaction fees and fully reimbursable global ATM fees)
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Thanks guys! Beric01, if not Betterment, where might you suggest investing an emergency fund as you were describing? And why are you opposed to Betterment? Is it mostly the fees?
Betterment is fairly controversial here - rather than making this another Betterment thread I'd suggest reading this one. (http://forum.mrmoneymustache.com/investor-alley/betterment/)
I just have all of my money in Vanguard index funds.
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This will be worth watching out for when it launches: https://intelligent.schwab.com/
Nice! I recently just opened checking and investment accounts with Schwab (mostly so that I would have access to that ATM/Debit card with no foreign transaction fees and fully reimbursable global ATM fees)
Then Schwab may be a great place to invest your emergency fund. Schwab has the lowest cost ETF's in the industry and also has access to over 100 commission-free ETFs. You could do something similar to me:
28% SCHB (Schwab US Multi-Cap Core)
12% SCHF (Schwab International Multi-Cap Core)
30% SHM (SPDR® Nuveen Barclays Short Term Municipal Bond)
30% TFI (SPDR® Nuveen Barclays Municipal Bond)
This is just an example of an easy 4-fund portfolio you could use at Schwab. The average expense ratio for the above is 0.17%.
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However the Schwab Intelligent Portfolio says it requires a $50k minimum investment. That might be too much for an emergency fund for some people.
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However the Schwab Intelligent Portfolio says it requires a $50k minimum investment. That might be too much for an emergency fund for some people.
$50k for tax loss harvesting. I believe the account minimum is only $5,000.
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Bogleheads is a great place for investment advice. Here's a recent post on investing your emergency fund and a lot of people gave examples of what they do: http://www.bogleheads.org/forum/viewtopic.php?f=1&t=150947
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Bogleheads is a great place for investment advice. Here's a recent post on investing your emergency fund and a lot of people gave examples of what they do: http://www.bogleheads.org/forum/viewtopic.php?f=1&t=150947
Thanks! I'm reading through it now. BTW: since I'm already investing with Fidelity, would it be advisable just continue with them even with a shorter-term emergency fund? I'm not sure what fund(s) I might want to get if I were to stick with Fidelity (if that's even advisable at all)
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Bogleheads is a great place for investment advice. Here's a recent post on investing your emergency fund and a lot of people gave examples of what they do: http://www.bogleheads.org/forum/viewtopic.php?f=1&t=150947
Thanks! I'm reading through it now. BTW: since I'm already investing with Fidelity, would it be advisable just continue with them even with a shorter-term emergency fund? I'm not sure what fund(s) I might want to get if I were to stick with Fidelity (if that's even advisable at all)
Fidelity offers iShares ETF's for free, so you could look into that if you'd like: https://www.fidelity.com/etfs/ishares-view-all
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Wow, I just stumbled across this on Bogleheads... I may consider just doing this! At least with $24k of the money!:
Mango, Union Plus, and Santander are worthwhile if you are willing to jump through the hoops. The best hands off method is:
$5000 in Mango savings
$5000 in Union Plus savings
$50 transfer to/from Mango
$500 transfer to/from Union Plus to avoid $2 fee (5.3% return at the margin for tying up an extra $450 makes it worthwhile)
$1500 transfer to/from Santander, less the amount of your 2 monthly bill payments
$12,050 total
This earns you:
$24 Mango
$20 Union Plus
$20 Santander
-$3 Mango fee
$732 total annually
Overall 6.1% annual return. This is where I keep my emergency fund and I have not had any issues with any of the accounts. If you have a spouse, you might be able to get 6% FDIC insured on $24k. That's a great deal.
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Oh yeah I read it wrong - the $50k minimum is only for the tax-harvesting part, same as Betterment. 5k minimum for the account then, you say? It doesn't say on the linked page. That's better. (Betterment is no minimum though)
However!
This part gives me pause:
"Schwab affiliates do earn revenue from the underlying assets in SIP accounts. This revenue comes from managing Schwab ETFs and providing services relating to certain third party ETFs that can be selected for the portfolio, and from the cash feature on the accounts."
So basically, since they don't make money from you directly, they will make money by buying Schwab ETFs.
I dunno.
That seems like it doesn't align their interests with yours.
I mean, Schwab ETFs are not like Vanguard's, right? Ultra-low load because it's really shareholder owned?
So they have a duty to you as manager of your account, but they have financial incentive to buy funds that give them better fees, whereas what it's in your best interest is funds with high performance, which means lower fees.
Classic opposing interests scenario it seems? Am I looking at this wrong?
When you charge direct fees up front like Betterment, the choice of funds to purchase is independent of the revenue stream so there is no financial incentive to skew fund selection away from what will actually perform the best for customers so that customer retention is high... Interests are aligned. (Whether the amount of the fee, 0.15-0.35% for betterment, is actually worth it is another matter. Personally I think it is indeed worth it in some cases but it's debatable regardless)
Hmmm.
If this analysis is correct, it means that Schwab Intelligent Portfolio might be a very bad deal...
(Potentially - I mean even if the fund selection is all reasonable fees now, that doesn't mean they can't invent new funds to buy at whatever fees they want in the future...)
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If this analysis is correct, it means that Schwab Intelligent Portfolio might be a very bad deal...
(Potentially - I mean even if the fund selection is all reasonable fees now, that doesn't mean they can't invent new funds to buy at whatever fees they want in the future...)
You have to wait and see what happens when it opens, but I expect the total fees for the underlying ETF's will come out very similar to Betterment's. Perhaps even a fraction lower.
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How? 90% of betterment's current fund selection are Vanguard funds...
Nobody beats Vanguard...
Or you mean the Schwab ETF load will be lower than the vanguard fees + betterment's 0.25% it puts on top?
Either way, it still incentivizes them to bias towards an asset allocation that makes them more money as opposed to less (whereas betterment makes the same money no matter the allocation). This is the whole point Vanguard started what he did -- because fund managers will never sell you what makes them the LEAST money -- he wanted to align the interests by making investors in the funds shareholders in the company (by making them the same people, poof! they're aligned)
EDIT: For example, what if your best interest happened to be an asset allocation that included NO schwab funds at all. That would result in them making no money at all. Obviously they wouldn't let that persist. So why would you believe they will play fair in the general case?
You can't let the fox guard the henhouse...
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Hey guys,
I started reading up a little more on how some are using Betterment for their safety nets. It seems this is kind of a controversial topic where the naysayers wouldn't advise *investing* your savings money whereas proponents advise that it's only as risky as you want (or can tolerate) and in the end shouldn't leave you worrying a whole lot. So what's the consensus? I'm assuming it comes down to how comfortable you are with the risk of "investing emergency money" so maybe I'm just answering my own question.
Any pointers on why I should or shouldn't consider this though? I read somewhere that one person stated (or maybe it was based off of advice from Betterment) he would only go this route if he had $12k in SAVINGS, and anything in excess would be the "safety net" - does that make sense? I'm in a position where I think I could maintain a true savings and put down probably around $50k for a 'safety net' investment. I have much more stashed away in other taxable investments with Fidelity in addition to my non-taxable/retirement funds, so it's not like this is the last leg or anything. The reason Betterment is appealing is because there are fewer restrictions on withdrawals and thus easier access to that money in case it becomes "need it now" or "need it soon" money. As far as the fees go, it seems reasonable to pay the .25% when it seems like they take care of A LOT of things that you'd otherwise be worrying about managing yourself. At this point, I think I'd rather prefer to have a "set and forget" it type of investment in Betterment with this shorter-to-mid term money. In fact, as much as I'd like to call it a "safety net" or "rainy day" funds, I'd probably just leave it open and flexible to even become a home down-payment or car fund. Digression: besides Betterment are there other/better of these "robo" management tools out there? Wealthfront? Learnvest? etc? There's so many of these guys that it's hard keeping up with what it is they are or are even offering!
All that said, if it sounds like stashing this $50k in Betterment might be a good idea, what would you suggest my target allocation be?
Thoughts?
1. In my opinion, if you feel you need a $50k "Safety Net", you need to rethink your asset allocation. Though honestly, the whole concept just reeks of someone trying to sell you something.
2. If you insist on a safety net, and absolutely don't want to think about anything I'd recommend one of the following:
Total Bond Market Index Admiral Shares (https://personal.vanguard.com/us/funds/snapshot?FundId=0584&FundIntExt=INT) - 100% Bonds at 0.08 ER
Short to mid term growth you say? How about Vanguard Balanced Index Fund Admiral Shares (https://personal.vanguard.com/us/funds/snapshot?FundId=0502&FundIntExt=INT) - 60/40 stocks/bonds - 0.09 ER
Both of these funds will automatically rebalance for you, won't charge you any transaction fees for buying/selling, allow for automatic monthly deposits, and let you withdraw it all back to your bank account at any time.
3. A 0.25 is ridiculously high. When you combine it with the 0.16 of the underlying funds, you're looking at a 0.41 total expense ratio. If you're doing Tax Loss Harvesting, this doesn't take into account any extra fees incurred from moving around your 401k to avoid wash sales. If you compare this to simply putting your money in a bond fund for just 10 years:
(http://i.imgur.com/2FVxRoc.png)
The extra fees you'll pay are the equivalent of a 6.25% Load. If you keep it there for 30 years, you will have spent over half your initial investment in fees.
(http://i.imgur.com/C5tEIlm.png)
http://www.begintoinvest.com/expense-ratio-calculator/
Two of the most important things to remember when investing:
1. Keep your expenses low
2. Keep it simple
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Hey guys,
I started reading up a little more on how some are using Betterment for their safety nets. It seems this is kind of a controversial topic where the naysayers wouldn't advise *investing* your savings money whereas proponents advise that it's only as risky as you want (or can tolerate) and in the end shouldn't leave you worrying a whole lot. So what's the consensus? I'm assuming it comes down to how comfortable you are with the risk of "investing emergency money" so maybe I'm just answering my own question.
Any pointers on why I should or shouldn't consider this though? I read somewhere that one person stated (or maybe it was based off of advice from Betterment) he would only go this route if he had $12k in SAVINGS, and anything in excess would be the "safety net" - does that make sense? I'm in a position where I think I could maintain a true savings and put down probably around $50k for a 'safety net' investment. I have much more stashed away in other taxable investments with Fidelity in addition to my non-taxable/retirement funds, so it's not like this is the last leg or anything. The reason Betterment is appealing is because there are fewer restrictions on withdrawals and thus easier access to that money in case it becomes "need it now" or "need it soon" money. As far as the fees go, it seems reasonable to pay the .25% when it seems like they take care of A LOT of things that you'd otherwise be worrying about managing yourself. At this point, I think I'd rather prefer to have a "set and forget" it type of investment in Betterment with this shorter-to-mid term money. In fact, as much as I'd like to call it a "safety net" or "rainy day" funds, I'd probably just leave it open and flexible to even become a home down-payment or car fund. Digression: besides Betterment are there other/better of these "robo" management tools out there? Wealthfront? Learnvest? etc? There's so many of these guys that it's hard keeping up with what it is they are or are even offering!
All that said, if it sounds like stashing this $50k in Betterment might be a good idea, what would you suggest my target allocation be?
Thoughts?
1. In my opinion, if you feel you need a $50k "Safety Net", you need to rethink your asset allocation. Though honestly, the whole concept just reeks of someone trying to sell you something.
2. If you insist on a safety net, and absolutely don't want to think about anything I'd recommend one of the following:
Total Bond Market Index Admiral Shares (https://personal.vanguard.com/us/funds/snapshot?FundId=0584&FundIntExt=INT) - 100% Bonds at 0.08 ER
Short to mid term growth you say? How about Vanguard Balanced Index Fund Admiral Shares (https://personal.vanguard.com/us/funds/snapshot?FundId=0502&FundIntExt=INT) - 60/40 stocks/bonds - 0.09 ER
Both of these funds will automatically rebalance for you, won't charge you any transaction fees for buying/selling, allow for automatic monthly deposits, and let you withdraw it all back to your bank account at any time.
3. A 0.25 is ridiculously high. When you combine it with the 0.16 of the underlying funds, you're looking at a 0.41 total expense ratio. If you're doing Tax Loss Harvesting, this doesn't take into account any extra fees incurred from moving around your 401k to avoid wash sales. If you compare this to simply putting your money in a bond fund for just 10 years:
(http://i.imgur.com/2FVxRoc.png)
The extra fees you'll pay are the equivalent of a 6.25% Load. If you keep it there for 30 years, you will have spent over half your initial investment in fees.
(http://i.imgur.com/C5tEIlm.png)
http://www.begintoinvest.com/expense-ratio-calculator/
Two of the most important things to remember when investing:
1. Keep your expenses low
2. Keep it simple
The above analysis is seriously flawed.
While it is true that low fees are one of, if not the most important factor for optimizing any investment strategy, all else being equal, it does not follow that you can compare any 2 approaches and assume they will have identical returns before fees.
Furthermore, even if that were your assumption, then for taxable accounts greater than 50,000 Betterment would generally be a better approach than DIY vanguard due to tax loss harvesting since TLH will on average more than cover the 0.15-0.25% fees. (this statement is particularly true for high tax bracket individuals, and untrue for those in the 15% tax bracket or lower.)
Also comparing total expenses over 10 years to a 6.25% load completely ignores the compounding effect and the discounted nature of future returns.
As an example if you assumed a 6.25 % load and started off with $46,874.66 (50,000- your "load") compounded at 7.6 %, after 10 years you would end up with $97,511.25, versus 104,014.22 if you had started off with the full $50,000. a difference of $6502.97.
