Wealthfront’s US Direct Indexing
Note: Wealthfront no longer offers the Wealthfront 500 (WF500) and Wealthfront 1000 (WF1000) strategies described in this white paper. Clients with account balances over $500,000 previously trading these strategies will now trade in the Smart Beta 500 or Smart Beta 1000 strategies, respectively. For information on these updated strategies, see our Smart Beta White Paper. Clients with account balances below $500,000 who were previously trading in US Direct Indexing will continue to trade in that strategy, without Smart Beta.
This white paper summarizes the motivation, design, and execution of Wealthfront’s US Direct Indexing service. All Wealthfront clients with taxable Investment Account balances over $100,000 can choose to use Wealthfront’s Direct Indexing service, which seeks to enhance clients’ after-tax returns. Our historical backtests and actual results demonstrate that US Direct Indexing can significantly improve the tax efficiency and ultimately the after-tax return of your taxable portfolio. We believe US Direct Indexing should be a fundamental component of most every individual’s investment management strategy.
Over the last 40 years, index funds and index-based ETFs have unlocked the power of passive investing for the individual investor by offering a cheap, easy, and highly accessible way to invest in a wide range of asset classes. Just one share of Vanguard’s Total Stock Market ETF (ticker: VTI) lets an investor mirror the investment performance of a portfolio of more than 3,500 US company stocks, all for an expense ratio of only 3 basis points (0.03%) of the invested assets.
Index funds work because they’re generally able to achieve two objectives:
- They track their benchmark index closely. This allows them to accurately represent a particular asset class.
- They track their benchmark index tax-efficiently, and pass on few taxable gains to their investors.
Index funds can achieve the latter goal because they are inherently tax-efficient. They have low turnover because securities that comprise an index seldom change (annual turnover is typically 5-20% depending on the index). Index fund issuers like iShares and Vanguard can also intelligently realize losses on the underlying securities in their funds to minimize the gains they have to distribute to their investors each year.
However, index funds and ETFs have two disadvantages relative to optimum performance in achieving the above goals and for their investors.
- Owning an index fund or ETF comes with a fee, often called an “expense ratio.” Although the fee may be small, it still acts as a barrier to fully replicating the performance of a passive index investment. This expense ratio can add to an investor’s overall costs because it is typically in addition to any advisory fees or commissions the investor already pays.
- Index funds and ETFs are legally prohibited by The Investment Company Act of 1940 from passing on tax losses to investors. While iShares and Vanguard can use any realized losses in their funds to minimize any gains they distribute to investors, any leftover losses cannot be used to reduce investors’ taxes even further.
Wealthfront’s US Direct Indexing service was developed to address both of these shortcomings.
By allowing a Wealthfront investor to hold the individual securities that comprise an index directly, US Direct Indexing effectively eliminates any index fund or ETF expense ratios beyond Wealthfront’s standard advisory fee on the associated position, which reduces overall portfolio cost. Furthermore, by directly owning the stocks that comprise an index, investors can harvest losses at the individual stock level. To understand the benefit of this capability, consider a common situation where an overall index trades up, but a number of its component stocks trade down because they missed their earnings estimates. The losses on these individual companies can be harvested and the resulting tax savings can be reinvested and compounded over time thus ultimately creating significant value.
The opportunity to deliver a US Direct Indexing service prompted firms like Aperio Group and Parametric Portfolio Associates to pioneer managed portfolios of stocks that harvest tax losses for their clients while emulating a specific index. Unlike index funds, Aperio and Parametric prioritize both harvesting tax losses as well as closely tracking the index. These firms have demonstrated you can generate significant outperformance in the form of tax savings if you are willing to incur modest tracking differences from the designated index. Together, these firms have attracted more than $400 billion under management.
Wealthfront is able to offer our US Direct Indexing service to a much broader set of investors through the extensive automation provided by our technology platform. Our service is also offered at no additional fee beyond our annual 0.25% advisory fee.
We believe our US Direct Indexing service meaningfully addresses the two remaining shortcomings with modern index investing – the cost of the index fund and ETF expense ratios and the missed tax savings from the inability to pass on tax losses. For this reason, we view US Direct Indexing as the next evolution of index investing.
