Debunking Bonds in Taxable

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JimInIllinois
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Re: Debunking Bonds in Taxable

Post by JimInIllinois » Tue Oct 23, 2018 10:07 pm

michaeljc70 wrote:
Tue Oct 23, 2018 9:28 am
JimInIllinois wrote:
Mon Oct 22, 2018 10:49 pm
michaeljc70 wrote:
Mon Oct 08, 2018 3:11 pm
One scenario I can envision where bonds in taxable is beneficial is:

-You retire early (before 59 1/2)
-The market is in a downturn so you don't want to sell stocks from taxable accounts
-You can't access bonds without special withdrawals from IRAs (like 72t)
Why would you not want to sell stocks from taxable accounts during a downturn? Lower stock prices reduce your capital gains, and you could even harvest losses. You can simultaneously repurchase similar assets in your tax-deferred/tax-free accounts to keep your asset allocation where you want it. I guess I could see your point if you were in danger of running out of taxable assets before age 59 1/2, but then you should always have a year or so of living expenses as accessible cash to ride out a downturn.
Most people prefer buying low and selling high.
You can be a net buyer by buying more stock in tax-advantaged than you sell in taxable.

MathWizard
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Re: Debunking Bonds in Taxable

Post by MathWizard » Tue Oct 23, 2018 10:17 pm

dwickenh wrote:
Mon Oct 08, 2018 4:42 pm
willthrill81 wrote:
Mon Oct 08, 2018 4:30 pm
dwickenh wrote:
Mon Oct 08, 2018 4:27 pm
willthrill81 wrote:
Mon Oct 08, 2018 4:25 pm
dwickenh wrote:
Mon Oct 08, 2018 3:55 pm


Always use a taxable account, along with your Roth and TIRA.

The three together are magic for controlling income for taxes and Health Insurance Subsidies.

Dan
I have no need for a taxable account as we have over $75k of tax-advantaged space every year.
Then the solution for you is to not use taxable accounts, though not for everyone.
I know. I was being facetious.
I should have known that :oops:
Would you both agree that you should save enough?

If one has sufficient tax advantaged space, then use that, if not invest in taxable.

So fill tax advantaged first, then turn to taxable. Now make sure that you take taxes into account for tax deffered. A dollar in taxable at retirement is not the same as a dollar in tax advantaged, but a dollar in a ROTH is clearly worth more than a dollar in taxable at any time.

international001
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Re: Debunking Bonds in Taxable

Post by international001 » Thu Oct 25, 2018 8:31 am

Cartographer wrote:
Tue Oct 23, 2018 12:42 pm

The risk is really in the margins though. If my investments return an extra dollar, that dollar will get taxed at the marginal rate. Therefore, the variation in portfolio outcomes is scaled down by the marginal rate, not the effective rate. So if you are trying to determine the optimal asset location, you should use marginal.

On the other hand, if you are just trying to estimate your after-tax net worth, you would use the effective tax rate.
We are talking asset allocation of taxable vs pre-tax, so it's about estimating the total after-tax net worth after years of investment

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White Coat Investor
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Re: Debunking Bonds in Taxable

Post by White Coat Investor » Thu Oct 25, 2018 9:17 am

Cartographer wrote:
Mon Oct 08, 2018 3:02 pm


Funnily enough, I actually got onto the whole topic of tax-adjusting asset allocation from the WCI article itself. In the comments section, someone brought up Traditional accounts, which weren’t discussed in the post. In response, WCI argued that you could tax-adjusted the Traditional to make it equivalent to Roth. Somehow, it appears WCI forgot to tax-adjust his taxable account...
Au contraire. WCI's taxable account IS tax adjusted right now, thanks to market activity. Besides, his taxable account generates negative taxes, since he tax loss harvests losses and donates gains to charity.

If you want to talk about a hypothetical taxable account, you can certainly claim expertise. If you want to talk about MINE, I'm clearly the expert. :)

At any rate, the point of my stocks vs bonds in taxable argument is that it is complicated, should be determined individually, and changes with interest rates and personal situations. The key is to remember that it isn't JUST about tax efficiency, but also about the ratio of tax protected to taxable space. That doesn't mean stocks in taxable can't be right for you and many others, including me.

If you're actually capable and interested in tax-adjusting your asset allocation, you don't need anyone else to answer this question for your portfolio. You can do it yourself.
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

international001
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Re: Debunking Bonds in Taxable

Post by international001 » Sun Oct 28, 2018 9:21 pm

Everything depends on personal situations. But I thought the simplified premise was clear. How to get at 65 the max return at the same level or risk with both a taxable and a tax-sheltered account. It is using bonds in tax-sheltered. I personally won't do it because I may not want to wait till retirement to use may taxable funds.

JustinR
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Re: Debunking Bonds in Taxable

Post by JustinR » Sun Oct 28, 2018 11:22 pm

The bonds in taxable argument is false.

This is easy enough to prove with historical performance and math.

1) Find out last year's performance (from Dec 31, 2016 to Dec 31, 2017) for:
  • VTSAX
  • VTIAX
  • VBTLX
2) Use Triceratop's tax efficiency spreadsheet to figure out distributions: viewtopic.php?f=10&t=242137

3) Calculate how much money you'll have at the end if you put each fund in taxable, Roth, 401k. So you'll have a 3x3 grid of results.

4) You can do this for other years, like 2015 and 2016, or other lengths of time.

Conclusion: Your highest return will be this combo: Bonds in 401k, international in Roth, US in taxable.

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White Coat Investor
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Re: Debunking Bonds in Taxable

Post by White Coat Investor » Sun Oct 28, 2018 11:30 pm

JustinR wrote:
Sun Oct 28, 2018 11:22 pm
The bonds in taxable argument is false.

This is easy enough to prove with historical performance and math.

1) Find out last year's performance (from Dec 31, 2016 to Dec 31, 2017) for:
  • VTSAX
  • VTIAX
  • VBTLX
2) Use Triceratop's tax efficiency spreadsheet to figure out distributions: viewtopic.php?f=10&t=242137

3) Calculate how much money you'll have at the end if you put each fund in taxable, Roth, 401k. So you'll have a 3x3 grid of results.

4) You can do this for other years, like 2015 and 2016, or other lengths of time.

Conclusion: Your highest return will be this combo: Bonds in 401k, international in Roth, US in taxable.
Right, because you failed to adjust for the fact that putting bonds in 401K, international in Roth, and US in taxable is a more aggressive asset allocation than bonds in Roth etc.
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

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raven15
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Re: Debunking Bonds in Taxable

Post by raven15 » Mon Oct 29, 2018 1:53 am

international001 wrote:
Sun Oct 28, 2018 9:21 pm
I personally won't do it because I may not want to wait till retirement to use may taxable funds.
Right. That's my reason for keeping most of the bonds in taxable space, and you are first to mention it. Money is not fungible, there is a 10% penalty to take it out of tax-disadvantaged accounts. I have $240k, but only $60k in taxable space. If the market goes down 30% and I want to spend $50k, I am hosed if I have only stocks in taxable. Or at least I will pay an extra 10% on part of the money. Whereas, a mixture of VWAHX and ibonds holds its own compared to bonds in any tax situation, and CDs/treasuries/money markets/account sign up bonuses/dozens of options are available for known expenses within 5 years. So I keep a balanced portfolio at the ready in taxable space, while going heavy on stocks and a tiny amount of long term treasury funds in tax-hiding places. It should work out like an 80/20 portfolio, except total bond is replaced with completely different and more diverse components placed more optimally but very similar in terms of composite duration, credit risk, and yield.
It's Time. Adding Interest.

