Automated Tax-Loss Harvesting? We’ll Pass

By Dr. Sylvia Kwan

Editor’s note: You might have seen that a digital advisor* was fined for over-promising on what they do on tax-loss harvesting. We're all for minimizing taxes, but we've never bought into the hype of automated tax-loss harvesting, believing that it's not beneficial for all clients and all types of investments. Read further down for the approach that we take — which is different from others.

No one enjoys paying taxes. It goes without saying: The less we can pay in taxes — whether on earned income, the property we own, realized investment gains, or on goods and services we purchase — the more we get to keep in our pockets. 

So minimizing taxes when and where we can is always a good thing. One of the ways to minimize current tax liabilities in investing is called tax-loss harvesting. Tax-loss harvesting is the practice of selling investments that have declined in value and using those losses to reduce your tax bill.

It’s time to set the record straight on automated tax-loss harvesting.

Many digital investment advisors tout this strategy to lower your taxes and thus increase your after-tax returns — risk-free. 

The thinking behind automated tax-loss harvesting is simple: Search continuously for investments that have declined in value, sell them, and then use those losses to reduce your taxes. What results is a lower tax bill that year, and enthusiasts claim the tax savings give you higher after-tax returns. Some even go so far as to claim that it’s practically a surefire way to maximize them.

But tax-loss harvesting is only a temporary fix for lowering taxes; you may save some money on taxes now, but you’re just deferring them. In almost every scenario (except certain situations that may only become clear in hindsight), you'll still end up paying taxes (possibly higher ones) eventually. Even advisors who offer automated tax-loss harvesting admit this, though they tend to bury this important detail somewhere in the fine print at the bottom of a page.

We don’t offer automated tax-loss harvesting at Ellevest. Investing is for reaching financial goals, and we don’t believe that taxes alone should dictate how you invest. That’s not to say we ignore taxes; in fact, we try to minimize taxes as much as possible. This means avoiding pricey short-term capital gains when we can and realizing losses when it makes sense.

Because contrary to how automated tax-loss harvesting is often sold, it isn’t a no-brainer for every investment portfolio. A lot can affect how effective or ineffective tax-loss harvesting is for an investor. And we believe the potential benefits of automating this process — which doesn’t give much thought to those factors — rely on more “ifs” than are worth it for your financial goals.

The What and Why

Here’s how tax-loss harvesting works: You sell a losing investment and use that loss to offset capital gains. If your loss is greater than the amount of your capital gains, you can apply the remainder of the loss against up to $3,000 of your ordinary income to reduce your tax bill that year. The loss doesn’t offset your income tax directly; it offsets your gains and/or income, which is used to determine how much you owe in taxes.

After the sale, you replace the losing investment with one that's similar, but not identical, in order to maintain the investment portfolio’s asset allocation.

Tax-loss harvesting doesn’t work for tax-advantaged accounts, such as 529 college savings plans and retirement accounts like 401(k)s, 403(b)s, as well as traditional, Roth, and SEP IRAs. Earnings in these accounts aren’t subject to taxation until the funds are withdrawn, so any losses (or gains) won’t affect your year-to-year tax bill.

Deferring, Not Eliminating

Within the hype surrounding automated tax-loss harvesting, there’s a common misperception that this strategy can help you avoid taxes. This is wrong; in most cases, it only defers them.

Let’s say you have an ETF that’s a losing investment (ETF A) and you decide to “harvest” that loss by selling it and buying a similar one (ETF B). Should ETF A bounce back, ETF B is expected to rise, too, because the two ETFs are similar.

When you finally sell ETF B — presumably at a higher price — you'll be on the hook for any capital gains. Capital gains are calculated by subtracting the purchase price from the sale price, so any gains from ETF B will likely be higher than the gains you would have realized from holding onto ETF A. Make a lot of money when you sell ETF B, and the taxes you’ll see on those capital gains could easily cancel out some (possibly all) of the tax savings you realized from tax-loss harvesting. There’s also the chance that ETF A outperforms ETF B, which means you’ll miss out on bigger returns.

So, not quite as foolproof as the hype suggests. 

And this strategy really doesn’t lend itself to financial goals with a shorter investment horizon — like a six-year home goal, for example. If your new investment appreciates (like ETF B earlier), by the time you sell everything, your tax bill could be higher than it would have been had you not realized the loss in the first place. Plus, a bigger tax bill means you’ll have less money to put toward that house.

