How to Invest

[John Hudson]

If a person had $2,000,000 and wanted to recieve $80,000 per year return with as little tax as possible. What would you recommend.

 

[wabmester]

You can get a tax-free 4% yield from muni bonds by going out a little more than 10 years in maturity. Safe and tax-free, but not immune to the effects of inflation, of course.

 

[JWR1945]

I think that you need to address inflation. My guess is that you want to retain a constant level of buying power, but I may be wrong.

It may be that you are willing to allow your withdrawals to fluctuate according to how your portfolio fluctuates. If so, you might wish to withdraw 4% of your portfolio's current balance (whatever it happens to be) as opposed to 4% of your portfolio's initial balance plus an adjustment for inflation. [Typically, withdrawing 5% of the current balance and withdrawing 4% plus inflation based on the initial balance have produced similar results under stressful investment conditions.]

Another thing to address is how long you wish to make withdrawals.

What about a final balance? Are you willing to allow it to fall close to zero? Or is there a floor that you want to guarantee?

Have fun.

John R.

P.S. Be sure to play some what-if games using FIRECalc.

 

[charlie]

If you put about 30% into Vanguard's Total Stock
Market Index Fund and invest the rest as Wabmester
suggested your total port would grow about 3% per
year on average assuming you spent all the interest
and dividends. This assumes about 10% growth in
the stock fund, which is by no means certain.

After 1 year you could sell off the stock fund as needed at long term capital gain rates to make up the shortfall in interest and dividend income.

Thus $600,000 in TSM would yield about $8.2k per year in dividends and $1,400,000 in tax exempt bonds would yield about $56,000 per year in interest.
You would need to sell off about $16k (2.7%) of the stock fund to make up the difference. This leaves
about 7.3% for growth in the stock fund, which may
or may not beat inflation.

These are all very rough ball-park numbers just for
discussion purposes.

The approach outlined above is designed to minimize
taxes as you requested. You probably could do better
overall by increasing the stock allocation to the 50-60%
range and pay more tax. Play around with FIREcalc
to check various options.

Cheers,

Charlie (aka Chuck-Lyn)

 

[johnblake]

I am assuming that you have a fairly long time frame-- 20 years or more. Do you live in a income tax-free state? If not, move

Here's where I'd start:
1. Read William Bernstein's "Four Pillars of Investing"

I'd target a portfolio similiar to this:

50% stocks
20% Vanguard Total Stock Market Index
15% Vanguard International Index
15% Vanguard Tax Managed Capital Appreciation

50% Bonds
20% Vanguard Intermediate municipal fund
(10% of this in Vanguards State Fund if you live in a high tax state.
20% Vanguard Short Term Corporate (ST Treasury if you pay state tax and the after tax yeild is better.)
5% I-Bonds
5% Good money market fund.

Getting in:
If all your money is in cash now, I'd find a good money market fund to park most of it. I'd put the 20% into the ST corportate fund, and dollar cost average into the portfolio above, making investments quarterly, over a 2 year period. You should try to keep your expenses below your $80,000 goal for the first few years.

Transactions:
- Re-invest dividends in the stock and muni funds.
- Since you'll dollar cost average in, you will have
- Rebalance annually, adjusting your %stock/%bond ratio according to gains and losses in the portfolio.
- Take the rest of the cash you need via selling when you rebalance.

If you want to simplify try:
60% Vanguard Conservative Growth Lifestyle
40% Vanguard Moderate Growth Lifestyle

I'd try to keep my spending to 60,000, at least for the first few years.

Use the FIRECalc, and run some simulations.

 

[unclemick]

A. Buy Vanguard Tax-Managed Balanced(VFMFX) with auto deduct to your checking/savings. B. Enjoy your your ER.

Anything more complicated is the male hormone thing. Basically, I could never do it myself - gotta putz with my hobby stocks and watch the markets. 70-80% in balanced index which I don't watch and don't rebalance.

 

[John Galt]

I stopped by Barnes and Noble today and accidently
spotted "The Four Pillars". I did not read it all
but did skim it. I agree it's pretty good. One thing that
stuck with me was the comment that financial advice
from periodicals was 99% worse than useless and
financial advice from TV (and I assume radio) was 100%
worse than useless. Even egomaniacs like myself enjoy
having their opinions validated

John Galt

 

[trumpeting_angel]

Well, John, with our comments you and I are, of course, preaching to the choir.  I realized that the advice I was struggling to follow in Money Magazine was useless a few years after I invested my daughter's college fund.

It was a small amount at that time, but I was looking around for where to invest, and they had an article about "Five Funds that Have Never Lost Money."  So I put my little girl's $$ into Monetta Fund.  And you'll never guess what happened to the fund!

I didn't track the other funds that were in that article.  But now, probably 12-14 years later, I know better.  No more financial magazine recommendations for me.

