Help with tax efficient asset allocation for taxable account

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boglenobNYC
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Help with tax efficient asset allocation for taxable account

Post by boglenobNYC » Mon Jan 15, 2018 3:48 pm

I'm planning investing large lump sum into 3 fund portfolio (90%/10% stocks/bonds) in taxable account.

Age: 27
Federal tax rate: 22%
NY tax rate: 6.45%

Taxable
50% Vanguard Total Stock Market VTSAX (0.04%)
40% Vanguard Total International Stock Market VTIAX (0.11%)
10% Vanguard Total Bond Market VBTLX (0.05%)

That's asset allocation I was initially considering but according to Tax-efficient_fund_placement article bonds aren't tax efficient in taxable account so I wanted to ask if there're better alternatives in my situation?

Is it a good idea to replace VBTLX with Vanguard New York Long-Term Tax-Exempt Fund VNYUX (0.09%) which is both federal and NY state tax-exempt or buying series 1 bonds instead?

Is it a good idea to replace VTSAX and VTIAX with Vanguard 500 Index Fund VFIAX (0.04%) since it has QDI rate of 100% while QDI rates for VTSAX and VTIAX were 94.78% and 66.60% respectively for 2016? I understand that means less diversification but in long-term it should produce good returns anyway.

Thanks in advance.

JimInIllinois
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Re: Help with tax efficient asset allocation for taxable account

Post by JimInIllinois » Mon Jan 15, 2018 10:38 pm

Have you seen https://www.bogleheads.org/wiki/Tax-man ... comparison ?

If you have savings in tax-advantaged accounts, look at the asset allocation across your entire portfolio rather than treating taxable and tax-advantaged separately, so you could put small caps in tax-advantaged and S&P 500 in taxable.

Depending on what your time horizon for the lump sum is (at 90% stocks it had better be long), you could use the money (at least the dividends) to max out your tax-advantaged space every year until it is gone.

I like I-bonds, but you can only buy $10,000 per year (so it depends on your definition of "large"). You can compare the after-tax yields for the tax-exempt bond fund to taxable bonds of similar risk to tell if that would make sense for you.

boglenobNYC
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Re: Help with tax efficient asset allocation for taxable account

Post by boglenobNYC » Mon Jan 15, 2018 10:44 pm

I don't have tax-advantaged account and not planning to have. I have a goal of early retirement abroad.

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indexfundfan
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Re: Help with tax efficient asset allocation for taxable account

Post by indexfundfan » Mon Jan 15, 2018 10:48 pm

If you have access only to the taxable account, here's one suggestion:

60% Vanguard Total Stock Market VTSAX (0.04%)
30% Vanguard Total International Stock Market VTIAX (0.11%)
5% Vanguard New York Long-Term Tax-Exempt Fund VNYUX (0.09%)
5% Vanguard Limited Term Tax-Exempt Fund

My rule of thumb is to have international stocks about half that of US stocks. Reducing Total International Stock from 40% to 30% also helps to improve the QDI percentage.

The mix of NY Tax-Exempt and Limited Term Tax-Exempt balances the fund duration and state tax exemption.
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boglenobNYC
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Re: Help with tax efficient asset allocation for taxable account

Post by boglenobNYC » Mon Jan 15, 2018 11:13 pm

Thanks for suggestion.

Just to clarify: isn't having both limited-term and long-term funds redundant? I mean if minimizing risk and federal tax exemption is goal I can go with Intermediate-Term Tax-Exempt Fund, right?

4 fund portfolio will be a headache to manage and to calculate capital gains.

I just noticed Admiral version of NY tax-exempt fund has a minimum of 50k so I will have to opt for Investor version (0.19%
). Same goes for Limited-term tax-exempt fund (0.19%).
Last edited by boglenobNYC on Tue Jan 16, 2018 12:02 am, edited 2 times in total.

JimInIllinois
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Re: Help with tax efficient asset allocation for taxable account

Post by JimInIllinois » Mon Jan 15, 2018 11:16 pm

boglenobNYC wrote:
Mon Jan 15, 2018 10:44 pm
I don't have tax-advantaged account and not planning to have. I have a goal of early retirement abroad.
OK, that's outside my experience. I hope you've done your homework on this.

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indexfundfan
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Re: Help with tax efficient asset allocation for taxable account

Post by indexfundfan » Tue Jan 16, 2018 10:44 am

boglenobNYC wrote:
Mon Jan 15, 2018 11:13 pm
Just to clarify: isn't having both limited-term and long-term funds redundant? I mean if minimizing risk and federal tax exemption is goal I can go with Intermediate-Term Tax-Exempt Fund, right?
Some people find that the combination of Limited term fund and Long term fund produces a higher after-tax (Fed & State) yield. Sticking with just the Intermediate term fund is fine too. YMMV.
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boglenobNYC
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Re: Help with tax efficient asset allocation for taxable account

Post by boglenobNYC » Tue Jan 16, 2018 11:12 am

JimInIllinois wrote:
Mon Jan 15, 2018 11:16 pm
boglenobNYC wrote:
Mon Jan 15, 2018 10:44 pm
I don't have tax-advantaged account and not planning to have. I have a goal of early retirement abroad.
OK, that's outside my experience. I hope you've done your homework on this.
Retirement in US is very expensive.
I have an apartment in my home country where cost of living is much lower.