But if you start off with 50K in both accounts and compound at 7.52 % for the cheap account, and 7.19 % for the expensive account, you would end up with 103,243.46 in the cheap account versus 100,118.13 in the expensive account. A difference of 3125.33.
So unless $6502.97 = $3125.33, then an increase of 33 basis points in ER is not in any way equivalent to a 6.25% load.
Finally even if you did assume that both approaches returned an identical 7.6 % arithmetic return, the actual CAGR (ie the actual return) of the Betterment portfolio would generally be higher due to the lower volatility that comes with increased diversification. (If you disagree, feel free to backtest the sharp ratios of the betterment portfolio compared to your proposed portfolio.)
Betterment vs Vanguard for this purpose is a complex question, but the preceding analysis was so simple as to be uselsess. And as the saying goes; garbage in, garbage out....
The OP would be well served by either, and it ends up being a simple matter of preference.
In other words it is wise to keep it simple, but not too simple.
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Hey guys,
I started reading up a little more on how some are using Betterment for their safety nets. It seems this is kind of a controversial topic where the naysayers wouldn't advise *investing* your savings money whereas proponents advise that it's only as risky as you want (or can tolerate) and in the end shouldn't leave you worrying a whole lot. So what's the consensus? I'm assuming it comes down to how comfortable you are with the risk of "investing emergency money" so maybe I'm just answering my own question.
Any pointers on why I should or shouldn't consider this though? I read somewhere that one person stated (or maybe it was based off of advice from Betterment) he would only go this route if he had $12k in SAVINGS, and anything in excess would be the "safety net" - does that make sense? I'm in a position where I think I could maintain a true savings and put down probably around $50k for a 'safety net' investment. I have much more stashed away in other taxable investments with Fidelity in addition to my non-taxable/retirement funds, so it's not like this is the last leg or anything. The reason Betterment is appealing is because there are fewer restrictions on withdrawals and thus easier access to that money in case it becomes "need it now" or "need it soon" money. As far as the fees go, it seems reasonable to pay the .25% when it seems like they take care of A LOT of things that you'd otherwise be worrying about managing yourself. At this point, I think I'd rather prefer to have a "set and forget" it type of investment in Betterment with this shorter-to-mid term money. In fact, as much as I'd like to call it a "safety net" or "rainy day" funds, I'd probably just leave it open and flexible to even become a home down-payment or car fund. Digression: besides Betterment are there other/better of these "robo" management tools out there? Wealthfront? Learnvest? etc? There's so many of these guys that it's hard keeping up with what it is they are or are even offering!
All that said, if it sounds like stashing this $50k in Betterment might be a good idea, what would you suggest my target allocation be?
Thoughts?
1. In my opinion, if you feel you need a $50k "Safety Net", you need to rethink your asset allocation. Though honestly, the whole concept just reeks of someone trying to sell you something.
2. If you insist on a safety net, and absolutely don't want to think about anything I'd recommend one of the following:
Total Bond Market Index Admiral Shares (https://personal.vanguard.com/us/funds/snapshot?FundId=0584&FundIntExt=INT) - 100% Bonds at 0.08 ER
Short to mid term growth you say? How about Vanguard Balanced Index Fund Admiral Shares (https://personal.vanguard.com/us/funds/snapshot?FundId=0502&FundIntExt=INT) - 60/40 stocks/bonds - 0.09 ER
Both of these funds will automatically rebalance for you, won't charge you any transaction fees for buying/selling, allow for automatic monthly deposits, and let you withdraw it all back to your bank account at any time.
3. A 0.25 is ridiculously high. When you combine it with the 0.16 of the underlying funds, you're looking at a 0.41 total expense ratio. If you're doing Tax Loss Harvesting, this doesn't take into account any extra fees incurred from moving around your 401k to avoid wash sales. If you compare this to simply putting your money in a bond fund for just 10 years:
(http://i.imgur.com/2FVxRoc.png)
The extra fees you'll pay are the equivalent of a 6.25% Load. If you keep it there for 30 years, you will have spent over half your initial investment in fees.
(http://i.imgur.com/C5tEIlm.png)
http://www.begintoinvest.com/expense-ratio-calculator/
Two of the most important things to remember when investing:
1. Keep your expenses low
2. Keep it simple
The above analysis is seriously flawed.
While it is true that low fees are one of, if not the most important factor for optimizing any investment strategy, all else being equal, it does not follow that you can compare any 2 approaches and assume they will have identical returns before fees.
Furthermore, even if that were your assumption, then for taxable accounts greater than 50,000 Betterment would generally be a better approach than DIY vanguard due to tax loss harvesting since TLH will on average more than cover the 0.15-0.25% fees. (this statement is particularly true for high tax bracket individuals, and untrue for those in the 15% tax bracket or lower.)
Also comparing total expenses over 10 years to a 6.25% load completely ignores the compounding effect and the discounted nature of future returns.
As an example if you assumed a 6.25 % load and started off with $46,874.66 (50,000- your "load") compounded at 7.6 %, after 10 years you would end up with $97,511.25, versus 104,014.22 if you had started off with the full $50,000. a difference of $6502.97.
But if you start off with 50K in both accounts and compound at 7.52 % for the cheap account, and 7.19 % for the expensive account, you would end up with 103,243.46 in the cheap account versus 100,118.13 in the expensive account. A difference of 3125.33.
So unless $6502.97 = $3125.33, then an increase of 33 basis points in ER is not in any way equivalent to a 6.25% load.
Finally even if you did assume that both approaches returned an identical 7.6 % arithmetic return, the actual CAGR (ie the actual return) of the Betterment portfolio would generally be higher due to the lower volatility that comes with increased diversification. (If you disagree, feel free to backtest the sharp ratios of the betterment portfolio compared to your proposed portfolio.)
Betterment vs Vanguard for this purpose is a complex question, but the preceding analysis was so simple as to be uselsess. And as the saying goes; garbage in, garbage out....
The OP would be well served by either, and it ends up being a simple matter of preference.
In other words it is wise to keep it simple, but not too simple.
Ouch! Thanks for checking my math milesdividendmd. It's just about a 4.3% load, not 6.25%.
For your last objection, I've seen no evidence that past performance predicts future returns, and in terms of total number of assets (the standard definition of diversification) Betterment's portfolio is less diversified, so you and I will never agree on that point.
Honestly, this whole TLH thing just reeks of someone trying to sell you something. Not you specifically milesdividendmd, it just sounds like a marketing gimmick. This is the type of stuff I expect from companies trying to maximize profits. There are a lot of factors to consider here, like tax bracket (as you mentioned), total portfolio ER increases in other accounts in attempts to avoid the wash sale rule...etc. Let's ignore all that for a moment.
For someone making a single $50,000 deposit, tax loss harvesting will likely provide them no benefit after the first few years. There will simply be 0 gains to harvest. To understand how this can happen (for the newbies in the thread, I'm sure you already know where I'm going with this), let's take a look at a typical portfolio growth for someone 100% invested in stocks (Red Line):
(http://blogs-images.forbes.com/rickferri/files/2012/03/DividendsFig-1.png)
As you can see, the investor starting in 1950 had 0 losses to harvest over the lifetime of their investment. If we look closely, we can see there are a few years where the investor could have been "lucky" by investing at a short-term peak, and therefore had some losses to harvest, but even then it only happened once. Well, besides the year 2000, where they could've harvested relatively big losses twice, but we'll get to that.
Now let's look at someone 100% invested in bonds over almost the same time period (Orange Line):
(http://i.imgur.com/aoI1Jn0.png)
Again, 0 losses to harvest over the lifetime of their investment. As before, there are a few years where you could've been "lucky" but incurring a small temporary loss by investing at the peak, but I wouldn't count on it. Even if it happens, it won't last long.
Finally, let's look at a portfolio more like what the OP might be looking for, something like a 50/50 or 60/40 allocation (Orange Line):
(http://i.imgur.com/TjSzTZc.png)
As expected, putting stocks and bonds together, doesn't really change the calculation much. Looking at the chart, the absolute best time period for Tax Loss Harvesting, was in 2000. In the year 2000, you will have incurred two bear markets right at the beginning. Does no one else see a big red flag that it's the year 2000 Betterment choose to start with when explaining their service?
Anyway, let's see how much Tax Loss Harvesting Betterment says would have occurred during this period:
(http://i.imgur.com/ZCJwkZT.png)
Of course, they can't harvest losses which didn't happen, so once the investment actually has gains (passes the 2000 peak), there is no benefit to Tax Loss Harvesting. Despite the high likelihood of there being no benefit after just a few years (and possibly no benefit at all ever), the 0.41 ER will continue year, after year, after year. Considering all this, I wouldn't recommend Betterment for the OP's purpose of a safety net investment.
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My Betterment has harvested $2000 of losses in a 90/10 portfolio during 2014. This is during a year when the S&P is up over 10%. Just FYI.
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My Betterment has harvested $2000 of losses in a 90/10 portfolio during 2014. This is during a year when the S&P is up over 10%. Just FYI.
Great, that sure makes for a catchy selling point. Two questions for you:
1. Do you expect the ETFs in your portfolio to go up, past the price of your original purchase, over time?
2. If so, do you expect your portfolio to continue harvesting losses after that point?
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1. Don't know
2. Don't care
Not trying to sell you anything. Good luck!
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Of course I'm not claiming that past performance predicts future results.
In contrast your example relies on the explicit assumption that future results of the 2 proposed portfolios will be identical before fees.
I will bet you any amount of money that 10 years from now the before expense (and after expense ratios for that matter) returns of the example portfolios will not be identical.
As to TLH being a gimmick, I can only tell you that in less than 6 months I have personally saved enough in taxes to cover more than 2 years expense ratios. That's real savings and it was effortless. So experience tells me that it is not a gimmick. For me it was unequivocally cheaper than vanguard this year.
Besides all of this betterment is a better user experience than vanguard and even if you take away the betterment fees and features, I believe their portfolio to be far superior. (Though this is clearly a matter of personal preference....I'm a believer in the size and value premia, and modern portfolio theory. To each his own.)
As to your pictorial analysis, of TLH it ignores the slice and dice nature of the Betterment portfolio. As an example Emerging markets would have been harvested last year in betterment despite the overall growth of the portfolio, with Zero opportunity in the vanguard all in one fund.
Finally note that you could not harvest in only 3 of the 14 years in the Betterment graphic, and you can carry forward losses from earlier years to offset income in future years. So one would have had to be very unlucky indeed not to be able to take advantage of a 50K, lump investment in a betterment stock bond portfolio.
In fact even if you had started in 2005, you would have been able to take a loss in 07 and 08 based on the size of the bear market.
This years 7% sub-correction was not a rare event, in fact the past few years have been abnormally lacking in volatility if anything. (QE perhaps?)
And if you continue to contribute to your taxable account (as most investors do), your ability to really TLH never expires.
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Of course I'm not claiming that past performance predicts future results.
In contrast your example relies on the explicit assumption that future results of the 2 proposed portfolios will be identical before fees.
I will bet you any amount of money that 10 years from now the before expense (and after expense ratios for that matter) returns of the example portfolios will not be identical.
As to TLH being a gimmick, I can only tell you that in less than 6 months I have personally saved enough in taxes to cover more than 2 years expense ratios. That's real savings and it was effortless. So experience tells me that it is not a gimmick. For me it was unequivocally cheaper than vanguard this year.
Besides all of this betterment is a better user experience than vanguard and even if you take away the betterment fees and features, I believe their portfolio to be far superior. (Though this is clearly a matter of personal preference....I'm a believer in the size and value premia, and modern portfolio theory. To each his own.)
As to your pictorial analysis, of TLH it ignores the slice and dice nature of the Betterment portfolio. As an example Emerging markets would have been harvested last year in betterment despite the overall growth of the portfolio, with Zero opportunity in the vanguard all in one fund.
Finally note that you could not harvest in only 3 of the 14 years in the Betterment graphic, and you can carry forward losses from earlier years to offset income in future years. So one would have had to be very unlucky indeed not to be able to take advantage of a 50K, lump investment in a betterment stock bond portfolio.
In fact even if you had started in 2005, you would have been able to take a loss in 07 and 08 based on the size of the bear market.
This years 7% sub-correction was not a rare event, in fact the past few years have been abnormally lacking in volatility if anything. (QE perhaps?)
And if you continue to contribute to your taxable account (as most investors do), your ability to really TLH never expires.
You're missing the point. I understand they won't be identical, but I can't show someone how fees affect the account, if more than one variable is being considered.
I just read the fine print on that Betterment chart, and it's worse than I thought. Now it makes sense how they were able to tax loss harvest over this time, the portfolio, "deposits twice a month that start at $750 and increase annually by 5%". Over that 14 year period, the additional contributions totaled $364,423. Significantly more than the $50,000 initial deposit. This is the only way to take advantage of the volatility during this time period, as you can't tax loss harvest the same dollar again, unless the previous low is breached.
