My Tax-Inefficient Portfolio

[Maineman]

Hi Everyone-

I haven't been a member for long - and haven't posted often - but I read the forum nearly every day. I already feel more intelligent...

...but it's time for me to make some changes to my portfolio and I could use the Bogleheads help.

Here are my stats:

Emergency Funds: 9 Months of expenses

Debt - zero

Tax filing status: Married/Jointly, no children

Tax Rate: 28% federal, 9.3% California

Age: 32

Desired AA: 80% Stocks/20% Bonds

Desired IA: 30% of Stocks

Current Portfolio (low six figures):

Taxable:
11.1% - Cash for investing - (house purchase fell through recently and I had raised approx. 30% of pp in cash for down payment. Now, I am keeping 20% of our desired purchase price aside as we are still looking but would like to invest the other 10%)
8.3% - VIPSX (Vanguard Inflation Protected Securities) - .22%
20.8% - VTSAX (Vanguard Total Stock Market Admiral Shares - .07%
11.5% - VGSLX (Vanguard REIT Admiral Shares) - .12%
7.6% - Individual Stocks (General Electric, Exxon Mobil - DRIP Plans, no fee for reinvestment of dividends)

His Roth at Fidelity
23.1% - FFFFX (Fidelity Freedom Retirement 2040) - .78%
6.7% - FGRIX (Fidelity Growth and Income) - .72%

Her Roth at Vanguard
5.8% - VFORX (Vanguard Retirement 2040) - .19%

His SEP IRA at Vanguard
1.7% - VDE (Vanguard Energy ETF) - .19%
1.8% - VWO (Vanguard Emerging Markets ETF) - .22%
0.9% - VBK (Vanguard Small Cap Growth ETF) - .12%
0.7% - VBR (Vanguard Small Cap Value ETF) -.23%

Hope I entered everything correctly (That M-Xray tool is incredible!)

New Annual Contributions
$10,000 (His and Her Roth IRA's)
$24,000 (taxable - that is the current DCA allocation scheduled for 2012 anyway)
No 401k options

ROTH IRA funds available - anything that Fidelity or Vanguard has to offer

Questions:

1. An overall question, does anyone have suggestions on how I can improve my AA? As well as my overall performance?
2. My taxable portfolio is kind of a mess I know. I started a Vanguard portfolio years ago when I had more taxable money to invest but had already maxed out my ROTH IRA. The REIT and TIPS funds are quite tax-inefficient. What is the best way to transition these funds into a tax-advantaged account and out of my taxable portfolio?
3. I have been thinking of moving my Fidelity IRA over to Vanguard to save on expense ratios. If so, should that be where I look to put my REIT and TIPS funds?
4. Do I have other options for investing in tax-advantaged accounts?

And I am open for any other suggestions the Bogleheads have - thank you in advance!

[ObliviousInvestor]

For the taxable holdings (especially the REIT fund, the TIPS fund, and the individual stocks), how does your cost basis compare to the current value?

[Maineman]

My Cost Basis for taxable holdings:

VGSLX (REIT Fund) - $65.24 (currently at 82.55)
VIPSX (TIPS Fund) - $12.84 (currently at 14.17)
XOM (Exxon) - $67.34 (currently at 84.74)
GE (General Electric) - $15.48 (currently at 18.93)

An additional question, I am interested in adding more international to my portfolio and was looking at adding VGTSX to my taxable. What do you all think?

[grabiner]

My Cost Basis for taxable holdings:

VGSLX (REIT Fund) - $65.24 (currently at 82.55)

This should be sold as soon as you have a plan and have held most of the shares for a year. Your capital gains on REIT Index are 25% of the total, and at a 22% tax rate (combined federal and state, allowing for the deductibility of state taxes against federal taxes), you will lose 5.5% of your investment to taxes. However, if you keep the account in taxable, you will lose about an extra 1.25% every year.

8.3% - VIPSX (Vanguard Inflation Protected Securities) - .22%

This is probably OK to keep in your taxable account, as it is exempt from state tax and you pay a very high state tax rate, while you would pay state tax on capital gains in California if you sell it It's also OK to sell, as the gain is relatively small (and will probably be distributed by the fund on its own, as the TIPS it holds mature); if you are trying to hold Total International in your taxable account, selling the TIPS fund is probably a good deal.

XOM (Exxon) - $67.34 (currently at 84.74)
GE (General Electric) - $15.48 (currently at 18.93)

As long as these two stocks are not too much of your portfolio, there is no need to sell them for tax reasons. An individual stock that you never sell is just as tax-efficient as an index fund that never sells stocks.

An additional question, I am interested in adding more international to my portfolio and was looking at adding VGTSX to my taxable. What do you all think?

Total International is one of the best funds to hold in a taxable account.

[Maineman]

desideratafilms wrote:
My Cost Basis for taxable holdings:

VGSLX (REIT Fund) - $65.24 (currently at 82.55)


This should be sold as soon as you have a plan and have held most of the shares for a year. Your capital gains on REIT Index are 25% of the total, and at a 22% tax rate (combined federal and state, allowing for the deductibility of state taxes against federal taxes), you will lose 5.5% of your investment to taxes. However, if you keep the account in taxable, you will lose about an extra 1.25% every year.

