My effective marginal tax rate for ordinary/STCG income is very high: 43.8% federal + 10% state+local (considering NIIT, AMT and phaseouts). Very little tax-advantaged space.
The Bogleheads forum and wiki (e.g., managing a windfall, tax-efficient fund placement) have been extremely helpful in assessing the situation. It seems that my circumstances, above, makes things especially tricky.
I've considered the following options:
- Short-term treasury ETF (e.g., VGSH/SCHO). Matches my time horizon, but my after-tax yield is about %1.30, well less than inflation. (Similarly for short-term TIPs ETF, or individual bonds.)
- Intermediate/long-term muni fund in my state. After-tax yield is 2.2%, but effective duration is about 7 years. So high interest+call rate risk, under-diversified, and a bit of credit risk. (Going for national munis like VTEB would decrease after-tax yield to %1.87; national short-term like VMLUX, to just %1.54.)
- Domestic equity (e.g., VTI/SCHB). Good in diversification, tax efficiency and expected returns, but poor match for my 2-5 investment horizon. Especially with the widespead sentiments about an overstretched economic cycle (yeah, market timing, shoot me now).
- Residential REITs. I would love to get exposure to residential real-estate now, to roughly match the future liability. Put otherwise, given my major real-estate purchase in the future, I'm effectively short real-estate now and would like to remedy that. But REITs are notoriously tax-inefficient. They're also over-exposed to interest rate risk, which I'd already have plenty of with above bonds.
The little tax-advantaged space I have is already filled up with residential REITs. No good ETF here: they all have high expense ratios, wrong composition and/or low liquidity. So I went over the stock holdings of the REZ Residential REIT ETF, filtered out the weird stuff like mobile homes, and bought the top dozen stocks weighted by market cap. I was hoping that home construction ETFs, like ITB and XHB, would be a good proxy for residential real estate, but the correlation seems low.
- I could look for idiosyncratic non-brokered investments, such as local real estate (perhaps in a qualified opportunity zone!). But I have neither the experience nor the time to judge and manage such investments.
So... What to do?
I'm currently parked in mostly short-term treasuries, and while I got lucky with the recent drop in fed rates, I wouldn't want to get negative after-tax real yield over several years.