NEVER Have a Balanced Fund in Taxable?

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Justin28
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NEVER Have a Balanced Fund in Taxable?

Post by Justin28 » Sun Jan 06, 2008 1:17 am

Hello,

My wife and I are in our late twenties and maximize our 401ks and Roth IRAs with an asset allocation of roughly 80% in stocks and 20% in bonds. We have a six month emergency fund, which I’d like to bring up to a year’s worth. With the emergency fund that we now have though, we’re thinking of beginning to invest money in taxable accounts. We’re in the 28% tax bracket.

My original thinking was to have: (1) the emergency fund for emergencies only; (2) have some investments for future expenses that maybe have a timeline of seven to fifteen years, such as maybe moving to a more expensive locale, upgrading to a nicer house, buying a car in seven years, or just enjoying life more (we’re quite the cheapskates and we’re definitely like Ken and Kim Keeper in the Bogleheads’ Guide to Investing so I don’t want you to get the wrong idea); (3) continue to max out our retirement accounts; and (4) investing in index funds for their tax efficiency and viewing these investments as in the pool with our retirement accounts.

When we put money in our retirement accounts, it’s with the mindset of “see you in thirty years” and that’s what I’d like to do with the investments of index funds in taxable accounts. When we buy index funds in taxable accounts, we would adjust our retirement accounts to keep our asset allocation in check over time.

I was thinking of placing investments for future expenses with a timeline of say seven to fifteen years into a balanced fund, maybe the Wellington, which I’m thinking would be an acceptable risk and let us sleep at night. I’m concerned that if we held only stock index funds in our taxable accounts (besides the emergency fund) for those seven to fifteen years and the market tanks in nine years, we’re out of luck because we wouldn’t want to sell stocks that just dropped so much in value, or take money out of our retirement accounts and pay the penalty involved, or tap the emergency account.

I recently began reading Bogleheads’ Guide to Investing and checking some of the posts and it appears that my idea of having any sort of a balanced fund in a taxable account is foolish. Is my idea of thinking of a balanced fund in a taxable account for expenses in seven to fifteen years crazy? Any thoughts would be much appreciated. Thanks for your help.

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PiperWarrior
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Re: NEVER Have a Balanced Fund in Taxable?

Post by PiperWarrior » Sun Jan 06, 2008 1:39 am

I would stay out of balanced funds for your purpose. Perhaps, you could make your own balanced fund with a tax-exempt bond fund for your state of residence. You could start out with 50/50 and gradually move to 10/90 or something. You might want to use a money market fund at least partially toward the end. For your tax bracket, tax-exempt fund should make sense. Vanguard has taxable equivalent calculator:

https://personal.vanguard.com/us/FundsTaxEquivForYield

Alternatively, if you have a taxable account earmarked for retirement that is much (at least twice) larger than the amount of money you need in 7 to 15 years, then you might buy tax-efficient stock funds in a taxable account for your short-term goal and then increase bond allocation in tax-advantaged accounts. Effectively, you are holding bonds for your short-term purpose in a tax-advantaged account.

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Dale_G
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Post by Dale_G » Sun Jan 06, 2008 1:45 am

Under present tax law, it is indeed crazy to hold a balanced fund in taxable if you are holding any equities in deferred accounts. Simply put, equities belong in taxable accounts and bonds belong in deferred accounts to the extent possible for folks in the 25% or greater tax bracket.

If you really need bonds in your taxable account. buy a bond fund (muni's), Keeping bonds and equities separate will make it much easier if you have to rebalance.

Dale
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snowbound
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Post by snowbound » Sun Jan 06, 2008 8:21 am

Before I knew any better I had Wellington in a taxable account. I love the fund but hated the taxable gains it generated. I sold the fund quite some time ago and became much more tax efficient. If possible don't make the same mistake I did.

Good luck
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stratton
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Post by stratton » Sun Jan 06, 2008 9:25 am

There is Tax Managed Balanced (VTMFX). The problem is it has a 1% penalty within 5 years on withdrawls. Distributions aren't penalized. It's 47% equities and 53% bonds. You can do something similar with Total Stock Market and intermediate tax exempt bonds.

Paul

mithrandir
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Post by mithrandir » Sun Jan 06, 2008 10:10 am

70% of my taxable account is invested in income-generating cash and bonds. Conversely, 13% of my tax-deferred accounts are invested in cash/bonds. This says that I have an asset location problem.

