Betterment CEO: Senate tax bill is a hike on retail investors because of the FIFO mandate

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This provision mandates that when retail investors sell a portion of an investment, they must sell their oldest shares first—that is, the first shares "in" must be the first shares "out." While this technical change may sound innocuous, the FIFO mandate would dramatically harm millions of retail investors. It would raise taxes in unintuitive ways, distort investment behavior, and deprive investors of the opportunity to plan efficiently for retirement. Investing would become more complex and more time consuming—disempowering and disenfranchising everyday people who need to invest for their future.

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The Senate has already recognized that the FIFO mandate is bad news. In the first draft of the bill, the FIFO mandate applied to investments made by investment funds, but the Senate exempted them after an intense lobbying effort. As a result, investment companies will continue to have the freedom to decide which shares they want to sell. Retail investors deserve the same opportunity.

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Imagine an investor who, for the last 20 years, has been putting $100 each month into an index fund that has returned 10% on average. After 20 years, her deposits from the first year are now up approximately 600%. Say the market has been down this year, but she continues her monthly investments, knowing that in the long term, consistency is the best strategy.

Now assume that, before the index fund has recovered its value, our investor has an unforeseen expense of $600. She covers it by withdrawing from her portfolio. Under current tax law, she would be able get the $600 she needs by selling the shares that she purchased earlier in the year. Since these shares are currently trading at less than what she paid for them, she wouldn't owe any taxes because she actually lost money on those shares. In fact, she could use her losses on the shares to offset other income, reducing her overall tax burden.

In contrast, under the proposed FIFO mandate, she would not be able to sell her most recently purchased shares. Instead, she would be forced to first sell the shares that she purchased 20 years ago, which would mean that $500 of the appreciated value would be considered taxable gains. Assuming a combined federal/state long-term capital gains rate of 25%, she will owe $125 in taxes.

In trying to withdraw $600, she will be left with $475, net of the tax she owes. To get the full $600 out of her portfolio, she would have to sell about $760 worth of shares, despite the fact that she just put in $600 this year, and that her most recent investment has actually lost value! The FIFO mandate might cause her to attempt complex and burdensome strategies to avoid this harsh result. Or, more likely, she would simply decrease her investments in the market, impairing her own investment goals and the growth of the overall economy.

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