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Four Pillars Book Question - Taxable Accounts
Old 02-20-2007, 01:41 PM   #1
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Four Pillars Book Question - Taxable Accounts

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
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Re: Four Pillars Book Question - Taxable Accounts
Old 02-20-2007, 01:50 PM   #2
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Re: Four Pillars Book Question - Taxable Accounts

I am also in school at the time. My only advice would be, if you currently have a any sort of earned income to start a Roth now so that you can shelter some money now especially considering your low tax-rate. Perhaps you could get a job over the summer to have earned income for 2007 if you don't work during the school year.

Another thing I like about the Roth, is that I need the money for some emergency during my school years, you can withdraw the contributions penalty free for any reason. However I want to take advantage of compounding so I am going to try my hardest not to touch it.
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Re: Four Pillars Book Question - Taxable Accounts
Old 02-20-2007, 02:38 PM   #3
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Re: Four Pillars Book Question - Taxable Accounts

Quote:
Originally Posted by rjpatt
I am also in school at the time. My only advice would be, if you currently have a any sort of earned income to start a Roth now so that you can shelter some money now especially considering your low tax-rate. Perhaps you could get a job over the summer to have earned income for 2007 if you don't work during the school year.
Hi RJ,

Unfortunately I currently have no earned income or else I would definitely be taking advantage of this. And also, unfortunately fortunately, I am in a high-tax bracket.
Quote:
Another thing I like about the Roth, is that I need the money for some emergency during my school years, you can withdraw the contributions penalty free for any reason. However I want to take advantage of compounding so I am going to try my hardest not to touch it.
Heh, yes, I would work hard not to touch that money as well.

Here is a link to my situation from the "Hi I am..." board if anyone needs more details.

John
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Re: Four Pillars Book Question - Taxable Accounts
Old 02-20-2007, 03:14 PM   #4
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Re: Four Pillars Book Question - Taxable Accounts

Why would the poker money not be considered earned income? You have to report the earnings as income correct?
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Re: Four Pillars Book Question - Taxable Accounts
Old 02-20-2007, 04:10 PM   #5
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Re: Four Pillars Book Question - Taxable Accounts

Quote:
Originally Posted by rjpatt
Why would the poker money not be considered earned income? You have to report the earnings as income correct?
Actually think I would be able to setup a SEP IRA and contribute some to that, but I would still have 80%+ in taxable accounts. I am going to have to look into this further since it would provide me a little leeway. Over spring break I am going to have to see an accountant or specialist.

Ponks
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Re: Four Pillars Book Question - Taxable Accounts
Old 02-20-2007, 06:46 PM   #6
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Re: Four Pillars Book Question - Taxable Accounts

Ponks,

(IIRC, Taxable Ted held small caps through Vanguard's tax managed small cap fund.)

If I read your original post in this discussion correctly, you've got tax efficient Vanguard index funds [like VFINX + VTSMX] along with not so tax efficient Vanguard index funds [like VISVX]. Is this correct? Are you also doing a small and value tilt?

If so, you can always use Vanguard's ETF's for the Value and small value to complement the Total Stock Market Index, and possible tax managed small cap [which is a small cap blend fund].

You may have to check with Vanguard on this, but I believe you can exchange your Vanguard index funds for comparable Vanguard ETF's. For example, if you've got Vanguard's Value Index [VIVAX], you can exchange it for Vanguard's Value Viper [VTV]. Though, I believe you have to have a brokerage account for this. This may be preferable than selling those value and sv index funds to buy the ETF's.

I also saw in your original post that you're a psychology major interested in finance/economics. Well, there's a whole field of economics called Behavioral Finance that may be right up your alley. And one of the hubs of this field is at the University of Chicago, run by Richard Thaler. I know a couple of Econ PhD's that started out at psychology majors. Have you taken a look at Why Smart People Make Big Money Mistakes And How To Correct Them: Lessons From The New Science Of Behavioral Economics.? Your school library may have it.

Personally, I'd stay as far away as possible from the likes of NW Mutual and other sales jobs like that. I interviewed with NW Mutual when I got out of college [5 years ago], and they pretty much wanted me to make a list of suckers I could sell crap too people I knew well than needed "financial advice." These are sales jobs pure and simple, and you only really have to know just a bit more than your marks clients to snow them.

Run away, fast.

- Alec
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Re: Four Pillars Book Question - Taxable Accounts
Old 02-20-2007, 09:09 PM   #7
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Re: Four Pillars Book Question - Taxable Accounts

You have little income how much difference could it make having taxable accounts ?
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Re: Four Pillars Book Question - Taxable Accounts
Old 02-20-2007, 09:30 PM   #8
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Re: Four Pillars Book Question - Taxable Accounts

Quote:
Originally Posted by spideyrdpd
You have little income how much difference could it make having taxable accounts ?
For me, the "little" income that I have is significant and achieving better returns on it will allow me to ER earlier, especially with many years of compounding.

But hey, thanks for adding to the discussion.

Ponks
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Re: Four Pillars Book Question - Taxable Accounts
Old 02-20-2007, 09:32 PM   #9
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Re: Four Pillars Book Question - Taxable Accounts

Quote:
Originally Posted by ats5g
Ponks,

(IIRC, Taxable Ted held small caps through Vanguard's tax managed small cap fund.)

If I read your original post in this discussion correctly, you've got tax efficient Vanguard index funds [like VFINX + VTSMX] along with not so tax efficient Vanguard index funds [like VISVX]. Is this correct? Are you also doing a small and value tilt?

If so, you can always use Vanguard's ETF's for the Value and small value to complement the Total Stock Market Index, and possible tax managed small cap [which is a small cap blend fund].

You may have to check with Vanguard on this, but I believe you can exchange your Vanguard index funds for comparable Vanguard ETF's. For example, if you've got Vanguard's Value Index [VIVAX], you can exchange it for Vanguard's Value Viper [VTV]. Though, I believe you have to have a brokerage account for this. This may be preferable than selling those value and sv index funds to buy the ETF's.

I also saw in your original post that you're a psychology major interested in finance/economics. Well, there's a whole field of economics called Behavioral Finance that may be right up your alley. And one of the hubs of this field is at the University of Chicago, run by Richard Thaler. I know a couple of Econ PhD's that started out at psychology majors. Have you taken a look at Why Smart People Make Big Money Mistakes And How To Correct Them: Lessons From The New Science Of Behavioral Economics.? Your school library may have it.

Personally, I'd stay as far away as possible from the likes of NW Mutual and other sales jobs like that. I interviewed with NW Mutual when I got out of college [5 years ago], and they pretty much wanted me to make a list of suckers I could sell crap too people I knew well than needed "financial advice." These are sales jobs pure and simple, and you only really have to know just a bit more than your marks clients to snow them.

Run away, fast.

- Alec
Hmm, I will have to research some more into ETF's. I know of them, but not that much about them.

Also, I will definitely check out that book.

I reached that same phase in the NW mutual recruitment process and haven't talked to them since they asked me to make the list of suckers people I knew. I agree - not for me. I've got some ideas now that I am working on.

Ponks

EDIT- Can't type
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Re: Four Pillars Book Question - Taxable Accounts
Old 02-21-2007, 09:32 AM   #10
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Re: Four Pillars Book Question - Taxable Accounts

Pons, this goes against the grain, but I would ignore the advice about taxes for now. Unless you are in the 35% federal bracket, you stad to lose more by avoiding taxes than you would gain by having a proper allocation. I have lost a lot more money by trying to avoid taxes than I have by making investment mistakes caused by avoiding taxes.
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