Author Topic: Mimicking Vanguard LifeStrategy fund with mix of Stock and Cash, for tax efficiency??  (Read 3670 times)

FrugalFisherman10

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I’ve got some money I need to get invested, and I have it in the settlement fund for my taxable/brokerage account at Vanguard (yes, I already have my emergency fund established, and maxed out 401k/HSA/Roth IRA contributions for the year setup, etc.).
This is money I’ve been sitting on, saving up for a house down payment, and I’ve decided I do want to take a little risk with it, as opposed to leave it in the savings account earning nothing.
Here’s my question:
I have decided an asset mix like the one found in the Vanguard LifeStrategy Conservative Growth Fund(VSCGX) would be appropriate for this money given the time horizon, risk tolerance, etc. https://personal.vanguard.com/us/funds/snapshot?FundId=0724&FundIntExt=INT
The asset allocation is shown below.

Ranking
by
Percentage
 
Vanguard Total Bond Market II Index Fund Investor Shares†
42.6%
 
Vanguard Total Stock Market Index Fund Investor Shares
23.7%

Vanguard Total International Bond Index Fund Investor Shares
17.7%

Vanguard Total International Stock Index Fund Investor Shares
16.0%

I’m thinking, since this is a taxable account, couldn’t it be slightly more advantageous from a tax perspective to exclude the Bond funds (and instead just hold that portion of the money in cash)?

I read that "Investments such as high yield bond funds or REITs should go in IRAs, while municipal bonds, other low yielding bonds and non-dividend growth stocks should typically be purchased in taxable accounts.
Some fund types, like total market stock index funds, are extremely tax-efficient, because they produce low dividends (that are mostly qualified) and capital gains. By contrast, bond funds can be extremely tax-inefficient, because the interest they produce every year is taxed at your full marginal tax rate."

First question: How do I determine if the two bond funds mentioned above contain low yield/municipal bonds? i.e. what is considered “Low yield”?

Main/second question: Assuming these are high yield bond funds, would I be better off holding them to try and get any appreciation, while being taxed on any interest they produce, or would I be better off to buy only the total market stock index funds, and keep the rest of the money in cash? (I guess you’d need a crystal ball to answer this, because you don’t know what the bond funds will do?) If in cash, I wouldn’t receive the benefit of any bond appreciation, but I also won’t get taxed on the income the bond is producing.

Here’s how this would work: I’ve got $17k. If I dump it all into the LifeStrategy Conservative Growth fund,  42.6% + 17.7% = 60% of it will be invested in the two bond funds, or $10,200.
40% of it would be held in the two stock market funds, or $6,800.
Instead, I could just hold $10,200 of it in cash, and invest the $6800 in the stock market funds. And continue doing so going forward with that same ‘asset allocation’ for any new money I delegate for my "down payment savings".

Thanks for any input!

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seattlecyclone

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You say you don't want this money to sit in the savings account earning nothing, but then you propose to leave it in cash for tax efficiency? Either invest or don't. It's better to have a gain and pay the tax on it than not have any gain at all.

Auldtriangle8

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What funds are you invested in with your 401k/IRA?

I hold bonds in my 401k up to the total percentage of my total assets I want in bonds, then total stock market with remaining 401k and then just total stock market everywhere else.

If you want bonds, could you just sell the investments in your 401k/IRA, invest in bonds in your 401k/IRA, and then have your brokerage be fully total stock market? Your asset allocation would be the same in the end, but you'd have bonds in tax-advantaged accounts.

Interest Compound

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You're falling into the trap of being afraid to earn money, because it's less "tax efficient" than earning $0.

Stop it.

Radagast

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Low yield bonds are the ones which are pointless to own because they are not as good as CD's. So far as I know, no fund will ever contain tax exempt bonds unless it is named either "tax exempt" or "municipal" and in that case it will only contain tax exempt bonds.

There are tax exempt bond funds. To compare them, find a similar taxable bond fund and subtract the percentage that would be lost to taxes. For example, if you are in the 25% bracket multiply the taxable bond yield by 0.75 to compare with the tax exempt yield. As an approximate list of Vanguard tax exempt to taxable equivalents in terms of risk for 25% taxes:
High Yield Tax Exempt = 0.75 * Intermediate Term Corporate Bond Index
Long Term Tax Exempt = 0.75 * Inter Term Investment Grade Bond Index
Inter Term Tax Exempt = 0.75 * Intermediate Term Bond Index
Limited Term Tax Exempt = 0.75 * Total Bond Index
Short Term Tax Exempt = 0.75 * Short Term Bond Index
Choose the one with the higher yield for your risk tolerance.

Personally I am doing something similar. My bonds will be a 50/50 split between a single date 2027 Treasury STRIPS bond and Vanguard High Yield Tax Exempt (VWAHX). I am also doing a glide path from 100% stocks. As you might have guessed I anticipate buying a house in vaguely the 2027 era. Running the numbers, on our current path we should have enough to pay for a McMansion in cash 8-| .

