Note: Wealthfront’s Stock-level Tax-Loss Harvesting is now called US Direct Indexing.
Great things happen when you combine academic research with the power of software. It’s how we were able to deliver PassivePlus®, our signature suite of advanced investment features, which includes Tax-Loss Harvesting, Stock-level Tax-Loss Harvesting, and Smart Beta. Our research team, with PhD specialists in finance, economics and operations management, looks for time-tested investment strategies and develops methods to implement them in a diversified portfolio. Our engineers bring them to life in our clients’ accounts. The result is high-end investment strategies executed precisely and automatically at an incredibly low cost.
Just like PassivePlus, we applied the same power of research and software to Path, our financial planning solution. In our previous post, The Easier Way to Plan, we explained how our account linking technology is the foundation to understanding your true financial picture. In this post, we’ll explain how applying academic research to your actual financial data means better, more reliable insights that you can trust.
Drawing on our research expertise to project your future
A crucial piece of financial planning is estimating how much you will have in the future. While a simpler model might use a static, generic input (eg. overall investment returns of 4% for next 40 years), Path goes many steps further.
First, building on the work of several Nobel Prize winning financial economists – Merton (1973), and Fama and French (1992) being among the most cited ones – we created a factor-based framework for projecting investment returns. Instead of making general assumptions on the returns of your investments, this framework makes projections at the individual securities-level for over 40,000 securities found in our client portfolios. See more about our model in our blog post Understanding Your Path to Retirement.
Second, when it comes to projections, inflation is a factor not to be ignored because it can have a significant impact on your future purchasing power. Instead of making a judgment call on inflation (at which we are no better than anyone else), we look to the public markets and apply financial statistics to estimate the market expectations for inflation. We do so by comparing the yields of long-term nominal Treasury bonds and long-term inflation-protected Treasury securities. Learn more about our inflation model in our blog post How to Forecast Future Inflation.
Lastly, we know that what you earn today isn’t necessarily how much you’ll make in the future. We draw on recent academic research based on data from the Social Security Administration to understand how income grows over the careers of actual US workers. Path then applies these insights to project your income, taking into account your current age and income bracket.
It’s hard to explore your financial future and make decisions if the projections of your future finances are not reliable. That’s why we invested tremendous effort in building a model that we believe most accurately reflects what our clients’ financial futures will look like. And the best part is whenever any inputs change – whether it’s the investments in your account or a movement in inflation – Path will automatically reflect the latest data in an updated plan.
And with a solid foundation, we can then apply our research towards tackling specific question that clients have. Below are a few examples:
How much will I spend in retirement?
How much do you currently save and spend every month? Not everyone can answer this question confidently. How much will you spend later, say in retirement? That’s even harder to answer.
Through our analysis of the Consumer Expenditure Survey, a Census-based dataset on US consumer behavior that is widely used by academics, we found trends in how consumer spending changes over their lives. We applied these insights to create a nuanced model that estimates a client’s future spending based on their age and current spending. And since your plan is linked to your financial accounts, Path automatically classifies your transactional data to calculate your rolling 12-month savings and spending rates. From there, we project your future spending by year and use that information to estimate the type of lifestyle you can afford at retirement. Learn more in our post Understanding Your Path to Retirement.
What can I expect from Social Security?
While most people know that Social Security kicks in at 62, it’s not always simple to understand how much payout to expect. That’s because the amount depends on a number of factors: your retirement age, your income history, and your tax rates. For example, for a couple with annual taxable income above $44,000, in the 25% federal income tax bracket, and living in California, where Social Security benefits are tax exempt, we calculated that their after tax Social Security income would be $2,420 in after-tax benefits if they retired at age 62. But it would be 82% more – $4,400 in after-tax benefits – if they retired at 70. See more in our post The Surprising Value of Social Security.
The good news is that when you adjust your retirement age in your plan, we automatically estimate your Social Security benefits taking these factors into consideration. And if you’re a Social Security skeptic, we let you adjust how much value to attribute to these benefits.
How much college financial aid can I expect?
When it comes to saving for your children’s college tuitions, a huge question is whether you can expect financial aid in the future. In order to help our clients actually answer that question, we created a financial aid model that makes this estimate for 3,671 institutions (all 2-year and 4-year institutions that provide government financial aid). We researched the two financial aid formulas used by colleges, the Federal FAFSA Method and the Institution Method, and analyzed actual data on average grant amounts. When you plan for college with Path, we take into account what we know about your family, your finances, and the school you’ve chosen for your child to provide a pretty accurate and unique financial aid estimate.
Should I refinance my mortgage?
When it comes to refinancing your mortgage, there are several factors to consider beyond just the current interest rate. The type of the mortgage (fixed vs. adjustable), the duration of the loan, and the size of the loan relative to the value of your property (sometimes referred to as the Loan-To-Value ratio), and closing costs need to be considered as well. When analyzing 4,784 mortgages that our clients linked to Path, we accounted for all these factors and found that about one in five would benefit from a refinancing. See our analysis in the post The Value of Mortgage Refinancing.
We’re excited to do more
We know our clients have many more questions about their finances that research can help answer in a more accurate fashion. If you have some, we’d love to know – please reach out and let us know at email@example.com!
Nothing in this blog should be construed as tax advice, a solicitation or offer, or recommendation, to buy or sell any security. Financial advisory services are only provided to investors who become Wealthfront Inc. clients pursuant to a written agreement, which investors are urged to read carefully, that is available at www.wealthfront.com. All securities involve risk and may result in some loss. For more information please visit www.wealthfront.com or see our Full Disclosure. While the data Wealthfront uses from third parties is believed to be reliable, Wealthfront does not guarantee the accuracy of the information.
This article is not intended as tax advice, and Wealthfront does not represent in any manner that the outcomes described herein will result in any particular tax consequence. Prospective investors should confer with their personal tax advisors regarding the tax consequences based on their particular circumstances. Wealthfront assumes no responsibility for the tax consequences to any investor of any transaction. Investors and their personal tax advisors are responsible for how the transactions in an account are reported to the IRS or any other taxing authority.
PassivePlus® is a registered trademark and property of CSSC Investment Advisory Services, Inc. (“CSSC”) and is used under license. CSSC and Wealthfront are not affiliated companies.
About the author(s)
Pedro Olea de Souza e Silva is a Senior Quantitative Researcher at Wealthfront. His work mainly focuses on applying economic modeling and quantitative data analysis to Wealthfront’s financial planning experience. He earned a PhD in Economics from Princeton University where he studied behavioral economics. Prior to Princeton, he received an MS in Economics from the Getulio Vargas Foundation, and a BS in Economics from the University of Sao Paulo, both in Brazil. View all posts by Pedro Olea de Souza e Silva, PhD