Retirement · Roth IRA

Robo-Advisors Disillusionment

[As with anything tax-related, see my disclaimers.]

A couple years ago, I opened an account at Wealthfront, one of the popular robo-advisors. Their core tenets of low-cost investing in broadly diversified index funds aligned with my own investment philosophy, and I was curious to see how their tax-loss harvesting system behaved. At the time, they offered to manage the first $10k invested fee-free.

Last year I closed my account and transferred the shares and balance to my Vanguard brokerage account.

Why did Wealthfront lose its appeal?

Management Fees

Wealthfront’s management fee is currently .25%. In a world where investment advisors typically charge 1% or more, that looks like a bargain. If you can’t be bothered doing a little research or or setting aside the time to implement your own investment program and would rather turn it over to an expert, then Wealthfront is a great option.

For me the .25% was too high. I opened up both taxable and tax-advantaged IRA accounts at Vanguard and started buying the exact same ETFs used by Wealthfront with zero transaction costs.

Why pay .25% to someone else to do what I could do on my own?

What About Tax Savings?

But how about the tax loss harvesting? Doesn’t that justify the fee?

The big draw of tax loss harvesting is offsetting up to $3,000 of regular income. I was in the 22% tax bracket in 2018, so the potential tax savings were capped at $660.

At some point the shares bought during the tax loss harvesting event will be sold. Maybe you triggered it by withdrawing money, or maybe their fancy algorithm triggered it. Either way, you’ll likely be paying some tax on the gain. With Wealthfront’s tax loss harvesting, you’re arbitraging the difference between your capital gains rate and your regular income rate. Assuming a 15% capital gains rate, that $660 tax savings just got slashed to $210. Ouch!

If I’m only saving a maximum of $210, then the management fee overcomes any tax benefit after my total account balances at Wealthfront surpasses $84k. That’s not much.

Wash Sale Complexity

Tax-advantaged accounts, such as Traditional and Roth IRAs, have no tax loss harvesting benefit, so if you move these accounts to Wealthfront then you’ll be paying the fee with no tax loss benefit. How about you keep them where they are and avoid the fee?
Not so fast. The problem is that if your tax-advantaged accounts use the same ETFs or index funds that track the same indexes as the ETFs used by Wealthfront–likely!–then you could easily run afoul of the IRS’s wash sale rule. A purchase or sale made by you in one of those accounts could trigger a wash sale if Wealthfront sells something for a loss. And what makes this really painful is the tax loss could be permanently disallowed. Double ouch!

Wealtfront’s answer is to move all of your accounts, both tax-advantaged and taxable, to Wealthfront so they can coordinate trades across accounts and avoid wash sale problems. But this just exposes you even more to Wealthfront’s .25% management fee.

Charitable Contributions

Another nail in the coffin for me was the inability to gift shares to charities directly from my Wealthfront account, avoiding the capital gains tax. Ever since I started making charitable donations exclusively with appreciated shares, this inflexibility became a show stopper.

Conclusion

I’m not singling out Wealthfront. Everything I’ve said can be applied to Betterment, Personal Capital, or any of the other robo-advisors. I just happen to have experience using Wealthfront and not the others. Fees and details may differ, but the cons are generally the same.

The one exception I have to depositing funds at Wealthfront is their high yield savings account. It’s FDIC insured up to $1 million and has what looks like one of the best APY’s out there. It looks very tempting and doesn’t have the fee drawback that their investment accounts have.

For another critical look at robo-advisors, check out Go Curry Cracker’s “Why Betterment Has Zero of Our Dollars”.

Hasta luego!

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