Reducing my overall leverage?

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Enphuego
Posts: 13
Joined: Mon Oct 24, 2011 3:53 pm

Reducing my overall leverage?

Post by Enphuego » Tue Oct 03, 2017 5:39 pm

A brief history: Over the past years I've been maxing out my tax advantaged options. Despite a good savings rate, it always seems like there's more tax advantaged space to be filled than savings to fill them with. I started saving in 2010 or so and 2014 was the first year I really managed to get everything maxed out and 2015 I managed to fill up 2014's IRAs, my 457b and almost filled up the 2015 IRAs before 2016 started. However I started some catchup contributions on my pension plan at $2k a month for 2016 and 2017 which is finally fading this December. I managed to max out 2016's accounts, but my 457b is basically going to be nothing but the funds to get the employer match this year.

I've also got a small house worth maybe $600k and a mortgage of $300k on it at 3.25% interest with 26 years left. I've got $200k in investments - 10% Short Term US bond fund, 10% REIT, 25% International, 10% S&P500 45% Small Cap Value (all low fee index funds). My current marginal tax rate is 15% federal + 4% state and I'm unsure what my retirement rate will be, but I expect to be able to fill the 10% bracket. I'm currently 36 and the plan is to be financially independent around 40ish with a paid off house somewhere. My pension plan kicks in at 50 and would cover $1,600 a month adjusted for inflation. Planned expenses are $2000 a month so I'd probably need enough to cover $400 a month and enough money to get me through the first 10 years. I realize it's a pretty non-traditional plan but if it falls short for some reason a couple more years worked will rapidly close any gaps.

I've got two financial goals that I've had to put on hold - an experiment in value investing that's been working out better than expected and building an I-bond ladder to hold my emergency fund. Also, I've burned through my emergency fund and need to rebuild it once my cash flow returns to normal. In case of a big emergency, I have Roth contributions, credit card limits and 457b loans so I'm not tremendously worried, but getting back to a reasonable cash position is a definite priority. I've also got $3k in I-bonds that will gradually become liquid through May of next year.

The main problem is that what's best for me from a tax perspective isn't aligned with where I want to be for investments. I really want to have a 6 month cushion in I-bonds and I'd much rather pay down my mortgage than buy new stocks at the current prices. I want to continue my value investing experiment since the time weighted return was 35% in 2016 and 32% in 2017. However that relies on using a taxable Robinhood account for zero trade fees - the $5 fees at Schwab would eat into my returns unless I scaled up more than I find sensible. Doing those things means that I'd be taking a pass on tax advantaged space.

I've come up with a couple of options to try to capture the tax advantaged space while overall reducing my leverage but I'm wondering if I should just forget about it and start investing in the way that makes sense to my personal situation instead of trying to optimize for tax avoidance. It seems odd to just let tax advantaged space pass by unused.

Perhaps there's some way to have my cake and eat it too here but I'm just not seeing it.

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Pajamas
Posts: 2563
Joined: Sun Jun 03, 2012 6:32 pm

Re: Reducing my overall leverage?

Post by Pajamas » Tue Oct 03, 2017 6:51 pm

It's important to manage taxes, but it is best to manage them for the long term and within the context of your overall financial planning rather than primarily for the current year. Being overly-focused on taxes and allowing that to be the primary factor in everything financial is generally not going to produce the best outcomes overall. If you are foregoing tax-advantaged space to play around with value investing or to set up an I-bond ladder because you like I-bond ladders when you have plenty of other assets to draw on in an emergency, you are more likely than not making a mistake for long-term tax planning. If $5 fees make your value investing experiment not worthwhile, it's just not worthwhile in the grand scheme of things. Honestly, it sounds more like a hobby. Nothing wrong with that but you are probably letting the tax tail wag the investing dog.

People like to retire at the end of the year but I always encourage them to work just a few more months into the new year and direct their entire salary into tax-advantaged accounts. It gives a real boost to retirement finances. That's how important tax-advantaged space is.

Enphuego
Posts: 13
Joined: Mon Oct 24, 2011 3:53 pm

Re: Reducing my overall leverage?

Post by Enphuego » Tue Oct 03, 2017 7:11 pm

As far as tax planning, I'm keeping myself within the 15% tax bracket. There's not really a lot of room for optimization there - I'm paying 15% now and I'll probably be paying 15% later. Getting down to the 10% bracket in retirement may be possible, but it's only a 5% benefit. It's probably more likely that I'll end up paying 25% at some point, so I'm choosing to pay taxes up front when everything else is equal on the off chance that I end up continuing to work past 40.

The value investing plan has been to start out with $100 a month, make real trades and increase it every 6 months if the performance actually beats the S&P500. It's been two years now of steady out performance and I'd like to go up to $400 a month. It may be a hobby to some, but there are real people out there really doing this and I've done a ton of reading on the subject. The problem is that a $5 trade fee on $400 is an instant 1.2% drag. The number one thing I can do to improve performance is not pay that fee. I could bump the monthly amount to a bigger number, but then I'd be biting into this harder than I want to without an established track record. I'm trying to be objective and limit my risk here, but the upside to value investing is a lot more than small change over the next 50 years that I'll be alive. If it pans out (and that's a big if) then it could make a big difference in my life. Only time will tell and I need more data.

In any event the primary driver is that I'd rather not be heavily leveraged whenever the next crash comes along so I'm trying to figure out how to get rid of this $300k of borrowed money.

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Earl Lemongrab
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Joined: Tue Jun 10, 2014 1:14 am

Re: Reducing my overall leverage?

Post by Earl Lemongrab » Wed Oct 04, 2017 4:41 pm

Enphuego wrote:
Tue Oct 03, 2017 7:11 pm
The value investing plan has been to start out with $100 a month, make real trades and increase it every 6 months if the performance actually beats the S&P500. It's been two years now of steady out performance and I'd like to go up to $400 a month. It may be a hobby to some, but there are real people out there really doing this and I've done a ton of reading on the subject. The problem is that a $5 trade fee on $400 is an instant 1.2% drag.
What size portfolio are you working with? Merrill Edge has free equity trades with some tiers of their Preferred Rewards program, either 30/month or 100/month depending on level.
In any event the primary driver is that I'd rather not be heavily leveraged whenever the next crash comes along so I'm trying to figure out how to get rid of this $300k of borrowed money.
Why? If your only leverage is a mortgage, you don't have to worry about margin calls.
This week's fortune cookie: "The stock market may be your ticket to success." I sure hope so!

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