Sunday, February 16, 2014

Tax Efficient Portfolio Help

Over at Bogleheads we came across the following discussion: Tax Efficient Portfolio Help
11 posts • Page 1 of 1

Tax Efficient Portfolio Helpby pacificredhawk » Fri Feb 14, 2014 

7:39 pm

Hi everyone,


Need some serious help with my portfolio. I believe I can be much more tax efficient in my current situation. Here is my situation:


I take home about 20K, before taxes, each month. This is non-earned income and does not qualify for an investment account (trust me, I've talked to some great professionals about it). It is reported to the IRS through a 1099.


I am open to any ideas of how I can change my portfolio to be more tax efficient. I have been looking at these Vanguard funds lately (they are tax managed).


Vanguard Tax-Managed International Fund Admiral Shares (VTMGX)
Vanguard Tax-Managed Capital Appreciation Fund Admiral Shares (VTCLX)
Vanguard Tax-Managed Small-Cap Fund Admiral Shares (VTMSX)


I am at a 33% tax bracket federally. Texas has no income tax.


Here is my current portfolio:


VEMAX
Vanguard Emerging Markets Stock Index Fund Admiral Shares
$52,924.96


VWIUX
Vanguard Intermediate-Term Tax-Exempt Fund Admiral Shares
$55,698.41


VMVAX
Vanguard Mid-Cap Value Index Fund Admiral
$91,801.24


VSIAX
Vanguard Small-Cap Value Index Fund Admiral
$91,733.27


VTIAX
Vanguard Total International Stock Index Fund Admiral Shares
$60,634.36


VVIAX
Vanguard Value Index Fund Admiral Shares
$89,675.29


Thanks everyone!
Posts: 3
Joined: 14 Feb 2014

Re: Tax Efficient Portfolio Helpby grabiner » Fri Feb 14, 2014 9:10 pm

Welcome to the forum!


pacificredhawk wrote:I have been looking at these Vanguard funds lately (they are tax managed).


Vanguard Tax-Managed International Fund Admiral Shares (VTMGX)
Vanguard Tax-Managed Capital Appreciation Fund Admiral Shares (VTCLX)
Vanguard Tax-Managed Small-Cap Fund Admiral Shares (VTMSX)


I am at a 33% tax bracket federally. Texas has no income tax.



Wiki article link: Tax-managed fund comparison


Tax-Managed International is going away; the most tax-efficient way to hold international is likely with Total International. (You can choose to overweight emerging markets and hold Emerging Markets Index separately, which it appears that you do.)


80% Tax-Managed Capital Appreciation and 20% Tax-Managed Small-Cap is approximately equivalent to Total Stock Market, but the tax savings are about equal to the extra expenses.


VEMAX
Vanguard Emerging Markets Stock Index Fund Admiral Shares
$52,924.96
VWIUX
Vanguard Intermediate-Term Tax-Exempt Fund Admiral Shares
$55,698.41
VTIAX
Vanguard Total International Stock Index Fund Admiral Shares
$60,634.36



These three are excellent, if they fit your asset allocation. (In particular, you seem to have only 10% bonds; I would recommend raising that to 20% unless you already know how you will react to a bear market because you had a stock-heavy portfolio in 2007-2009.)


VMVAX
Vanguard Mid-Cap Value Index Fund Admiral
$91,801.24
VSIAX
Vanguard Small-Cap Value Index Fund Admiral
$91,733.27
VVIAX
Vanguard Value Index Fund Admiral Shares
$89,675.29


These three are somewhat less tax-efficient, because value stocks pay higher dividends. In addition, Mid-Cap Value overlaps Value Index; the CRSP large-cap indexes include the mid-cap indexes.


But they aren't wrong, as long as you are deliberately overweighting small-cap and value stocks; it's fine to pay a small tax cost to get the portfolio right. I would still advise against 100% value; your additional investments should be in blend funds such as Total Stock Market.


All of the funds that you have are good enough in a taxable account that you shouldn't sell them for a significant gain to restructure your portfolio. If you want to get rid of your value overweight, keep the value funds that you have (or use them for charitable contributions later) and buy growth index funds to balance them out.