Cartographer
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Re: Debunking Bonds in Taxable

Post by Cartographer » Mon Oct 29, 2018 1:34 pm

White Coat Investor wrote:
Thu Oct 25, 2018 9:17 am
At any rate, the point of my stocks vs bonds in taxable argument is that it is complicated, should be determined individually, and changes with interest rates and personal situations. The key is to remember that it isn't JUST about tax efficiency, but also about the ratio of tax protected to taxable space. That doesn't mean stocks in taxable can't be right for you and many others, including me.
The ratio of tax-advantaged to taxable space is irrelevant. For an extremely simplified example, suppose for now taxable was only taxed on withdrawal (so no immediate taxes on dividends/interest), but that the entire account value (including principal and dividends) was taxed at 15%. Now compare to Roth. If you tax-adjust the taxable account by 15%, the two portfolios (bonds in taxable vs bonds in Roth) will have the same exact distribution of returns. This is despite the fact that bonds in taxable will result in a much larger tax-advantaged space.

Now let's add back some complication. Only taxing growth can be easily adjusted for and will not affect things. Next, we start taxing dividends/interest, which will affect the growth rate of the investments. This is where the real difference between the two comes out. And here is where bonds in Roth will generally win due to their tax-inefficiency.


I agree that it's complicated, but the example in the article appears to make it really obvious that bonds should go into taxable. For example, a quote from the article:
Now, I’m sure if we try hard enough we can come up with a set of assumptions that will favor putting bonds in tax-protected (it will likely involve a great deal of tax-loss harvesting and donation of shares or getting the step-up in basis at death), but under any reasonable assumptions in our current environment, it’s pretty hard to justify that advice.
But if you tax-adjust the allocation in the example from the article, I think this conclusion will no longer be valid

Greenman72
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Re: Debunking Bonds in Taxable

Post by Greenman72 » Mon Oct 29, 2018 6:15 pm

This sounds like a really touchy argument, considering that it probably doesn’t amount to a hill of beans anyway.

Assuming bonds have a yield of 4%, all of which is realized every year, and at a 40% tax rate. That’s a “tax drag” of 1.6%. So for every $100 invested in bonds, I lose $1.60 to the tax man.

Assuming stocks have a 10% total return, 2% is realized as dividend yield, and the portfolio has a 50% turnover rate (about average for a mutual fund). Well, assuming my math skills are correct, we would have (.5 x 8%) + 2% = 6% income. And since I don’t have a calculator, I’ll just round off the 23.8% up to 25%, and say that stocks have a “tax drag” of 1.5%. (6% x .25)

Now, I don’t know much about anything. But 1.6% ain’t all that different from 1.5%. I think it’s 0.1%. If we,re talking about $100,000, that’s what....$100 per year? Hardly enough to get in a twist over.

Greenman72
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Re: Debunking Bonds in Taxable

Post by Greenman72 » Mon Oct 29, 2018 6:22 pm

Moreover, if bonds are yielding 1% (which they have for most of the past decade) and you are saving 40% in taxes, then that’s what...$400 out of of a $100k account? (100k x .01 x 40%). That comes out to what....$33 per month?
I spend about that much on ice cream and bubble gum every month.

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Re: Debunking Bonds in Taxable

Post by White Coat Investor » Mon Oct 29, 2018 8:34 pm

Cartographer wrote:
Mon Oct 29, 2018 1:34 pm
White Coat Investor wrote:
Thu Oct 25, 2018 9:17 am
At any rate, the point of my stocks vs bonds in taxable argument is that it is complicated, should be determined individually, and changes with interest rates and personal situations. The key is to remember that it isn't JUST about tax efficiency, but also about the ratio of tax protected to taxable space. That doesn't mean stocks in taxable can't be right for you and many others, including me.
The ratio of tax-advantaged to taxable space is irrelevant. For an extremely simplified example, suppose for now taxable was only taxed on withdrawal (so no immediate taxes on dividends/interest), but that the entire account value (including principal and dividends) was taxed at 15%. Now compare to Roth. If you tax-adjust the taxable account by 15%, the two portfolios (bonds in taxable vs bonds in Roth) will have the same exact distribution of returns. This is despite the fact that bonds in taxable will result in a much larger tax-advantaged space.

Now let's add back some complication. Only taxing growth can be easily adjusted for and will not affect things. Next, we start taxing dividends/interest, which will affect the growth rate of the investments. This is where the real difference between the two comes out. And here is where bonds in Roth will generally win due to their tax-inefficiency.


I agree that it's complicated, but the example in the article appears to make it really obvious that bonds should go into taxable. For example, a quote from the article:
Now, I’m sure if we try hard enough we can come up with a set of assumptions that will favor putting bonds in tax-protected (it will likely involve a great deal of tax-loss harvesting and donation of shares or getting the step-up in basis at death), but under any reasonable assumptions in our current environment, it’s pretty hard to justify that advice.
But if you tax-adjust the allocation in the example from the article, I think this conclusion will no longer be valid
Sounds like you missed both the comments section and follow-up articles.
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grabiner
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Re: Debunking Bonds in Taxable

Post by grabiner » Mon Oct 29, 2018 9:10 pm

raven15 wrote:
Mon Oct 29, 2018 1:53 am
international001 wrote:
Sun Oct 28, 2018 9:21 pm
I personally won't do it because I may not want to wait till retirement to use may taxable funds.
Right. That's my reason for keeping most of the bonds in taxable space, and you are first to mention it. Money is not fungible, there is a 10% penalty to take it out of tax-disadvantaged accounts. I have $240k, but only $60k in taxable space. If the market goes down 30% and I want to spend $50k, I am hosed if I have only stocks in taxable. Or at least I will pay an extra 10% on part of the money.
This is the reason you should only keep your short-term needs in a tax-deferred account if the taxable account is at least double the size of your need; you want the taxable account to stay large enough even if the market crashes.

But under what circumstances will you need $50K in a short time? That is more than the typical emergency fund, which you use to deal with things such as roof replacements and medical bills. If you need to replace a car, you can take out a loan, and pay it back quickly (say by reducing your 401(k) contributions) with minimal interest costs.

One situation in which it might be important is if you are saving for a home down payment (although you can take $10,000 out of an IRA penalty-free for this as well). Your home down payment does need to be in short-term bonds or something similar, unless you can stand a 50% crash and still have the home down payment available in your taxable account.
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raven15
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Re: Debunking Bonds in Taxable

Post by raven15 » Mon Oct 29, 2018 11:00 pm

grabiner wrote:
Mon Oct 29, 2018 9:10 pm
raven15 wrote:
Mon Oct 29, 2018 1:53 am
international001 wrote:
Sun Oct 28, 2018 9:21 pm
I personally won't do it because I may not want to wait till retirement to use may taxable funds.
Right. That's my reason for keeping most of the bonds in taxable space, and you are first to mention it. Money is not fungible, there is a 10% penalty to take it out of tax-disadvantaged accounts. I have $240k, but only $60k in taxable space. If the market goes down 30% and I want to spend $50k, I am hosed if I have only stocks in taxable. Or at least I will pay an extra 10% on part of the money.
This is the reason you should only keep your short-term needs in a tax-deferred account if the taxable account is at least double the size of your need; you want the taxable account to stay large enough even if the market crashes.

But under what circumstances will you need $50K in a short time? That is more than the typical emergency fund, which you use to deal with things such as roof replacements and medical bills. If you need to replace a car, you can take out a loan, and pay it back quickly (say by reducing your 401(k) contributions) with minimal interest costs.

