Bonds in Taxable

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
User avatar
Doc
Posts: 8601
Joined: Sat Feb 24, 2007 1:10 pm
Location: Two left turns from Larry

Bonds in Taxable

Post by Doc » Mon Aug 08, 2016 11:07 am

Another respected pundit chimes in.

"How Do Interest Rates and Dividend Yields Affect Asset Location" The Oblivious Investor
http://www.obliviousinvestor.com/how-do ... -location/
For many years, the conventional wisdom with asset location has been that, if you have to hold some investments in taxable accounts
... it’s better to hold stocks rather than bonds in the taxable account

...

In short, the idea that stocks are more tax-efficient than bonds is only sometimes true. It depends which bonds and which stocks we’re talking about. And it depends on whether interest rates (and dividend yields) are currently high or low. With interest rates as low as they are right now, bonds are more tax-efficient than they would otherwise be.
Last edited by Doc on Mon Aug 08, 2016 11:55 am, edited 1 time in total.
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.

User avatar
Kevin M
Posts: 10092
Joined: Mon Jun 29, 2009 3:24 pm
Contact:

Re: Bonds in Taxable

Post by Kevin M » Mon Aug 08, 2016 11:28 am

It's nice that Mike published a blog post on this, but we've already seen blog posts by other highly-respected forum members saying basically the same thing--quite some time ago:

October 2012, The Finance Buff (forum member tfb): Tax Efficiency: Relative or Absolute?

October 2012 (forum member EmergDoc): Rethinking Bonds In Taxable | The White Coat Investor

February 2014: Asset Location - Bonds Go In Taxable! | The White Coat Investor

Kevin
Wiki ||.......|| Suggested format for Asking Portfolio Questions (edit original post)

columbia
Posts: 901
Joined: Tue Aug 27, 2013 5:30 am

Re: Bonds in Taxable

Post by columbia » Sat Aug 13, 2016 11:24 am

The hand wringing over placement of bonds often seems skewed here; most investors are not above the 25% bracket.

soboggled
Posts: 901
Joined: Mon Jun 27, 2016 10:26 am

Re: Bonds in Taxable

Post by soboggled » Sat Aug 13, 2016 11:26 am

columbia wrote:The hand wringing over placement of bonds often seems skewed here; most investors are not above the 25% bracket.
Many are when adding state/local income tax.

livesoft
Posts: 62706
Joined: Thu Mar 01, 2007 8:00 pm

Re: Bonds in Taxable

Post by livesoft » Sat Aug 13, 2016 11:31 am

Kevin M wrote:It's nice that Mike published a blog post on this, but we've already seen blog posts by other highly-respected forum members saying basically the same thing--quite some time ago:
I think you may have mischaracterized what Mike Piper wrote. He didn't write that bonds go in taxable like WhiteCoatInvestor.

And WhiteCoatInvestor has sort of backtracked because his article title was as far as many people got even though the article was about taxable versus Roth and not about taxable versus tax-deferred.

And I should mention that Rick Ferri was sort of agnostic about the whole thing even though I also think people mis-interpreted what he wrote, too.
Wiki This signature message sponsored by sscritic: Learn to fish.

User avatar
Toons
Posts: 12963
Joined: Fri Nov 21, 2008 10:20 am
Location: Hills of Tennessee

Re: Bonds in Taxable

Post by Toons » Sat Aug 13, 2016 11:32 am

columbia wrote:The hand wringing over placement of bonds often seems skewed here; most investors are not above the 25% bracket.


+1 :happy
"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee

User avatar
Doc
Posts: 8601
Joined: Sat Feb 24, 2007 1:10 pm
Location: Two left turns from Larry

Re: Bonds in Taxable

Post by Doc » Sat Aug 13, 2016 11:41 am

"Most investors are not above the 25% bracket."

Depends who you mean by "most". Many retirees find themselves with a marginal tax rate of 28% for ordinary income and an 8.5% LTCG/QD. And the metric is not tax rate but tax rate times return. See the WIKI

Short Treasuries in taxable are probably more tax efficient than equities for majority of us in the current market.
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.

User avatar
Toons
Posts: 12963
Joined: Fri Nov 21, 2008 10:20 am
Location: Hills of Tennessee

Re: Bonds in Taxable

Post by Toons » Sat Aug 13, 2016 11:44 am

I have Taxable bonds and,,,
Tax Exempt Bonds in taxable account.
It could be better It could be worse.
I pay taxes,
but I am not going to overthink ,,
the tax tail wagging the dog.
:mrgreen:
"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee

User avatar
Doc
Posts: 8601
Joined: Sat Feb 24, 2007 1:10 pm
Location: Two left turns from Larry

Re: Bonds in Taxable

Post by Doc » Sat Aug 13, 2016 11:53 am

Toons wrote:I have Taxable bonds and,,,
Tax Exempt Bonds in taxable account.
It could be better It could be worse.
I pay taxes,
but I am not going to overthink ,,
the tax tail wagging the dog.
:mrgreen:
But you only have to "wag the dog" every 3 to 5 years unless your tax rate is all over the map each year. And even then going two brackets from 25% to 33% is not going to affect the result very much.

In any case preferred "tax placement" is likely going to be much more than Investor vs. Admiral share classes. Is that choice wagging the dog also?
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.

User avatar
Toons
Posts: 12963
Joined: Fri Nov 21, 2008 10:20 am
Location: Hills of Tennessee

Re: Bonds in Taxable

Post by Toons » Sat Aug 13, 2016 12:02 pm

Doc wrote:
Toons wrote:I have Taxable bonds and,,,
Tax Exempt Bonds in taxable account.
It could be better It could be worse.
I pay taxes,
but I am not going to overthink ,,
the tax tail wagging the dog.
:mrgreen:
But you only have to "wag the dog" every 3 to 5 years unless your tax rate is all over the map each year. And even then going two brackets from 25% to 33% is not going to affect the result very much.

