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

[jively]

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If we do this in an IRA we don't have to worry about long term vs short term gains, or any other tax matter, correct?

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That's correct; investments in IRAs are not taxed annually, so you can rebalance without having to worry about taxes. It still might be best to rebalance infrequently (once per year or so).

-Tom

[jively]

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muni coupons can be triple-tax-free, which is a huge boost to returns if you live in a locality with high state and/or city taxes.

i think this might be moot if you are in the amt, but if you have enough investments for this to be a big issue, you should be asking a tax attorney or a real financial adviser or something.

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Only municipal bonds that are for "private use" are taxable for AMT purposes. So, a muni bond for the state, or a locality, or for highways, and so on are not taxable for AMT. But, bonds that are to build a stadium or things like that are taxable for AMT purposes.

I don't think you would need a "tax attorney" but an accountant should know about this.

-Tom

[ahnuld]

good thread. This will allow me to lock the million ETF threads each week cause im adding this to the sticky.

[Newt_Buggs]

Thanks again jively for all of your help, I've really appreciated all of the posts that you've been making in this forum for a long time.

two questions:
Why REIT? I understand mixing small cap, large cap, european, pacific, etc as a way to diversify so is REIT just adding in more diversification? Why REIT over any other sector specific fund?



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20% US large cap
20% US large cap value
10% US small cap
10% US small cap value
10% US real estate stocks
20% International stocks
10% Emerging markets stocks


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My portfolio looks similar to this but with a little bit more weight on international and significantly more weight on small cap and value. Any recommendations for an investor willing to assume a very large amount of risk for possible higher expected returns?

[jively]

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two questions:
Why REIT? I understand mixing small cap, large cap, european, pacific, etc as a way to diversify so is REIT just adding in more diversification? Why REIT over any other sector specific fund?

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I think the academic researchers looked at the stock prices of all of the sectors. For almost every sector (financial, consumer discretionary, and so on), the average return had only to do with the amount of value vs. growth and the amount of large vs. small. Real estate stocks (REITs) were actually classified as a separate asset class as they moved in a completely different cycle.

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My portfolio looks similar to this but with a little bit more weight on international and significantly more weight on small cap and value. Any recommendations for an investor willing to assume a very large amount of risk for possible higher expected returns?

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I think tilting further toward small and value is OK if you have a high risk tolerance. Having a higher allocation to international is fine too as long as you are OK with "tracking error;" your portfolio will not move in synch with the US markets (and CNBC and so on). As long as you pick an allocation, rebalance periodically, and stick with the same allocation year in and year out, you should do well.

-Tom

[Sherpa]

Jively: Why do you have a focus on value and total market funds and no growth funds?

FWIW my portfolio (goal for balancing purposes) is

20% Large Value
20% Large Growth
10% Small Value
10% Small Growth
30% total International (fund is split 33% between Euro, Pacific, and Emerging)
10% REIT

(All vanguard funds)

[jively]

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Jively: Why do you have a focus on value and total market funds and no growth funds?

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Here is a good page regarding the value factor. From 1927-2005, value outperformed the market and the market outperformed growth, for both large stocks and small stocks in the US. Small cap growth had the lowest average return (9.33%) of all of the "corners" of the market.

-Tom

[jimmysnow]

Giving up a lot of EV being so diversified and passive. Great for Joe Sixpack but the readers here should understand risk. With the new leveraged ETF's, readers here could easily beat that portfolio with same risk and minimal time invested.

[jively]

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Giving up a lot of EV being so diversified and passive. Great for Joe Sixpack but the readers here should understand risk. With the new leveraged ETF's, readers here could easily beat that portfolio with same risk and minimal time invested.

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There is no such thing as a free lunch. It is possible to create portfolios with higher EV but at a cost of higher risk. I'd be willing to discuss your portfolio recommendation, but I'd prefer to do it in another thread. This is a thread on index investment strategy. Why don't you start a new thread on leveraged ETF allocations.

-Tom