Improving tax efficiency of my investments

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4three
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Joined: Sun Mar 19, 2023 7:12 pm

Improving tax efficiency of my investments

Post by 4three »

[Moved into a new thread from: Improving tax efficiency and allocation of investment accounts --admin LadyGeek]

I’m new to this forum. Thank you all for your sage advice.
I’m in a similar boat as the original poster, except I’m in my mid-40s, and I will have a pension through my current employer (county government).
I’m also a California resident, and my federal and state tax rates are the same as the original poster.
Instead of a 401k, I have a a 457 DCP, which I believe is the public sector equivalent of a 401k: it has the same annual contribution limits as a 401k (eg, $22,500 in 2023).
In my 457 DCP, I’ve been investing 100% into Fidelity 500 Index Fund (FXAIX), which has a nice low expense ratio of 0.015%.

But from what I’ve gleaned from this thread about improving the tax efficiency of my investments, I should probably switch my future investments in my 457 to 100% Fidelity U.S. Bond Index Fund (FXNAX), right?
But does the fact that I have a pension mean that I don’t really need bonds in my retirement portfolio? Does the pension basically serve as my fixed income investments, and so I should just keep investing in FXAIX (S&P 500 index fund) in my 457 (tax-advantaged) account? I recall the Boglehead Wiki said the main criticism of the “bond fund in tax-deferred account” approach was the potential opportunity cost of much greater yields with equities, especially when my time horizon is still >> 10 years away.

I also have a taxable brokerage account, into which I am auto-investing a fixed amount every month into 100% VTSAX, but I also have $20k invested in VBTLX. It sounds like I should keep investing in VTSAX in this taxable account, and I should sell my VBTLX shares (which are down a little bit) and tax-loss harvest my losses, and exchange this money for VTSAX, or alternatively, I could exchange it for a California-specific municipal bond fund like VCLAX. Right?
I was also considering keeping investing about half of my emergency fund (which is currently 100% in a high-yield online savings account) into VCLAX, accepting that there is some risk to principal with a muni bond fund.

I’d appreciate any feedback folks may have on my thinking.
Thanks in advance!
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Duckie
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Re: Improving tax efficiency of my investments

Post by Duckie »

4three, welcome to the forum.
4three wrote: Tue Mar 21, 2023 1:58 pm In my 457 DCP, I’ve been investing 100% into Fidelity 500 Index Fund (FXAIX), which has a nice low expense ratio of 0.015%.

But from what I’ve gleaned from this thread about improving the tax efficiency of my investments, I should probably switch my future investments in my 457 to 100% Fidelity U.S. Bond Index Fund (FXNAX), right?
Maybe. You might want to switch both your future contributions AND switch some of your current allocation from FXIAX to FXNAX. It depends on what your desired bond allocation is and how much room you have in the 457b.
But does the fact that I have a pension mean that I don’t really need bonds in my retirement portfolio? Does the pension basically serve as my fixed income investments,
There are disagreements on this. Right now you have limited control, if any, over your future pension and can't access it if needed, so I would not consider it part of your portfolio now. Also, I consider a pension to be an income stream like social security and not part of your portfolio when you actually start taking it. So to me a future pension has nothing to do with how much the bond allocation should be now.

How old are you? The older you are the less likely you are to take risks and that means more bonds.
I also have a taxable brokerage account, into which I am auto-investing a fixed amount every month into 100% VTSAX, but I also have $20k invested in VBTLX. It sounds like I should keep investing in VTSAX in this taxable account, and I should sell my VBTLX shares (which are down a little bit) and tax-loss harvest my losses, and exchange this money for VTSAX,
Selling VBTLX in taxable for a loss and buying FXNAX in your 457b plan is a good idea. (Do you hold VBTLX anywhere else? You want to avoid a wash sale.)
or alternatively, I could exchange it for a California-specific municipal bond fund like VCLAX. Right?

I was also considering keeping investing about half of my emergency fund (which is currently 100% in a high-yield online savings account) into VCLAX, accepting that there is some risk to principal with a muni bond fund.
Choosing to put some of your emergency fund in VCLAX is one thing, but unless your 457b is less than your desired bond allocation I would not bother with bonds in taxable.
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grabiner
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Re: Improving tax efficiency of my investments

Post by grabiner »

Duckie wrote: Tue Mar 21, 2023 6:56 pm Choosing to put some of your emergency fund in VCLAX is one thing, but unless your 457b is less than your desired bond allocation I would not bother with bonds in taxable.
While this is normally a good recommendation, I do not believe it is correct for the OP, who is in a 35% federal and 9.3% CA tax bracket.

The reason is that they have a higher tax cost than other investors on a taxable account (15% or 20% federal + 3.8% NIIT + 9.3% CA = 27.1% or 32.1% on qualified dividends and long-term gains, and 47.1% on any non-qualified dividends), but no more tax cost than anyone else on CA munis. (The tax cost of munis is the difference between yields of muni and taxable bonds of comparable risk). Therefore, I would recommend holding CA munis in the taxable account, in Vanguard CA Long-Term or Intermediate-Term Tax-Exempt.

If the single-state risk of holding all the bonds in CA munis is too great, then it may make sense to hold half the bonds in CA munis, and half in a high-quality taxable bond fund in the 457(b).
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peteyboy
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Re: Improving tax efficiency of my investments

Post by peteyboy »

Figure what you want for overall portfolio asset allocation (AA) based on your risk tolerance and time horizon.

For example 70/20/10 (US stock/Int stock/bond), 80/0/20, 60/20/20, 50/0/50, 34/33/33, 20/10/70....or whatever.

Now think of all your accounts (taxable, tax-deferred, and Roth) as one big pool of $.

Once you know your desired AA, then put all the bond investments in the tax-deferred account and then fill up the rest with stock investments. Keep the tax inefficient investments in the tax-deferred account.

Note: Don't put muni bonds in the tax-deferred account.

You might find these two wiki topics useful if you haven't seen them before:
https://www.bogleheads.org/wiki/Tax-eff ... et_classes
https://www.bogleheads.org/wiki/Three-fund_portfolio
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