I would probably do something like what you are doing if my portfolio were 100% taxable. Since mine is about half tax-deferred, I can hold bonds in my employer plan and value stocks in my Roth IRA, so I don't need to hold either in my taxable account. I would like to overweight value a bit more, but I don't believe the benefit is worth the extra tax cost. David Grabiner
Advisory Board
Posts: 11783
Joined: 21 Feb 2007
Location: Columbia, MD

Re: Tax Efficient Portfolio Helpby BolderBoy » Fri Feb 14, 2014 

10:54 pm

pacificredhawk wrote:I take home about 20K, before taxes, each month. This is non-earned income and does not qualify for an investment account (trust me, I've talked to some great professionals about it). It is reported to the IRS through a 1099.


Pardon my ignorance, but what does this mean? Are you prohibited from investing this money in any way? Is there a law with your name on it that prohibits same?


Maybe you mean you cannot use it to invest in retirement-type accounts?


I can - and have - taken non-earned (you mean unearned?) income, such as interest on a savings account and used it to buy more mutual fund shares in a taxable account. Why can't you?
Posts: 723
Joined: 7 Apr 2010
Location: Colorado

Re: Tax Efficient Portfolio Helpby abuss368 » Fri Feb 14, 2014 

11:01 pm

I would consider a very simple and effective Three Fund Portfolio. There is an excellent (and log) thread on the forum with the title of the same name.


* Total Stock Market
* Total International Market
* Intermediate Term Tax Exempt (in place of Total Bond Market)


There are so many positives and advantages to this portfolio.
John C. Bogle: "You simply do not need to put your money into 8 different mutual funds!" | | Disclosure: Three Fund Portfolio + REITs
Posts: 4889
Joined: 3 Aug 2009
Location: On the Beach

Re: Tax Efficient Portfolio Helpby Laura » Fri Feb 14, 2014 11:07 

pm

The IRS requires "earned income" or "qualified income" before someone can use retirement accounts. There is a very specific meaning to this phrase. The OP apparently has zero "earned income" but has $20k of cash inflow each month. So, they are unable to use retirement accounts but can use a taxable account for investing. You can find more information on fairmark.com


Laura
Posts: 6338
Joined: 19 Feb 2007

Re: Tax Efficient Portfolio Helpby pacificredhawk » Fri Feb 14, 

2014 11:15 pm

Thanks for your replies, everyone.


I agree that I need to stay away from high dividend stocks, since they force me to take a tax hit. Instead, I want higher appreciation, so that I don't have to get hit with taxes until I sell and realize a gain (if any). I kind of shy away from Total Stock Index because the market seems super overvalued. All I can think about when I see the market and the effect that QE is having on it is...bubble!


And, the non-earned income is from a source I would rather not disclose. Nothing illegal about it at all (heck, I play all my taxes on it). Just for reference sake though, trust me when I say I cannot open an IRA or any other traditional retirement account with it. And, I'm not hot about annuities.


Keep the recommendations coming!
Posts: 3
Joined: 14 Feb 2014

Re: Tax Efficient Portfolio Helpby Laura » Fri Feb 14, 2014 11:18 

pm

If you are investing for the long term then the value today doesn't matter. If you are planning to need the money in 20, 30, 40 years will the market be higher then than today? If the answer is no then I suggest not investing at all. If the answer is yes then the value today isn't too high. If this is a bubble then you can tax loss harvest when it bursts. If it isn't a bubble, being in the market means you win. There is no way to time this. The Callan Table just shows that it is impossible to know what is going up next. And the Total Stock Market just invests in the US market. You have other money in exactly the same holdings but in funds with different names in your portfolio today. Market timing doesn't work.


Laura
Posts: 6338
Joined: 19 Feb 2007

Re: Tax Efficient Portfolio Helpby pacificredhawk » Fri Feb 14, 

2014 11:19 pm

grabiner wrote:Welcome to the forum!


pacificredhawk wrote:I have been looking at these Vanguard funds lately (they are tax managed).


Vanguard Tax-Managed International Fund Admiral Shares (VTMGX)
Vanguard Tax-Managed Capital Appreciation Fund Admiral Shares (VTCLX)
Vanguard Tax-Managed Small-Cap Fund Admiral Shares (VTMSX)


I am at a 33% tax bracket federally. Texas has no income tax.



Wiki article link: Tax-managed fund comparison


Tax-Managed International is going away; the most tax-efficient way to hold international is likely with Total International. (You can choose to overweight emerging markets and hold Emerging Markets Index separately, which it appears that you do.)