But I just don't have the risk tolerance for loading up my taxable account with equities. I don't consider my taxable account as a retirement savings vehicle. It is there for emergencies, for fixing the roof or heater should either fail, for tuition if I should ever go back to school, for a down payment on another house should I decide to move, for whatever life throws. I don't have a clear time horizon for these things other than knowing I may need to tap my investments from time to time.

I fear I'll become debilitated by a lack of liquidity if stocks should encounter a bear market like 1973-74. I can handle that more-or-less in my retirement accounts but taxable is different. I sleep well at night because I know I'm liquid. I understand I am paying a tax penalty but I remain unconvinced it's as bad as some declare.

If you hold bonds in a tax-deferred account, you will pay income taxes when you make withdrawals. You aren't avoiding taxes, you may not even be getting a lower tax rate; you are simply deferring them. The question is: does tax deferral trump other concerns?

I wish I can recall the source (some online professional journal) but I read that keeping bonds in taxable instead of tax-deferred incurs a penalty of approx 30 bps. Yes, the penalty is indeed real but 30 bps (if it is accurate) does not jolt me to move bonds to tax-deferred.

Currently bond yields are low by historical standards so my cash/bond investments don't throw off much income. For 2007 tax year, my taxable dividends amounted to less than 4% of my gross salary. They aren't putting me in a higher bracket. That's an important point.

If the dividends provided by cash and bonds investments in one's taxable account significantly raises their income, that's a problem. The definition of "significantly" is for the reader to decide.

Just to be clear: if you are making retirement investments in your taxable account then asset location should be a factor. But the OP stated they have a 7-to-15 year time horizon for these "life events" I mentioned above.

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Post by Wagnerjb » Sun Jan 06, 2008 10:26 am

Justin: it is important to understand that using Muni bonds in a taxable account may not give you even an ounce of "tax efficiency".

Tax efficiency can mean lower rates, or deferral of tax payments. With equities, you get a lower rate (15% on capital gains and dividends) as well as tax deferral (don't pay until you sell the shares).

With bonds in a taxable account, you don't get tax deferral. Even if you use Muni bonds, you get the "after-tax" interest today, as opposed to getting a "pre-tax" interest today and paying the taxes much later. So, there is no tax deferral.

If you are in the 28% tax bracket, it is likely that Muni's will be a wash for you. That is, the yield on a Muni bond may be about equivalent to paying a 28% tax on a regular bond. (I don't live in a state with state taxes, but this may make a slight difference for somebody)

You can certainly use Muni bonds if you choose, but don't fool yourself that you are getting much - if any - tax efficiency by doing so.

Best wishes.
Andy

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Post by livesoft » Sun Jan 06, 2008 10:51 am

An asset location article: http://www.fpanet.org/journal/articles/ ... 5-art6.cfm
We describe a generic framework for finding the optimal location for multiple asset classes. The proposed location approach (referred to as the "difference approach") is shown to provide an average 20-bps-per-year, after-tax return benefit over simply using identical allocations in the multiple accounts with different characteristics.

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Post by mithrandir » Sun Jan 06, 2008 1:04 pm

livesoft wrote:An asset location article: http://www.fpanet.org/journal/articles/ ... 5-art6.cfm
We describe a generic framework for finding the optimal location for multiple asset classes. The proposed location approach (referred to as the "difference approach") is shown to provide an average 20-bps-per-year, after-tax return benefit over simply using identical allocations in the multiple accounts with different characteristics.
Thank you for posting that. I don't have the time to read it thoroughly but here's one of their conclusions:
Low-return classes can be placed in either account, since the difference in end-wealth will be small.
I consider cash and short-term taxable bonds to be low-return classes and that's why I go against the common wisdom to keep these out of taxable just for tax reasons. The "small difference in end-wealth" is not enough to overcome liquidity concerns.

Note that the amount of money invested makes a difference. If I had $500K in taxable and $500K in tax-deferred as mentioned in the article my concerns regarding liquidity would be different. As an example, even if stocks were to drop by 50% and you had 100% equities in taxable, you'd still have $250K. But as it stands now, my taxable account is smaller than my gross annual salary and I need that money to "be there". It's not simply emergency funds, it's just money to have.

