Beating the market sounds nice, but in reality, it usually doesn\u2019t work. No matter how long you spend scouring the internet for stock tips and reading page after page of expert commentary, you\u2019re unlikely to consistently generate outsized pre-tax returns.<\/p>\n\n\n\n
But at Wealthfront, we do<\/em> think it\u2019s possible to beat the market on an after-tax basis\u2014<\/em>and that\u2019s exactly what we try to help you do in our Automated Investing Accounts<\/a>, Automated Bond Portfolio<\/a>, and Wealthfront\u2019s S&P 500 Direct<\/a>. In this post, I\u2019ll explain Wealthfront\u2019s focus on your after-tax returns and how our tax-optimization features can help you come out ahead. <\/p>\n\n\n\n First, let\u2019s look at why you\u2019re unlikely to beat the market on a pre-tax basis.<\/p>\n\n\n\n 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\u2019t work.<\/p>\n\n\n\n For instance, according to the most recent SPIVA Scorecard research<\/a> released in 2024, 57% of actively managed large-cap funds performed worse than the S&P 500\u00ae index over the year ending on June 30, 2024. Over the last 10 years, that underperformance rate rises to nearly 85%. <\/p>\n\n\n\n What should you take away from this? Even professional investors generally don\u2019t beat the market on a pre-tax basis\u2014<\/em>or if they do, they rarely do so consistently over time. As a result, it\u2019s probably not a great use of your time to try.<\/p>\n\n\n\n If you want to try to beat the market on an after-tax<\/em> 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.<\/p>\n\n\n\n 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 <\/em>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\u2014we\u2019ve worked hard to build what we believe is the best automated tax-loss harvesting available.<\/p>\n\n\n\n As we\u2019ve written before<\/a>, we think tax-loss harvesting (just one of the ways<\/a> 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, \u201charvesting\u201d 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\u2019ve 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<\/a> after year<\/a>.<\/p>\n\n\n\n Let\u2019s look at an example that shows what improving your after-tax return with tax-loss harvesting might look like and why it\u2019s valuable. In this very simplified example, we\u2019ll 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\u2019ll further assume you\u2019ll pay a combined tax rate of 20% when you sell your investments. Keep in mind that the purpose of this example isn\u2019t to suggest you\u2019ll receive specific pre- or post-tax returns, but instead to show you how you might apply this math to your own situation.<\/p>\n\n\n\n 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.<\/p>\n\n\n\n $70,000 – ($60,000 gain x 20% tax rate) = $58,000 after taxes<\/em><\/p>\n\n\n\n We\u2019ll assume you start with the same $10,000 and 30-year time frame. After one year, let\u2019s say your investment is down 10%, so you\u2019re 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\u2019t use the $200 to pay taxes, we\u2019ll 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.)<\/p>\n\n\n\n $71,555.56 ending balance – ($62,355.56 gain x 20% tax rate) = $59,084.45 after taxes<\/em><\/p>\n\n\n\n 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\u2019s 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<\/a>). <\/p>\n\n\n\n How much has Wealthfront\u2019s Tax-Loss Harvesting helped our clients over time? For clients who use Wealthfront\u2019s Tax-Loss Harvesting in a Classic portfolio, our software harvested<\/a> enough losses from 2013 to 2023 to generate an average annual estimated tax benefit worth 1.63% of their portfolio value.<\/p>\n\n\n\n If your goal is to beat the market, here\u2019s what you should keep in mind:<\/p>\n\n\n\nWhy you probably won\u2019t beat the market on a pre-tax basis<\/h2>\n\n\n\n
Start with passive investing, then optimize for your taxes<\/h2>\n\n\n\n
The power of improving your after-tax returns<\/h2>\n\n\n\n
Approach #1: No tax-loss harvesting<\/h3>\n\n\n\n
Approach #2: Tax-loss harvesting<\/strong><\/h3>\n\n\n\n
Key takeaways<\/h2>\n\n\n\n