Stocks always in taxable for tax efficient investing?

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B4Xt3r
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Stocks always in taxable for tax efficient investing?

Post by B4Xt3r » Sat Dec 09, 2017 10:43 am

Hi All,

I'm beginning to question the rule of thumb that stocks should always be in taxable account. I agree that it minimizes your tax rate (in percentage) but thats not what we actually care about, correct? Don't we care about minimizing the total principal we pay to the gov (i.e. tax rate * tax income)?

Lets say bonds yield 2% real, and my marginal rate is 25%. Holding $100 of bonds in taxable brokerage means that I have after one year 100+2*.75=101.5. So my after-tax real growth rate is 1.5% if I hold bonds in taxable.

Lets say that stocks yield 5% real, and my long-term cap gains rate is 15%. Holding $100 of stocks in taxable brokerage means that I have after one year 100+5*.85=104.25. So my after-tax real growth rate is 4.25% if I hold stocks in taxable (and sold them after one year to fund expenses).

If I held the bonds in roth, I recapture 0.5% of growth per year? If I hold stocks in roth, I recapture .75% of growth per year. Doesn't that mean that, when deciding wether or not it is better to hold stocks or bonds in taxable, I have to look at the difference between the long-term capital gains rate and my marginal rate, and then also look at the expected difference between bonds and stocks growth rate?

Let me know your thoughts,

-kehyler

Edit: Let's assume that I have already filled all my tax-advantaged accounts.
Last edited by B4Xt3r on Sun Dec 10, 2017 4:52 pm, edited 1 time in total.

livesoft
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Re: Stocks always in taxable for tax efficient investing?

Post by livesoft » Sat Dec 09, 2017 10:54 am

There is no rule that stocks should always be in a taxable account. Where did you read that?

If I could put all my investments in a Roth without paying taxes before I make the contribution, then I would certainly do that.

If I could put all my investments in tax-deferred without paying taxes before I make the contribution, then I would certainly do that.

But yes, one can look at tax rates to help one decide the best solution to one's personal puzzle of where to put assets.
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Iorek
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Re: Stocks always in taxable for tax efficient investing?

Post by Iorek » Sat Dec 09, 2017 11:16 am

For what it's worth, in my Roth I have mostly stocks, in my 401k I have both stocks and bonds according to my general asset allocation, and for taxable I buy index funds and i-bonds (overweighting the i-bonds, which serve as EF as well). My 401k is the large majority of our investments.

Personally the benefit of trying to manage asset allocation across different accounts is not clear enough to me to warrant the effort (but that may be a function of the relative size of the accounts as well as uncertainties about how to balance growth potential vs tax treatment).

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Re: Stocks always in taxable for tax efficient investing?

Post by Church Lady » Sat Dec 09, 2017 11:46 am

It's more nuanced than that.

You can only put so much per year into Roth or tax deferred accounts, so your asset allocation may demand you place stocks in a taxable account. So much for choosing the best account!

Mutual funds with large distributions are inefficient in a taxable account because you pay taxes every year and you won't know til year's end what your tax liability will be (grrr!). I'd have all my funds in tax favored accounts, except you can put only so much in those sort of accounts. Index funds and tax managed funds aren't too bad.

Individual stocks can be great in a taxable account because you can control when you take the gains. QDI dividends also are taxed very favorably. But if you trade short term, that's taxed at ordinary income rates.

Something like REITs pay dividends that are never qualified, so that's a 'stock' that's better off in a tax favored account. I have REITS in tax deferred because I have an uber low fee fund available to me there, but you could argue it belongs in a Roth account.

Of course, Bogleheads don't do individual stocks. Just saying! You did say 'stocks'. :) Whether you do stocks or mutual funds, you can harvest tax losses and gains in a taxable account. You can't do that in tax favored accounts. :(

Any money you put into a tax deferred account is going to be taxed sooner or later at ordinary income rates. An index fund in a taxable account can come out ahead of the same fund in a taxable account. It depends on how long you hold the index, what its annual distributions are, your tax rate now and at retirement, etc, etc, etc.

Hope this helps!
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Re: Stocks always in taxable for tax efficient investing?

Post by rkhusky » Sat Dec 09, 2017 11:56 am

It all depends on how different investments perform. If stocks see large increases, Roth is the best place for them. If stocks see large decreases, Roth is the worst place for them, while taxable or tax-deferred would be better. If bonds earn 0%, taxable is fine.

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Re: Stocks always in taxable for tax efficient investing?

Post by retiredjg » Sat Dec 09, 2017 12:04 pm

kehyler wrote:
Sat Dec 09, 2017 10:43 am
I'm beginning to question the rule of thumb that stocks should always be in taxable account.
There is no such rule of thumb. I don't know where people are getting this idea...you are certainly not the first. If it is from our Wiki page, it needs to be edited.

The rule of thumb is more like... "Fill your tax-advantaged accounts like 401k, IRA, Roth IRA with stocks and bonds. When they get full and you have more to save, put stocks in taxable." There are some who put both stocks and bonds in taxable.

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Re: Stocks always in taxable for tax efficient investing?

Post by Dandy » Sat Dec 09, 2017 12:23 pm

I like having the taxable account heavily weighted toward equities and the tax advantaged account heavily weighted toward fixed income. I always re balance in my tax advantaged account so avoid any taxes when I re balance. I am almost 70 and the disadvantage of equities in my taxable account is that they have large cap gain liabilities (nice problem but still a pain). I wish I had had more access to Roth during the accumulation stage - but there are always some disadvantages in placement decisions. e.g. more contributions to a Roth and that would have meant higher taxes than if I put that money in a TIRA/401k.

The expression " the grass always looks greener ..." sometimes applies.

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Re: Stocks always in taxable for tax efficient investing?

Post by delamer » Sat Dec 09, 2017 12:29 pm

retiredjg wrote:
Sat Dec 09, 2017 12:04 pm
kehyler wrote:
Sat Dec 09, 2017 10:43 am
I'm beginning to question the rule of thumb that stocks should always be in taxable account.
There is no such rule of thumb. I don't know where people are getting this idea...you are certainly not the first. If it is from our Wiki page, it needs to be edited.

