Your 2016 Year-End Personal Finance Checklist

Unfortunately, it’s human nature to push off thinking about personal finances until the end of the year, if at all. If this describes you, don’t despair! There’s still time left before 2016 draws to a close to make some meaningful decisions, which is why we put together a
checklist of important tasks you should consider before the New Year.

Top off your emergency fund
Give yourself and your family the gift of an emergency fund. We typically suggest you set aside three to six months of your monthly spending, but everyone’s situation is different. To help determine what’s right for you, we suggest you read Build the Emergency Fund That’s Right for You. Our recommendation is to keep your emergency fund in a low-risk, liquid account such as a money market fund or savings account – do not invest your emergency fund in the market!

Harvest your losses to lower your tax bill

Tax-loss harvesting is a method of reducing your taxes by selling an investment that is trading at a significant loss and replacing it with a highly correlated though not identical investment. In doing so, you maintain the risk and return characteristics of your portfolio and generate losses that can be used to reduce your current taxes. The tax savings you generate can then be reinvested and will compound over time. According to our research, on average year-end tax loss harvesting could generate tax savings on the order of up to 0.5% of your portfolio value. It’s a powerful strategy, which is why we offer our clients daily tax-loss harvesting which could add almost triple that value over the course of a year.1

Pay down your credit card debt

Credit cards typically charge as much as 18% on your outstanding balances, so paying off your debt is the equivalent of getting a risk free 18% return. There is no investment product that offers that kind of risk adjusted return.

Pay down your student debt

If you have money left over after contributing to your emergency fund and paying down your credit card debt, then you should consider paying down or refinancing your student debt if it charges an interest rate of 6% or more. Again, paying down debt with a 6% interest rate is like getting a risk-free 6% return, which even Wealthfront can’t match. You might also consider refinancing your student loans through some new companies like Earnest.  

Contribute to your 401(k) account

As we explained in Why Your 401(k) Plan Sucks, it makes tremendous sense to contribute at least as much this year to your 401(k) account as your employer is willing to match. If your employer does not offer matching contributions, then you are likely better served investing your savings in a Wealthfront IRA or taxable account. Fortunately, you have until April 15th of next year to contribute to an IRA and still get the tax deduction for 2016, so you don’t need to be in a rush if you choose the IRA over the 401(k) option.

Don’t exercise your stock options if you can wait

Unless you are worried about your employer’s stock price dropping precipitously before year end, you should consider deferring your exercise until after December 31st. That will defer the tax you owe from exercising your options until the 2017 tax year, which you may not have to pay until April 2018.

Open a 529 college savings plan account for your kids

The IRS has given parents an incredible gift to help them save for their child’s college education costs – the 529 college savings plan. When it comes to planning for your family, few things have the potential to prove as financially rewarding as enrolling early in a 529 and growing your savings tax free. That’s why Wealthfront launched its own 529 this fall. In 529 Plans and Saving for College we cover the basics from the types of accounts available and their pros and cons to giving you an idea of how much you’ll likely need to save.

Superfund your 529 college savings plan

If you are fortunate enough to have a more substantial amount of money, superfunding a 529 offers significant benefits both in terms of objective savings results, as well as from a behavioral finance perspective. Instead of the $14,000 annual contribution limit, each parent can pre-fund up to five years’ worth of contributions, up to $70,000 (5 x $14,000). Together, that means a married couple can open a 529 plan with $140,000 for each child and get even more value from compounding the larger contribution from the outset. We explain the benefits of superfunding in greater detail in 529 Plans: The Benefits of Superfunding.

Spend down your FSA

If you have a flexible spending account for health care expenses, usually referred to as a health FSA , and you haven’t used all the money in it, you’ll need to use the bulk of it before the end of the year.  If you don’t use of it by year end, plan sponsors have the option to allow employees participating in health FSAs to carry over, instead of forfeiting, up to $500 of unused amounts remaining at year-end. Check with your plan sponsor to see if this option is available to you. A key difference between these types of accounts and a health savings account is that the latter allows you to roll over all your funds year to year.

Give a tax-deductible charitable contribution

Now is a good time to donate to a cause you believe in and simultaneously benefit from it on your 2016 taxes. Just remember – a tax deduction only saves you a fraction of the total amount you donate, so make that charitable contribution because you really want to support the cause and not just for the potential tax write-off. Giving directly to causes is also deemed a good alternative for those wrestling with whether to pursue a socially responsible investing strategy.

Claim your residential energy efficient property credit

If you, as an individual homeowner who has considered purchasing residential alternative energy equipment, such as solar hot water heaters, solar electricity equipment, etc., you should consider this tax credit. The credit runs through 2016 for qualified geothermal heat pumps, small wind turbines and fuel cell property placed in service by December 31, 2016 and has been extended for solar electric property and solar water heating property placed in service through December 31, 2021.  For 2016, the credit is 30%2 of the cost of qualified equipment. And according to the IRS this generally includes labor costs when figuring the credit, and you can carry forward any unused portions of this credit.

