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Wealthfront
Tax-Optimized
Direct
Indexing
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The Wealthfront Tax-Optimized Direct Indexing

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To achieve the projected returns described here, we assume the Wealthfront portfolio with basic service has a risk score of 7, which results in a projected annual 5.2% return. This projected return does not take into consideration the effect of taxes, changing risk profiles, or future investment decisions. Projected returns do not represent actual accounts and may not reflect the effect of material economic and market factors. The results shown do not represent the results of actual trading using client assets, but were achieved by means of forward-looking analysis. This projected return is not a guarantee of actual performance.

We simulated the potential annual after-tax benefits of our Tax-Loss Harvesting services and found that asset-class Tax-Loss Harvesting as per our Daily Tax-Loss Harvesting service combined with the stock-level Tax-Loss Harvesting per our Tax-Optimized Direct Indexing added an annual benefit of at least 2.03%.

We used several assumptions to create these possible approximations, but did not rely on actual client trading history and thus our results should not be relied upon for predicting future performance. The results are hypothetical only. These results are based on a study Wealthfront conducted for the years between January 2000 and August 2014 (described here), assuming a Wealthfront account with a risk score of 7, an initial deposit of $500,000, additional quarterly deposits of $50,000, and periodic rebalancing for stock-level Tax-Loss Harvesting combined with asset-class Tax-Loss Harvesting. Dividends and interest were not considered.

Using these assumptions we projected a rolling incremental IRR of 2.03% for the combination of our Wealthfront Tax-Optimized Direct Indexing and Tax-Loss Harvesting services. We then compounded for 15 years the basic Wealthfront service portfolio and the portfolio with Tax-Optimized Direct Indexing (and the added IRR) — both starting with $500,000. The estimated difference between the two portfolios at the end of 15 years was about $665,000.

A different methodology may have resulted in different outcomes. For example, we assume that an investor’s risk profile and target allocation would not have changed during the time periods shown; however, actual investors may have experienced changes to their allocation plan in response to changing suitability profiles and investment objectives. Furthermore, material economic and market factors that might have occurred during the time periods could have had an impact on decision-making. Actual investors on Wealthfront may experience different results from the results shown. There is a potential for loss as well as gain that is not reflected in the hypothetical information portrayed.

While the data used for its historical simulation are from sources that Wealthfront believes are reliable, the results represent Wealthfront’s opinion only. The return information uses or includes information compiled from third-party sources, including independent market quotations and index information. Wealthfront believes the third-party information comes from reliable sources, but Wealthfront does not guarantee the accuracy of the information and may receive incorrect information from third-party providers. Unless otherwise indicated, the information has been prepared by Wealthfront and has not been reviewed, compiled or audited by any independent third party or public accountant. Wealthfront does not control the composition of the market indices or fund information used for its calculations, and a change in this information could affect the results shown.

Wealthfront does not represent in any manner that the tax consequences described herein will be obtained or that Wealthfront’s Tax-Loss Harvesting strategies, or any of its products and/or services, will result in any particular tax consequence. The tax consequences of the Tax-Loss Harvesting strategy and other strategies that Wealthfront may pursue are complex and uncertain and may be challenged by the IRS.

Prospective investors should confer with their personal tax advisors regarding the tax consequences of investing with Wealthfront and engaging in these tax strategies, based on their particular circumstances. Investors and their personal tax advisors are responsible for how the transactions conducted in an account are reported to the IRS or any other taxing authority on the investor’s personal tax returns. Wealthfront assumes no responsibility for the tax consequences to any investor of any transaction.

What is Wealthfront's Tax-Optimized Direct Indexing?

Wealthfront's Tax-Optimized Direct Indexing is the next step in index investing — an easy way to replace the U.S. stock investment pieces of a diversified portfolio while permitting for an enhanced form of Tax-Loss Harvesting and lowering investment costs.

Single U.S. Stock ETF

Index Replacement

Instead of using a single ETF or Index Fund to invest in U.S. stocks, Wealthfront's Tax-Optimized Direct Indexing directly purchases up to 1,001 individual securities on your behalf — up to 1,000 stocks from the S&P 500® and S&P 1500® Indices and an ETF of much smaller companies.

This allows us to take advantage of the countless opportunities for tax-loss harvesting presented by the movement of individual stocks, to further improve your investment performance. Combined with our Daily Tax-Loss Harvesting service, we believe this could add as much as 2.03% to your annual investment performance. Read Our White Paper.