The rule of thumb is more like... "Fill your tax-advantaged accounts like 401k, IRA, Roth IRA with stocks and bonds. When they get full and you have more to save, put stocks in taxable." There are some who put both stocks and bonds in taxable.
Right. I never am sure if people misstate these principles in the forum because they just are using a language short-cut or because they don't understand the underlying rule-of-thumb.

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Re: Stocks always in taxable for tax efficient investing?

Post by eye.surgeon » Sat Dec 09, 2017 12:32 pm

I've found this video from the boglehead wiki to be very helpful in clarifying this issue.

https://vimeo.com/23072225
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retiredjg
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Re: Stocks always in taxable for tax efficient investing?

Post by retiredjg » Sat Dec 09, 2017 12:34 pm

delamer wrote:
Sat Dec 09, 2017 12:29 pm
Right. I never am sure if people misstate these principles in the forum because they just are using a language short-cut or because they don't understand the underlying rule-of-thumb.
And the third possibility is that statements are correct as intended, but misinterpreted by the reader. I'd have to guess that all three origins contribute to this myth.

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Re: Stocks always in taxable for tax efficient investing?

Post by willthrill81 » Sat Dec 09, 2017 12:57 pm

retiredjg wrote:
Sat Dec 09, 2017 12:04 pm
kehyler wrote:
Sat Dec 09, 2017 10:43 am
I'm beginning to question the rule of thumb that stocks should always be in taxable account.
There is no such rule of thumb. I don't know where people are getting this idea...you are certainly not the first. If it is from our Wiki page, it needs to be edited.

The rule of thumb is more like... "Fill your tax-advantaged accounts like 401k, IRA, Roth IRA with stocks and bonds. When they get full and you have more to save, put stocks in taxable." There are some who put both stocks and bonds in taxable.
The advice to put stocks, rather than bonds, into taxable accounts come straight from the Wiki.

If investors are trying to minimize their taxes, then this strategy is fine. But if their strategy is to maximize their after-tax wealth, it is probably sub-optimal.

The White Coat Investor has demonstrated how, when using some very simple and straightforward assumptions (e.g. stocks' will outperform bonds in terms of total return in the long-run), bonds should be placed in taxable accounts instead of stocks. There are obviously some factors that can complicate this issue, but it seems to me that the 'default' position should be that bonds go in taxable, especially in the current environment where bonds produce such little income.
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Re: Stocks always in taxable for tax efficient investing?

Post by retiredjg » Sat Dec 09, 2017 1:22 pm

willthrill81 wrote:
Sat Dec 09, 2017 12:57 pm
The advice to put stocks, rather than bonds, into taxable accounts come straight from the Wiki.
I agree many people get that message from the Wiki, but they are missing the fact that filling your tax-advantaged accounts first is a goal of higher importance. It is stated in the Wiki, but people are missing it. I think they are missing it because the message is too subtle and most people are only reading the highlights and looking at the charts.

From the link https://www.bogleheads.org/wiki/Tax-eff ... l_strategy
  • In considering asset location keep the following points in mind:

    If your investments are all in tax-advantaged accounts, fund placement will not have a large impact on your returns. Tax-advantaged accounts include tax-deferred accounts, such as 401(k) and 403b, and tax-free accounts such as Roth IRA.

    If you have a taxable account, you should first consider whether it's better to move the money into a tax advantaged account by contributing more to a tax advantaged account.

    If you are already contributing the maximum to every tax advantaged account available to you, and you have additional funds to invest, you need to consider tax efficiency when choosing your funds

    Investors should always establish an emergency fund first, and then fund their deductible retirement account or Roth IRA before their taxable accounts. Tax-advantaged retirement accounts are the most tax-efficient accounts, which should not be overlooked.

The White Coat Investor has demonstrated how, when using some very simple and straightforward assumptions (e.g. stocks' will outperform bonds in terms of total return in the long-run), bonds should be placed in taxable accounts instead of stocks. There are obviously some factors that can complicate this issue, but it seems to me that the 'default' position should be that bonds go in taxable, especially in the current environment where bonds produce such little income.
In my opinion, a careful reading of Jim's blog does not say what you said. It says that "bonds should go into taxable rather than Roth IRA". That is different from "bonds should go in taxable instead of tax-deferred accounts". And certainly different from "bonds should be placed in taxable accounts instead of stocks".

Read it again and see if you don't agree. :happy

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Re: Stocks always in taxable for tax efficient investing?

Post by nedsaid » Sat Dec 09, 2017 1:30 pm

retiredjg wrote:
Sat Dec 09, 2017 12:04 pm
kehyler wrote:
Sat Dec 09, 2017 10:43 am
I'm beginning to question the rule of thumb that stocks should always be in taxable account.
There is no such rule of thumb. I don't know where people are getting this idea...you are certainly not the first. If it is from our Wiki page, it needs to be edited.

The rule of thumb is more like... "Fill your tax-advantaged accounts like 401k, IRA, Roth IRA with stocks and bonds. When they get full and you have more to save, put stocks in taxable." There are some who put both stocks and bonds in taxable.
I am glad somebody is saving this. The thing is, my workplace savings and my IRAs are deferred wages and are my future paycheck in retirement. Don't you want your future paychecks to be as large as possible in light of an investor's need and ability to take risk? I really have a concern about people loading up retirement accounts with bonds and dooming themselves to low returns.

The relative size of taxable and tax deferred retirement accounts also is a big factor. If you have most of your investments in tax deferred retirement accounts, it makes sense to invest your retirement accounts for maximum return. If you have large taxable and tax deferred retirement accounts, it makes sense to make the taxable accounts stock heavy and tax deferred accounts more bond heavy. Rick Ferri has posted that he allocates taxable and tax deferred accounts the same. There are different schools of thought on this.
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willthrill81
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Re: Stocks always in taxable for tax efficient investing?

