Investing for dividends in a taxable account

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DFWinvestor
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Investing for dividends in a taxable account

Post by DFWinvestor » Tue Feb 03, 2015 4:49 pm

Hello fellow bogleheads, I know this strategy has some flaws and I am hoping some of you can poke holes in my strategy.

First a little background: 37 years old, current net worth around $770K after subtracting out my loans (student loan and car loan total around $100K).

I have a taxable investment account with $220K, money market with three month's living expenses, $175K home equity, and the remainder of my investments is in tax deferred accounts.

Annual salary around $300K.

I have a three year plan to cut back on work, if certain financial milestones are achieved. I envision myself earning about $200K after I cut back on work.

I have two investments in my taxable account which for some reason defaulted to paying me dividends/capital gains rather than reinvesting them. I am not quite sure how/why this happened because previously all of my investments held in this account would re-invest all dividends and capital gains. What I have discovered is I really am not bothered with SOME of my investments in this account not having dividends/capital gains reinvested. I like to see the cash reward and I have been using it to pay down my student loans a little more aggressively. It is not a large amount of money, but enough to cover 1/2 of my student loan payments in a given year.

So what I am considering is building up these investments------and perhaps adding a few new investments----into my taxable account with the intention of using the dividends/capital gains to pay a few bills once the student loan is gone and car loan is gone. I figure if I am cutting back on work, even though it is very feasible based on our current standard of living to max out retirement savings at that income level and still have money left over, having my money "work for me" rather than me working for my money, and utilizing that to pay a few bills every month would be nice. I know there are arguments against this, but given my tax bracket I don't see the capital gains tax as being an issue.

So what I am envisioning is 2.5 years from now:

1) Having "two comma" net worth with 25-30% of that money in a taxable account
2) Cutting back on work to about 2/3 of what I am working now
3) Maxing out on tax deferred retirement savings every year
4) Having 80-100K invested in dividend/capital gains producing investments in my taxable account, and using those returns to pay a few bills each month
5) Having a ten year plan in place where I could feasibly retire. This would involve some combination of paying off our house, building up additional dividend producing investments to support us to some extent, and continuing to invest in tax deferred accounts

Please poke holes in my plan and tell me what major flaws you see.

malabargold
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Re: Investing for dividends in a taxable account

Post by malabargold » Tue Feb 03, 2015 5:05 pm

you just need to instruct your brokerage on which stock's dividends you want
reinvested and which you want in cash. Should be able to do this on their website.

you will need earned income to keep investing in tax-defered accounts down the road

Stock ETF's are relatively tax efficient. Mid and small caps generally
pay a lower percentage dividend, so less tax bite.

Something like BRK- a/b is very tax efficient with no dividends.
of course the taxable bonds and reits are better kept in tax-free or defered accounts

Only 37 and you want to retire in 10? to each his own, but is there a job/ career
you might be happier in?

Best of luck!

DFWinvestor
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Re: Investing for dividends in a taxable account

Post by DFWinvestor » Tue Feb 03, 2015 5:48 pm

malabargold wrote: Only 37 and you want to retire in 10? to each his own, but is there a job/ career
you might be happier in?

Best of luck!
Actually what I really want is to have the ability to retire in 13 years but still want to continue working long after that, but by choice rather than by necessity. That would be the ideal situation. The ten year horizon I mentioned was after 2-3 years from now when I hit the milestones I am hoping to hit.

The ultimate goal is by reducing my hours in three years, that my work/life balance will be such that I have a lot more in my tank and don't feel the need/want to retire early but could if I chose to. It would give me more time to pursue hobbies, read, travel, etc while I am relatively young.

For all of these reasons I believe that having some dividend producing investments in a taxable account, and using those dividends/capital gains, would help me reach that goal. Although it goes against the traditional bogleheads wisdom of minimizing your tax burden in taxable accounts.

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avenger
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Re: Investing for dividends in a taxable account

Post by avenger » Thu Feb 05, 2015 2:12 am

Why can't you just invest in tax efficient funds? Don't focus on just income-producing funds. It is total return that matters.
cheers ... -Mark | "Our life is frittered away with detail. Simplify. Simplify." -Henry David Thoreau | [3 fund portfolio: VTI, VXUS, SV fund (yield 3.01%)]

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Aptenodytes
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Re: Investing for dividends in a taxable account

Post by Aptenodytes » Thu Feb 05, 2015 9:08 am

You seem to be fetishizing dividends which will make you suffer unnecessarily. Complicate taxes and lower returns.

