Strategy and tactics for auto-pilot investing

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Strategy and tactics for auto-pilot investing

Postby frylock » Thu Jul 25, 2013 12:02 am

Hi everyone,

First of all, thank you for all the great information in this forum. I'm a novice investor and this forum usually answers all my questions :)

I'm looking to do independent (taxed) investments. I can generally put ~$2K aside every month, and also I have more lumpy sums coming in couple of times a year (employee stock options vesting, bonuses) -- considerably more than what I put aside totally throughout the year. I have questions both on strategy and tactics and I would love to get a sanity check here as well.

Strategy
In my ideal world I would get all my compensation spread out equally throughout all my paychecks, and would invest in one "balanced every security ever" index for every paycheck. But, my paydays are lumpy and there is no one perfect index. The latter is relatively easily solved -- invest in a mix of US stock (VTSAX or similar), Int'l stock (VTIAX or similar), and US bonds (VBTLX or similar), so I would like to ultimately hold only three securities.

The first is a bit harder. For the sake of the example, let's say I get $48K once a year as a lump sum, on top of the $2K I save every month. I'm a big fan of dollar-cost-averaging, so I plan to just let the $48K go to my bank, and invest $48K/12 + $2K = $6K every month (or $3K twice a month). The upside is that I have my peace of mind, the downside is that I'm losing $48K * six months of interest, which should be $1K-$2K with historical averages.

Last, I've been burned in the past with timing-the-market psychology so I really really want to make sure that investments are automated.

Tactics
I have two main questions here: brokerage firm and the kind of funds I use to track the index (ETF vs MF).

ETF vs MF: I'm generally leery about mutual funds, but I now find there are pretty good no-load mutual funds with expense ratios competitive with ETFs (especially if you qualify for "admiral shares"), and that there are no tax implications because of the way that Vanguard sets up the funds. In addition, even though I would buy no-commission ETFs, there's the bid-ask spread, and potential of being at a premium or discount of the tracked assets at the time of purchase. Also it just seems harder to set up automatic buys for ETFs. So even though I was initially leaning towards ETFs I'm now leaning towards MFs.

Brokerage firm: I narrowed it down to Vanguard and TD Ameritrade. I will only buy securities that are 0-commission, so it's either having the option of all Vanguard MFs / ETFs (within Vanguard), OR having TD Ameritrade with 100+ "select" ETFs at no commission (http://research.tdameritrade.com/grid/p ... onfree.asp -- including some Vanguard ETFs) or their no commission MFs (https://research.tdameritrade.com/grid/ ... p?tab=ntfs -- not including Vanguard MFs).

I guess ultimately my questions are:
(1) Does the strategy make sense? Is the dollar cost averaging plan a little excessive/paranoid?
(2) How well do the no-fee securities of TD Ameritrade stack up against these of Vanguard? Particularly, are there any good no-load, low-expense MFs that you recognize in the TD Ameritrade link? And how well does each handle automatic buys?
(3) Mutual funds vs ETFs -- are there any considerations that I've missed? Which of these would you use for $2K-$3K of automatic investment twice a month, spread across three indexes?
(4) Any other considerations I've missed in general?

Thanks!
Last edited by frylock on Thu Jul 25, 2013 9:24 pm, edited 1 time in total.
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Re: strategy and tactics for auto-pilot investing

Postby Duckie » Thu Jul 25, 2013 7:14 pm

frylock wrote:(4) Any other considerations I've missed in general?

If you need to put bonds in taxable (because you've run out of room in tax-sheltered) then taxable bonds (VBTLX or similar) are not a good idea. You'd be better off buying 
I Savings Bonds through Treasury Direct up to the limit and then using a muni fund like (VWITX) Vanguard Intermediate-Term Tax-Exempt Fund Investor Shares (0.20%) and/or a state-specific fund.
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Re: strategy and tactics for auto-pilot investing

Postby frylock » Thu Jul 25, 2013 9:19 pm

Duckie wrote:If you need to put bonds in taxable (because you've run out of room in tax-sheltered) then taxable bonds (VBTLX or similar) are not a good idea. You'd be better off buying 
I Savings Bonds through Treasury Direct up to the limit and then using a muni fund like (VWITX) Vanguard Intermediate-Term Tax-Exempt Fund Investor Shares (0.20%) and/or a state-specific fund.


That's interesting -- actually my 401(k) is with Target 20XX Retirement so I in fact, according to the conventional wisdom that bonds should be put in tax-deferred account, I should probably divert some of *that* to VBTLX, and make the taxable account purely stock-based.