Post by willthrill81 » Sat Dec 09, 2017 1:56 pm

retiredjg wrote:
Sat Dec 09, 2017 1:22 pm
willthrill81 wrote:
Sat Dec 09, 2017 12:57 pm
The advice to put stocks, rather than bonds, into taxable accounts come straight from the Wiki.
I agree many people get that message from the Wiki, but they are missing the fact that filling your tax-advantaged accounts first is a goal of higher importance. It is stated in the Wiki, but people are missing it. I think they are missing it because the message is too subtle and most people are only reading the highlights and looking at the charts.

From the link https://www.bogleheads.org/wiki/Tax-eff ... l_strategy
  • In considering asset location keep the following points in mind:

    If your investments are all in tax-advantaged accounts, fund placement will not have a large impact on your returns. Tax-advantaged accounts include tax-deferred accounts, such as 401(k) and 403b, and tax-free accounts such as Roth IRA.

    If you have a taxable account, you should first consider whether it's better to move the money into a tax advantaged account by contributing more to a tax advantaged account.

    If you are already contributing the maximum to every tax advantaged account available to you, and you have additional funds to invest, you need to consider tax efficiency when choosing your funds

    Investors should always establish an emergency fund first, and then fund their deductible retirement account or Roth IRA before their taxable accounts. Tax-advantaged retirement accounts are the most tax-efficient accounts, which should not be overlooked.
Yes, it's undeniable that tax advantage space, whether tax deferred or Roth, is nearly always superior to taxable space, though exceptions could exist for those retiring prior to age 59.5 and in a few other instances as well.
retiredjg wrote:
Sat Dec 09, 2017 1:22 pm
The White Coat Investor has demonstrated how, when using some very simple and straightforward assumptions (e.g. stocks' will outperform bonds in terms of total return in the long-run), bonds should be placed in taxable accounts instead of stocks. There are obviously some factors that can complicate this issue, but it seems to me that the 'default' position should be that bonds go in taxable, especially in the current environment where bonds produce such little income.
In my opinion, a careful reading of Jim's blog does not say what you said. It says that "bonds should go into taxable rather than Roth IRA". That is different from "bonds should go in taxable instead of tax-deferred accounts". And certainly different from "bonds should be placed in taxable accounts instead of stocks".

Read it again and see if you don't agree. :happy
From the comments on that blog post:

"'HP'
Makes sense when comparing Roth vs. Taxable, but what about traditional IRA/401k vs. taxable? Especially since you’re then comparing LT cap gains on the taxable stocks vs. normal income bracket from tax-deferred.'

Reply
'White Coat Investor'
It’s the same thing, just more complicated due to the additional arbitrage factor. For these purposes, just consider that a traditional IRA is 2/3 a Roth IRA that belongs to you and 1/3 a Roth IRA that belongs to the government."

So yes, he is saying precisely what I'm saying.
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retiredjg
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Re: Stocks always in taxable for tax efficient investing?

Post by retiredjg » Sat Dec 09, 2017 2:26 pm

In other words, it only makes sense if you tax adjust your asset allocation and pretend you don't have money that is in your accounts....not going there. :happy

My point is that people think they need to create taxable space for stocks and that stocks should only be held in taxable accounts. That was the premise of the original post. I'm saying that premise is incorrect. I also wish the wiki information reflected that.

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Re: Stocks always in taxable for tax efficient investing?

Post by willthrill81 » Sat Dec 09, 2017 2:37 pm

retiredjg wrote:
Sat Dec 09, 2017 2:26 pm
My point is that people think they need to create taxable space for stocks and that stocks should only be held in taxable accounts. That was the premise of the original post. I'm saying that premise is incorrect. I also wish the wiki information reflected that.
On that point we can wholeheartedly agree. :beer
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Re: Stocks always in taxable for tax efficient investing?

Post by pezblanco » Sat Dec 09, 2017 2:38 pm

willthrill81 wrote:
Sat Dec 09, 2017 1:56 pm
retiredjg wrote:
Sat Dec 09, 2017 1:22 pm
willthrill81 wrote:
Sat Dec 09, 2017 12:57 pm
The advice to put stocks, rather than bonds, into taxable accounts come straight from the Wiki.
I agree many people get that message from the Wiki, but they are missing the fact that filling your tax-advantaged accounts first is a goal of higher importance. It is stated in the Wiki, but people are missing it. I think they are missing it because the message is too subtle and most people are only reading the highlights and looking at the charts.

From the link https://www.bogleheads.org/wiki/Tax-eff ... l_strategy
  • In considering asset location keep the following points in mind:

    If your investments are all in tax-advantaged accounts, fund placement will not have a large impact on your returns. Tax-advantaged accounts include tax-deferred accounts, such as 401(k) and 403b, and tax-free accounts such as Roth IRA.

    If you have a taxable account, you should first consider whether it's better to move the money into a tax advantaged account by contributing more to a tax advantaged account.

    If you are already contributing the maximum to every tax advantaged account available to you, and you have additional funds to invest, you need to consider tax efficiency when choosing your funds

    Investors should always establish an emergency fund first, and then fund their deductible retirement account or Roth IRA before their taxable accounts. Tax-advantaged retirement accounts are the most tax-efficient accounts, which should not be overlooked.
Yes, it's undeniable that tax advantage space, whether tax deferred or Roth, is nearly always superior to taxable space, though exceptions could exist for those retiring prior to age 59.5 and in a few other instances as well.
retiredjg wrote:
Sat Dec 09, 2017 1:22 pm
The White Coat Investor has demonstrated how, when using some very simple and straightforward assumptions (e.g. stocks' will outperform bonds in terms of total return in the long-run), bonds should be placed in taxable accounts instead of stocks. There are obviously some factors that can complicate this issue, but it seems to me that the 'default' position should be that bonds go in taxable, especially in the current environment where bonds produce such little income.
In my opinion, a careful reading of Jim's blog does not say what you said. It says that "bonds should go into taxable rather than Roth IRA". That is different from "bonds should go in taxable instead of tax-deferred accounts". And certainly different from "bonds should be placed in taxable accounts instead of stocks".

Read it again and see if you don't agree. :happy
From the comments on that blog post:

"'HP'
Makes sense when comparing Roth vs. Taxable, but what about traditional IRA/401k vs. taxable? Especially since you’re then comparing LT cap gains on the taxable stocks vs. normal income bracket from tax-deferred.'