I don't doubt that tax loss harvesting is possible in the short term. If you expect each individual ETF in your portfolio to rise over time, however, it will not be there for the long term. But the higher ER will. Since the ER is percentage based, this is easily hidden, but let's see if I can highlight it. Milesdividendmd has saved enough in taxes to cover 2 years of fees. I presume he means the additional 0.15 ER that Betterment adds on, so let's make it 4 years of fees just in case. let's see what that looks like with a $100,000 deposit, and the worst case scenario (hehe), each ETF individually has an 11.5% yearly growth:
Year 1: $100,000 deposit, market goes up 11.5%, but is volatile enough that tax loss harvesting got you a $600 gain -$310 fee = $111,754
Year 2: 11.5% gain across all ETFs - Account is now $124,220 (after 0.0031% fee), you can no longer tax loss harvest, as there are no losses to harvest. Current year fee on $124,220= $386
Year 3: 11.5% gain across all ETFs every year from here on out - Account is now $138,076, with a $429 fee
Year 4: $153,477 with a $477 fee
Year 5: $170,597 with a $530 fee
Year 6: $189,626 with a $590 fee
Year 7: $210,777 with a $655 fee
Year 8: $234,288 with a $729 fee
Year 9: $260,421 with a $810 fee
Year 10: $289,469 with a $900 fee (total fees so far = $5,817)
...
Year 20: $833,426 with a $2,592 fee (total fees so far = $22,673)
How is this easily hidden? It's easily hidden, because if you invest another $100,000 in the second year, and get another $600 tax gain that year, you'd be up big-time! As far as you can see, each $100,000 invested, nets another $600 gain in taxes. To visualize this, imagine each $100,000 deposit, as a separate container. It's really easy to see the gain when your taxes are reduced, but not so easy to see the ER fee. I suspect this is why many people think they are turning a profit from their mortgage interest tax deduction. This strategy is essentially laddering you into higher and higher fees, which will never tip back in your favor. After the second year that each $100,000 container stays in the portfolio, the fees overcome the initial $600 gain, and it's all downhill from there. You can hide this if you keep depositing, but after a few more years even the $600 gain from that year will be usurped by the overall fees.
Even if you deposit significantly more than your initial deposit (as in the Betterment chart above), that does not affect the fees on the initial $100,000 container, you're just digging yourself deeper. I charted this out in Excel, hopefully it makes sense:
(http://i.imgur.com/aQLcI3s.png)
That's a single $100,000 deposit. Column A is the account value each year, and Column B is the fee incurred that year, 0.31 ER. I included a +$600 boost the first year form TLH. Now let's see what that looks like laddered, if you make the same $100,000 deposit each year, for 6 years:
(http://i.imgur.com/N0CqzFn.png)
and calculated the fees incurred:
(http://i.imgur.com/Fuf14fp.png)
Long story short, for the OP who will be making a single deposit, the extra fee very much seems to outweigh the gains. For someone continually making deposits, you're just making it worse.
Note, I attached the excel sheet used to make the calculations. I'm sure I messed up somewhere, but the overall story shouldn't change.
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You are again making The elemental mistake of counting future expenses as equivalent to current savings. A dollar saved now (with TLH) is worth much more than a dollar saved in 20 years (from a 15 basis point expense ratio.)
You are once again forgetting about the elemental importance of compound interest. This is the point that I already made regarding your original flawed statement equating expenses charged over 10 years to an initial load.
The assumptions in the betterment scenario are all quite reasonable. for most investors saving is a lifelong endeavor, and savings rates go up over time as people get closer to retirement. This is certainly my plan.
As such for the typical investor tax loss harvesting will be a continual benefit that more than offsets betterments low fees. (Keep in mind that once accounts are over $100,000, the fee drops to 0.15%.)
Over The next 20 years there is some probability that the betterment portfolio will outperform Vanguard, and vice versa.
For an investor who continues to invest his taxable savings in betterment, the fees will usually be lower than Vanguard because of ongoing tax loss harvesting (again dependent on the tax rates during employment and retirement years.)
This fixation on making betterment out to be some nefarious High cost product is totally dependent on straw man arguments and bad math.
It would think it would give you pause that MMM and Mad Fientist have both come to a very different conclusion from you. (I make no claims about my own wisdom.)
The sad fact is that most investors will underperform both approaches because of behavioral errors, tax decisions, and performance chasing.
Presenting this decision as a black and white choice is nothing more than a distraction.
OP would do very well with either approach.
It just comes down to individual factors and personal preference.
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You are again making The elemental mistake of counting future expenses as equivalent to current savings. A dollar saved now (with TLH) is worth much more than a dollar saved in 20 years (from a 15 basis point expense ratio.)
You are once again forgetting about the elemental importance of compound interest. This is the point that I already made regarding your original flawed statement equating expenses charged over 10 years to an initial load.
Nope. I included the +$600 in the first year of every $100,000 deposit. The compound interest is fully taking into account the money gained from tax loss harvesting. It doesn't help, as it is very quickly spent in fees, at the end of the second year in that example. The concept is quite simple. A fixed benefit in the beginning, is trumped by a percentage fee later on. Even if I change the math so you get a full $600 tax benefit for the first 5 years, the percentage still catches up within a few years:
(http://i.imgur.com/hIQrkn9.png)
(http://i.imgur.com/b5e60dH.png)
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Unfortunately, I made a mistake in the last post. Even if we assume someone is in a ridiculously high tax bracket, earning $400,000 a year in taxable income, the maximum amount you can get from Tax Loss Harvesting in any one particular year, is $990. Instead of doing all the calculations over again, here's that last calculation, taking the cap into account:
(http://i.imgur.com/uxQIdzY.png)
(http://i.imgur.com/qdUdQxX.png)
In short, even if you make six $100,000 deposits, one a year, and have market conditions which allow you to tax loss harvest a +$600 gain each year for the first 5 years, the amount of fees accumulated by the year after your 6th deposit, will be larger than the total amount of tax loss harvesting you will ever accumulate.
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Say what? Your assumption here is a real head scratcher.
You can use tax losses to offset $3000 in ordinary income! So assuming a top state/federal income tax rate of 50% that's 1500/year before you offset one dollar in capital gains.
I think it's hilarious that you critique betterment for assuming A 5% increase in taxable contributions per year, and then you model contributing 100,000 a year for 5 years, and then never contributing again!
Who does that?
Talk about cringe worthy assumptions.
Garbage in, garbage out.....
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Say what? Your assumption here is a real head scratcher.
You can use tax losses to offset $3000 in ordinary income! So assuming a top state/federal income tax rate of 50% that's 1500/year before you offset one dollar in capital gains.
I assumed the person has a yearly income of $400,000
(http://i.imgur.com/Rlu7BkD.png)
Changing this to 50% does not significantly change the numbers. It's a still a loser.
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That's a 39.6 federal tax rate. Your calculation does not include state income taxes, or short and long term capital gains.
And last time I checked 50% of $3000 is not $990. (Your stated "maximum you can get from TLH")
But whatever, we all make simple math errors.
The more important point is that Betterment's assumptions are far more reality based than yours.
Your scenario is completely unrealistic for 99.9 % of investors.
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I think it's hilarious that you critique betterment for assuming A 5% increase in taxable contributions per year, and then you model contributing 100,000 a year for 5 years, and then never contributing again!
Who does that?
Stopping contributions after 5 years puts the numbers more in favor of Betterment. Contributing more into a strategy that gets an early bump, then loses over the long term, only puts you further behind. Do it more than a few times, and the losses from the first deposit, are higher than the tax loss benefit from the latest contribution. In other words, the more you put in, the more behind you get, as the fee is percentage based, and the fee just gets higher.
Adding more to a loser, only makes a bigger loser. Here's how it looks when you make a deposit once a year, for 10 years:
(http://i.imgur.com/Qlds4dz.png)
The fee in year 13 is $8,168, whereas the fee with a DIY Vanguard portfolio for that year would only be $1,839. I do not recommend continuing to add to this portfolio to gain Tax Loss Harvesting, as even the maximum possible gain is dwarfed by fees.
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The longer you add the more likely it is that you can TLH at every possibility.
The more you have, the more important it is to have tax efficient deposits and withdrawals from your account.
Plus if you get toThe point where your account is so large that a 0.15% additional fee,is so large that it significantly impacts your portfolio, out of proportion to tax loss harvesting, then you can simply transfer your ETFs holdings to another brokerage with no accounts under management fees.
But the decreased likelihood of you making mistakes and rebalancing, poorly timing the market, and otherwise doing what 99.9% of the investors do will likely make the 0.15% betterment fee well worth the money.
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But the decreased likelihood of you making mistakes and rebalancing, poorly timing the market, and otherwise doing what 99.9% of the investors do will likely make the 0.15% betterment fee well worth the money.
Compared to a 3 fund DIY portfolio at Vanguard, it's a 0.24% increase. Since you said 0.15% though, you are indeed comparing Apples to Apples. Fully Automated at Vanguard vs. Fully Automated at Betterment is a 0.15% difference. I have yet to see a convincing argument why someone would be more likely to make mistakes with one Fully Automated system vs another. Can you explain your reasoning?
Now that I think about it, I do remember a compelling argument against Betterment's Fully Automated system:
-------------------
When I'm talking to my Dad, or someone who doesn't know about investing (happens often), it's important to watch my words. If I recommend he move to Betterment, because the tilts have beaten the market in the past, and I believe it will beat the market in the future, that's a dangerous seed to plant. He might, as Ben did above, feel the need to bail out because, "The tilts aren't beating the market anymore, I'm DOWN this year!!!"
Or he might feel the need to bail out, because "I've done some research, and if I put all my money into the Healthcare fund (or your 3X leverage fund), I would have DESTROYED the market over the last 5 years! I'm putting my money there!"
I don't believe the general public, or people who don't know much about the market, will do well with that information. If we recommend they tilt a certain way based on past performance, and the results aren't what they expect ("the TV says the market is up today, but I checked online and my portfolio is DOWN 5%!"), it's natural for them to start thinking about ways to tinker with the formula, which can lead to bailing out at a market low.
Recommending total market index funds, or Vanguard LifeStrategy funds, doesn't have that problem. When recommending this to a friend, I stress this is the best way forward, not because of past performance, but because math. Since you can't know what the future will bring, going with an index (the average) mathematically ensures you will either beat, or match, at least half of all dollars invested in the market.
This is a very different mindset.
...
Indeed, the inclusion of bonds will likely have a tracking effect vs the S&P500, but if you have the right mindset, you won't care. In my opinion recommending a tilt is a step away from that.
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Compelling to whom?
I am sure that your own arguments are quite compelling to yourself Dodge.
So you've always got that...
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And if you want to compare apples to apples,
Vanguard's coming roboadvisory service will cost 0.3% AUM, for assets over $100,000. In other words it will be twice the cost of betterment!
https://www.kitces.com/blog/vanguard-personal-advisor-services-vpas-the-first-low-cost-indexing-solution-for-financial-planning-services/
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And if you want to compare apples to apples,
Vanguard's coming roboadvisory service will cost 0.3% AUM, for assets over $100,000. In other words it will be twice the cost of betterment!
https://www.kitces.com/blog/vanguard-personal-advisor-services-vpas-the-first-low-cost-indexing-solution-for-financial-planning-services/
This does not refute my position.
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Just got a nice email message from betterment that they TLH'd another $393.
Another year of fee free investing in the bag.
It would be tough to oversell how happy that makes me. Especially since I had to do exactly nothing to make it happen.
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I hear you... I'm up to $2500 harvested for the year. I look at it as getting my dividends for "free" in 2014. At our income levels anything that helps offset the tax burden is a nice bonus.
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In fact, as much as I'd like to call it a "safety net" or "rainy day" funds, I'd probably just leave it open and flexible to even become a home down-payment or car fund.
To answer your original question, it really doesn't make sense to use Tax Loss Harvesting in this situation. Tax Loss Harvesting isn't free money, whatever you deduct is owed back when you sell. If you earn $100,000 a year (28% tax bracket), and get the full $3000 deductible, you'll get $840 back in taxes this year. However, if you plan on cashing out your investments in 5 years to buy a house/car, while you're still in the 28% tax bracket, you will owe the government an additional $840 in taxes that year. In other words, while tax loss harvesting doesn’t necessarily produce any net tax savings, it is the equivalent of getting an interest-free loan from the Federal government.
(https://www.kitces.com/wp-content/uploads/2014/12/Graphics_Scenario12.png)
If you invest that $840 back into the Betterment, and get an 11.5% gain for the year, your $840 will have grown to $936, for a profit of $96 from your interest free loan. Not bad! And how much will Betterment charge you for this service? $255. How much would Vanguard have charged you for a fully automatic "set it and forget it" 60/40 stock/bond fund that handles rebalancing across 10,752 unique assets? $56
Don't pay $199 to earn $96. Keep it simple.
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In fact, as much as I'd like to call it a "safety net" or "rainy day" funds, I'd probably just leave it open and flexible to even become a home down-payment or car fund.
To answer your original question, it really doesn't make sense to use Tax Loss Harvesting in this situation. Tax Loss Harvesting isn't free money, whatever you deduct is owed back when you sell. If you earn $100,000 a year (28% tax bracket), and get the full $3000 deductible, you'll get $840 back in taxes this year. However, if you plan on cashing out your investments in 5 years to buy a house/car, while you're still in the 28% tax bracket, you will owe the government an additional $840 in taxes that year. In other words, while tax loss harvesting doesn’t necessarily produce any net tax savings, it is the equivalent of getting an interest-free loan from the Federal government.
(https://www.kitces.com/wp-content/uploads/2014/12/Graphics_Scenario12.png)
If you invest that $840 back into the Betterment, and get an 11.5% gain for the year, your $840 will have grown to $936, for a profit of $96 from your interest free loan. Not bad! And how much will Betterment charge you for this service? $255. How much would Vanguard have charged you for a fully automatic "set it and forget it" 60/40 stock/bond fund that handles rebalancing across 10,752 unique assets? $56
Don't pay $199 to earn $96. Keep it simple.
This is terrible analysis for almost any mustachian.