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grabiner
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Re: Help with tax efficient asset allocation for taxable account

Post by grabiner » Tue Jan 16, 2018 8:47 pm

boglenobNYC wrote:
Mon Jan 15, 2018 11:13 pm
Just to clarify: isn't having both limited-term and long-term funds redundant? I mean if minimizing risk and federal tax exemption is goal I can go with Intermediate-Term Tax-Exempt Fund, right?
The idea is to use Limited-Term Tax-Exempt and NY Long-Term Tax-Exempt, so that you can get an intermediate-term duration with only half your bonds in NY (reducing the single-state risk), and more than half your income exempt from NY tax.

However, in a 22% bracket, I wouldn't recommend Limited-Term Tax-Exempt; taxable bonds are likely better in that bracket. Use I-Bonds first, since they are exempt from state tax and the federal tax is deferred. Once you have maxed out on I-Bonds, you might use a TIPS fund, which is also a low-risk bond fund, and which is exempt from NY tax.
Wiki David Grabiner

boglenobNYC
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Re: Help with tax efficient asset allocation for taxable account

Post by boglenobNYC » Wed Jan 17, 2018 12:27 am

grabiner wrote:
Tue Jan 16, 2018 8:47 pm
boglenobNYC wrote:
Mon Jan 15, 2018 11:13 pm
Just to clarify: isn't having both limited-term and long-term funds redundant? I mean if minimizing risk and federal tax exemption is goal I can go with Intermediate-Term Tax-Exempt Fund, right?
The idea is to use Limited-Term Tax-Exempt and NY Long-Term Tax-Exempt, so that you can get an intermediate-term duration with only half your bonds in NY (reducing the single-state risk), and more than half your income exempt from NY tax.

However, in a 22% bracket, I wouldn't recommend Limited-Term Tax-Exempt; taxable bonds are likely better in that bracket. Use I-Bonds first, since they are exempt from state tax and the federal tax is deferred. Once you have maxed out on I-Bonds, you might use a TIPS fund, which is also a low-risk bond fund, and which is exempt from NY tax.
Total Bond Market has 2.6% yield. I calculated taxable-equivalent yields for tax-exempt funds and here's what I got:

Limited-Term Tax-Exempt
1.80% / (1 - 0.22) = 2.3%

Intermediate-Term Tax-Exempt
2.14% / (1 - 0.22) = 2.74%

New York Long-Term Tax-Exempt
2.26% / (1 - 0.22) = 2.89%

Looks like Intermediate-Term Tax-Exempt is optimal with the level of risk and yield.
It holds 7261 bonds and while it's much less than number of bonds in Total Bond Market (8420) it's still pretty diversified I think.

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triceratop
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Re: Help with tax efficient asset allocation for taxable account

Post by triceratop » Wed Jan 17, 2018 1:34 am

boglenobNYC wrote:
Wed Jan 17, 2018 12:27 am
grabiner wrote:
Tue Jan 16, 2018 8:47 pm
boglenobNYC wrote:
Mon Jan 15, 2018 11:13 pm
Just to clarify: isn't having both limited-term and long-term funds redundant? I mean if minimizing risk and federal tax exemption is goal I can go with Intermediate-Term Tax-Exempt Fund, right?
The idea is to use Limited-Term Tax-Exempt and NY Long-Term Tax-Exempt, so that you can get an intermediate-term duration with only half your bonds in NY (reducing the single-state risk), and more than half your income exempt from NY tax.

However, in a 22% bracket, I wouldn't recommend Limited-Term Tax-Exempt; taxable bonds are likely better in that bracket. Use I-Bonds first, since they are exempt from state tax and the federal tax is deferred. Once you have maxed out on I-Bonds, you might use a TIPS fund, which is also a low-risk bond fund, and which is exempt from NY tax.
Total Bond Market has 2.6% yield. I calculated taxable-equivalent yields for tax-exempt funds and here's what I got:

Limited-Term Tax-Exempt
1.80% / (1 - 0.22) = 2.3%

Intermediate-Term Tax-Exempt
2.14% / (1 - 0.22) = 2.74%

New York Long-Term Tax-Exempt
2.26% / (1 - 0.22) = 2.89%

Looks like Intermediate-Term Tax-Exempt is optimal with the level of risk and yield.
It holds 7261 bonds and while it's much less than number of bonds in Total Bond Market (8420) it's still pretty diversified I think.
Your math isn't right because you should be using 22% plus NY state tax for the computation of tax-equivalents yield for the NY tax-exempt fund.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

3funder
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Re: Help with tax efficient asset allocation for taxable account

Post by 3funder » Wed Jan 17, 2018 8:56 am

Your original asset allocation is pretty tax-efficient. Yes, you could hold muni bonds, but given that your bond allocation is only 10%, I don't think it will make a tremendous difference (unless your balance is quite high).

