How can I use ETFs to further diversify my taxable account?

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zayd13
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How can I use ETFs to further diversify my taxable account?

Post by zayd13 » Fri Jun 05, 2015 7:17 am

Hello everyone,

So I’m a little late to the party being 26 years old and having just recently started my investment life. To be fair, I do come from a single-parent immigrant family, and understanding finance, among other things (i.e., grad school), was something I just had to venture out and figure out on my own.
Anyhoot -over the past few months I’ve been reading a lot and talking to people, and in the past month or so these are some of the investment moves I’ve made:

-Maxed out my 2015 Roth IRA ($4500 in VFFVX, $1000 in VGSTX) (to supplement the PERS plan I’ve been contributing 10% of my pre-tax income to over the last three years)

-Opened a taxable account w/ $3000 in VSTMX

Now, I have up to $5000 in discretionary funds (emergency savings already established) and want to know how I can further (or if I should further) diversify my taxable account with ETFs, as it currently only has VSTMX (Vanguard Total Stock Market Index). I say ETFs because I hear they are very tax efficient and don’t have the same minimums as a mutual fund, and so I figured they’d be a great vehicle to help further diversify that taxable account at a relatively lower cost. I also wonder if maybe I'm trying to do too much too soon...

In terms of my goals, they are simple: 1) contribute as much as I can per year to my Roth IRA, and 2) use my taxable account as nothing else other than a way to grow my net worth over the long run (10+ years). I am beginning the process of saving for a down payment on a house in 2-3 years from now, but will likely put those funds into something like a CD/MMF. Other than these, I have no other major long-term investment goals.

Any and all help you can give me regarding how to further diversify my taxable with ETFs - and which ETFs you'd recommend- is deeply appreciated! I'd like to classify myself as someone who is okay with moderate risk seeing that I am still pretty young.

livesoft
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Re: How can I use ETFs to further diversify my taxable account?

Post by livesoft » Fri Jun 05, 2015 7:30 am

If for retirement, it seems like contributing more to your PERS plan would be in order.

I'm a big fan of ETFs, but also a fan of mutual funds. If you want to try out ETFs, and since you already are invested in VTSMX (the total US stock market index fund), you really only have a few choices:

1. VXUS the total international stock market index fund. You could use VGTSX instead if you had the initial minimum investment.
2. A bond ETF, but you mentioned tax-efficiency and also that you were going to use CDs/savings account, thus a bond ETF does not make sense.

So that leaves you with only one choice: VXUS. I would suggest that this is only for trying out to see what ETFs are like. You may change your mind later at any time.
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The Wizard
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Re: How can I use ETFs to further diversify my taxable account?

Post by The Wizard » Fri Jun 05, 2015 8:01 am

Livesoft pretty well nailed it.
Tax efficiency over coming decades means mainly stock index funds in your taxable account, yielding minimal or zero Capital Gains Distributions.
You'll eventually need to manage your overall AA to meet your goals properly,

If it turns out that you start having a major percentage of assets in taxable later on, you might want to consider a municipal bond fund in taxable also. But not right now...
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retiredjg
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Re: How can I use ETFs to further diversify my taxable account?

Post by retiredjg » Fri Jun 05, 2015 8:04 am

At 26, you are not late to the party. :happy

Do you have some kind of 403k or 430b or SEP or SIMPLE IRA at work? If you do, you should be using that instead of a taxable account for your retirement savings.

If you have no plan at work, you'll have to just use the taxable account and the Roth IRA (or traditional IRA if you want to reduce your taxable income).

Before you decide what to put into the taxable account, you need to consider what stock to bond ratio you want for your portfolio. Have you considered that yet?

Is it possible you have the amounts backwards on your Target Retirement and Total International?

Also, about how much do you think you'll be able to save in taxable each year in the next few years?

dbr
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Re: How can I use ETFs to further diversify my taxable account?

Post by dbr » Fri Jun 05, 2015 8:22 am

Investing is not about using ETF's vs using mutual funds. In reality ETFs are pretty much mutual funds in a little bit different form anyway. I haven't heard that Vanguard ETFs are different in tax efficiency from Vanguard funds anyway. The vast majority of ETFs, like the vast majority of mutual funds are codged up vehicles no one should be buying anyway.