However, one challenge to that: even though the capital gains on the stocks are not taxed, they will be taxed upon gain harvesting. Since on average these will gain more than the bonds, wouldn't I ultimately be paying more in taxes?

For the sake of example I assumed 40% tax rate, that bonds are yielding 2.5% annually and stocks 5%. Over 30 years:
>>> t = 0.4
>>> b = 1.025
>>> s = 1.05
>>> y = 30
>>> b**y - (1+((b-1))*(1-t))**y # total tax paid for bonds, per dollar invested (paid yearly on the interest)
0.5344873585909344
>>> (s**y-1)*t # total tax paid for stocks, per dollar invested (paid once at the end of 30 years)
1.3287769500602673

What am I missing here?
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Re: Strategy and tactics for auto-pilot investing

Postby livesoft » Fri Jul 26, 2013 12:08 am

I think gain harvesting would only be done if one could do it at a tax rate of 0%. Certainly no one would sell just to pay a 40% tax.
It's all about short-term opportunistic rebalancing due to a short-term change in one's asset allocation, uh, I mean opportunistic rebalancing, uh I mean rebalancing, uh I mean market timing.
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Re: Strategy and tactics for auto-pilot investing

Postby kenyan » Fri Jul 26, 2013 1:15 am

Your goal should be to maximize post-tax assets, not to minimize taxes paid. They are not the same thing.
Retirement investing is a marathon.
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Re: Strategy and tactics for auto-pilot investing

Postby frylock » Fri Jul 26, 2013 11:07 am

Maybe I used the wrong term with "harvesting", I just meant selling the stocks for a gain.

Let's say I have $200 to invest for 30 years, and I can put half of it in a tax-sheltered account (say Roth IRA). Let's say as before, I have 40% tax rate, bonds yield 2.5% annually, stocks appreciate 5% annually (no dividends).

Option A:
Put the stocks in the taxable account.
Stocks will grow to about 100*1.05^30 ~= $432, I would have to pay (432-100)*0.4 ~= $132 as capital gains tax, and am left with $300.
Bonds will grow to about 100*1.025^30 ~= $210, no taxes.
Total - $300+$210 = $510.

Option B:
Put the bonds in the taxable account.
Stocks will grow as before to $432, but I will not be taxed at all.
Bonds will grow post-tax at the yearly rate of 1.5%, since they grow by 2.5% but the tax man takes 40% of that grow, every year, which is equivalent to one percentage-point of the fund. So in total, bonds will grow to 100*1.015^30 ~= $156.
Total - $432+$156 = $588.

From this back-of-the-envelope calculation it seems like it's more important to consider the average gain rather than whether the taxes are deferred. But I do know that the conventional wisdom is to put bonds in tax-sheltered accounts, so I must be missing something, what is it?

Also, any ideas on the ETFs vs MFs or Vanguard vs TD Ameritrade? I'm a bit befuddled with all the options and a little advice would go a long way...
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Re: Strategy and tactics for auto-pilot investing

Postby livesoft » Fri Jul 26, 2013 11:33 am

If you are befuddled then you must use Vanguard and only their mutual funds. Only folks who are not befuddled may use something else.

I use Vanguard and TDAmeritrade.
It's all about short-term opportunistic rebalancing due to a short-term change in one's asset allocation, uh, I mean opportunistic rebalancing, uh I mean rebalancing, uh I mean market timing.
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Re: Strategy and tactics for auto-pilot investing

Postby fulltilt » Fri Jul 26, 2013 12:37 pm

frylock wrote:From this back-of-the-envelope calculation it seems like it's more important to consider the average gain rather than whether the taxes are deferred. But I do know that the conventional wisdom is to put bonds in tax-sheltered accounts, so I must be missing something, what is it?


livesoft is razzing you: How to pay ZERO taxes in retirement with 6-figure expenses
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Re: Strategy and tactics for auto-pilot investing

Postby slbnoob » Fri Jul 26, 2013 1:16 pm

Thanks to OP for this thread and others for responding. I have a similar situation, except with $1-2K each month. I'm leaning towards ETFs over MFs for lower cost and Vanguard account for Vanguard ETFs. Need to decide over which platform to use for my investment. Now after this, I'm also looking into Ameritrade.
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Re: Strategy and tactics for auto-pilot investing

Postby DSInvestor » Fri Jul 26, 2013 1:49 pm

If you're making regular investments once or twice a month, mutual funds would be easier to work with since those purchases can be automated. ETF purchases cannot be automated so IMO it would be a little more work than automated MF purchases.

