Author Topic: New tax loss harvesting algorithm: Betterment.  (Read 6834 times)

milesdividendmd

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New tax loss harvesting algorithm: Betterment.
« on: June 20, 2014, 11:16:05 PM »
My bias is well documented.  I already thought that Betterment was  a great product for low information/low interest investors who just wanted to "set it and forget it."

In the original review of Betterment I wrote on my site, my main criticism was that by buying a "fund of funds" through Betterment, investors missed out on the opportunity to tax loss harvest.

I was suprised to see today that the case for Betterment just got even stronger.  (At least for taxable accounts greater than 50K.)

https://www.betterment.com/resources/tax-loss-harvesting-white-paper/

I don't necessarily buy the backtesting numbers here, (I am always leery of backtesting.)  But I have no trouble believing that the tax loss harvesting algorithm will more than cover the 0.15-0.25 ER in taxable acccounts >50K , when compared to a slice and dice portfolio simply rebalanced once a year.  This is a perfect application for a well designed algorithm, and by the looks of their white paper, Betterment has addressed many of the pitfalls of TLH with their Algo (wash rule, switchbacks, and IRA interactions.)

I am impressed by the continual innovation of this company, and I will continue to recommend it to friends and family who want to get into the market without really learning the nuts and bolts of investing.

I look forward to everyone elses thoughts, (especially the skeptics of Betterment.)

GGNoob

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Re: New tax loss harvesting algorithm: Betterment.
« Reply #1 on: June 21, 2014, 12:18:50 PM »
I am very excited about this TLH+ that Betterment introduced.

I only opened my Betterment account a little over a year ago and only got serious about funding it earlier this year (after experimenting with other investments before deciding Betterment was the choice for me), but Betterment has already made many changes and continuously gets better. Right now I only have a little over $10,000 in Betterment between Roth IRAs for my wife and I, our Safety Net goal, and our Early Retirement goal.

Because our Safety Net and Early Retirement goal will be invested with Betterment, I think this TLH+ will really help us reduce our taxes while we build up our savings. I've read the blog post and the white paper and both make me really excited. It will be a year or two before we have the minimum of $50,000, but by then Betterment should be able to link my account with my wife's so I can take advantage of TLH+ while still contributing to her Betterment Roth IRA.

I too am an advocate for Betterment and try to convince all of my friends/co-workers who are not currently saving money to open an account. It honestly doesn't get easier and I feel the features and advice are worth the extra fee.

Cyrano

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Re: New tax loss harvesting algorithm: Betterment.
« Reply #2 on: June 21, 2014, 01:53:17 PM »
Innovative, but it can't help with the expense ratio on a tax advantaged account.

Thedudeabides

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Re: New tax loss harvesting algorithm: Betterment.
« Reply #3 on: June 21, 2014, 02:44:00 PM »
I love the automated system but have personally been a little skeptical of TLH.

Because your basis is reset when losses are harvested, you are betting that future taxes will be the same or lower and that your portfolio will do better as a result of the tax deferment to the extent that the tax savings will offset the fees.

Assuming a $100k portfolio invested for 20 years at average market return invested in vanguard index funds:


Condition 1: No TLH

100,000 * (1.07)^20 = 403,873

Condition 2: TLH/Fees
Assume 25% tax bracket, $750 tax savings reinvested. Assume additional fees of 0.35:

(100,000 * (1.0665)^20) + (750 * ((1.0665)^20 - 1) / 1.0665)

You still come out ahead by $22,698 in the first scenario mostly due to fewer fees. That and taxes are so much easier.

Maybe I'm thinking about this incorrectly or doing my math wrong.

I don't mean to douse your enthusiasm by any means, just trying to learn the benefits and determine if they are worth it.

Thedudeabides

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Re: New tax loss harvesting algorithm: Betterment.
« Reply #4 on: June 21, 2014, 02:57:30 PM »
I kind of messed up the math here switching back and forth between my financial calculator and writing out the equations on my phone. The 403,873 should be 386,968 and to be clear that's annual compounding not monthly compounding.