One situation in which it might be important is if you are saving for a home down payment (although you can take $10,000 out of an IRA penalty-free for this as well). Your home down payment does need to be in short-term bonds or something similar, unless you can stand a 50% crash and still have the home down payment available in your taxable account.
Unemployment comes to my mind, and is the main reason $50k might be needed. There are also many short term possibilities such as you mentioned. If I don't need bonds for potential expenses, I can't think of a reason for them at all (except a tiny amount for rebalancing, a euphemism for market timing). We are also saving to buy a house, but optimistically that is two-ten years out. At that point any bond fund or portfolio whose annualized return exceeds its annualized standard deviation since 2006 will be OK with me until the final months, I don't place homeownership on a sacred pedestal of "risk-free or die."

But mostly it is a philosophy: bonds have little use except to ensure cash is available when needed. So in general they must belong in taxable space unless you arrange for retirement.
(although you can take $10,000 out of an IRA penalty-free for this as well).
Cool, thanks. Did not know that,
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grabiner
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Re: Debunking Bonds in Taxable

Post by grabiner » Mon Oct 29, 2018 11:38 pm

raven15 wrote:
Mon Oct 29, 2018 11:00 pm
grabiner wrote:
Mon Oct 29, 2018 9:10 pm
But under what circumstances will you need $50K in a short time? That is more than the typical emergency fund, which you use to deal with things such as roof replacements and medical bills. If you need to replace a car, you can take out a loan, and pay it back quickly (say by reducing your 401(k) contributions) with minimal interest costs.
Unemployment comes to my mind, and is the main reason $50k might be needed. There are also many short term possibilities such as you mentioned.
If you are unemployed for long enough to need $50K from your portfolio, you will be in a low tax bracket and can withdraw from your IRA with a lower tax cost to offset the 10% penalty. If you have a large medical bill, there is no penalty for IRA withdrawals to cover the medical expenses in excess of 10% of adjusted gross income.
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raven15
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Re: Debunking Bonds in Taxable

Post by raven15 » Tue Oct 30, 2018 12:34 am

grabiner wrote:
Mon Oct 29, 2018 11:38 pm
raven15 wrote:
Mon Oct 29, 2018 11:00 pm
grabiner wrote:
Mon Oct 29, 2018 9:10 pm
But under what circumstances will you need $50K in a short time? That is more than the typical emergency fund, which you use to deal with things such as roof replacements and medical bills. If you need to replace a car, you can take out a loan, and pay it back quickly (say by reducing your 401(k) contributions) with minimal interest costs.
Unemployment comes to my mind, and is the main reason $50k might be needed. There are also many short term possibilities such as you mentioned.
If you are unemployed for long enough to need $50K from your portfolio, you will be in a low tax bracket and can withdraw from your IRA with a lower tax cost to offset the 10% penalty. If you have a large medical bill, there is no penalty for IRA withdrawals to cover the medical expenses in excess of 10% of adjusted gross income.
Yup, but any withdrawal means you have that much less limited space to grow tax free. And why pay a 10% penalty if you don't need to?
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JustinR
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Re: Debunking Bonds in Taxable

Post by JustinR » Tue Oct 30, 2018 1:58 am

raven15 wrote:
Mon Oct 29, 2018 1:53 am
international001 wrote:
Sun Oct 28, 2018 9:21 pm
I personally won't do it because I may not want to wait till retirement to use may taxable funds.
Right. That's my reason for keeping most of the bonds in taxable space, and you are first to mention it. Money is not fungible, there is a 10% penalty to take it out of tax-disadvantaged accounts. I have $240k, but only $60k in taxable space. If the market goes down 30% and I want to spend $50k, I am hosed if I have only stocks in taxable. Or at least I will pay an extra 10% on part of the money. Whereas, a mixture of VWAHX and ibonds holds its own compared to bonds in any tax situation, and CDs/treasuries/money markets/account sign up bonuses/dozens of options are available for known expenses within 5 years. So I keep a balanced portfolio at the ready in taxable space, while going heavy on stocks and a tiny amount of long term treasury funds in tax-hiding places. It should work out like an 80/20 portfolio, except total bond is replaced with completely different and more diverse components placed more optimally but very similar in terms of composite duration, credit risk, and yield.
If you had equities in taxable and bonds in your 401k, couldn't you just sell some equities in taxable, then sell bonds in your 401k and buy the equities back there?

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Re: Debunking Bonds in Taxable

Post by Tanelorn » Tue Oct 30, 2018 2:33 am

Look this is really easy from a hypothetical perspective. If bonds pay 0% but are taxed at a high rate (40% say), not too far from a few years ago, while stocks earn 10% or whatever annually and are taxed at some lower rate, how much tax do you incur with stocks in Roth and bonds in taxable? Zero dollars. How about the reverse? It’s more than zero, as long as the stocks are up when you sell or rebalance them. This tells you when bond interest rates are super low, they go in taxable.

Now you can run lots of models to your hearts content about your personal situation and include the risk adjusted AA, rebalancing effects, the non zero bond returns vs your favorite guess on stocks, tax rates and time frames, varying sizes of taxable vs IRA accounts compared to your AA, etc, etc.
JustinR wrote:
Tue Oct 30, 2018 1:58 am
raven15 wrote:
Mon Oct 29, 2018 1:53 am
international001 wrote:
Sun Oct 28, 2018 9:21 pm
I personally won't do it because I may not want to wait till retirement to use may taxable funds.
Right. That's my reason for keeping most of the bonds in taxable space, and you are first to mention it. Money is not fungible, there is a 10% penalty to take it out of tax-disadvantaged accounts. I have $240k, but only $60k in taxable space. If the market goes down 30% and I want to spend $50k, I am hosed if I have only stocks in taxable. Or at least I will pay an extra 10% on part of the money. Whereas, a mixture of VWAHX and ibonds holds its own compared to bonds in any tax situation, and CDs/treasuries/money markets/account sign up bonuses/dozens of options are available for known expenses within 5 years. So I keep a balanced portfolio at the ready in taxable space, while going heavy on stocks and a tiny amount of long term treasury funds in tax-hiding places. It should work out like an 80/20 portfolio, except total bond is replaced with completely different and more diverse components placed more optimally but very similar in terms of composite duration, credit risk, and yield.
If you had equities in taxable and bonds in your 401k, couldn't you just sell some equities in taxable, then sell bonds in your 401k and buy the equities back there?
Yes, exactly.

In addition, the argument about not knowing future bond rates doesn’t matter. If bonds are in taxable, as they should be in a low yield environment, if rates rise and bonds are now indicated to go in tax free, you can sell the bonds (at a loss) and buy stocks in taxable. And in the IRA sell stocks and buy bonds with no tax hit. When you’ve got stocks in taxable with lots of appreciation, that’s when you can’t easily switch back.