Here is good article in the Wiki:

https://www.bogleheads.org/wiki/Exchange-traded_fund

and one can find a book titled The ETF Book, by some good author or another (sorry).

It is reasonable to use ETFs to avoid minimums and trading costs at some brokers, but I think minimums are a red herring as before long one should save enough to get around that anyway and with small accounts too many funds aren't needed.

The first steps involve planning how to save and devising asset allocation and location. Investment selection is a last step. It would be a rare case where a person would have to use an ETF to get truly needed diversity in a portfolio, aside from cost and convenience of purchasing in some accounts. I use ETFs in a brokerage link in my 401K to get certain basic investments that aren't offered in the plan per se.

zayd13
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Re: How can I use ETFs to further diversify my taxable account?

Post by zayd13 » Fri Jun 05, 2015 10:44 am

livesoft wrote:If for retirement, it seems like contributing more to your PERS plan would be in order.

I'm a big fan of ETFs, but also a fan of mutual funds. If you want to try out ETFs, and since you already are invested in VTSMX (the total US stock market index fund), you really only have a few choices:

1. VXUS the total international stock market index fund. You could use VGTSX instead if you had the initial minimum investment.
2. A bond ETF, but you mentioned tax-efficiency and also that you were going to use CDs/savings account, thus a bond ETF does not make sense.

So that leaves you with only one choice: VXUS. I would suggest that this is only for trying out to see what ETFs are like. You may change your mind later at any time.



Great advice. Thanks for the insight!

zayd13
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Re: How can I use ETFs to further diversify my taxable account?

Post by zayd13 » Fri Jun 05, 2015 10:58 am

retiredjg wrote:At 26, you are not late to the party. :happy

Do you have some kind of 403k or 430b or SEP or SIMPLE IRA at work? If you do, you should be using that instead of a taxable account for your retirement savings.

If you have no plan at work, you'll have to just use the taxable account and the Roth IRA (or traditional IRA if you want to reduce your taxable income).

Before you decide what to put into the taxable account, you need to consider what stock to bond ratio you want for your portfolio. Have you considered that yet?

Is it possible you have the amounts backwards on your Target Retirement and Total International?

Also, about how much do you think you'll be able to save in taxable each year in the next few years?



I do have a plan at work. I work at a public university and we have to choose from a 403b or the PERS program. I opted into the PERS program 3 years ago when I didn't have as much info as I do now.

The taxable account I opened with 3k in VSTMX actually is not for retirement purposes. I opened that because I want to grow my excess funds but also want to have access to them 5, 10, 15 years down the line if I ever need it without having to take it from my IRA and incur further penalties. In other words, for now, I have a pension plan and a Roth IRA for retirement, and a taxable account to store excess funds.

I was correct when I stated the amounts: I have 4.5k invested into target date fund VFFVX, and 1k invested in STAR (VGSTX). Both funds currently make up my Roth IRA. The stock to bond ratio I currently have in my IRA is where I want it (85-15).

In my taxable account, as of right now, I am comfortable with a higher stock allocation (i.e., 85-90 stocks, 15-0 bonds) because I have time to make it up and become more conservative later on. The reason I'm inquiring about ETFs is because I'm thinking they're a cheap way to diversify this taxable account (since VSTMX is mainly US stocks).

retiredjg
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Re: How can I use ETFs to further diversify my taxable account?

Post by retiredjg » Fri Jun 05, 2015 11:44 am

zayd13 wrote:I do have a plan at work. I work at a public university and we have to choose from a 403b or the PERS program. I opted into the PERS program 3 years ago when I didn't have as much info as I do now.

It is very unlikely, though I suppose it is possible, that you have to choose between these two options. You should be using the 403b plan in addition to Roth IRA for your retirement savings.

The taxable account I opened with 3k in VSTMX actually is not for retirement purposes. I opened that because I want to grow my excess funds but also want to have access to them 5, 10, 15 years down the line if I ever need it without having to take it from my IRA and incur further penalties. In other words, for now, I have a pension plan and a Roth IRA for retirement, and a taxable account to store excess funds.

You are losing the benefits of tax-deferral by doing this. There are times when that is reasonable (such as saving for a house) but don't do it because you don't want your money "tied up". It is a fear that many people have but it turns out to not matter much.