Obviouslyin most cases your marginal tax rate at peak earning will be higher than your marginal tax rate in retirement.
Furthermore, even mediocre tax planning will get you to a 15% earned income bracket or less during retirement,meaning you will have no long-term capital gains liabilities in retirement!l.
So money save now is never lost later if you have any intelligence in tax planning.
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In fact, as much as I'd like to call it a "safety net" or "rainy day" funds, I'd probably just leave it open and flexible to even become a home down-payment or car fund.
To answer your original question, it really doesn't make sense to use Tax Loss Harvesting in this situation. Tax Loss Harvesting isn't free money, whatever you deduct is owed back when you sell. If you earn $100,000 a year (28% tax bracket), and get the full $3000 deductible, you'll get $840 back in taxes this year. However, if you plan on cashing out your investments in 5 years to buy a house/car, while you're still in the 28% tax bracket, you will owe the government an additional $840 in taxes that year. In other words, while tax loss harvesting doesn’t necessarily produce any net tax savings, it is the equivalent of getting an interest-free loan from the Federal government.
(https://www.kitces.com/wp-content/uploads/2014/12/Graphics_Scenario12.png)
If you invest that $840 back into the Betterment, and get an 11.5% gain for the year, your $840 will have grown to $936, for a profit of $96 from your interest free loan. Not bad! And how much will Betterment charge you for this service? $255. How much would Vanguard have charged you for a fully automatic "set it and forget it" 60/40 stock/bond fund that handles rebalancing across 10,752 unique assets? $56
Don't pay $199 to earn $96. Keep it simple.
This is terrible analysis for almost any mustachian.
Obviouslyin most cases your marginal tax rate at peak earning will be higher than your marginal tax rate in retirement.
Furthermore, even mediocre tax planning will get you to a 15% earned income bracket or less during retirement,meaning you will have no long-term capital gains liabilities in retirement!l.
So money save now is never lost later if you have any intelligence in tax planning.
This thread is about using a $50,000 "Safety Net" which will be used:
to even become a home down-payment or car fund.
Not retirement.
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Right. So let's say you need to withdraw 10K to fix your roof.
Betterment will automatically withdraw your 10K from the funds with the highest cost basis (ie the funds that have the least delta between their basis and their current value. )
Compare this to a target date fund of funds where you will be taxed on every penny of appreciation above your basis.
Betterment is much more efficient.
If your question is whether to invest a safety net at all, that's one thing, but if you are arguing that Betterment with TLH is less efficient than an all in one fund, that's simply nonsense. It is the opposite of true.
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Right. So let's say you need to withdraw 10K to fix your roof.
Betterment will automatically withdraw your 10K from the funds with the highest cost basis (ie the funds that have the least delta between their basis and their current value. )
Compare this to a target date fund of funds where you will be taxed on every penny of appreciation above your basis.
Betterment is much more efficient.
If your question is whether to invest a safety net at all, that's one thing, but if you are arguing that Betterment with TLH is less efficient than an all in one fund, that's simply nonsense. It is the opposite of true.
Withdrawing from the funds with the highest cost basis first does not change the numbers presented.
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In fact, as much as I'd like to call it a "safety net" or "rainy day" funds, I'd probably just leave it open and flexible to even become a home down-payment or car fund.
To answer your original question, it really doesn't make sense to use Tax Loss Harvesting in this situation. Tax Loss Harvesting isn't free money, whatever you deduct is owed back when you sell. If you earn $100,000 a year (28% tax bracket), and get the full $3000 deductible, you'll get $840 back in taxes this year. However, if you plan on cashing out your investments in 5 years to buy a house/car, while you're still in the 28% tax bracket, you will owe the government an additional $840 in taxes that year. In other words, while tax loss harvesting doesn’t necessarily produce any net tax savings, it is the equivalent of getting an interest-free loan from the Federal government.
(https://www.kitces.com/wp-content/uploads/2014/12/Graphics_Scenario12.png)
If you invest that $840 back into the Betterment, and get an 11.5% gain for the year, your $840 will have grown to $936, for a profit of $96 from your interest free loan. Not bad! And how much will Betterment charge you for this service? $255. How much would Vanguard have charged you for a fully automatic "set it and forget it" 60/40 stock/bond fund that handles rebalancing across 10,752 unique assets? $56
Don't pay $199 to earn $96. Keep it simple.
The problem with your analysis is that when you "cash out" the investments in 5 years, they will be long-term holdings, so you will pay the long-term capital gains tax rate (http://www.irs.gov/taxtopics/tc409.html) of 15%, not your earned income marginal tax rate of 28%. In other words, by deferring the tax for 5 years, Betterment saved you 13 percentage points of the $3000, or $390 in real tax savings. You can then add that to the $96 for a total of $486 in gross savings as a result of using Betterment. After subtracting the fee of $255, you have a net savings of $198. Looks like Betterment wins in your example.
In fact, despite your claim that it is merely tax deferral, tax loss harvesting usually results in real tax savings so long as you use the losses to offset ordinary income or short-term gains and then don't close the position until it is a long-term holding. Even if your earned income marginal tax rate is the same on both sides, you have real tax savings.
Good point. But if you're holding for 5 years, and keep getting 11.5% gains (so you are unable to tax loss harvest past the first year), you will end up paying a cumulative $1,419 in fees at Betterment, compared to $310 at Vanguard.
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In fact, as much as I'd like to call it a "safety net" or "rainy day" funds, I'd probably just leave it open and flexible to even become a home down-payment or car fund.
To answer your original question, it really doesn't make sense to use Tax Loss Harvesting in this situation. Tax Loss Harvesting isn't free money, whatever you deduct is owed back when you sell. If you earn $100,000 a year (28% tax bracket), and get the full $3000 deductible, you'll get $840 back in taxes this year. However, if you plan on cashing out your investments in 5 years to buy a house/car, while you're still in the 28% tax bracket, you will owe the government an additional $840 in taxes that year. In other words, while tax loss harvesting doesn’t necessarily produce any net tax savings, it is the equivalent of getting an interest-free loan from the Federal government.
(https://www.kitces.com/wp-content/uploads/2014/12/Graphics_Scenario12.png)
If you invest that $840 back into the Betterment, and get an 11.5% gain for the year, your $840 will have grown to $936, for a profit of $96 from your interest free loan. Not bad! And how much will Betterment charge you for this service? $255. How much would Vanguard have charged you for a fully automatic "set it and forget it" 60/40 stock/bond fund that handles rebalancing across 10,752 unique assets? $56
Don't pay $199 to earn $96. Keep it simple.
The problem with your analysis is that when you "cash out" the investments in 5 years, they will be long-term holdings, so you will pay the long-term capital gains tax rate (http://www.irs.gov/taxtopics/tc409.html) of 15%, not your earned income marginal tax rate of 28%. In other words, by deferring the tax for 5 years, Betterment saved you 13 percentage points of the $3000, or $390 in real tax savings. You can then add that to the $96 for a total of $486 in gross savings as a result of using Betterment. After subtracting the fee of $255, you have a net savings of $198. Looks like Betterment wins in your example.
In fact, despite your claim that it is merely tax deferral, tax loss harvesting usually results in real tax savings so long as you use the losses to offset ordinary income or short-term gains and then don't close the position until it is a long-term holding. Even if your earned income marginal tax rate is the same on both sides, you have real tax savings.
Good point. But if you're holding for 5 years, and keep getting 11.5% gains (so you are unable to tax loss harvest past the first year), you will end up paying a cumulative $1,419 in fees at Betterment, compared to $310 at Vanguard.
You only need to hold for 1 year to get the tax benefit, not 5 years. I only said 5 years in the original version of my post because of how you wrote "5 years" in your post. However, despite you writing "5 years", your example was written for 1 year, and in the 1 year case, Betterment wins.
Betterment may win in the 5 year case as well, because the analysis becomes a lot more complicated over the 5 year horizon, and is not anywhere near as simple as what you just said.
+1
It's almost as if Dodge is hell-bent on coming up with unrealistic scenarios to prove a point that he wishes to be true.
Here is a simple point. Based on the amount of tax loss harvesting that betterment has already performed for me in the last six months,and my tax bracket, my expenses at betterment will be cheaper than the same amount of money invested at Vanguard for the next three years.
Simple fact.
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In fact, as much as I'd like to call it a "safety net" or "rainy day" funds, I'd probably just leave it open and flexible to even become a home down-payment or car fund.
To answer your original question, it really doesn't make sense to use Tax Loss Harvesting in this situation. Tax Loss Harvesting isn't free money, whatever you deduct is owed back when you sell. If you earn $100,000 a year (28% tax bracket), and get the full $3000 deductible, you'll get $840 back in taxes this year. However, if you plan on cashing out your investments in 5 years to buy a house/car, while you're still in the 28% tax bracket, you will owe the government an additional $840 in taxes that year. In other words, while tax loss harvesting doesn’t necessarily produce any net tax savings, it is the equivalent of getting an interest-free loan from the Federal government.
(https://www.kitces.com/wp-content/uploads/2014/12/Graphics_Scenario12.png)
If you invest that $840 back into the Betterment, and get an 11.5% gain for the year, your $840 will have grown to $936, for a profit of $96 from your interest free loan. Not bad! And how much will Betterment charge you for this service? $255. How much would Vanguard have charged you for a fully automatic "set it and forget it" 60/40 stock/bond fund that handles rebalancing across 10,752 unique assets? $56
Don't pay $199 to earn $96. Keep it simple.
The problem with your analysis is that when you "cash out" the investments in 5 years, they will be long-term holdings, so you will pay the long-term capital gains tax rate (http://www.irs.gov/taxtopics/tc409.html) of 15%, not your earned income marginal tax rate of 28%. In other words, by deferring the tax for 5 years, Betterment saved you 13 percentage points of the $3000, or $390 in real tax savings. You can then add that to the $96 for a total of $486 in gross savings as a result of using Betterment. After subtracting the fee of $255, you have a net savings of $198. Looks like Betterment wins in your example.
In fact, despite your claim that it is merely tax deferral, tax loss harvesting usually results in real tax savings so long as you use the losses to offset ordinary income or short-term gains and then don't close the position until it is a long-term holding. Even if your earned income marginal tax rate is the same on both sides, you have real tax savings.
Good point. But if you're holding for 5 years, and keep getting 11.5% gains (so you are unable to tax loss harvest past the first year), you will end up paying a cumulative $1,419 in fees at Betterment, compared to $310 at Vanguard.
You only need to hold for 1 year to get the tax benefit, not 5 years. I only said 5 years in the original version of my post because of how you wrote "5 years" in your post. However, despite you writing "5 years", your example was written for 1 year, and in the 1 year case, Betterment wins.
Betterment may win in the 5 year case as well, because the analysis becomes a lot more complicated over the 5 year horizon, and is not anywhere near as simple as what you just said.
Beginning of year 1: Deposit $50,000, +11.5% growth - $229 fee = $55,521
Beginning of year 2: Get +$840 from tax return + 11.5% growth - $258 fee = $62,584
We have now held for one year. Instead of owing $840, I owe 450, so my total is $62,134.
Compared to Vanguard:
Beginning of year 1: Deposit $50,000, grows to $55,750, minus $50 fee = $55,700
Beginning of year 2: 11.5% growth - $55 fee = $62,050
Yes, at this point Betterment's tax loss harvesting would have increased the portfolio by $84, you are correct. But what happens in year 3? If you can't keep tax loss harvesting, which Betterment's own data shows they can't, the fees will usurp the advantage.
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Here is a simple point. Based on the amount of tax loss harvesting that betterment has already performed for me in the last six months,and my tax bracket, my expenses at betterment will be cheaper than the same amount of money invested at Vanguard for the next three years.
Simple fact.
This assumes you would have harvested zero losses in your Vanguard account, but there have been some easy opportunities for manual tax loss harvesting this year.
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Tough to harvest in a "fund of funds" account, which Dodge advocates as a cheaper alternative to Betterment, because everything has to go down not just some components.
Also I am quite confident that I would not have harvested $1000 on 60K invested in the past 6 months were I invested in a taxable slice and dice portfolio. That would require constant monitoring and constant vigilance.
Computers are much better at that sort of thing.....
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Yes, to exploit harvesting opportunities, it's better to hold the individual funds directly rather than a "fund of funds."
Depending on when your investments were made, a harvest of 1.6% of your principal this year would have been pretty easy to achieve without much work or monitoring. You paid Betterment's computers to do it for you, which is fine but less consistent with the mustachian ethos, but admittedly it is also only true looking back with 20/20 hindsight -- in periods of low volatility, Betterment's computers will be able to tax loss harvest when we mere humans cannot.
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Yes, to exploit harvesting opportunities, it's better to hold the individual funds directly rather than a "fund of funds."
Depending on when your investments were made, a harvest of 1.6% of your principal this year would have been pretty easy to achieve without much work or monitoring. You paid Betterment's computers to do it for you, which is fine but less consistent with the mustachian ethos, but admittedly it is also only true looking back with 20/20 hindsight -- in periods of low volatility, Betterment's computers will be able to tax loss harvest when we mere humans cannot.
I'll take 3.2%/year in annualized tax loss harvesting any year I can.
Can you honestly claim that you have done as well with your taxable accounts this year, Brooklyn?
If so you are a much more meticulous invester than I am. Which is entirely possible, I guess. (I have my doubts)
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In fact, as much as I'd like to call it a "safety net" or "rainy day" funds, I'd probably just leave it open and flexible to even become a home down-payment or car fund.