In any case preferred "tax placement" is likely going to be much more than Investor vs. Admiral share classes. Is that choice wagging the dog also?
My tax rate is not all over the place :happy
Currently 15
May see 25.
Maybe Not.
I use quicken to assist me in tax ramifications and forecasting.
Regarding your question........
I do not have a clue ,,,,yet..
I have to put on my thinking cap, :wink:
"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee

dabblingeconomist
Posts: 115
Joined: Wed Jul 13, 2016 8:42 pm

Re: Bonds in Taxable

Post by dabblingeconomist » Sat Aug 13, 2016 12:07 pm

I agree that lower yields have changed a great deal here. (They have muddled a number of points as well - for instance, the home mortgage deduction is a much lesser advantage of homeownership than it used to be.)

Another key point, which is rarely mentioned, is that the bottleneck for tax-advantaged space is at the contribution stage. If you can grow your initial contribution into a larger sum, then you earn greater benefits from the tax-advantaged account down the road. This (may) justify putting higher-return equities into the tax-advantaged accounts, especially when the conventional tax inefficiency of bonds is no longer so relevant

User avatar
White Coat Investor
Posts: 13443
Joined: Fri Mar 02, 2007 9:11 pm
Location: Greatest Snow On Earth

Re: Bonds in Taxable

Post by White Coat Investor » Sat Aug 13, 2016 12:10 pm

Mike sums up the main issue well, which some Bogleheads still don't get.

Both the tax-efficiency of the asset with regard to your particular tax circumstances and the return of the asset matter in choosing whether to put bonds in taxable or tax-protected. In some situations, bonds in taxable are the right thing, especially at low bond yields. In other situations, bonds in tax-protected are right. The only way to get it right for sure is to use accurate assumptions and guess correctly about future returns. For most of us, however, it matters far less than we fear it does.

The tax-deferred vs tax-free account is a non-issue. A tax-deferred account is (almost) simply a tax-free account plus an account you're investing on the government's behalf. The reason for the almost is RMDs. So a very valid simplification is to compare a taxable account to a tax-free account when determining this issue.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course

User avatar
dodecahedron
Posts: 3691
Joined: Tue Nov 12, 2013 12:28 pm

Re: Bonds in Taxable

Post by dodecahedron » Sat Aug 13, 2016 12:27 pm

Doc wrote:"

Short Treasuries in taxable are probably more tax efficient than equities for majority of us in the current market.
Short Treasuries in the current market pay so little that they are dominated by carefully chosen direct CDs with modest early withdrawal penalties. But those are trickier to manage in an IRA due to additional paperwork moving assets between custodians. Then again, there are sometimes special rate deals only available in IRAs.

The big variable for many of us is what we plan to do with our equities. If we are planning large charitable donations and/or holding assets in taxable till death, when heirs will get stepup in basis, then equities in taxable becomes relatively more attractive. If we are planning to liquidate equities for spending during our lifetimes, equities in taxable are relatively less attractive.

User avatar
Doc
Posts: 8601
Joined: Sat Feb 24, 2007 1:10 pm
Location: Two left turns from Larry

Re: Bonds in Taxable

Post by Doc » Sat Aug 13, 2016 12:38 pm

dodecahedron wrote:Doc wrote:
"

Short Treasuries in taxable are probably more tax efficient than equities for majority of us in the current market.


Short Treasuries in the current market pay so little that they are dominated by carefully chosen direct CDs with modest early withdrawal penalties.
So put your short term CD's in taxable also.

(Although if you subscribe to Kevin M's philosophy of a 100 bps difference you are going to have to take the higher interest rate and higher tax rate for state tax into account. Look at Mike Piper's link in the OP.)
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.

User avatar
dodecahedron
Posts: 3691
Joined: Tue Nov 12, 2013 12:28 pm

Re: Bonds in Taxable

Post by dodecahedron » Sat Aug 13, 2016 12:45 pm

White Coat Investor wrote:Mike sums up the main issue well, which some Bogleheads still don't get.
+1 His final paragraph sums up the nuances well, as does yours, quoted below. (Emphasis mine.)
White Coat Investor wrote: Both the tax-efficiency of the asset with regard to your particular tax circumstances and the return of the asset matter in choosing whether to put bonds in taxable or tax-protected. In some situations, bonds in taxable are the right thing, especially at low bond yields. In other situations, bonds in tax-protected are right. The only way to get it right for sure is to use accurate assumptions and guess correctly about future returns. For most of us, however, it matters far less than we fear it does.
Heartily agree. Other factors (e.g., what funds are available to us in tax-deferred may be far more important than tax factors. In my case, I have access to TIAA Trad fixed income in my tax-deferred 403b, and it is hard to find anything comparable in taxable. I am not going to let the tax tail wag the dog.
White Coat Investor wrote: A tax-deferred account is (almost) simply a tax-free account plus an account you're investing on the government's behalf. The reason for the almost is RMDs. So a very valid simplification is to compare a taxable account to a tax-free account when determining this issue.
Those of us planning a retirement budget with large charitable donations (made either via QCDs or donations of appreciated assets in taxable) may view our tax-deferred accounts as a taxfree account plus an account we are investing on charity's behalf.

User avatar
dodecahedron
Posts: 3691
Joined: Tue Nov 12, 2013 12:28 pm

Re: Bonds in Taxable

Post by dodecahedron » Sat Aug 13, 2016 12:56 pm

Doc wrote:
dodecahedron wrote:Doc wrote:
"

Short Treasuries in taxable are probably more tax efficient than equities for majority of us in the current market.


Short Treasuries in the current market pay so little that they are dominated by carefully chosen direct CDs with modest early withdrawal penalties.
So put your short term CD's in taxable also.

(Although if you subscribe to Kevin M's philosophy of a 100 bps difference you are going to have to take the higher interest rate and higher tax rate for state tax into account. Look at Mike Piper's link in the OP.)
I am a subscriber to Kevin M's philosophy so I don't hold short term CD's since they are dominated by intermediate term CDs with modest EWPs. (That's what I meant by "carefully chosen.") Going with intermediate term CDs also reduces the frequency of paperwork involved in reinvestment (unless rates soar and early withdrawal becomes worthwhile), which is especially important with IRA transfers.

