Bogle 3 Fund Majesty of Simplicity vs evils of dividends

[BBQ-Nut]

Been reading about the Boglehead lazy 3 fund AA and the 'majesty of simplicity', but am concerned about the evils of dividends.

In the 3 fund AA - I understand that bonds should be in tax deferred and equities (domestic and int'l) should then be for any tax free (Roth) or after tax.

But my wife for example has a Vanguard 500 index etf and it throws off a lot of ordinary dividends.

Wouldn't any "total" domestic or international index eth throw off dividends?

So isn't this conflicting goals: simplicity but generating dividends in after tax?

[oops - Mods - could you please move this to FIRE and Money? Thanks/sorry]

 

[Amethyst]

Depends on your POV, I guess. We like dividends and don't consider them a complication, even though we pay IRS and state taxes on them. Better to make money and pay taxes, than not to make money.

Amethyst

Been reading about the Boglehead lazy 3 fund AA and the 'majesty of simplicity', but am concerned about the evils of dividends.

In the 3 fund AA - I understand that bonds should be in tax deferred and equities (domestic and int'l) should then be for any tax free (Roth) or after tax.

But my wife for example has a Vanguard 500 index etf and it throws off a lot of ordinary dividends.

Wouldn't any "total" domestic or international index eth throw off dividends?

So isn't this conflicting goals: simplicity but generating dividends in after tax?

[oops - Mods - could you please move this to FIRE and Money? Thanks/sorry]

 

[W2R]

What's wrong with dividends? As long as the share price increase exceeds inflation, I am happy with getting dividends as well.

In retirement, my dividends (from both taxable and tax-sheltered accounts) provide me with the money that I live on.

Part of my portfolio is total bond index, total stock index, and international stock index, so that would be your lazy portfolio. I also have Wellesley and the TSP "G Fund". Pretty simple portfolio. My state and federal taxes combined are around 9.5% to 10% of my AGI.

 

[NW-Bound]

... concerned about the evils of dividends.

Money is evil? Or is it tax that's evil?

One easy way to avoid the latter is to stop working. No more income, no more tax.

 

[38Chevy454]

I guess I am not sure what you are asking. Any dividend profits in the after tax account would be taxable. So would any increase in value (capital gains) once they are sold. You might avoid the yearly dividend tax exposure by focusing on growth of the asset value vs yearly dividend, but you will pay the tax in the end.

 

[eta2020]

I like ETFs with raising dividends IE: VIG, SCHD

 

[Which Roger]

I guess I am not sure what you are asking. Any dividend profits in the after tax account would be taxable. So would any increase in value (capital gains) once they are sold. You might avoid the yearly dividend tax exposure by focusing on growth of the asset value vs yearly dividend, but you will pay the tax in the end.

I'm thinking the OP is referring to dividends in the accumulation phase, when one is generally in a high-ish tax bracket and must pay taxes on them when the dividends are paid. Investing in growth (non-dividend-paying) stocks allows one to defer paying taxes on the capital gains until the stock is sold, possibly when one has ERd and can pay 0 tax on capital gains.

 

[eta2020]

I'm thinking the OP is referring to dividends in the accumulation phase, when one is generally in a high-ish tax bracket and must pay taxes on them when the dividends are paid. Investing in growth (non-dividend-paying) stocks allows one to defer paying taxes on the capital gains until the stock is sold, possibly when one has ERd and can pay 0 tax on capital gains.

But high quality companies with raising dividends and wide moat are best long term investments. So getting dividend is good thing. (though yes you have to pay taxes on it)

Raising dividend is usually caused by growth of earnings and that sooner or later will result in higher stock price.

 

[photoguy]

But high quality companies with raising dividends and wide moat are best long term investments. So getting dividend is good thing. (though yes you have to pay taxes on it)

This is a somewhat contentious statement -- I think many believe (myself included) that dividends are irrelevant (you get your return as capital gains if not as dividends) and don't influence total return once other factors are held constant.

If you hold this view, dividends are a bad thing because you can't control your tax burden.

 

[eta2020]

https://assetmanagement.gs.com/cont...utions-quality-companies-rising-dividends.pdf

 

[marko]

I never met a dividend I didn't like....

 

[NW-Bound]

Umm... Those high dividends from financial companies did not last too long once the housing bubble popped.

 

[eta2020]

Umm... Those high dividends from financial companies did not last too long once the housing bubble popped.

I said high quality companies with wide moat and with raising dividends.
Not companies with LARGE dividends.

Look at VIG dividend yield and what happened to it during market crash.
Looks to me index went from 147 companies to 140 and yield dropped down from 1.026 to 0.979 dollars per year. And then in 2010 again it resumed going up.

 

[NW-Bound]

I said high quality companies with wide moat and with raising dividends.
Not companies with LARGE dividends...

Sure. But "quality" of a company changes with time.

My point is "diversify, diversify". I do not hold VIG, but that might work.