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Toons
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Re: Investing for dividends in a taxable account

Post by Toons » Thu Feb 05, 2015 9:21 am

"having my money "work for me" rather than me working for my money"

In a nutshell that encapsulates it for me.
That mantra has been one of my primary goals since day one of investing,
Having dividends,capital gains,interest pay a large majority of living expenses in retirement.
I like the strategy :happy
"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee

Grt2bOutdoors
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Re: Investing for dividends in a taxable account

Post by Grt2bOutdoors » Thu Feb 05, 2015 9:54 am

Hate to be the one to pop your bubble, but please tell us how you are going to go from $595K in current investments ($220K taxable + deferred), home equity is not an investment so I've excluded it unless you plan on selling the home and taking up residence under a highway overpass? That implies at a minimum your investments will be yielding on the order of 6-8% - how? After tax, you will be coming home with less, you'll be subject to the ACA tax and Medicare surcharge - if you are single and even if you were married, you'll likely be subject to additional taxes. Retirement in 10 years? Again, how? Short of winning the Powerball, you're going to have to really up your savings rate and/or downsize your expectations. I don't see you reaching 2 comma land in 2.5 years unless you are socking away a heck of a lot more money, annual returns are not linear, they have zigs and zags and after a 5 year move up, I fail to see it. However, hope does spring eternal, and I hope you're right because I'm long the market, but have zero expectations of a return larger than 4% nominal over the next 5 years. Conservative, I know, but I'd rather be pleasantly surprised than the alternative.
Last edited by Grt2bOutdoors on Thu Feb 05, 2015 3:31 pm, edited 1 time in total.
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ralph124cf
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Re: Investing for dividends in a taxable account

Post by ralph124cf » Thu Feb 05, 2015 1:56 pm

What are the interest rates on the loans? If the interest is above 4-5% I would recommend selling some taxable investments to pay them off.

Ralph

keith6014
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Re: Investing for dividends in a taxable account

Post by keith6014 » Thu Feb 05, 2015 7:08 pm

i am in a similar situation as you. Bit younger and 10% less income.
I invest in high quality dividend paying stocks (35+) to supplement my income and "pay" my bills. i don't reinvest my dividends but buy other stocks.

recently, i have been buying dividend based ETFs such as VIG + SCHD (my favorite) with the dividend proceed.

It makes me happy to get the dividend. i don't know how long i will live but i am happy receiving them on a bi-weekly basis. It is inefficient especially since we are in a high tax bracket but then again you can be splurging on other things like new cars.

you should consider getting into muni bond ETFs (with no AMT).

DFWinvestor
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Re: Investing for dividends in a taxable account

Post by DFWinvestor » Fri Feb 06, 2015 4:38 pm

Grt2bOutdoors wrote:Hate to be the one to pop your bubble, but please tell us how you are going to go from $595K in current investments ($220K taxable + deferred), home equity is not an investment so I've excluded it unless you plan on selling the home and taking up residence under a highway overpass? That implies at a minimum your investments will be yielding on the order of 6-8% - how? After tax, you will be coming home with less, you'll be subject to the ACA tax and Medicare surcharge - if you are single and even if you were married, you'll likely be subject to additional taxes. Retirement in 10 years? Again, how? Short of winning the Powerball, you're going to have to really up your savings rate and/or downsize your expectations. I don't see you reaching 2 comma land in 2.5 years unless you are socking away a heck of a lot more money, annual returns are not linear, they have zigs and zags and after a 5 year move up, I fail to see it. However, hope does spring eternal, and I hope you're right because I'm long the market, but have zero expectations of a return larger than 4% nominal over the next 5 years. Conservative, I know, but I'd rather be pleasantly surprised than the alternative.
I would disagree on home equity and net worth. That is a whole other discussion really but I do consider my home equity as part of my net worth. And I believe it to be feasible to hit "two comma" status in 2.5 years. No one can predict future returns, we may not reach that goal as soon as I anticipate but really hitting "two commas" is a goal of mine but also kind of a side issue here. The real objective for me is to reach a point where I can feasibly cut back on work and improve my quality of life, while still saving for the future although not as aggressively as I have in the past. Getting rid of my student loan and car loan, while also creating a little bit of passive income, allows me to accomplish that without feeling uncomfortable when my checks are smaller than what I've seen in the past.