Thanks Grabiner! I was thinking I may want to do something like that with Cap gains rates potentially jumping next year. Your information has helped to solidify that idea.

What are your thoughts on a good AA model for my wife and I? As we can't contribute very much to our retirement accounts, how should we look to divide our contributions going forward?

[Liquid]

Would caution overweighting/performance chasing of emerging markets, they seem to be in a bubble.

Would get rid of small cap growth, the worst performing class in market history.

Would not speculate on the energy sector.

My 2c.

[grabiner]

What are your thoughts on a good AA model for my wife and I? As we can't contribute very much to our retirement accounts, how should we look to divide our contributions going forward?

Your plan of 80% stock, 20% bonds, with 30% international, looks fine; it is a standard recommendation.

Your taxable account can hold plenty of tax-efficient funds. A default plan, given your interest in REITS, is something like:

49% US stock
21% foreign stock
10% REITs
20% bonds

And you could do this efficiently with just four funds and a portfolio which is up to 70% taxable:

21% Total International (in taxable)
49% Total Stock Market Index (split between taxable and tax-deferred; could all be in taxable if necessary)
10% REIT Index (in tax-deferred)
20% Total Bond Market Index (in tax-deferred; if not enough room, use CA Long-Term Tax-Exempt for the taxable portion of your bond portfolio)

This is the default portfolio for your asset allocation; you can then decide whether you want to add more complications, such as holding half the bonds as TIPS.

[Maineman]

What are your thoughts on a good AA model for my wife and I? As we can't contribute very much to our retirement accounts, how should we look to divide our contributions going forward?

Your plan of 80% stock, 20% bonds, with 30% international, looks fine; it is a standard recommendation.

Your taxable account can hold plenty of tax-efficient funds. A default plan, given your interest in REITS, is something like:

49% US stock
21% foreign stock
10% REITs
20% bonds

And you could do this efficiently with just four funds and a portfolio which is up to 70% taxable:

21% Total International (in taxable)
49% Total Stock Market Index (split between taxable and tax-deferred; could all be in taxable if necessary)
10% REIT Index (in tax-deferred)
20% Total Bond Market Index (in tax-deferred; if not enough room, use CA Long-Term Tax-Exempt for the taxable portion of your bond portfolio)

This is the default portfolio for your asset allocation; you can then decide whether you want to add more complications, such as holding half the bonds as TIPS.

Thank you very much for the clearly laid out thoughts. I read too much WSJ and need to spend more time simplifying.

With what you have stated above, would you recommend an "exchange" of funds (as you can do on Vanguard), turning the REIT in taxable into the International? And then buying the REIT afresh in the non-taxable?

If you do recommend an exchange, would you do it all at once? Or sell-off specific lots (with the 0/no gain) until enough has been raise to enter the international. These are the two options I'm wrestling with now. All at once for simplicity, or gradually, keeping an eye on the tax man with each lot.

What do you think?

Daniel

[Duckie]

desideratafilms, you want 80% stocks, 20% bonds, with 30% stocks in international. That breaks down to 56% US stocks, 24% international stocks, 20% bonds. Here is a possible retirement portfolio:

Taxable at Vanguard -- 59%
24% (VTIAX) Vanguard Total International Stock Index Fund Admiral Shares (0.20%)
35% (VTSAX) Vanguard Total Stock Market Index Fund Admiral Shares (0.07%)

His Roth IRA at Vanguard -- 30%
9% (VBTLX) Vanguard Total Bond Market Index Fund Admiral Shares (0.11%)
10% (VGSLX) Vanguard REIT Index Fund Admiral Shares (0.12%)
11% (VTSAX) Vanguard Total Stock Market Index Fund Admiral Shares (0.07%)

Her Roth IRA at Vanguard -- 6%
6% (VIPSX) Vanguard Inflation-Protected Securities Fund Investor Shares (0.22%)

His SEP IRA at Vanguard -- 5%
5% (VBMFX) Vanguard Total Bond Market Index Fund Investor Shares (0.22%)

* This ignores the tax consequences of selling in taxable.
* I put TISM in taxable because of the Foreign Tax Credit.
* I gave you REIT because you had it, but I'm not a fan of overweighting it, especially not to your degree.
* I think you ought to up your bonds to at least 25%, but it's your choice.
* Do you still have the self-employment that allowed you to contribute to the SEP IRA?

Something to think about.

[grabiner]

With what you have stated above, would you recommend an "exchange" of funds (as you can do on Vanguard), turning the REIT in taxable into the International? And then buying the REIT afresh in the non-taxable?

If you do recommend an exchange, would you do it all at once? Or sell-off specific lots (with the 0/no gain) until enough has been raise to enter the international. These are the two options I'm wrestling with now. All at once for simplicity, or gradually, keeping an eye on the tax man with each lot.

