Author Topic: Advice for inexperienced investor  (Read 4222 times)

Jacob1234098

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Advice for inexperienced investor
« on: July 24, 2014, 12:18:35 PM »
I thought I had this stuff figured out, but I've read some articles recently that completely went against how I have been doing things. Apparently, I've been making some big mistakes and want to avoid those going forward. For instance, I've been investing in a Roth IRA and Roth 401k, not aware that you can use tax avoidance strategies if you invest in the traditional IRA/401k.

My current breakdown is:

$75,000 / year income
0% 401k match
$15,000 annual expenses

401k account:
(All funds at lowest possible .7% expense ratio. All other possible funds are 1.5% ER or higher. Very bad 401k plan.)
US Large S&P Index fund -   $32,066
US Mid S&P Index fund -     $30,379
US Small S&) Index fund -    $30,665
----------------------------------------------------------
Vanguard:
Roth    IRA
Vanguard Target Retirement 2055 Fund (VFFVX)       -                                    $21,262.06
Vanguard Total International Stock Index Fund Investor Shares (VGTSX) -    $5,933

Taxable (Admiral) Acct   
Vanguard Target Retirement 2055 Fund (VFFVX) -                                            $2,400.00
Vanguard Total International Stock Index Fund Investor Shares (VGTSX) -   $15,088
Vanguard Total Bond Market Index Fund Admiral Shares (VBTLX) -             $11,924
Int bond fund   $0
----------------------------------------------
Checking (2% annual interest up to $15,000): $20,283

HSA (on PPO now and can't contribute) -    $2805.56
----------------------------------------------

Based on all these numbers, my exposure profile is:
US Stock - 62.5%
US Bond - 8%
Int Stock - 15.9%
Int Bond - 0.3%
Cash - 13.4%

I'm young, looking to retire early, but willing to work longer if stocks do poorly, so I want to invest aggressively. Something along the lines of:
US Stock - 59.85%
US Bond - 7.6%
Int Stock - 25.65%
Int Bond - 1.9%
Cash - 5% (2% return)

New discoveries:
1. I should be investing in Traditional Roth/401k, so I can significantly reduce taxes in early retirement. I plan to withdraw 25-30k/year in retirement, around age 38-40 probably. I'm 27.
2. Invest in either bonds (taxed as income) or high growth stocks in non-taxable accounts, avoiding being taxed on gains. Since bond returns are low, I am thinking of putting international stocks in my non-taxable account.
3. Maybe stop using the Vanguard 2055 fund as I can't harvest tax losses since the fund isn't an individual asset class. But, how beneficial is tax loss harvesting, and is it worth selling the fund and paying my long-term capital gains on the growth?
3b. Does it even matter if long-term capital gains are sold now and I pay tax on it now, or leave the 2055 fund there and sell it in a decade or two paying the long-term capital gains then? I am really confused on this one. Is there a benefit in delaying long-term capital gains tax? Do you make more money delaying the tax?

Sorry for so many questions. I just realized I don't know so much, and I am about to make some big stock purchases as I'm too heavy in cash. My plan in the next day or two is to create a Vanguard Traditional IRA and transfer $5,500 from cash to the Vanguard Total International Stock Index Fund (VGTSX). I want to make sure I don't make any more obvious investor mistakes.

Thank you!!!



« Last Edit: July 24, 2014, 12:28:52 PM by Jacob1234098 »

matchewed

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Re: Advice for inexperienced investor
« Reply #1 on: July 24, 2014, 12:40:05 PM »
3 and 3b) How much would you pay on the capital gains taxes today? Probably not much if you only have $2.4k in that fund. Then just buy into your desired asset allocation. Alternatively you could just ignore it and increase your positions in the funds you want to be in to get to your desired asset allocation and not eat the taxes today. Then you'd pay the taxes later but it is an uncertain future regarding the future of taxation. So it's a half knowledgeable question. You know how much it will cost you today to change and can only make educated guesses how much it will cost you to change in the future. Compare the various scenarios against each other and make the decision which goes best with your plan.

Eric

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Re: Advice for inexperienced investor
« Reply #2 on: July 24, 2014, 12:52:16 PM »
I'll tackle of couple of these for you.

1. I should be investing in Traditional Roth/401k, so I can significantly reduce taxes in early retirement. I plan to withdraw 25-30k/year in retirement, around age 38-40 probably. I'm 27.
You have a few things jumbled up here.  There's a Traditional IRA and a Traditional 401(k).  And then there's a Roth IRA and a Roth 401(k).  The former is all pre-tax money, so contributing to a Traditional IRA or 401(k) reduces your taxable income NOW.  This is important because as you mention, you're making $75K now but will only be making $30K in retirement.  (withdrawing $30K per year)  Therefore, it's advantageous to reduce your current tax bill since you're making more money now.