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raven15
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Re: Debunking Bonds in Taxable

Post by raven15 » Tue Oct 30, 2018 2:48 am

JustinR wrote:
Tue Oct 30, 2018 1:58 am
raven15 wrote:
Mon Oct 29, 2018 1:53 am
international001 wrote:
Sun Oct 28, 2018 9:21 pm
I personally won't do it because I may not want to wait till retirement to use may taxable funds.
Right. That's my reason for keeping most of the bonds in taxable space, and you are first to mention it. Money is not fungible, there is a 10% penalty to take it out of tax-disadvantaged accounts. I have $240k, but only $60k in taxable space. If the market goes down 30% and I want to spend $50k, I am hosed if I have only stocks in taxable. Or at least I will pay an extra 10% on part of the money. Whereas, a mixture of VWAHX and ibonds holds its own compared to bonds in any tax situation, and CDs/treasuries/money markets/account sign up bonuses/dozens of options are available for known expenses within 5 years. So I keep a balanced portfolio at the ready in taxable space, while going heavy on stocks and a tiny amount of long term treasury funds in tax-hiding places. It should work out like an 80/20 portfolio, except total bond is replaced with completely different and more diverse components placed more optimally but very similar in terms of composite duration, credit risk, and yield.
If you had equities in taxable and bonds in your 401k, couldn't you just sell some equities in taxable, then sell bonds in your 401k and buy the equities back there?
No, I would have less than I needed in taxable because of the 30% market decline. Or rather, there would be a 10% penalty on the $8,000 from the (IRA) to match the $50,000 I needed. As far as I am concerned if I am wealthy enough to not need bonds in taxable accounts, then I am wealthy enough to not need bonds at all. Until I retire.
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Re: Debunking Bonds in Taxable

Post by Cartographer » Tue Oct 30, 2018 7:43 am

Greenman72 wrote:
Mon Oct 29, 2018 6:15 pm
This sounds like a really touchy argument, considering that it probably doesn’t amount to a hill of beans anyway.

Assuming bonds have a yield of 4%, all of which is realized every year, and at a 40% tax rate. That’s a “tax drag” of 1.6%. So for every $100 invested in bonds, I lose $1.60 to the tax man.

Assuming stocks have a 10% total return, 2% is realized as dividend yield, and the portfolio has a 50% turnover rate (about average for a mutual fund). Well, assuming my math skills are correct, we would have (.5 x 8%) + 2% = 6% income. And since I don’t have a calculator, I’ll just round off the 23.8% up to 25%, and say that stocks have a “tax drag” of 1.5%. (6% x .25)

Now, I don’t know much about anything. But 1.6% ain’t all that different from 1.5%. I think it’s 0.1%. If we,re talking about $100,000, that’s what....$100 per year? Hardly enough to get in a twist over.
I don't think many here have a 50% turnover rate. For many index funds, turnover is just a couple percent. Funds with high turnover - such as active funds - are generally considered tax-inefficient and should probably be placed in tax-advantaged too.

If you ignore turnover, your example tax drag becomes 0.5%. Now the difference from bonds it quite large (1.1%).

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Re: Debunking Bonds in Taxable

Post by Cartographer » Tue Oct 30, 2018 8:16 am

White Coat Investor wrote:
Mon Oct 29, 2018 8:34 pm
Sounds like you missed both the comments section and follow-up articles.
I'm not an active reader of your site, and only found the post through links on this forum. The follow-up articles were not clearly linked in the original article. So no, I didn't read any follow-up articles. I just read one of the subsequent articles (https://www.whitecoatinvestor.com/my-tw ... et-peeves/) and the same mistake of not tax-adjusting taxable accounts is made.

I did skim much of the comments on the first article. There's lots of discussion regarding tax-adjusting tax-deferred accounts relative to tax-free accounts. One user did bring up tax-adjusting the taxable account. The response was:
Only the gains are worth 15-20% less than a Roth at any given time. The portfolio with stocks [in Roth] isn’t riskier, it’s simply that it’s larger.
But this is simply false. After 30 years, the vast majority of the stocks in taxable portfolio is subject to capital gains, and therefore the government "owns" part of your portfolio and is taking on some of your risk.

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Re: Debunking Bonds in Taxable

Post by international001 » Tue Oct 30, 2018 1:47 pm

There seems to be many compromises around.

For instance, I don't want my taxable go down 50% during a recession, because this is money I may use to buy a house, for instance, or if one day I get tired of working and I decide to pursue FI. If you make one special (mental or actual account) that you are only going to use for retirement, then by all means fill it with stocks.

Given that you can move +$60k to tax-sheltered accounts these days, it only makes sense to use taxable for retirement if you have a very high income or if you plan to retire early.

Some other consideration.. if you have to invest bonds on taxable.. use treasuries. They give you the lowest yield (less taxes) and counter-balance better stocks (don't get corporate bonds or high yield bonds).

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Re: Debunking Bonds in Taxable

Post by willthrill81 » Tue Oct 30, 2018 2:16 pm

international001 wrote:
Tue Oct 30, 2018 1:47 pm
Given that you can move +$60k to tax-sheltered accounts these days, it only makes sense to use taxable for retirement if you have a very high income or if you plan to retire early.
There are several very effective and realistic means of accessing money prior to age 59.5 from tax-advantaged accounts (e.g. 72(t) rule, age '55' rule with 401ks, Roth conversion ladder, 457 plans have no age restriction on withdrawals).

I'm planning on retiring no later than age 55, possibly earlier, and will do so using exclusively tax-advantaged accounts.
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Re: Debunking Bonds in Taxable

Post by raven15 » Tue Oct 30, 2018 3:42 pm

international001 wrote:
Tue Oct 30, 2018 1:47 pm
Some other consideration.. if you have to invest bonds on taxable.. use treasuries. They give you the lowest yield (less taxes) and counter-balance better stocks (don't get corporate bonds or high yield bonds).
There are so many great options that are best or only available in taxable space such as account signup bonuses, i-bonds, and VWALX/VWAHX that I see no need for the ordinary options here or regret for holding bonds in taxable. A small portion of treasuries in tax sheltered accounts for rebalancing aka timing the market seems valuable though.
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Re: Debunking Bonds in Taxable

Post by White Coat Investor » Tue Oct 30, 2018 7:38 pm

Cartographer wrote:
Tue Oct 30, 2018 8:16 am


But this is simply false. After 30 years, the vast majority of the stocks in taxable portfolio is subject to capital gains, and therefore the government "owns" part of your portfolio and is taking on some of your risk.
Maybe in yours. My point is this is very individual. I have zero capital gains in my taxable account. In fact, I've got a bunch of losses I still need to harvest. And when I do get shares with gains, I donate them to charity. So how should I "tax-adjust" that taxable account? I shouldn't. How about somebody who never plans to sell their taxable shares? None of that is going to the government as the heirs will get a step-up in basis at death. How about somebody in the 0% capital gains tax bracket? So you have to have some idea how much tax will be paid on those taxable assets in order to make any sort of a calculation, and that's going to be different for everyone.

The end point of the discussion was that this is a very individual thing where you put your bonds, that it doesn't matter much (or at least matters less) at low bond yields, and that it may be difficult for anyone to determine in advance what the right move for them is. Also, that it doesn't JUST depend on the tax-efficiency of the asset, it also depends on the expected return.

The right answer for YOU may very well be stocks in taxable (and as yields rise, that's likely the right move for me too) as it was kind of a wash for me at the low yields, but they've now risen.
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Re: Debunking Bonds in Taxable

Post by international001 » Sat Nov 03, 2018 2:09 pm

raven15 wrote:
Tue Oct 30, 2018 3:42 pm
international001 wrote:
Tue Oct 30, 2018 1:47 pm
Some other consideration.. if you have to invest bonds on taxable.. use treasuries. They give you the lowest yield (less taxes) and counter-balance better stocks (don't get corporate bonds or high yield bonds).
There are so many great options that are best or only available in taxable space such as account signup bonuses, i-bonds, and VWALX/VWAHX that I see no need for the ordinary options here or regret for holding bonds in taxable. A small portion of treasuries in tax sheltered accounts for rebalancing aka timing the market seems valuable though.
For the same level of risk, non-tax free bonds are usually better. Unless perhaps you are in a high tax bracket. So I wouldn't use them.