The general analysis should still stand though. With the added fees it would be difficult in my opinion to come out ahead.

danielegan

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Re: New tax loss harvesting algorithm: Betterment.
« Reply #5 on: June 21, 2014, 03:40:10 PM »
Hi all,

Daniel Egan, in charge of Investing at Betterment here.

I just wanted to respond to the math by Thedudeabides. Unfortunately it's not quite right for two reasons.

First, Betterment's fees on a $100,000 portfolio are 15bps, not 35bps.

Second, while you've compounded out 20 years worth of fees, you've only tax loss harvested once. While you may be quite optimistic about markets only going up, thinking that you'd only tax loss harvest in one year out of 20, and only get one year's worth of tax offsets doesn't seem fair.

So, if we do it for just one year, with the correct fees:

No TLH+:
100,000 * (1.07) = $107,000

With TLH+:
100,000 * (1.0685) + $750 = $107,600

So in one year it has raised your after-fee return 60bps.

Obviously, that's a very simple case, and doesn't include growth while deferred, nor final liquidation tax. We take these concerns seriously, and thus did the correct analysis over the most recent 13 year period using the portfolio's internal rate of return with and without TLH to properly adjust for cashflows. You can find that detailed analysis here:
https://www.betterment.com/resources/tax-loss-harvesting-white-paper/#alpha

We found that for a moderate rate tax payer, TLH+ increases returns by 0.77% per year, after deducting Betterment's fees.

Glad to see the discussion ongoing, and happy to answer any other questions.

Kind regards,
Dan


milesdividendmd

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New tax loss harvesting algorithm: Betterment.
« Reply #6 on: June 21, 2014, 03:57:29 PM »
Thedudeabides. I am wondering where you get the added expense of  0.35%?

Fees at betterment on accounts over 50k are 0.15-0.25%.

Also, I am not sure why you separate the 750$ in cash savings from the return on investment.

Wouldn't it be more accurate to take the expected gains from of TLH and subtract the fees?

ie if fees = 0.15% (in your example of 100K invested) and your expected improved return in a taxable account is 1% with TLH, I would calculate the returns to be

(100,000 * (1.0785^20 ) = 453,318 or ahead by 50K)
« Last Edit: June 21, 2014, 04:10:52 PM by milesdividendmd »

arebelspy

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Re: New tax loss harvesting algorithm: Betterment.
« Reply #7 on: June 21, 2014, 05:10:05 PM »
Hi all,

Daniel Egan, in charge of Investing at Betterment here.

I just wanted to respond to the math by Thedudeabides. Unfortunately it's not quite right for two reasons.

First, Betterment's fees on a $100,000 portfolio are 15bps, not 35bps.

Second, while you've compounded out 20 years worth of fees, you've only tax loss harvested once. While you may be quite optimistic about markets only going up, thinking that you'd only tax loss harvest in one year out of 20, and only get one year's worth of tax offsets doesn't seem fair.

So, if we do it for just one year, with the correct fees:

No TLH+:
100,000 * (1.07) = $107,000

With TLH+:
100,000 * (1.0685) + $750 = $107,600

So in one year it has raised your after-fee return 60bps.

Obviously, that's a very simple case, and doesn't include growth while deferred, nor final liquidation tax. We take these concerns seriously, and thus did the correct analysis over the most recent 13 year period using the portfolio's internal rate of return with and without TLH to properly adjust for cashflows. You can find that detailed analysis here:
https://www.betterment.com/resources/tax-loss-harvesting-white-paper/#alpha

We found that for a moderate rate tax payer, TLH+ increases returns by 0.77% per year, after deducting Betterment's fees.

Glad to see the discussion ongoing, and happy to answer any other questions.

Kind regards,
Dan

Dan,
Thanks for chiming in.  We always appreciate when companies interact positively and help clear up information about their services and offerings.
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Thedudeabides

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Re: New tax loss harvesting algorithm: Betterment.
« Reply #8 on: June 21, 2014, 05:27:51 PM »
Hi all,

Daniel Egan, in charge of Investing at Betterment here.

I just wanted to respond to the math by Thedudeabides. Unfortunately it's not quite right for two reasons.