So let's just assume you are correct and I am at 900K in 2.5 years. Student loan and car loan are gone, I start to utilize some passive income streams to pay a few bills each month, get just 4% growth over the following decade, and contribute 20% of 200K income for retirement until I am 50. By my math that would put me at $1.77M when I am 50 years old. Not a huge nest egg but enough that I could feasibly retire if I was careful. Again, as I mentioned before my hope is I will want to continue to work at that point in time, I could continue to scale back on work if I wanted and if I absolutely wanted to retire I could. Just some rough numbers here but I don't think my plan is that far off.

DFWinvestor
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Re: Investing for dividends in a taxable account

Post by DFWinvestor » Fri Feb 06, 2015 4:44 pm

ralph124cf wrote:What are the interest rates on the loans? If the interest is above 4-5% I would recommend selling some taxable investments to pay them off.

Ralph
Interest rates are 1.7% for both student loan and car loan. It really doesn't make much sense for me to be aggressive in paying them down but for now I am doing just that, at least with the student loan I am starting to get more aggressive in paying it off. I am ready to get that off my plate for good.

mhalley
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Re: Investing for dividends in a taxable account

Post by mhalley » Fri Feb 06, 2015 6:39 pm

Bogleheads generally are not big into the dividend strategy. They generally recommend the "total return" way of investing. There is certainly nothing wrong if you want to put some of your money into a fund that pays dividends, it is just not the generally accepted as the "best" way to do things around here. Vanguard does have a couple of dividend paying funds, so I suppose you could use those instead of a total stock market fund, but you will pay more taxes. Here is a comparison of the vanguard total stock market vs several vanguard dividend funds:
Average annual total return—after taxes on distributions
Vanguard Total Stock Mkt Idx Inv Vanguard Dividend Growth Fund Vanguard High Dividend Yld Idx Inv Vanguard Dividend Apprec Idx Inv
1-year 11.97% 10.90% 12.63% 9.47% —
3-year 19.88% 16.85% 17.71% 15.98% —
5-year 15.16% 14.10% 15.27% 13.51% —
10-year 7.65% 8.68% — — —
Since inception 9.05% 7.07% 6.44% 7.45% —
Inception date 04/27/1993 05/15/1992 11/16/2006 04/27/2006
Plus you are going to be paying higher ER on the dividend funds.
Mike
Dang, the returns got compressed when the post went up, hopefully you can figure it out.

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WolfpackFan
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Re: Investing for dividends in a taxable account

Post by WolfpackFan » Fri Feb 06, 2015 8:17 pm

Why not pay the bills with your income from your job? Keep the taxable account in a more tax efficient stock index fund and re-invest those dividends and make your money work harder and more efficient than what you've got going now. In the accumulation phase it doesn't make sense to be triggering a bunch of unnecessary taxes.

DFWinvestor
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Re: Investing for dividends in a taxable account

Post by DFWinvestor » Fri Feb 06, 2015 9:11 pm

WolfpackFan wrote:Why not pay the bills with your income from your job? Keep the taxable account in a more tax efficient stock index fund and re-invest those dividends and make your money work harder and more efficient than what you've got going now. In the accumulation phase it doesn't make sense to be triggering a bunch of unnecessary taxes.

This is a very good question and honestly it probably makes more sense on paper, at least from a tax standpoint and growth of investments standpoint. I have given this some consideration and I am not sure it makes sense for my goals. And I believe I could still max out tax deferred accounts, and have some wiggle room on top of that, if I went with the plan I am considering. So I would still be getting the tax benefit from my contributions, I would just be dealing with a small tax burden on dividends. I think I would be OK with a tax hit on dividends if it was allowing me to pay some bills and live (slightly) above my income level, after considering pre tax investments.

I suppose what it all boils down to is at some point having to make decisions about what makes the most sense on paper vs. what kind of lifestyle you want and how you go about achieving that. I don't think it is horribly irresponsible what I am considering, it may hinder my net worth a bit but the lifestyle trade off I believe would likely be worth it. Essentially I am still trying to wrap my brain around what is a rough road map of the future. In the past few weeks I have only worked a couple of days. This is the most down time I've had in over a decade and it has been glorious :D It's really opened my eyes to what could lie ahead if I plan right.

Thank you everyone for the input.

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