Breakeven on selling high ER funds with LTCG

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Strifey
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Breakeven on selling high ER funds with LTCG

Post by Strifey »

I discovered the Boglehead ways at the beginning of the this year and have worked on converting to a 3 fund portfolio. At the start of this year I did an in-kind transfer from AF and sold off my highest ER funds (.8-1.3%) and bought into VTI.

I had some time today to take a deep look at the remaining positions I want to exit in my taxable and I want to confirm that this is the correct decision. It looks like with ~25 years until retirement (60) it should be a no brainer that I should take the tax hit now (breakeven is around 12-13 years). Below is my analysis using VTI real returns as a baseline and assuming same return on this fund bucket less the difference in ER. I'd be paying $10K in LTCG now for +$53K at 60.

Is there anything else I should consider (i.e. wait for a market correction that will likely happen in the next 10 years?).

Also I probably won't pull the trigger until next year because I already have ~$10K LTCG bill from the positions I exited in Q1, but trying to think through it now when I have time so I can pull the trigger in Jan 2022.

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Thanks!
123
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Re: Breakeven on selling high ER funds with LTCG

Post by 123 »

To avoid making the situation worse be sure you have turned off dividend reinvestment on funds you anticipate selling.

I don't know that your consideration of the tax cost of switching is valid. You'd have to pay taxes if you were "gain capturing" with VTI (i.e. sell and then buy again to increase your basis).

If paying the tax rubs you the wrong way just clear one undesired position a year.
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Doctor Rhythm
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Re: Breakeven on selling high ER funds with LTCG

Post by Doctor Rhythm »

If you typically give cash donations to charities, look into gifting appreciated shares of the fund(s) instead.
123
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Re: Breakeven on selling high ER funds with LTCG

Post by 123 »

Doctor Rhythm wrote: Sat Jul 17, 2021 4:22 pm If you typically give cash donations to charities, look into gifting appreciated shares of the fund(s) instead.
+1 or run them through a DAF for simplicity. With a DAF the charity just get a check.
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goingup
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Re: Breakeven on selling high ER funds with LTCG

Post by goingup »

Strifey wrote: Sat Jul 17, 2021 3:53 pm Is there anything else I should consider (i.e. wait for a market correction that will likely happen in the next 10 years?).

Also I probably won't pull the trigger until next year because I already have ~$10K LTCG bill from the positions I exited in Q1, but trying to think through it now when I have time so I can pull the trigger in Jan 2022.
Many American funds distribute big dividends and capital gains distributions. Put that in the “con” column unless you like that kind of thing.

I don’t think a $10k bill is too terribly daunting, but you could wait until closer to year end, and use any TLH opportunity along the way. Or break up the sales into 2-3 years. Waiting till closer to year end can avoid needing to pay estimated taxes. Just remember to sell before any div/cap gains distributions in December.
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Strifey
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Re: Breakeven on selling high ER funds with LTCG

Post by Strifey »

123 wrote: Sat Jul 17, 2021 4:14 pm To avoid making the situation worse be sure you have turned off dividend reinvestment on funds you anticipate selling.

I don't know that your consideration of the tax cost of switching is valid. You'd have to pay taxes if you were "gain capturing" with VTI (i.e. sell and then buy again to increase your basis).

If paying the tax rubs you the wrong way just clear one undesired position a year.
Yep did that a couple years ago. I even do it for VTI/SCHB that I hold for my 3-fund portfolio now, I TLH when I can and turning off DRIP from everything and buying back in bigger lots into whichever of the TLH harvest partner I'm using at the time.

And good point on #2, I guess it's just increasing my cost basis, I don't do any gain capturing though, only TLH.

Thanks everyone else as well for the input.
Last edited by Strifey on Sat Jul 17, 2021 5:13 pm, edited 1 time in total.
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Re: Breakeven on selling high ER funds with LTCG

Post by Wiggums »

Doctor Rhythm wrote: Sat Jul 17, 2021 4:22 pm If you typically give cash donations to charities, look into gifting appreciated shares of the fund(s) instead.
We have a DAF.
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Re: Breakeven on selling high ER funds with LTCG

Post by ruralavalon »

Turn off reinvestment of distributions in funds you want to get rid of.

