Unintended overallocation in taxable with high capital gains, how to get back to AA?

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Topic Author
miasma
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Unintended overallocation in taxable with high capital gains, how to get back to AA?

Post by miasma »

Prior to learning more about the boglehead way, I invested a good chunk of my taxable to a tech-focused mutual fund (FSCSX). In general, it's paid off since the fund has performed well. But, I'd prefer to be better diversified and primarily in low-cost, total market index funds. This fund now has substantial gains and I'm concerned about selling it to take the capital gains hit. It represents about 11% of my total portfolio (taxable and tax-advantaged) and has gains in the low 6 figures.

What strategy should I use to draw myself closer to my target AA in my taxable?

Details:
Age: 40

Desired AA: 90/10

Taxable:
11%, FIDELITY SELECT SOFTWARE & IT SRVC (FSCSX), ER 0.71
13%, FIDELITY TOTAL MARKET INDEX FUND (FSKAX) ER 0.015
13%, FIDELITY 500 INDEX FUND (FXAIX), ER 0.015
1.5%, FIDELITY INTERNATL INDEX FUND (FSPSX), ER 0.035
5%, FIDELITY TOTAL INTL INDEX FUND (FTIHX), ER 0.06
5.5%, FIDELITY MUNICIPAL BOND INDEX FUND (FMBIX), ER 0.07

The US Market (FSKAX, FXAIX) and International Market (FSPSX, FTIHX) are both there primarily for TLH purposes.

Unfortunately, I didn't configure my settings for my cost basis tracking to be actual cost until later, so the cost basis for the FSCSX is average cost (all the same for all shares). I stopped purchasing this fund back in 2018. I set distributions to go to core account. My current strategy has been to just leave this be and place new automatic investments in my desired funds.

FSCSX has a 23% turnover rate, and distributes both dividends and capital gains twice a year (capital gains can be significant)

Given that total US market is already tech-heavy, I'm a bit concerned about what would happen if tech funds took a significant hit in the future.

Ideally, I'd love to diversify, but I don't want to take a hit on the capital gains. I'm already at a high tax rate. I'm considering in future years doing a career change and I may take a year off or so in the process, creating an opportunity for a low income year, but that's not set really. I'm also filing Single, and in the future I may be MFJ or MFS. So my main questions are:

Questions:
1) Should I sell these mutual funds as soon as possible? Do it over time? Hold until a specific event/condition? Never?
2) Is a 11% tilt to tech that bad?
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happenstance
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Re: Unintended overallocation in taxable with high capital gains, how to get back to AA?

Post by happenstance »

I think you are right to get out of the tech-focused fund and are being wise about the taxes.

The first thing to do would be to see if any of your taxable positions have lots with unrealized losses. You can realize those losses (i.e. tax loss harvest), use that loss to offset gains from selling FSCSX, and put the proceeds into a similar but not substantially identical fund.

Once you reach the limit of your losses, you should compare the annual tax drag of FSCSX’s distributions to the tax you’d have to pay on liquidating everything now. Since you say the annual distributions for FSCSX are on the high side, it may make more sense to just lock in your gain, bite the tax bullet, and switch over to a total market index fund. I would look at it this way: if the value of the fund stayed the same, how many years of distributions would be equal to the capital gain if you were to sell it all now?

Another option would be to gift some of the shares to charity, which you can deduct at the current value on your income. Having a donor advised fund makes this easy.
Topic Author
miasma
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Re: Unintended overallocation in taxable with high capital gains, how to get back to AA?