Reply
'White Coat Investor'
It’s the same thing, just more complicated due to the additional arbitrage factor. For these purposes, just consider that a traditional IRA is 2/3 a Roth IRA that belongs to you and 1/3 a Roth IRA that belongs to the government."

So yes, he is saying precisely what I'm saying.
As I recall, it's actually a bit subtle ... the optimality of bonds in taxable depends on marginal tax rate and the spread between tax-exempt bonds and non tax-exempt bonds and an assumed rate of return on stocks. Virtually everyone needs to do their own calculation to see where things stand. As bond rates lower .... more investors will find that bonds go in taxable. I ended up writing a simple program so that anyone can see what their allocation should be ... for me it ended up being municipal bonds in taxable ....

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Re: Stocks always in taxable for tax efficient investing?

Post by sambb » Sat Dec 09, 2017 2:45 pm

I think the wiki is not a good one at all.
So many other factors - munis, yield on the index stock fund, tax equivalent yield, tax bracket, future capital gains tax rate (does anyone know what it will be in 15 years?), inflation, etc.

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Re: Stocks always in taxable for tax efficient investing?

Post by livesoft » Sat Dec 09, 2017 2:53 pm

nedsaid wrote:
Sat Dec 09, 2017 1:30 pm
Rick Ferri has posted that he allocates taxable and tax deferred accounts the same. There are different schools of thought on this.
Yes, but he hinted that the reason was that he was tired of working against behavioral biases of his clients. Many of them wanted to have the same asset allocation in all their accounts -- or at least equities and bonds in every account. There is a nice chapter in Statman's "Finance for Normal People" on Behavior Life Cycle on Saving and Spending Theory which delves into this. Do you tell your clients "No!" and possibly lose them, or do you go along with their feelings and make them happy?

I don't think Ferri did this for all his clients.
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Re: Stocks always in taxable for tax efficient investing?

Post by nedsaid » Sat Dec 09, 2017 3:20 pm

livesoft wrote:
Sat Dec 09, 2017 2:53 pm
nedsaid wrote:
Sat Dec 09, 2017 1:30 pm
Rick Ferri has posted that he allocates taxable and tax deferred accounts the same. There are different schools of thought on this.
Yes, but he hinted that the reason was that he was tired of working against behavioral biases of his clients. Many of them wanted to have the same asset allocation in all their accounts -- or at least equities and bonds in every account. There is a nice chapter in Statman's "Finance for Normal People" on Behavior Life Cycle on Saving and Spending Theory which delves into this. Do you tell your clients "No!" and possibly lose them, or do you go along with their feelings and make them happy?

I don't think Ferri did this for all his clients.
I did see Rick comment that he allocated the same across accounts though in that post he did not elaborate why. Yes, in business, there is a "keep the customer happy" aspect to this.

I have also commented that investors should not let the tax tail wag the investment dog. Of course, we should strive for tax efficiency but sometimes people tie themselves in knots just to save a small amount in taxes. Good ideas can be taken to extremes. Again, everyone's circumstances are different and these issues needed to be looked at case by case. I don't give detailed tax advice in part because one piece of omitted information can change the advice given. Better to talk in generalities and point people to places where people can research in depth or get detailed advice. The problem with a forum is that you almost never know the whole picture of someone's life and finances.
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Re: Stocks always in taxable for tax efficient investing?

Post by triceratop » Sat Dec 09, 2017 3:48 pm

I don't see how proper financial planning with a view towards maximizing after-tax returns can be taken to extremes. I've seen that statement before and it's never made any sense.
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Re: Stocks always in taxable for tax efficient investing?

Post by itstoomuch » Sat Dec 09, 2017 4:00 pm

I am resigned to the fact that, my IRA trading account will be inefficient but will be the most profitable. :oops: :| :annoyed
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Re: Stocks always in taxable for tax efficient investing?

Post by n00b590 » Sat Dec 09, 2017 4:01 pm

triceratop wrote:
Sat Dec 09, 2017 3:48 pm
I don't see how proper financial planning with a view towards maximizing after-tax returns can be taken to extremes. I've seen that statement before and it's never made any sense.
Maximizing after-tax returns would mean buying only individual zero-dividend domestic stock(s) in taxable and never selling them - withdrawing on margin as needed to cover expenses. And no international stocks even in tax-advantaged accounts. This would significantly reduce your diversification and increase volatility, too extreme for all but the most risk-tolerant.

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Re: Stocks always in taxable for tax efficient investing?

Post by triceratop » Sat Dec 09, 2017 4:06 pm

n00b590 wrote:
Sat Dec 09, 2017 4:01 pm
triceratop wrote:
Sat Dec 09, 2017 3:48 pm
I don't see how proper financial planning with a view towards maximizing after-tax returns can be taken to extremes. I've seen that statement before and it's never made any sense.
Maximizing after-tax returns would mean buying only individual zero-dividend domestic stock(s) in taxable and never selling them - withdrawing on margin as needed to cover expenses. And no international stocks even in tax-advantaged accounts. This would significantly reduce your diversification and increase your volatility.. taking a good idea too far for all but the most risk-tolerant.
That is not true. Buying only zero dividend stocks would increase your likelihood of achieving less wealth than one would with more diversification. I care about that quite a lot, it's why I diversify; I didn't say to focus only on expected returns -- risk-adjusted returns obviously play a role too. I don't advocate people invest solely in dividend paying stocks for the same reason: diversification. And reducing diversification to international stocks has the same effect. What's more, for some investors holding international stocks in tax-advantaged is more efficient. So all of those suggestions fail the proper financial planning test.
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Re: Stocks always in taxable for tax efficient investing?

Post by nedsaid » Sat Dec 09, 2017 4:08 pm

triceratop wrote:
Sat Dec 09, 2017 3:48 pm
I don't see how proper financial planning with a view towards maximizing after-tax returns can be taken to extremes. I've seen that statement before and it's never made any sense.
Tax people often make the statement that home ownership has its tax advantages and of course that is true. What happens is that people will take a piece of advice like that and rush out and make a decision that may not be in their economic best interest. For one thing, time horizon is a consideration. Is someone is moving every 3-4 years, home ownership probably doesn't make sense. You should probably look at a time horizon of 5-7 years. There have been situations where it is actually cheaper to rent than to own for the same housing. You have to make economic decisions taking into consideration a family's entire financial picture rather than more narrow tax considerations.