My concern, really, is the almost knee-jerk reaction board members seem to make when a poster says they have or want to have bonds in taxable. I know people are trying to mean well but I caution that tax-efficiency is not the end-all.

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grabiner
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If you hold stocks and bonds in taxable, use separate funds

Post by grabiner » Sun Jan 06, 2008 4:00 pm

The problem with holding a balanced fund in a taxable account is that you must sell it all at once. If you have separate bond and stock funds, you can sell bonds, or switch to a different type of bonds, or change your asset allocation to hold fewer bonds, or keep your asset allocation by selling taxable bonds and buying bonds in your IRA, by selling only the bond fund. If you have a balanced fund, you must sell the stocks at the same time, and pay taxes on the stock gains even if you invest the money right back in stocks.

In addition, the balanced fund will incur tax costs when it sells stocks and buys bonds to rebalance. If you have separate funds, you can rebalance by adding new money, or rebalance by selling stock inside your IRA.
Wiki David Grabiner

livesoft
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Post by livesoft » Sun Jan 06, 2008 4:03 pm

grabiner, thanks, that's a nice tidbit that I will add to my standard diatribe against balanced funds. :)

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Post by edge » Sun Jan 06, 2008 4:34 pm

Mithrandir,

All of your points in this conversation are fine and all but it can be summed up in one simple sentence: Your taxable holdings are not part of your retirement portfolio.

This means that the investment lifetime, risk tolerance, etc, are all going to be different.

If the original poster has an investing goal that is significantly different than his retirement savings goal then he can do a few things:

- He can manage the second investing goal as a separate and potentially more conservative portfolio
- He can integrate it with his retirement portfolio and when it comes time to spend the investment (possibly equities in taxable accounts) he will have to rebalance aggressively in his tax advantaged accounts to re-establish his retirement asset allocation.

The second option is more risky because if the taxable equities do very poorly then he will not meet his investing goal and he cannot pull out of his tax advantaged accounts to make up for it.
mithrandir wrote:
livesoft wrote:An asset location article: http://www.fpanet.org/journal/articles/ ... 5-art6.cfm
We describe a generic framework for finding the optimal location for multiple asset classes. The proposed location approach (referred to as the "difference approach") is shown to provide an average 20-bps-per-year, after-tax return benefit over simply using identical allocations in the multiple accounts with different characteristics.
Thank you for posting that. I don't have the time to read it thoroughly but here's one of their conclusions:
Low-return classes can be placed in either account, since the difference in end-wealth will be small.
I consider cash and short-term taxable bonds to be low-return classes and that's why I go against the common wisdom to keep these out of taxable just for tax reasons. The "small difference in end-wealth" is not enough to overcome liquidity concerns.

Note that the amount of money invested makes a difference. If I had $500K in taxable and $500K in tax-deferred as mentioned in the article my concerns regarding liquidity would be different. As an example, even if stocks were to drop by 50% and you had 100% equities in taxable, you'd still have $250K. But as it stands now, my taxable account is smaller than my gross annual salary and I need that money to "be there". It's not simply emergency funds, it's just money to have.

My concern, really, is the almost knee-jerk reaction board members seem to make when a poster says they have or want to have bonds in taxable. I know people are trying to mean well but I caution that tax-efficiency is not the end-all.

Justin28
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Post by Justin28 » Sun Jan 06, 2008 4:53 pm

Thanks to everyone for their help. I think I will try to manage my second investing goal as a separate and more conservative portfolio. I will NOT be investing in a balanced fund in a taxable account but will invest in separate stock and bond funds as suggested. Thanks again for the ideas and discussion, it has really given me a lot to think about and has been quite helpful.

robert22033
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Post by robert22033 » Sun Jan 06, 2008 11:36 pm

Snowbound wrote:
>>Before I knew any better I had Wellington in a taxable account. I love the fund but hated the taxable gains it generated. I sold the fund quite some time ago and became much more tax efficient. If possible don't make the same mistake I did

So, why is it a bad idea to have Wellington in a taxable account? And how bad an idea is it?

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Post by livesoft » Mon Jan 07, 2008 7:55 am

robert22033 wrote:So, why is it a bad idea to have Wellington in a taxable account? And how bad an idea is it?
Because it is a balanced fund, which is the main topic if this thread.

floyd
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Post by floyd » Mon Jan 07, 2008 9:01 am

i've read somewhere that oakmark equity income, oakbx, which i think is a balanced fund, is not a bad fund to hold in a taxable account. did i read wrong?