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Re: Debunking Bonds in Taxable

Post by international001 » Sat Nov 03, 2018 2:11 pm

willthrill81 wrote:
Tue Oct 30, 2018 2:16 pm
international001 wrote:
Tue Oct 30, 2018 1:47 pm
Given that you can move +$60k to tax-sheltered accounts these days, it only makes sense to use taxable for retirement if you have a very high income or if you plan to retire early.
There are several very effective and realistic means of accessing money prior to age 59.5 from tax-advantaged accounts (e.g. 72(t) rule, age '55' rule with 401ks, Roth conversion ladder, 457 plans have no age restriction on withdrawals).

I'm planning on retiring no later than age 55, possibly earlier, and will do so using exclusively tax-advantaged accounts.
I didn't know about the 55 rule. Thanks for the info.
About the Roth Ira conversion ladder, it's very convenient. This is why i favor Roth IRAs vs 401k if your tax bracket is not too high. I'm considering not contributing to 401k anymore (beyond employer match) and just do after-tax-401k -> megabackdoor conversion to Roth

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Re: Debunking Bonds in Taxable

Post by MotoTrojan » Sat Nov 03, 2018 2:20 pm

michaeljc70 wrote:
Mon Oct 08, 2018 3:11 pm
One scenario I can envision where bonds in taxable is beneficial is:

-The market is in a downturn so you don't want to sell stocks from taxable accounts
Sell equities in taxable (if at a loss, even better tax-wise), buy equities and sell bonds in tax-advantaged. What did you "really" sell?

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Re: Debunking Bonds in Taxable

Post by JustinR » Sat Nov 03, 2018 2:34 pm

international001 wrote:
Sat Nov 03, 2018 2:11 pm
willthrill81 wrote:
Tue Oct 30, 2018 2:16 pm
international001 wrote:
Tue Oct 30, 2018 1:47 pm
Given that you can move +$60k to tax-sheltered accounts these days, it only makes sense to use taxable for retirement if you have a very high income or if you plan to retire early.
There are several very effective and realistic means of accessing money prior to age 59.5 from tax-advantaged accounts (e.g. 72(t) rule, age '55' rule with 401ks, Roth conversion ladder, 457 plans have no age restriction on withdrawals).

I'm planning on retiring no later than age 55, possibly earlier, and will do so using exclusively tax-advantaged accounts.
I didn't know about the 55 rule. Thanks for the info.
About the Roth Ira conversion ladder, it's very convenient. This is why i favor Roth IRAs vs 401k if your tax bracket is not too high. I'm considering not contributing to 401k anymore (beyond employer match) and just do after-tax-401k -> megabackdoor conversion to Roth
Huh? Roth Conversion Ladder is about paying minimal taxes on your 401k.

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Re: Debunking Bonds in Taxable

Post by international001 » Mon Nov 05, 2018 12:59 pm

Ok.. so let me understand

You can convert 401k-pre-tax -> Roth IRA after you have left the job for which 401k was associated
You can withdraw these conversions to Roth IRA as long as they had stayed 5 years in the Roth IRA
If you do another type of contribution (direct, backdoor, mega-backdoor) to the Roth IRA, you still can withdraw this contributions as long as they had been 5 years inside the Roth, no?

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Re: Debunking Bonds in Taxable

Post by retiredjg » Mon Nov 05, 2018 2:38 pm

international001 wrote:
Mon Nov 05, 2018 12:59 pm
Ok.. so let me understand

You can convert 401k-pre-tax -> Roth IRA after you have left the job for which 401k was associated
You can withdraw these conversions to Roth IRA as long as they had stayed 5 years in the Roth IRA
Yes. You could withdraw the conversions, but maybe not the earnings that have happened in the Roth IRA.
If you do another type of contribution (direct, backdoor, mega-backdoor) to the Roth IRA, you still can withdraw this contributions as long as they had been 5 years inside the Roth, no?
That part is no so simple.

The first thing that comes out are direct contributions. There is no clock attached to those. Then you can get to the conversions (including back doors) and rollovers like mega backdoor that may have a 5 tax year clock attached to the part that was taxed because of the rollover.

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Re: Debunking Bonds in Taxable

Post by Cartographer » Mon Nov 05, 2018 6:48 pm

White Coat Investor wrote:
Tue Oct 30, 2018 7:38 pm
Maybe in yours. My point is this is very individual. I have zero capital gains in my taxable account. In fact, I've got a bunch of losses I still need to harvest. And when I do get shares with gains, I donate them to charity. So how should I "tax-adjust" that taxable account? I shouldn't. How about somebody who never plans to sell their taxable shares? None of that is going to the government as the heirs will get a step-up in basis at death. How about somebody in the 0% capital gains tax bracket? So you have to have some idea how much tax will be paid on those taxable assets in order to make any sort of a calculation, and that's going to be different for everyone.
If you do not pay capital gains on your taxable account, then you shouldn't tax adjust. But then also the account is also worth more since it won't get taxed. The examples in the WCI articles both have the taxable account incurring capital gains, in which case the asset allocation needs to be tax adjusted. If you change the examples to that the taxable account does not have capital gains (but don't tax-adjust either), then you will see that stocks in taxable wins. Either way, the math in the examples are wrong.
White Coat Investor wrote:
Tue Oct 30, 2018 7:38 pm
The end point of the discussion was that this is a very individual thing where you put your bonds, that it doesn't matter much (or at least matters less) at low bond yields, and that it may be difficult for anyone to determine in advance what the right move for them is. Also, that it doesn't JUST depend on the tax-efficiency of the asset, it also depends on the expected return.
The effects are small, but I think it is important. Many folks here TLH, which I've read can increase returns by about 0.5%. But I claim that asset location can have a similar-magnitude effect. If you bother TLH, then you should bother getting the correct fund placement.

In more detail, if you tax-adjust using the marginal rate of taxation, then you remove the effects of taxes at liquidation (capital gains for taxable or income taxes on tax-deferred accounts). What's left is the drag from taxes on dividends/interest. Then if you think about it carefully, what matters is the amount of drag from taxes over the course of the rebalancing period. If you rebalance every year, then the drag on stocks is, say, 0.15*1.9=0.285%, whereas the drag on bonds is, say 0.22*3.25=0.715%. The difference is 0.43%. So having stocks in taxable will result in a 0.43% higher return than bonds in taxable, once you've appropriately tax-adjusted everything.

A couple more points:
- Of course we don't necessarily know the taxes at liquidation. So if we had a crystal ball that told us what our marginal tax rate would be, we would tax-adjust our portfolios to give us the right asset allocation, but in reality we just have to make a guess. However, in terms of asset placement, the exact tax rate doesn't really matter, as the calculation above didn't actually need to look at the liquidation tax rates. All that matters for asset location is the taxes paid on and amount of dividends/interest.
- The returns of an asset don't directly matter either. All that matters is the drag due to continual taxation. Now, it is true that if I don't rebalance for long periods of time, then stocks will grow a lot, and you will loose more to taxes since the percentages are based on a higher amount. However, every time you rebalance, everything gets reset. So what matters is the drag incurred over the rebalancing period. For periods of 1 year or so, even at today's low yields stocks in taxable will produce higher returns for a given level of risk.