To answer your original question, it really doesn't make sense to use Tax Loss Harvesting in this situation. Tax Loss Harvesting isn't free money, whatever you deduct is owed back when you sell. If you earn $100,000 a year (28% tax bracket), and get the full $3000 deductible, you'll get $840 back in taxes this year. However, if you plan on cashing out your investments in 5 years to buy a house/car, while you're still in the 28% tax bracket, you will owe the government an additional $840 in taxes that year. In other words, while tax loss harvesting doesn’t necessarily produce any net tax savings, it is the equivalent of getting an interest-free loan from the Federal government.
(https://www.kitces.com/wp-content/uploads/2014/12/Graphics_Scenario12.png)
If you invest that $840 back into the Betterment, and get an 11.5% gain for the year, your $840 will have grown to $936, for a profit of $96 from your interest free loan. Not bad! And how much will Betterment charge you for this service? $255. How much would Vanguard have charged you for a fully automatic "set it and forget it" 60/40 stock/bond fund that handles rebalancing across 10,752 unique assets? $56
Don't pay $199 to earn $96. Keep it simple.
The problem with your analysis is that when you "cash out" the investments in 5 years, they will be long-term holdings, so you will pay the long-term capital gains tax rate (http://www.irs.gov/taxtopics/tc409.html) of 15%, not your earned income marginal tax rate of 28%. In other words, by deferring the tax for 5 years, Betterment saved you 13 percentage points of the $3000, or $390 in real tax savings. You can then add that to the $96 for a total of $486 in gross savings as a result of using Betterment. After subtracting the fee of $255, you have a net savings of $198. Looks like Betterment wins in your example.
In fact, despite your claim that it is merely tax deferral, tax loss harvesting usually results in real tax savings so long as you use the losses to offset ordinary income or short-term gains and then don't close the position until it is a long-term holding. Even if your earned income marginal tax rate is the same on both sides, you have real tax savings.
Good point. But if you're holding for 5 years, and keep getting 11.5% gains (so you are unable to tax loss harvest past the first year), you will end up paying a cumulative $1,419 in fees at Betterment, compared to $310 at Vanguard.
You only need to hold for 1 year to get the tax benefit, not 5 years. I only said 5 years in the original version of my post because of how you wrote "5 years" in your post. However, despite you writing "5 years", your example was written for 1 year, and in the 1 year case, Betterment wins.
Betterment may win in the 5 year case as well, because the analysis becomes a lot more complicated over the 5 year horizon, and is not anywhere near as simple as what you just said.
+1
It's almost as if Dodge is hell-bent on coming up with unrealistic scenarios to prove a point that he wishes to be true.
Here is a simple point. Based on the amount of tax loss harvesting that betterment has already performed for me in the last six months,and my tax bracket, my expenses at betterment will be cheaper than the same amount of money invested at Vanguard for the next three years.
Simple fact.
Of your current portfolio size, yes. If you get the 11.5% growth for the next 3 years, your portfolio will be around $92,375, making your yearly Betterment fee a much higher $380. You will have paid over $1,300 in fees compared to my $217, and the fees will never be recovered with tax loss harvesting. As shown in my earlier examples, the gap only widens from there.
(http://i62.tinypic.com/2mmh1qs.png)
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I've paid 95 dollars in fees in over a year. I have saved over $400 in taxes. In other words I have spent much less in fees than you. This is an indisputable fact that requires no assumptions.
Your math is once again flawed. If I have 92,375 in 3 years this will not effect what I have already paid in the past year (in fact my savings are already compounding Unlike your fees.)
I Anticipate that I will harvest more losses next year too.
Good luck with your 11.5 % assumed returns!
Remember: garbage in, garbage out.
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I've paid 95 dollars in fees in over a year. I have saved over $400 in taxes. In other words I have spent much less in fees than you. This is an indisputable fact that requires no assumptions.
Your math is once again flawed. If I have 92,375 in 3 years this will not effect what I have already paid in the past year (in fact my savings are already compounding Unlike your fees.)
I Anticipate that I will harvest more losses next year too.
Good luck with your 11.5 % assumed returns!
Remember: garbage in, garbage out.
Good l
The fees are calculated by looking at the current year only. Instead of looking forward 4 years, if we look back 4 years, we still see it. This is a chart of all of Betterment's stocks:
(http://i.imgur.com/MbTOl7U.png)
They all hit their bottom in the 6th month. A theoretical Betterment portfolio which started 4 years ago, would have had 0 tax loss harvesting after the 6th month. While the portfolio, and the fee, would have nearly doubled. Thanks to reinvesting dividends, it is unlikely this money will ever have the opportunity to tax loss harvest again. It will end up looking like the chart I posted earlier (red line):
(http://blogs-images.forbes.com/rickferri/files/2012/03/DividendsFig-1.png)
Maybe 2010 was a bad year to start, lets try some others:
2011: 1.5 years
(http://i.imgur.com/wzYSFxp.png)
2012: 1 year
(http://i.imgur.com/ul3ZBXA.png)
2009: 3 months
(http://i.imgur.com/gpUfEGn.png)
2004-2007 all hit their bottom at the predictable 2008-2009 bottom, which was easily captured with manual tax loss harvesting. So between 1-3 years was the maximum tax-loss-harvesting time.
2003: 3 months
(http://i.imgur.com/AThhpjx.png)
2002: 9 months:
(http://i.imgur.com/OgFkzjf.png)
...etc
As you can see, after the first year or so, tax loss harvesting ceases. Your portfolio, however, rises significantly, along with the percentage-based fee.
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Yes, to exploit harvesting opportunities, it's better to hold the individual funds directly rather than a "fund of funds."
Depending on when your investments were made, a harvest of 1.6% of your principal this year would have been pretty easy to achieve without much work or monitoring. You paid Betterment's computers to do it for you, which is fine but less consistent with the mustachian ethos, but admittedly it is also only true looking back with 20/20 hindsight -- in periods of low volatility, Betterment's computers will be able to tax loss harvest when we mere humans cannot.
I'll take 3.2%/year in annualized tax loss harvesting any year I can.
Can you honestly claim that you have done as well with your taxable accounts this year, Brooklyn?
If so you are a much more meticulous invester than I am. Which is entirely possible, I guess. (I have my doubts)
No, I harvested exactly zero dollars of losses this year. My contributions have been spread out equally across the year and I didn't consider the dollar amounts of my taxable investing to be high enough to jump on any harvesting opportunities. That's why I said "depending on when your investments were made". If I had invested $60K as a lump sum at a point during the year right before the markets took a 7% dip (as they did in the third quarter), it would have been easy to harvest a significant loss.
I was just trying to point out that it's not really an apples-to-apples to comparison if you include the benefit of algorithmic TLH for Betterment but entirely discount the possibility of manual tax loss harvesting in traditional investing. Obviously, during periods of extreme volatility or extended downward market movement, manual tax loss harvesting will be easy, while during periods of low volatility and upward market movement, manual tax loss harvesting will be difficult or impossible. Paying for Betterment's algorithmic TLH is like buying insurance against the absence of opportunities for manual TLH, which is a rational thing to do. (But for me personally, as we discussed before, the maximum amount I stand to gain by paying for TLH is very low, so I'd prefer to go without that insurance.)
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Dodge,
You seem to assume that you can only tax loss harvest at the lowest level of a trough which is quite simply wrong.
Assuming ongoing contributions (a pretty reasonable assumption based on how people actually invest) you can tax loss harvest indefinitely as long as the value of any one asset drops below its basis.
If you want to limit the discussion to an emergency fund, then fine, but most people don't invest in an emergency fund and then stop investing in taxable accounts.
And in that case it would still be smarter to invest in betterment until your fees caught up with your money saved in tax losses, and then switch your ETFs over to another provider. In this way you would compound your savings for a few years.
But again for most investors, investing does not stop once they save 50K.
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Yes, to exploit harvesting opportunities, it's better to hold the individual funds directly rather than a "fund of funds."
Depending on when your investments were made, a harvest of 1.6% of your principal this year would have been pretty easy to achieve without much work or monitoring. You paid Betterment's computers to do it for you, which is fine but less consistent with the mustachian ethos, but admittedly it is also only true looking back with 20/20 hindsight -- in periods of low volatility, Betterment's computers will be able to tax loss harvest when we mere humans cannot.
I'll take 3.2%/year in annualized tax loss harvesting any year I can.
Can you honestly claim that you have done as well with your taxable accounts this year, Brooklyn?
If so you are a much more meticulous invester than I am. Which is entirely possible, I guess. (I have my doubts)
No, I harvested exactly zero dollars of losses this year. My contributions have been spread out equally across the year and I didn't consider the dollar amounts of my taxable investing to be high enough to jump on any harvesting opportunities. That's why I said "depending on when your investments were made". If I had invested $60K as a lump sum at a point during the year right before the markets took a 7% dip (as they did in the third quarter), it would have been easy to harvest a significant loss.
I was just trying to point out that it's not really an apples-to-apples to comparison if you include the benefit of algorithmic TLH for Betterment but entirely discount the possibility of manual tax loss harvesting in traditional investing. Obviously, during periods of extreme volatility or extended downward market movement, manual tax loss harvesting will be easy, while during periods of low volatility and upward market movement, manual tax loss harvesting will be difficult or impossible. Paying for Betterment's algorithmic TLH is like buying insurance against the absence of opportunities for manual TLH, which is a rational thing to do. (But for me personally, as we discussed before, the maximum amount I stand to gain by paying for TLH is very low, so I'd prefer to go without that insurance.)
Brooklyn,
I think that's kind of the point.
If my taxable accounts were in say Schwab, or Vanguard, I doubt I would've tax loss harvested a single dollar this year.
Tax loss harvesting is one of those things that's conceptually easy to understand, but difficult in practice. to do it well requires constant vigilance, and focus, and algorithmic decision-making, which most humans are quite simply not capable of.
It is exceptionally easy with betterment to take full advantage of tax loss harvesting opportunities because it requires zero effort on the investor's part.
buying and holding, rebalancing once a year, maintaining the discipline to stick to your plan, these are all conceptually easy but difficult in practice. And the evidence suggests that most investors are simply not up to the task.
When you add in tax loss harvesting that more than pays for itself,as well as all of the rest of it, betterment becomes a very attractive option.
And behaviorally I can't tell you how heartwarming it is on a down market day to get a message that you've just saved another couple of hundred dollars on next year's taxes. Talk about positive reinforcement for good behavior!
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Dodge,
You seem to assume that you can only tax loss harvest at the lowest level of a trough which is quite simply wrong.
Assuming ongoing contributions (a pretty reasonable assumption based on how people actually invest) you can tax loss harvest indefinitely as long as the value of any one asset drops below its basis.
If you want to limit the discussion to an emergency fund, then fine, but most people don't invest in an emergency fund and then stop investing in taxable accounts.
And in that case it would still be smarter to invest in betterment until your fees caught up with your money saved in tax losses, and then switch your ETFs over to another provider. In this way you would compound your savings for a few years.
But again for most investors, investing does not stop once they save 50K.
Don't you see? That's exactly how the government looks at it when determining capital gains/losses. It treats each individual deposit as its own separate container, a tax lot. If you invested $100,000 at the beginning of each year I charted, that's exactly how it would have played out.
Your $100,000 deposit from 2010 would have received no more tax loss harvesting after the 6th month, and would have cost you about $1,250 more in fees over going directly with Vanguard. With your fee in year 5 is poised to hit $532, increasing the total fee paid by about 33%. A similar outcome would have occurred for all your other yearly deposits:
(http://i.imgur.com/hhJ8IiA.png)
This is the ladder I tried to visualize earlier in the thread:
(http://i.imgur.com/kVnNuvO.png)
Is it possible to transfer just the tax lot from deposit #1 to another provider for the lower fee, while leaving the other tax lots alone? If so, then yes that would be a much smarter move. But then you would be stuck manually managing possibly all 12 of their ETFs, plus the 12 alternates it uses for tax loss harvesting. Manually managing a 24 fund portfolio, for the rest of my investment horizon (50 years), for a benefit that only lasts 2 years doesn't seem very "set it and forget it". I do not believe this is a good recommendation for someone seeking a "set it and forget it" portfolio.
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Dodge, you seem to be acting like the entire Betterment portfolio is a single security. That's not the case. The fact that it consists of multiple securities actually offers more tax harvesting opportunities and is not equivalent to it being an ETF.
In fact, there would be even more tax harvesting opportunities if instead of owning ETFs, you bought the individual securities directly. If you have over $500,000, Wealthfront will actually buy the individual companies inside the S&P 500 to do that for you.
Your entire fancy spreadsheet seems to be based on treating the entire Betterment portfolio as if it were a single security with harvesting only being possible if the value of that security drops below the cost basis. That is not how it works.
Check this post (http://forum.mrmoneymustache.com/investor-alley/betterment-$50k-'safety-net'/msg487131/#msg487131)to see the graphs, showing each individual stock ETF in Betterment's portfolio. Had you made deposits on Jan 1 of each of those years, all possible tax loss harvesting would have stopped for that tax lot after the indicated time (3 months after the 2009 deposit, 3 months after the 2002 deposit...etc).
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You are actually correct that you eventually stop getting a benefit for certain lots. However, the claim is that it may be worthwhile if you keep contributing because the benefits on the future lots may outweigh the costs of the lots no longer harvestable.
The other thing that all of your analyses ignore is that Betterment is actually basically free because it's very easy to rack up a few free years with referrals. The total amount I've actually paid to Betterment so far is $0 and I won't have to pay anything for another couple years, assuming I get no more free time in in the interim.
