What to do with active funds in taxable in current market?

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kacang
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What to do with active funds in taxable in current market?

Post by kacang » Wed Dec 19, 2018 7:03 pm

We have ~350k of active funds in our taxable account (eg. Wellington VWENX, Primecap VPMAX) which was a rookie error. I have since learned about 3-fund portfolio & tax-efficiency and have been thinking for a while about what to do about it. Which of the following do you think makes most sense?

1. They are showing a loss in the current market, mostly long term. Sell it now for tax loss and invest in VTSAX. Tax loss benefit may be greatest this year (expected marginal tax rate 37% & we have some long term capital gain from selling company stock), and we solve the tax-inefficiency once and for all. But that means we eat the loss.

2. Wait for the loss to lessen over the next few years. Tax loss benefit will lessen, as marginal tax rate will also be lower, 32-35% in 2019-2024, once I retire next year.

3. Our original plan. We expect our marginal tax rates to be 22-24% post-2024, as DH plans to retire then. We can withdraw from these active funds first for our expenses. This gives the funds a chance to regain and only long term capital gains will be paid on the withdrawal.

Are there any other option I may have missed? Thanks!

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whodidntante
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Re: What to do with active funds in taxable in current market?

Post by whodidntante » Wed Dec 19, 2018 7:06 pm

You do not want to own active funds in taxable in a downtrending market. In addition to your losses, active funds generate wicked capital gains distributions once they run out of losers to sell to offset realized gains.

I would put in the sell order tonight. The market could jump 20% next year and then you'll be in a pickle.

Immediately reinvest in equity index ETFs.

livesoft
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Re: What to do with active funds in taxable in current market?

Post by livesoft » Wed Dec 19, 2018 7:10 pm

Don't wait for losses to go away. Sell them and realize the losses. To do otherwise would be crazy (as in insane). If you like, wait until the first week of January 2019 to sell if you don't want to offset LTCG that you have already realized.
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grabiner
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Re: What to do with active funds in taxable in current market?

Post by grabiner » Wed Dec 19, 2018 9:33 pm

kacang wrote:
Wed Dec 19, 2018 7:03 pm
3. Our original plan. We expect our marginal tax rates to be 22-24% post-2024, as DH plans to retire then. We can withdraw from these active funds first for our expenses. This gives the funds a chance to regain and only long term capital gains will be paid on the withdrawal.
You will still be paying 15% tax on your capital gain even at those tax rates. In theory, it could make sense to wait to take a capital gain if it would be tax-free. (In practice, I wouldn't wait six years even for that; you can only take a limited amount of tax-free gains, and your gains might be more than that.)

If the market recovers between now and 2024, these funds will recover, but so will any replacement funds you buy. Therefore, you would be better off selling in 2018 (or 2019 if the capital loss will be more valuable then), as you expect to have a smaller capital gain, and pay less in tax along the next six years. (And if the market drops instead, you can sell in 2020 for another capital loss.)
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drzzzzz
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Re: What to do with active funds in taxable in current market?

Post by drzzzzz » Wed Dec 19, 2018 9:36 pm

Other options to consider other than selling and paying the taxes - I have gifted shares to family members in lower tax brackets since the shares are gifted with my tax basis and if they decide to sell the tax consequences are lower; II sell any losers for tax loss harvesting; and have donated appreciated shares in active funds that have large distributions coming up to a donor advised fund.

OldSport
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Re: What to do with active funds in taxable in current market?

Post by OldSport » Wed Dec 19, 2018 10:33 pm

kacang wrote:
Wed Dec 19, 2018 7:03 pm
We have ~350k of active funds in our taxable account (eg. Wellington VWENX, Primecap VPMAX) which was a rookie error. I have since learned about 3-fund portfolio & tax-efficiency and have been thinking for a while about what to do about it. Which of the following do you think makes most sense?

1. They are showing a loss in the current market, mostly long term. Sell it now for tax loss and invest in VTSAX. Tax loss benefit may be greatest this year (expected marginal tax rate 37% & we have some long term capital gain from selling company stock), and we solve the tax-inefficiency once and for all. But that means we eat the loss.

2. Wait for the loss to lessen over the next few years. Tax loss benefit will lessen, as marginal tax rate will also be lower, 32-35% in 2019-2024, once I retire next year.

3. Our original plan. We expect our marginal tax rates to be 22-24% post-2024, as DH plans to retire then. We can withdraw from these active funds first for our expenses. This gives the funds a chance to regain and only long term capital gains will be paid on the withdrawal.

Are there any other option I may have missed? Thanks!
Vanguard Primecap is an excellent fund closed to new investors that has outperformed practically everything over the long term. I know actively managed funds are against purist BH philosophy, but I would consider holding on to Primecap, unless they changed their managemenet, investing strategy/philosophy. If I could, I would certainly hold some.

Wellesley and Wellington are the only actively managed VG funds I presently own. I would add Primecap if I could. They are very well managed for what they are. Wellington has beat the pants off of lifecycle funds of similar asset allocation over the long term.

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kacang
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Re: What to do with active funds in taxable in current market?

Post by kacang » Thu Dec 20, 2018 12:12 pm

Thanks for the comments, it helps me to think more clearly.
grabiner wrote:
Wed Dec 19, 2018 9:33 pm
You will still be paying 15% tax on your capital gain even at those tax rates. In theory, it could make sense to wait to take a capital gain if it would be tax-free. (In practice, I wouldn't wait six years even for that; you can only take a limited amount of tax-free gains, and your gains might be more than that.)