User avatar
Toons
Posts: 12963
Joined: Fri Nov 21, 2008 10:20 am
Location: Hills of Tennessee

Re: Bonds in Taxable

Post by Toons » Sat Aug 13, 2016 1:01 pm

White Coat Investor wrote:Mike sums up the main issue well, which some Bogleheads still don't get.

Both the tax-efficiency of the asset with regard to your particular tax circumstances and the return of the asset matter in choosing whether to put bonds in taxable or tax-protected. In some situations, bonds in taxable are the right thing, especially at low bond yields. In other situations, bonds in tax-protected are right. The only way to get it right for sure is to use accurate assumptions and guess correctly about future returns. For most of us, however, it matters far less than we fear it does.

The tax-deferred vs tax-free account is a non-issue. A tax-deferred account is (almost) simply a tax-free account plus an account you're investing on the government's behalf. The reason for the almost is RMDs. So a very valid simplification is to compare a taxable account to a tax-free account when determining this issue.

+1 :happy
Thank You
"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee

User avatar
Doc
Posts: 8601
Joined: Sat Feb 24, 2007 1:10 pm
Location: Two left turns from Larry

Re: Bonds in Taxable

Post by Doc » Sat Aug 13, 2016 1:10 pm

dodecahedron wrote:Those of us planning a retirement budget with large charitable donations (made either via QCDs or donations of appreciated assets in taxable) may view our tax-deferred accounts as a taxfree account plus an account we are investing on charity's behalf.
So? Your tax situation is not like "most" of us. You plug in zero as your tax rate in the return times tax rate metric and get everything with the same tax efficiency. It's just a different way to get to the same place. It matters not whether the asset is CD's (short or intermediate), junk bonds, a TBM fund, a Total Stock Market fund or whatever. They all have for the same tax efficiency for you.
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.

User avatar
Kevin M
Posts: 10092
Joined: Mon Jun 29, 2009 3:24 pm
Contact:

Re: Bonds in Taxable

Post by Kevin M » Sat Aug 13, 2016 2:01 pm

livesoft wrote:
Kevin M wrote:It's nice that Mike published a blog post on this, but we've already seen blog posts by other highly-respected forum members saying basically the same thing--quite some time ago:
I think you may have mischaracterized what Mike Piper wrote.
I don't think so.
livesoft wrote:He didn't write that bonds go in taxable like WhiteCoatInvestor.
Mike may not have said it explicitly, but he covered the exact same ground with respect to considering both the expected return as well as the tax rate. That is the commonality in all of these blog posts.
livesoft wrote:And WhiteCoatInvestor has sort of backtracked because his article title was as far as many people got even though the article was about taxable versus Roth and not about taxable versus tax-deferred.
Apparently Jim sees it the same way I do:
White Coat Investor wrote:Mike sums up the main issue well, which some Bogleheads still don't get.

Both the tax-efficiency of the asset with regard to your particular tax circumstances and the return of the asset matter in choosing whether to put bonds in taxable or tax-protected.
And points out the obfuscation of differentiating between Roth and tax-deferred, especially with respect to this discussion:
White Coat Investor wrote:The tax-deferred vs tax-free account is a non-issue. A tax-deferred account is (almost) simply a tax-free account plus an account you're investing on the government's behalf. The reason for the almost is RMDs. So a very valid simplification is to compare a taxable account to a tax-free account when determining this issue.
livesoft wrote:And I should mention that Rick Ferri was sort of agnostic about the whole thing even though I also think people mis-interpreted what he wrote, too.
I'm somewhat agnostic about it as well, holding both tax-exempt bond funds and CDs in taxable accounts. And I think that just as people use desire for simplicity as a reason not to use CDs, I think it's also a valid reason to simply hold an all-in-one fund like a Vanguard Target Retirement or LifeStrategy fund in a taxable account. Especially if people are going to dismiss the 100-165 basis point advantage of CDs over Treasuries as not worth the hassle, it seems that the possible tax inefficiency of holding an all-in-one fund in taxable is even less of a sin.

I must admit that I still lean a bit to the old school thinking though, holding mostly fixed-income in my tax-advantaged accounts (with my REIT fund being the main exception), and holding my stocks mostly in taxable (I am swayed by the benefits of tax-loss harvesting and the basis step-up for my heirs at death).

Kevin
Wiki ||.......|| Suggested format for Asking Portfolio Questions (edit original post)

livesoft
Posts: 62706
Joined: Thu Mar 01, 2007 8:00 pm

Re: Bonds in Taxable

Post by livesoft » Sat Aug 13, 2016 2:19 pm

Kevin M wrote:
White Coat Investor wrote:So a very valid simplification is to compare a taxable account to a tax-free account when determining this issue.
Just because he writes it, does not make it true. Let me show you how that works:
livesoft wrote:So a completely invalid simplification is to compare a taxable account to a tax-free account when determining this issue.
Wiki This signature message sponsored by sscritic: Learn to fish.

User avatar
dodecahedron
Posts: 3691
Joined: Tue Nov 12, 2013 12:28 pm

Re: Bonds in Taxable

Post by dodecahedron » Sat Aug 13, 2016 4:24 pm

Doc wrote:
dodecahedron wrote:Those of us planning a retirement budget with large charitable donations (made either via QCDs or donations of appreciated assets in taxable) may view our tax-deferred accounts as a taxfree account plus an account we are investing on charity's behalf.
So? Your tax situation is not like "most" of us. You plug in zero as your tax rate in the return times tax rate metric and get everything with the same tax efficiency. It's just a different way to get to the same place. It matters not whether the asset is CD's (short or intermediate), junk bonds, a TBM fund, a Total Stock Market fund or whatever. They all have for the same tax efficiency for you.
Agree that my current tax situation is unlike most. In retrospect, my late husband over-Rothified our holdings because we had been planning for both of us to be living longer than wound up being the case after his unexpected death. As a result, my material needs are less than we had originally been planning for as a couple and my tax-deferred holdings are basically earmarked for charity and LTC (if necessary).

There is an interesting historical tax reason why our Roth holdings wound up being so large relative to our tax-deferred holdings, but it has to do with tax hassles rather than tax rates.