First, Betterment's fees on a $100,000 portfolio are 15bps, not 35bps.

Second, while you've compounded out 20 years worth of fees, you've only tax loss harvested once. While you may be quite optimistic about markets only going up, thinking that you'd only tax loss harvest in one year out of 20, and only get one year's worth of tax offsets doesn't seem fair.

So, if we do it for just one year, with the correct fees:

No TLH+:
100,000 * (1.07) = $107,000

With TLH+:
100,000 * (1.0685) + $750 = $107,600

So in one year it has raised your after-fee return 60bps.

Obviously, that's a very simple case, and doesn't include growth while deferred, nor final liquidation tax. We take these concerns seriously, and thus did the correct analysis over the most recent 13 year period using the portfolio's internal rate of return with and without TLH to properly adjust for cashflows. You can find that detailed analysis here:
https://www.betterment.com/resources/tax-loss-harvesting-white-paper/#alpha

We found that for a moderate rate tax payer, TLH+ increases returns by 0.77% per year, after deducting Betterment's fees.

Glad to see the discussion ongoing, and happy to answer any other questions.

Kind regards,
Dan

Hi Dan,

Thank you for responding. I really appreciate your participation in the discussion.

The difference in fees certainly makes a big difference, and you're right about the $750 each year (I did this on my financial calculator initially and then did not write out the right formula when writing the post), but I'm still not convinced it changes my conclusion.

No TLH:
$100,000 * (1.07)^20 = $403,873
When Sold:
Basis = $100,000
Gain = $303,873
LTCG @ 15% = $303,873 * 0.15 = $45,580.95
Net = $403,873 - $45,580.95 = $358,292.93

TLH:
$100,000 * (1.0685)^20 = $376,262
$750 each year for 19 years @ 1.0685 = $30,248
Total = $406,509.68

So far, we're ahead with TLH, but if taxes are taken into consideration, this is where it starts to become less of an advantage. Let's say that during the first year (I know this is completely contrived), the market falls by 60% at one point. The $100,000 stock is now worth $40,000. Shares are repurchased and the market recovers at the end of the year to end at $106,850.00. There are $60,000 losses harvested, $3000 of which are used in the current tax year and the remainder of the $57,000 carried forward.

At the end of the 20 years:
Basis = $40,000
Gain = $406,509.68 - $40,000 = $366,509.68
LTCG = $366,509.68 * 0.15 = $54,976.45
Net = $406,509.68 - $54,976.45 = $351,533.23

Taking taxes at the time of sale into consideration, in this scenario you are behind $6,759.09 if taxes stay the same.

If taxes rates rise, the difference would be greater (for example if capital gains taxes were to be 28%).

Am I thinking about this correctly?

milesdividendmd

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New tax loss harvesting algorithm: Betterment.
« Reply #9 on: June 21, 2014, 06:23:34 PM »
And don't forget that at a mustachian level of earned income during retirement you can gradually tax gain harvest to reestablish your basis at the higher level while paying no tax penalties at all.

See

http://www.gocurrycracker.com/never-pay-taxes-again/

If you pursue this strategy you get gains on the front-end, compounded gains during growth, and no penalty upon withdrawal.

Unfortunately, there are not enough Mustachians in the country yet to take advantage of this loophole (of being exempt from capital gains at low levels of earned income. ) Fortunately it is likely that because of this fact that The loophole will stay open for a long, long, time.

Thedudeabides

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Re: New tax loss harvesting algorithm: Betterment.
« Reply #10 on: June 21, 2014, 06:47:18 PM »

And don't forget that at a mustachian level of earned income during retirement you can gradually tax gain harvest to reestablish your basis at the higher level while paying no tax penalties at all.

See

http://www.gocurrycracker.com/never-pay-taxes-again/

If you pursue this strategy you get gains on the front-end, compounded gains during growth, and no penalty upon withdrawal.

Unfortunately, there are not enough Mustachians in the country yet to take advantage of this loophole (of being exempt from capital gains at low levels of earned income. ) Fortunately it is likely that because of this fact that The loophole will stay open for a long, long, time.

That is an awesome post. Thanks for linking that :)