Which begs the question: Is it worth delaying taxes until you want all the money you can get?

Sure, there are times where deferring taxes can be beneficial. If you expect to be in a lower tax bracket in the future, deferring taxes could mean a more favorable tax rate down the line. This is a gamble — a political one even — because you don’t know what the tax rates will be. As for the two scenarios where you can eliminate deferred taxes — by donating the replacement investment to a non-profit or passing it down to your heirs — those tax breaks aren’t unique to tax-loss harvesting. You can get them simply by donating or passing down your investments anyway.

Better Performance Not Guaranteed

Now we come to another frustrating part of the conversation around automated tax-loss harvesting: advisors overstating tax-loss harvesting’s role in driving portfolio performance. One digital advisor has even gone so far as to publicly guarantee in a television appearance that its investment portfolios could beat the S&P 500 by 1–2% due to automated tax-loss harvesting.

These numbers rely on testing the strategy for limited historical data and making assumptions that may or may not apply: The advisor, along with others making similar claims, assumes that an investor will re-invest the savings from not paying taxes to help their portfolio grow. Then, there’s the assumption that the portfolio is heavy on equities; this is fine for long-term goals, but less so for short-term goals where you can’t afford as much risk.

And in calculating tax-loss harvesting benefits, providers of automated tax-loss harvesting services don’t always include in their forecast returns that you may sell your entire portfolio at the end of your horizon and thus have the bill for those deferred taxes come due. 

So the stated savings and the eventual cost aren’t exactly apples-to-apples, are they?

Furthermore, automated daily tax-loss harvesting, as offered by some advisors, requires you to continuously sell your investments in a down market. Keep in mind that the federal wash sale rule states that you can only write off your losses if your replacement investment, when purchased within 30 days of the sale, is similar — but not identical — to your original investment.

So if you replace ETF A with ETF B and ETF B continues to go down, you would have to buy ETF C, and so on and forth. And if the market continues to decline, each replacement ETF will become less similar to ETF A, which can throw off your original asset allocation — and financial goals.

“Ifs” Galore and How Ellevest Minimizes Taxes

The bottom line? 

The benefits of tax-loss harvesting depend on an investor’s goals, tax situation, whether she has capital gains to offset now and/or in the future, and the state of tax policy in the coming years. There are a lot of unknowns here, and we believe it’s hard to definitively state that deferring taxes will increase your portfolio’s return, as some advisors claim.

That’s why we decided early on we weren’t going to focus on trying to play around with your taxes through automated tax-loss harvesting. We also won’t place bets or predict what tax rates or your tax circumstances might be in the future. Instead, we focus on what we believe matters most: developing a low-cost diversified approach to investing, giving you tools to help you make trade-offs among your goals, minimizing your taxes when we can, and constructing investment portfolios that are personalized to you and your goals.

At Ellevest, tax minimization methodology (TMM) is the method we use for our digital clients to strategically reduce their taxes where possible, to help them boost their potential returns. This works in two ways:

Tax-optimized asset location: We place less tax-efficient securities (like corporate and government bonds) in tax-deferred retirement accounts and more tax-efficient securities (like municipal bonds) in taxable accounts.

Tax-smart rebalancing: Our rebalancing algorithm is designed to minimize the affect on taxes. It keeps track of individual cost basis of ETFs in clients' accounts and sells the highest tax lot first to keep realized capital gains low.

The benefit of this over “automated tax-loss harvesting” is that we can maintain the same asset allocation through our approach (whereas with tax-loss harvesting, the investment company needs to reinvest the proceeds in a different investment to have the tax treatment stand).

We’ll stick to minimizing your taxes the Ellevest way: with investment portfolios built with tax-smart techniques and forecasts that account for taxes — all so we can help you see and reach your goals.


It’s been in the news lately because of the SEC’s recent charges against investment advisor Betterment that it made misstatements and omissions about its automated tax loss harvesting service. Betterment paid $9 million to settle the charges and agreed to compensate the approximately 25,000 clients who were impacted. The SEC’s charges are a reminder that tax loss harvesting is a tax deferral, not a tax elimination strategy (except at death and certain circumstances).

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Dr. Sylvia Kwan

Dr. Sylvia Kwan is the Chief Investment Officer of Ellevest.