Basically, we briefly held some equities in taxable with a DRIP in the early 1990s (these were gifts from a relative of funds we didn't want to hold long-term but held onto for a while out of politeness.) We had very busy and chaotic lives back then, with young children and self-employment income, and keeping track of basis was far more of a pain back in the day. I was the person in charge of doing taxes in our family and I complained enough (some might call it "bitching and moaning" :twisted: ) about this that my husband took it to heart. Once Roth accounts appeared on the scene, we did some opportunistic conversions (our self-employment income had large swings) and from then on, virtually all our equities went into the Roth accounts, simply to avoid my complaints about dealing with basis.

Of course, nowadays with "covered" stock basis reporting and specific ID, it is much easier to have equities in taxable than back in the day.

But it is precisely because my Roth accounts ended up becoming so unexpectedly large relative to my needs that I can mentally earmark my RMDs from tax-deferred to go toward charity (or possibly other large deductible expenses, like LTC or our epically high and growing property taxes in beautiful and bucolic upstate NY.)

gilgamesh
Posts: 1102
Joined: Sun Jan 10, 2016 9:29 am

Re: Bonds in Taxable

Post by gilgamesh » Sat Aug 13, 2016 8:55 pm

Is the 1.8% of yield representative of a stock fund for each and every year? I am not an expert but it sounds awfully high?

gilgamesh
Posts: 1102
Joined: Sun Jan 10, 2016 9:29 am

Re: Bonds in Taxable

Post by gilgamesh » Sat Aug 13, 2016 9:09 pm

columbia wrote:The hand wringing over placement of bonds often seems skewed here; most investors are not above the 25% bracket.
I am new to this, but this doesn't make sense to me either. If it's lower than 25% then it's even better for Bonds to be in taxable. So, by saying most investors are not above 25%, you are saying many are below it. That actually gives a more compelling reason for bonds to be in taxable, if we are to look at it from the article's perspective.

More experienced responders are obviously not seeing it this way, what am I missing?

User avatar
cookymonster
Posts: 175
Joined: Wed Nov 05, 2014 12:22 pm

Re: Bonds in Taxable

Post by cookymonster » Sat Aug 13, 2016 9:39 pm

White Coat Investor wrote: The tax-deferred vs tax-free account is a non-issue. A tax-deferred account is (almost) simply a tax-free account plus an account you're investing on the government's behalf. The reason for the almost is RMDs. So a very valid simplification is to compare a taxable account to a tax-free account when determining this issue.
I've been trying for years to get my mind around how this is a non-issue and just can't do it. I don't see how you can ignore the degree of investing you're doing on the government's behalf.

Can't a taxable account also be broken down into a tax-free account and an account you're investing on the government's behalf?
with a tax deferred account you can break it down to your account and a percent you're investing for the government at your effective tax rate.
With a taxable account you can break it down to your account and a percent you're investing for the government at LTCG rates (for most, 15%)
With a Roth account, 100% is yours and 0% goes to the government.

To me, independent of tax efficiency considerations, it is quite obvious that the more I load the lower returning assets, such as bonds, in tax-deferred accounts, and the more I load equities in Roth and taxable accounts, the higher the overall return of my portion of all three accounts will be, and the lower the portion I'm investing for the government will be (since tax-deferred accounts have the greatest percentage you're investing for the government).
Is there a fallacy here?

stlutz
Posts: 4739
Joined: Fri Jan 02, 2009 1:08 am

Re: Bonds in Taxable

Post by stlutz » Sat Aug 13, 2016 9:41 pm

Is the 1.8% of yield representative of a stock fund for each and every year? I am not an expert but it sounds awfully high?
Over the past 15 years the yield on VTSAX has varied between 1.1% and 2.9%. So, yes, 1.8% is pretty representative. The yield on international equity funds tends to be higher.

stlutz
Posts: 4739
Joined: Fri Jan 02, 2009 1:08 am

Re: Bonds in Taxable

Post by stlutz » Sat Aug 13, 2016 9:46 pm

I have been one who has been objecting to the "bonds belong only in tax advantaged" mantra for a number of years now. But, there are good points that it's not always clear cut the other direction either. I would propose that our "default" position on this board should probably be along the lines of equal location, especially given that tax policies will change in significant ways over time.

For many investors, what they hold where is determined mostly by what low cost options are available in their 401Ks. For some folks, an S&P 500 fund is the only such option. On their other hand, stable assets funds which many like are not available outside of 401Ks.

Asset allocation > low costs > asset location

User avatar
dodecahedron
Posts: 3691
Joined: Tue Nov 12, 2013 12:28 pm

Re: Bonds in Taxable

Post by dodecahedron » Sat Aug 13, 2016 9:50 pm

stlutz wrote:
Is the 1.8% of yield representative of a stock fund for each and every year? I am not an expert but it sounds awfully high?
Over the past 15 years the yield on VTSAX has varied between 1.1% and 2.9%. So, yes, 1.8% is pretty representative. The yield on international equity funds tends to be higher.
I agree that 1.8% is pretty representative.

Although the higher yield on international creates more tax drag, there is also the foreign tax credit which can somewhat offset the tax drag.

randomguy
Posts: 6295
Joined: Wed Sep 17, 2014 9:00 am

Re: Bonds in Taxable

Post by randomguy » Sat Aug 13, 2016 10:03 pm

gilgamesh wrote:
columbia wrote:The hand wringing over placement of bonds often seems skewed here; most investors are not above the 25% bracket.
I am new to this, but this doesn't make sense to me either. If it's lower than 25% then it's even better for Bonds to be in taxable. So, by saying most investors are not above 25%, you are saying many are below it. That actually gives a more compelling reason for bonds to be in taxable, if we are to look at it from the article's perspective.

More experienced responders are obviously not seeing it this way, what am I missing?
Tax cost in the 15% bracket
Intermediate bond: .95*.15 = .14
stocks : 1.84*.06 = .11

The difference between LTGC and OI is 10% in the 25% bracket. In the 15% bracket, it is 15%.

