It’s also important to keep in mind that unless you gift or bequeath your portfolio, you will one day pay tax on these built-in gains. You can assess the break-even point of switching with our investment switching costs calculator. Take a hard look at your investor returns in your current investments. If you’re invested in actively managed funds, you may be losing, on average, 1.01% in returns, compared to an all index-fund portfolio, research shows. We automatically take care of maintaining your investments for you—including rebalancing, dividend reinvestment, diversifying, tax efficiency, free trades and more.
He asked if he would have to pay a one-time tax cost to liquidate, and considering that cost, would the switch still be worth it?
The real question to ask yourself when looking to move your investments to Betterment is, If you’re a short-term investor and plan to hold assets for a couple of years, or less, there’s not much to gain from transitioning to a more efficient portfolio (although it should be noted that under this scenario, you’ll realize the capital gains very soon in any case.) And as a general rule, you should only consider moving appreciated investments that you’ve held for more than a year in order to qualify for long-term capital gains on liquidation.
If your investments have not appreciated since you bought them, or if they are held in an IRA or 401(k), you can generally transition them tax-free.¹ The process by which we pay tax versus fees on our investments subtly biases us to overestimate the impact of taxes, and underestimate the impact of fees.
Small-cap funds sometimes face situations that require them to liquidate their holdings, for example when the market capitalization of a small firm increases so much that it is no longer suitable for inclusion in a "small cap" fund.
In these cases the funds often liquidate their positions in these winner stocks and thereby realize taxable capital gains.