If the market recovers between now and 2024, these funds will recover, but so will any replacement funds you buy. Therefore, you would be better off selling in 2018 (or 2019 if the capital loss will be more valuable then), as you expect to have a smaller capital gain, and pay less in tax along the next six years. (And if the market drops instead, you can sell in 2020 for another capital loss.)
That makes sense. I'm also grateful for the pointer about STCG v LTCG (which livesoft also mentioned, thanks!). I tallied up our CG tax rates, wow. I knew we pay high taxes but DH files the taxes, so I was not aware of all the numbers. After NITT, STCG will be roughly 40%, LTCG 25% for 2018-2024. We have realized significant LTCG due to company stock sale this year (fixing another rookie error of holding vested stock, but luckily we don't work for GE), so I should wait till 2019 to TLH these funds. Will investigate if there is TLH for state tax (CA).
OldSport wrote:
Wed Dec 19, 2018 10:33 pm
Vanguard Primecap is an excellent fund closed to new investors that has outperformed practically everything over the long term. I know actively managed funds are against purist BH philosophy, but I would consider holding on to Primecap, unless they changed their managemenet, investing strategy/philosophy. If I could, I would certainly hold some.

Wellesley and Wellington are the only actively managed VG funds I presently own. I would add Primecap if I could. They are very well managed for what they are. Wellington has beat the pants off of lifecycle funds of similar asset allocation over the long term.
Their impressive past performance was what that attracted me too. Unfortunately I have learned that the taxable account is a terrible place to have them at our tax bracket. I have a small token stake in Primecap in my Roth, so that should keep our status as existing investor if I get rid of them in our taxable. I would consider buying them in my Roth but keep them to <5% of total assets, as part of our experiment stash.

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grabiner
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Re: What to do with active funds in taxable in current market?

Post by grabiner » Thu Dec 20, 2018 6:59 pm

kacang wrote:
Thu Dec 20, 2018 12:12 pm
Will investigate if there is TLH for state tax (CA).
CA follows the federal rules for offsetting gains and losses, but does not distinguish short-term from long-term gains; all capital gains in CA are taxed at your full rate. Thus you get a CA state benefit from tax loss harvesting.

(CA does have a form for reporting capital gain and loss adjustments, in case you have a gain treated differently by CA. For example, if you have an HSA, capital gains in that account are taxed by CA, and capital losses can be harvested there against your CA tax.)
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kacang
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Re: What to do with active funds in taxable in current market?

Post by kacang » Thu Dec 20, 2018 8:00 pm

Thanks!! Thus our federal + state STCG is ~50%, LTCG ~35%. Ouch. A good problem to have, but we should have paid more attention to tax issues.

kaboora
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Re: What to do with active funds in taxable in current market?

Post by kaboora » Fri Dec 21, 2018 10:24 am

whodidntante wrote:
Wed Dec 19, 2018 7:06 pm
You do not want to own active funds in taxable in a downtrending market. In addition to your losses, active funds generate wicked capital gains distributions once they run out of losers to sell to offset realized gains.

I would put in the sell order tonight. The market could jump 20% next year and then you'll be in a pickle.

Immediately reinvest in equity index ETFs.
why ETFs ? Why not index funds ?

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whodidntante
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Re: What to do with active funds in taxable in current market?

Post by whodidntante » Fri Dec 21, 2018 10:42 am

kaboora wrote:
Fri Dec 21, 2018 10:24 am
whodidntante wrote:
Wed Dec 19, 2018 7:06 pm
You do not want to own active funds in taxable in a downtrending market. In addition to your losses, active funds generate wicked capital gains distributions once they run out of losers to sell to offset realized gains.

I would put in the sell order tonight. The market could jump 20% next year and then you'll be in a pickle.

Immediately reinvest in equity index ETFs.
why ETFs ? Why not index funds ?
ETFs can shed appreciated shares through the redemption process, so a well run fund that trades actively is much less likely to distribute capital gains. This allows you to defer tax for a longer time, in many cases for as long as you hold the ETF. A mutual fund has to trade in order to raise cash to meet redemptions, perhaps realizing net capital gains that they distribute to shareholders. Just to make things as confusing as possible, Vanguard has a few mutual funds that have an ETF share class, so those funds get some of the tax advantages according to the ETF redemption volume.

Blackrock has proven to be a tax efficient low cost provider of ETFs, best in class. Their "core" line is interesting for a lot of Bogleheads. State Street has a significantly worse tax efficiency record.

noco-hawkeye
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Re: What to do with active funds in taxable in current market?

Post by noco-hawkeye » Fri Dec 21, 2018 10:46 am

whodidntante wrote:
Wed Dec 19, 2018 7:06 pm
You do not want to own active funds in taxable in a downtrending market. In addition to your losses, active funds generate wicked capital gains distributions once they run out of losers to sell to offset realized gains.

I would put in the sell order tonight. The market could jump 20% next year and then you'll be in a pickle.

Immediately reinvest in equity index ETFs.
+1 - Though I don't think ETFs vs funds is going to be the end of the world. If you prefer the mutual fund version, I think the difference is going to be relatively small over the long run.

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