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Re: Debunking Bonds in Taxable

Post by White Coat Investor » Tue Nov 06, 2018 9:23 am

Cartographer wrote:
Mon Nov 05, 2018 6:48 pm
White Coat Investor wrote:
Tue Oct 30, 2018 7:38 pm
Maybe in yours. My point is this is very individual. I have zero capital gains in my taxable account. In fact, I've got a bunch of losses I still need to harvest. And when I do get shares with gains, I donate them to charity. So how should I "tax-adjust" that taxable account? I shouldn't. How about somebody who never plans to sell their taxable shares? None of that is going to the government as the heirs will get a step-up in basis at death. How about somebody in the 0% capital gains tax bracket? So you have to have some idea how much tax will be paid on those taxable assets in order to make any sort of a calculation, and that's going to be different for everyone.
If you do not pay capital gains on your taxable account, then you shouldn't tax adjust. But then also the account is also worth more since it won't get taxed. The examples in the WCI articles both have the taxable account incurring capital gains, in which case the asset allocation needs to be tax adjusted. If you change the examples to that the taxable account does not have capital gains (but don't tax-adjust either), then you will see that stocks in taxable wins. Either way, the math in the examples are wrong.
White Coat Investor wrote:
Tue Oct 30, 2018 7:38 pm
The end point of the discussion was that this is a very individual thing where you put your bonds, that it doesn't matter much (or at least matters less) at low bond yields, and that it may be difficult for anyone to determine in advance what the right move for them is. Also, that it doesn't JUST depend on the tax-efficiency of the asset, it also depends on the expected return.
The effects are small, but I think it is important. Many folks here TLH, which I've read can increase returns by about 0.5%. But I claim that asset location can have a similar-magnitude effect. If you bother TLH, then you should bother getting the correct fund placement.

In more detail, if you tax-adjust using the marginal rate of taxation, then you remove the effects of taxes at liquidation (capital gains for taxable or income taxes on tax-deferred accounts). What's left is the drag from taxes on dividends/interest. Then if you think about it carefully, what matters is the amount of drag from taxes over the course of the rebalancing period. If you rebalance every year, then the drag on stocks is, say, 0.15*1.9=0.285%, whereas the drag on bonds is, say 0.22*3.25=0.715%. The difference is 0.43%. So having stocks in taxable will result in a 0.43% higher return than bonds in taxable, once you've appropriately tax-adjusted everything.

A couple more points:
- Of course we don't necessarily know the taxes at liquidation. So if we had a crystal ball that told us what our marginal tax rate would be, we would tax-adjust our portfolios to give us the right asset allocation, but in reality we just have to make a guess. However, in terms of asset placement, the exact tax rate doesn't really matter, as the calculation above didn't actually need to look at the liquidation tax rates. All that matters for asset location is the taxes paid on and amount of dividends/interest.
- The returns of an asset don't directly matter either. All that matters is the drag due to continual taxation. Now, it is true that if I don't rebalance for long periods of time, then stocks will grow a lot, and you will loose more to taxes since the percentages are based on a higher amount. However, every time you rebalance, everything gets reset. So what matters is the drag incurred over the rebalancing period. For periods of 1 year or so, even at today's low yields stocks in taxable will produce higher returns for a given level of risk.
Let's start at the beginning, with a little theoretical exercise.

Do you agree there is a bond yield/expected return at which it is correct for you to put stocks in tax-protected?

The answer should be yes and it will be a number greater than 0%.

As that yield rises, it becomes less and less advantageous to do so until at a certain point, stocks in taxable becomes the correct answer.

When that column was written, the yield on the 2 year T note was under 0.5%. That is very close to 0%. It is now nearly 3%. If/as it continues to rise, the likelihood that bonds in taxable will be right for any given person will continue to fall.

Hope that helps.
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Re: Debunking Bonds in Taxable

Post by EnjoyIt » Tue Nov 06, 2018 10:01 am

Back when yields were very low, I felt I was not sure exactly what the best answer was so I split my bonds 50/50 between taxable and tax advantaged. My taxable bonds are not actually taxable since they are in intermediate munis which after taxes yield a bit more than taxable bonds. I am glad I did this because it very early allows for rebalancing. When times comes for early retirement I will also be glad I have many options on where to withdraw my living expenses from. If rates continue to rise I may re-evaluate and re-adjust but for now my strategy has worked very well.

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Re: Debunking Bonds in Taxable

Post by afan » Tue Nov 06, 2018 4:48 pm

This discussion highlights that the optimal location can vary among investors depending on their long term plans for the money, their marginal tax rates, the appetite for risk,bond yields and stock dividend yields. There can be no single correct answer for all people, all tax rates and all levels of yields.

If the only taxes one will ever pay on sticks are on qualified dividends, with capital gains never realized and stepped up basis at death, the stocks in taxable becomes highly efficient.

If one needs some bonds in taxable to have a relatively stable store of value against unforseen expenses, then the argument for bonds in tax advantaged accounts becomes much weaker. For nvestor for whom the amount they want in bonds in taxable is equal to their total bond allocation, the need for liquidity may be more important than the, small, benefits of bonds in retirement accounts.

People who will not have a low income time for the rest of their lives may never be in a position to do Roth conversions. The value of pretax contributions can make backdoor Roth or Roth in employer plans the wrong moves.

Those conditions do not apply to everyone, but they apply to some people. For them a general argument, based on incorrect assumptions about their financial situations, would be misleading.
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Re: Debunking Bonds in Taxable

Post by international001 » Tue Nov 06, 2018 6:15 pm

retiredjg wrote:
Mon Nov 05, 2018 2:38 pm

That part is no so simple.

The first thing that comes out are direct contributions. There is no clock attached to those. Then you can get to the conversions (including back doors) and rollovers like mega backdoor that may have a 5 tax year clock attached to the part that was taxed because of the rollover.
Thanks for the info!

In anycase, to my point, after 5 years you can withdraw any contribution. It's good enough. So I'll try to get as much as I can in Roth IRA. At least now that taxes are low.

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Re: Debunking Bonds in Taxable

Post by international001 » Tue Nov 06, 2018 6:51 pm

White Coat Investor wrote:
Tue Nov 06, 2018 9:23 am

Do you agree there is a bond yield/expected return at which it is correct for you to put stocks in tax-protected?
I disagree.

Let's assume infinite amount of time, so what matters is compound return
If you want to keep a constant level or volatility, it's better to have bonds in tax-protected (you have to balance among stocks and bonds, likely selling stocks). This is Cartographer's insight and what I agree with. If you leave stocks in tax-protected without ever balance, you average (expected) return will grow, but at the expense of increasing volatility over time.

I think you can do a spreadsheet/script and see that keeping a constant proportion of stocks/bonds (re-balancing every year), assuming taxable drag to be higher for bonds, and waiting long enough, stocks are better in taxable. Whatever marginal tax rate you are in at retirement.

I wonder if there is such a calculator online. Otherwise, I'll try to make one (by retirement age :happy )

Other considerations are liquidity and whether or not you can re balance with new money and to which accounts. If you have enough income every year to re-balance (likely by adding mostly bonds), by all means leave the stocks in the tax-protected.

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Re: Debunking Bonds in Taxable

Post by White Coat Investor » Tue Nov 06, 2018 9:58 pm

international001 wrote:
Tue Nov 06, 2018 6:51 pm
White Coat Investor wrote:
Tue Nov 06, 2018 9:23 am

Do you agree there is a bond yield/expected return at which it is correct for you to put stocks in tax-protected?
I disagree.