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Post by ndchamp » Mon Jan 07, 2008 9:13 am

robert22033 wrote:
So, why is it a bad idea to have Wellington in a taxable account? And how bad an idea is it?

Because it is a balanced fund, which is the main topic if this thread.

Seems like it would be better to pay taxes on a balanced fund that earns 5 to 10pct, then to keep the money in a savings account and pay taxes on less than 1pct earnings.
Especially if you are not in the big-bucks tax brackets yet.

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Post by livesoft » Mon Jan 07, 2008 9:34 am

ndchamp wrote:Seems like it would be better to pay taxes on a balanced fund that earns 5 to 10pct, then to keep the money in a savings account and pay taxes on less than 1pct earnings.
Especially if you are not in the big-bucks tax brackets yet.
I used to think that way as well, then a few years went by and the earnings in my balanced fund became so large that they bumped me into a higher tax bracket and prevented me from having a Roth IRA. But I was trapped because if I sold the balanced fund, I would have to pay huge capital gains taxes.

So you have to think about the future and not just the present.

Just don't keep the money in a savings account. Put the equity portion in a tax-efficient passive-managely index fund of stocks. Put the bond portion in a tax-advantaged account.

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Post by grabiner » Tue Jan 08, 2008 10:59 pm

ndchamp wrote:robert22033 wrote:
So, why is it a bad idea to have Wellington in a taxable account? And how bad an idea is it?

Because it is a balanced fund, which is the main topic if this thread.

Seems like it would be better to pay taxes on a balanced fund that earns 5 to 10pct, then to keep the money in a savings account and pay taxes on less than 1pct earnings.
Especially if you are not in the big-bucks tax brackets yet.
But it is better to have the right individual funds rather than a balanced fund. If you like Wellington's asset allocation, then 65% in Value Index and 35% in a municipal-bond fund is similar and will save you a lot in taxes, or if you want to match Wellington as closely as possible, 65% in Windsor and 35% in Total Bond Market Index still allows you to sell bonds without paying any taxes.
Wiki David Grabiner

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Re: NEVER Have a Balanced Fund in Taxable?

Post by guyesmith » Mon Apr 16, 2018 2:27 pm

It seems to me the OP is saving for a non-retirement. Goal within 7-15 years. In a case like that why would he only sell the bonds to avoid taxes? Say for example he is saving for a house down payment. When it’s time to spend he is selling most if not all anyway. He’ll be paying tax no matter what. Seems like most of these answers are geared toward early retirement strategies rather than saving for a big expense or mid-term goal.
You must each decide in your heart how much to give. And don’t give reluctantly or in response to pressure. For God loves a person who gives cheerfully. - 2 Corinthians 9:7

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Re: NEVER Have a Balanced Fund in Taxable?

Post by fposte » Mon Apr 16, 2018 2:28 pm

Given that the post was from 10 years ago, OP may be retired by now :-).

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Re: NEVER Have a Balanced Fund in Taxable?

Post by guyesmith » Mon Apr 16, 2018 2:37 pm

fposte wrote:
Mon Apr 16, 2018 2:28 pm
Given that the post was from 10 years ago, OP may be retired by now :-).
Woops! Thought that said 2018 lol.
You must each decide in your heart how much to give. And don’t give reluctantly or in response to pressure. For God loves a person who gives cheerfully. - 2 Corinthians 9:7

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Re:

Post by CedarWaxWing » Mon Apr 16, 2018 3:20 pm

stratton wrote:
Sun Jan 06, 2008 9:25 am
There is Tax Managed Balanced (VTMFX). The problem is it has a 1% penalty within 5 years on withdrawls. Distributions aren't penalized. It's 47% equities and 53% bonds. You can do something similar with Total Stock Market and intermediate tax exempt bonds.

Paul
But the balanced index was almost as tax efficient, and over the last 15 yrs did better after taxes.