Invest the cash from distributions in funds that you want to keep, if any. In a taxable brokerage account prefer only very tax-efficient stock index funds such as Vanguard Total Stock Market Index Fund (VTSAX), the ETF share class Vanguard Total Stock Market ETF (VTI), or the equivalent from other fund providers.

Wiki article"Paying a tax cost to switch funds".
Last edited by ruralavalon on Sun Jul 18, 2021 11:58 am, edited 2 times in total.
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exodusNH
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Re: Breakeven on selling high ER funds with LTCG

Post by exodusNH »

Strifey wrote: Sat Jul 17, 2021 3:53 pm I discovered the Boglehead ways at the beginning of the this year and have worked on converting to a 3 fund portfolio. At the start of this year I did an in-kind transfer from AF and sold off my highest ER funds (.8-1.3%) and bought into VTI.

I had some time today to take a deep look at the remaining positions I want to exit in my taxable and I want to confirm that this is the correct decision. It looks like with ~25 years until retirement (60) it should be a no brainer that I should take the tax hit now (breakeven is around 12-13 years). Below is my analysis using VTI real returns as a baseline and assuming same return on this fund bucket less the difference in ER. I'd be paying $10K in LTCG now for +$53K at 60.

Is there anything else I should consider (i.e. wait for a market correction that will likely happen in the next 10 years?).

Also I probably won't pull the trigger until next year because I already have ~$10K LTCG bill from the positions I exited in Q1, but trying to think through it now when I have time so I can pull the trigger in Jan 2022.

Image

Thanks!
How did the transfer from American Funds go? Did they bring over your cost basis? How old was the account?

I have one from 2004 that I've been thinking of transferring over, but was worried with such an old account whether they'd capture all the basis data.
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Strifey
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Re: Breakeven on selling high ER funds with LTCG

Post by Strifey »

exodusNH wrote: Sun Jul 18, 2021 11:54 am How did the transfer from American Funds go? Did they bring over your cost basis? How old was the account?

I have one from 2004 that I've been thinking of transferring over, but was worried with such an old account whether they'd capture all the basis data.
It was pretty painless, I gave a heads up to my advisor, he didn't really try to pressure me to stay, just like a minute talk about how the funds do better than the S&P 500, don't sell any current funds because of capital gains etc., then said thanks for the business kind of thing.

The actual transfer was easy through Fidelity, took about a week with no issues and did it all through their electronic forms online.

My account was opened in 2007 which was the first year I started working, the cost basis came over automatically but it used the average cost basis for all lots. Fidelity does have an option to manually set your cost basis for each lot that you can do one time only when you do the in-kind transfer but I didn't bother since I knew I was exiting these anyways.

This is an example of one of the funds I still have left that I need to exit, you can see it auto-populated the average cost basis:
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bradpevans
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Re: Breakeven on selling high ER funds with LTCG

Post by bradpevans »

I guess I don’t understand the “break even” part
If you do nothing you get that performance minus fees and taxes when you cash out

If you sell now, you get tax hit now then future performance of new holding less the smaller fees less the tax hit when you cash out

If you want out to avoid high ER or single security risk, then i would think the question is: how to minimize taxes while getting out?

That relates to your current tax bracket(s) and how the gains might move you into (still) higher brackets and/or higher LTCG brackets. Hence the suggestions to split the sales over different tax years
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Re: Breakeven on selling high ER funds with LTCG

Post by gwe67 »

It would be a no-brainer to sell if not for the additional California long-term capital gains tax. According to the wiki, it's still good to sell with these numbers. But there is a chance that the high-fee funds will lower their fees over time in order to compete with low fee (and zero fee) funds, which may make holding on more desirable.

Note that the "second from bottom" ordinary income tax rate is 12% today but goes to 15% in 2026. This will then match the "second from bottom" long-term capital gain rate of 15%. The perception of the 15% LTCG rate will be better in the future than it is today.
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Re: Breakeven on selling high ER funds with LTCG

Post by illumination »

I would recommend selling and taking the tax hit. You said you wanted to wait until next year, if in between then and now a bear market happens, that would likely be an even better time to sell and rebalance, even if its not according to schedule an you're bumped up a bracket.