10-Year Additional Return (IRR) of Direct Indexing

Whoa… Will Wealthfront really buy up to 1,000 individual stocks on my behalf?

That’s right. We’re able to do it because we are the largest automated investment service. Our software algorithms are able to efficiently trade and tax-loss harvest all of the hundreds of stocks we buy on your behalf commission free – something that is incredibly challenging and expensive to do in any other way.

As a result, we’re able to bring a service that has normally only been available to investors with $5 million or more to investors like you.

What’s more, with the added tax-loss harvesting opportunities of individual stocks, our research shows that incorporating Tax-Optimized Direct Indexing into your Wealthfront portfolio could potentially add an average of 2.03% to your annual after-tax returns. Read Our White Paper.

VTI vs Direct Indexing Performance Chart

Common Questions

Why can’t I gain the benefits of Tax-Optimized Direct Indexing by buying an S&P 500® ETF, such as SPY, or a broad U.S. market ETF, such as VTI?

Low-cost ETFs and Index Funds are very good investments and form the core of every Wealthfront portfolio.

However, ETF and Index Funds have one disadvantage – legally they are not able to pass on tax-losses to their investors.

So while ETFs such as SPY or VTI are able to use the movements of their individual component stocks and their own cash in-flows and out-flows to minimize or eliminate any taxable gain passed on to you, they are never able to pass on any tax losses that you’re able to write off against gains in other assets or your regular income.

Thus, an ETF or index fund investment is never able to generate a tax-loss harvesting benefit from the movement of its individual component stocks.

This is the reason why the back-tested performance of Tax-Optimized Direct Indexing consistently outperforms a broad U.S. market ETF such as VTI. See the chart here.

Isn't Tax-Optimized Direct Indexing the equivalent of active management and/or stock picking? I thought Wealthfront only advocated passive investing.

Indeed, Wealthfront believes that attempting to time the market or to pick individual stocks are some of the biggest mistakes that investors can make.

That's why the Tax-Optimized Direct Indexing position in your Wealthfront portfolio is meant to replicate and track the performance of the broad U.S. market.

For example, a Tax-Optimized Direct Indexing position owns stocks from the S&P 500® Index. For a larger account, that position also includes stocks from the broader S&P 1500® Index. Even when one or more stocks are sold for tax-loss harvesting reasons, they are immediately replaced with a collection of stocks meant to ensure that the performance of Tax-Optimized Direct Indexing is still consistent with the broad U.S. market. What's more, the rest of your Wealthfront portfolio continues to hold all the passive index ETFs we typically recommend, with only the U.S. allocation replaced partially with an individual stock position.

Learn more.

What accounts are eligible for Tax-Optimized Direct Indexing?

Any Wealthfront Taxable account with over $100,000 to invest is eligible for Tax-Optimized Direct Indexing.

How much does it cost to add Tax-Optimized Direct Indexing to my account?

Tax-Optimized Direct Indexing is available for any Taxable Wealthfront account with more than $100,000 in assets at no additional charge.

You’ll also pay no commissions on any trades generated by Tax-Optimized Direct Indexing.

What if I trade individual stocks in other accounts? Will there be any issue with the trades in my Tax-Optimized Direct Indexing portfolio?

If you actively trade any U.S. stocks in another account, trades in the same stocks in Tax-Optimized Direct Indexing portfolio may result in wash sales as defined by the IRS.

Wash sales are not illegal and do not result in any additional tax liability but they may reduce the tax-loss harvesting benefits of Tax-Optimized Direct Indexing.

Therefore, we recommend that you add any of the stocks you hold or trade in other accounts to the Exclusion List you’re able to set-up when adding Tax-Optimized Direct Indexing to your account.

If you’re married, you should also add any stocks that your spouse may trade in other accounts.

What if am I restricted from trading certain stocks, like those of my employer? Can I still get Tax-Optimized Direct Indexing?

Absolutely. When you add Tax-Optimized Direct Indexing to your Wealthfront portfolio you’ll be asked to set-up an Exclusion List of stocks that we should never trade on your behalf.

Please add the stock ticker for your employer and any other stocks you are restricted from owning/trading to the list and we’ll make sure to never buy or sell those stocks as part of Tax-Optimized Direct Indexing within your portfolio.

If you’re married, then please also add any stocks that your spouse is restricted from trading to the list.

Additional Resources
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