1-Mo 3-Mo 6-Mo YTD 1-Yr 3-Yr 5-Yr 10-Yr 15-Yr Since Inception
(03/31/2018)
Pretax Return
VTMFX -0.89 -0.73 2.56 -0.73 7.96 6.12 7.65 7.07 7.29 7.52
VBIAX -0.93 -0.88 3.05 -0.88 8.74 6.65 8.52 7.58 8.17 —
Tax-adjusted Return *
VTMFX -1.10 -0.94 2.10 -0.94 7.01 5.33 6.82 6.39 6.65 7.06
VBIAX -1.14 -1.08 2.59 -1.08 7.80 5.81 7.65 6.79 7.36 —
% Rank in Category 67 28 5 28 6 2 1 1 3 —
Tax Cost Ratio
VTMFX — — — — 0.88 0.74 0.78 0.63 0.59 —
VBIAX — — — — 0.87 0.79 0.79 0.73 0.75 —

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Re: Re:

Post by guyesmith » Mon Apr 16, 2018 3:49 pm

CedarWaxWing wrote:
Mon Apr 16, 2018 3:20 pm
stratton wrote:
Sun Jan 06, 2008 9:25 am
There is Tax Managed Balanced (VTMFX). The problem is it has a 1% penalty within 5 years on withdrawls. Distributions aren't penalized. It's 47% equities and 53% bonds. You can do something similar with Total Stock Market and intermediate tax exempt bonds.

Paul
But the balanced index was almost as tax efficient, and over the last 15 yrs did better after taxes.

1-Mo 3-Mo 6-Mo YTD 1-Yr 3-Yr 5-Yr 10-Yr 15-Yr Since Inception
(03/31/2018)
Pretax Return
VTMFX -0.89 -0.73 2.56 -0.73 7.96 6.12 7.65 7.07 7.29 7.52
VBIAX -0.93 -0.88 3.05 -0.88 8.74 6.65 8.52 7.58 8.17 —
Tax-adjusted Return *
VTMFX -1.10 -0.94 2.10 -0.94 7.01 5.33 6.82 6.39 6.65 7.06
VBIAX -1.14 -1.08 2.59 -1.08 7.80 5.81 7.65 6.79 7.36 —
% Rank in Category 67 28 5 28 6 2 1 1 3 —
Tax Cost Ratio
VTMFX — — — — 0.88 0.74 0.78 0.63 0.59 —
VBIAX — — — — 0.87 0.79 0.79 0.73 0.75 —
Thanks for this breakdown! That fits what I’ve been thinking. You’re going to pay taxes on income. Period. Capital gains are a lower rate. It’s really just about which pocket do you want Uncle Sam to reach into and when.
You must each decide in your heart how much to give. And don’t give reluctantly or in response to pressure. For God loves a person who gives cheerfully. - 2 Corinthians 9:7

CedarWaxWing
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Re: Re:

Post by CedarWaxWing » Mon Apr 16, 2018 4:22 pm

But the balanced index was almost as tax efficient, and over the last 15 yrs did better after taxes.

1-Mo 3-Mo 6-Mo YTD 1-Yr 3-Yr 5-Yr 10-Yr 15-Yr Since Inception
(03/31/2018)
Pretax Return
VTMFX -0.89 -0.73 2.56 -0.73 7.96 6.12 7.65 7.07 7.29 7.52
VBIAX -0.93 -0.88 3.05 -0.88 8.74 6.65 8.52 7.58 8.17 —
Tax-adjusted Return *
VTMFX -1.10 -0.94 2.10 -0.94 7.01 5.33 6.82 6.39 6.65 7.06
VBIAX -1.14 -1.08 2.59 -1.08 7.80 5.81 7.65 6.79 7.36 —
% Rank in Category 67 28 5 28 6 2 1 1 3 —
Tax Cost Ratio
VTMFX — — — — 0.88 0.74 0.78 0.63 0.59 —
VBIAX — — — — 0.87 0.79 0.79 0.73 0.75 —
[/quote]

Thanks for this breakdown! That fits what I’ve been thinking. You’re going to pay taxes on income. Period. Capital gains are a lower rate. It’s really just about which pocket do you want Uncle Sam to reach into and when.
[/quote]

My son is newly married and in a very busy Phd Stem program. He came across some unexpected funds last year (cashed in capital gains with no tax burden due to his currently low income from his stipend.) He decided that since P/Es were so high at that time, he would put his cash into the balanced index fund (VBIAX) which is almost as efficient and did as well both pre and post tax as the VTMFX did. His plan, like yours, was that he will keep it for several years, but consider selling if there is what he considers to be a significant drop in equities, and over a time period determined by the size of the drop to slowly sell it off and put it into a three fund portfolio. He would have done that right away if he was not so busy with this studies... he does not wish to take time to mess with rebalancing right now... or if he was not prepared to hang onto it for several years.

