Tax-inefficient total return investing ideas

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jasyang
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Joined: Thu Dec 18, 2014 9:46 am

Tax-inefficient total return investing ideas

Post by jasyang »

First-time poster.

Most investors think about tax-efficiency in making our investments. Of course, many tax-advantaged investments (i.e., municipal bonds) are no free lunch because they trade to significantly lower (pre-tax) expected returns. It’s even fair to assume (although reasonable people might disagree) that US public equity markets should have relatively lower expected returns because of the tremendous tax advantages over income-generating instruments.

Now, I’ve been lucky enough to have spent a lot of my adult life in reasonably high income-tax brackets, and have developed investment habits to match—contributions to 401(k) and IRA accounts, and a preference for qualified dividends and long-term capital gains. However, that’s all about to change as I’ve started working on an entrepreneurial endeavor and, frankly, expect to be in a very low tax bracket for the near future.

I wanted to ask for interesting/fun ideas for tax-inefficient investing options, so I can take as much advantage as possible of my relatively tax-advantaged situation over the next few years. There’s no sense in optimizing for better tax treatment when I expect to be in a pretty low income bracket. So it almost seems like I should develop a new preference for tax-inefficient options, and I want to get help getting ideas to reset my frame of reference!

Some things I’ve considered already—looking for thoughts on these, as well as additional ideas:
  • * There are various “income portfolios” out there, but they seem often designed for retirees who are also in a relatively low tax bracket. But the problem with a lot of these is that I’m still in my mid-30s, so I have much higher risk tolerance than most retirees.
  • * TLT (iShares 20+ Yr Tsy ETF) is a nice starting point, but the yield is definitely not exciting, plus “everyone knows” rates are going up (which is a whole ‘nother topic)
  • * High yield ETFs and closed-end funds seem to give a chance at better pre-tax returns, but it’s still lower-risk and lower-return than, say, equities. Plus a large concentration in that market would make me uneasy, since the high yield market isn't really that diversified (witness the recent panic in energy-related high yield)
  • * REIT preferred shares seem promising because the dividend yields are pretty high and the income is largely non-qualified. Notice REIT preferreds have a higher yield than REIT common shares because they aren’t going to participate in capital appreciation. But again, doesn't seem diversified enough to occupy a large piece of my portfolio
The theme here seems to be that many of the obvious candidates for income-generating investments (from a tax perspective) also happen to be relatively low risk, so it’s surprisingly hard to build a tax-inefficient portfolio that is anywhere nearly as high-returning as an equity-heavy diversified portfolio. Am I missing something?
jdilla1107
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Re: Tax-inefficient total return investing ideas

Post by jdilla1107 »

The better thing to do here is convert traditional 401ks and iras to Roth ira. That should generate plenty of "income". I would do this up until the 25% tax bracket.
randomguy
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Re: Tax-inefficient total return investing ideas

Post by randomguy »

jdilla1107 wrote:The better thing to do here is convert traditional 401ks and iras to Roth ira. That should generate plenty of "income". I would do this up until the 25% tax bracket.
Tax gain harvesting is the other option that comes to mind. I am unaware of any evidence that tax inefficient investing gives higher pre tax returns. If it did, we should all be loading up our IRAs with those investments instead of buying stocks.
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powermega
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Re: Tax-inefficient total return investing ideas

Post by powermega »

You could look into some tax gain harvesting.

Wiki here:
http://www.bogleheads.org/wiki/Tax_gain_harvesting
Even a stopped clock is right twice a day.
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Electron
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Re: Tax-inefficient total return investing ideas

Post by Electron »

jasyang wrote:The theme here seems to be that many of the obvious candidates for income-generating investments (from a tax perspective) also happen to be relatively low risk, so it’s surprisingly hard to build a tax-inefficient portfolio that is anywhere nearly as high-returning as an equity-heavy diversified portfolio. Am I missing something?
There are securities offering high income along with high risk. Examples are leveraged closed end bond funds, leveraged Mortgage REITs, and Master Limited Partnerships. Morningstar has a forum for closed end funds. These types of investments are generally not recommended by users of this forum.

Qualified Dividends and Capital Gains still make sense for those in a low tax bracket especially if you qualify for the 0% QD & CG bracket.
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Topic Author
jasyang
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Joined: Thu Dec 18, 2014 9:46 am

Re: Tax-inefficient total return investing ideas

Post by jasyang »

Thanks jdilla1107, the Roth conversion suggestion probably wins the silver bullet award for an elegant and flexible way to use up my low-income tax allowance.

And also thanks Electron for pointing out the 0% GC/QD rate-- another thing I'd overlooked, hence the importance of asking for help!
randomguy wrote:I am unaware of any evidence that tax inefficient investing gives higher pre tax returns. If it did, we should all be loading up our IRAs with those investments instead of buying stocks.
I'm unaware of any evidence either, and yet, shouldn't that stand to reason? If "tax efficient investing has lower pre-tax returns", then shouldn't the contrapositive of "higher pre-tax returns are not tax-efficient" hold? So if not, then why not? (I suppose this is creeping into a theoretical discussion.)
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