Review your insurance policies

Make sure you and your loved ones are well protected if something happens to you. Now is a good time to consider whether any major life changes, like the birth of a child in the past year, might mean the need for insurance. If you do have enough coverage, it’s still a good time to review the different types of coverage you have. As we explained in Why Whole Life Insurance Is a Bad Investment, term life insurance makes more sense for most young people than whole or universal life insurance. And while it might seem like a bad time to do so, it is actually a good time of the year to gently review with parents or elders their own coverage. Long-term care coverage for older parents is one area often overlooked, even by many financial advisers. Also, many retiring boomers fail to consider how much they will have in the way of out-of-pocket healthcare costs post-retirement. If you want to perform a quick back-of-the-napkin calculation to estimate these costs for an older parent or loved one check out this free one-click cost calculator.

Turn on Direct Indexing in your Wealthfront account

If you are a Wealthfront client who has invested at least $100,000 with us in a taxable account, there’s no time like the present to opt in to our Direct Indexing service. Direct Indexing is unique in that the more money you invest, the greater the potential benefit. That’s because the more you invest, the more securities you own. The more securities you own, the greater the opportunity for harvesting losses. For example, assuming you have short-term gains against which you can apply the extra losses you receive from Direct Indexing, over the long term a $100,000 Direct Indexing portfolio will generate losses that could equate up to an extra 0.22% of your portfolio value per year after-tax. At $500,000 the annual benefit could be approximately 0.35% and at $1 million the annual benefit could be up to 0.48%3.

Review your spending and set up automated savings

As our CIO Dr. Burt Malkiel says “Start saving early and save regularly. You will do very, very well over time and likely have a very happy retirement when the time comes.” To do that, you need to reflect on your spending and develop a budget for next year. So, take advantage of the time you have during the holidays and bite the bullet. A great step after setting a budget for 2017 is to take the pressure off and just automate your savings to your emergency fund and your investment accounts. You can read more of Dr. Malkiel’s suggestions at Burt Malkiel’s Rule for Young Investors: Save Regularly. Yes, we are intentionally reiterating the point of saving regularly.

Check to see if your portfolio is invested the right way

Do you know how your portfolio is doing? The answer is likely not really, which is why we created an objective portfolio review tool that analyzes your existing portfolio to see if you’re properly diversified, holding too much in cash (and thereby losing out on the opportunity to grow your money) or paying too much in fees. If appropriate you can always effortlessly transfer your portfolio to Wealthfront using our Tax-minimized Brokerage Account Transfer process.

Roll over your old 401(k) into an IRA

Most 401(k) plans are poor performers and the fees you pay on them add up (as we pointed out in Why Your 401(k) Plan Sucks). If you leave one company for another, it’s usually a bad idea to roll your 401(k) over into your next employer’s 401(k) unless you’re lucky enough to find one of the few good plans that offer Vanguard index and target date funds. Consider rolling your old 401(k) over into a low cost, set it and forget it Wealthfront IRA. The transfer process is electronic and you don’t have to talk to anyone.

We want to sincerely thank all of our clients who trust us every day with their hard earned money. We promise to continue to deliver value to you in 2017 and beyond. In the meantime, please let us know if you have any other suggestions that we should share. Happy Holidays!

1. To understand the value that our daily strategy brings versus the more common end-of-year strategies, we back-tested the average annual tax benefit over six recent 10-year periods for both approaches. See our disclosures below for more information on the methodology.
2. Fuel cell property, however, is subject to a limitation, which is $500 with respect to each half kilowatt of capacity of the qualified fuel cell property.
3. Please see our disclosures below for more information on our methodology.


To understand the value that our daily strategy brings versus the more common end-of-year strategies, we back-tested the average tax alpha over the six most recent 10-year periods for both approaches. To precisely quantify the value of tax-deferral created through tax-loss harvesting, we performed a Monte Carlo analysis. This type of simulation is the gold standard for quantifying the expected future impact of investment decisions.We evaluated the performance of our daily tax-loss harvesting algorithms across three investment periods (10 years, 20 years, and 30 years) and three different withdrawal rates (none, 50% at the end of the investment period, and full withdrawal at the end of the investment period). In the investment phase, we simulated the future returns of two portfolios: the Wealthfront diversified risk level 7 portfolio with daily tax-loss harvesting and the Wealthfront diversified risk level 7 portfolio with no tax-loss harvesting.

To model the expected return of the asset classes in these portfolios, we constructed an asset return model by estimating a two-regime multivariate Gaussian model from historical data. The two regimes correspond to the bull-market regime and bear-market regime respectively. The market alternates between the two regimes, where the bull-market regime was characterized by positive expected return, low volatility and low correlation while the bear-market regime was characterized by negative expected return, high volatility and high correlation, as we observed in the asset classes’ historical behavior. The asset returns’ conditional joint distribution conditioned on each regime was modeled using a multivariate Gaussian distribution. In our Monte Carlo simulation, we first sampled asset class returns from the asset class return joint distribution model and transformed them into ETF prices. For the daily tax-loss harvesting portfolio, any tax savings generated by tax-loss harvesting were assumed to be reinvested into the portfolio at the beginning of the next tax year. For both portfolios, we assumed an initial deposit of $100,000 and follow on deposits of $10,000 at the beginning of every quarter. At the end of the investment phase, we calculated the value of each simulated portfolio and applied the three liquidation strategies. We then subtracted each liquidation scenario’s expected taxes to produce after-tax values for all the portfolios. This allowed us to compare the after-tax value of a tax-loss harvesting portfolio vs. a non tax-loss harvesting portfolio under the three liquidation scenarios – simply by taking the difference between the two post-liquidation, after-tax portfolio values.

