In recent years, numerous software solutions have sprung up that aim to automate the process of tax-loss harvesting. Both retail-focused robo-advisors and advisor-focused TAMPs have begun to offer automated tax-loss harvesting, which – by systematically checking for losses to harvest, typically on a daily basis – purports to increase investors’ after-tax returns by 1% or more.
But what the providers of automated tax-loss harvesting often don’t mention is that the actual value of tax-loss harvesting depends highly on an individual’s own tax circumstances. The 1%+ added value of automated tax-loss harvesting may be achievable in some ‘ideal’ cases, such as an investor who frequently contributes to their portfolio, has short-term losses to offset, and/or has many individual security holdings. But in other cases where those factors aren’t present, the added value of tax-loss harvesting is often much lower – which suggests that the value of automated tax-loss harvesting is less about the automation itself, and more about capturing losses under the right circumstances when the factor(s) that enhance the value of losses are present.
Unfortunately, much of the technology dedicated to automated tax-loss harvesting fails to consider the individual tax circumstances that drive most of the true value of harvesting losses, and instead focuses on the portfolio-management aspect of efficiently capturing as many losses as possible. Which can be a problem when such technology advertises itself as an all-in-one solution for tax-loss harvesting with no additional effort required by the investor or advisor because, in reality, not all investors may benefit from tax-loss harvesting, and the crucial information necessary to decide whether an investor is (or isn’t) a good candidate for tax-loss harvesting is often the very information that automated tax-loss harvesting software fails to capture.
While there still can be uses for technology that automatically harvests losses – such as in the occasional circumstances where it really is beneficial to harvest as many losses as possible – many investors may be able to realize nearly the same value by harvesting losses tactically (that is, by recognizing when their circumstances might be beneficial for tax-loss harvesting, and harvesting losses only when those circumstances occur). And when factoring in the fees charged by those technology platforms, the value of such ‘tactical’ tax-loss harvesting might exceed the value the investor would have realized by relying on a technology solution to do it automatically!
Ultimately, the key point is that tax-loss harvesting is a tax planning strategy and not (just) a portfolio management strategy. What matters is not simply the amount of losses the investor is able to harvest – which most technology seeks to maximize – but that they are harvested when the investor is able to benefit the most from them. In this light, it may be worth spending a little extra time on the tax planning side before handing the process over to automation, to ensure that the losses harvested will be truly valuable in the long run.Read More...