Nobody knows what will happen, but I tend to think simply subtracting the expense ratio from a fund like VTI is probably overly optimistic for the funds you have. So your "break even" guess is probably going to be sooner. Actively managed funds usually underperform, and its not just the margin of the expense ratio. They face a lot of headwinds besides management fees.

These actively managed funds also throw off a lot of capital gains every year, that's hard to accurately estimate, but it's going to be way more than something like VTI.
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Re: Breakeven on selling high ER funds with LTCG

Post by grabiner »

Another reason to sell is that the ongoing cost of holding these funds versus the index is greater than the expense ratio. All of these funds have high enough turnover that they regularly distribute capital gains, and you will pay federal and CA capital-gains tax on that amount.
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Strifey
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Re: Breakeven on selling high ER funds with LTCG

Post by Strifey »

Yes good point on the dividends/cap gain distribution everyone.

My plan is basically sell in-year if there is a market correction, if not I'll re-evaluate if I can sell at the end of this year (given I already have ~$10K LTCG taxes this year), if none of those pass I'll sell early next year.

If there's opportunity to TLH in my VTI position (~$120K) that will make things easier for this year as well.
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Re: Breakeven on selling high ER funds with LTCG

Post by JoinToday »

Strifey wrote: Sat Jul 17, 2021 3:53 pm ...
Also I probably won't pull the trigger until next year because I already have ~$10K LTCG bill from the positions I exited in Q1, but trying to think through it now when I have time so I can pull the trigger in Jan 2022.
1. I am not following the reason why you don't exit this year (like exiting in July 2021). Will the overall tax burden be less if you spread it out over 2 tax years (2021 and 2022)?
2. Why wait for a market correction? do you expect your current funds to have a lower beta than the total stock market, and drop less?
3. Unless there is a tax reason for holding, I would just rip the bandage off and sell. Get it behind you.
4. Don't forget about tax drag associated with dividends and capital gains, in addition to the higher ER.
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Re: Breakeven on selling high ER funds with LTCG

Post by lazynovice »

JoinToday wrote: Mon Jul 19, 2021 11:34 pm
Strifey wrote: Sat Jul 17, 2021 3:53 pm ...
Also I probably won't pull the trigger until next year because I already have ~$10K LTCG bill from the positions I exited in Q1, but trying to think through it now when I have time so I can pull the trigger in Jan 2022.
1. I am not following the reason why you don't exit this year (like exiting in July 2021). Will the overall tax burden be less if you spread it out over 2 tax years (2021 and 2022)?
2. Why wait for a market correction? do you expect your current funds to have a lower beta than the total stock market, and drop less?
3. Unless there is a tax reason for holding, I would just rip the bandage off and sell. Get it behind you.
4. Don't forget about tax drag associated with dividends and capital gains, in addition to the higher ER.
He may be bumping up against the net investment income tax which would add another 3.8% tax to the bill.
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Strifey
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Re: Breakeven on selling high ER funds with LTCG

Post by Strifey »

JoinToday wrote: Mon Jul 19, 2021 11:34 pm
Strifey wrote: Sat Jul 17, 2021 3:53 pm ...
Also I probably won't pull the trigger until next year because I already have ~$10K LTCG bill from the positions I exited in Q1, but trying to think through it now when I have time so I can pull the trigger in Jan 2022.
1. I am not following the reason why you don't exit this year (like exiting in July 2021). Will the overall tax burden be less if you spread it out over 2 tax years (2021 and 2022)?
2. Why wait for a market correction? do you expect your current funds to have a lower beta than the total stock market, and drop less?
3. Unless there is a tax reason for holding, I would just rip the bandage off and sell. Get it behind you.
4. Don't forget about tax drag associated with dividends and capital gains, in addition to the higher ER.
Edit: Just realized NIIT is an issue as well if I exit all positions this year (can exit a couple though).

If I pay $20K in taxes this year I would either need to touch some of my emergency funds (in I-Bonds) which I don't really want to do, or keep a portion of the proceeds of exiting these stocks to help pay for taxes.