The Direct Indexing results are based on a study Wealthfront conducted for the years between January 2000 and December 2014, using 3 different Wealthfront hypothetical accounts. We assumed an account with a risk score of 7, an initial deposit of $100,000 and additional quarterly deposits of $10,000. The second $100,000 account had an initial deposit of $500,000 and additional quarterly deposits of $50,000. The third account had an initial deposit of $1,000,000, and additional quarterly deposits of $100,000. For $100,000 accounts, Wealthfront assumed a 42.7% combined federal and state short-term capital gain tax rate and assumed a 24.7% combined federal and state long-term capital gain tax rate. For the $500,000 and $1,000,000 accounts, Wealthfront assumed a 44.5% combined federal and state short-term capital gain tax rate, and a 24.5% combined federal and state long-term capital gain tax rate. For the asset class composition of the assumed Wealthfront account with a risk score of 7, please see Wealthfront’s Tax-Optimized Direct Indexing White Paper. The simulations compare the potential additional return achieved through six (6) distinct 10 year periods from 2000 through 2014 using IRR (Internal Rate of Return). These results are historical simulated returns based on backtesting and do not rely on actual trading using client assets.

The information regarding the likelihood of various investment outcomes using Monte Carlo simulations and backtesting are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. The simulations are based on numerous assumptions, including but not limited to those set forth above. There can be no assurance that the results shown will be achieved or sustained.Actual results will vary, and such results may be better or worse than the simulated scenarios. Backtested results are calculated by the retroactive application of a model constructed on the basis of historical data and based on assumptions integral to the model which may or may not be testable and are subject to losses. Hypothetical results have inherent limitations. Specifically, hypothetical results do not reflect actual trading or the effect of material economic and market factors on the decision-making process. The results are not predictions, but they should be viewed as reasonable estimates. Hypothetical results are adjusted to reflect the reinvestment of dividends and other income and, are presented net of fees.

Wealthfront assumed that Wealthfront would have been able to purchase the securities recommended by the model and that the markets were sufficiently liquid to permit all trading. 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. For further information on our testing methodology please see our Tax-Loss Harvesting White Paper. The information provided in this blog is not intended as tax advice, and Wealthfront does not represent in any manner that the outcomes described herein will result in any particular tax consequence. Prospective investors should confer with their personal tax advisors regarding the tax consequences based on their particular circumstances. Wealthfront assumes no responsibility for the tax consequences to any investor of any transaction. Investors and their personal tax advisors are responsible for how the transactions in an account are reported to the IRS or any other taxing authority. Tax loss harvesting (TLH) may generate a higher number of trades due to attempts to capture losses. There is a chance that Wealthfront trading attributed to TLH may create capital gains and wash sales and could be subject to higher transaction costs and market impacts. In addition, TLH 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.

Wealthfront’s 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.
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. Wealthfront assumes no responsibility to any investor for the tax consequences of any transaction.

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. 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.

Wealthfront only monitors for tax-loss harvesting for accounts within Wealthfront. The client is responsible for monitoring their and their spouse’s accounts outside of Wealthfront to ensure that transactions in the same security or a substantially similar security do not create a “wash sale.” A wash sale is the sale at a loss and purchase of the same security or substantially similar security within 30 days of each other. If a wash sale transaction occurs, the IRS may disallow or defer the loss for current tax reporting purposes. More specifically, the wash sale period for any sale at a loss consists of 61 calendar days: the day of the sale, the 30 days before the sale, and the 30 days after the sale. The wash sale rule postpones losses on a sale, if replacement shares are bought around the same time.

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 and type of investments (e.g., taxable or nontaxable) or holding period (e.g., short- term or long-term). Except as set forth below, Wealthfront will monitor only a client’s (or client’s spouse’s) Wealthfront accounts to determine if there are unrealized losses for purposes of determining whether to harvest such losses. Transactions outside of Wealthfront accounts may affect whether a loss is successfully harvested and, if so, whether that loss is usable by the client in the most efficient manner.
A client may also request that Wealthfront monitor the client’s spouse’s accounts or their IRA accounts at Wealthfront to avoid the wash sale disallowance rule. A client may request spousal monitoring online or by calling Wealthfront at 650-249-4258. If Wealthfront is monitoring multiple accounts to avoid the wash sale disallowance rule, the first taxable account to trade a security will block the other account(s) from trading in that same security for 30 days.

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