If you re-run the models with Betterment being free, I think you'll find it comes out comfortably ahead.
I calculated this too, in this post (http://forum.mrmoneymustache.com/investor-alley/betterment-$50k-'safety-net'/msg478834/#msg478834):
"In short, even if you make six $100,000 deposits, one a year, and have market conditions which allow you to tax loss harvest a +$600 gain each year for the first 5 years (which won't happen), the amount of fees accumulated by the year after your 6th deposit, will be larger than the total amount of tax loss harvesting you will ever accumulate."
While Betterment might not charge you the extra 0.35-0.15 ER if you have some credits saved up, you will still be charged the 0.16 ER from the underlying funds of course, so it's not completely free. Since your portfolio is comparatively low during the first few years, it's not as big an impact as you might think. Also, everyone won't have this opportunity, so it seems weird calculating it in like it's a given...but I'll do it for comparison's sake:
(http://i.imgur.com/a9quCo6.png)
If you have no extra Betterment fee for the first three years, the new "Catch-up Year" is now year 4, when you consider the tax-adjusted portfolio value (Betterment has an additional $450 tax burden in this example). Every year thereafter that this tax lot is with Betterment, you will be losing more and more money.
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I've already shared my concerns with your assumptions above, which are far less realistic than Betterment's in their TLH white paper. (And they're selling something.)
Your's is an unrealistic model with unrealistic assumptions. Do you know anybody who invests 100k in a taxable account for 5 Straight years? I certainly don't.
If the costs got too high, one could simply transfer their entire lot to a new provider, not specifically identified shares.
And before you dismiss managing a 12 asset slice and dice portfolio, you should ask yourself, why bother tilting small? Why bother tilting to value? Why bother diversifying internationally?
Since betterment gets a flat 0.15-0.35% AUM fee, it would certainly be cheaper for them to have a simpler portfolio with fewer transactions.
And the answer is: expected returns. They have constructed the portfolio to maximize expected returns.
These are not guaranteed returns, they are just the best guess on future returns based on past evidence. For more on this concept, I would suggest reading this book:
http://www.amazon.com/Expected-Returns-Investors-Harvesting-Rewards/dp/1119990726
I invested in betterment before they offered tax loss harvesting, and I still thought it was worth it. Now is a complete no-brainer.
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Dude, what you're missing is that Betterment is free forever under their current rules, assuming you're willing to put in a minimum amount of effort. If that stops being the case, I'll re-evaluate.
I'm not sure why you mention the expenses of the underlying funds because that will apply no matter where you buy them. I am obviously aware of them. The impact would be the same whether you buy those funds through Vanguard, Bank of America, or Interactive Brokers.
Also another misunderstanding you may or may not have is that the fee is based on the total of your contributions minus your withdrawals. The fee is not affected by the market value of the securities.
(http://i.imgur.com/uybMA1H.png)
I wouldn't count on Betterment giving away their product for free for very long. They got some big venture capital investments, and as such are likely under pressure to maximize profits. In any case, I calculated the numbers assuming Betterment were free forever as you stated:
(http://i.imgur.com/zuspMUK.png)
The new "Catch-up" year is 7. If your investment horizon is longer than 7 years, you are better off going with with Vanguard.
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I've already shared my concerns with your assumptions above, which are far less realistic than Betterment's in their TLH white paper. (And they're selling something.)
Your's is an unrealistic model with unrealistic assumptions. Do you know anybody who invests 100k in a taxable account for 5 Straight years? I certainly don't.
If the costs got too high, one could simply transfer their entire lot to a new provider, not specifically identified shares.
And before you dismiss managing a 12 asset slice and dice portfolio, you should ask yourself, why bother tilting small? Why bother tilting to value? Why bother diversifying internationally?
Since betterment gets a flat 0.15-0.35% AUM fee, it would certainly be cheaper for them to have a simpler portfolio with fewer transactions.
And the answer is: expected returns. They have constructed the portfolio to maximize expected returns.
These are not guaranteed returns, they are just the best guess on future returns based on past evidence. For more on this concept, I would suggest reading this book:
http://www.amazon.com/Expected-Returns-Investors-Harvesting-Rewards/dp/1119990726
I invested in betterment before they offered tax loss harvesting, and I still thought it was worth it. Now is a complete no-brainer.
The math is clear, the deposits don't matter, they all have the same result. Here is the same math, following the same investing schedule from their chart, for the same number of years:
(http://i.imgur.com/0M2nWvM.png)
There are some typos in the screenshot above, but the story stays the same. Vanguard wins due to lower fees over time. The best part is, you don't really see the difference until we look at the long term, since again the fee is percentage based. If you stopped contributing at this point, the gap grows to $90,000 in Vanguard's favor after another 10 years. Add another 10 years on top of that, and the gap grows to over $400,000. Add another 10 years, and it's $2,000,000 in Vanguard's favor...etc.
I dismiss managing a 12-24 fund for the rest of your investment horizon (30-60 years for Mustachians) as a viable option, in threads where the OP is specifically looking for a "set it and forget it" portfolio.
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Dodge, there are four things to address with your latest post.
1. Your annotation of the website does not mean what you think it does. The way Betterment defines "balance" is as the sum of your contributions minus the sum of your withdrawals, with some complicated special cases if you withdrew too much. You will have to read the full terms and conditions to understand this: https://wwws.betterment.com/document/BettermentCustomerAgreements.pdf?documentType=3
In particular I draw your attention to pages 39-40, where it is stated that "No asset-based Fee adjustment will be made at any time for appreciation or depreciation in Account asset value during a given period."
Strange, I know, but that's how they do it.
2. I'm already locked in free for 3 years including the time I already had. Even if I don't get anymore, that's three years of a great product. At this time, I might be tempted to go beyond three years and simply average the fee over the years I got free for a more fair comparison.
3. Your latest suggestion that Vanguard beats Betterment even if Betterment is assumed to have no fees is completely silly. At that point, you're just comparing hypothetical future returns of the underlying securities -- i.e. your crystal ball is somehow predicting that Betterment's portfolio will do worse than whatever you are defining as "Vanguard" (is it just an S&P 500 ETF?). I have no idea what you are trying to show there, but if you assume that Betterment charges no advisory fee, it purely comes down to which portfolio you are using, which is something you cannot model into the future.
4. Betterment charges no fee for an ACAT transfer out, unlike virtually every other broker-dealer including Vanguard, so you can do that whenever the fees become too large for you to stomach.
1. I'll read up on that, but as noted in my "completely free forever" example, it doesn't matter.
3. I detailed this in prior posts. Vanguard wins because the fees are lower. Yes, even when Betterment isn't charging you anything.
4. I dismiss managing a 12-24 fund for the rest of your investment horizon (30-60 years for Mustachians) as a viable option, in threads where the OP is specifically looking for a "set it and forget it" portfolio.
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Dodge,
Your graphic is unreadable. Literally.
I have no idea what you are attempting to show here. Literally.
The one constant in all of your models is that your assumptions are bizarre.
You assume that you can get identical returns from two completely different portfolios.
You assume that you can only tax loss harvest for one year.
You assume that the value anomaly and the size anomaly are fiction.
You assume that the average investor contributes $100,000 a year to their taxableaccount on January 1.
You assume that international diversification makes no difference to future portfolio returns.
All of these faulty assumptions lead to worthless output.
But my assumption is no assumption at all. It is simply the observation that my taxable account has been much cheaper than yours for the past year. And all things considered it is likely to continue to be cheaper than yours for at least the next 2 to 3 years.
It is also easier to use, A better user experience overall, and for me, at least, an approach that is less likely to lead to my own behavioral errors.
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Dodge,
Your graphic is unreadable. Literally.
I have no idea what you are attempting to show here. Literally.
Haha, I don't blame you. Trying to show both portfolios with yearly contributions matching the contributions in Betterment's example. Each column is a new deposit, made in the next year. I'm keeping each deposit (tax lot) separate from the main portfolio, so you can see how tax loss harvesting provides an early boost for each deposit (tax lot), but after a few years is beaten by Vanguard's lower fee.
I'll try again tomorrow.
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Dodge,
Your graphic is unreadable. Literally.
I have no idea what you are attempting to show here. Literally.
The one constant in all of your models is that your assumptions are bizarre.
You assume that you can get identical returns from two completely different portfolios.
You assume that you can only tax loss harvest for one year.
You assume that the value anomaly and the size anomaly are fiction.
You assume that the average investor contributes $100,000 a year to their taxableaccount on January 1.
You assume that international diversification makes no difference to future portfolio returns.
All of these faulty assumptions lead to worthless output.
But my assumption is no assumption at all. It is simply the observation that my taxable account has been much cheaper than yours for the past year. And all things considered it is likely to continue to be cheaper than yours for at least the next 2 to 3 years.
It is also easier to use, A better user experience overall, and for me, at least, an approach that is less likely to lead to my own behavioral errors.
It's clear there's a misunderstanding here. The math is quite simple, making those assumptions irrelevant. Tomorrow I will model the same time period as Betterment's data, with the same contributions, so you can see more clearly.
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If the only thing a person is looking for, is an “automatic fund” that handles everything for them, because they are a complete newbie and don’t understand any of this stuff, the correct answer to their question should be one of Vanguard’s 18 or so fully automatic funds. They will be mathematically guaranteed to beat or match 50% of the dollars invested in the market, and will never have to worry about underperforming. They will also have the most diversified, in terms of unique assets held, portfolio available in a single fund, for the cheapest cost. You need to have a good reason to deviate beyond these choices.
For some people, like Milesdividend, that reason is a tilt. If these people don’t want to worry about managing the 12+ funds needed to construct that tilt, and this pain is worth the additional yearly percentage fee to them, then going with Betterment, or Wealthfront, or some other fund manager who will manage this portfolio can make sense. I personally don’t agree with tilting, but it’s a valid argument that can be made.
Is Tax Loss Harvesting alone a good enough reason to justify paying an additional yearly percentage fee? The most important thing they need to understand for this question, is that the benefits from TLH have a limited shelf-life. Paying an extra percentage fee for TLH mathematically stops making sense when one of these four things happen (whichever comes first):
1. You have more than a certain amount of money invested. This number can be anywhere from $0 to $700,000 depending on your income, your tax bracket, and when you make the withdrawal.
2. You stop contributing new money for too long.
3. There aren’t enough tax loss harvesting opportunities.
4. You stop having taxable income (retired/lost your job) or are living off capital gains income of less than $72,500 (assuming you’re married).
Eventually, one of these four things will happen. It is inevitable. I do not believe paying an additional yearly percentage fee solely for Tax Loss Harvesting is a good recommendation for a complete newbie, as the fee will be higher than the gain over the long term, or they will have to move their assets of around 12-24 funds to another company so they can manage it themselves without the extra fee, which is the opposite of what they’re looking for (an automatic fund).
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Dodge,
My thoughts.
Where we disagree:
1. I believe Vanguards all in one funds Have poor International diversification, and no exposure to the value or size factors. It is virtually impossible to manually tax loss harvest with them unless there's a major bear market. And they are expensive for what they are.
2. If past is prologue (as in the last 100 years), and the value factor and the size factor anomies persist, then the betterment portfolio is a good bet to beat the vanguard all in one portfolios, even after expenses, and before tax loss harvesting.
With ongoing contributions to the betterment portfolio, I feel it is likely the betterment with tax loss harvesting will actually be cheaper for taxable accounts in the Vanguard portfolio for a long period of time. (betterments white paper supports this thesis.)
In the end we have a difference of opinion. And it's unlikely that we will bridge this gap. Which is to be expected.
And it should be said that I have zero problem with someone owning a slice and dice Vanguard portfolio and rebalancing once a year. For me behaviorally, I feel such an approach would likely underperform betterment.
But each investor has to figure this out for themselves.
The exchange was enjoyable!
AZ
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I think...I think I'm in love.
The math. The beautiful math. The excel sheets. The data graphs. Structured information! *tears up* So beautiful Q_______Q
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In fact, as much as I'd like to call it a "safety net" or "rainy day" funds, I'd probably just leave it open and flexible to even become a home down-payment or car fund.
To answer your original question, it really doesn't make sense to use Tax Loss Harvesting in this situation. Tax Loss Harvesting isn't free money, whatever you deduct is owed back when you sell. If you earn $100,000 a year (28% tax bracket), and get the full $3000 deductible, you'll get $840 back in taxes this year. However, if you plan on cashing out your investments in 5 years to buy a house/car, while you're still in the 28% tax bracket, you will owe the government an additional $840 in taxes that year. In other words, while tax loss harvesting doesn’t necessarily produce any net tax savings, it is the equivalent of getting an interest-free loan from the Federal government.
(https://www.kitces.com/wp-content/uploads/2014/12/Graphics_Scenario12.png)
If you invest that $840 back into the Betterment, and get an 11.5% gain for the year, your $840 will have grown to $936, for a profit of $96 from your interest free loan. Not bad! And how much will Betterment charge you for this service? $255. How much would Vanguard have charged you for a fully automatic "set it and forget it" 60/40 stock/bond fund that handles rebalancing across 10,752 unique assets? $56
Don't pay $199 to earn $96. Keep it simple.
"..is the equivalent of getting an interest-free loan from the Federal government."
That you get to earn 11.5% for 5 years, year over year, compounding interest on.
The most powerful force on the planet in the world of finance is compounding interest.
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Soo...*cough* while I think I found my dinosaurs of the investment world (experienced power players).
Hypothetical question and questions.