Post by miasma »

Thanks for the insight!
happenstance wrote: Sun Oct 04, 2020 3:03 pm The first thing to do would be to see if any of your taxable positions have lots with unrealized losses. You can realize those losses (i.e. tax loss harvest), use that loss to offset gains from selling FSCSX, and put the proceeds into a similar but not substantially identical fund.
Unfortunately no lots have unrealized losses due to being late for how to model the cost basis. So all lots have the same +117.43% gain. The only way lots would have unrealized losses if it the whole fund tanked by that amount.

happenstance wrote: Sun Oct 04, 2020 3:03 pm Once you reach the limit of your losses, you should compare the annual tax drag of FSCSX’s distributions to the tax you’d have to pay on liquidating everything now. Since you say the annual distributions for FSCSX are on the high side, it may make more sense to just lock in your gain, bite the tax bullet, and switch over to a total market index fund. I would look at it this way: if the value of the fund stayed the same, how many years of distributions would be equal to the capital gain if you were to sell it all now?
Hrmm, that's somewhat interesting to see. How would I go about doing that? Just look at the history of dividend and capital gains by % of NAV?
Dividends:
Date Per Share Amount Reinvestment Price
4/08/20 $0.15 $18.15
12/20/19 $0.034 $19.86
4/12/19 $0.011 $17.87
12/14/18 $0.006 $16.87

Capital Gains:
Date Per Share Amount Reinvestment Price
4/08/20 $0.409 $18.15
12/20/19 $0.579 $19.86
4/12/19 $1.893 $17.87
12/14/18 $0.668 $16.87
happenstance wrote: Sun Oct 04, 2020 3:03 pm Another option would be to gift some of the shares to charity, which you can deduct at the current value on your income. Having a donor advised fund makes this easy.
I hadn't considered this. But overall isn't this a loss? Like, if I donated $30k worth (total gain of $15k), and I had say like a .33 marginal tax rate, then I'd pay $10k less in taxes but be out $30k - ($15k * 0.15) = $27,750, no? Didn't I just lose $17,750 this way?
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happenstance
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Re: Unintended overallocation in taxable with high capital gains, how to get back to AA?

Post by happenstance »

miasma wrote: Sun Oct 04, 2020 3:38 pm Unfortunately no lots have unrealized losses due to being late for how to model the cost basis. So all lots have the same +117.43% gain. The only way lots would have unrealized losses if it the whole fund tanked by that amount.
Do you have losses on any of your funds in taxable, not just FSCSX?
Hrmm, that's somewhat interesting to see. How would I go about doing that? Just look at the history of dividend and capital gains by % of NAV?
Dividends:
If you haven’t added to the fund in several years, the easiest thing to do would be to take the average of the last few years’ distributions, and use that as an estimate for future income. Your broker probably breaks that out on the annual 1099-DIV. Otherwise, you shouldn’t need to worry about % of NAV; just multiply the per-share distribution by the number of shares you have to get the amount of total income.
I hadn't considered this. But overall isn't this a loss? Like, if I donated $30k worth (total gain of $15k), and I had say like a .33 marginal tax rate, then I'd pay $10k less in taxes but be out $30k - ($15k * 0.15) = $27,750, no? Didn't I just lose $17,750 this way?
It’s a loss if you don’t plan on donating that much to charity. But one of the advantages of donor advised funds is bunching contributions [PDF], where you donate a large sum one year to get the deduction, then effect grants from it over several years. So if you typically give $7,500/year in charity, that one donation is four years worth of contributions.
Topic Author
miasma
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Re: Unintended overallocation in taxable with high capital gains, how to get back to AA?

Post by miasma »

miasma wrote: Sun Oct 04, 2020 12:10 pm Taxable:
11%, FIDELITY SELECT SOFTWARE & IT SRVC (FSCSX), ER 0.71
13%, FIDELITY TOTAL MARKET INDEX FUND (FSKAX) ER 0.015
13%, FIDELITY 500 INDEX FUND (FXAIX), ER 0.015
1.5%, FIDELITY INTERNATL INDEX FUND (FSPSX), ER 0.035
5%, FIDELITY TOTAL INTL INDEX FUND (FTIHX), ER 0.06
5.5%, FIDELITY MUNICIPAL BOND INDEX FUND (FMBIX), ER 0.07

The US Market (FSKAX, FXAIX) and International Market (FSPSX, FTIHX) are both there primarily for TLH purposes.
As an update, I went by the suggestion here to sell to match against my previous TLH across my portfolio (luckily I did some of that this year during the big drop in March), so I'm now looking at:

