Want To Beat the Market? Focus on After-Tax Returns Instead

Beating the market sounds nice, but in reality, it usually doesn’t work. No matter how long you spend scouring the internet for stock tips and reading page after page of expert commentary, you’re unlikely to consistently generate outsized pre-tax returns.

But at Wealthfront, we do think it’s possible to beat the market on an after-tax basis—and that’s exactly what we try to help you do in our Automated Investing Accounts, Automated Bond Portfolio, and Wealthfront’s S&P 500 Direct. In this post, I’ll explain Wealthfront’s focus on your after-tax returns and how our tax-optimization features can help you come out ahead. 

Why you probably won’t beat the market on a pre-tax basis

First, let’s look at why you’re unlikely to beat the market on a pre-tax basis.

Trying to beat the market by picking specific investments at particular times is known as active investing, while just tracking the market (usually by buying and holding an index fund, and getting roughly the same returns as the market) is known as passive investing. Research tells us that active investing often doesn’t work.

For instance, according to the most recent SPIVA Scorecard research released in 2024, 57% of actively managed large-cap funds performed worse than the S&P 500® index over the year ending on June 30, 2024. Over the last 10 years, that underperformance rate rises to nearly 85%. 

What should you take away from this? Even professional investors generally don’t beat the market on a pre-tax basis—or if they do, they rarely do so consistently over time. As a result, it’s probably not a great use of your time to try.

Start with passive investing, then optimize for your taxes

If you want to try to beat the market on an after-tax basis, we think you should start with a passive (not active) investing strategy. Many robo-advisors, including Wealthfront, offer diversified portfolios of index funds built using Nobel Prize-winning research known as Modern Portfolio Theory. This is a great place to start.

Because many robo-advisors use the same approach to passive investing, they will also generate fairly similar pre-tax returns. That means if your goal is to come out ahead, you should consider picking a robo-advisor that is focused on optimizing your after-tax returns through strategies like tax-loss harvesting so you can keep more of what you earn. This is not an area of focus for all robo-advisors, but it is for Wealthfront—we’ve worked hard to build what we believe is the best automated tax-loss harvesting available.

As we’ve written before, we think tax-loss harvesting (just one of the ways Wealthfront works to lower your tax bill) represents the biggest and most important difference among robo-advisors. Tax-loss harvesting involves selling investments that have declined in value, “harvesting” the loss, and replacing those investments with similar ones that maintain the overall risk and return characteristics of your portfolio. At tax time, you can then use the losses you’ve harvested to offset capital gains and up to $3,000 in ordinary income. Wealthfront completely automates the process of tax-loss harvesting, and we publish the results of our service year after year.

The power of improving your after-tax returns

Let’s look at an example that shows what improving your after-tax return with tax-loss harvesting might look like and why it’s valuable. In this very simplified example, we’ll assume you have $10,000 invested that grows to $70,000 over the course of 30 years (which assumes a compounded growth rate of 6.70%), at which point you liquidate the portfolio. We’ll further assume you’ll pay a combined tax rate of 20% when you sell your investments. Keep in mind that the purpose of this example isn’t to suggest you’ll receive specific pre- or post-tax returns, but instead to show you how you might apply this math to your own situation.

Approach #1: No tax-loss harvesting

You invest $10,000 that grows to $70,000 over 30 years. When you liquidate your portfolio, you pay 20% x $60,000 in taxes, for a post-tax return of $58,000.

$70,000 – ($60,000 gain x 20% tax rate) =  $58,000 after taxes

Approach #2: Tax-loss harvesting

We’ll assume you start with the same $10,000 and 30-year time frame. After one year, let’s say your investment is down 10%, so you’re able to harvest a $1,000 loss. At a 20% tax rate, you receive a tax benefit of $200 (20% x $1,000) that year, assuming you have capital gains or ordinary income to offset. Because you don’t use the $200 to pay taxes, we’ll assume you reinvest it and it grows at the same rate as the rest of your portfolio. In the following 29 years, this investment would appreciate to $1,555.56 ($70,000/$9,000 x $200). At liquidation, your after-tax return would be $59,084.45. (For a more detailed look at our math, check out the disclosures at the end of this post.)

$71,555.56 ending balance – ($62,355.56 gain x 20% tax rate) = $59,084.45 after taxes

As you can see in this example, by reinvesting savings from tax-loss harvesting, the investment outperforms the same investment without tax-loss harvesting by about $1,000. This example assumes you never make another deposit after the initial $10,000 and the subsequent $200 in tax savings, but your after-tax returns could be even greater over time if you did. Implementing tax-loss harvesting manually can be complicated and time-consuming, but by automating it, Wealthfront makes it effortless for you. It’s also worth noting that the deferred gain in the example above would be even more valuable if a higher tax rate applied to the loss (which it very well could based on 2025 tax rates). 

How much has Wealthfront’s Tax-Loss Harvesting helped our clients over time? For clients who use Wealthfront’s Tax-Loss Harvesting in a Classic portfolio, our software harvested enough losses from 2013 to 2023 to generate an average annual estimated tax benefit worth 1.63% of their portfolio value.

Key takeaways

If your goal is to beat the market, here’s what you should keep in mind:

• You probably can’t beat the market on a pre-tax basis. Even if you manage to generate outsized returns one year, it’s very unlikely you’ll be able to do so consistently over time.
• A passive investing strategy informed by Modern Portfolio Theory can help you track the market and take on an appropriate level of risk.
• You can then use tax-optimization strategies like tax-loss harvesting with the goal of beating the market on an after-tax basis. Wealthfront offers automated Tax-Loss Harvesting at no additional cost.

At Wealthfont, we’re on a mission to build a new financial system that favors people, not institutions. In practice, that means making sophisticated investing strategies that have historically been reserved for the wealthy available to far more people. Tax-loss harvesting is just one of those strategies. As we’ve said before, we believe tax-loss harvesting represents the only reliable way for investors to outperform the market precisely because it allows you to do so on an after-tax basis. Best of all, Wealthfront’s Tax-Loss Harvesting is completely automated and available at no additional cost in all of our Automated Investing Accounts. 

Tax-Loss Harvesting is also available in Wealthfront’s S&P 500 Direct, a new portfolio that offers similar performance to an S&P 500® ETF plus valuable tax savings. And because S&P 500 Direct offers Tax-Loss Harvesting with the stocks that make up an index rather than index funds themselves, and individual stocks may be down and present tax-loss harvesting opportunities even when the index as a whole is up, it can generate even more potential tax savings than our Automated Investing Account.