Vanguard Admiral shares have the same expense ratios as Vanguard ETFs. Vanguard Admiral shares of index funds are only available at Vanguard.

If you invest with TDAmeritrade, you can trade many Vanguard ETFs commission free. There will likely be commissions for buying and selling shares of Vanguard mutual funds. No-Load funds that aren't part of the NTF (No-Transaction-Fee list) are subject to $49.99 commission.

If you invest with Vanguard, you can trade Vanguard Mutual funds (investor and Admiral) commission free. Vanguard ETFs are commission free at Vanguard but you'd need to open a Vanguard Brokerage account. Vanguard index funds that offer an ETF share class will have the option to convert mutual fund shares to ETF shares.
Last edited by DSInvestor on Fri Jul 26, 2013 2:38 pm, edited 1 time in total.
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Re: Strategy and tactics for auto-pilot investing

Postby Default User BR » Fri Jul 26, 2013 2:03 pm

DSInvestor wrote:If you invest with TDAmeritrade, you can trade Vanguard ETFs commission free.

Many, but not all, Vanguard ETFs are on the list.


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Re: Strategy and tactics for auto-pilot investing

Postby frylock » Fri Jul 26, 2013 9:22 pm

fulltilt wrote:
frylock wrote:From this back-of-the-envelope calculation it seems like it's more important to consider the average gain rather than whether the taxes are deferred. But I do know that the conventional wisdom is to put bonds in tax-sheltered accounts, so I must be missing something, what is it?


livesoft is razzing you: How to pay ZERO taxes in retirement with 6-figure expenses


So the idea is that by the time I start selling my stocks, I'll be in a lower tax bracket that I am now? But by the same logic shouldn't we all forgo Roth-y plans? I'm confused :(
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Re: Strategy and tactics for auto-pilot investing

Postby Kevin M » Fri Jul 26, 2013 10:30 pm

First, if you want to keep things simple, just use Vanguard and mutual funds. If you want something like a simple three-fund portfolio, why complicate things?

Next, you are onto something with the tax efficiency thing. Google: relative absolute tax efficiency site:TheFinanceBuff.com. In his blog post he argues that at today's low rates it's actually more tax efficient to hold stocks in tax-advantaged and bonds in taxable. The more conventional wisdom, as you know, is to go the other way, and that's what most on this forum will recommend.

As to using tax-exempt funds in taxable account, it depends on your effective marginal tax rate. You seem to have the math chops that you can calculate which is better for your own situation. Be sure to consider state-specific TE funds if you are in a state for which Vanguard offers them.

As to dollar cost averaging, it has been shown conclusively that statistically, in the long run, you are better off with lump sum investing. The expected return of stocks is always higher than that of cash, and you are likely to do better with lump-sum about 2/3 of the time. However, the psychological aspects of big market drops after a big lump sum investment can be discouraging.

I personally like value averaging better than dollar cost averaging. When unsure about something, I tend to split the difference. So how about putting 1/2 into your funds right away, and value average or DCA the rest in over the next 12 months (using your scenario)?

Kevin
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Re: Strategy and tactics for auto-pilot investing

Postby frylock » Sat Jul 27, 2013 11:41 pm

Kevin M wrote:First, if you want to keep things simple, just use Vanguard and mutual funds. If you want something like a simple three-fund portfolio, why complicate things?

Next, you are onto something with the tax efficiency thing. Google: relative absolute tax efficiency site:TheFinanceBuff.com. In his blog post he argues that at today's low rates it's actually more tax efficient to hold stocks in tax-advantaged and bonds in taxable. The more conventional wisdom, as you know, is to go the other way, and that's what most on this forum will recommend.

As to using tax-exempt funds in taxable account, it depends on your effective marginal tax rate. You seem to have the math chops that you can calculate which is better for your own situation. Be sure to consider state-specific TE funds if you are in a state for which Vanguard offers them.

As to dollar cost averaging, it has been shown conclusively that statistically, in the long run, you are better off with lump sum investing. The expected return of stocks is always higher than that of cash, and you are likely to do better with lump-sum about 2/3 of the time. However, the psychological aspects of big market drops after a big lump sum investment can be discouraging.

I personally like value averaging better than dollar cost averaging. When unsure about something, I tend to split the difference. So how about putting 1/2 into your funds right away, and value average or DCA the rest in over the next 12 months (using your scenario)?