I was teasing Marko about him liking all dividends.

 

[catotx]

Replying to the OP: For the US market, you can use ETFs that track the large-cap growth segment. These generally have lower yields. FWIW, I have am putting new investments into VUG (yield 1.19%), the Vanguard Growth ETF.

This is lower than the yield for the 500 index, which is close to 2%.

 

[RunningBum]

This is a somewhat contentious statement -- I think many believe (myself included) that dividends are irrelevant (you get your return as capital gains if not as dividends) and don't influence total return once other factors are held constant.

If you hold this view, dividends are a bad thing because you can't control your tax burden.

Some also believe (myself to some extent) that dividends are given when the company doesn't have better prospects for the money. A good growth company often does better by reinvesting the money to continue growing and increasing its value greater than the dividend rate would be.

 

[LOL!]

Bond dividends are taxed at your marginal income tax rate unless they are tax-exempt from tax-exempt muni bond funds.

The dividends from those broad market index funds are predominantly qualified ordinary dividends which are taxed at a special low rate --- as low as 0%. This is why these funds are tax-efficient and can be in a taxable account. Furthermore, the foreign taxes paid on the international fund dividends can be credited to your US taxes if the int'l fund is held in your taxable account, but not if your int'l fund is held in a IRA or 401(k).

Nothing wrong with those qualified dividends from those "total" stock funds. It is practically impossible to avoid them. Fortunately, they get taxed in a special low way.

 

[pb4uski]

Dividends are subject to preferential tax rates compared to interest and that is why they are carried in taxable accounts. We are retired and pay 0% federal tax on our dividends and get a nice tax credit for international equities in our taxable accounts.

 

[eta2020]

Dividends are subject to preferential tax rates compared to interest and that is why they are carried in taxable accounts. We are retired and pay 0% federal tax on our dividends and get a nice tax credit for international equities in our taxable accounts.

I have learned something here.... I did not realize benefit of international equities in Taxable account.

 

[Animorph]

While minimizing taxable events in your taxable accounts is nice, it is not something you need to avoid 100%. Choose your AA, then do the best placement of shares that you can. You can spreadsheet a few scenarios if you are unsure about that. You don't want to fill your IRA/Roth accounts with a bunch of low total return stuff just to avoid minor taxes on dividends.

 

[LOL!]

… and pay 0% federal tax on our dividends and get a nice tax credit for international equities in our taxable accounts.

The above is only true if the foreign taxes (and thus foreign tax credit (FTC)) is relatively low and you get a "gimme" because they are below a limit for checking carefully if you are allowed a credit, see Form 1116. But how to explain this ….

The idea of the FTC is to not pay taxes twice, but pay taxes at least once. So if the US says your taxes on foreign dividends are 0%, you should not get a foreign tax credit because you would not be offseting any extra US taxes. Form 1116 is complicated for this reason.

 

[Amethyst]

Even with munis, the AMT steps in so the government still gets its bite!

Bond dividends are taxed at your marginal income tax rate unless they are tax-exempt from tax-exempt muni bond funds.

.

 

[Ready]

I'm not a fan of dividends. They just require me to receive income and pay taxes when the funds choose, rather than realized capital gains, which allow me to choose when to take the gains and pay the taxes. That being said, index funds tend to pay fewer capital gains than actively managed funds, because they don't have managers constantly buying and selling funds to time the market or take advantage of all the research they charge for. So an index fund is still the best bet for minimizing dividends and capital gains while in a higher tax bracket.

 

[pb4uski]

The above is only true if the foreign taxes (and thus foreign tax credit (FTC)) is relatively low and you get a "gimme" because they are below a limit for checking carefully if you are allowed a credit, see Form 1116. But how to explain this ….

The idea of the FTC is to not pay taxes twice, but pay taxes at least once. So if the US says your taxes on foreign dividends are 0%, you should not get a foreign tax credit because you would not be offseting any extra US taxes. Form 1116 is complicated for this reason.

The relatively low amount of international equities in our taxable accounts allow us to use the simplified method - no form, just a credit for foreign taxes paid. It can be up to $600 a year for a couple for 2013. Also, unlike domestic equity dividends which are all qualified dividends in our case, some of our international dividends are not qualified, and so is included in ordinary income subject to tax.

http://www.irs.gov/pub/irs-pdf/i1040.pdf see instructions for line 47 on page 44.

 

[pb4uski]

While minimizing taxable events in your taxable accounts is nice, it is not something you need to avoid 100%. Choose your AA, then do the best placement of shares that you can. You can spreadsheet a few scenarios if you are unsure about that. You don't want to fill your IRA/Roth accounts with a bunch of low total return stuff just to avoid minor taxes on dividends.

+1 That is the way I looked at it as well. Overall AA first, then tax efficiency second. Luckily, our mix of taxable, tax-deferred and tax-free accounts can be very tax efficient while still conforming to our target AA.

But don't let the tax tail wag the investing dog.