Wealthfront’s Smart Beta
Smart Beta is Wealthfront’s next evolution of US Direct Indexing, and is available to all clients with taxable account balances over $500k. Like US Direct Indexing, it replaces the ETF normally used to represent US stocks in a Wealthfront portfolio with a combination of large and mid-capitalization US stocks and an additional ETF. However, rather than hold the individual securities in proportion to their market capitalization (as is the case with US Direct Indexing), the weights on a portion of the portfolio are shifted to increase the expected after-tax return of the portfolio.
Smart Beta takes advantage of decades of time-tested academic research on the drivers of asset returns. The underlying research — recognized with two Nobel Prizes (1990, 2013) — demonstrated that a security’s return is determined by the set of risk factors that it is exposed to, rather than its standalone risk (e.g. as measured by its volatility). Thus, by optimizing the composition of the factors to which a portfolio of stocks is exposed, its expected return can be increased while leaving volatility unchanged. Using a multi-factor methodology, Smart Beta identifies securities which are likely to have the highest risk-adjusted returns, and overweights them relative to their allocation in the cap-weighted benchmark.
By combining this portfolio construction methodology with our US Direct Indexing stock-level tax loss harvesting service, we expect the incremental gains to be delivered in a tax-efficient manner. Specifically, employing a non-cap-weighted allocation to individual securities requires periodic trading, such that some of the incremental gains could be subject to short-term tax rates. However, the availability of tax losses harvested by our stock-level tax-loss harvesting service enables the taxation of these gains to be offset, thus deferring their taxation to a future date (i.e. when the portfolio is liquidated) when a potentially lower, long-term capital gains rate will apply.
We deliver these features to eligible clients at no incremental cost to our basic service.
Relation to US Direct Indexing
In 2013 Wealthfront launched US Direct Indexing, a stock-level tax-loss harvesting service. US Direct Indexing offers two significant advantages over our ETF-level tax-loss harvesting service, which is available to all clients. First, by replacing the ETF used to gain exposure to US equity markets with individual securities, it lowers the portfolio’s expense ratio. Second, trading in individual securities enables US Direct Indexing to harvest more losses than ETF-level harvesting service which only relies on a pair of ETFs (Vanguard’s Total Stock Market Index, VTI, and Schwab’s US Broad Market ETF, SCHB). 
Unlike Smart Beta, the individual stock component of the US Direct Indexing portfolio tracks a market capitalization-weighted benchmark. In other words, it seeks to deliver a return matching that of a broad US equity index, while maximizing the quantity of harvested losses. Smart Beta balances two objectives: (a) delivering a superior return relative to the cap-weighted benchmark by relying on a multi-factor portfolio construction methodology; and, (b) maximizing the quantity of harvested tax losses. For the non-US Stocks portion of the portfolio (such as Foreign Stocks, Emerging Markets, etc. listed in the chart below), there is no change to the ETFs held. For those ETFs, all Smart Beta accounts also benefit from our Tax-Loss Harvesting service, which harvests tax savings at the ETF level outside the US stock component of the portfolio.
Costs and Minimums
For taxable accounts larger than $500,000, we offer to replace the ETF normally used to represent a broad market of US stocks (Vanguard’s Total Stock Market ETF, VTI) with stocks from the CRSP US Large-Cap Index (which contains around 600 of the largest capitalization US stocks) and the Vanguard Small-Cap ETF (VB) to represent the remaining smaller capitalization companies. By replacing VTI with a combination of individual securities and a completion ETF, you will pay a lower overall expense ratio than you would for VTI.
Around 85% of the Smart Beta position is composed of individual stocks and thus has no expense ratio. The remaining 15% or so is composed of the Vanguard Small-Cap ETF (VB). The combined portfolio remains subject to Wealthfront’s advisory fee.
Our minimums for Smart Beta are based on dollar amounts required to hold a reasonable collection of individual US stocks while continuing to track the performance of the broad US market. We found that holding hundreds of stocks requires a US equity allocation of roughly $150,000 – thus necessitating an account minimum of about $500,000 (because on average approximately 30% of our recommended portfolios are allocated to US Equities).
