Over at Bogleheads we read: Tax-Efficiency and Introduction
5 posts • Page 1 of 1
Tax-Efficiency and Introduction
by ShimmyShuffle » Thu Jan 02, 2014 5:05 pm
Hi Everyone,
I'm a total noob, and before a few weeks ago never even considered investing my money in the stock market. After lurking for a while and reading all of the wonderfully honest and simple advice here I decided to go all in. I'm currently perplexed as to how I should go about contributing to my current investments from here on out. I'm 31 and just lump summed my savings into some Vanguard funds. Breakdown below along with some other pertinent info about myself:
22k VTSAX Vanguard Total Stock Market Index Fund Admiral Shares (personal taxable account)
3k VBMFX Vanguard Total Bond Fund (personal taxable account)
11k Target Retirement 2050 Fund (personal Roth IRA maxed for 2013 and 2014)
4,774 Target Retirement 2050 Fund (401k with no match and started in March 2013)
10k approximately in Emergency Fund (estimated 5 months expenses), but I'm going to be renting a new apartment soon and it will likely be cut in half. My job is stable, so I'm confident I will be able to replenish soon enough.
Single, 31, no debt, 55k/year base salary (made over 60k with bonuses and overtime and I will probably get a raise of a few grand next week). I figure after all my monthly expenses I would be left with close to about 800-1000 dollars to invest most months. This is after factoring in the 200/month I currently contribute to the 401k.
I'd like to always max out my Roth and obviously step up contributions to the 401k, but my mind seems to focus on the non-retirement account. Does anyone think I'm making a big mistake by not getting as close as possible to maxing out the 401k? Depending on my raise... I'm thinking the max I would want to contribute each month is 600. That, I'm hoping, would leave me enough room to save for the Roth max and keep my taxable account growing nicely. Also, am I looking at any serious tax costs with my taxable accounts, especially considering the Total Bond Fund is in there?
I'd like to thank in advance all the helpful members of this forum for providing me with so much great information in so short a time. Any help or advice for my particular situation would be greatly appreciated. I look forward to continuing to learn from all the great info provided by this amazing community.
Posts: 4
Joined: 2 Jan 2014
Re: Tax-Efficiency and Introduction
by Peter Foley » Thu Jan 02, 2014 5:44 pm
First welsome - you are off to a good start just by living below your means. Having no debt at your age is a real plus. As to your question . . .
$36,250 in taxable income is the top of the 15% bracket. Unless you have some big deductions you are solidly into the 25% bracket. I would be inclined to save more in a 401k. Look at it this way, your are only funding 75% of what you put in, plus it gets to compound tax free. It is the best place to hold your bond fund. While there has been some debate due to low interest rates, taxable is not the best place to hold bonds if low cost options are available elsewhere. Is this a big mistake? No. You could just be investing a little more tax efficiently.
Posts: 1768
Joined: 23 Nov 2007
Location: Lake Wobegon
Re: Tax-Efficiency and Introduction
by Laura » Thu Jan 02, 2014 9:44 pm
Welcome to the forum,
You are doing well by savings and investing but I think we can make a few adjustments to your holdings.
The general rule of thumb for investing priority is:
1. 401k to receive the full match (are you here yet?)
2. Max out Roth (you seem to be doing this)
3. Max out 401k contributions
4. Taxable investing
You skipped step 3 and went right to step 4. You want to change that and still can. For now, I suggest you max out 401k contributions and use that money you just invested in taxable for your living expenses. You won't have much tax to pay since there probably isn't much gain there yet. That allows you to "transfer" money from taxable into your 401k. Once you have that done you can reduce your 401k contributions again to the amount you can afford. Hopefully that means maximizing 401k contributions but perhaps you will just be close.
Another way to improve your portfolio is to focus on tax efficiency. You placed Total Bond Market in your taxable account. This fund generates dividends which are taxed at your normal income tax rate. It is normally best to hold bonds in a tax advantaged 401k if you have a decent bond option in your plan.
For someone who is new to investing you also invested in the Target Retirement funds that holds 90% in stocks and only 10% in bonds. That is very aggressive and you can expect some big losses when the market declines. Are you able to watch the value of your portfolio decline like without wanting to bail out? You may want to select a fund that is more conservative, perhaps something like 70/30 as a starting point.
22k VTSAX Vanguard Total Stock Market Index Fund Admiral Shares (personal taxable account) Fine choice for a taxable account
3k VBMFX Vanguard Total Bond Fund (personal taxable account) Best not held in a taxable account
11k Target Retirement 2050 Fund (personal Roth IRA maxed for 2013 and 2014) FIne for roth
4,774 Target Retirement 2050 Fund (401k with no match and started in March 2013) Fine for 401k
What other funds do you have available in your 401k? Any other Vanguard index funds? What are the expense ratios?
Don't get discouraged by all my questions. You are doing well but I think with a few modifications we can set you up to have a low cost, tax efficient, broadly diversified portfolio that is very easy to manage.
Laura
Posts: 5548
Joined: 19 Feb 2007
Re: Tax-Efficiency and Introduction
by ShimmyShuffle » Fri Jan 03, 2014 1:11 pm
Peter Foley wrote:First welsome - you are off to a good start just by living below your means. Having no debt at your age is a real plus. As to your question . . .