Note that if you hold non treasury bonds and are paying 6% state tax on them, things look worse for bonds in taxable. Or imagine you live in a 0% state tax

Immediate Bond = .14
Stocks: 0.0

and holding stocks in taxable looks really good.

User avatar
tfb
Posts: 7947
Joined: Mon Feb 19, 2007 5:46 pm
Contact:

Re: Bonds in Taxable

Post by tfb » Sat Aug 13, 2016 10:22 pm

cookymonster wrote:
White Coat Investor wrote: The tax-deferred vs tax-free account is a non-issue. A tax-deferred account is (almost) simply a tax-free account plus an account you're investing on the government's behalf. The reason for the almost is RMDs. So a very valid simplification is to compare a taxable account to a tax-free account when determining this issue.
I've been trying for years to get my mind around how this is a non-issue and just can't do it. I don't see how you can ignore the degree of investing you're doing on the government's behalf.

Can't a taxable account also be broken down into a tax-free account and an account you're investing on the government's behalf?
No. If you don't want to invest money on the government's behalf in the traditional account, you can give them their share now and make it a Roth (you don't do that now because you think you can do better than a Roth). You don't have that option in the taxable account. Therefore when all you money can't fit into a Roth or better-than-Roth, you are comparing placing different assets between a taxable account and a Roth.
Harry Sit, taking a break from the forums.

User avatar
njboater74
Posts: 632
Joined: Mon Apr 25, 2016 8:21 pm

Re: Bonds in Taxable

Post by njboater74 » Sat Aug 13, 2016 10:53 pm

For those who consider a portion of a tax-deferred account to be money you are investing on behalf of the government, do you also weight your accounts when calculating your Asset Allocation?

For instance, here are my two accounts:

Roth
---------
$10000 - Total Stock Market Index Fund

Traditional
---------
$10000 - Total Bond Market Index Fund

What do you consider to be my Asset Allocation (assuming a 25% tax rate in retirement) ?
Last edited by njboater74 on Sun Aug 14, 2016 7:53 am, edited 1 time in total.
When the mob and the press and the whole world tell you to move, your job is to plant yourself like a tree beside the river of truth and tell the whole world - 'No, YOU move'--Captain America, Boglehead

AlohaJoe
Posts: 3751
Joined: Mon Nov 26, 2007 2:00 pm
Location: Saigon, Vietnam

2

Post by AlohaJoe » Sat Aug 13, 2016 11:26 pm

Kevin M wrote:It's nice that Mike published a blog post on this, but we've already seen blog posts by other highly-respected forum members saying basically the same thing--quite some time ago:

October 2012, The Finance Buff (forum member tfb): Tax Efficiency: Relative or Absolute?

October 2012 (forum member EmergDoc): Rethinking Bonds In Taxable | The White Coat Investor

February 2014: Asset Location - Bonds Go In Taxable! | The White Coat Investor
All of these, including the link the OP provided are just rehashes of the same analysis that Daryanani did in his 2004 paper on asset location. None of them address Reichenstein's criticism of that analysis. For instance his most recent entry on subject is his November 2013 paper showing that (among other things) even if rates on bonds drop to 1% you still should not hold bonds in taxable space.

gilgamesh
Posts: 1102
Joined: Sun Jan 10, 2016 9:29 am

Re: Bonds in Taxable

Post by gilgamesh » Sun Aug 14, 2016 4:59 am

Edit: never mind, I got it
Last edited by gilgamesh on Sun Aug 14, 2016 6:40 am, edited 3 times in total.

gilgamesh
Posts: 1102
Joined: Sun Jan 10, 2016 9:29 am

Re: Bonds in Taxable

Post by gilgamesh » Sun Aug 14, 2016 5:12 am

randomguy wrote:
gilgamesh wrote:
columbia wrote:The hand wringing over placement of bonds often seems skewed here; most investors are not above the 25% bracket.
I am new to this, but this doesn't make sense to me either. If it's lower than 25% then it's even better for Bonds to be in taxable. So, by saying most investors are not above 25%, you are saying many are below it. That actually gives a more compelling reason for bonds to be in taxable, if we are to look at it from the article's perspective.

More experienced responders are obviously not seeing it this way, what am I missing?
Tax cost in the 15% bracket
Intermediate bond: .95*.15 = .14
stocks : 1.84*.06 = .11

The difference between LTGC and OI is 10% in the 25% bracket. In the 15% bracket, it is 15%.

Note that if you hold non treasury bonds and are paying 6% state tax on them, things look worse for bonds in taxable. Or imagine you live in a 0% state tax

Immediate Bond = .14
Stocks: 0.0

and holding stocks in taxable looks really good.
What I missed was the 0% LTCG/QD at 15% tax bracket. Makes sense.

Also, if it is bond funds, wouldn't a sale of it result in OI as well?

User avatar
Doc
Posts: 8601
Joined: Sat Feb 24, 2007 1:10 pm
Location: Two left turns from Larry

Re: Bonds in Taxable

Post by Doc » Sun Aug 14, 2016 7:28 am

njboater74 wrote:For those who consider a portion of a tax-deferred account to be money you are investing on behalf of the government, do you also weight your accounts when calculating your Asset Allocation?

For instance, here are my two accounts:

Roth
---------
$10000 - Total Stock Market Index Fund

Traditional
---------
$10000 - Total Bond Market Index Fund

What do you consider to be my Asset Allocation?
57/43

Assuming you will be in the 25% bracket when you withdraw from your tIRA.

An easy way to get around this complexity is just to change your "unadjusted" AA. So in the example above if you want a "true" 50/50 allocation maybe you want to use 47/53 on an unadjusted basis. (I didn't calculate this. I just guessed.) You should make the actual calculation for your own situation at least once and then review it at least once every five years or whenever your uncle Joe bequeaths you $5 million.

(At least one highly respected poster on this board has even suggested correcting for unrealized capital gains in taxable accounts.)
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.