US Direct Indexing Overview
Wealthfront’s US Direct Indexing service replaces the ETF normally used to represent US stocks in a Wealthfront portfolio with a combination of individual securities and one or two additional ETFs. The resulting position uses the individually held stocks to capture the market performance of large-capitalization and mid-capitalization US stocks, while using the ETF to represent the performance of smaller-capitalization companies. As a result, the position is able to track the movement of the overall broad US market, while maintaining a significant holding of individual stocks.
We offer three levels of US Direct Indexing:
- For accounts between $100,000 and $500,000, we will replace the ETF normally used to represent a broad market of US Stocks (Vanguard’s Total Stock Market ETF) with up to 100 of the largest capitalization US stocks and a combination of the Vanguard Extended Market ETF (VXF) and the Vanguard S&P 500® ETF (VOO) to represent the remaining smaller-capitalization companies.
- For accounts between $500,000 and $1 million, we will replace the ETF normally used to represent a broad market of US stocks (Vanguard’s Total Stock Market ETF) with up to 500 of the largest capitalization US stocks and the Vanguard Extended Market ETF (VXF) used to represent the remaining smaller capitalization companies.
- For accounts above $1 million, we will replace our Vanguard Total Stock Market ETF with up to 1,000 of the largest capitalization US stocks (typically representing US large-cap and mid-cap companies) and the Vanguard Small-Cap ETF (VB) used to represent the remaining small-capitalization US companies.
For all levels of US Direct Indexing, we will occasionally use additional ETFs — especially in cases where the above ETFs are sold for tax-loss harvesting purposes. Thus, US Direct Indexing clients may see a combination of the Vanguard Large-Cap ETF (VV), the Vanguard Small-Cap ETF (VB), the Vanguard S&P 500® ETF (VOO), and the Vanguard Extended Market ETF (VXF) in their portfolios in addition to their individual stock positions. As shown below, the resulting Wealthfront account replaces Vanguard’s VTI with a combination of individual stocks and completion ETFs, but continues to hold the other ETFs common to Wealthfront investments (such as Foreign Stocks, Emerging Markets, Dividend Stocks, etc.). All US Direct Indexing accounts also benefit from our Tax-Loss Harvesting service, which harvests tax savings at the ETF level.
Wealthfront is one of the first companies to combine asset-level Tax-Loss Harvesting and US Direct Indexing. We offer this capability to accounts of only $100,000, a fraction of what the competition typically requires.
Costs and Minimums
The cost of our US Direct Indexing service is lower than the Vanguard ETF it replaces. Vanguard currently charges an annual 0.03% expense ratio for VTI, while the equivalent fee for all three levels of US Direct Indexing is lower, because clients do not pay an expense ratio for the majority of the US Direct Indexing position that’s composed of individual stocks. The cost of that service is included in our annual 0.25% advisory fee.
For US Direct Indexing accounts with $100,000 to $500,000, clients pay no expense ratio for the 50% of the US Direct Indexing position holding individual stocks. The remaining 50% — comprised of roughly a 45% allocation to the Vanguard Extended Market ETF (ticker VXF, expense ratio 0.06%) and a 5% allocation to the Vanguard S&P 500 ETF (ticker VOO, expense ratio 0.03%) — results in a weighted average US Direct Indexing fee of 0.0285%, which is just under Vanguard’s 0.03% fee for VTI.
The cost is even lower for larger accounts. For accounts between $500,000 and $1 million, roughly 80% of the US Direct Indexing position consists of individual stocks and thus has no expense ratio. For the remaining portion of the portfolio, we hold either the Vanguard Extended Market ETF (ticker VXF) for accounts between $500,000 and $1 million, or the Vanguard Small Cap ETF (ticker VB) for accounts above $1 million. The expense ratios of these completion ETFs are 0.06% and 0.05% respectively, resulting in a weighted average US Direct Indexing fee of 0.012% for $500,000 accounts (where VXF represents 20% of the position) and a fee of 0.01% for accounts over $1 million (where VB represents 16% of the position) — both below the equivalent 0.03% fee from Vanguard.