Investment Returns and Factors
The expected return on an asset can be decomposed into compensation for the passage of time, and compensation for exposure to common, non-diversifiable sources of risk (i.e. “factors”). The compensation for passage of time is captured by the risk-free rate, which measures the opportunity cost of parting with your money, and can be proxied by rates of return on US Treasuries. The compensation for bearing risk is captured by the product of a security’s exposure to a factor (measured by its beta) and the premium for bearing that risk. “Active” managers seek to identify deviations from this relationship, but decades of research show that they fail to outperform their properly risk-matched benchmarks.
The earliest model of security returns was the Capital Asset Pricing Model (CAPM), proposed independently by Treynor (1961), Sharpe (1964), Mossin (1965), and Lintner (1966), and recognized with the Nobel Prize in 1990. The CAPM is known as a single-factor model, where the only source of compensated risk (the “factor”) is a security’s exposure to the broad equity market. In other words, the single predictor of a security’s future expected return is how much or little it moves relative to the aggregate equity market.
Over time, researchers identified several deficiencies with the CAPM. For example, Banz (1980) showed that small firm common stocks (as measured by their market capitalization) have a tendency to outperform large firm common stocks, and this return differential cannot be explained by differences in their market betas. A decade later, a sequence of influential papers by Professors Eugene Fama and Kenneth French documented an even more significant shortcoming of the CAPM: the “value effect.” Specifically, cheap stocks (firms with a high ratio of book equity to market equity) on average outperformed expensive stocks (firms with a low ratio of book equity to market equity), even though their market betas were lower. These findings led them to extend the single-factor CAPM model to include a value factor (measured by book equity to market equity ratio) and a size factor (measured by market capitalization). The Fama-French three-factor model (1992, 1993) was an early multi-factor model, and has become an important benchmark in academic work. Around the same time, Jegadeesh and Titman (1993) identified a “momentum effect,” or the tendency for securities that have been the best (or worst) performers over the last six to 12 months to continue to be best (or worst) performers. This effect could not be rationalized by Fama and French’s three-factor model, leading researchers to include momentum as an additional, fourth factor. In 2015, Fama and French expanded the original three-factor model to a five-factor model, as they discovered that companies with strong operating profitability outperform the ones with weak profitability and companies with conservative level of investments (stable total assets) outperform the ones with aggressive level of investments. The five-factor model includes a profitability factor (measured by revenue minus costs of goods sold, interest expense, selling, general, and administrative expenses, divided by book equity) and what they call an investment factor (measured by change of total assets on the company’s balance sheet). Professor Kenneth French tabulates the historical performance of these factors on his website.
Over the past few decades, academia and industry alike embarked on a search for additional characteristics (factors) that can be used to sort stocks in a manner that produces a return spread that cannot be accounted for by exposure to the market, size, value, and momentum factors. Out of the hundreds of characteristics that have been considered, some findings disappeared following publication and others were shown to be concentrated in areas of capital markets where they cannot be reliably incorporated in portfolios at scale (e.g. among stocks with small capitalizations or where it is difficult to short). However, a small subset has proven to be robust across time, across geographies (i.e. work reliably outside of the United States), and — in some instances — across asset classes.
Smart Beta blends five single-factor strategies (momentum, high profitability, high dividend yield, low market beta, and low volatility) with the cap-weighted market index to generate a modified index. This index then serves as the benchmark for our direct indexing service, which seeks to maximize the quantity of harvested losses while minimizing the tracking error from the supplied benchmark.
Our portfolio construction procedure begins by constructing single-factor strategies. Each of these strategies ranks securities based on a single characteristic, and then invests in a subset of securities based on this characteristic (e.g. momentum, high profitability etc.). The resulting portfolio can be interpreted as a simple single-factor strategy and its composition is periodically refreshed. Our strategy is implemented using around 600 stocks in the CRSP US Large Cap Index, which represents approximately 85% of the market cap associated with the US equity market. The CRSP index was launched in 2011 and our Smart Beta strategy was launched in 2017. We will present Smart Beta strategy’s actual performances from 2017 in later sections. For the backtest portion prior to the CRSP US Large Cap index launch in 2011, we approximate the index by using stocks in the top 85% market capitalization of the US equity market, consistent with the broad definition of the index. Strategy returns are presented gross of fees.
