Supercharge your Investments with Tax-Loss Harvesting

Supercharge your Investments with Tax Loss Harvesting wealthfront.com

Tax-Loss Harvesting ENGINEER YOUR PORTFOLIO WITH ETFs » ©2013 Wealthfront, Inc. 3  We’ve already shown how to build a low-cost investment plan and personalize it for your risk tolerance in our SlideShare presentation:  Now, let’s talk about how to use tax-loss harvesting to improve your after-tax return.

The Basics of Tax-Loss Harvesting

What is Tax-Loss Harvesting? We encourage you to consult a tax professional to see if tax-loss harvesting is right for you. ©2013 Wealthfront, Inc. 5  Tax-loss harvesting is a way to make your investments work harder on your behalf – by generating tax savings in addition to investment returns.  It works by identifying investment losses in your taxable investment portfolio and selling those securities to recognize the loss.  These capital losses can be used to offset other gains and reduce or postpone income taxes.  Even if you cannot realize the full benefit this year, you can move your tax losses to future years, via a "tax-loss carryforward.”

A Simple Tax-Loss Harvesting Example Let’s assume you buy 100 shares of an ETF at $65 per share in a taxable investment account. We’ll refer to it as your primary ETF. ©2013 Wealthfront, Inc. 6 2008 2009 $65 Example data from one ETF during this period. Not representative of your results. We encourage you to consult a tax professional to see if tax-loss harvesting is right for you.

A Simple Tax-Loss Harvesting Example If the price drops to $41 (below its cost of $65), you can harvest the loss of $24 per share. ©2013 Wealthfront, Inc. 7 $24 $41 Primary ETF 2008 2009 $65 Example data from one ETF during this period. Not representative of your results. We encourage you to consult a tax professional to see if tax-loss harvesting is right for you.

A Simple Tax-Loss Harvesting Example The total potential tax benefit is the loss of $24/share multiplied by the number of shares you own and then multiplied by your tax rate. With a Federal + State income tax rate of 51%... * The tax benefit assumes that you can take advantage of the full credit. ©2013 Wealthfront, Inc. 8 $65 – $41 = $24 x 100 = $2,400 x 51% Cost Basis Current Price Loss / Share # of Shares Total Loss Tax Rate Tax Benefit: $1,224* This benefit is typically referred as as Tax Alpha and expressed as an additional % return of your investment portfolio (since it effectively adds to your investment return). In this case, you generated a Tax Alpha of nearly 19% on the original $6,500 investment.

A Simple Tax-Loss Harvesting Example ©2013 Wealthfront, Inc. 2008 2009 Example data from one ETF during this period. Not representative of your results. 9 After harvesting, you can maintain the risk & return of your portfolio by replacing your harvested primary ETF with a similar, but not identical, secondary ETF, such as an ETF that tracks a different index for the same asset class. Thirty days later you can sell the secondary ETF and return to the primary ETF. These steps are required to claim a tax benefit while avoiding the IRS wash-sale rule (see appendix). Primary ETF Secondary ETF We encourage you to consult a tax professional to see if tax-loss harvesting is right for you.

Wealthfront’s Tax-Loss Harvesting Strategies ©2013 Wealthfront, Inc. 10  Wealthfront has two different strategies available for Tax-Loss Harvesting on client portfolios 1. Daily Tax-Loss Harvesting 2. Tax-Optimized Direct Indexing  Both of Wealthfront’s Tax-Loss Harvesting strategies run every day, selling underperforming assets and replacing them with similar but not identical ones as opportunities arise.

Daily Tax-Loss Harvesting

Daily Tax-Loss Harvesting ©2013 Wealthfront, Inc. 12  Wealthfront’s Daily Tax-Loss Harvesting service applies Tax- Loss Harvesting to the ETFs that make up your Wealthfront portfolio.  We look across all ETFs and investment lots in your portfolio every single day to spot harvesting opportunities.  With a diversified portfolio like the one at Wealthfront, there are bound to be some underperforming assets that can be harvested. 6.8% -4.5% -2.9% 3.4% 1.8% -4.5% Gains Losses US Stock Emerging Markets Foreign Developed Real Estate Natural Resources Bonds

What does it take to do Daily Tax-Loss Harvesting? ©2013 Wealthfront, Inc. 13  You need to understand the IRS wash sale rule and its implications. – Running afoul of this rule can easily negate any benefits from tax-loss harvesting – Wealthfront had to build a system to specifically track what we could and could not trade according to the rule  You need to monitor your portfolio daily – To avoid missing harvesting opportunities  You need to integrate tax-loss harvesting into your overall investment strategy – Alongside deposits, withdrawals, rebalancing, and dividend reinvestment – All of those transactions need to comply with the wash sale rule and otherwise take the right opportunities to harvest  You need to track the purchase price of every share – This detailed accounting is critical to identifying which shares can be harvested and which can not.