User avatar
Doc
Posts: 8601
Joined: Sat Feb 24, 2007 1:10 pm
Location: Two left turns from Larry

Re: Bonds in Taxable

Post by Doc » Sun Aug 14, 2016 7:38 am

randomguy wrote:The difference between LTGC and OI is 10% in the 25% bracket. In the 15% bracket, it is 15%.
White Coat Investor wrote:The tax-deferred vs tax-free account is a non-issue. A tax-deferred account is (almost) simply a tax-free account plus an account you're investing on the government's behalf. The reason for the almost is RMDs
The tax code is complicated.

The gal that has been in the 15% tax bracket for most of her life sees her marginal tax rate jump to 28% because her husband goes on Social Security.

Or the guy that sees the tax on his RMD jump from the expected 15% to 30% because of his father in law passed away.

People should try to understand the concepts behind this discussion and apply it to their own situation. There is just too much chance of "bias of the familiar" in any broad statements that relate to the tax code.
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.

User avatar
Doc
Posts: 8601
Joined: Sat Feb 24, 2007 1:10 pm
Location: Two left turns from Larry

Re: Bonds in Taxable

Post by Doc » Sun Aug 14, 2016 8:00 am

AlohaJoe wrote:All of these, including the link the OP provided are just rehashes of the same analysis that Daryanani did in his 2004 paper on asset location. None of them address Reichenstein's criticism of that analysis. For instance his most recent entry on subject is his November 2013 paper showing that (among other things) even if rates on bonds drop to 1% you still should not hold bonds in taxable space.
Reichensteinn comments on this subject have also come under criticism in the past.

In the 25% bracket a 1% Treasury costs you 25 bps loss to taxes.

A US large cap fund with a 7% return costs you 30 bps on the 2% dividend and maybe another 35-50 bps on the LTCG when you sell.

(Large cap return of 7% based on Portfolio Solutions 30 year forecast. The loss on LTCG is based on an effective rate of 7 - 10 % because of the tax deferment. The LTCG tax loss could be as low as zero if you give everything to charity or die before you need the money but that is a special circumstance. It could also be higher if you sell sooner than later.)
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.

User avatar
njboater74
Posts: 632
Joined: Mon Apr 25, 2016 8:21 pm

Re: Bonds in Taxable

Post by njboater74 » Sun Aug 14, 2016 8:04 am

Doc wrote:
57/43

Assuming you will be in the 25% bracket when you withdraw from your tIRA.
So if I move all of my bonds into the Roth, and my stocks into the Traditional, I'll have a lower expected after-tax return in retirement. But not because of 'tax inefficienct bond placement', but because I've effectively changed my Asset Allocation by changing my Asset Location.

That makes sense, I wonder what % of people calculate their AA this way.
When the mob and the press and the whole world tell you to move, your job is to plant yourself like a tree beside the river of truth and tell the whole world - 'No, YOU move'--Captain America, Boglehead

livesoft
Posts: 62706
Joined: Thu Mar 01, 2007 8:00 pm

Re: Bonds in Taxable

Post by livesoft » Sun Aug 14, 2016 8:08 am

Doc wrote:
AlohaJoe wrote:All of these, including the link the OP provided are just rehashes of the same analysis that Daryanani did in his 2004 paper on asset location. None of them address Reichenstein's criticism of that analysis. For instance his most recent entry on subject is his November 2013 paper showing that (among other things) even if rates on bonds drop to 1% you still should not hold bonds in taxable space.
Reichensteinn comments on this subject have also come under criticism in the past.

In the 25% bracket a 1% Treasury costs you 25 bps loss to taxes.

A US large cap fund with a 7% return costs you 30 bps on the 2% dividend and maybe another 35-50 bps on the LTCG when you sell.

(Large cap return of 7% based on Portfolio Solutions 30 year forecast. The loss on LTCG is based on an effective rate of 7 - 10 % because of the tax deferment. The LTCG tax loss could be as low as zero if you give everything to charity or die before you need the money but that is a special circumstance. It could also be higher if you sell sooner than later.)
OK, but how much do they cost in a tax-deferred account? Since you included selling for LTCG, please include selling (conversion to Roth or withdrawing for expenses) from a tax-deferred account, too.

Giving to charity might be about the same with QCD, but not quite as it does not shelter other additional income from taxes like giving from a taxable account (for those that can itemize).
Last edited by livesoft on Sun Aug 14, 2016 8:16 am, edited 1 time in total.
Wiki This signature message sponsored by sscritic: Learn to fish.

User avatar
njboater74
Posts: 632
Joined: Mon Apr 25, 2016 8:21 pm

Re: Bonds in Taxable

Post by njboater74 » Sun Aug 14, 2016 8:12 am

Doc wrote:
AlohaJoe wrote:All of these, including the link the OP provided are just rehashes of the same analysis that Daryanani did in his 2004 paper on asset location. None of them address Reichenstein's criticism of that analysis. For instance his most recent entry on subject is his November 2013 paper showing that (among other things) even if rates on bonds drop to 1% you still should not hold bonds in taxable space.
Reichensteinn comments on this subject have also come under criticism in the past.

In the 25% bracket a 1% Treasury costs you 25 bps loss to taxes.

A US large cap fund with a 7% return costs you 30 bps on the 2% dividend and maybe another 35-50 bps on the LTCG when you sell.

(Large cap return of 7% based on Portfolio Solutions 30 year forecast. The loss on LTCG is based on an effective rate of 7 - 10 % because of the tax deferment. The LTCG tax loss could be as low as zero if you give everything to charity or die before you need the money but that is a special circumstance. It could also be higher if you sell sooner than later.)
Reichenstein has two substantial flaws in his analysis:

1. Does not use tax-exempt bonds for the comparison
2. Assumes that you will 'settle up' every year with the IRS by realizing whatever losses or gains you have.
When the mob and the press and the whole world tell you to move, your job is to plant yourself like a tree beside the river of truth and tell the whole world - 'No, YOU move'--Captain America, Boglehead

User avatar
Doc
Posts: 8601
Joined: Sat Feb 24, 2007 1:10 pm
Location: Two left turns from Larry

Re: Bonds in Taxable

Post by Doc » Sun Aug 14, 2016 8:42 am

livesoft wrote:OK, but how much do they cost in a tax-deferred account? Since you included selling for LTCG, please include selling (conversion to Roth or withdrawing for expenses) from a tax-deferred account, too.

