Hi I am NameRedacted (Sorry I'm not retired yet)

[pb4uski]

What is a loss?

Honestly, the average position in my taxable accounts has a 42% gain and the worst purchase lot is an 11% gain.

 

[NameRedacted]

The reason to hold bonds in tax-deferred accounts is because bonds generate ordinary income which is taxed at ordinary rates, just like tax-deferred account withdrawals. Qualified dividends on equities and long-term capital gains are taxed at preferential tax rates, generally 0% for those in the 15% tax bracket and lower and 15% for those in the 25% tax bracket and higher.

Holding equities in tax-deferred accounts essentially converts income that would be taxed at 0% or 15% to income that is taxed at 15% or 25%... and that 10-15% difference adds up. Also, while a portion of international equity holdings are not tax preferenced as described above, you get the foreign tax credit if you hold international equities in a taxable account and you lose that benefit if you hold international equities in a tax-deferred account.

Also see https://www.bogleheads.org/wiki/Tax-efficient_fund_placement

Liquidity is not an issue, you just sell taxable account investments as needed to fund spending and then sell bonds and buy stocks as needed in your tax-deferred accounts to rebalance.

How much of this is mitigated by allowing for the potentially greater growth in equities to grow tax free?

A quick back of the envelope calculation: Let's say I have $200,000. $100,000 is bonds and $100,000 in equities.

Let's say that bonds grow at 2% and equities at 7%.

If the bonds are in the taxable account, the taxes are 25% say on $2,000 = $500. In the equities are placed in the taxable account, I pay 15% on $7,000 which is $1050. The break even point would be if the bonds earned 4.2% at which point the taxes would both be $1050.

This does not take into account the transaction costs which would be tripled if I have to sell equities in one account and do an exchange in the other.

Granted, at some point in the future I would have to pay more taxes on the tax-advantaged account but it should have a much greater value by then if it contains equities.

I'm probably missing something obvious here.

 

[pb4uski]

First, you need to differentiate between tax-deferred and tax-free accounts.

Tax-deferred accounts are like your pre-tax 401k or deductible IRA and you'll get taxed on withdrawals. That is where the bonds go because you are going to pay 25% tax on bond interest whether it is in taxable or tax deferred.

Roths and HSAs would be tax-free and are a good place for domestic equities because of tax-free growth, but not international equities because you would lose the foreign tax credit.

Transaction costs are irrelevant... for most of us they are zero with free brokerage trades and no fees in tax-deferred accounts.

If you hold equities in a tax-deferred account you will (eventually) pay 25% on the growth and lose the benefit if the foreign tax credit, whereas if you hold equities in a taxable account you will pay 15% and receive the benefit of the foreign tax credit.

Let's say you have $100k in taxable and $100k in tax-deferred.

Scenario 1 is that you invest in equities in the taxable account and in bonds in the tax-deferred account. At a 5.95% after-tax rate of return (7% *(1-15% tax rate)) the $100k of equities grows over 10 years to $178k. At 2%, the $100k of bonds grow to $122k which is withdrawn and is $91k after paying the 25% in tax. So you have a total of $270k.

Scenario 2 is the inverse, you invest in bonds in the taxable account and equities in the tax-deferred account. At 1.5% after-tax rate of return (2% *(1-25% tax rate)) the $100k in bonds grows over 10 years to $116k. At 7% the equities grow to $197k which is withdrawn and is $148k after paying the 25% in tax. So you have a total of $264k.

Not a huge difference, but still a benefit and the foreign tax credit helps make it even better. If there were no difference in tax rates then it would favor investing equities in tax deferred by about the same difference, so the impact of the difference in tax rates is worth ~11k.