I have never advised people to just rush out and buy a house just for tax reasons. One has to take into account the entire financial picture and family circumstances. No reason to buy a house you really can't afford to save a few bucks on taxes.

People have rushed to buy Limited Partnerships to minimize taxes and found their tax efficient investment to be a landmine when in later years the IRS disallowed some of these. This happened a lot in the 1980's and the 1990's. You got a tax savings now in exchange for a big tax bill later after the IRS disallowed the tax shelter. Yes, tax efficiency can be taken to extremes with some pretty big consequences.

Making an investment portfolio tax efficient is a good goal and we should all strive for that. The thing is, I want my retirement accounts to achieve maximum return, at least to the degree that I am willing and able to take risks. People who blindly load up their retirement accounts with bonds doom these accounts to very low returns. People can overdo a good idea and I have seen people do some crazy things based upon a piece of advice that somehow stuck in their head. I am amazed that people will make a decision based upon something they heard from a brother-in-law or whoever and don't think things through. Often people rush into a decision without looking at the big picture.

If I have a tax benefit available, of course I will take it. But I don't plan my whole life around the US Tax Code. There is a whole lot more out there than conventional wisdom which in specific situations can be very wrong.
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Re: Stocks always in taxable for tax efficient investing?

Post by mhop » Sat Dec 09, 2017 4:12 pm

I mirror my AA in my accounts. I waver on this from time to time. In my “taxable” accounts I’m buying ibonds and most likely EEs for my bonds.

I would not underestimate leaving a lot of your stock AA in your 401ks and IRAs if you plan on retiring early and then start converting that money to Roth IRAs in a controlled manner to control your tax rates.

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Re: Stocks always in taxable for tax efficient investing?

Post by n00b590 » Sat Dec 09, 2017 4:13 pm

double post
Last edited by n00b590 on Sat Dec 09, 2017 4:14 pm, edited 1 time in total.

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Re: Stocks always in taxable for tax efficient investing?

Post by n00b590 » Sat Dec 09, 2017 4:13 pm

triceratop wrote:
Sat Dec 09, 2017 4:06 pm
n00b590 wrote:
Sat Dec 09, 2017 4:01 pm
triceratop wrote:
Sat Dec 09, 2017 3:48 pm
I don't see how proper financial planning with a view towards maximizing after-tax returns can be taken to extremes. I've seen that statement before and it's never made any sense.
Maximizing after-tax returns would mean buying only individual zero-dividend domestic stock(s) in taxable and never selling them - withdrawing on margin as needed to cover expenses. And no international stocks even in tax-advantaged accounts. This would significantly reduce your diversification and increase your volatility.. taking a good idea too far for all but the most risk-tolerant.
That is not true. Buying only zero dividend stocks would increase your likelihood of achieving less wealth than one would with more diversification. And reducing diversification to international stocks has the same effect.
That is not true. Zero dividend stocks have higher after-tax returns, which more than makes up for the lack of diversification if you can tolerate it. You can still build a fairly well-diversified portfolio with zero-dividend stocks, starting with a heavy dose of BRK.
What's more, for some investors holding international stocks in tax-advantaged is more efficient.
A (dividend-paying) international stock will never be as efficient as an equivalent domestic stock in tax-advantaged, due to the foreign tax withheld.

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Re: Stocks always in taxable for tax efficient investing?

Post by livesoft » Sat Dec 09, 2017 4:19 pm

mhop wrote:
Sat Dec 09, 2017 4:12 pm
I would not underestimate leaving a lot of your stock AA in your 401ks and IRAs if you plan on retiring early and then start converting that money to Roth IRAs in a controlled manner to control your tax rates.
I've converted all my traditional IRA money to Roth IRA. The bond funds in the tIRAs ended up in equity funds in the Roth IRA. And then my spouse's traditional IRAs and 401(k) were adjusted to have more bond funds in order to get to our desired overall portfolio asset allocation.

If all our portfolio ends up in Roth IRAs, then the Roth IRAs will definitely have some bond funds in them. :)
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Re: Stocks always in taxable for tax efficient investing?

Post by mhop » Sat Dec 09, 2017 4:27 pm

livesoft wrote:
Sat Dec 09, 2017 4:19 pm
mhop wrote:
Sat Dec 09, 2017 4:12 pm
I would not underestimate leaving a lot of your stock AA in your 401ks and IRAs if you plan on retiring early and then start converting that money to Roth IRAs in a controlled manner to control your tax rates.
I've converted all my traditional IRA money to Roth IRA. The bond funds in the tIRAs ended up in equity funds in the Roth IRA. And then my spouse's traditional IRAs and 401(k) were adjusted to have more bond funds in order to get to our desired overall portfolio asset allocation.

If all our portfolio ends up in Roth IRAs, then the Roth IRAs will definitely have some bond funds in them. :)
Big question is, could you have converted more (by possibly having more stock in those accounts from the beginning rather than bonds)?

Edit: assuming your AA would’ve allowed you to do so

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Re: Stocks always in taxable for tax efficient investing?

Post by livesoft » Sat Dec 09, 2017 4:29 pm

Sure, I could have had more stocks in those accounts, but that would have messed up my asset allocation. Instead, I have stocks in my taxable account where the amounts have grown huge since I have invested very tax efficiently in stocks in my taxable account.
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Re: Stocks always in taxable for tax efficient investing?

Post by mhop » Sat Dec 09, 2017 4:50 pm

livesoft wrote:
Sat Dec 09, 2017 4:29 pm
Sure, I could have had more stocks in those accounts, but that would have messed up my asset allocation. Instead, I have stocks in my taxable account where the amounts have grown huge since I have invested very tax efficiently in stocks in my taxable account.
Which has grown about 25% this year and will probably cost you 15% of that on the way out unless you start donating shares or TGH which limits the amount you can put through a conversion ladder in a given year. In hindsight is that tax bill higher than stocks in your 401k and munis or treasuries in taxable?