9%, FIDELITY SELECT SOFTWARE & IT SRVC (FSCSX), ER 0.71
16%, FIDELITY TOTAL MARKET INDEX FUND (FSKAX) ER 0.015
13%, FIDELITY 500 INDEX FUND (FXAIX), ER 0.015
1.5%, FIDELITY INTERNATL INDEX FUND (FSPSX), ER 0.035
5%, FIDELITY TOTAL INTL INDEX FUND (FTIHX), ER 0.06
5.5%, FIDELITY MUNICIPAL BOND INDEX FUND (FMBIX), ER 0.07

Basically all its resulted in is a 2.5% shift-ish from FSCSX to FSKAX. Suggestions of what to do next? I'd rather not take the tax hit, even if it is 15% for LTCG.
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happenstance
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Re: Unintended overallocation in taxable with high capital gains, how to get back to AA?

Post by happenstance »

miasma wrote: Fri Oct 16, 2020 8:44 pm Basically all its resulted in is a 2.5% shift-ish from FSCSX to FSKAX. Suggestions of what to do next? I'd rather not take the tax hit, even if it is 15% for LTCG.
You could dollar-cost average out of the fund over the next several years, taking a small tax hit by doing so but amortizing it. That would also give you some time to see if more capital losses can be realized in the future. There are really only two options: really to hold and wait or sell and take the tax hit. Dollar-cost averaging is kind of a middle ground between those.
LuckyGuy
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Re: Unintended overallocation in taxable with high capital gains, how to get back to AA?

Post by LuckyGuy »

Haven’t you paid capital gains on this fund every year thus your basis is large?
Topic Author
miasma
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Re: Unintended overallocation in taxable with high capital gains, how to get back to AA?

Post by miasma »

happenstance wrote: Sat Oct 17, 2020 4:20 pm
miasma wrote: Fri Oct 16, 2020 8:44 pm Basically all its resulted in is a 2.5% shift-ish from FSCSX to FSKAX. Suggestions of what to do next? I'd rather not take the tax hit, even if it is 15% for LTCG.
You could dollar-cost average out of the fund over the next several years, taking a small tax hit by doing so but amortizing it. That would also give you some time to see if more capital losses can be realized in the future. There are really only two options: really to hold and wait or sell and take the tax hit. Dollar-cost averaging is kind of a middle ground between those.
True, I guess I'm back to asking whether a 9% tilt to a this computer sector is that bad in the whole scheme of things. As I continue to contribute, the % should effectively reduce (unless for whatever reason FSCSX does astronomically better than the rest of my portfolio). How can I test my feeling about the 9% tilt?
retiredjg
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Re: Unintended overallocation in taxable with high capital gains, how to get back to AA?

Post by retiredjg »

miasma wrote: Sun Oct 04, 2020 12:10 pm Ideally, I'd love to diversify, but I don't want to take a hit on the capital gains. I'm already at a high tax rate.
If you were offered a higher paying job that offered you something you wanted, would you refuse it because you didn't want to pay more in taxes? Probably not.

Thes capital gains are the same thing. You have made money. Right now, those gains are unrealized so you have not paid taxes on that income yet. Right now, you have the opportunity to get something you want and all you have to do is pay tax on some income you have already made.

See how dumb is is to avoid taxes on this? If you avoid the taxes, you don't get something you want - a lower allocation to the high cost, tax-inefficient, and risky fund that you would rather have less of.

The capital gains will not increase your tax rate. Yes, it will increase your tax dollars, but not the rate. You will pay 15% on it (maybe more if you are subject to NIIT) but it will not push you into a higher tax bracket on your other income.

With an ER like that, you are paying extra every year. You are also paying every year on dividends and capital gains distributions.

Just dump it.
JoinToday
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Re: Unintended overallocation in taxable with high capital gains, how to get back to AA?

Post by JoinToday »

How close are you to NIIT ($200K taxable income if single, $250K taxable income if married)? NIIT carries an additional 3.8% tax burden.