The Roth IRA/40k(k) is post tax money, so you'll pay no taxes on this money when you sell/withdrawal from your account, because you've already paid them.  However, this is inefficient because your tax bracket will be lower in retirement than it is now.

http://www.madfientist.com/traditional-ira-vs-roth-ira/


3b. Does it even matter if long-term capital gains are sold now and I pay tax on it now, or leave the 2055 fund there and sell it in a decade or two paying the long-term capital gains then? I am really confused on this one. Is there a benefit in delaying long-term capital gains tax? Do you make more money delaying the tax?
There is a benefit to delaying payment for capital gains taxes.  If you're in the 15% tax bracket (or lower), there are no capital gains taxes at all (subject to change, obviously).  Also, if your retirement "income" is low enough, you might not even pay taxes on your pre-tax 401(k)/IRA accounts. 

http://www.gocurrycracker.com/never-pay-taxes-again/

My plan in the next day or two is to create a Vanguard Traditional IRA and transfer $5,500 from cash to the Vanguard Total International Stock Index Fund (VGTSX). I want to make sure I don't make any more obvious investor mistakes.

Good plan!

GGNoob

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Re: Advice for inexperienced investor
« Reply #3 on: July 24, 2014, 01:57:41 PM »
401k account:
(All funds at lowest possible .7% expense ratio. All other possible funds are 1.5% ER or higher. Very bad 401k plan.)
US Large S&P Index fund -   $32,066
US Mid S&P Index fund -     $30,379
US Small S&) Index fund -    $30,665
----------------------------------------------------------
Vanguard:
Roth    IRA
Vanguard Target Retirement 2055 Fund (VFFVX)       -                                    $21,262.06
Vanguard Total International Stock Index Fund Investor Shares (VGTSX) -    $5,933

Taxable (Admiral) Acct   
Vanguard Target Retirement 2055 Fund (VFFVX) -                                            $2,400.00
Vanguard Total International Stock Index Fund Investor Shares (VGTSX) -   $15,088
Vanguard Total Bond Market Index Fund Admiral Shares (VBTLX) -             $11,924

I'm no expert, but I wanted to comment on these...

First the 401k:
It looks like you just split your deposits equally between Large, Mid, and Small Cap funds. I have no idea if that's a bad thing, but I think usually you would have more funds in the Large Cap and less in the Mid and Small. Maybe something like 50/30/20? Just something you may want to look into.

Vanguard IRA:
The Target Retirement 2055 fund already has the Total International Stock Index Fund inside of it. Because your 401k has all US stocks in it, you may want to consider investing in just International Stocks and and US Bonds in your IRA and taxable accounts. Your IRA could hold whatever bonds you want (better for taxes) and then the Total International Stock Index Fund. Do Admiral Shares for both if you can to get lower fees.

Taxable:
This could be 100% the Vanguard Total International Stock Index Fund Admiral Shares. I've heard that holding foreign stocks in your taxable account is good to get a foreign tax credit. I'm sure somebody here could explain why.

Try to look at your accounts as a whole overall to get the right allocation of US Stocks, International Stocks, and Bonds. The books I've read suggest doing a 50/50 split on your stocks for US and International. I'm aiming for an allocation of about 45% US stocks, 45% International stocks, and 10% bonds. You of course can do what you want and I'm sure others here have different opinions. I just wanted to share mine.

Oh and my order of investments would be: IRA (because you set it up and Vanguard and it's cheaper than your 401k), 401k, then taxable with whatever you have left. Whether you do Roth or Traditional is up to you. With your income, you may not be able to get any tax deduction from a Traditional IRA (http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/2014--IRA-Contribution-and-Deduction-Limits---Effect-of-Modified-AGI-on-Deductible-Contributions-If-You-ARE-Covered-by-a-Retirement-Plan-at-Work) unless you max out your Traditional 401k first to lower your MAGI. You could even mix it up with a Traditional 401k and a Roth IRA.
« Last Edit: July 24, 2014, 02:02:30 PM by logant1337 »

Jacob1234098

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Re: Advice for inexperienced investor
« Reply #4 on: July 30, 2014, 10:15:57 AM »
Thank you Logant. You make a very good point about my asset allocation. I probably need to revisit my 33/33/33 small/mid/large approach.

I have actually read that due to foreign tax credits, international stocks are at a tax disadvantage. Also, international stock growth is typically much higher than bonds these days, so I see the tax benefits of putting the international stock fund in my IRA.

I have read between 30-50% international stocks. I probably need to increase this a bit from my current 26%.

THANK YOU for pointing out the income limits on IRA deductions. I had no idea that existed!! It looks like I will fall into the only partially deductible or not deductible at all category: (http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/2014--IRA-Contribution-and-Deduction-Limits---Effect-of-Modified-AGI-on-Deductible-Contributions-If-You-ARE-Covered-by-a-Retirement-Plan-at-Work). Therefore, I will be contributing to my Roth IRA this year (after-tax).

So, in summary, I will:
A. Revisit a different small/mid/large balance, probably 20/30/50.
B. Increase my international stock exposure.
C. Deposit into my Roth IRA this year and purchase the vanguard international stock fund within it.

Thanks everyone. Please let me know if I'm still missing anything.