Four Pillars Book Question - Taxable Accounts

[Ponks]

Hey All,

So I just finished reading The Four Pillars of Investing - good book, highly recommended.

In Chapter 13, "Defining Your Mix" in the scenario of Taxable Ted, who has all his money in taxable accounts, they recommend not holding any small cap stocks, value stocks, total international funds, and REITs in taxable accounts because of their tax inefficiency.

Currently I am 22 years old and have all my investments in taxable accounts at Vanguard with a well diversified balance. However, I own many of these tax inefficient index funds because I wanted to keep my portfolio diversified. The book recommends instead purchasing the Tax-Advantaged International and Value funds in order to diversify. I was wondering everyone's thoughts on this as I hardly ever see it recommended. Do you think I should rebalance my portfolio to include the tax-advantaged index funds instead of their tax-inefficient partner? I plan on it, but would like to hear arguments against.

I'm trying to plan ahead for when I have tax-sheltered accounts, but currently I'm still in school and don't have a regular job yet. I was thinking I would rebalance my portfolio with more weight going to the Total Stock Market index and Short Term Tax-Advantaged Bonds (more to follow on this later) because they are relatively tax-efficient, and then purchase a small percent in tax-managed international and tax-managed small cap value fund and possibly a few others (haven't looked into all the tax-advantaged funds yet at vanguard), and when I accept a job and contribute to my 401(k) and Roth IRA I would then buy back the REIT and rebalance my portfolio accordingly throughout the years so that my tax-sheltered plans have value stocks, international, and REIT stocks while my taxable accounts have large growth/blend and bonds. Even if I only have a 35k/yearly job out of school I still plan to contribute the max and I will draw down on my taxable accounts to live off if needed so I can get as much money tax-sheltered as quick as possible. It appears to me that because of this my taxable accounts have become more short-term then I originally calculated, that is why I would have a larger weight to the tax-advantaged short-term bonds then I originally planned, but it's hard to predict the future drain or growth on my taxable accounts because my income is so uncertain right now.

How does this plan sound? Any pitfalls I should be aware of, specifically other tax pitfalls? Are the tax-advantaged funds worth rebalancing my whole portfolio? Obviously the tax bracket that I think I will be in matters a lot in this calculation, but I really can't say for sure how much I will be getting paid from my job - if poker stays alive and healthy in the US I could reach the top tax bracket with poker and my job, or if poker fades out and I can't find a good job, I could just as easily be in a low tax bracket.

If I'm missing any relevant information that would help you analyze my scenario, please let me know and I'll provide any details needed.

Thanks,
Ponks

[jively]

Your plan sounds good. I'm looking at Intelligent Asset Allocator, his previous book. He says European Stock Index and Pacific Stock Index were OK in taxable or tax-sheltered accounts. If you can use both funds, you'd be OK. If you have Total International, that should be changed to Tax-Managed.

Tax advantage bonds? Do you mean munis? They are definitely worthwhile if you are in the top bracket, and definitely not worthwhile if you are in 0%, 10%, or 15% bracket. There generally is not a large capital gain or loss if you sell a short-term bond fund, so you can switch between taxable and munis if your tax rate changes year after year.

You might want to wait to sell/rebalance out of anything until it becomes long-term. If you can, you might keep what you have and only put new money into your new funds.

You read a great book and seem to know what you are doing. Congrats!

-Tom

[Ponks]

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Your plan sounds good. I'm looking at Intelligent Asset Allocator, his previous book. He says European Stock Index and Pacific Stock Index were OK in taxable or tax-sheltered accounts. If you can use both funds, you'd be OK. If you have Total International, that should be changed to Tax-Managed.

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In Four Pillars he lists that European, Pacific, and Emerging Markets indexes seperately are OK in both taxable or sheltered accounts, but the Total International should be reserved for tax-sheltered accounts. In case others are curious as to why this is, it looks like the Total International Stock Fund is not eligible for the foreign dividend tax exclusion.