Giving to charity might be about the same with QCD, but not quite as it does not shelter other additional income from taxes like giving from a taxable account (for those that can itemize).
If the RMD's from your tax-deferred account don't change your tax rate it matters not. Unless you don't acknowledge that part of the account was taxes that you owed from the beginning and were able to defer along with any profit that the government's money earned during the time. In other word that you don't put the ROTH/tIRA both on an after tax basis. Certainly you are not bringing that settled discussion back up here. If you try to bring the RMD rate change into the present discussion it becomes too much of an issue for each individual to get anything accomplished.

I don't put charitable or inheritance issues into the discussion. Again each of our own personal situation can change the result. Obviously if you are going to give everything away you don't really care about taxes. (Unless you are a Libertarian maybe.)
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.

livesoft
Posts: 62706
Joined: Thu Mar 01, 2007 8:00 pm

Re: Bonds in Taxable

Post by livesoft » Sun Aug 14, 2016 9:08 am

RMDs do change tax rates for many people in a big way.

OK, forget about charitable giving. Are you saying that LTCG in taxable are taxed at the same rate as tax-deferred withdrawals and Roth conversions? (OK, I know you are not, but these tax rates matter.)
Wiki This signature message sponsored by sscritic: Learn to fish.

User avatar
White Coat Investor
Posts: 13443
Joined: Fri Mar 02, 2007 9:11 pm
Location: Greatest Snow On Earth

Re: Bonds in Taxable

Post by White Coat Investor » Sun Aug 14, 2016 10:14 am

Doc wrote:
People should try to understand the concepts behind this discussion and apply it to their own situation. There is just too much chance of "bias of the familiar" in any broad statements that relate to the tax code.
That's an excellent point. One also must keep this in mind when reading articles and blogs. For instance, the target audience for my blog is high-income professionals. If you are in the 15% bracket, you may not be my intended audience of any given article. For instance, I just got done writing an article about financial aid planning and how it's basically pointless. That's not true for most people, but it is for my readers.

I think the people who have looked at this subject and come away agnostic or without strong feelings one way or the other get it. The articles I wrote about it are mostly a reaction to the dogmatic (bonds go in tax-protected) way of thinking that I think most people get from places like this forum and many good books. But even the wiki has been updated and I think people are more aware now that it isn't as cut and dried as we'd all like it to be.

If you are actually trying to make a decision for your own portfolio, you need a crystal ball, not only about future tax rates but about whether you'll leave appreciated taxable assets to heirs, give them to charity, or spend them themselves. Pretty hard to predict. I think it's important to realize that you might just be better off with bonds in taxable, but there is no way to know for sure.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course

AlohaJoe
Posts: 3751
Joined: Mon Nov 26, 2007 2:00 pm
Location: Saigon, Vietnam

Re: Bonds in Taxable

Post by AlohaJoe » Sun Aug 14, 2016 10:19 am

njboater74 wrote:Reichenstein has two substantial flaws in his analysis:

1. Does not use tax-exempt bonds for the comparison
This seems like it would undermine his results but not his approach, which is about trying to account for the different risk/reward profiles of the assets in different locations and needing to use mean-variance optimisation.
2. Assumes that you will 'settle up' every year with the IRS by realizing whatever losses or gains you have.
I don't think this is accurate. He has written a number of papers looking at various scenarios including:
(1) day traders who realize all returns each year as short- term gains that are taxed as ordinary income, (2) active investors who realize all gains after one year and one day, (3) passive investors who let gains grow unharvested until realized in n years, and (4) exempt investors who either sell the stock after receiving the step-up in basis at death or donate the appreciated asset to a qualified charity

livesoft
Posts: 62706
Joined: Thu Mar 01, 2007 8:00 pm

Re: Bonds in Taxable

Post by livesoft » Sun Aug 14, 2016 10:22 am

White Coat Investor wrote:If you are actually trying to make a decision for your own portfolio, you need a crystal ball, not only about future tax rates but about whether you'll leave appreciated taxable assets to heirs, give them to charity, or spend them themselves. Pretty hard to predict. I think it's important to realize that you might just be better off with bonds in taxable, but there is no way to know for sure.
^Excellent advice.

So when is your "Bonds Go In Taxable!" title going to be changed to "Bonds Might Go in Taxable"?

And that's your exclamation point, not mine. :)
Wiki This signature message sponsored by sscritic: Learn to fish.

User avatar
White Coat Investor
Posts: 13443
Joined: Fri Mar 02, 2007 9:11 pm
Location: Greatest Snow On Earth

Re: Bonds in Taxable

Post by White Coat Investor » Sun Aug 14, 2016 10:28 am

livesoft wrote:
White Coat Investor wrote:If you are actually trying to make a decision for your own portfolio, you need a crystal ball, not only about future tax rates but about whether you'll leave appreciated taxable assets to heirs, give them to charity, or spend them themselves. Pretty hard to predict. I think it's important to realize that you might just be better off with bonds in taxable, but there is no way to know for sure.
^Excellent advice.

So when is your "Bonds Go In Taxable!" title going to be changed to "Bonds Might Go in Taxable"?

And that's your exclamation point, not mine. :)
I'm not sure you understand how and why titles are written. This might help:
http://www.forbes.com/sites/jeffbercovi ... 4967063358
Forget everything you know. Specifically, forget the rules that say headlines must be informative, objective or even grammatically correct. While sites like Upworthy, Buzzfeed, the Huffington Post and Business Insider are often mocked for formulaic display copy — “You’ll Never BELIEVE Who Taylor Swift Is Dating Now,” or “These 13 Otters Are So Cute You’ll Plotz” — the quantitative approach has in fact led to major innovations in headline writing and the creation of effective new tropes, says Koechley.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course

livesoft
Posts: 62706
Joined: Thu Mar 01, 2007 8:00 pm

Re: Bonds in Taxable

Post by livesoft » Sun Aug 14, 2016 10:32 am

White Coat Investor wrote:I'm not sure you understand how and why titles are written.
Of course, I know. Haven't you seen some of the thread titles I have created? :)
Wiki This signature message sponsored by sscritic: Learn to fish.