Table 1 displays the backtested returns for each of the five single-factor strategies from 1965 to 2016, matching the span of data available from CRSP (Center for Research in Security Prices). We report the annualized (arithmetic) mean return, volatility, and Sharpe Ratio (computed as factor return minus the one-month Treasury Bill return, divided by volatility. This measures the risk-adjusted return). We observe that on average all factors outperformed the index and have higher Sharpe Ratios – in other words, a better risk-adjusted return.
There are substantial benefits to be gained from factor diversification. To illustrate this, Table 2 displays the correlation matrix of the return differentials of each factor relative to the cap-weighted index. The factors exhibit low (and sometimes negative) correlations, such that different factors are likely to contribute incremental returns at different points in time. A second benefit of the low factor correlations is that ranking securities on different characteristics will generally point to different securities, resulting in a well-diversified portfolio once the single-factor strategies are combined. Smart Beta exploits this feature by combining the five single-factor strategies.
Constructing the Modified Index
After constructing the single-factor strategies, we combine them to produce a multi-factor “overlay” portfolio, which includes securities with strong momentum, high profitability, high dividend yield, low market beta, and low volatility. These factors are equally weighted in the portfolio. This overlay portfolio is blended at a ratio of 30% overlay and 70% cap-weighted index to produce a modified index, which serves as the benchmark relative to which the direct indexing service will seek to minimize tracking error. The goal of this construction is to overweight securities with high expected returns, while ensuring the modified index remains close to the cap-weighted benchmark, thus keeping overall portfolio risk unchanged.
Table 3 follows the format of Table 1, but compares the performance of the cap-weighted benchmark and the modified index. As before, the underlying data span the period from 1965 to 2016. Over this period the modified index outperformed the cap-weighted index by 0.86% per year before taxes. These results were accomplished while maintaining portfolio volatilities that were no greater than the volatilities of the cap-weighted indexes. As a result, the Sharpe Ratios of the modified indexes are 20% greater, indicating an improvement in the risk-adjusted return from deploying the multi-factor overlay.
To provide more detail on their relative performance, Figure 1 below displays the annualized return differential between the modified and capitalization-weighted indexes over three-year rolling windows. Positive (or negative) values indicate that the modified index has outperformed (or underperformed) the cap-weighted benchmark. Although the modified index outperformed in over three quarters of the three-year periods, it is important to note that there have been three-year periods in which the annual underperformance equaled almost 2% per year.
Combining the Modified Index with US Direct Indexing
Smart Beta combines the multi-factor overlay described in the previous section with Wealthfront’s direct indexing service to deliver portfolio gains tax-efficiently. Since the overlay requires periodic rebalancing, a portion of the gains that it generates will be from securities held less than one year, and therefore “short-term” in nature for tax purposes. These gains would typically be subject to the relatively higher tax rates applicable to short-term capital gains. However, by offsetting these gains with harvested tax losses, it is possible to defer their taxation into the distant future and pay the lower long term capital gains rate. We implement this by using the modified index as the benchmark for the direct indexing service, which seeks to balance tracking error from the modified index with the quantity of harvested losses. We refer the reader to the US Direct Indexing whitepaper for additional details on how this works, the underlying optimization objective, as well as assumptions used to derive estimated potential tax benefit.
To evaluate the economic benefit of Smart Beta, we carry out a backtest using data from 2000 to 2016. Once again, since the CRSP US Large Cap Index launched in April 2011, we approximated prior years using the top 85% of the US equity market. The backtest reflects a retroactive application of the proposed portfolio construction methodology. It does not reflect the realized performance of any client, and does not represent a guarantee that the future benefit of the strategy is likely to be similar.
Figure 2 compares the cumulative performance of the Smart Beta strategy to the cumulative performance of the US Stock segment of the Wealthfront diversified Classic portfolio, represented by Vanguard’s Total Stock Market Index ETF (VTI). We conservatively assume clients make an initial deposit necessary to meet the minimum account size for Smart Beta ($500K) and then continue to make add-on deposits amounting to 10% of their initial deposit every quarter (this is based on the typical behavior of Wealthfront clients who use the service). All strategy returns are displayed net of Wealthfront’s advisory fee. Our Smart Beta strategy outperformed US stocks and had lower annual volatility (14.7%) compared to US Stocks (15.3%).