 

[phil1ben]

I am retiring December 31. I am 56 and my wife is 53. I have always only owned individual stocks. Like you, I do this myself and I am very comfortable with the research. On the fixed income side I only own individual municipal bonds. I treat them like stocks and do my own research trading through a national broker. I also buy when everyone is leaving the store which has (so far) done well. Bought Illinois bonds when the governor was being indicted and bought California bonds when everyone said California was in trouble. However, fortunately never bought Puerto Rico bonds. I do not own any funds and do my own research. I am (about to be was) in the finance field. My portfolio is about 40% muni bonds, 20% stock and 40% real estate. Bonds cannot be bought and held because they are often called and all do mature. However, I almost always hold until call or maturity. Obviously which tax bracket you fall into during retirement plays an important role. Congratulations.

 

[NameRedacted]

Yes I'm sure you are right based on that calculation.

Not a huge difference, but still a benefit and the foreign tax credit helps make it even better. If there were no difference in tax rates then it would favor investing equities in tax deferred by about the same difference, so the impact of the difference in tax rates is worth ~11k.

A 6k difference based on 100K is actually quite a big difference ~ over $600 dollars year and the real number will be much higher because the bond portion is a lot more than 100K.

Still, it's difficult to predict returns on equities 10 years in advance and it's also difficult to predict the tax rates on different asset classes that far ahead either.

Since all the cash is sitting there in the taxable account I'm going to go ahead and just buy the bonds anyway. The other option is to buy a whole bunch of equities in the taxable account (I really don't want to buy an equity ETF - I enjoy researching stocks and trying to beat the market) and sell a whole bunch of equities in the IRA. Sadly, I don't have time to do the necessary research right now.

Thanks for your patience in teaching a newb though. As I purchase more bonds in the future I'll probably start doing so in the IRA.

 

[FiveDriver]

Name -- Congrats on your upcoming Retirement.

Concerning Bonds, I tend to be cautious on just plowing money into Bond Funds. Interest Rates are at historically low levels and really have nowhere to go but up. In the coming months Trumpenomics will become better defined, but with Goldman Sachs filling so many Cabinet positions......I'd take a wait and see approach. You could start with a 10% allotment into the Bond Fund -- just to track performance. If you are satisfied with the behavior in this environment, you can move more into the Fund with a phone call or a mouse click. Pick a Fund with a Short Duration.

I have a CD Ladder at 2-month intervals that I count as part of my Bond Allotment. I just roll it over as they mature. I also count Cash as part of the Bond portion.

Good Luck to you in whatever you decide to do.

 

[NameRedacted]

I am retiring December 31. I am 56 and my wife is 53. I have always only owned individual stocks. Like you, I do this myself and I am very comfortable with the research. On the fixed income side I only own individual municipal bonds. I treat them like stocks and do my own research trading through a national broker. I also buy when everyone is leaving the store which has (so far) done well. Bought Illinois bonds when the governor was being indicted and bought California bonds when everyone said California was in trouble. However, fortunately never bought Puerto Rico bonds. I do not own any funds and do my own research. I am (about to be was) in the finance field. My portfolio is about 40% muni bonds, 20% stock and 40% real estate. Bonds cannot be bought and held because they are often called and all do mature. However, I almost always hold until call or maturity. Obviously which tax bracket you fall into during retirement plays an important role. Congratulations.

Well congratulation to you too and good luck. I did think about buying individual bonds myself but since I know nothing about them and the purpose of holding them is to reduce risk I decided that prudence would be the better course - at least until I get up to speed.

 

[NameRedacted]

Name -- Congrats on your upcoming Retirement.

Concerning Bonds, I tend to be cautious on just plowing money into Bond Funds. Interest Rates are at historically low levels and really have nowhere to go but up. In the coming months Trumpenomics will become better defined, but with Goldman Sachs filling so many Cabinet positions......I'd take a wait and see approach.

I hear ya! I thought long and hard about that and my initial plan was to wait until after the Fed meeting, but then I thought I have to do this sooner or later and the longer I delay the more interest I'm losing. I still have about a 1/3 of the cash available and plan to switch more from equities in the coming months. So there is still some powder left.

The thing that really worries me more than anything else is his threat to renege on the US's debt repayments. I'm expecting that was just an empty threat to curry favor with a certain part of the electorate but you never know.

I'll shut up now as this is probably getting too political.