Kevin


Thanks Kevin, this is super helpful.

The only advantage of TD Ameritrade is the option to trade ETFs automatically and having non-Vanguard ETFs. But you're right, if I want to keep it simple, there's absolutely no reason not to go with Vanguard. Half lump sum and half DCA makes sense. Most of the lump sum I will get is due to my stock units, so I bet it correlates with the stock market. So it might be best to do a lump-sum since I can think of it as converting one stock into an index.

I just read about dollar value averaging, and it looks interesting. Do you know of a site/system that does that automatically?

I understand that it might change per-case basis, but it's weird for me that it's entirely against the principles described here: http://www.bogleheads.org/wiki/Principl ... _Placement. But right now bonds are only 10% of my allocation so I'm not going to worry about it too much, then maybe I'll reopen a thread just for this issue.
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Re: Strategy and tactics for auto-pilot investing

Postby fulltilt » Sun Jul 28, 2013 1:40 pm

frylock wrote:
fulltilt wrote:
frylock wrote:From this back-of-the-envelope calculation it seems like it's more important to consider the average gain rather than whether the taxes are deferred. But I do know that the conventional wisdom is to put bonds in tax-sheltered accounts, so I must be missing something, what is it?


livesoft is razzing you: How to pay ZERO taxes in retirement with 6-figure expenses


So the idea is that by the time I start selling my stocks, I'll be in a lower tax bracket that I am now? But by the same logic shouldn't we all forgo Roth-y plans? I'm confused :(


It isn't about the taxes being deferred. It is about stocks and bonds being taxed differently. Stocks sold for long term capital gains and qualified dividends are taxed differently than bond interest.

Play around with TaxCaster for a good demonstration of these effects.
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Re: Strategy and tactics for auto-pilot investing

Postby Kevin M » Sun Jul 28, 2013 4:24 pm

frylock wrote:I just read about dollar value averaging, and it looks interesting. Do you know of a site/system that does that automatically?

No, but it's not hard to create a spreadsheet to guide you. I wouldn't mess around with the formulas used in the book on it by Edleson. Just decide on a target monthly growth rate for your portfolio, then for months when stock returns give you all the growth or more, you don't add anything, and for months where they give you less than the target growth path requires, you add enough to hit your target growth rate. Note that if stocks drop a lot, you'll add a lot more than you would with DCA, and if stocks increase a lot, you'll add a lot less (maybe nothing).

You can pick a target growth rate such that if stocks didn't budge, you would end up adding all of your money by the end of your chosen period (in your case, sounds like 12 months). Or you could be more aggressive and set a path so that even if stocks grow at some chosen rate (e.g., 1%/month or about 12%/year--much higher than what most would consider the current expected return for stocks), you'd still end up investing all of your money. Either way, depending on the starting size of your portfolio, you could end up investing everything toward the beginning of the period if we get a large correction, or at the other extreme, nothing if we get a huge bull market.

Here's a really rough example, ignoring compounding. Say you're starting with $100K and you want to assume an aggressive stock return of 1% per month, or about $1,000, and you have $24,000 in cash to deploy (half of your $48,000 or so), so $2,000/month. Your target growth rate would be 3%/month or about $3,000 per month. If stocks rise by 3% or more in month 1, you add nothing. Stocks are flat, you add $3,000. Stocks drop by 3% ($3,000), you add $6,000.

You can easily have the spreadsheet formula include compounding. Using the scenario above, just start with your initial portfolio value, multiply by 1.3, to get the dollar target for one month later ($103,000), the next month would be $103,000 x 1.3 = $133,900, etc.. That gives you 12 rows for your target monthly portfolio values. Each month enter the actual portfolio value in the cell to the right, then in the next cell to the right calculate the difference between actual and target, and that tells you how much to add to your fund(s) (if anything).

There may no be a good scientific justification for this approach, but I found it to be very good emotional training, since you must add more when markets decline (helping overcome fear), and less when markets go up (helping overcome greed).

frylock wrote:I understand that it might change per-case basis, but it's weird for me that it's entirely against the principles described here: http://www.bogleheads.org/wiki/Principl ... _Placement. But right now bonds are only 10% of my allocation so I'm not going to worry about it too much, then maybe I'll reopen a thread just for this issue.

Yes, one thing I really like about Harry's blog (TheFinanceBuff) is that he often challenges conventional wisdom, and provides persuasive arguments to back up his points. But like you say, with such a small bond allocation, and such low bond yields, it really won't make much difference.

Kevin
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