I was correct when I stated the amounts: I have 4.5k invested into target date fund VFFVX, and 1k invested in STAR (VGSTX). Both funds currently make up my Roth IRA. The stock to bond ratio I currently have in my IRA is where I want it (85-15).

Sorry, I misread the ticker for the STAR fund. This is a good example of why we ask that people post both fund names and tickers.

In my taxable account, as of right now, I am comfortable with a higher stock allocation (i.e., 85-90 stocks, 15-0 bonds) because I have time to make it up and become more conservative later on. The reason I'm inquiring about ETFs is because I'm thinking they're a cheap way to diversify this taxable account (since VSTMX is mainly US stocks).

If you want to do this, you should probably use Total Stock Market, Total International, and a bond fund or CDs. Which bond fund you use, taxable, or tax-exempt, depends on your tax bracket which we don't know.

It seems like someone said that VG does not have any tax-exempt bond ETFs. You could buy the international ETF and a tax-exempt bond mutual fund though.

Your allocation will not be what you want, but that simply does not matter at this point. When the amounts are small, you could be all stocks or all bonds and end up with about the same amount of money in the end. This is because right now your contributions grow the account more than the investments themselves.

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ogd
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Re: How can I use ETFs to further diversify my taxable account?

Post by ogd » Fri Jun 05, 2015 1:34 pm

zayd13 wrote:The reason I'm inquiring about ETFs is because I'm thinking they're a cheap way to diversify this taxable account (since VSTMX is mainly US stocks).

I'd like to put in a mild recommendation against using an ETF. There's nothing fundamentally wrong with them, but they're more annoying to handle, more so when mixed with a mutual fund when it comes to switching money between the two.

Read carefully http://www.bogleheads.org/wiki/ETFs_vs_ ... uard_funds , and then the whole page. Things you might be missing are: 1) tax efficiency is the same; 2) fee differences are small, below $20 per year, before you hit Admiral shares; 3) using a MF allows you to switch to an ETF later if you like without a tax event, while the opposite is not true and if you have capital gains you'll be locked into the ETF choice.

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BL
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Re: How can I use ETFs to further diversify my taxable account?

Post by BL » Fri Jun 05, 2015 2:10 pm

Here is a nice little booklet written by a Boglehead author just for you:
http://www.etf.com/docs/IfYouCan.pdf

The Wiki has a lot of good information. The 3-fund portfolio has a lot of comparable funds with different companies and ETFs. I agree that you don't need many to be diversified, in fact, you may end up less diversified if you acquire a collection instead of the above. The 3 Vanguard funds mentioned are just as efficient as their ETFs, and are really the same.

With 5k, you could do 3k total International and add 2k to total stock market, as an example. I agree that you need to check out the 403b account. Perhaps it is just the matching that you don't get if you choose the pension. If available, look for a list of funds and their ERs, which are often quite high, compared to Vanguard funds.

asif408
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Re: How can I use ETFs to further diversify my taxable account?

Post by asif408 » Fri Jun 05, 2015 2:22 pm

A couple of points mildly in favor of the ETFs in a taxable account:

1) Assuming you are at Vanguard, ETF shares are not subject to Vanguard frequent trading policy: https://personal.vanguard.com/us/whatwe ... tionpolicy:

"If you sell or exchange shares of a Vanguard fund, you will not be permitted to buy or exchange back into the same fund, in the same account, within 60 calendar days.

However, this rule does not apply to:

Vanguard money market and short-term bond funds.
Vanguard ETF® Shares."


If you desire this flexibility ETF shares would be preferable. I wouldn't suggest frequent trading but if you need to move things around and make a mistake it's nice to know you wouldn't have to wait 60 days to buy into the fund again.

2) If you will have less than the limit for Admiral shares ($10,000/fund) it would be slightly cheaper to hold the ETFs. And I believe the bid/ask spread cost is exaggerated here. Particularly if you buy the ETF at a discount to NAV.

zayd13
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Re: How can I use ETFs to further diversify my taxable account?

Post by zayd13 » Sat Jun 06, 2015 10:13 am

Thanks all of you for your advice as well as the reading materials. I'm learning more about ETFs and taking it all in.

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