You will have to pay the taxes anyway, so you might as well sell everything at once for simplicity, and get the funds into the right places.

There are two reasons you might need to wait to make some of the transactions. If you have a large short-term gain on some shares, you should wait until the gain becomes long-term. And if you have a loss on some shares, you have to wait 31 days between selling those shares in your taxable account and buying the same fund in your Roth IRA, IRA, or other retirement account, or else you will have a wash sale and lose the deduction for the loss.

[Maineman]

* Do you still have the self-employment that allowed you to contribute to the SEP IRA?

Something to think about.

Thanks Duckie, your sample portfolio looks good, right along the simplicity I'm looking for. About once every two-three years I take a job where I get 1099'd and so can contribute to the SEP IRA...so not very often.

[Maineman]

There are two reasons you might need to wait to make some of the transactions. If you have a large short-term gain on some shares, you should wait until the gain becomes long-term. And if you have a loss on some shares, you have to wait 31 days between selling those shares in your taxable account and buying the same fund in your Roth IRA, IRA, or other retirement account, or else you will have a wash sale and lose the deduction for the loss.

Do you recommend specifying which lots to be sold so I can take advantage of potential losses? If I do average cost, I have gains across the board (very fortunately), but I do have some lots that have lost value.

[grabiner]

Do you recommend specifying which lots to be sold so I can take advantage of potential losses? If I do average cost, I have gains across the board (very fortunately), but I do have some lots that have lost value.

If you are selling only part of your holding in a fund (either because it is overweighted or because you have losses to harvest), then you should use specific identification to maximize your loss or minimize your gain.

If you are selling your entire holding, your overall gain will be the same regardless of how you sell. However, if you bought any shares in the last year, you may be better off using first-in-first-out (which doesn't require that you do anything at the time of sale, and is equivalent to specifically identifying all your shares to be sold), rather than average-cost. The reason is that average-cost is likely to increase your short-term gain. For example, if you have 500 long-term shares with a cost of $14, and 100 short-term shares with a cost of $20, and you sell now at $21, then you have $3500 in long-term gains and $100 in short-term gains using FIFO, but $3000 in long-term gains and $600 in short-term gains using average cost of $19 for all the shares.

[HJG0989]

XOM (Exxon) - $67.34 (currently at 84.74)
GE (General Electric) - $15.48 (currently at 18.93)

As long as these two stocks are not too much of your portfolio, there is no need to sell them for tax reasons. An individual stock that you never sell is just as tax-efficient as an index fund that never sells stocks.

Do you mean there is no reason to sell for tax reasons but there may be a reason to sell for diversification reasons? I'm not sure why the amount of stock would make a difference in regards to tax-efficiency.

[Midpack]

You may be familiar with this, if not I think you may find it very helpful http://www.bogleheads.org/wiki/Principl ... _Placement.

I actually look up and track tax efficiency for each of my holdings on the M* website (for free), makes placement priorities very easy. Best of luck...

[grabiner]

XOM (Exxon) - $67.34 (currently at 84.74)
GE (General Electric) - $15.48 (currently at 18.93)

As long as these two stocks are not too much of your portfolio, there is no need to sell them for tax reasons. An individual stock that you never sell is just as tax-efficient as an index fund that never sells stocks.

Do you mean there is no reason to sell for tax reasons but there may be a reason to sell for diversification reasons? I'm not sure why the amount of stock would make a difference in regards to tax-efficiency.

Yes, I mean that the only reason you would want to sell them is diversification. If an individual stock is 20% of your portfolio, it is still tax-efficient, but you should sell some of it.

[grabiner]

You may be familiar with this, if not I think you may find it very helpful http://www.bogleheads.org/wiki/Principl ... _Placement.

I actually look up and track tax efficiency for each of my holdings on the M* website (for free), makes placement priorities very easy. Best of luck...

Use Vanguard's numbers for Vanguard funds, not Morningstar's; Morningstar doesn't always know about qualified dividends and thus has inaccurate after-tax returns for many funds. For example, Total Stock Market Index Admiral and ETF shares have the same expenses and thus the same dividend yield and tax cost, but Morningstar doesn't have all of the qualified dividend data for the ETF shares and reports a higher tax cost.

[Midpack]

You may be familiar with this, if not I think you may find it very helpful http://www.bogleheads.org/wiki/Principl ... _Placement.

I actually look up and track tax efficiency for each of my holdings on the M* website (for free), makes placement priorities very easy. Best of luck...

Use Vanguard's numbers for Vanguard funds, not Morningstar's; Morningstar doesn't always know about qualified dividends and thus has inaccurate after-tax returns for many funds. For example, Total Stock Market Index Admiral and ETF shares have the same expenses and thus the same dividend yield and tax cost, but Morningstar doesn't have all of the qualified dividend data for the ETF shares and reports a higher tax cost.

Actually I do use Vanguard, thanks for jogging my memory. Not sure why I mentioned M* except I used it as a link for someone else yesterday who was asking about tax efficiency of other than VG funds. Glad we cleared that up, thanks...