Investing for tax efficiency
Automated Investor uses advanced online investing technology and strategy to help you reach your goal over the long-term. Tax-loss harvesting is one of the following core principles we use to manage your investments:
- Minimize investing risk: We provide regular rebalancing and portfolio diversification.
- Maintain low fees: We’ll construct your portfolio from low-fee exchange-traded funds (ETFs).1
- Apply a tax-smart strategy: We’ll monitor your portfolio for opportunities for tax-loss harvesting.
Here we explain tax-loss harvesting and how Automated Investor uses it for your account. For your particular situation, please consult with your tax advisor regarding the implications of these tax strategies.2
Tax-loss harvesting is a standard strategy used for larger taxable portfolios to help reduce taxes on gains. The good news is that Automated Investor is among the few robo-advisors and other automated investing algorithms that now make it possible to use tax-loss harvesting without a high minimum-balance requirement.
- Automated Investor monitors your portfolio daily for tax-loss harvesting opportunities.
- Losses are used to realize tax benefits by offsetting taxes on gains from other investments.
- Your portfolio will remain on target, as account proceeds are usually invested in ETFs already in your portfolio. In some cases, the proceeds may be temporarily held in your portfolio as cash.
- Losses can be used to offset taxes that you would pay on gains or income. You can also carry forward losses to future tax years.
Note: Tax-loss harvesting is not relevant for tax-advantaged accounts such as traditional, Roth, and SEP IRAs, 401(k)s and 529 plans.
How tax-loss harvesting works
Let’s say your Automated Investor portfolio consists of $50,000 invested in ETF X. Then, in a year where the market declines, the value of that holding decreases to $45,000.
Most robo-advisors in this situation would do nothing. However, Automated Investor would sell the $45,000 holding in ETF X and either invest it in ETFs you already own in your portfolio or hold it in your portfolio in cash for 30 days. After 30 days, the cash proceeds would then be used to repurchase shares in ETF X. In either case, you have “harvested” the $5,000 loss for tax purposes. (Note that Automated Investor won’t buy back ETF X within 30 days, so it complies with the IRS’ wash sale rule.)
Now, because you have a $5,000 capital loss from the sale of ETF X, at tax time, you can apply this loss against capital gains elsewhere in your portfolio, thereby reducing the amount of capital gains tax owed. In a year when your capital losses outweigh gains, the IRS allows you to apply up to $3,000 in losses against your other income, and to carry over the remaining losses to offset income in future years.
This example is for illustration purposes only. Any benefits of tax-loss harvesting could be impacted by activity in other investment accounts, and this does not suggest that Automated Investor’s tax-loss harvesting strategy will have any tax implications.
Advantages of Automated Investor for tax-loss harvesting
Tax-loss harvesting requires diligent tracking of tax lots across a portfolio, as well as frequent monitoring of market movements, since opportunities for tax-loss harvesting could occur at any time. Robo-investing services such as Automated Investor can save you time and effort by monitoring these opportunities daily.
IRS rules related to tax-loss harvesting
Done correctly, tax-loss harvesting is consistent with IRS guidelines. Two key things to avoid are (1) a "wash sale," in which the same investment is repurchased within 30 days of being sold, and (2) the purchase of an investment that is "substantially identical" to the investment being sold. Either of these actions invalidates any potential gains from tax-loss harvesting. Instead, when executing tax-loss harvesting trades on your behalf, Automated Investor will either reinvest proceeds in an ETF you already own or temporarily place the proceeds in cash in your portfolio for 30 days.
Tax-loss harvesting is not the only consideration in our investment approach. While Automated Investor’s algorithm uses tax-loss harvesting to help you avoid short-term gains and the resulting negative tax impact, it also uses tax-efficient factors, such as optimizing your stock/bond split or investing new cash. We weigh a number of goals to invest in the instruments that have the largest possible benefit (considering costs, diversification, tax efficiency, transaction costs, etc.) to your expected future returns.
Automated Investor from U.S. Bancorp Investments is exclusively for our customers. Log into usbank.com to open an account today or call 866-758-8655.