If I were you, I would either just sell it all right now, or possibly split it up so half the gains are in this year, half in January 2021 if it makes a difference with respect to NIIT. Just rip the bandage off & get it done. Put this behind you. BUT: try to get some idea of how much is short term capital gains, and how much is LTCG. I would be inclined to wait if I had a large amount with STCG, if waiting a month or two would change to LTCG.

I am assuming you are above the 12% tax bracket, so any capital gains will be taxed at 15% minimum. But the penalty for more capital gains is not too severe. Can you switch to specific cost basis even if it was previously average cost basis?
I wish I had learned about index funds 25 years ago
Topic Author
miasma
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Re: Unintended overallocation in taxable with high capital gains, how to get back to AA?

Post by miasma »

JoinToday wrote: Sat Oct 17, 2020 4:58 pm How close are you to NIIT ($200K taxable income if single, $250K taxable income if married)? NIIT carries an additional 3.8% tax burden.

If I were you, I would either just sell it all right now, or possibly split it up so half the gains are in this year, half in January 2021 if it makes a difference with respect to NIIT. Just rip the bandage off & get it done. Put this behind you. BUT: try to get some idea of how much is short term capital gains, and how much is LTCG. I would be inclined to wait if I had a large amount with STCG, if waiting a month or two would change to LTCG.

I am assuming you are above the 12% tax bracket, so any capital gains will be taxed at 15% minimum. But the penalty for more capital gains is not too severe. Can you switch to specific cost basis even if it was previously average cost basis?
I'm hitting NIIT, yes -- but as above, all of the gains from this are LTCG, I haven't purchased more of this fund in years. I cannot reset the cost basis, I've already switched to use specific cost basis but that doesn't impact things retroactively, so all previous lots use average cost basis.
Katietsu
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Re: Unintended overallocation in taxable with high capital gains, how to get back to AA?

Post by Katietsu »

miasma wrote: Sat Oct 17, 2020 5:13 pm I'm hitting NIIT, yes -- but as above, all of the gains from this are LTCG, I haven't purchased more of this fund in years. I cannot reset the cost basis, I've already switched to use specific cost basis but that doesn't impact things retroactively, so all previous lots use average cost basis.
I am confused by this. There are no lots using average cost basis until you sell. Even if you never specified and therefore have a statement defaulting to average cost basis, this can be changed if you have never sold shares. Now, apparently you have sold shares since starting this thread. Were those done as specific tax lot or average basis?

Also, I just looked at the price of this mutual fund over the last decade. Are you sure that your capital gain if you sold it all would be as high as you stated? Want to make sure number you gave is not your total investment gain as opposed to your unrealized capital gain. I have no idea how much you invested when. The capital gains if you sold everything in the same year=Net sales proceeds-purchases from outside funds- dividends reinvested - capital gains reinvested.
Topic Author
miasma
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Re: Unintended overallocation in taxable with high capital gains, how to get back to AA?

Post by miasma »

Katietsu wrote: Sat Oct 17, 2020 5:32 pm
miasma wrote: Sat Oct 17, 2020 5:13 pm I'm hitting NIIT, yes -- but as above, all of the gains from this are LTCG, I haven't purchased more of this fund in years. I cannot reset the cost basis, I've already switched to use specific cost basis but that doesn't impact things retroactively, so all previous lots use average cost basis.
I am confused by this. There are no lots using average cost basis until you sell. Even if you never specified and therefore have a statement defaulting to average cost basis, this can be changed if you have never sold shares. Now, apparently you have sold shares since starting this thread. Were those done as specific tax lot or average basis?

Also, I just looked at the price of this mutual fund over the last decade. Are you sure that your capital gain if you sold it all would be as high as you stated? Want to make sure number you gave is not your total investment gain as opposed to your unrealized capital gain. I have no idea how much you invested when. The capital gains if you sold everything in the same year=Net sales proceeds-purchases from outside funds- dividends reinvested - capital gains reinvested.
The cost basis per share is the same for all lots. When I purchased the shares, I had not set any cost basis tracking -- and so I believe Fido set it to average cost basis tracking. I have since set it to actual cost basis tracking, but have not purchased any shares since. All previous lots still share the average cost basis per share tracking method. When I sold shares, I sold specific shares but did First-In First-Out (FIFO). I guess I could call Fido and see if they can adjust the tracking method - https://www.fidelity.com/tax-informatio ... cost-basis .