Let's assume infinite amount of time, so what matters is compound return
If you want to keep a constant level or volatility, it's better to have bonds in tax-protected (you have to balance among stocks and bonds, likely selling stocks). This is Cartographer's insight and what I agree with. If you leave stocks in tax-protected without ever balance, you average (expected) return will grow, but at the expense of increasing volatility over time.

I think you can do a spreadsheet/script and see that keeping a constant proportion of stocks/bonds (re-balancing every year), assuming taxable drag to be higher for bonds, and waiting long enough, stocks are better in taxable. Whatever marginal tax rate you are in at retirement.

I wonder if there is such a calculator online. Otherwise, I'll try to make one (by retirement age :happy )

Other considerations are liquidity and whether or not you can re balance with new money and to which accounts. If you have enough income every year to re-balance (likely by adding mostly bonds), by all means leave the stocks in the tax-protected.
If you're unwilling to agree to that starting principle, I don't see any reason to continue the discussion. You're missing the entire point of the article.

Clearly, with no return on the bonds, you're better off with bonds in taxable. They are 100% tax-efficient in that scenario and the tax protected account will grow maximally since stocks will always be in it (along with an increasing amount of bonds as it grows.)

Tax-efficiency matters in determining the appropriate asset location. So does expected return.

But hey, if your theory, whatever it might be, leads to putting bonds in tax-protected, you'll be right most of the time, so no harm done.
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Re: Debunking Bonds in Taxable

Post by Greenman72 » Wed Nov 07, 2018 8:12 am

White Coat Investor wrote:
Tue Nov 06, 2018 9:58 pm

Tax-efficiency matters in determining the appropriate asset location. So does expected return.
I agree with WCI. Is there any other way to see it?

Let's take some extreme examples. Suppose you have a bond fund that pays exactly 0.0% yield and 0.0% expected capital appreciation. What would be the point of holding that in an IRA? There's no tax on it, and there never will be tax on it, so all you're doing is complicating your life by cluttering up your IRA space. This investment belongs in a taxable account.

Similar situation--say you have a REIT that pays a 15% dividend yield, taxable at ordinary income tax rates, with zero capital appreciation. Assuming you're in a 33% tax bracket, you can expect to lose 5% per year to the tax man. So this absolutely belongs in the non-taxable accounts.

Just for reference--$100k invested at 0% interest for 30 years = $100k. If you hold it in an IRA, $100k. If held in a taxable account, $100k.

$100k invested at 15% interest for 30 years = $6.6m. If held in an IRA, its after-tax value would be $4.4m. If held in a taxable account it would be worth $1.7m.

The situation in both of the above is the same--you have the exact same tax rate (33%), but one obviously belongs in the taxable account and one obviously belongs in the non-taxable one. So to simply say "tax rates are all that matters" is foolish. Rate of return matters too.

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Re: Debunking Bonds in Taxable

Post by Cartographer » Wed Nov 07, 2018 10:38 am

White Coat Investor wrote:
Tue Nov 06, 2018 9:23 am
Let's start at the beginning, with a little theoretical exercise.

Do you agree there is a bond yield/expected return at which it is correct for you to put stocks in tax-protected?

The answer should be yes and it will be a number greater than 0%.

As that yield rises, it becomes less and less advantageous to do so until at a certain point, stocks in taxable becomes the correct answer.

When that column was written, the yield on the 2 year T note was under 0.5%. That is very close to 0%. It is now nearly 3%. If/as it continues to rise, the likelihood that bonds in taxable will be right for any given person will continue to fall.

Hope that helps.
Yes, at low enough bond yields, bonds will make more sense in taxable. But the article claims that bonds in taxable is actually very robust to varying bond yields, which is false. For example, there's a second calculation using 5% yield for taxable bonds, and 4% yield for muni, which supposedly still supports bonds in taxable. But if you appropriately tax-adjust, you'll see that this actually performs somewhat worse than bonds in Roth (over 0.5% per year). Even the first example in the article (which presumably was using 30 year T notes, with rates over 2%) ends up favoring bonds in Roth once you tax-adjust.

In any case, I've been picking on this article because it's the one linked often here, and its one with a concrete example worked out. The point of this post is to challenge the common line of reasoning that leads people to put bonds in taxable thinking it will produce better returns.

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Re: Debunking Bonds in Taxable

Post by White Coat Investor » Wed Nov 07, 2018 4:19 pm

Cartographer wrote:
Wed Nov 07, 2018 10:38 am


In any case, I've been picking on this article because it's the one linked often here, and its one with a concrete example worked out. The point of this post is to challenge the common line of reasoning that leads people to put bonds in taxable thinking it will produce better returns.
Yea, I wish they'd link to the other one too. I wish I could, but I can't. I think it is far better (in many ways thanks to criticism in the comments section and on this forum.) This one isn't my best article, it just had the best title.
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Re: Debunking Bonds in Taxable

Post by international001 » Thu Nov 08, 2018 10:27 am

Greenman72 wrote:
Wed Nov 07, 2018 8:12 am

Let's take some extreme examples. Suppose you have a bond fund that pays exactly 0.0% yield and 0.0% expected capital appreciation. What would be the point of holding that in an IRA? There's no tax on it, and there never will be tax on it, so all you're doing is complicating your life by cluttering up your IRA space. This investment belongs in a taxable account.

Similar situation--say you have a REIT that pays a 15% dividend yield, taxable at ordinary income tax rates, with zero capital appreciation. Assuming you're in a 33% tax bracket, you can expect to lose 5% per year to the tax man. So this absolutely belongs in the non-taxable accounts.
REITs are tax inefficient and high return, so they belong t tax-protected. Let's stick with stocks that are high return and tax-efficient vs bonds that are low return vs tax-inefficient.

But I think I get it
Let's assume you want a 60/40 portfolio. stocks grows 10% and bonds 1%. At some point your tax-protected is 50% of your portfolio,

Let's take stocks in taxable case:
tax-protected: 80% bonds, 20% stoks
taxable: 100% stocks

At the end of the year, you'd probably want to sell some stocks from tax-protected and buy some bonds in tax-protected. So you still have a overall 60/40. You avoided selling in taxable. But the 10% gain of stocks was taxed, even if at 15%

Let's take stocks in tax-protected case:
tax-protected: 100% stocks
taxable: 80% bonds, 20% stocks

At the end of the year, you'd probably want to sell some stocks from taxable and buy some bonds in taxable. So you still have a overall 60/40. You have to pay capital gains because selling in taxable. You also have to pay income tax of the small 1% return your bonds gave you (marginal tax rate), plus over 10% of those 20% of stocks in taxable (15%).

Am I getting it?

So. at the end, do we have to compare

15% * stocks return vs marginal-tax% * bonds return

to decide where to allocate?

-J

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Re: Debunking Bonds in Taxable

Post by grabiner » Thu Nov 08, 2018 9:20 pm

international001 wrote:
Thu Nov 08, 2018 10:27 am
So. at the end, do we have to compare

15% * stocks return vs marginal-tax% * bonds return

to decide where to allocate?
No, because the return on the stocks is deferred. If you have $100K in stock with an 8% return, you now have $108K, but your tax cost is not $1200. If the dividend yield is 2%, you pay an immediate $300. But the other $900 is not due until you sell all of the stock; even if you have to sell some to spend or rebalance, you will pay tax on only a small part of the $6000 capital gain. The deferral of the $900 in tax reduces its cost, and the cost is reduced even more because you might never sell some of that stock, leaving it to your heirs or donating it to charity.

In addition, in a high tax bracket, the tax cost of bonds should be no more than 33% of the muni yield, assuming that you can buy munis with 3/4 of the yield of taxable bonds of the same risk. This makes munis more attractive in higher tax brackets, particularly if your income is high enough that you pay more than 15% tax on qualified dividends.