Anne

 

[trumpeting_angel]

AND -

My interlibrary loan copy of 4 Pillars arrived today. I had been planning to come to this board and BEG for support as I take all of my inheritance out of the accounts managed by my late sister's broker. He has been SO nice to me, and I am a sucker for anyone who was nice to me through this whole ordeal.

Fortunately, I may not need as much help. I opened Bernstein and, somewhere in the first few pages, he starts pointing out that brokers don't even have the fiduciary accountability to the client that lawyers and accountants do! The broker's interests do not coincide with mine! (And as my accountant pointed out, this is why he was so nice to me.)

It still stinks that he was a personal friend of my sister's. However, I don't know how much money he made from her. Although she wasn't an indexer, she was strictly buy-and-hold, and there were absolutely no churning fees to be gotten from her.

Now that I'm rambling. . . I think I'll go back and see if I can get past the first few pages of Bernstein. Did everybody know he's a physician??

Anne

 

[John Galt]

Hi Anne! In reading Bernstein, I thought some of his
numbers looked "doctored".

John Galt

 

[db]

Anne,

I had read that Bernstein is a physician, and that made me a bit sceptical when I read his "The Intelligent Asset Allocator." But I also rely on Malkiel's "A Random Walk Down Wall Sreet," Gibson's "Asset Allocation," and Bogel's "Common Sense on Mutual Funds," and you get a rather consistent point of view. And, of course, you need to always apply your own judgment about what's comfortable for you.

(I haven't figure out how to make italics apply, so I used quotes.)

db

 

[unclemick]

Bernstein is a neurologist.

What most people fail to grasp most of the time is power of doing absolutely nothing. The greatest fallacy of investment 'community' is the gross inability (per Bogle) to: 'do nothing just stand there'.

All the rest - books, commentary, rebalancing slice and dice portfolios, etc., etc. is for most people a 'good therapy for nerves'.
If not overdone by too much trading or overly skewed diversification - not too much harm is done.

Owning something in hand grenade distance of all stocks and bonds in the US in roughly portion they exist with auto rebalancing and doing nothing funds my ER.

Of course - hobby stocks are more fun than neurologists. And all that MPT stuff is fun to read.

 

[wabmester]

I read somewhere that Bernstein took a vacation, read the most recent academic research on investing (i.e., MPT), and then wrote a book about what he read. A useful service, to be sure, but I felt he didn't really take a critical view towards the research.

What I find especially interesting is that both he and Swedroe admit that they don't necessarily follow their own advice. Swedroe's mostly in municipal bonds, and I believe Bernstein talks about his stock-picking "hobby" somewhere on his website.

Caveat Emptor, I guess.

 

[Cut-Throat]

Wab,

I think you should read his book. Even a smart guy like yourself is bound to get something usefull out of it.

 

[unclemick]

The urge to putz will never die. That and the inertia of the stuff you bought along the way while figuring out your 'current' advice.
We 'could' switch from Lifestrategy to Balanced index to achieve 'better theoretical purity' but probably won't.

 

[wabmester]

C-T, I read Pillars last year. I enjoyed the market history, but I frankly didn't find a lot of useful investing insight.

I basically got two take-home messages, both of which are academic cliches:

1) Capital markets are efficient, so don't try to beat them.

2) The only free lunch is reduction of volatility (i.e., risk) via asset allocation.

Did I miss any important points?

 

[Cut-Throat]

Wab,

Well I got a lot more than that from the book.

Let me ask you a question. What do you think your overall rate of return has been on your portfolio over the last 25 years?

Myself, I admit to having screwed myself by trading too much, listening to 'financial advice', worrying about my investments etc. etc. etc. In spite of this I have averaged over 13% over the last 25 years.

If I would have taken Bernstein's Advice, I would have probably averaged over 15% and not have had to fret as much.

I admit to being my own worst enemy and that my financial moves have been hazerdous to my portfolio.

 

[wabmester]

What do you think your overall rate of return has been on your portfolio over the last 25 years?

That's not a fair question! I gave up on Quicken years ago, so I really have no idea. And I've only been investing for about 20 years (I'm relatively young as retirees go).

However, a quick back-of-the-website calculation tells me that my after-tax annual return over the last 20 years is around 20%. I'm working backwards from my current net worth and guessing what my annual investments were, so I could be off by a few points.

That 20% is comprised of mediocre stock returns, pretty good real estate returns, and one "superstock" (the sale of a small company I started) that made all of the difference.

Of course, Bernstein's advice looks good in retrospect. A lot of things look good in retrospect (I only recently stopped kicking myself for turning down a gig at MSFT in 1987).

If you believe Bernstein, then his prediction for the future is lower returns and continued volatility. To me, that seems like a good reason to look for alternative investments to the stock market. That's partly why these days I'm mostly in waterfront real estate and not so much in stock.

BTW, your 13% annualized return is not bad at all.

 

[ESRBob]

If a person had $2,000,000 and wanted to recieve $80,000 per year return with as little tax as possible. What would you recommend.