Why do we Tax-Loss Harvest Daily? BECAUSE SOMETIMES HARVESTING OPPORTUNITIES DISAPPEAR AS THE MARKET REBOUNDS ©2013 Wealthfront, Inc. 14 Example data from one ETF during an investment period. Not representative of your results. Great time to harvest this asset The asset rebounded and the harvesting opportunity is now gone In our simulations, we’ve found that daily harvesting provides up to 50% more value than the more common once-a-year harvesting (typically done at the end of the year). To dive into the details of our analysis, see our technical white paper.

Tax-Optimized Direct Indexing

How can you take Tax-Loss Harvesting to the next level? We encourage you to consult a tax professional to see if tax-loss harvesting is right for you. ©2013 Wealthfront, Inc. 18  What if in addition to harvesting broad asset classes / indexes / ETFs you could harvest the individual stocks that make up each ETF / index ?  If the S&P 500 is up for the year, there probably aren’t a lot of tax-loss harvesting opportunities via an S&P 500 ETF investment.  But even if the S&P 500 is up overall, there are probably some individual S&P 500 stocks that are still down. What if you could harvest those?  We call that Stock Level Tax-Loss Harvesting GOOG AAPL

Stock Level Tax-Loss Harvesting We encourage you to consult a tax professional to see if tax-loss harvesting is right for you. ©2013 Wealthfront, Inc. 19  Stock Level Tax-Loss Harvesting is not possible with ETF or index fund investments because legally ETFs / index funds can not pass on losses for individual stocks on to their investors  So ETF / index fund investors miss out on opportunities for additional tax savings  However, it’s possible to benefit from harvesting losses from the individual stocks that comprise an index if you own the index’s underlying stocks directly  Wealthfront’s Tax-Optimized Direct Indexing does this for you by directly owning the individual stocks tracked by major US indices like the S&P 500 and the S&P 1500 GOOG AAPL

Does Stock-Level Tax-Loss Harvesting Work? ©2013 Wealthfront, Inc. 20 Direct Indexing outperformed VTI in a substantial majority of years, especially in bad markets. As expected, adding more individual stocks to the Direct Indexing position (i.e. moving from the Wealthfront 500 to the Wealthfront 1000) improved performance. This is in large part due to the extra tax-loss harvesting opportunities available with the larger set of individual securities. See disclosure for model assumptions.

What’s the bottom line? ©2013 Wealthfront, Inc. 21  Adding Daily Tax-Loss Harvesting and Tax- Optimized Direct Indexing to your investments can increase after-tax investment returns by 2.03% per year!  In 15 years, a portfolio that started with a$500,000 deposit can have +$662,000 in additional value over a portfolio with no tax-loss harvesting applied to it. See disclosure for model assumptions. $500k +$662k From Harvested Losses 15 years

How can I get this? ©2013 Wealthfront, Inc. 22  Wealthfront clients with a minimum investment of $100,000 get access to Daily Tax-Loss Harvesting:  Wealthfront clients with a minimum investment of $500,000 get access to the Tax-Optimized Direct Indexing:  You can also get a basic diversified Wealthfront portfolio starting at $5,000: GET A DIVERSIFIED PORTFOLIO WITH DAILY TAX-LOSS HARVESTING » GET A DIVERSIFIED PORTFOLIO WITH THE TAX-OPTIMIZED DIRECT INDEXING» INVEST NOW »