Benefits of Smart Beta
We measure the effectiveness of Smart Beta on three dimensions: how much Incremental Return it generates from the multi-factor overlay, how much potential tax benefit it generates from tax-loss harvesting (Harvesting Yield), and how significantly it deviates from the original ETF it replaced to achieve the first two objectives (Tracking Error). We also compute the annual trading turnover of the strategy (Turnover) to evaluate the impact of transaction costs. Portfolio turnover is computed as the total dollar value of sales or purchases (whichever is lower) divided by the value of the portfolio.
We use the term Incremental Return to describe the difference between the portfolio’s return and the original ETF’s return in a given time period and Tracking Error for the standard deviation of the incremental returns. Harvesting Yield, defined as realized capital losses as a percentage of the total portfolio value, is computed assuming the client has sufficient external gains to take advantage of all harvested losses, unless stated otherwise. One’s tax benefit is calculated by multiplying the harvesting yield by one’s tax rate.
Table 4 summarizes these metrics for the Smart Beta strategy over the period 2000-2016. As reflected by the Incremental Return, the overlay contributed an additional 1.38% per year relative to the cap-weighted index (proxied by Vanguard’s Total Stock Market Index, VTI). The annualized portfolio turnover is approximately 62%. We assume that the roundtrip trading cost for large-cap U.S. equities used in the construction of the overlay during this time period was 0.20%, which should be a conservative estimate of trading costs (Marketwatch (2019)). Trading costs in the Smart Beta strategy are solely from bid-ask spreads – Wealthfront clients never pay commissions on any trades. Thus, the incremental return generated by the strategy after accounting for trading costs is roughly 1.38% – (62% * 0.20%) = 1.26%. Even after utilizing some of the harvested losses to offset gains generated by the overlay, the direct indexing delivers 4.49% per year in Harvesting Yield, of which 5.41% is short term realized capital loss and 0.91% is long term realized capital gain. If the client is assumed to be a resident of California and is therefore subject to a combined federal and state short-term and long-term capital gain rates of 44.5% and 24.5% respectively, the final tax benefit is 5.41% * 44.5% + (-0.91%) * 24.5% = 2.18%. The Tracking Error of 3.34% reflects the combined effects of deviations induced by the multi-factor overlay and tax-loss harvesting.
This section compares the actual performance of our Smart Beta strategy to mutual funds and ETFs and explores the underlying factors that drive differences in performance. The analysis runs from July 1, 2017 (the launch date of the service) to November 30, 2021, just before the value factor was replaced by the profitability factor and the stock universe was updated from the largest 500 stocks to the entire CRSP US large-cap index (approximately 600 stocks). All returns shown in this section are annualized.
Our analysis focuses on the Wealthfront Smart Beta strategy  that was in effect from July 1, 2017, which generally owned the 500 US stocks with the largest market capitalization, and the VXF ETF to provide exposure to small-cap US stocks. For each trading day, we calculate the return for each client enrolled in Wealthfront Smart Beta strategy and compute a value-weighted average. The number we display is a compounded and annualized total return over the comparison window. As a benchmark, we display the total return of the CRSP US Total Market Index.
Table 5 shows the benchmark and Smart Beta strategy returns. We see that the smart beta tilts failed to add value over this period – the return of the Smart Beta strategy is 1.16% less than the CRSP US Total Market Index. Note that the Smart Beta returns do not include Wealthfront’s 0.25% annual portfolio advisory fee, which includes management of a diversified global portfolio and our tax-loss harvesting service. Had this fee been deducted, the Smart Beta performance number would be 15.88%.
Next, we compare the returns of Wealthfront’s Smart Beta strategy to several smart beta mutual funds and ETFs over the same period. All the funds included in the comparison invest in diversified portfolios across all sectors of US stocks and, like Wealthfront’s Smart Beta strategy, employ a “multi-factor” approach. The funds differ in the selection of factors used, as well as the exact universe of stocks included in the portfolios. Some salient characteristics of the funds used in the comparison are in Table 6. Besides the visible differences, there are a number of decisions in portfolio construction which can drive differences in returns – these include (potentially time-varying) factor weightings, choices of underlying descriptors to construct factor scores, trading frequency, and portfolio constraints . Note that we include two funds managed by Dimensional Fund Advisors – both funds invest in the same universe and use the same set of factors, but the US Core Equity 2 fund takes more tracking error than US Core Equity 1, with the intent of achieving higher returns above the benchmark.