Our minimums for US Direct Indexing are based on dollar amounts required to hold a reasonable collection of individual US stocks in a US Direct Indexing position while continuing to track the performance of the broad US market. For a $100,000 account, the average Wealthfront client will allocate about $30,000 to US equities. We found this $30,000 to be the minimum amount that allows for ownership of up to 100 large-cap US stocks while maintaining a good ability to track broad US market performance.
To expand this position to hundreds of stocks requires a much larger account, as you need to include allocations to smaller mid-cap stocks in the position. We found that moving to hundreds of stocks requires a US equity allocation of roughly $150,000 — thus necessitating an account minimum of about $500,000. This minimum increases again as you exceed 500 stocks and start holding some of the smaller mid-cap stocks in the position — thus necessitating a $1 million minimum for the highest level of our Direct Indexing service.
Wealthfront 100 (WF100), Wealthfront 500 (WF500), and the Wealthfront 1000 (WF1000)
We call the up to 100 individual stocks owned as part of our Stock-level Tax-Loss Harvesting service the Wealthfront 100. When US Direct Indexing employs 500 or 1,000 individual stocks, we refer to that collection of stocks as the Wealthfront 500 or the Wealthfront 1000 respectively.
The individual stocks we buy are always selected to minimize tracking error with Vanguard’s Total Stock Market ETF, VTI, not based on their fundamentals or any perspective on whether they are fairly valued by the market. We harvest losses on individual stocks based on a threshold and use the proceeds to purchase other highly correlated stocks within the appropriate US stock index.
We balance two competing objectives with our US Direct Indexing service: maximize the after-tax benefit of harvesting losses (Tax Alpha) and minimize tracking error. We do this by maximizing a function of Tax Alpha minus tracking error squared. The Tax Alpha component encourages selling losing stocks. The tracking error component penalizes sales that cause significant tracking differences from the relevant index and encourages buying correlated replacement stocks that keep the overall portfolio close to the index. In some cases, we may purchase more of an existing holding. For example, if Coca-Cola misses an earnings estimate and drops precipitously in value, we may sell Coca-Cola and use the proceeds to buy more PepsiCo to maintain the correlation with VTI in the absence of Coca-Cola.
We manage the portfolio and avoid wash sales by applying constraints to our optimization. For example, we enforce a maximum constraint on each stock’s relative portfolio weight to ensure portfolio diversification. We also enforce a maximum drift constraint on each stock’s weight to ensure it stays relatively close to its benchmark weight and trade direction constraints to avoid wash sales. Portfolio weights are determined by solving the following optimization problem:
maximize: 𝛼⋅(Tax Alpha) – (Tracking Error)²
subject to: Portfolio is long-only
Portfolio weights ≤ maximum weight parameter
Portfolio weights – benchmark weights| ≤ drift parameter
Do not trade stocks in wash-sale window
In this formulation, the parameter 𝛼 represents the weighting given to Tax Alpha in the objective. We chose the value of 𝛼 to give a good trade-off between tax benefit and tracking error vs. the benchmark.
In addition to avoiding wash sales through a constraint on our optimization, we also do not trade in stocks identified by the client via an “Exclusion List”. By adding stocks to an “Exclusion List” you’re able to identify stocks that you are restricted from trading (e.g., the stock of your employer) as well stocks where trading is more likely to cause wash sales due to significant individual stock positions held outside of Wealthfront. Once identified, the US Direct Indexing optimizer will not suggest any trades in “Exclusion List” stocks and, if needed, will buy one or more highly correlated replacement stocks or ETFs to maintain low tracking error to the broad US stock market performance.
We measure the effectiveness of US Direct Indexing on two dimensions: how closely it tracks the original ETF it replaced and how much benefit it generates.
We use the term tracking difference 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 tracking differences.
We track the benefit generated by US Direct Indexing in two ways. Tax Alpha is used to directly measure the tax benefit generated by proactively selling stocks with capital losses within a certain short period of time (say a single tax year). A Differential IRR is used to measure the additional return generated by reinvesting tax savings from US Direct Indexing vs. a portfolio where no such savings are generated.
