Best Index Investment Strategy?

[jively]

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Can you elaborate a bit on what you mean when you say "you might consider a municipal bond fund instead of these taxable fund, although it should still be short or intermediate term." I'm in a high tax bracket, combined with my wife's income, and I have absolutely no idea how that should, if at all, alter our strategy today.

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When people are in the lowest tax brackets, (0%, 10%, 15%), it always makes sense to have taxable bonds and pay the tax on it. When people are in the highest tax bracket (35%), it always makes sense to have tax-free municipal bonds. The yield is lower, but you end up with more money than if you had taxable bonds and paid the tax on it.

In between (25%, 28%, 33%), it sometimes is better to use one or the other, depending on where the yields are. If your state or local tax rates are high, lean toward municipals.

For Vanguard, instead of using the taxable funds, you could use Short-Term Tax-Exempt Inv and Inter-Term Tax-Exempt Inv. If you live in California, you could use CA IT Tax-Exempt Investor as in the intermediate-term bond fund.

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Also, when you mention "tax efficient," in relation to the Total Stock market fund, what does that mean? How can I judge the "efficiency" of a fund and is it an important consideration for an investor in my shoes?

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All funds distribute their income annually to their shareholders. The dividends from the stocks, and the interest from the bonds and the money markets are distributed. Also, if the fund sells a stock for a gain, the capital gain is distributed. Funds that sell their stocks frequently have more distributed capital gains.

Most index funds do have to follow their benchmark closely (or exactly), so that some stocks are removed from their index and must be sold, and other stocks are added to the index and must be bought. For example, a small-cap value index has a bit of turnover, because stocks either grow to be too big or are not "value" anymore.

The Total Stock Market index is more tax-efficient than an S&P 500 Index fund because it has less turnover.

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Also when you say "you definitely want to wait at least one year and one day so that any sales are considered long-term capital gains," pardon my ignorance but, does this mean that tax rates are different on a sale of a fund or stock held a month versus one held for over a year? If so, how different?

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Significant. Investments held one year or less are taxed as short-term capital gains at ordinary tax rates, and could be 25%, 28%, 33%, or 35%. Investments held more than one year are taxed at long-term capital gains, generally all at 15%. (This may be a tax law that is set to expire, and may go up to 20% in a few years.) The investment strategy I suggested has you wait more than one year before selling anything, so you never create short-term capital gains for yourself.

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Regarding forecasting, although your against it I have to ask if it is a bad idea to touch REIT's right now.

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REITs are down this year. They may go down more from here. I don't make these kinds of forecasts. I like all of the asset classes in the allocation. They should all have good positive returns over long periods of time. I buy and hold all of them every year. By forecasting, you are second-guessing the allocation, and are giving yourself the chance to make a big mistake.

The biggest mistake that most investors make again and again throughout their investing lifetimes is buying asset classes that have gone up a lot recently (buying high), and selling asset classes that have gone down a lot recently (selling low). It happens generation after generation and in every market cycle. Most recently, huge numbers of investors got into tech stocks in 1999 and early 2000 (and got killed), then sold stocks in 2002 and early 2003 (near the bottom). Many of those investors then put their extra money into real estate - buying a rental property and so on, and they are having trouble now.

By having a globally diversified allocation, and rebalancing unemotionally, you can buy low, sell high, and avoid the big mistakes.

-Tom