Source: See footnote 
Figure 3 shows the total return of each fund, in addition to the total returns of Wealthfront Smart Beta and two index ETFs: VTI, which tracks the CRSP US Total Market Index, and VOO, which tracks the S&P 500. We include both VTI and VOO as comparisons because the funds we selected to compare trade over different universes, and we don’t want to misrepresent a choice of universe as underperformance – for example, the Russell 1000 outperformed the S&P 500 over this time period, but we would not say that a fund designed to track the S&P 500 underperformed because it returned less than the Russell 1000. As mentioned above, the Wealthfront Smart Beta returns do not not deduct Wealthfront’s 0.25% advisory fee, which includes the management of assets in other asset classes, as well as our tax-loss harvesting service. If this fee was deducted, the performance of Wealthfront Smart Beta would be 15.88% . The returns of the other funds are net of the funds’ respective management fees, but also do not deduct any additional advisory fee. According to AdvisoryHQ , the average AUM-based advisory fee in 2020 was 1.02% for a $1 million account.
Of the six smart-beta funds in our study, only GSLC outperformed the VTI index fund, by an annualized 0.18% over the comparison period. The others underperformed to varying degrees, with JPUS and LRGF lagging VTI by around 5% annually. All funds underperformed VOO, including GSLC, which underperformed by 0.06%.
We stress that four years and five months is a relatively short period to compare realized performance – our intent is to show that the performance of Wealthfront’s Smart Beta portfolios relative to index funds during this period was not abnormal. We do, however, point out that Wealthfront’s Smart Beta strategy is available at no extra cost beyond the Wealthfront advisory fee, unlike funds in the study, which all have higher expense ratios than both VOO and VTI and don’t offer tax-loss harvesting which can add significant value.
All of the returns in Figure 3 are pre-tax. In our research, we find that Wealthfront’s US Direct Indexing, which is automatically included at no extra fee in Smart Beta portfolios, in some instances may add over 2% in average annual after-tax performance. For example, in the back test from previous sections, with certain tax rate assumptions, the Smart Beta strategy added 2.18% of annual tax benefit. On an after-tax basis, Wealthfront Smart Beta may have relatively better performance than an index or a fund that does not include tax-loss harvesting.
Finally, we examine the performance of the individual factors used in Wealthfront Smart Beta, to indicate which factors contributed to or detracted from the performance of Smart Beta. Consistent with other analysis in this section, we calculate daily returns from July 1, 2017, to November 30, 2021.
As described in previous sections, each factor portfolio is an equally weighted basket of stocks. The baskets are defined by ranking around 500 of the largest US stocks by a certain characteristic, and choosing subsets of the highest-ranked stocks. The baskets are refreshed approximately monthly as we obtain new market data.
Figure 4 shows the total return of each factor portfolio over the comparison period, along with an equally weighted average and the total return of the S&P 500. We observe that only momentum outperformed the S&P 500, while other factors underperformed the S&P 500. On average, the performance of the factor portfolios is lower than that of the S&P 500, which we saw reflected in the performance of client portfolios. The Wealthfront Smart Beta strategy underperformed less than the average of the single-factor portfolios because the modified index only has 30% of its weight given to the overlay portfolio (which is an equal-weighted average of the five single-factor portfolios). We note that these performance numbers are hypothetical – they do not represent the performance of any actual portfolio, and do not incorporate the costs of trading or other constraints placed on Wealthfront Smart Beta accounts. Their purpose is only to help explain the performance of Wealthfront Smart Beta at a more granular level.
We initially launched the Smart Beta strategy with a value factor (book-to-price ratio) based on the Fama French three-factor model, hence it is shown in the list of factor portfolios above. We removed the value factor in December 2021 (see blog post for details) and replaced it with the profitability factor from the new Fama French five-factor model.