Definitely a win-win scenario either way when you’ve truly won the game.

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Re: Stocks always in taxable for tax efficient investing?

Post by livesoft » Sat Dec 09, 2017 4:52 pm

I'm fortunate enough not to have to pay tax on capital gains and qualified dividends. So 0% is not too high for me.
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Re: Stocks always in taxable for tax efficient investing?

Post by Thesaints » Sat Dec 09, 2017 4:57 pm

Stocks are intrinsically more tax efficient than bonds, therefore it makes sense to generally place bonds in tax advantaged accounts, rather than stocks (assuming one cannot put both).

Stock gains come mostly in the form of capital gains that the long term investor can choose to keep unrealized and therefore not subject to taxation.
Furthermore, QDI and LTG have their own asvantageous federal tax rate, if they are in a taxable account. If one puts them in a 401k, they will be taxed as income, at the marginal rate.

That said, it is always proper to examine carefully each individual situation instead of blindly trusting “rules”.

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Re: Stocks always in taxable for tax efficient investing?

Post by inbox788 » Sat Dec 09, 2017 5:05 pm

kehyler wrote:
Sat Dec 09, 2017 10:43 am
Don't we care about minimizing the total principal we pay to the gov (i.e. tax rate * tax income)?

Lets say bonds yield 2% real, and my marginal rate is 25%. Holding $100 of bonds in taxable brokerage means that I have after one year 100+2*.75=101.5. So my after-tax real growth rate is 1.5% if I hold bonds in taxable.

Lets say that stocks yield 5% real, and my long-term cap gains rate is 15%. Holding $100 of stocks in taxable brokerage means that I have after one year 100+5*.85=104.25. So my after-tax real growth rate is 4.25% if I hold stocks in taxable (and sold them after one year to fund expenses).

If I held the bonds in roth, I recapture 0.5% of growth per year? If I hold stocks in roth, I recapture .75% of growth per year. Doesn't that mean that, when deciding wether or not it is better to hold stocks or bonds in taxable, I have to look at the difference between the long-term capital gains rate and my marginal rate, and then also look at the expected difference between bonds and stocks growth rate?
No! Don't lose sight of the real goal, which is to MAXIMIZE the return. You can minimize the amount you pay the government by minimizing your income. This doesn't really achieve what you really want.

Also, it's not often detailed here, but your AA should really be adjusted for tax advantaged accounts and the impact of taxes on the investments. Going from 100% bonds in IRA and 100% stocks in taxable vs the reverse isn't the same after tax AA. You can look at the differences in returns and the tax advantaged accounts they're in, but once you adjust for after tax AA, you'll wind up being a lot closer to indifference.

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Re: Stocks always in taxable for tax efficient investing?

Post by triceratop » Sat Dec 09, 2017 5:10 pm

n00b590 wrote:
Sat Dec 09, 2017 4:13 pm
triceratop wrote:
Sat Dec 09, 2017 4:06 pm
n00b590 wrote:
Sat Dec 09, 2017 4:01 pm
triceratop wrote:
Sat Dec 09, 2017 3:48 pm
I don't see how proper financial planning with a view towards maximizing after-tax returns can be taken to extremes. I've seen that statement before and it's never made any sense.
Maximizing after-tax returns would mean buying only individual zero-dividend domestic stock(s) in taxable and never selling them - withdrawing on margin as needed to cover expenses. And no international stocks even in tax-advantaged accounts. This would significantly reduce your diversification and increase your volatility.. taking a good idea too far for all but the most risk-tolerant.
That is not true. Buying only zero dividend stocks would increase your likelihood of achieving less wealth than one would with more diversification. And reducing diversification to international stocks has the same effect.
That is not true. Zero dividend stocks have higher after-tax returns, which more than makes up for the lack of diversification if you can tolerate it. You can still build a fairly well-diversified portfolio with zero-dividend stocks, starting with a heavy dose of BRK.
Unless you are willing to write an insurance contract for the possible performance difference we are going to have to disagree and I'll stick with diversification.
What's more, for some investors holding international stocks in tax-advantaged is more efficient.
A (dividend-paying) international stock will never be as efficient as an equivalent domestic stock in tax-advantaged, due to the foreign tax withheld.
No. You forgot "equally-yielding" and "with same proportion of qualified dividends". There are also state taxes to consider once these are out of balance and it becomes a subtler question. I even wrote a spreadsheet about this -- you might consider reading it! Here is a link: viewtopic.php?t=208818

A lot of people were surprised by it because of conventional wisdom like yours not being so correct.
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Re: Stocks always in taxable for tax efficient investing?

Post by triceratop » Sat Dec 09, 2017 5:13 pm

nedsaid wrote:
Sat Dec 09, 2017 4:08 pm
triceratop wrote:
Sat Dec 09, 2017 3:48 pm
I don't see how proper financial planning with a view towards maximizing after-tax returns can be taken to extremes. I've seen that statement before and it's never made any sense.
Tax people often make the statement that home ownership has its tax advantages and of course that is true. What happens is that people will take a piece of advice like that and rush out and make a decision that may not be in their economic best interest. For one thing, time horizon is a consideration. Is someone is moving every 3-4 years, home ownership probably doesn't make sense. You should probably look at a time horizon of 5-7 years. There have been situations where it is actually cheaper to rent than to own for the same housing. You have to make economic decisions taking into consideration a family's entire financial picture rather than more narrow tax considerations.

I have never advised people to just rush out and buy a house just for tax reasons. One has to take into account the entire financial picture and family circumstances. No reason to buy a house you really can't afford to save a few bucks on taxes.

People have rushed to buy Limited Partnerships to minimize taxes and found their tax efficient investment to be a landmine when in later years the IRS disallowed some of these. This happened a lot in the 1980's and the 1990's. You got a tax savings now in exchange for a big tax bill later after the IRS disallowed the tax shelter. Yes, tax efficiency can be taken to extremes with some pretty big consequences.