$36,250 in taxable income is the top of the 15% bracket. Unless you have some big deductions you are solidly into the 25% bracket. I would be inclined to save more in a 401k. Look at it this way, your are only funding 75% of what you put in, plus it gets to compound tax free. It is the best place to hold your bond fund. While there has been some debate due to low interest rates, taxable is not the best place to hold bonds if low cost options are available elsewhere. Is this a big mistake? No. You could just be investing a little more tax efficiently.
Thanks Peter. The lack of debt is from being a total slacker in life and not bothering to even establish any credit until I was about 29 
Gladly, I've taken care of that since then and now have a respectable credit score.
Gladly, I've taken care of that since then and now have a respectable credit score.
I live in NY, so my taxes kill me when it comes to available money left over to invest. I'm definitely going to be bumping up the 401k contributions this year, and hopefully will still have enough to max out the Roth and have something left to put towards my taxable account. I'd like that to grow over the next 5,10, maybe 15 years or more and have a nice amount of money to either buy a house or maybe invest in a business with. I may just exchange the bond fund in the taxable for more of the Total Stock Market fund. My entire portfolio would be heavily tilted towards stocks, but I don't mind. I honestly feel I'm fully prepared to take the risk and ride out the ups and downs, and I'd be a bit more tax efficient.
Posts: 4
Joined: 2 Jan 2014
Re: Tax-Efficiency and Introduction
by ShimmyShuffle » Fri Jan 03, 2014 3:38 pm
Laura wrote:Welcome to the forum,
You are doing well by savings and investing but I think we can make a few adjustments to your holdings.
The general rule of thumb for investing priority is:
1. 401k to receive the full match (are you here yet?)
2. Max out Roth (you seem to be doing this)
3. Max out 401k contributions
4. Taxable investing
You skipped step 3 and went right to step 4. You want to change that and still can. For now, I suggest you max out 401k contributions and use that money you just invested in taxable for your living expenses. You won't have much tax to pay since there probably isn't much gain there yet. That allows you to "transfer" money from taxable into your 401k. Once you have that done you can reduce your 401k contributions again to the amount you can afford. Hopefully that means maximizing 401k contributions but perhaps you will just be close.
Another way to improve your portfolio is to focus on tax efficiency. You placed Total Bond Market in your taxable account. This fund generates dividends which are taxed at your normal income tax rate. It is normally best to hold bonds in a tax advantaged 401k if you have a decent bond option in your plan.
For someone who is new to investing you also invested in the Target Retirement funds that holds 90% in stocks and only 10% in bonds. That is very aggressive and you can expect some big losses when the market declines. Are you able to watch the value of your portfolio decline like without wanting to bail out? You may want to select a fund that is more conservative, perhaps something like 70/30 as a starting point.
22k VTSAX Vanguard Total Stock Market Index Fund Admiral Shares (personal taxable account) Fine choice for a taxable account
3k VBMFX Vanguard Total Bond Fund (personal taxable account) Best not held in a taxable account
11k Target Retirement 2050 Fund (personal Roth IRA maxed for 2013 and 2014) FIne for roth
4,774 Target Retirement 2050 Fund (401k with no match and started in March 2013) Fine for 401k
What other funds do you have available in your 401k? Any other Vanguard index funds? What are the expense ratios?
Don't get discouraged by all my questions. You are doing well but I think with a few modifications we can set you up to have a low cost, tax efficient, broadly diversified portfolio that is very easy to manage.
Laura
Thanks very much for taking the time to respond, Laura.
You bring up some interesting points about "transferring" money from the taxable to the 401k. I will need to seriously mull that over. I think my apprehension hinges on two things: I feel safer with the taxable account holding the majority of the savings I just invested because I can withdraw it at any time. I would love to be able to buy a property or maybe invest in a business someday with that. I've done enough homework to know that things will rise and fall, and I can't expect to buy a home in a few years. I do hope, though, that after a substantial amount of time that investment will have grown and given me some readily available options (if the markets allow 
).
).
Also, I think it's hard to wrap my mind around the tax benefits of the 401k. I do believe it's a misconception on my part, but knowing I will be taxed on that money when I eventually withdraw it in retirement causes me to lose enthusiasm. I have trouble fully understanding the benefits of the tax-deferral. I'm literally weeks into reading about investing, though, so I hope to gain a clearer understanding of it over time. Also, my employer does not match and to max it out, I would probably have very little left over to live on let alone invest with if i maxed. I have some personal changes coming up soon, though, so I hope to be able to have an increased budget.
I was considering just buying more of the total stock market with the bond fund money for better tax efficiency. I know that leaves me heavily invested in stocks overall, but I'm confident I will not sell when things drop. I have the time and patience to ride things out.
As far as the available 401k funds go, I don't have any the standard popular ones such as Total U.S. Stock or Bonds. It's primarily the Target funds with some other actively managed funds, and a few passively managed ones, that I wouldn't feel too confident about. They're all Vanguard, though. Do you think I should be looking to move into something other than the Target funds even if I'm OK with the risk?
0 comments:
Post a Comment