Say you make, roughly 250k (before investments) as a household.
You max out both 401k, both roth, and you have roughly 80k left over after bills and taxes take out.
Currently playing your current tax game is getting old fast (international corps buying state side corps under state side parent corps under international holding corp, assets structured as raw material costs, preplanned corporate buyouts on projected losses, amortizing capital costs over time, really complicated.)
Say you want to get away from this, to a "set and leave it" concept.
I noticed with this "tax harvest", new term for me, that you guys project people dont have the money, what if they do? How does this tax harvesting help them? How does it hurt them?
I'm seeing lots of good debate on both sides, both of which are accounting for the concept of taxes, but one side argues no taxes paid, higher fees, while the other side argues no taxes paid, lower fees. (at least for loss periods, and if Im not mistaken, amortized losses over time for periods of gains?)
General gist of everything from what I'm seeing. Am I grasping this concept correctly? This is a very unique, very complex concept. I like the idea of it, but I never bite on things I don't understand.
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In fact, as much as I'd like to call it a "safety net" or "rainy day" funds, I'd probably just leave it open and flexible to even become a home down-payment or car fund.
To answer your original question, it really doesn't make sense to use Tax Loss Harvesting in this situation. Tax Loss Harvesting isn't free money, whatever you deduct is owed back when you sell. If you earn $100,000 a year (28% tax bracket), and get the full $3000 deductible, you'll get $840 back in taxes this year. However, if you plan on cashing out your investments in 5 years to buy a house/car, while you're still in the 28% tax bracket, you will owe the government an additional $840 in taxes that year. In other words, while tax loss harvesting doesn’t necessarily produce any net tax savings, it is the equivalent of getting an interest-free loan from the Federal government.
(https://www.kitces.com/wp-content/uploads/2014/12/Graphics_Scenario12.png)
If you invest that $840 back into the Betterment, and get an 11.5% gain for the year, your $840 will have grown to $936, for a profit of $96 from your interest free loan. Not bad! And how much will Betterment charge you for this service? $255. How much would Vanguard have charged you for a fully automatic "set it and forget it" 60/40 stock/bond fund that handles rebalancing across 10,752 unique assets? $56
Don't pay $199 to earn $96. Keep it simple.
"..is the equivalent of getting an interest-free loan from the Federal government."
That you get to earn 11.5% for 5 years, year over year, compounding interest on.
The most powerful force on the planet in the world of finance is compounding interest.
In the example above, you don't get to earn compound interest, because your overall portfolio value ends up going down. As Cathy and Milesdividendmd pointed out, this example only applies if you sell before it becomes long term gains.
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I noticed with this "tax harvest", new term for me, that you guys project people dont have the money, what if they do?
I'm not sure what you mean. Have the money for what?
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Dodge, there are four things to address with your latest post.
1. Your annotation of the website does not mean what you think it does. The way Betterment defines "balance" is as the sum of your contributions minus the sum of your withdrawals, with some complicated special cases if you withdrew too much. You will have to read the full terms and conditions to understand this: https://wwws.betterment.com/document/BettermentCustomerAgreements.pdf?documentType=3
In particular I draw your attention to pages 39-40, where it is stated that "No asset-based Fee adjustment will be made at any time for appreciation or depreciation in Account asset value during a given period."
Strange, I know, but that's how they do it.
2. I'm already locked in free for 3 years including the time I already had. Even if I don't get anymore, that's three years of a great product. At this time, I might be tempted to go beyond three years and simply average the fee over the years I got free for a more fair comparison.
3. Your latest suggestion that Vanguard beats Betterment even if Betterment is assumed to have no fees is completely silly. At that point, you're just comparing hypothetical future returns of the underlying securities -- i.e. your crystal ball is somehow predicting that Betterment's portfolio will do worse than whatever you are defining as "Vanguard" (is it just an S&P 500 ETF?). I have no idea what you are trying to show there, but if you assume that Betterment charges no advisory fee, it purely comes down to which portfolio you are using, which is something you cannot model into the future.
4. Betterment charges no fee for an ACAT transfer out, unlike virtually every other broker-dealer including Vanguard, so you can do that whenever the fees become too large for you to stomach.
"No asset-based Fee adjustment will be made at any time for appreciation or depreciation in Account asset value during a given period."
Based on the screenshot I took of their page, I'd guess the "given period" is a year. After the period is over, expect to pay a fee on your appreciation.
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Dodge, there are four things to address with your latest post.
1. Your annotation of the website does not mean what you think it does. The way Betterment defines "balance" is as the sum of your contributions minus the sum of your withdrawals, with some complicated special cases if you withdrew too much. You will have to read the full terms and conditions to understand this: https://wwws.betterment.com/document/BettermentCustomerAgreements.pdf?documentType=3
In particular I draw your attention to pages 39-40, where it is stated that "No asset-based Fee adjustment will be made at any time for appreciation or depreciation in Account asset value during a given period."
Strange, I know, but that's how they do it.
2. I'm already locked in free for 3 years including the time I already had. Even if I don't get anymore, that's three years of a great product. At this time, I might be tempted to go beyond three years and simply average the fee over the years I got free for a more fair comparison.
3. Your latest suggestion that Vanguard beats Betterment even if Betterment is assumed to have no fees is completely silly. At that point, you're just comparing hypothetical future returns of the underlying securities -- i.e. your crystal ball is somehow predicting that Betterment's portfolio will do worse than whatever you are defining as "Vanguard" (is it just an S&P 500 ETF?). I have no idea what you are trying to show there, but if you assume that Betterment charges no advisory fee, it purely comes down to which portfolio you are using, which is something you cannot model into the future.
4. Betterment charges no fee for an ACAT transfer out, unlike virtually every other broker-dealer including Vanguard, so you can do that whenever the fees become too large for you to stomach.
"No asset-based Fee adjustment will be made at any time for appreciation or depreciation in Account asset value during a given period."
Based on the screenshot I took of their page, I'd guess the "given period" is a year. After the period is over, expect to pay a fee on your appreciation.
On the other hand, the same page you took a picture of has some language that could suggest otherwise. See attached picture.
That's not talking about their fee. Considering it's a yearly fee, they specifically mentioned "during a given period", and "of your average annual balance" it's pretty clear in my opinion.
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Also another misunderstanding you may or may not have is that the fee is based on the total of your contributions minus your withdrawals. The fee is not affected by the market value of the securities.
This is news to me. It's industry standard to charge the AUM based on assets invested, I'd be shocked if Betterment worked differently.
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Also another misunderstanding you may or may not have is that the fee is based on the total of your contributions minus your withdrawals. The fee is not affected by the market value of the securities.
This is news to me. It's industry standard to charge the AUM based on assets invested, I'd be shocked if Betterment worked differently.
They confirmed via e-mail that it is indeed applied as a normal AUM.
The phrase “It is not impacted by market changes” applies to the pricing tier, rather than how the fee is applied.
The fee is applied to the balance, no matter the market change. The pricing tier, only changes if there is growth, never when there is a loss.
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Hey guys,
I started reading up a little more on how some are using Betterment for their safety nets. It seems this is kind of a controversial topic where the naysayers wouldn't advise *investing* your savings money whereas proponents advise that it's only as risky as you want (or can tolerate) and in the end shouldn't leave you worrying a whole lot. So what's the consensus? I'm assuming it comes down to how comfortable you are with the risk of "investing emergency money" so maybe I'm just answering my own question.
Any pointers on why I should or shouldn't consider this though? I read somewhere that one person stated (or maybe it was based off of advice from Betterment) he would only go this route if he had $12k in SAVINGS, and anything in excess would be the "safety net" - does that make sense? I'm in a position where I think I could maintain a true savings and put down probably around $50k for a 'safety net' investment. I have much more stashed away in other taxable investments with Fidelity in addition to my non-taxable/retirement funds, so it's not like this is the last leg or anything. The reason Betterment is appealing is because there are fewer restrictions on withdrawals and thus easier access to that money in case it becomes "need it now" or "need it soon" money. As far as the fees go, it seems reasonable to pay the .25% when it seems like they take care of A LOT of things that you'd otherwise be worrying about managing yourself. At this point, I think I'd rather prefer to have a "set and forget" it type of investment in Betterment with this shorter-to-mid term money. In fact, as much as I'd like to call it a "safety net" or "rainy day" funds, I'd probably just leave it open and flexible to even become a home down-payment or car fund. Digression: besides Betterment are there other/better of these "robo" management tools out there? Wealthfront? Learnvest? etc? There's so many of these guys that it's hard keeping up with what it is they are or are even offering!
All that said, if it sounds like stashing this $50k in Betterment might be a good idea, what would you suggest my target allocation be?
Thoughts?
Going back to your original question...
I started out by putting $10,000 using Betterment Safety Net. My original plan was to scale that amount up to use it to cover my emergency fund. The Betterment recommendation is to have 6-12 months of living expenses + 30% in the Safety Net option (to allow for market fluctuation.)
My experience so far is that the Safety Net option is pretty stable. Day-to-day fluctuations are minor, but the balance is below my original deposit (not by a lot). Since the original deposit, however, I have rethought my overall investing strategy. (I will probably either be changing the risk category of that money or removing it from Betterment altogether.)
If you plan to use the 3- or 4- passive index fund strategy for your primary investments, then you can park the bond fund component in your taxable investment account. Use a tax-free (municipal or treasury) bond fund to minimize taxes. Put all your non-immediate emergency funds into that bond fund, and let it do double-duty. All new money goes into the stock index funds only until your overall account is balanced (since this will start you out with an over-sized bond component.)
If an emergency comes up, you can tap the bond fund. This strategy has the following advantages:
- It lets you start your primary investing plan right away. It reduces the lost opportunity cost of having an emergency fund.
- It lets you have an emergency fund "invested" right away.
- If your overall portfolio is large enough, your bond component may already be bigger than your emergency fund. In that case, there is no opportunity cost, and you can fully invest the entire amount per your desired mix.
- The emergency fund is liquid (takes 1-2 days to transfer electronically to your bank account if you need it.)
- The emergency fund is in a taxable account, so there are no penalties for withdrawing it from IRA or Roth early.
- If you tap the emergency fund, you can either re-fund it using new money, or it will be taken care of when you rebalance. Basically, it gives you options.
- The concept of treating all your accounts (taxable and non-taxable) as a single big portfolio will let you concentrate all your bond fund requirements in a single location. This means the funds available to you in an emergency will actually grow over time.
- With your bond component in a taxable account, your limited tax-deferred or tax-free space may be used for the assets with the greatest appreciation potential (stocks.)
By incorporating the emergency fund into the bond component of your overall investments, you're technically investing it right away, but you're investing it into something that is still liquid and less volatile.
Wealthfront, Betterment, and the DIY Vanguard schemes all discussed here are really the same basic strategy. That is passive investment into low-expense index funds, managed in a way to increase returns over long timeframes while minimizing taxes and reduce risk (volatility).
In fact, all the schemes use mostly the same funds to achieve this goal (Vanguard ETFs). The primary difference is in the number of funds used, the balance of how it is done, and extra features (TLH) and fees (.25% or .15% above fund expenses) resulting from using a managed account (WealthFront or Betterment). It's impossible to know which variant provides the most return in the long run. They have the same concept using the same underlying funds, so they'll probably all be in the same ballpark of returns. Betterment has a slight value tilt, a higher international percentage, and a lower bond allocation. Wealthfront has a real estate component for greater diversification. The 3- and 4- fund DIY Vanguard strategies are easier to understand and maintain.
In the end, getting started is the most important part.
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Soo...*cough* while I think I found my dinosaurs of the investment world (experienced power players).
Hypothetical question and questions.
Say you make, roughly 250k (before investments) as a household.
You max out both 401k, both roth, and you have roughly 80k left over after bills and taxes take out.
Currently playing your current tax game is getting old fast (international corps buying state side corps under state side parent corps under international holding corp, assets structured as raw material costs, preplanned corporate buyouts on projected losses, amortizing capital costs over time, really complicated.)
Say you want to get away from this, to a "set and leave it" concept.
I noticed with this "tax harvest", new term for me, that you guys project people dont have the money, what if they do? How does this tax harvesting help them? How does it hurt them?
I'm seeing lots of good debate on both sides, both of which are accounting for the concept of taxes, but one side argues no taxes paid, higher fees, while the other side argues no taxes paid, lower fees. (at least for loss periods, and if Im not mistaken, amortized losses over time for periods of gains?)
General gist of everything from what I'm seeing. Am I grasping this concept correctly? This is a very unique, very complex concept. I like the idea of it, but I never bite on things I don't understand.
I never bite on things I don't understand, either. I'm also trying to understand this, but I might be further along.
For simplicity, I'm focusing on the "set it and forget it" strategy. On the Vanguard camp side, this means that you put your money into a Vanguard Life Strategy Fund or a Vanguard Targeted Date fund. Depending upon the fund you select (based on your risk tolerance or date requirements), this fund will have an expense ratio (probably around .18%). This expense ratio is how much you pay the fund managers -- that rate multiplied by your total assets.
On the robo-advisor side, that means you give your money to Betterment, who manages your money for you. For this, they charge you .15%. The catch is that they're managing your money by putting them into (mostly) Vanguard funds, which themselves have an expense ratio. So your costs are slightly higher because you're paying Vanguard + Betterment management fees.
So why do Betterment customers pay the extra money? Tax loss harvesting. When Betterment is buying ETFs for you, some of them will drop in value. They will then sell those at a loss, then replace it with a proxy (similar asset but not the same.) At tax time, they will provide a statement so you can claim those losses on your taxes.