80% Tax-Managed Capital Appreciation and 20% Tax-Managed Small-Cap is approximately equivalent to Total Stock Market, but the tax savings are about equal to the extra expenses.


VEMAX
Vanguard Emerging Markets Stock Index Fund Admiral Shares
$52,924.96
VWIUX
Vanguard Intermediate-Term Tax-Exempt Fund Admiral Shares
$55,698.41
VTIAX
Vanguard Total International Stock Index Fund Admiral Shares
$60,634.36



These three are excellent, if they fit your asset allocation. (In particular, you seem to have only 10% bonds; I would recommend raising that to 20% unless you already know how you will react to a bear market because you had a stock-heavy portfolio in 2007-2009.)


VMVAX
Vanguard Mid-Cap Value Index Fund Admiral
$91,801.24
VSIAX
Vanguard Small-Cap Value Index Fund Admiral
$91,733.27
VVIAX
Vanguard Value Index Fund Admiral Shares
$89,675.29


These three are somewhat less tax-efficient, because value stocks pay higher dividends. In addition, Mid-Cap Value overlaps Value Index; the CRSP large-cap indexes include the mid-cap indexes.


But they aren't wrong, as long as you are deliberately overweighting small-cap and value stocks; it's fine to pay a small tax cost to get the portfolio right. I would still advise against 100% value; your additional investments should be in blend funds such as Total Stock Market.


All of the funds that you have are good enough in a taxable account that you shouldn't sell them for a significant gain to restructure your portfolio. If you want to get rid of your value overweight, keep the value funds that you have (or use them for charitable contributions later) and buy growth index funds to balance them out.


I would probably do something like what you are doing if my portfolio were 100% taxable. Since mine is about half tax-deferred, I can hold bonds in my employer plan and value stocks in my Roth IRA, so I don't need to hold either in my taxable account. I would like to overweight value a bit more, but I don't believe the benefit is worth the extra tax cost.



Can you give me some good Vanguard Admiral share funds that focus on capital appreciation, rather that dividend payout?
Posts: 3
Joined: 14 Feb 2014

Re: Tax Efficient Portfolio Helpby BolderBoy » Sat Feb 15, 2014 

12:22 am

pacificredhawk wrote:I take home about 20K, before taxes, each month. This is non-earned income and does not qualify for an investment account...


This is why I challenged you. It most certainly CAN be used for an "investment account", just not for a retirement account. Words matter.


A simple, three-fund, taxable account portfolio would suit you fine.
Posts: 723
Joined: 7 Apr 2010
Location: Colorado

Re: Tax Efficient Portfolio Helpby Mazz » Sat Feb 15, 2014 12:25 

am

ETFs are most tax efficient vehicle. No cap gains distributions. For the kind of funds your looking at, tHere are plenty of ETF options.
Posts: 70
Joined: 19 Oct 2010

Re: Tax Efficient Portfolio Helpby grabiner » Sat Feb 15, 2014 5:08 pm

pacificredhawk wrote:Can you give me some good Vanguard Admiral share funds that focus on capital appreciation, rather that dividend payout?



Almost all stock funds (exceptions: REITs and high-dividend funds) are expected to get most of their return from capital appreciation. Value stocks pay more dividends than growth stocks, so they aren't quite as tax-efficient, but as long as they are held in an ETF or an index with an ETF class, the tax bill won't be that great. You have to decide whether you want to overweight value or not, paying a small tax cost for the possible benefit that value stocks have historically had higher returns.


Tax-Managed Capital Appreciation would be the fund you are looking for, as it is a blend fund which specifically selects stocks for lower dividend yields. However, with the 15% tax rate on qualified dividends, the yield difference isn't really worth it. Total Stock Market should have about the same after-tax return as the similar allocation of 80% TM Capital Appreciation and 20% TM Small-Cap, because Total Stock Market saves as much in lower expenses as it costs in extra taxes.


But before you focus on minimizing taxes, you need to have a target asset allocation; the small amount you lose to taxes is less important to your finances than the potential gains or losses from your stock portfolio. Your current portfolio looks like about 12% bonds, 24% international, 64% US stock, which is very aggressive; is this right for you? David Grabiner
Advisory Board
Posts: 11783
Joined: 21 Feb 2007

Location: Columbia, MD

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