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Wealthfront’s US Direct Indexing

US Direct Indexing is designed to be an enhanced form of Tax-Loss Harvesting that looks for movements in individual stocks to harvest more tax losses and help lower your tax bill even more. US Direct Indexing is available for taxable Automated Index Investing accounts of at least $100,000. If your account balance reaches $500,000, we will automatically weight your investments more intelligently with Smart Beta. If you add US Direct Indexing to your account and your account balance is under $100,000, you’ll hold VTI (or ITOT) until your account balance reaches the minimum.

How does it work?

Instead of using a single ETF (such as VTI) or index fund to invest in US stocks, US Direct Indexing purchases up to 100 or 600 (depending on your account size) of the individual stocks with the largest market capitalizations in the US equity market on a market-weighted basis, along with a completion ETF of smaller companies, to follow the behavior of an ETF that seeks to represent the total market of US stocks (VTI). This allows us to take advantage of the countless opportunities for tax-loss harvesting presented by the movement of individual stocks, in an attempt to further improve your investment performance.

What does it cost?

The annual advisory fee for an Automated Index Investing Account is 0.25%. US Direct Indexing and Smart Beta are available at no additional cost. 

Why is US Direct Indexing only available for taxable accounts?

The primary benefit of US Direct Indexing is the ability to harvest losses on individual stocks that can be used to help reduce your tax liability. Because IRAs are tax-deferred accounts, you don’t owe taxes on gains and aren’t allowed to apply realized losses to reduce your taxes. This means Tax-Loss Harvesting and US Direct Indexing are of no value in IRA accounts. The same goes for Smart Beta, which is built on top of our US Direct Indexing service.

Why can’t I gain the benefits of US Direct Indexing from holding a broad US market ETF?

Low-cost ETFs and index funds are very good investments and form the core of every Wealthfront recommended portfolio. However, ETF and index funds have one disadvantage — legally, they can’t pass on tax losses to their investors.

So while an ETF such as VTI is able to use the movements of individual component stocks and its own cash inflows and outflows to minimize or eliminate any taxable gain passed on to you, it is 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.

To learn more, watch this video or read our US Direct Indexing white paper

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This content is for informational purposes only and is not intended as tax advice. Wealthfront Advisers and its affiliates do not provide legal or tax advice and do not assume any liability for the tax consequences of any client transaction. Clients should consult with their personal tax advisors regarding the tax consequences of investing with Wealthfront Advisers and engaging in these tax strategies, based on their particular circumstances.

The effectiveness of the tax-loss harvesting strategy to reduce the tax liability of the client will depend on the client’s entire tax and investment profile, including purchases and dispositions in a client’s (or client’s spouse’s) accounts outside of Wealthfront Advisers and type of investments (e.g., taxable or nontaxable) or holding period (e.g., short- term or long-term).

Tax-loss harvesting involves certain risks, including, among others, the risk that the new investment could have higher costs than the original investment and the strategy could introduce portfolio tracking error into your account. Tracking error is a measure of financial performance that determines the difference between the return fluctuations of an investment portfolio and the return fluctuations of a chosen benchmark. There may also be unintended tax implications.

Wealthfront Advisers’ investment strategies, including portfolio rebalancing and tax loss harvesting, can lead to high levels of trading. High levels of trading could result in (a) bid-ask spread expense; (b) trade executions that may occur at prices beyond the bid ask spread (if quantity demanded exceeds quantity available at the bid or ask); (c) trading that may adversely move prices, such that subsequent transactions occur at worse prices; (d) trading that may disqualify some dividends from qualified dividend treatment; (e) unfulfilled orders or portfolio drift, in the event that markets are disorderly or trading halts altogether; and (f) unforeseen trading errors. The performance of the new securities purchased through the tax-loss harvesting service may be better or worse than the performance of the securities that are sold for tax-loss harvesting purposes.

Tax loss harvesting may generate a higher number of trades due to attempts to capture losses. There is a chance that trading attributed to tax loss harvesting may create capital gains and wash sales and could be subject to higher transaction costs and market impacts. In addition, tax loss harvesting strategies may produce losses, which may not be offset by sufficient gains in the account and may be limited to a $3,000 deduction against income. The utilization of losses harvested through the strategy will depend upon the recognition of capital gains in the same or a future tax period, and in addition may be subject to limitations under applicable tax laws, e.g., if there are insufficient realized gains in the tax period, the use of harvested losses may be limited to a $3,000 deduction against income and distributions. Losses harvested through the strategy that are not utilized in the tax period when recognized (e.g., because of insufficient capital gains and/or significant capital loss carryforwards), generally may be carried forward to offset future capital gains, if any.

Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.

Investment management and advisory services–which are not FDIC insured–are provided by Wealthfront Advisers LLC (“Wealthfront Advisers”), an SEC-registered investment adviser, and financial planning tools are provided by Wealthfront Software LLC (“Wealthfront”). Brokerage products and services are offered by Wealthfront Brokerage LLC, member FINRA / SIPC. All investing involves risk, including the possible loss of money you invest, and past performance does not guarantee future performance. Please see our Full Disclosure for important details.

Wealthfront Advisers, Wealthfront Brokerage and Wealthfront are wholly owned subsidiaries of Wealthfront Corporation.

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