Saving for Depreciating Assets

[ReadytoLearn]

Hello Everyone,

I am in my first year of retirement and I'm wondering how y'all save for depreciating assets (ex. roof, new car, car repairs, new cell phone, etc.) that you don't buy every year, but you know will eventually need to be paid for.  Ideally, I'll generate "income" solely by selling stocks from my portfolio and a bit of interest from savings.  I see two ways of accomplishing this.....

1 - Take the cost of the item divided by an estimate how long it will last, and sell that much each year in stocks, then throw it in a savings account for the day that item needs to be replaced. Ex: New car costs $25k and you expect it to last 10 years, so each year sell $2500 worth of stocks/bonds and stick that $2500 in a savings account.  10 years later you roughly have $25k for that new car when the old one wears out.  I ~think~ this is the way to go as it has few advantages:

- I am selling a volatile asset (stocks) each year and setting them aside in an ultra-safe investment vehicle (savings account) as I cannot afford NOT to have those funds for a new car at the end of 10 years when I need them.
- I am getting hit with $2500 in taxes (well, less because only taxed on capital gains, not the full amount) each year vs. $25k once.  The former leads to a lower taxes paid over 10 years because the income tax rate is progressive.

2 - Save nothing for the cost of the big ticket item over ten years.  Then when year 10 comes up, sell my newest, least appreciated stocks to accumulate that $25k for the price of the car all in one tax year.

- I am allowing my net worth to appreciate as long as possible by leaving the $ in stocks for as long a possible before I need it.
- Though I may have some"new" stocks without much Capital Gains appreciation right now during the start of my retirement, over time as stocks appreciate, I will naturally have Capital Gains I cannot avoid and by selling $25k of stocks all at once, that will shoot me up the progressive income tax brackets, no matter how many "newer" stocks I have in my portfolio and how little the actual gains are between the price I acquired the stock and the price I sold it for.

What would/are you do/doing in these scenarios?

Thanks!

[zolotiyeruki]

Well, first of all, I probably wouldn't buy a brand new car.  The easiest way to avoid paying taxes on the capital gains is to not have capital gains :P

This is really an asset allocation question, and depends on your risk tolerance.  You could simply shift your portfolio to 10 or 20% bonds vs 80-90% stocks, and pay for those larger, infrequent purchases out of your bond fund when they arise.

[ReadytoLearn]

Well, first of all, I probably wouldn't buy a brand new car.  The easiest way to avoid paying taxes on the capital gains is to not have capital gains :P

This is really an asset allocation question, and depends on your risk tolerance.  You could simply shift your portfolio to 10 or 20% bonds vs 80-90% stocks, and pay for those larger, infrequent purchases out of your bond fund when they arise.

I would agree, this would be safer than holding those funds in my brokerage stock funds and selling $25k in the one year I need it, but this to me would be the worst scenario for taxes and net worth appreciation.  If I did a one-time transaction for $25k and sold out of my brokerage bond allocation for the "new" car, then I would be taxed at less-favorable earned income rates, all in a single taxable year.  In this case, I'm not only being taxed on a full $25k extra in income for a single year, it's happening in the less-favorable earned income tax brackets as opposed to the capital gains tax brackets, right?  Also, I've been taught not to rely on bonds for appreciation (vs. stocks), so I assume returns would be less than stellar vs. keeping it all in stocks and selling $2500/year and than transferring that $2500 to a savings account earning a pitance. Do you agree?

[zolotiyeruki]

Well, first of all, I probably wouldn't buy a brand new car.  The easiest way to avoid paying taxes on the capital gains is to not have capital gains :P

This is really an asset allocation question, and depends on your risk tolerance.  You could simply shift your portfolio to 10 or 20% bonds vs 80-90% stocks, and pay for those larger, infrequent purchases out of your bond fund when they arise.

I would agree, this would be safer than holding those funds in my brokerage stock funds and selling $25k in the one year I need it, but this to me would be the worst scenario for taxes and net worth appreciation.  If I did a one-time transaction for $25k and sold out of my brokerage bond allocation for the "new" car, then I would be taxed at less-favorable earned income rates, all in a single taxable year.  In this case, I'm not only being taxed on a full $25k extra in income for a single year, it's happening in the less-favorable earned income tax brackets as opposed to the capital gains tax brackets, right?  Also, I've been taught not to rely on bonds for appreciation (vs. stocks), so I assume returns would be less than stellar vs. keeping it all in stocks and selling $2500/year and than transferring that $2500 to a savings account earning a pitance. Do you agree?

The reason I mention bonds is because they generally have higher returns than a savings account, but are also very low-risk.  Not zero risk (see the GM bailout 12 years ago), but pretty close to it.  Yes, because you have higher gains, you'll also pay slightly higher taxes....but you'll also have higher gains to pay those taxes with.

It really does come down to your risk profile:  On the one hand, you can pull the money out yearly, thus guaranteeing to slightly lower your tax burden, at the cost of likely missing out on significant gains.  On the other hand, you can pull the money out when you need the full amount, thus increasing your chances of realizing the full gains, but also slightly increasing your tax burden, and there's also the risk that you'd need to pull the money out at an inopportune time (i.e. when the market is significantly down).