Disclosure This presentation was prepared to support the marketing of Wealthfront's investment products, as well as to explain its tax-loss harvesting strategy. Nothing in this presentation should be construed as a solicitation or offer, or recommendation, to buy or sell any security. Financial advisory services are only provided to investors who become Wealthfront clients. This presentation is not intended as tax advice, and Wealthfront does not represent in any manner that the tax consequences described herein will be obtained or that Wealthfront's tax-loss harvesting strategy, 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. This presentation was not prepared to be used, and cannot be used, by any investor to avoid penalties or interest that can be imposed on the investor. Prospective investors should confer with their personal tax advisors regarding the tax consequences of investing with Wealthfront and engaging in this tax strategy, 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. Wealthfront assumes no responsibility for the tax consequences to any investor of any transaction. When Wealthfront replaces investments with “similar” investments as part of the tax-loss harvesting strategy, it is a reference to investments that are expected, but are not guaranteed, to perform similarly and that might lower an investor’s tax bill while maintaining a similar expected risk and return on the investor’s portfolio. Expected returns and risk characteristics are no guarantee of actual performance. The chart showing potential tax savings (“Bottom Line of Tax Loss Harvesting”) from the tax-loss harvesting strategy and the charts showing the performance comparison between the up-to-500 individual stock position in the Tax-Optimized Direct Indexing(“Wealthfront 500”) vs. the SPY ETF are historical simulated returns (Does Stock Level Tax- Loss harvesting Work?) based on backtesting and do not rely on actual trading using client assets. The results are hypothetical only. Several processes, assumptions and data sources were used to create one possible approximations of how Wealthfront’s tax-loss harvesting strategy might have benefited investors in the past, and a different methodology may have resulted in different outcomes. These results were achieved by means of the retroactive application of a model designed with the benefit of hindsight. The results of the historical simulations are intended to be used to help explain possible benefits of the tax-loss harvesting strategy and should not be relied upon for predicting future performance. We simulated the potential after-tax benefits of our tax-loss harvesting services and found that asset-class tax-loss harvesting it added an average of at least 1.29% annually and stock-level tax-loss harvesting combined with asset-class tax-loss harvesting added an average of at least 2.03%. We used several assumptions to create these possible approximations, but did not rely on actual client trading history. These results are based on a study Wealthfront conducted for the years between January 2000 and August 2014, assuming a Wealthfront account with a risk score of 7 an initial deposit of $100,000, additional quarterly deposits of $10,000, and periodic rebalancing for asset-class tax-loss harvesting and 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. To compare the possible benefit of continuous vs. annual year-end tax-loss harvesting, we use the same assumptions for the historical simulation for the years between January 2000 and August 2014 but with tax-loss harvesting opportunities examined daily vs. annually at year-end. The chart showing the tax alpha and cumulative return for daily tax-loss harvesting (Why do we Tax-Loss Harvest Daily) clients is based on Wealthfront’s estimates from existing client data since we launched our asset-class tax-loss harvesting in October 2012 through August 2014. The chart was based on the subset of our clients with tax-loss harvesting enabled in their accounts and the returns and tax alpha were estimated for their accounts only. The return estimates were based on time-weighted returns. The cumulative returns were calculated by taking the composite’s daily return based on its daily balance series, where the composite’s balance is the aggregated value of all the accounts under our TLH strategy. We then compound the daily return series to get the compounded return over the period. The monthly tax alpha was calculated using the net tax benefit/liability and dividing by the aggregate balance. The net tax benefit over the period includes the liquidation of positions transferred in and sold to invest the client account in the Wealthfront portfolio. ©2013 Wealthfront, Inc.

Disclosure To achieve the projected returns (What’s the bottom line), 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 assume the 2.03% annual “tax alpha” from our simulation is reinvested back into the basic Wealthfront service portfolio to obtain a projected return of 6.11% (vs. the 5.99% projected return for the basic service). We compounded for twenty years the basic Wealthfront service portfolio and the Wealthfront portfolio with Daily Tax-Loss Harvesting combined with the Tax-Optimized Direct Indexing both starting with $500,000. The estimated difference between the two portfolios at the end of the twenty years was approximately $662,166.70. With regard to the historical simulated results presented, different methodologies 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 period 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 period 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. Investors evaluating this information should carefully consider the processes, data, and assumptions used by Wealthfront in creating its historical simulation. While the data used for its simulations 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. ©2013 Wealthfront, Inc.

Appendix: FAQs

The Wash Sale Rule ©2013 Wealthfront, Inc. 26  Usually, you can recognize a loss when you sell a security for less than its cost basis. However, if you buy the same or substantially identical security within 30 days of the sale, the wash sale rule applies and you cannot claim the tax benefit.  Consider the wash sale rule when trading for asset reallocation, rebalancing, dividend reinvesting, withdrawal, or deposit.  Remember that the wash sale rule applies across all accounts for which you are the beneficial owner – such as retirement accounts – as well as spousal accounts for joint tax-filers. For more information about the wash sale rule, look at the IRS’s webpage: http://www.irs.gov/publications/p550/ch04.html#en_US_2011_publink100010601

What Do I Do With My Lowered Cost Basis? ©2013 Wealthfront, Inc. 27  While tax-loss harvesting systematically lowers the cost bases of your investments, you may be concerned that tax benefits now will merely postpone or magnify future tax obligations.  It’s true that tax rates and laws are unpredictable. The time value of money, however, means that tax liabilities due in future years are less costly than the same liabilities due now.  You can use the tax savings to help your portfolio grow. Even with potential tax rate increases in the future, the deferral of tax liabilities will most likely yield net benefits.  Instead of selling investments directly, you could make charitable donations with low-cost-basis assets, or pass them to your heirs at a stepped-up basis.  We encourage you to consult a tax professional to see if tax-loss harvesting is right for you.

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