The Tax Harvesting Water Hole

September 23, 2014

by Michael Edesess

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This is in response to Dan Egan and Boris Khentov’s article, The Tax Harvesting Oasis, which was in response to my Advisor Perspectives article, The Tax Harvesting Mirage, which appeared Aug. 12. This article is also part of an ongoing conversation about my article on APViewpoint, which you can view here. If you are not a member of APViewpoint, you can join here.

Dan Egan and Boris Khentov of Betterment, a so-called robo-advisory company, have written a response to my Advisor Perspectives article, “The Tax Harvesting Mirage.” Their response is a mixture of disparate parts.

In part, Egan and Khentov are responding not to me, but to their competition. In part, they are explaining the reasons for using their methodologies. In part, they are responding to me.

And they are, of course, also marketing their product.

Their response is complicated by the fact that they sometimes get these diverse purposes mixed up. They draw paragraphs from other material they have written, then add further material in response to my article. But they don’t integrate it all very well.

For example, they say “Edesess suggests that purveyors of automated TLH [tax loss harvesting] services gravitate towards assumptions that overestimate the benefit of TLH. We would argue that he does the opposite.” Later they add, “Edesess departs from our assumptions early and often, always in a direction that downplays the benefit of TLH.”

They don’t seem to have noticed that in between these statements, they list the assumptions that “will inflate the estimated value of TLH.” These include, for example, “Assuming the highest possible tax rates.”

They overlook that in my article I assumed the highest possible tax rates – as does Betterment’s competitor Wealthfront. This assumption, of course, has the effect of biasing the results in favor of TLH. And yet, even with this TLH-friendly assumption, I found only a small TLH benefit. None of my other assumptions were chosen for the purpose of downplaying the benefit of TLH.

Betterment versus Wealthfront

Their paragraph about the assumptions that will inflate the estimated value of TLH was written, I suspect, not for the purpose of responding to me but as a response to Wealthfront.

I understand Betterment’s predicament. It has launched a service for a laudable purpose, to make it easier for investors to invest in a reasonably sound manner without paying a hefty fee to an advisor. It also faces competitors, Wealthfront chief among them. Wealthfront advertises that it offers a TLH service that can add more than a 1% “tax alpha” annually to an investor’s bottom line. Wealthfront uses an invalid methodology to calculate that number, but few people will understand that.

Betterment must preempt its competition or lose customers. To its credit, Betterment uses a valid measure to calculate tax alpha. It explains why its tax alpha of 0.77% is right. But still, its alpha must not be too much lower than Wealthfront’s tax alpha or the comparison will ruin Betterment.

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