There are limits. You can only claim $3,000 in passive losses per year. This reduces your income by that amount, saving you from paying the income taxes. If you are conducting trades in Vanguard funds outside of Betterment, some of the Betterment trades may be disallowed (this is eliminated if you give Betterment everything to manage). After 2-3 years, the stock market has probably gone up enough that your older assets are no longer generating losses. Losses will typically come only from new money. When you sell, your assets will have a lower cost basis. That means the taxes will be higher. Betterment will manage your money to minimize taxes when you withdraw money.
So far, this is all good. You pay Betterment a little more for portfolio management, and they give you a tangible return through Tax Loss Harvesting. The issue is that the "little more" you're paying is a % of assets. Assuming you're paying .05% more than you'd pay by using the Life Strategy fund, when your assets hit $1Million, your fee is $500 more per year. Meanwhile, that TLH loss can't grow bigger than $3,000.
So if you truly want 100% hands off, Betterment isn't a bad choice. But if you are willing to follow a simple indexing strategy (DIY), your fund costs are the same as Betterment, and you save the entire .15% management fee. With assets at $1Million, your Betterment fees are $1,500 per year extra. (Betterment estimates that if you contribute $80,000 per year, or $6,666/mo, you will hit $1Million in 9 years.)
When you finally stop adding new funds, there is no more Tax Loss Harvesting. At that point, you are still paying extra Betterment fees as long as you stay with them. Okay, some argue that that's when you leave Betterment. But how? If you cash out, you take the capital gains for a very large (hopefully multi-million dollar portfolio.) If you transfer the assets in kind to a brokerage, you get 1-2 dozen funds in investments you don't understand, with years of complex accounting records to boot. We're no longer talking set it and forget it. So you stay with Betterment forever, and consider the fee just the cost of having someone else managing your multi-million dollar portfolio.
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Soo...*cough* while I think I found my dinosaurs of the investment world (experienced power players).
Hypothetical question and questions.
Say you make, roughly 250k (before investments) as a household.
You max out both 401k, both roth, and you have roughly 80k left over after bills and taxes take out.
Currently playing your current tax game is getting old fast (international corps buying state side corps under state side parent corps under international holding corp, assets structured as raw material costs, preplanned corporate buyouts on projected losses, amortizing capital costs over time, really complicated.)
Say you want to get away from this, to a "set and leave it" concept.
I noticed with this "tax harvest", new term for me, that you guys project people dont have the money, what if they do? How does this tax harvesting help them? How does it hurt them?
I'm seeing lots of good debate on both sides, both of which are accounting for the concept of taxes, but one side argues no taxes paid, higher fees, while the other side argues no taxes paid, lower fees. (at least for loss periods, and if Im not mistaken, amortized losses over time for periods of gains?)
General gist of everything from what I'm seeing. Am I grasping this concept correctly? This is a very unique, very complex concept. I like the idea of it, but I never bite on things I don't understand.
I never bite on things I don't understand, either. I'm also trying to understand this, but I might be further along.
For simplicity, I'm focusing on the "set it and forget it" strategy. On the Vanguard camp side, this means that you put your money into a Vanguard Life Strategy Fund or a Vanguard Targeted Date fund. Depending upon the fund you select (based on your risk tolerance or date requirements), this fund will have an expense ratio (probably around .18%). This expense ratio is how much you pay the fund managers -- that rate multiplied by your total assets.
On the robo-advisor side, that means you give your money to Betterment, who manages your money for you. For this, they charge you .15%. The catch is that they're managing your money by putting them into (mostly) Vanguard funds, which themselves have an expense ratio. So your costs are slightly higher because you're paying Vanguard + Betterment management fees.
So why do Betterment customers pay the extra money? Tax loss harvesting. When Betterment is buying ETFs for you, some of them will drop in value. They will then sell those at a loss, then replace it with a proxy (similar asset but not the same.) At tax time, they will provide a statement so you can claim those losses on your taxes.
There are limits. You can only claim $3,000 in passive losses per year. This reduces your income by that amount, saving you from paying the income taxes. If you are conducting trades in Vanguard funds outside of Betterment, some of the Betterment trades may be disallowed (this is eliminated if you give Betterment everything to manage). After 2-3 years, the stock market has probably gone up enough that your older assets are no longer generating losses. Losses will typically come only from new money. When you sell, your assets will have a lower cost basis. That means the taxes will be higher. Betterment will manage your money to minimize taxes when you withdraw money.
So far, this is all good. You pay Betterment a little more for portfolio management, and they give you a tangible return through Tax Loss Harvesting. The issue is that the "little more" you're paying is a % of assets. Assuming you're paying .05% more than you'd pay by using the Life Strategy fund, when your assets hit $1Million, your fee is $500 more per year. Meanwhile, that TLH loss can't grow bigger than $3,000.
So if you truly want 100% hands off, Betterment isn't a bad choice. But if you are willing to follow a simple indexing strategy (DIY), your fund costs are the same as Betterment, and you save the entire .15% management fee. With assets at $1Million, your Betterment fees are $1,500 per year extra. (Betterment estimates that if you contribute $80,000 per year, or $6,666/mo, you will hit $1Million in 9 years.)
When you finally stop adding new funds, there is no more Tax Loss Harvesting. At that point, you are still paying extra Betterment fees as long as you stay with them. Okay, some argue that that's when you leave Betterment. But how? If you cash out, you take the capital gains for a very large (hopefully multi-million dollar portfolio.) If you transfer the assets in kind to a brokerage, you get 1-2 dozen funds in investments you don't understand, with years of complex accounting records to boot. We're no longer talking set it and forget it. So you stay with Betterment forever, and consider the fee just the cost of having someone else managing your multi-million dollar portfolio.
Wolf,
What about the risk of Betterment being acquired/disbanded? Then you're wtuck with 10-12 ETF's at Apex Clearing anyway. Personally, I'm waiting to see what Schwab's robo-advising product looks like. They claim that they will not charge fees for the service.
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Personally, I'm waiting to see what Schwab's robo-advising product looks like. They claim that they will not charge fees for the service.
I really hope that launches on time (Q1 2015). I'll have some money to invest soon and don't really want to keep it in cash waiting for them to launch. Schwab would be a very safe place to invest in a "robo-advisor."
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Personally, I'm waiting to see what Schwab's robo-advising product looks like. They claim that they will not charge fees for the service.
I really hope that launches on time (Q1 2015). I'll have some money to invest soon and don't really want to keep it in cash waiting for them to launch. Schwab would be a very safe place to invest in a "robo-advisor."
Agree. I'm selling my rental property in late Q2 or early Q3, and hope to use the Schwab product for my stock portion of my portfolio. (Bonds will go directly to a Vanguard mutual fund - I see no need to use a robo-advisor for bonds.
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If you plan to use the 3- or 4- passive index fund strategy for your primary investments, then you can park the bond fund component in your taxable investment account. Use a tax-free (municipal or treasury) bond fund to minimize taxes. Put all your non-immediate emergency funds into that bond fund, and let it do double-duty. All new money goes into the stock index funds only until your overall account is balanced (since this will start you out with an over-sized bond component.)
If an emergency comes up, you can tap the bond fund. This strategy has the following advantages:
- It lets you start your primary investing plan right away. It reduces the lost opportunity cost of having an emergency fund.
- It lets you have an emergency fund "invested" right away.
- If your overall portfolio is large enough, your bond component may already be bigger than your emergency fund. In that case, there is no opportunity cost, and you can fully invest the entire amount per your desired mix.
- The emergency fund is liquid (takes 1-2 days to transfer electronically to your bank account if you need it.)
- The emergency fund is in a taxable account, so there are no penalties for withdrawing it from IRA or Roth early.
- If you tap the emergency fund, you can either re-fund it using new money, or it will be taken care of when you rebalance. Basically, it gives you options.
- The concept of treating all your accounts (taxable and non-taxable) as a single big portfolio will let you concentrate all your bond fund requirements in a single location. This means the funds available to you in an emergency will actually grow over time.
- With your bond component in a taxable account, your limited tax-deferred or tax-free space may be used for the assets with the greatest appreciation potential (stocks.)
By incorporating the emergency fund into the bond component of your overall investments, you're technically investing it right away, but you're investing it into something that is still liquid and less volatile.
We have about $60k that is our "emergency fund" that is just sitting in a savings account now. We are thinking of doing exactly this. Although we are more of the set it and forget it type so I'm thinking of keeping it really simple and just doing two funds in Vanguard...VTSAX and an intermediate municipal bond fund. Are there any downsides to this that I am missing? This seems like a great place to put our emergency fund. This is great because this also helps me have a more moderate asset allocation too as I have been 100% in stocks in my 401k/IRA since I thought before finding MMM that I wouldn't retire until a very long time frame so was okay with a riskier AA. But now that the timeline to retirement is much shorter, I like the idea of having my EF in bonds as that will bring my AA down to a less risky 75% stocks/25% bonds.
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A poster on Bogleheads as highlighted a limitation of Betterment's TLH program:
Something interesting I've learned is to not expect a switchback after 30 days. In all of these TLH events the market has recovered by then, and Betterment won't switch back at a gain. So the TLH'ed funds tend to get "stuck" in the secondary ETFs until a bigger downturn occurs. At some point the unrealized gain of TLH'ed shares will be so big that there will be almost no chance of a downturn being big enough to TLH them again, and there's more or less a 50/50 chance of whether they'll be in the primary or secondary ETF at that time. Currently more than 50% of every asset class category is in the secondary ETF. So I may end up paying the higher expense ratio of the secondary ETFs "forever" due to the TLH. But I'm essentially reinvesting the tax savings, and expense ratios will change over time, so it's hard to say whether it's a net gain or loss in the long run in the case of, e.g., a mere 2% harvested loss in VOE (which occurred on 10/10) into IWS with 0.16% in extra expenses. My guess is that if TLH is considered "in aggregate" then it's a net benefit long-term but that some individual TLH events may not be.
As Dodge has repeatedly pointed out, most of the TLH happens in the beginning. After some time, all positions have large unrealized gains. There's nothing to harvest. The new money you are adding becomes a smaller and smaller percentage of the total invested. Meanwhile, you are stuck in the secondary ETFs paying higher expenses.
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A poster on Bogleheads as highlighted a limitation of Betterment's TLH program:
Something interesting I've learned is to not expect a switchback after 30 days. In all of these TLH events the market has recovered by then, and Betterment won't switch back at a gain. So the TLH'ed funds tend to get "stuck" in the secondary ETFs until a bigger downturn occurs. At some point the unrealized gain of TLH'ed shares will be so big that there will be almost no chance of a downturn being big enough to TLH them again, and there's more or less a 50/50 chance of whether they'll be in the primary or secondary ETF at that time. Currently more than 50% of every asset class category is in the secondary ETF. So I may end up paying the higher expense ratio of the secondary ETFs "forever" due to the TLH. But I'm essentially reinvesting the tax savings, and expense ratios will change over time, so it's hard to say whether it's a net gain or loss in the long run in the case of, e.g., a mere 2% harvested loss in VOE (which occurred on 10/10) into IWS with 0.16% in extra expenses. My guess is that if TLH is considered "in aggregate" then it's a net benefit long-term but that some individual TLH events may not be.
As Dodge has repeatedly pointed out, most of the TLH happens in the beginning. After some time, all positions have large unrealized gains. There's nothing to harvest. The new money you are adding becomes a smaller and smaller percentage of the total invested. Meanwhile, you are stuck in the secondary ETFs paying higher expenses.
I mostly agree with Dodge that TLH on a lump sum loses it's benefit over time, but as the portfolio rebalances (they auto-rebalance, right?), won't that create new tax-lots to possibly harvest losses in?
I don't think this is something easily added to a spreadsheet,
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A poster on Bogleheads as highlighted a limitation of Betterment's TLH program:
Something interesting I've learned is to not expect a switchback after 30 days. In all of these TLH events the market has recovered by then, and Betterment won't switch back at a gain. So the TLH'ed funds tend to get "stuck" in the secondary ETFs until a bigger downturn occurs. At some point the unrealized gain of TLH'ed shares will be so big that there will be almost no chance of a downturn being big enough to TLH them again, and there's more or less a 50/50 chance of whether they'll be in the primary or secondary ETF at that time. Currently more than 50% of every asset class category is in the secondary ETF. So I may end up paying the higher expense ratio of the secondary ETFs "forever" due to the TLH. But I'm essentially reinvesting the tax savings, and expense ratios will change over time, so it's hard to say whether it's a net gain or loss in the long run in the case of, e.g., a mere 2% harvested loss in VOE (which occurred on 10/10) into IWS with 0.16% in extra expenses. My guess is that if TLH is considered "in aggregate" then it's a net benefit long-term but that some individual TLH events may not be.
As Dodge has repeatedly pointed out, most of the TLH happens in the beginning. After some time, all positions have large unrealized gains. There's nothing to harvest. The new money you are adding becomes a smaller and smaller percentage of the total invested. Meanwhile, you are stuck in the secondary ETFs paying higher expenses.
I mostly agree with Dodge that TLH on a lump sum loses it's benefit over time, but as the portfolio rebalances (they auto-rebalance, right?), won't that create new tax-lots to possibly harvest losses in?
I don't think this is something easily added to a spreadsheet,
Yes, but the additions are miniscule. If you start with a $200k portfolio and add $20k per year, as time goes on $20k is going from a 10% of your portfolio value to 1% or perhaps even less, and you could be stuck with the secondary ETF with high capital gain exposure.