Right now I max out my 401K, HSA, Backdoor Roth IRA, and additional 20% of my paycheck into a mega-backdoor Roth conversion from after-tax. I've basically calculated that I have ~$10K/yr in extra money that would normally go in my taxable brokerage that I'm using for this LTCG tax instead (which I increased withholdings on my paycheck to cover).

I don't make enough if I increase withholdings for ~$20K in est. taxes while still balancing my expenses and other savings goals above. Rather then be out of the market (by taking $10K of my proceeds for exiting positions and then slowly replenishing over the next year) it seemed to make more sense to just split it across two years and let extra withholdings on my paycheck cover it.
Last edited by Strifey on Wed Jul 21, 2021 12:51 pm, edited 1 time in total.
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Re: Breakeven on selling high ER funds with LTCG

Post by grabiner »

Strifey wrote: Tue Jul 20, 2021 1:39 pm I don't make enough if I increase withholdings for ~$20K in est. taxes while still balancing my expenses and other savings goals above. Rather then be out of the market (by taking $10K of my proceeds for exiting positions and then slowly replenishing over the next year) it seemed to make more sense to just split it across two years and let extra withholdings on my paycheck cover it.
You don't need to be out of the market. You mention that your goal is a 3 fund portfolio, which includes a bond fund. Therefore, you can keep the same dollar amount in stock by moving an equal amount from bonds to stocks in whichever account holds the bonds; if this is your taxable account, the capital gain on that move would be very small.
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Re: Breakeven on selling high ER funds with LTCG

Post by JoinToday »

Strifey wrote: Tue Jul 20, 2021 1:39 pm
JoinToday wrote: Mon Jul 19, 2021 11:34 pm
Strifey wrote: Sat Jul 17, 2021 3:53 pm ...
Also I probably won't pull the trigger until next year because I already have ~$10K LTCG bill from the positions I exited in Q1, but trying to think through it now when I have time so I can pull the trigger in Jan 2022.
1. I am not following the reason why you don't exit this year (like exiting in July 2021). Will the overall tax burden be less if you spread it out over 2 tax years (2021 and 2022)?
2. Why wait for a market correction? do you expect your current funds to have a lower beta than the total stock market, and drop less?
3. Unless there is a tax reason for holding, I would just rip the bandage off and sell. Get it behind you.
4. Don't forget about tax drag associated with dividends and capital gains, in addition to the higher ER.
It's more or less to spread the tax burden over 2 years. I make ~$150K/yr so the 3.8% NIIT isn't really a risk.

If I pay $20K in taxes this year I would either need to touch some of my emergency funds (in I-Bonds) which I don't really want to do, or keep a portion of the proceeds of exiting these stocks to help pay for taxes.

Right now I max out my 401K, HSA, Backdoor Roth IRA, and additional 20% of my paycheck into a mega-backdoor Roth conversion from after-tax. I've basically calculated that I have ~$10K/yr in extra money that would normally go in my taxable brokerage that I'm using for this LTCG tax instead (which I increased withholdings on my paycheck to cover).

I don't make enough if I increase withholdings for ~$20K in est. taxes while still balancing my expenses and other savings goals above. Rather then be out of the market (by taking $10K of my proceeds for exiting positions and then slowly replenishing over the next year) it seemed to make more sense to just split it across two years and let extra withholdings on my paycheck cover it.
1. I would sell now (sell high), pay tax from proceeds, and buy replacement next year (buy low). [OT comment removed by admin LadyGeek] (and my crystal ball hasn't given me a bad prediction today ... that I know about).

2. Having said that, the tax is only 7-8% of the proceeds, and a smaller percentage of your portfolio. The difference by being "out of the market" (?) is minuscule.
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Strifey
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Re: Breakeven on selling high ER funds with LTCG

Post by Strifey »

Nvm I'm dumb, NIIT is actually an issue as I just looked at the YTD Tax Activity report on Fidelity.

I currently have $2.8K in Dividends/Capital Gains distributions and $42K in realized gain from the positions I exited in Q1.

I'm on-track to make ~$150K gross this year, I do max out my 401K which puts my MAGI ~$130K + $45K I already have in gains + dividends.

So I need to be careful about how much of the remaining positions I exit this year to not bump into the $200K limit before NIIT kicks in.
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