Helvegen

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You're falling into the trap of being afraid to earn money, because it's less "tax efficient" than earning $0.

Stop it.

+1

As an aside, I find a lot of advice on Bogleheads as far as tax efficiency simply is not applicable or important to someone in my tax bracket. Sometimes even where the advice is applicable to those in higher brackets, you'll find people regretting making investment decisions based solely on taxation - 'letting the tail wag the dog' is a lament you find there without looking too hard for it.

FrugalFisherman10

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What funds are you invested in with your 401k/IRA?

I hold bonds in my 401k up to the total percentage of my total assets I want in bonds, then total stock market with remaining 401k and then just total stock market everywhere else.

If you want bonds, could you just sell the investments in your 401k/IRA, invest in bonds in your 401k/IRA, and then have your brokerage be fully total stock market? Your asset allocation would be the same in the end, but you'd have bonds in tax-advantaged accounts.
Thanks for the comments. Yes I could do that but the key is I'd like relatively quick access to this money for a house down payment..so I consider the taxable/brokerage account a better avenue for that than my 401k or IRA. Im not looking at my whole asset allocation as one big picture. It's like my 401k + IRA make up the  'things I think of in terms of asset allocation' bucket. This is just sideline money.

To answer your question, I'm in Target date 2055 fund with Vanguard in one 401k, and the Invesco Retire Trust 500 index in my other 401k.
In my IRA I'm in VTSAX Admiral shares

FrugalFisherman10

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Low yield bonds are the ones which are pointless to own because they are not as good as CD's. So far as I know, no fund will ever contain tax exempt bonds unless it is named either "tax exempt" or "municipal" and in that case it will only contain tax exempt bonds.

There are tax exempt bond funds. To compare them, find a similar taxable bond fund and subtract the percentage that would be lost to taxes. For example, if you are in the 25% bracket multiply the taxable bond yield by 0.75 to compare with the tax exempt yield. As an approximate list of Vanguard tax exempt to taxable equivalents in terms of risk for 25% taxes:
High Yield Tax Exempt = 0.75 * Intermediate Term Corporate Bond Index
Long Term Tax Exempt = 0.75 * Inter Term Investment Grade Bond Index
Inter Term Tax Exempt = 0.75 * Intermediate Term Bond Index
Limited Term Tax Exempt = 0.75 * Total Bond Index
Short Term Tax Exempt = 0.75 * Short Term Bond Index
Choose the one with the higher yield for your risk tolerance.

Personally I am doing something similar. My bonds will be a 50/50 split between a single date 2027 Treasury STRIPS bond and Vanguard High Yield Tax Exempt (VWAHX). I am also doing a glide path from 100% stocks. As you might have guessed I anticipate buying a house in vaguely the 2027 era. Running the numbers, on our current path we should have enough to pay for a McMansion in cash 8-| .
Well shoot, you've got me confused by saying that low yield bond funds are pointless to own. After further research, I confirmed these are what I think is considered "low yield", so I was planning on going ahead and just buying this mutual fund and being done with it.

After further research to answer my question of what is “low yield” vs. what is “high yield”:
A high-yield bond is a high paying bond with a lower credit rating than investment-grade corporate bonds, Treasury bonds and municipal bonds.

Here’s what Vanguard says about the bonds held in the Lifestrategy Conservative Growth fund:
The fund’s indirect bond holdings are a diversified mix of short-, intermediate- and long-term U.S. government, U.S. agency, and investment-grade U.S. corporate bonds; mortgage-backed and asset-backed securities; and government, agency, corporate, and securitized investment-grade foreign bonds issued in currencies other than the U.S. dollar (but hedged by Vanguard to minimize currency exposures).

This sounds like low yield to me (Except for maybe the mortgage backed and asset backed ones? ), so I thought maybe I’m overcomplicating this and it would indeed make sense to buy this fund in my taxable account

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Radagast

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This sounds like low yield to me (Except for maybe the mortgage backed and asset backed ones? ), so I thought maybe I’m overcomplicating this and it would indeed make sense to buy this fund in my taxable account
No, I am overcomplicating it.

Generally, the opposite of "high yield" is "investment grade," and "low yield" though not generally used is a subset of investment grade. The mortgage backed securities in total bond are probably GNMA's which makes them as safe as treasury bonds (at least in terms of credit quality).

Total bond index ETF is yielding 2.4%, while tax exempt index ETF is yielding 2.28% right now. This may show that tax exempt index is the better buy, especially if your income tax marginal rate is 25% or more. In fact the tax exempt index has a higher yield for all tax rates, but it may tend to be fractionally more volatile which may not make it worth it for the very bottom rate.

FrugalFisherman10

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This sounds like low yield to me (Except for maybe the mortgage backed and asset backed ones? ), so I thought maybe I’m overcomplicating this and it would indeed make sense to buy this fund in my taxable account
No, I am overcomplicating it.