The individual factor returns can help explain the performance of the smart-beta mutual funds and ETFs we considered as well. An important contributor to GSLC’s outperformance is its momentum factor, which is the only factor that outperformed the index in Figure 4. Both GSLC and Wealthfront’s Smart Beta strategy equally weigh the factors. GSLC has four factors, giving the momentum factor a 25% weight. Wealthfront Smart Beta strategy has five factors, giving the momentum factor a slightly lower weight at 20%. The 5% weight difference in the momentum factor is one reason for the performance difference between the two strategies during the time period. Another reason is GSLC’s quality factor. Generic quality factor’s performance over the period is close to flat with the index, thus ranks right below momentum and outperforms the rest of the factors over the period. As mentioned in the previous paragraph, Wealthfront has replaced the value factor with the profitability factor, a flavor of the quality factor, in December 2021.
We see results consistent with our factor performance in the returns of “single-factor” funds from other managers. iShares, Fidelity, and Invesco each offer a suite of ETFs containing funds designed to capture one single factor. Not all managers offer the same set of factors, but all three offer value- and momentum-tilted funds. Table 7 shows the annualized returns of each manager’s offerings, along with the returns of Wealthfront’s factor portfolios over the same time period. The returns of other managers’ funds are net of expense ratios, while the Wealthfront returns do not include a fee – as noted above, they are purely hypothetical.
We see similar patterns within each family of funds. Momentum and quality were the best two performers among the factors. Momentum also outperformed the S&P 500 index in most cases. For most managers, value, dividend yield, and low volatility factors have been lagging. This again highlights the value of diversification from a multi-factor approach.
Wealthfront Smart Beta provides clients with taxable accounts in excess of $500k access to a tax-efficient multi-factor investing strategy at no incremental cost. Unlike single-factor smart beta ETFs available from other managers, the Wealthfront Smart Beta strategy relies on multiple factors when selecting which securities to overweight. This ensures the portfolio remains highly diversified, and minimizes the chances of underperforming the cap-weighted index. Moreover, by combining this approach with our direct indexing service, clients can defer the taxation of the incremental gains relative to the cap-weighted index until portfolio liquidation. All this, at no incremental cost to our standard advisory fee.
Over the period where we have actual results, Smart Beta accounts have, on average, failed to outperform an index fund on a pre-tax basis. This is not unique to Wealthfront – five of the six multi-factor funds we evaluated also underperformed index funds over the same period. Despite the disappointing recent performance of certain factors, we continue to trust the decades of empirical evidence and believe that a diversified multi-factor approach, delivered at a reasonable price, can add returns over an index over the long term.
Nothing in this whitepaper should be construed as tax advice, a solicitation or offer, or recommendation, to buy or sell any security. Financial advisory services are only provided to investors who become Wealthfront Inc. clients pursuant to a written agreement available at www.wealthfront.com, which investors are urged to read carefully. All securities involve risk and may result in losses. While the data Wealthfront uses from third parties is believed to be reliable, Wealthfront does not guarantee the accuracy of the information. For more information please visit www.wealthfront.com or see our Full Disclosure.
 Intuitively, even though an asset class as a whole may be appreciating, thus offering few opportunities for harvesting at the asset class level, there will almost always be some securities within the asset classes that have declined in value, and can be used to harvest losses. As a result, US Direct Indexing is able to magnify the quantity of harvested losses, delivering more potential Harvesting Yield to clients, while lowering the expense ratio of the portfolio.
Wealthfront Smart Beta is a strategy available to Wealthfront clients whose account balances meet a qualifying minimum value. Wealthfront Smart Beta is not available as a mutual fund or ETF.
As an example, the annualized returns of the S&P 500, Russell 1000, and Russell 3000 – three cap-weighted indices of US Stocks – over our analysis period were 17.5%, 17.6%, and 17.3%, respectively.