Total gain is in low six figures. Last purchase of this mutual fund was in 2018, first was in 2013. All lot terms are long-term.
retiredjg
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Re: Unintended overallocation in taxable with high capital gains, how to get back to AA?

Post by retiredjg »

All your gains may not be long term if you are investing dividends. However, the short term gain shares should not be very many.
Topic Author
miasma
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Re: Unintended overallocation in taxable with high capital gains, how to get back to AA?

Post by miasma »

retiredjg wrote: Sat Oct 17, 2020 7:22 pm All your gains may not be long term if you are investing dividends. However, the short term gain shares should not be very many.
Nope, I changed the dividends and capital gains to deposit into core account, not reinvest over a year ago.
Katietsu
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Re: Unintended overallocation in taxable with high capital gains, how to get back to AA?

Post by Katietsu »

miasma wrote: Sat Oct 17, 2020 7:12 pm The cost basis per share is the same for all lots. When I purchased the shares, I had not set any cost basis tracking -- and so I believe Fido set it to average cost basis tracking. I have since set it to actual cost basis tracking, but have not purchased any shares since. All previous lots still share the average cost basis per share tracking method. When I sold shares, I sold specific shares but did First-In First-Out (FIFO). I guess I could call Fido and see if they can adjust the tracking method - https://www.fidelity.com/tax-informatio ... cost-basis .

Total gain is in low six figures. Last purchase of this mutual fund was in 2018, first was in 2013. All lot terms are long-term.
If you have only sold shares by specifying FIFO, then you have never sold using average cost basis. Therefore, your cost basis is not the same for each lot. It is very possible that you can not see the actual cost basis per lot. But from an IRS perspective, you are not stuck with average cost basis until you sell using, or allowing, a default to average cost basis.

What was your reasoning for using FIFO? This gets you the highest capital gain per share. If you instead sell the shares with the smallest gains per share, you reduce your exposure and expenses for a lot less tax cost.
lakpr
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Re: Unintended overallocation in taxable with high capital gains, how to get back to AA?

Post by lakpr »

It is also my understanding that brokerages must track the specific ID basis tracking, by law, since 2012, whether or not the client chooses to do so. The legal term is "covered shares". If all shares have been bought since 2013 and at Fidelity and not transferred from elsewhere, I refuse to take the assertion that all shares have the same cost basis, at face value.

Yes, specific ID basis tracking can be retroactive you may just need to press Fidelity for it.
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Re: Unintended overallocation in taxable with high capital gains, how to get back to AA?

Post by Outer Marker »

miasma wrote: Fri Oct 16, 2020 8:44 pm I'd rather not take the tax hit, even if it is 15% for LTCG.
I'd pay the modest tax and move to your desired AA. The potential losses from being over-exposed in what appears to be a tech bubble are much higher than the tax. Further, I would look at it as "tax gain harvesting" which is actually a thing. Many expect LTCG to be higher in the next administration and going forward, and so are realizing gains now to avoid paying them in the future.
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happenstance
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Re: Unintended overallocation in taxable with high capital gains, how to get back to AA?

Post by happenstance »

miasma wrote: Sat Oct 17, 2020 4:43 pm True, I guess I'm back to asking whether a 9% tilt to a this computer sector is that bad in the whole scheme of things. As I continue to contribute, the % should effectively reduce (unless for whatever reason FSCSX does astronomically better than the rest of my portfolio). How can I test my feeling about the 9% tilt?
It’s often quoted here that 10% is the minimum allocation to make a modest difference in outcomes, so while not large it’s also not insignificant. I agree with the others: if it were me, I’d just sell now, pay the tax, and stop thinking about it. Just set aside some of the sale proceeds to pay the tax next year.
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