My estimate is that the break-even point in an ordinary tax situation occurs when muni and stock yields are equal; if muni yields are higher than stock yields, you should prefer stocks in a taxable account. (Munis become more attractive if you are in the top tax bracket and pay 23.8% tax on stock dividends, or if you can use a muni fund for your high-tax state.)

Currently, Admiral shares of Vanguard Total Stock Market Index yield 1.90%, while Admiral shares of Vanguard Intermediate-Term Tax-Exempt yield 2.83%, which makes stock a more attractive taxable investment.
Wiki David Grabiner

columbia
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Re: Debunking Bonds in Taxable

Post by columbia » Thu Nov 08, 2018 9:33 pm

While interesting, these conversations would be more useful, if they focused on....um....ordinary people, who would never consider munis, because we’re just trying to scrape by.

Maybe there should be a wealthy people only sub-forum?

I kid, but only slightly.

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Re: Debunking Bonds in Taxable

Post by raven15 » Thu Nov 08, 2018 11:46 pm

international001 wrote:
Sat Nov 03, 2018 2:09 pm
raven15 wrote:
Tue Oct 30, 2018 3:42 pm
international001 wrote:
Tue Oct 30, 2018 1:47 pm
Some other consideration.. if you have to invest bonds on taxable.. use treasuries. They give you the lowest yield (less taxes) and counter-balance better stocks (don't get corporate bonds or high yield bonds).
There are so many great options that are best or only available in taxable space such as account signup bonuses, i-bonds, and VWALX/VWAHX that I see no need for the ordinary options here or regret for holding bonds in taxable. A small portion of treasuries in tax sheltered accounts for rebalancing aka timing the market seems valuable though.
For the same level of risk, non-tax free bonds are usually better. Unless perhaps you are in a high tax bracket. So I wouldn't use them.
So in other words typing 5 characters VWALX into google, choosing the Morningstar result, and comparing to VFIDX was too much effort. Perhaps also VBTLX and some other intermediate term bond funds. Well I did it so I am good to go.
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Re: Debunking Bonds in Taxable

Post by grabiner » Fri Nov 09, 2018 12:27 am

raven15 wrote:
Thu Nov 08, 2018 11:46 pm
international001 wrote:
Sat Nov 03, 2018 2:09 pm
raven15 wrote:
Tue Oct 30, 2018 3:42 pm
There are so many great options that are best or only available in taxable space such as account signup bonuses, i-bonds, and VWALX/VWAHX that I see no need for the ordinary options here or regret for holding bonds in taxable. A small portion of treasuries in tax sheltered accounts for rebalancing aka timing the market seems valuable though.
For the same level of risk, non-tax free bonds are usually better. Unless perhaps you are in a high tax bracket. So I wouldn't use them.
So in other words typing 5 characters VWALX into google, choosing the Morningstar result, and comparing to VFIDX was too much effort. Perhaps also VBTLX and some other intermediate term bond funds. Well I did it so I am good to go.
You missed "for the same level of risk." VWALX (Vanguard High-Yield Tax-Exempt Admiral) is a fine bond fund, but the fact that it has almost as high a yield as VFIDX (Vanguard Intermediate-Term Investment-Grade Admiral) suggests that it has more risk. And your comparison should confirm that; High-Yield Tax-Exempt has a longer duration, and more bonds rated BBB and lower.
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Re: Debunking Bonds in Taxable

Post by raven15 » Fri Nov 09, 2018 1:19 am

grabiner wrote:
Fri Nov 09, 2018 12:27 am
raven15 wrote:
Thu Nov 08, 2018 11:46 pm
international001 wrote:
Sat Nov 03, 2018 2:09 pm
raven15 wrote:
Tue Oct 30, 2018 3:42 pm
There are so many great options that are best or only available in taxable space such as account signup bonuses, i-bonds, and VWALX/VWAHX that I see no need for the ordinary options here or regret for holding bonds in taxable. A small portion of treasuries in tax sheltered accounts for rebalancing aka timing the market seems valuable though.
For the same level of risk, non-tax free bonds are usually better. Unless perhaps you are in a high tax bracket. So I wouldn't use them.
So in other words typing 5 characters VWALX into google, choosing the Morningstar result, and comparing to VFIDX was too much effort. Perhaps also VBTLX and some other intermediate term bond funds. Well I did it so I am good to go.
You missed "for the same level of risk." VWALX (Vanguard High-Yield Tax-Exempt Admiral) is a fine bond fund, but the fact that it has almost as high a yield as VFIDX (Vanguard Intermediate-Term Investment-Grade Admiral) suggests that it has more risk. And your comparison should confirm that; High-Yield Tax-Exempt has a longer duration, and more bonds rated BBB and lower.
You might think so. The extra risk didn’t show up in 2008 and the risk adjusted returns (Sharpe Ratio) have been very comparable though that is more of a Portfolio Visualizer enquiry. There is an extra year of duration. Morningstar has them both in the center box and I cannot recall how credit ratings compare between corporates and munis. Personally with VWALX available I see no need to burden tax advantaged space with credit risky bond funds.
It's Time. Adding Interest.

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Re: Debunking Bonds in Taxable

Post by international001 » Sun Nov 11, 2018 3:17 pm

grabiner wrote:
Thu Nov 08, 2018 9:20 pm
international001 wrote:
Thu Nov 08, 2018 10:27 am
So. at the end, do we have to compare

15% * stocks return vs marginal-tax% * bonds return

to decide where to allocate?
No, because the return on the stocks is deferred. If you have $100K in stock with an 8% return, you now have $108K, but your tax cost is not $1200. If the dividend yield is 2%, you pay an immediate $300. But the other $900 is not due until you sell all of the stock; even if you have to sell some to spend or rebalance, you will pay tax on only a small part of the $6000 capital gain. The deferral of the $900 in tax reduces its cost, and the cost is reduced even more because you might never sell some of that stock, leaving it to your heirs or donating it to charity.
Sorry, I meant, more accurately

dividends tax % * stocks yield %
vs
marginal-tax% * bonds interest %

of course, for a good analysis you need to consider that one day you'll have to sell the stocks. I'm assuming a very long term to capture just the compounding effects

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Re: Debunking Bonds in Taxable

Post by UpperNwGuy » Sun Nov 11, 2018 3:47 pm

columbia wrote:
Thu Nov 08, 2018 9:33 pm
While interesting, these conversations would be more useful, if they focused on....um....ordinary people, who would never consider munis, because we’re just trying to scrape by.

Maybe there should be a wealthy people only sub-forum?

I kid, but only slightly.
Do you consider a person in the 24 percent tax bracket to be wealthy?

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Re: Debunking Bonds in Taxable

Post by JBTX » Sun Nov 11, 2018 8:49 pm

From my own calculations I concur with those here that it just doesn't make that much difference.

It is pretty straightforward. If cap gains taxes are 15% and ordinary income is 22 or 24%, stocks will need to get generate 1.5 to 1.75 times the bond return to have an equivalent tax liability. So if you got 3.5% on bonds you'd need to get 7% on stocks. That isn't an improbable relationship. Yes, with stocks in taxable you will be able to defer some of the returns, but that deferral doesnt make a huge difference.

When I look at it I use taxable vs Roth to simplify. Comparing traditional complicates it, but first compare taxsble to Roth, then compare Roth to traditional.

If you can defer taxable capital gains to 0% then yes stocks in taxable will have a slight advantage.

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