The following mutual funds and ETFs were used as sources in our study: Dimensional US Core Equity 1; Dimensional US Core Equity 2; AQR Large Cap Multi-Style Fund; iShares MSCI USA Multifactor ETF; Goldman Sachs ActiveBeta US Large Cap Equity ETF; JP Morgan Diversified Return US Equity ETF
The charts displaying performance and Harvesting Yield from Smart Beta are based on backtesting, and assume initial investments of $500,000, and $50,000 quarterly deposit thereafter. Investors may experience different results from the hypothetical returns shown. The hypothetical returns shown do not represent the results of actual trading using client assets and were calculated by means of a retroactive application of a model designed with the benefit of hindsight. Hypothetical expected returns information have many inherent limitations, some of which, but not all, are described herein. No representation is being made that any client account will or is likely to achieve performance returns or losses similar to those shown herein. There are frequently sharp differences between hypothetical expected returns and the actual returns subsequently realized by any particular trading program. One of the limitations of hypothetical expected returns is that they are generally prepared with the benefit of hindsight. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results, all of which can adversely affect actual trading results. Hypothetical expected returns are presented for illustrative purposes only. No representation or warranty is made as to the reasonableness of the assumptions made or that all assumptions used in achieving the returns have been stated or fully considered. Changes in the assumptions may have a material impact on the hypothetical returns presented. Actual results, performance or events may differ materially from those in such statements due to, without limitation, (1) general economic conditions, (2) performance of financial markets, (3) changes in laws and regulations and (4) changes in the policies of governments and/or regulatory authorities. Backtested results were adjusted to reflect the reinvestment of dividends and other earnings and are presented gross of advisory fees, except Figure 2 data which was plotted after deducting 25 bps.
Wealthfront’s investment strategies, including portfolio rebalancing and tax loss harvesting, can lead to high levels of trading. High levels of trading could result in (a) bid-ask spread expense; (b) trade executions that may occur at prices beyond the bid ask spread (if quantity demanded exceeds quantity available at the bid or ask); (c) trading that may adversely move prices, such that subsequent transactions occur at worse prices; (d) trading that may disqualify some dividends from qualified dividend treatment; (e) unfulfilled orders or portfolio drift, in the event that markets are disorderly or trading halts altogether; and (f) unforeseen trading errors.
Wealthfront does not represent in any manner that the outcomes described herein will result in any particular tax consequence. Prospective investors should confer with their personal tax advisors regarding the tax consequences based on their particular circumstances. The effectiveness of the tax-loss harvesting strategy to reduce the tax liability of the client will depend on the client’s entire tax and investment profile, including purchases and dispositions in a client’s (or client’s spouse’s) accounts outside of Wealthfront and type of investments (e.g., taxable or nontaxable) or holding period (e.g., short- term or long-term). The performance of the new securities purchased through the tax-loss harvesting service may be better or worse than the performance of the securities that are sold for tax-loss harvesting purposes.
There is a chance that Wealthfront trading attributed to tax loss harvesting may create capital gains and wash sales and could be subject to higher transaction costs and market impacts. In addition, tax loss harvesting strategies may produce losses, which may not be offset by sufficient gains in the account and may be limited to a $3,000 deduction against income. The utilization of losses harvested through the strategy will depend upon the recognition of capital gains in the same or a future tax period, and in addition may be subject to limitations under applicable tax laws, e.g., if there are insufficient realized gains in the tax period, the use of harvested losses may be limited to a $3,000 deduction against ordinary income and distributions.
Wealthfront only monitors for tax-loss harvesting for accounts within Wealthfront. The client is responsible for monitoring their and their spouse’s accounts outside of Wealthfront for “wash sales.” A client may request spousal monitoring online or by calling Wealthfront at (844) 995-8437. If Wealthfront is monitoring multiple accounts to avoid the wash sale disallowance rule, the first taxable account to trade a security will block the other account(s) from trading in that same security for 30 days. A wash sale is the sale at a loss and purchase of the same security or substantially similar security within 30 days of each other. If a wash sale transaction occurs, the IRS may disallow or defer the loss for current tax reporting purposes.
Investment management and advisory services–which are not FDIC insured–are provided by Wealthfront Advisers LLC (“Wealthfront Advisers”), an SEC-registered investment adviser, and financial planning tools are provided by Wealthfront Software LLC (“Wealthfront”). Brokerage products and services are offered by Wealthfront Brokerage LLC (formerly known as Wealthfront Brokerage Corporation), member FINRA / SIPC. All investing involves risk, including the possible loss of money you invest, and past performance does not guarantee future performance. Please see our Full Disclosure for important details.
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