We view Tax Alpha as an easy-to-compute and understandable metric to quantify the performance of US Direct Indexing, but believe Differential IRR is the more appropriate metric because it does a better job of taking into consideration the additional cash flows, tax savings reinvestment, and multi-year compounding inherent in tax-loss harvesting.
- Tracking Difference = (Portfolio Pre-Tax Return) – (Benchmark Return)
- Tracking Error = Standard Deviation(Tracking Difference)
- Tax Alpha = (STCL * STTR + LTCL * LTTR) / (Portfolio Beginning Balance)
- Differential IRR = IRR(US Direct Indexing Portfolio with tax savings reinvested) – IRR (Portfolio with same asset-allocation and cash flows but no Direct Indexing or Tax-Loss Harvesting)
- STCL is the short-term net capital loss realized
- STTR is the combined federal and state short-term capital gains tax rate
- LTCL is the long-term net capital loss realized
- LTTR is the combined federal and state long-term capital gains tax rate
- Portfolio Beginning Balance is the value of the portfolio at the beginning of each year
Wherever possible, we use assumptions for our analyses that are based on the actual observed behavior of Wealthfront clients. For this analysis, we used two sets of client data. To describe Wealthfront 100 clients, we used information on clients of our Tax-Loss Harvesting service.. Similarly, to describe our Wealthfront 500 and Wealthfront 1000 clients, we use data on the earliest adopters of our US Direct Indexing service.
Thus, our critical assumptions are:
- Client age: 37 (median age of our US Direct Indexing and Tax-Loss Harvesting clients)
- Marital status: Married (the majority of our clients are married)
- Annual income:
- WF100 Clients: $260,000 (the average joint income reported by our Tax-Loss Harvesting clients)
- WF500/WF1000 Clients: $422,000 (the average joint income reported by our US Direct Indexing clients)
- State of residence: California (the most popular state of residence for our US Direct Indexing and Tax-Loss Harvesting clients. Residents of states with high income taxes represent the vast majority of such clients).
- Combined federal and state short-term capital gain tax rate:
- WF100 Clients: 42.7% (the marginal tax rate for married California clients with an average annual income of $260K = 33% federal tax rate + 3.8% additional tax on Net Investment Income for those earning above $200K (ACA tax) + 9.3% CA tax rate – the anticipated deduction of California state taxes from federal taxes)
- WF500/WF1000 Clients: 44.5% (the marginal tax rate for married California clients with an average annual income of $422K = 35% federal tax rate + 3.8% additional tax on Net Investment Income for those earning above $200K (ACA tax) + 9.3% CA tax rate – the anticipated deduction of California state taxes from federal taxes)
- Combined federal and state long-term capital gain tax rate:
- WF100 Clients: 24.7% (the marginal tax rate for married California clients with an average annual income of $260K = 15% federal tax rate + 3.8% additional tax on Net Investment Income for those earning above $200K (ACA tax) + 9.3% CA tax rate – the anticipated deduction of California state taxes from federal taxes)
- WF500/WF1000 Clients: 24.5% (the marginal tax rate for married California clients with an average annual income of $422K = 15% federal tax rate + 3.8% additional tax on Net Investment Income for those earning above $200K (ACA tax) + 9.3% CA tax rate – the anticipated deduction of California state taxes from federal taxes)
- Portfolio risk level: 7 (the average risk score on a scale of 0 – 10 for our US Direct Indexing clients). A risk level 7 portfolio for such clients would be allocated across six asset classes as follows:
- Investment cash flows: We assume clients make an initial deposit necessary to meet the minimum account size of the desired level of US Direct Indexing and then continue to make add-on deposits amounting to 10% of their initial deposit every quarter. For an account with the Wealthfront 100, therefore, this would mean an initial deposit of $100,000 followed by add-on deposits of $10,000 every quarter. For the Wealthfront 500 this would mean an initial deposit of $500,000 followed by $50,000 deposits every quarter. Note that these assumptions underestimate actual client deposits. Clients of our early $500,000-minimum version of US Direct Indexing, for example, made quarterly deposits equal to an average of 14% of their initial deposit during the year that this service has been available, as reflected in the chart below.