Making an investment portfolio tax efficient is a good goal and we should all strive for that. The thing is, I want my retirement accounts to achieve maximum return, at least to the degree that I am willing and able to take risks. People who blindly load up their retirement accounts with bonds doom these accounts to very low returns. People can overdo a good idea and I have seen people do some crazy things based upon a piece of advice that somehow stuck in their head. I am amazed that people will make a decision based upon something they heard from a brother-in-law or whoever and don't think things through. Often people rush into a decision without looking at the big picture.

If I have a tax benefit available, of course I will take it. But I don't plan my whole life around the US Tax Code. There is a whole lot more out there than conventional wisdom which in specific situations can be very wrong.
Very good points, we are in agreement. None of what you describe is proper financial planning.
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Re: Stocks always in taxable for tax efficient investing?

Post by itstoomuch » Sat Dec 09, 2017 5:13 pm

^
inbox788 wrote:you'll wind up being a lot closer to indifference
That works for me. I often fall to sleep by trying to calculate that difference. :mrgreen: :oops: :greedy
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Re: Stocks always in taxable for tax efficient investing?

Post by Thesaints » Sat Dec 09, 2017 5:16 pm

Buying non-divided paying stocks would also increase his likelihood of achieving more wealth, to be fair. This is one of those cases where reduced diversification increases volatility, but does not change expected return.

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Re: Stocks always in taxable for tax efficient investing?

Post by triceratop » Sat Dec 09, 2017 5:17 pm

Thesaints wrote:
Sat Dec 09, 2017 5:16 pm
Buying non-divided paying stocks would also increase his likelihood of achieving more wealth, to be fair. This is one of those cases where reduced diversification increases volatility, but does not change expected return.
Correct. Most of us invest with an eye towards risk-adjusted return. No reason to ignore that just to prove a point about how we should invest less tax efficiently. :confused
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Re: Stocks always in taxable for tax efficient investing?

Post by Thesaints » Sat Dec 09, 2017 5:22 pm

triceratop wrote:
Sat Dec 09, 2017 5:17 pm
Thesaints wrote:
Sat Dec 09, 2017 5:16 pm
Buying non-divided paying stocks would also increase his likelihood of achieving more wealth, to be fair. This is one of those cases where reduced diversification increases volatility, but does not change expected return.
Correct. Most of us invest with an eye towards risk-adjusted return. No reason to ignore that just to prove a point about how we should invest less tax efficiently. :confused
Why would dividend paying stocks be more tax efficient ? Also the number of investors who seek higher volatility is not as small as you probably think.

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Re: Stocks always in taxable for tax efficient investing?

Post by n00b590 » Sat Dec 09, 2017 5:27 pm

triceratop wrote:
Sat Dec 09, 2017 5:10 pm
n00b590 wrote:
Sat Dec 09, 2017 4:13 pm
triceratop wrote:
Sat Dec 09, 2017 4:06 pm
n00b590 wrote:
Sat Dec 09, 2017 4:01 pm
triceratop wrote:
Sat Dec 09, 2017 3:48 pm
I don't see how proper financial planning with a view towards maximizing after-tax returns can be taken to extremes. I've seen that statement before and it's never made any sense.
Maximizing after-tax returns would mean buying only individual zero-dividend domestic stock(s) in taxable and never selling them - withdrawing on margin as needed to cover expenses. And no international stocks even in tax-advantaged accounts. This would significantly reduce your diversification and increase your volatility.. taking a good idea too far for all but the most risk-tolerant.
That is not true. Buying only zero dividend stocks would increase your likelihood of achieving less wealth than one would with more diversification. And reducing diversification to international stocks has the same effect.
That is not true. Zero dividend stocks have higher after-tax returns, which more than makes up for the lack of diversification if you can tolerate it. You can still build a fairly well-diversified portfolio with zero-dividend stocks, starting with a heavy dose of BRK.
Unless you are willing to write an insurance contract for the possible performance difference we are going to have to disagree and I'll stick with diversification.
Sure fair enough, there is risk involved. But you're backpedaling from a statement of fact, to now just stating your personal risk preferences.
triceratop wrote:
Sat Dec 09, 2017 5:10 pm
What's more, for some investors holding international stocks in tax-advantaged is more efficient.
A (dividend-paying) international stock will never be as efficient as an equivalent domestic stock in tax-advantaged, due to the foreign tax withheld.
No. You forgot "equally-yielding" and "with same proportion of qualified dividends". There are also state taxes to consider once these are out of balance and it becomes a subtler question. I even wrote a spreadsheet about this -- you might consider reading it! Here is a link: viewtopic.php?t=208818

A lot of people were surprised by it because of conventional wisdom like yours not being so correct.
I wrote "equivalent domestic stock", which implies equal yield and qualified dividends. And thanks, I've read your spreadsheet and it's very useful as far as it goes, but it doesn't say what you claim it does. I agree it can be better on a relative basis to hold international in tax-advantaged--contrary to conventional wisdom--but that's a separate issue from whether it's even best to hold international in the first place. I'm saying international will always underperform domestic on an after-tax basis if you assume equal yield, equal return, etc.
Last edited by n00b590 on Sat Dec 09, 2017 5:30 pm, edited 1 time in total.

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Re: Stocks always in taxable for tax efficient investing?

Post by triceratop » Sat Dec 09, 2017 5:28 pm

Thesaints wrote:
Sat Dec 09, 2017 5:22 pm
triceratop wrote:
Sat Dec 09, 2017 5:17 pm
Thesaints wrote:
Sat Dec 09, 2017 5:16 pm
Buying non-divided paying stocks would also increase his likelihood of achieving more wealth, to be fair. This is one of those cases where reduced diversification increases volatility, but does not change expected return.
Correct. Most of us invest with an eye towards risk-adjusted return. No reason to ignore that just to prove a point about how we should invest less tax efficiently. :confused
Why would dividend paying stocks be more tax efficient ? Also the number of investors who seek higher volatility is not as small as you probably think.
I'm not saying they are more tax efficient. They're not. But the zero-dividend stock poster above is trying to take my advice to an extreme while ignoring the bounds of my advice: maximum diversification for highest risk-adjusted return followed by tax efficient planning for.