boglenobNYC
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Re: Help with tax efficient asset allocation for taxable account

Post by boglenobNYC » Wed Jan 17, 2018 9:18 am

triceratop wrote:
Wed Jan 17, 2018 1:34 am
boglenobNYC wrote:
Wed Jan 17, 2018 12:27 am
grabiner wrote:
Tue Jan 16, 2018 8:47 pm
boglenobNYC wrote:
Mon Jan 15, 2018 11:13 pm
Just to clarify: isn't having both limited-term and long-term funds redundant? I mean if minimizing risk and federal tax exemption is goal I can go with Intermediate-Term Tax-Exempt Fund, right?
The idea is to use Limited-Term Tax-Exempt and NY Long-Term Tax-Exempt, so that you can get an intermediate-term duration with only half your bonds in NY (reducing the single-state risk), and more than half your income exempt from NY tax.

However, in a 22% bracket, I wouldn't recommend Limited-Term Tax-Exempt; taxable bonds are likely better in that bracket. Use I-Bonds first, since they are exempt from state tax and the federal tax is deferred. Once you have maxed out on I-Bonds, you might use a TIPS fund, which is also a low-risk bond fund, and which is exempt from NY tax.
Total Bond Market has 2.6% yield. I calculated taxable-equivalent yields for tax-exempt funds and here's what I got:

Limited-Term Tax-Exempt
1.80% / (1 - 0.22) = 2.3%

Intermediate-Term Tax-Exempt
2.14% / (1 - 0.22) = 2.74%

New York Long-Term Tax-Exempt
2.26% / (1 - 0.22) = 2.89%

Looks like Intermediate-Term Tax-Exempt is optimal with the level of risk and yield.
It holds 7261 bonds and while it's much less than number of bonds in Total Bond Market (8420) it's still pretty diversified I think.
Your math isn't right because you should be using 22% plus NY state tax for the computation of tax-equivalents yield for the NY tax-exempt fund.
Thanks for correction.

Total Bond Market
2.6%

Limited-Term Tax-Exempt
1.80% / (1 - 0.22) = 2.3%

Intermediate-Term Tax-Exempt
2.14% / (1 - 0.22) = 2.74%

New York Long-Term Tax-Exempt
2.26% / (1 - 0.22 - 0.0645) = 3.15%

Average yield for Limited-Term Tax-Exempt and New York Long-Term Tax-Exempt
(2.3% + 3.15%) / 2 = 2.72%

It still looks like Intermediate-Term has slightly better yield while exposing to same risk.

boglenobNYC
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Re: Help with tax efficient asset allocation for taxable account

Post by boglenobNYC » Wed Jan 17, 2018 9:20 am

3funder wrote:
Wed Jan 17, 2018 8:56 am
Your original asset allocation is pretty tax-efficient. Yes, you could hold muni bonds, but given that your bond allocation is only 10%, I don't think it will make a tremendous difference (unless your balance is quite high).
I'm planning to put additional investment each month.
Will have to turn off automatic re-investment of dividends otherwise it will be a total nightmare for taxes.

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grabiner
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Re: Help with tax efficient asset allocation for taxable account

Post by grabiner » Wed Jan 17, 2018 8:23 pm

boglenobNYC wrote:
Wed Jan 17, 2018 9:18 am
Total Bond Market
2.6%

Limited-Term Tax-Exempt
1.80% / (1 - 0.22) = 2.3%

Intermediate-Term Tax-Exempt
2.14% / (1 - 0.22) = 2.74%

New York Long-Term Tax-Exempt
2.26% / (1 - 0.22 - 0.0645) = 3.15%

Average yield for Limited-Term Tax-Exempt and New York Long-Term Tax-Exempt
(2.3% + 3.15%) / 2 = 2.72%

It still looks like Intermediate-Term has slightly better yield while exposing to same risk.
The risk of the two-fund combination is probably slightly lower. It has a slightly shorter duration (4.9 years versus 5.4 years), so it will lose a bit less if rates rise. Also, there is probably less credit risk; NY Long-Term Tax-Exempt has a lower yield than Long-Term Tax-Exempt, which implies that bond investors believe that NY bonds are less risky than the average muni bond.
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3funder
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Re: Help with tax efficient asset allocation for taxable account

Post by 3funder » Wed Jan 17, 2018 8:23 pm

I was under the impression that most investors re-invest dividends. Maybe I was wrong.

boglenobNYC
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Re: Help with tax efficient asset allocation for taxable account

Post by boglenobNYC » Wed Jan 17, 2018 9:07 pm

3funder wrote:
Wed Jan 17, 2018 8:23 pm
I was under the impression that most investors re-invest dividends. Maybe I was wrong.
That's true but I think it mostly applies to those with tax-advantaged account.

I'm opening taxable account and planning to invest additional amount each month (or even 2 weeks) with dividends that I earn. If I choose to automatically re-invest dividends it should create enormous amount of tax lots.

I understand that I miss compounding in this case but better that than red tape during tax return season.
As an alternative there's an option to put dividends into high-yield saving account but I'm not sure it's worth putting them for a month before transferring to portfolio.

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