The graph below presents backtested return results for the three levels of our US Direct Indexing service compared to VTI (the ETF used to track a broad market of US stocks in a Wealthfront portfolio).
These results assume the tax rates and cash flow patterns listed above and incorporate the added performance from the tax savings generated via Direct Indexing (i.e. Tax Alpha).
US Direct Indexing outperformed VTI in a substantial majority of years, especially in bad markets. Interestingly, it outperformed VTI in some very good markets as well. The average (geometric mean) after-tax annual return for VTI over the 14-year period was 3.22% vs. 5.99% for the Wealthfront 100, 6.09% for the Wealthfront 500, and 6.14% for the Wealthfront 1000.
As expected, adding more individual stocks to the US Direct Indexing position (i.e. moving from the Wealthfront 100 to the Wealthfront 500 to the Wealthfront 1000) improved after-tax performance. This is in large part due to the extra tax-loss harvesting opportunities available with the larger set of individual securities.
Under the same assumptions, the graph below presents the Tax Alpha generated by US Direct Indexing. US Direct Indexing generated Tax Alpha nearly every year and had an average annual Tax Alpha of 2.15% for the Wealthfront 100 version, 2.50% for the Wealthfront 500 version, and 2.66% for the Wealthfront 1000 version. Interestingly, US Direct Indexing generated Tax Alpha even in some years when the market traded up (2003 to 2007). It should be noted that our asset-level tax-loss harvesting service failed to generate much tax alpha in that same period.
The graph below displays the US Direct Indexing tracking differences from its VTI benchmark by year based on the same assumptions. The tracking differences each year were modest. In some years they were positive (i.e. the portfolio outperformed the benchmark) and in some years negative (i.e. the portfolio underperformed the benchmark). In this limited time sample the average difference was very slightly positive, but over the long term you should expect an average difference of zero.
The table below summarizes the Tax Alpha, tracking difference, and tracking error for US Direct Indexing vs. VTI based on annualized monthly tracking error and the same deposit assumptions as above. As expected, the Tax Alpha of US Direct Indexing increases as the number of individual stocks held increases (moving from the Wealthfront 100 to the Wealthfront 500 to the Wealthfront 1000) and the tracking error decreases.
Thus, for an extra 1.72% of tracking error, you could have the opportunity to increase your annual after-tax returns on the US equity portion of your portfolio by as much as 2.66%. We believe that is a trade-off well worth making.
Finally, the graph below displays the overall portfolio differential IRR produced by an average (i.e. risk level 7) portfolio that includes the Wealthfront 100, Wealthfront 500, and Wealthfront 1000 across multiple 10-year holding periods. We also assume both portfolios benefit from Wealthfront’s Tax-Loss Harvesting service.
We believe this differential IRR metric is the best way to quantify the incremental return from the US Direct Indexing strategy. As the graph shows, US Direct Indexing can generate an impressive incremental IRR for a Wealthfront portfolio over a 10-year period. The minimum IRR generated was 1.21% for the Wealthfront 500 over the 2005 to 2014 time frame. The maximum IRR was around 2.42% for both the Wealthfront 500 and the Wealthfront 1000 over the 2000-2009 timeframe.
Across these six 10-year periods, the Wealthfront 100 version of US Direct Indexing generated an average IRR of 1.77%, while the Wealthfront 500 version generated an average IRR of 1.88%, and the Wealthfront 1000 version generated an average IRR of 2.03%.
The results above use backtested data. In this section, we analyze the tax-loss harvesting performance of US Direct Indexing in comparison to ETF-level Tax-Loss Harvesting (TLH) using actual client account data since the launch of the service in 2014. We focus on a measurement called Harvesting Yield, defined as:
- Harvesting Yield = (Short-Term Capital Losses + Long-Term Capital Losses) / Starting Portfolio Value
Harvesting Yield measures the ability of each type of TLH to realize capital losses. The actual after-tax return benefit from loss-harvesting depends on each client’s individual tax rates, which we will not measure here. Because US Stocks is the only asset class in which Direct Indexing is implemented, we only compare the Harvesting Yield within the US Stocks portion of clients’ portfolios.