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Tax advantage bonds? Do you mean munis? They are definitely worthwhile if you are in the top bracket, and definitely not worthwhile if you are in 0%, 10%, or 15% bracket. There generally is not a large capital gain or loss if you sell a short-term bond fund, so you can switch between taxable and munis if your tax rate changes year after year.


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Yes, sorry, I meant Munis. Excellent, this is what the book recommends, calculating the yields and moving into whatever provides the best after-tax yield adjusted for risk.

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You might want to wait to sell/rebalance out of anything until it becomes long-term.



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Definitely - I have to wait a little longer since I also have to avoid some of the redemption fees if I sell within the first year of buying. The capital gains will become long-term after just 1 year, is that correct? I will have to wait about 4-6 months before I can start moving some of my money around, but I also remember reading on this forum there is an advantage to waiting until after the year ends incase some of my funds lose money I will be able to deduct some of this loss on my tax return, so should I just wait another few months until the new year or does it not matter much? I don't really want to go chasing every basis point that I can, but definitely don't want to miss something as big as 10 basis points.

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If you can, you might keep what you have and only put new money into your new funds.

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I thought about this, but I have such a large lump sum for someone my age that it makes sense for me to correct this as soon as possible as it may take many years to rebalance through depositing alone.

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You read a great book and seem to know what you are doing. Congrats!

-Tom


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Thanks - this means a lot coming from you; I was hoping you would reply to my post. [img]/images/graemlins/smile.gif[/img]

I think I am going to move onto Bogle's book now and some of the books Berstein recommends in The Four Pillars as well.

Ponks

[jively]

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You might want to wait to sell/rebalance out of anything until it becomes long-term.

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Definitely - I have to wait a little longer since I also have to avoid some of the redemption fees if I sell within the first year of buying. The capital gains will become long-term after just 1 year, is that correct? I will have to wait about 4-6 months before I can start moving some of my money around, but I also remember reading on this forum there is an advantage to waiting until after the year ends incase some of my funds lose money I will be able to deduct some of this loss on my tax return, so should I just wait another few months until the new year or does it not matter much? I don't really want to go chasing every basis point that I can, but definitely don't want to miss something as big as 10 basis points.

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The taxable event is the day you sell your investment. If you sell 12/31/07, it is a taxable event in 2007, and if you sell on 1/2/08, it is a taxable event in 2008.

If your taxable event is a capital gain, it is taxable in that tax year. If it is a loss, you can deduct up to $3,000 of your capital loss against other income. If you have more than a $3,000 capital loss, you deduct $3,000 this year, and carry-forward the rest of your losses to future capital gains or other income.

So, if you have a loss, take it this year, and if you have a gain, wait until next year is a better strategy.

In order to be long-term, it has to sold "more than a year" from when it is purchased, so it is a year and a day.

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Thanks - this means a lot coming from you; I was hoping you would reply to my post. [img]/images/graemlins/smile.gif[/img]

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You honor me. [img]/images/graemlins/smile.gif[/img]

-Tom

[chaz64]

I just finished reading this book as well. He seems to be in the value camp (rather than growth) and also thinks that long term bonds are a bad bet - expected return is not worth the risk you are taking.

Is this the general consensus here - value is better than growth (over the long haul, anyway) and long term bonds should be avoided? If so, are TIPS a good bet for your bond position?

[jively]

[ QUOTE ]
I just finished reading this book as well. He seems to be in the value camp (rather than growth) and also thinks that long term bonds are a bad bet - expected return is not worth the risk you are taking.

Is this the general consensus here - value is better than growth (over the long haul, anyway) and long term bonds should be avoided? If so, are TIPS a good bet for your bond position?

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I think a lot of academic research points to value over growth, and long bonds not being worth the risk.

TIPS are OK if you want to protect yourself against "unexpected" inflation. But I think stocks are better to protect against inflation.

-Tom