User avatar
njboater74
Posts: 632
Joined: Mon Apr 25, 2016 8:21 pm

Re: Bonds in Taxable

Post by njboater74 » Sun Aug 14, 2016 10:32 am

AlohaJoe wrote:
njboater74 wrote:Reichenstein has two substantial flaws in his analysis:

1. Does not use tax-exempt bonds for the comparison
This seems like it would undermine his results but not his approach, which is about trying to account for the different risk/reward profiles of the assets in different locations and needing to use mean-variance optimisation.
2. Assumes that you will 'settle up' every year with the IRS by realizing whatever losses or gains you have.
I don't think this is accurate. He has written a number of papers looking at various scenarios including:
(1) day traders who realize all returns each year as short- term gains that are taxed as ordinary income, (2) active investors who realize all gains after one year and one day, (3) passive investors who let gains grow unharvested until realized in n years, and (4) exempt investors who either sell the stock after receiving the step-up in basis at death or donate the appreciated asset to a qualified charity
Here's his own paper:
https://www.onefpa.org/journal/Pages/No ... sited.aspx

and his own text:
The first group of studies examined whether, everything else the same, it is better to locate stocks in taxable accounts and bonds in TDAs, or vice versa. For example, Daryanani and Cordaro (2005) calculated the after-tax ending wealth to two asset location strategies assuming a 30-year investment horizon, 30 percent ordinary income tax bracket, 15 percent capital gain tax bracket, 5 percent bond returns, and 8 percent stock returns in the form of capital gains that are realized each year (technically, in one year and one day). The after-tax ending wealth values for initial investments of $500,000 of pre-tax funds in TDAs and $500,000 of after-tax funds in taxable accounts are as follows:

Strategy 1: stocks in tax-deferred account
Bonds in taxable accounts: $500,000 (1 + .05(1–0.3))30 = $1,403,397
Stocks in TDA: $500,000 (1.08)30 (1–0.3) = $3,521,930
Total: $4,925,327

Strategy 2: bonds in tax-deferred account
Stocks in taxable accounts: $500,000 (1 + .08(1–0.15))30 = $3,598,385
Bonds in TDA: $500,000 (1.05)30 (1–0.3) = $1,512,680
Total: $5,111,065
It's technically Daryanani and Cordaro making the assumptions, but Reichenstein is using it as evidence. The paper says he considered passive investors who let gains grow unharvested, but that comparison doesn't seem to make it's way in his conclusions.
When the mob and the press and the whole world tell you to move, your job is to plant yourself like a tree beside the river of truth and tell the whole world - 'No, YOU move'--Captain America, Boglehead

User avatar
Doc
Posts: 8601
Joined: Sat Feb 24, 2007 1:10 pm
Location: Two left turns from Larry

Re: Bonds in Taxable

Post by Doc » Sun Aug 14, 2016 10:39 am

livesoft wrote: OK, forget about charitable giving. Are you saying that LTCG in taxable are taxed at the same rate as tax-deferred withdrawals and Roth conversions? (OK, I know you are not, but these tax rates matter.)
Of course not. The tax rate on tax-deferred withdrawals is not even relevant to this discussion.

You cannot compare the after tax gain on AFTER tax money directly with after tax gain on PRE tax money.

The ROTH versus traditional IRA comparison has long been settled. If your tax rate doesn't change between contribution and withdrawal they are exactly equivalent. It's just grade school arithmetic not high finance. It is not relevant to the current discussion.

ROTH: Earn wages, Pay tax, Grow money, Withdraw it

Future Value = Wages *(1-TaxRate)* (1+Growth)

tIRA: Earn wages, Grow money, Pay tax, Withdraw it

Future Value = Wages * (1+Growth) * (1-TaxRate)

A*B*C = A*C*B

"The Commutative Property of Multiplication"
http://www.coolmath.com/prealgebra/06-p ... ication-01

It's the tax on the initial wages in the tIRA vs ROTH comparison. It is the LTCG/QD or OI rate on your investments that is relevant to the "Bonds in Taxable" comparison. The tax on the ROTH is zero. The tax you pay on your tIRA is just the future vale of the tax on your wages which you chose to defer and didn't belong to you in the first place. The tax relevant here is the tax paid on bond interest vs. the tax paid on equity growth both in taxable accounts that matters.
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.

livesoft
Posts: 62706
Joined: Thu Mar 01, 2007 8:00 pm

Re: Bonds in Taxable

Post by livesoft » Sun Aug 14, 2016 10:43 am

Doc wrote:It is the LTCG/QD or OI rate on your investments that is relevant to the "Bonds in Taxable" comparison.
[…]
The tax relevant here is the tax paid on bond interest vs. the tax paid on equity growth both in taxable accounts that matters.
Exactly my point. Thanks.
Wiki This signature message sponsored by sscritic: Learn to fish.

gilgamesh
Posts: 1102
Joined: Sun Jan 10, 2016 9:29 am

Re: Bonds in Taxable

Post by gilgamesh » Sun Aug 14, 2016 11:37 am

The way I see it. It might not be fare to compare tax deferred which I haven't paid taxes to taxable where I have paid taxes, but who cares! That's the choice I have. Just to make it fare, I can't pretend to have the option of investing in a Roth, when I do not have that option. What am I missing?

This is quite an easy decision on an individual basis.

I have X dollars to invest in after tax because I've maxed out other better options. I also have a simple IRA (401k for others). I have to decide whether to park my X dollars of my bond allocation in tax deferred or taxable.

I DO NOT have the option of investing in Roth. So, I don't care what Roth does. I do not have the option to invest in Roth even if I wanted to. I did not choose IRA over Roth, I did not have that option at all.

Then it's just doing the math. I have to make assumptions though.

My tax bracket in retirement, capital gains rate in retirement, stock/Bond fund gain over the relevant time period and bonds/stock annual distribution.

The same kind of assumptions we do for all of the other retirement aspects.

Then put it all together, including tax implications upon withdrawal.

Simple!.... Obviously I am missing something.

Post Reply