We take two important measures to help make the comparison between US Direct Indexing and ETF-level TLH cleaner. We first divide our client accounts into “cohorts” by the year of the initial deposit into the account. This helps control for differences in market conditions that may exist in different periods, which can have a significant effect on loss harvesting. We compare the harvesting yield of US Direct Indexing and ETF-level TLH within the same cohort with respect to only the US asset class portion of the client accounts.
Next we control for deposit and withdrawal patterns, which can affect an account’s ability to harvest losses. As an example, consider two accounts — one which makes a single initial deposit, and one which makes monthly deposits. If markets generally rise, the value of the positions in the first account will gradually drift above their cost, making it difficult to harvest losses except in the case of extreme market drops. In contrast, the second account is continually buying positions at the new, higher prices. This account will be able to take advantage of smaller market drops by realizing losses in the newer positions.
Due to the impact of cash flow on loss-harvesting ability, simply averaging harvesting yield across all accounts wouldn’t give an apples-to-apples comparison. To produce a valid one, we apply an algorithm to accounts within each cohort. The algorithm assigns a weight to every individual client account, and sums up the weighted portfolios to create an “aggregate account” for each tax-loss harvesting type. The weights assigned to the individual client accounts are chosen to minimize the sum of the total deviations between the daily US Stocks cash flow values of the two aggregate accounts. As an example, the portfolio of holdings of the aggregate account for the ETF-level TLH group is the sum of the US Stock holdings of each individual ETF-level TLH account, multiplied by the weight assigned to each account. The weights do not change over time, although the holdings of the client accounts, and thus the aggregate accounts, will. The algorithm is applied separately to each yearly cohort to produce five pairs of aggregate accounts (one pair for each year from 2014 to 2020).
Although the aggregate accounts produced by this algorithm are created using actual live client accounts, the tax-loss harvesting results of the aggregate accounts are not intended to be representative of a typical client account. The number of accounts receiving non-zero weight may be significantly smaller than the total number of accounts. The algorithm is employed to remove the confounding effect of cash flow on loss-harvesting ability and provide a cleaner comparison between the two loss-harvesting methods.
The graph below shows the average quarterly net cash flow of the US Stocks portion of each aggregate account created by the algorithm, expressed as a fraction of current market value in US Stocks. Notice that the values for each TLH type are nearly identical, eliminating any potential difference in loss-harvesting ability caused by cash flow patterns.
We can now calculate the Harvesting Yield produced by each account cohort and TLH method. The table below shows the annualized Harvesting Yield of each aggregate account, from the time of initial deposit through the end of 2020. Remember that because Direct Indexing only applies to the US Stock slice of the portfolio, all Harvesting Yield numbers are expressed as a fraction of portfolio value in US Stocks.
For the earlier cohorts, we get a result consistent with our expectations, with US Direct Indexing producing a higher Harvesting Yield. For the 2014 through 2017 cohorts, US Direct Indexing produced an average Harvesting Yield of 3.44%, while ETF-level TLH produced an average of 1.66%. However, the pattern reverses starting with the 2018 cohort, with ETF-level TLH producing higher Harvesting Yields. The reversal is most pronounced in the 2020 cohort, which received an average Harvesting Yield of only 5.39% from US Direct Indexing, versus 19.75% from ETF-level TLH!
This naturally leads to the question: what made the later years different? We believe the answer is broad market performance. Before we go into detail, consider the following simple example: suppose a market index contains two stocks, at equal weight. A portfolio using US Direct Indexing holds both stocks at equal weight as well. If both stocks drop by 10% from the initial purchase prices, the portfolio manager can sell one stock and buy the other, yielding 5% in realized losses. However, a portfolio holding an ETF tracking the index could sell that ETF and buy a similar one as a replacement, yielding 10% in realized losses. In this situation, ETF-level TLH is at an advantage.
This was in fact what happened in 2018 and 2020. The US Equity market (measured using the SPY ETF which tracks the S&P 500 index) experienced more negative performance in these years than the others in the sample period. 2018 was the only year in the sample in which SPY posted a loss, and the market suffered severe drawdowns in early 2020 during the onset of the COVID-19 crisis. The chart below illustrates the effect for 2020. It shows the cumulative performance of SPY in 2020 along with the cumulative Harvesting Yield of the 2020 cohorts in the US Direct Indexing and ETF-level Tax-Loss Harvesting strategies. As you can see, the difference in Harvesting Yields widened in March and April of 2020, when SPY was far below its level from the beginning of 2020. During this time, recent purchases of index ETFs could be sold to harvest sizable losses.
