Author Topic: Making taxable investments in light of tax-deferred portfolio  (Read 2575 times)

Freedom2016

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Hi everyone,

I've spent the last couple of days buried in Bogleheads, jlcollinsnh, the Vanguard site, and combing this forum, so I hope my questions are semi-intelligent.

DH and I are 42 and 40, w/ a 2-year old and one on the way. We have something like a 10-15 year investment horizon before ER (depending on how my business performs in the coming years). We will max retirement accounts this year, and for the first time be in a position to begin making taxable investments (yay!). We also have a $20k emergency fund, and a 529 with $6700 in it, in a Vanguard target date fund.

Our retirement portfolio is allocated as follows: 81% equities / 14% bonds / 5% cash. It is actively managed at Merrill Lynch (I know - we were very financially illiterate when we hired our adviser, and to her credit she has been very helpful on the financial planning side of things...but, yeah). She's got us in a Global Aggressive portfolio.

Re taxable accounts we're (obviously?) looking @ Vanguard. I am pretty sure we want to invest in mutual funds and not ETF's (though happy to be convinced otherwise). Vanguard spat out two different allocation recommendations when I answered questions slightly differently on their site:

Option 1 (Moderate)
49% VTSMX
21% VGTSX
24% VBMFX
6% VTIBX

Option 2 (Aggressive) (LifeStrategy Growth)
VASGX which is allocated as:
56% Stock
24% Int'l Stock
16% Bond
4% Int'l Bond

I understand that bonds are not tax efficient and are better held in tax-advantaged accounts. Let's assume for the time being that we're not ready to fire our adviser and so our ML portfolio is going to stay as-is (i.e. not modified to throw more bonds into it). Another conversation for another time.

Questions:

(1) Should we avoid bonds entirely in our taxable accounts? Or is the tax hit going to be fairly minimal given small bond returns and bonds remain a useful diversification tool even in taxable accounts? (If it matters, we're in the 39% tax bracket this year, though usually 28%)

(2) If "yes" to keeping some bonds in the taxable accounts, what percentage? Option 1 has 30% bonds; Option 2 has 20% bonds. Is even 20% too much?

(3) It looks like the benefit of VASGX over the four separate funds is that it automatically rebalances - that is a plus for us. Its fees are 0.17 which is the same as VTSMX and lower than the other 3 funds in Option 1. Are there any other differences between VASGX vs. 4 separate funds that I should be aware of?

(4) Finally, should we consider REIT's in our taxable accounts? If I understand correctly they're tax-inefficient so I hadn't given them much thought.

Thanks so much for any input you can provide. I already feel more empowered just by having invested a few hours in reading all these websites - hopefully I'm asking the "right" questions and if not, I look forward to being set straight. :)
« Last Edit: April 22, 2014, 12:01:58 AM by course11 »

innerscorecard

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Re: Making taxable investments in light of tax-deferred portfolio
« Reply #1 on: April 22, 2014, 01:33:14 AM »
The downside of VASGX over individual index funds/ETFs (besides slightly higher expenses) is that you can't slice and dice assets for the most tax-efficient asset placement.

Since your earned income tax bracket is so high I would definitely avoid bonds in taxable accounts as much as possible. You're basically losing 39%+ of that bond income to the tax man as ordinary income! That really, really sucks. It's not as bad with stocks since more of the gains in stocks are not paid out and are retained (so are thus inherently tax-deferred).

I know your advisor may be a nice person. But since you've started self-educating, you really have no more need for them. Have you seen the Wolf of Wall Street? The movie was about penny stocks, not all of the financial industry, but the line about the goal of the financial industry being to transfer as much money from your pockets to theirs is totally true.

They are your enemies and are out to get you. That's just the way the incentives are set up. Any fees you pay for active management will be a huge drag on your performance.  Either you get the money or they do. You're not a charity, and even if you were, there are better places to give your money than to financial firms.

skyrefuge

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Re: Making taxable investments in light of tax-deferred portfolio
« Reply #2 on: April 22, 2014, 08:52:31 AM »
It really bothers me when people answer a question and immediately ignore one of the constraints given by the question-asker, but I'm afraid I'm going to have to bother myself here.

You really need to at least talk to your ML adviser.

The optimal way to design an investment portfolio is to first determine your desired asset allocation as if all your money was in a single giant account, and THEN you decide which investments to hold in which accounts (tax-sheltered vs. taxable), based on their tax-efficiency.

By declaring your retirement accounts an immutable part of the overall picture, you're unnecessarily tying your hands behind your back (especially since one of the big advantages of retirement accounts is the ability to shift your allocation around without costs!)

I mean, holy crap, even if you're too scared or whatever to claim all your money back from your adviser, for all the money you're paying her (implicitly or explicitly) it seems like the least she could freakin' do is take your information about investments you hold outside of her control, and adjust your allocation among the investments she does control in order to keep your total portfolio in line with your desired allocation. If she can't even do that, that would be like paying a doctor who can't even diagnose and illness or prescribe treatments.

So I say put all your taxable money into something tax-efficient like VTSAX, and then, at a minimum, tell your adviser to adjust the allocation in your retirement accounts accordingly. Ideally, you would take all of your money back from your adviser and do the adjustments yourself, after deciding what you truly want your overall asset allocation to be (your post suggests you haven't actually done this important first step for yourself, and instead are just taking whatever an adviser/Vanguard tool spits out at you). It's hard to say, but it's possible that the fees you're paying to ML could be a greater detriment to your early retirement plans than any tax-efficiency issues, and if so, it would be silly to care about the latter while completely ignoring the former.

Freedom2016

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Re: Making taxable investments in light of tax-deferred portfolio
« Reply #3 on: April 22, 2014, 05:14:13 PM »
Thanks for the replies. Agree with you skyrefuge about talking with our ML adviser. I also have much to discuss with DH -- I've been holed up reading financial websites all weekend while he was out of town with our toddler. So, first we need to be sure we're on the same page with each other, then tackle the discussion with the adviser. :)

Joel

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Re: Making taxable investments in light of tax-deferred portfolio
« Reply #4 on: April 22, 2014, 09:25:07 PM »
The best bet is definitely to think of your asset allocation as a whole. Meaning bonds should be in tax-deferred accounts and international stocks in your taxable accounts. Modify and adjust as necessary. And ditch the active manager and buy index funds.