Market timing? I don't think so, since he is waiting for a change in values of equities to go to the three fund portfolio... or getting out of his degree finished, or having a need for the funds. He simply sees this as a low energy way to park it safely for a few years... and he already has a roth more aggressively invested, which he will not touch for at least 35 years or more. He does expect to use the VBAIX funds within the next ten years or so, but not the next 3-5. I think he sees it as a way to get a better return than bonds, be somewhat tax efficient, but have less over all volatility if his horizon to use it becomes shorter than his initial intent. I suppose some folks would look as that as goofy... but he is comfortable with that plan enough that he can forget about it for a while during a very busy low income time of his life.

(The tax burden during these low income years, and the amount is still enough to allow admiral shares in the index but not the non index . )

guyesmith
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Re: Re:

Post by guyesmith » Mon Apr 16, 2018 9:22 pm

CedarWaxWing wrote:
Mon Apr 16, 2018 4:22 pm
But the balanced index was almost as tax efficient, and over the last 15 yrs did better after taxes.

1-Mo 3-Mo 6-Mo YTD 1-Yr 3-Yr 5-Yr 10-Yr 15-Yr Since Inception
(03/31/2018)
Pretax Return
VTMFX -0.89 -0.73 2.56 -0.73 7.96 6.12 7.65 7.07 7.29 7.52
VBIAX -0.93 -0.88 3.05 -0.88 8.74 6.65 8.52 7.58 8.17 —
Tax-adjusted Return *
VTMFX -1.10 -0.94 2.10 -0.94 7.01 5.33 6.82 6.39 6.65 7.06
VBIAX -1.14 -1.08 2.59 -1.08 7.80 5.81 7.65 6.79 7.36 —
% Rank in Category 67 28 5 28 6 2 1 1 3 —
Tax Cost Ratio
VTMFX — — — — 0.88 0.74 0.78 0.63 0.59 —
VBIAX — — — — 0.87 0.79 0.79 0.73 0.75 —
Thanks for this breakdown! That fits what I’ve been thinking. You’re going to pay taxes on income. Period. Capital gains are a lower rate. It’s really just about which pocket do you want Uncle Sam to reach into and when.
[/quote]

My son is newly married and in a very busy Phd Stem program. He came across some unexpected funds last year (cashed in capital gains with no tax burden due to his currently low income from his stipend.) He decided that since P/Es were so high at that time, he would put his cash into the balanced index fund (VBIAX) which is almost as efficient and did as well both pre and post tax as the VTMFX did. His plan, like yours, was that he will keep it for several years, but consider selling if there is what he considers to be a significant drop in equities, and over a time period determined by the size of the drop to slowly sell it off and put it into a three fund portfolio. He would have done that right away if he was not so busy with this studies... he does not wish to take time to mess with rebalancing right now... or if he was not prepared to hang onto it for several years.

Market timing? I don't think so, since he is waiting for a change in values of equities to go to the three fund portfolio... or getting out of his degree finished, or having a need for the funds. He simply sees this as a low energy way to park it safely for a few years... and he already has a roth more aggressively invested, which he will not touch for at least 35 years or more. He does expect to use the VBAIX funds within the next ten years or so, but not the next 3-5. I think he sees it as a way to get a better return than bonds, be somewhat tax efficient, but have less over all volatility if his horizon to use it becomes shorter than his initial intent. I suppose some folks would look as that as goofy... but he is comfortable with that plan enough that he can forget about it for a while during a very busy low income time of his life.

(The tax burden during these low income years, and the amount is still enough to allow admiral shares in the index but not the non index . )
[/quote]

Appreciate the great insight.

My thoughts are a little different. Rather than hold for a while and then move on I’m thinking hold inevitably, add funds monthly forever, and only pull out funds every 4-6 years when needing a new car.
You must each decide in your heart how much to give. And don’t give reluctantly or in response to pressure. For God loves a person who gives cheerfully. - 2 Corinthians 9:7

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