We believe the results presented in this white paper clearly demonstrate that Wealthfront’s US Direct Indexing could significantly improve your after-tax investment results.
Investing directly in stocks provides an immediate cost savings by avoiding the expense ratios charged by index funds and ETFs. ETF-level TLH could be at an advantage in years with steep market declines, as we have seen in recent years where ETF-level TLH outperformed US Direct Indexing. While times like this can (and will) occur, US Direct Indexing often provides better opportunities to harvest tax losses. We believe US Direct Indexing reflects the next evolution in index investing and thus should be a key element of every investor’s portfolio.
This white paper was prepared to support the marketing of Wealthfront’s investment products, as well as to explain its tax-loss harvesting strategies. This white paper is not intended as tax advice, and Wealthfront does not represent in any manner that the tax consequences described herein will be obtained or that Wealthfront’s tax-loss harvesting strategies, or any of its products and/or services, will result in any particular tax consequence. The tax consequences of the tax-loss harvesting strategy and other strategies that Wealthfront may pursue are complex and uncertain and may be challenged by the IRS. This white paper was not prepared to be used, and it cannot be used, by any investor to avoid penalties or interest.
Prospective investors should confer with their personal tax advisors regarding the tax consequences of investing with Wealthfront and engaging in these tax strategies, based on their particular circumstances. Investors and their personal tax advisors are responsible for how the transactions conducted in an account are reported to the IRS or any other taxing authority on the investor’s personal tax returns. Wealthfront assumes no responsibility for the tax consequences to any investor of any transaction.When Wealthfront says it replaces investments with “similar” investments as part of the tax-loss harvesting strategy, it is a reference to investments that are expected, but are not guaranteed, to perform similarly and that might lower an investor’s tax bill while maintaining a similar expected risk and return on the investor’s portfolio. Expected returns and risk characteristics are no guarantee of actual performance.
The various charts displaying simulated Tax Alpha from tax-loss harvesting are historical simulated returns based on backtesting and do not rely on actual trading using client assets. The results are hypothetical only. Several processes, assumptions and data sources were used to create one possible approximation of how Wealthfront’s tax-loss harvesting strategy might have benefited investors in the past, and a different methodology may have resulted in different outcomes. These results were achieved by means of the retroactive application of a model designed with the benefit of hindsight. The results of the historical simulations are intended to be used to help explain possible benefits of the tax-loss harvesting strategy and should not be relied upon for predicting future performance.
Different methodologies may have resulted in different outcomes. For example, we assume that an investor’s risk profile and target allocation would not have changed during the time period shown; however, actual investors may have experienced changes to their allocation plan in response to changing suitability profiles and investment objectives. Furthermore, material economic and market factors that might have occurred during the time period could have had an impact on decision-making. Actual investors on Wealthfront may experience different results from the results shown. There is a potential for loss as well as gain that is not reflected in the hypothetical information portrayed. Investors evaluating this information should carefully consider the processes, data, and assumptions used by Wealthfront in creating its historical simulations.
While the data used for its simulations are from sources that Wealthfront believes are reliable, the results represent Wealthfront’s opinion only. The return information uses or includes information compiled from third-party sources, including independent market quotations and index information. Wealthfront believes the third-party information comes from reliable sources, but Wealthfront does not guarantee the accuracy of the information and may receive incorrect information from third-party providers. Unless otherwise indicated, the information has been prepared by Wealthfront and has not been reviewed, compiled or audited by any independent third-party or public accountant. Wealthfront does not control the composition of the market indices or fund information used for its calculations, and a change in this information could affect the results shown.
Correlation is a measure of statistical association, or dependence, between two random variables. The values presented here are based on a particular historical sample period, data frequency, and are specific to the assets/indices used in the analysis. Correlations may change over time, such that future values of correlation may significantly depart from those observed historically.