John,
I guess the advice here, done much better by Chuck-Lyn and John Blake, is that there are lots of ways to 'not pay taxes', and it isn't always simple like buying munis (which won't keep up with inflation). If you just look at the old 1040 form, you'll see you get some real goodies if you can arrange to have yourself taxed like the "working poor". For instance, 10% income tax rate, going up to 15% income tax rate ( your interest from any taxable fixed income on 2 million would go in that slot.) Your dividends and capital gains can be taxed at 5% if you are paying income tax at these percent levels -- that is a real bargain. You can sell appreciated securities, paying capgains tax only on the part that has appreciated, at 5%. Then you've left all the other appreciated securities in your portfolio, not sold them, and deferred taxes on those gains indefinitely.

This is how you can have huge gains in the portfolio, more than enough to offer you a SWR and keep up with inflation, and pay really low taxes.

We haven't even talked about the fact that you have deductions like personal exemptions, Schedule A and S-Corp expenses (I assume you have an S-corp or LLC to manage some little something on the side that might make some money for you and offer you lots of things you can deduct, show losses on for a long time, too, and which are legitimate business expenses -- like the cost of your computer and web connectivity, your phones and meals out with potential clients, plus investing newspapers and so forth?)

So by the time you put up that wall of deductions, to say nothing for any old losses you've accumulated over the last 5 years, it could be a long time before you are paying taxes at anything more than a tiny proportion of your portfolio.

I have calculated that a 2 million dollar portfolio, 10% of it in IRAs, invested a-la Bernstein's Gap Portfolio, could end up with taxes for a normal guy with normal deductions at something like 0.3% of the portfolio value each year, without any munibonds whatsoever. Lots of assumptions in this, but do the numbers for your own situation and you might be shocked. That is not 3% and it is not 30% of the portfolio, but 0.3% or about 5 or 6 k per year max. Most of that is from the state tax, too, where there are fewer goodies and places to hide.

It is an eye opener. I haven't paid more than $1000 of federal tax on a bigger portfolio than that for the past 3 years now, with 50% bonds in the portfolio, almost all taxable. (I have loss carryforwards due to stupid things i did in the late 90s which helps that somewhat

So with taxes that low, you can look beyond those darned munibonds, with their low interest rates and their no-hoper record keeping you up with inflation. Hope this helps,
Bob

 

[charlie]

Bernstein brought home to me the fact that you
need to consider ALL of your financial assets as
one portfolio.

Also, to add to Wabmester's summary, the only
other free lunches of index investing are lower
cost, elimination of manager risk and elimination
of style drift.

Bernstein is a "splitter" rather than a "lumpier"
(a la unclemick). I have decided that being a
"lumper" is probably best for the great majority
of people in the accumulation phase primarily due
to the automatic re-balancing.

However, in the distribution phase, being a "splitter"
is probably the best way to minimize the "reverse"
dollar cost averaging effect. However, only those
who can handle re-balancing your stock allocation to
a fixed dollar amount plus inflation each year should
consider this strategy.

I ramble and grow weary. ZZZZZZZZzzzz

Charlie

 

[wabmester]

I have calculated that a 2 million dollar portfolio, 10% of it in IRAs, invested a-la Bernstein's Gap Portfolio, could end up with taxes for a normal guy with normal deductions at something like 0.3% of the portfolio value each year, without any munibonds whatsoever.

Bob, could you walk me through this (without cap loss carry-forwards)?

If I want income of $80K, are you saying to keep the interest income below $14K (taxed at 10%) and the rest of the income as cap gains (taxed at 5%)? That seems hard to do with a reasonable asset allocation.

BTW, you don't need an S-Corp or LLC to take business deductions -- all you need is a legitimate business.

 

[wabmester]

Bernstein is a "splitter" rather than a "lumper"

Somebody over at M* put forth a pretty good argument against slice + dice.   Basically, the fundamental assumption of this MPT stuff is the Efficient Market Hypothesis.   If you believe that the market is efficient, then it follows that you should have a stock allocation that mirrors the global market's cap weighting.

Basically, this means 50% TSM + 50% total international.  Anything else is an attempt to "beat the market," which we all know is a Bad Thing.

 

[unclemick]

Amen, amen,amen

Low investment expense, infrequent turnover/trading, 'reasonable' diversification and a disciplined plan/methodology that fits 'you' emotion and sleep wise will probably work. Whether Ben Graham, Bogle, Bernstein, Phil Fisher, Swedroe or whomevever.

 

[db]

Basically, this means 50% TSM + 50% total international.  Anything else is an attempt to "beat the market," which we all know is a Bad Thing.  

Really? I've been using 2/3 TSM 1/3 TIS for my 60% equity allocation.

db

 

[wabmester]

According to one reference, the US stock market represented 48% of the world's total stock market capitalization in 2002.

So, you might be underweighted in international if you believe that the world is smart enough to correctly allocate capital.

Keep in mind however, this is the same world that brought you the Yugo, Tamogachis, Michael Jackson, and France. How smart can it be?