Generally, the opposite of "high yield" is "investment grade," and "low yield" though not generally used is a subset of investment grade. The mortgage backed securities in total bond are probably GNMA's which makes them as safe as treasury bonds (at least in terms of credit quality).

Total bond index ETF is yielding 2.4%, while tax exempt index ETF is yielding 2.28% right now. This may show that tax exempt index is the better buy, especially if your income tax marginal rate is 25% or more. In fact the tax exempt index has a higher yield for all tax rates, but it may tend to be fractionally more volatile which may not make it worth it for the very bottom rate.
Ok thanks - got it.
New question - can you take the interest income that a taxable bond fund is spitting off and immediately reinvesting it to avoid taxes? Or no, and that's (part of) why you'd want to buy the tax exempt bond fund...

I'm starting to wonder why I put this money into my taxable account at all..since I'm expecting to use it for a house, I may have been better off just keeping it in a high yield savings or something getting 1%

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FrugalFisherman10

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I'm starting to wonder why I put this money into my taxable account at all..since I'm expecting to use it for a house, I may have been better off just keeping it in a high yield savings or something getting 1%

Actually no, what am I talking about? Are you saying that I could be earning tax exempt 2.28% interest right now, with little risk? That is way better than the rate a high yield savings account would pay  (like Ally or Capital one).

And, conveniently in terms of market timing although I don't care to try market timing, isn't this somewhat a 'valley' for bond prices?

How "guaranteed" is that interest rate (yield) of 2.28% though?...could it fluctuate quite a bit?

Also, the price of the shares could fluctuate too right? So if they (the gubmint) keep raising interest rates, the price of the tax exempt Bond ETF is likely to go down?
« Last Edit: January 25, 2017, 07:28:05 AM by FrugalFisherman10 »

Radagast

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As usual, the market has already adjusted to reflect the best guesses of every human being who has contemplated investing their own money in these things. As an approximation for the 15% tax rate I would say
- an Ally savings account will yield .85% +/- 0%
- total bond index will yield 2% +/- 3%
- tax exempt bond ETF will yield 2.25% +/- 3.5%
If my time was longer than two years and my tax rate was 15% I'd maybe choose tax exempt bonds. At 25% tax rate I'd definitely take tax exempt for two years or more.

FrugalFisherman10

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As usual, the market has already adjusted to reflect the best guesses of every human being who has contemplated investing their own money in these things. As an approximation for the 15% tax rate I would say
- an Ally savings account will yield .85% +/- 0%
- total bond index will yield 2% +/- 3%
- tax exempt bond ETF will yield 2.25% +/- 3.5%
If my time was longer than two years and my tax rate was 15% I'd maybe choose tax exempt bonds. At 25% tax rate I'd definitely take tax exempt for two years or more.
And if time horizon was less than two years, definitely the Ally?   //facepunch..I'm realizing I got all overzealous about return with this money, and now I'm feeling more conservative. Afterall,  you don't want the money to be exposed to the market and have the market tank right when you "need it" to buy a house right..

If and when I buy, I would love to buy a "live in flip" or "live in duplex"

FrugalFisherman10

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As usual, the market has already adjusted to reflect the best guesses of every human being who has contemplated investing their own money in these things. As an approximation for the 15% tax rate I would say
- an Ally savings account will yield .85% +/- 0%
- total bond index will yield 2% +/- 3%
- tax exempt bond ETF will yield 2.25% +/- 3.5%
If my time was longer than two years and my tax rate was 15% I'd maybe choose tax exempt bonds. At 25% tax rate I'd definitely take tax exempt for two years or more.
Also, when you say Tax Exempt bond ETF will yield 2.25% +/- 3.5%, where are you getting that "standard deviation" of sorts? Is that based off your knowledge, experience, or can I look it up for myself somehow to try and understand it?
Also, if it were to go to the 'extreme' negative of the deviation you cite there, would that mean 2.25 - 3.5 = -1.25% yield right?

Radagast

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As usual, the market has already adjusted to reflect the best guesses of every human being who has contemplated investing their own money in these things. As an approximation for the 15% tax rate I would say
- an Ally savings account will yield .85% +/- 0%
- total bond index will yield 2% +/- 3%
- tax exempt bond ETF will yield 2.25% +/- 3.5%
If my time was longer than two years and my tax rate was 15% I'd maybe choose tax exempt bonds. At 25% tax rate I'd definitely take tax exempt for two years or more.
Also, when you say Tax Exempt bond ETF will yield 2.25% +/- 3.5%, where are you getting that "standard deviation" of sorts? Is that based off your knowledge, experience, or can I look it up for myself somehow to try and understand it?
Also, if it were to go to the 'extreme' negative of the deviation you cite there, would that mean 2.25 - 3.5 = -1.25% yield right?
If you can't tolerate even the possibility of a small loss, then a high yield savings account is better.

I don't know which time period I looked at for those numbers, or more likely I guessed. You can type in two or more funds here and see annualized standard deviation.
https://www.portfoliovisualizer.com/asset-correlations

You are correct that bond funds can and sometimes do have negative returns even after a few years.