This argument is extremely silly but let me distill it:

Me: we should always implement our proper financial plan in the most tax efficient way possible; within the bounds of a good financial plan this cannot be taken to extremes.

Others: but you can do dumb thing X, Y, and Z, like investing in zero-dividend stocks or home ownership when it doesn't make sense.

Me: yes, those things are dumb.
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Re: Stocks always in taxable for tax efficient investing?

Post by n00b590 » Sat Dec 09, 2017 5:29 pm

Thesaints wrote:
Sat Dec 09, 2017 5:16 pm
This is one of those cases where reduced diversification increases volatility, but does not change expected return.
Wrong. Better tax efficiency means higher expected (after-tax) returns.

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Re: Stocks always in taxable for tax efficient investing?

Post by triceratop » Sat Dec 09, 2017 5:31 pm

n00b590, your assumptions haven't been true in recent memory. In fact they're almost never true.
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Re: Stocks always in taxable for tax efficient investing?

Post by n00b590 » Sat Dec 09, 2017 5:33 pm

triceratop wrote:
Sat Dec 09, 2017 5:28 pm
Thesaints wrote:
Sat Dec 09, 2017 5:22 pm
triceratop wrote:
Sat Dec 09, 2017 5:17 pm
Thesaints wrote:
Sat Dec 09, 2017 5:16 pm
Buying non-divided paying stocks would also increase his likelihood of achieving more wealth, to be fair. This is one of those cases where reduced diversification increases volatility, but does not change expected return.
Correct. Most of us invest with an eye towards risk-adjusted return. No reason to ignore that just to prove a point about how we should invest less tax efficiently. :confused
Why would dividend paying stocks be more tax efficient ? Also the number of investors who seek higher volatility is not as small as you probably think.
I'm not saying they are more tax efficient. They're not. But the zero-dividend stock poster above is trying to take my advice to an extreme while ignoring the bounds of my advice: maximum diversification for highest risk-adjusted return followed by tax efficient planning for.

This argument is extremely silly but let me distill it:

Me: we should always implement our proper financial plan in the most tax efficient way possible; within the bounds of a good financial plan this cannot be taken to extremes.

Others: but you can do dumb thing X, Y, and Z, like investing in zero-dividend stocks or home ownership when it doesn't make sense.

Me: yes, those things are dumb.
They're dumb for you because of your personal risk preferences. That was my point - what is extreme for you might be optimal for someone else. I'll gladly take the added volatility to avoid the 0.5% annual tax drag of VTI, thank you very much.

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Re: Stocks always in taxable for tax efficient investing?

Post by Thesaints » Sat Dec 09, 2017 5:49 pm

n00b590 wrote:
Sat Dec 09, 2017 5:29 pm
Thesaints wrote:
Sat Dec 09, 2017 5:16 pm
This is one of those cases where reduced diversification increases volatility, but does not change expected return.
Wrong. Better tax efficiency means higher expected (after-tax) returns.
Ii is a small difference. A lot more worrisome is shunning foreign stocks trying to bank on said small difference. In that case volatility increase is a lot higher than simply avoiding high-divided paying stocks. Consider the extra tax paid as the cost of insurance against personal poverty.

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Re: Stocks always in taxable for tax efficient investing?

Post by IlliniDave » Sat Dec 09, 2017 6:43 pm

I have roughly similar allocations between taxable and retirement, though retirement is a little more stock-heavy. I tend to use a bit of bucket mentality and look at my taxable assets as usable for spending from retirement (~ age 55) to age 70. So I'm a little more conservative there, but keep a dollop of equities. With the potential for tax laws to change I don't like going all-in one way or another in my taxable account based on tax strategy. I expect my retirement income to be much lower compared to my working income, so hopefully the price I pay for hedging won't be too steep.

I still try to minimize transactions and use muni bonds in taxable but wouldn't sleep well at night with all equities or all bonds in taxable.
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Re: Stocks always in taxable for tax efficient investing?

Post by BuyAndHoldOn » Sat Dec 09, 2017 6:49 pm

willthrill81 wrote:
Sat Dec 09, 2017 12:57 pm
retiredjg wrote:
Sat Dec 09, 2017 12:04 pm
kehyler wrote:
Sat Dec 09, 2017 10:43 am
I'm beginning to question the rule of thumb that stocks should always be in taxable account.
There is no such rule of thumb. I don't know where people are getting this idea...you are certainly not the first. If it is from our Wiki page, it needs to be edited.

The rule of thumb is more like... "Fill your tax-advantaged accounts like 401k, IRA, Roth IRA with stocks and bonds. When they get full and you have more to save, put stocks in taxable." There are some who put both stocks and bonds in taxable.
The advice to put stocks, rather than bonds, into taxable accounts come straight from the Wiki.

If investors are trying to minimize their taxes, then this strategy is fine. But if their strategy is to maximize their after-tax wealth, it is probably sub-optimal.

The White Coat Investor has demonstrated how, when using some very simple and straightforward assumptions (e.g. stocks' will outperform bonds in terms of total return in the long-run), bonds should be placed in taxable accounts instead of stocks. There are obviously some factors that can complicate this issue, but it seems to me that the 'default' position should be that bonds go in taxable, especially in the current environment where bonds produce such little income.

Exactly. Don't let the tax tail wag the dog, as they say.

I have bonds in taxable because they are stable, and can be tapped into more readily at a time of need. I have some Munis, and some taxable bonds --> In the 25% Federal tax bracket, they are about break-even in after tax returns [with a similar risk/reward profile]. But the returns are so low overall that they don't impact my taxes much at all. (If they did, that would be fine --> I'd make more money, thus pay more taxes).

Munis make a bigger difference if you are in a high tax state, however. Fortunately those states are commonly represented in accessible bond funds to retail investors.
Last edited by BuyAndHoldOn on Sat Dec 09, 2017 6:54 pm, edited 1 time in total.

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Re: Stocks always in taxable for tax efficient investing?

Post by Thesaints » Sat Dec 09, 2017 6:54 pm

WCI’s analysis is based on Roth vs. Taxable.
For many investors Roth acconts are a small subset of their tax advantaged accounts.

The same analysis based on 401k vs. Taxable would show that bonds belong to the 401k

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