I received a long email recently about taxable investing accounts which basically boiled down to this question:
Q.
We max out all available tax-protected accounts including 401(k), 457, Backdoor Roth(s) and a 529 for our child. We also invest about $4K a month in taxable. In order to keep things simple, we have chosen four very tax-efficient mutual funds and invest $500 in each of them every two weeks.
However, I'm just now realizing, as I recently wanted to tax-loss harvest, that I have a ton of different tax lots to keep track of and that tax-loss harvesting is going to require me to own even more funds, with even more tax lots. Any advice for a guy who wants to keep things as simple as possible?
A.
It is easy to see the dilemma. You want to have tax-efficient investing. You want to manage your own investments. You want to keep things as simple as possible, including your tax return. But you also don't want to leave free money on the table and everyone says you should be tax-loss harvesting. There is unlikely to be any perfect solution, but there are a couple of options and certainly some general principles to keep in mind.Option # 1 Hire someone else to manage your taxable account
Some roboadvisors, such as Betterment, have shown they can do a great job managing a taxable account in a very tax-efficient way, and perhaps even get more tax losses than you can get on your own. There is a cost, of course, at 0.15-0.30% of AUM.
There is some argument as to whether their ability to tax-loss harvest can actually make up that cost. But there is no doubt if you highly value removing this hassle from your plate that 15 basis points is a very low price to pay to do that.
You could also hire a regular, full-service advisor. Managing your own investments can be a very profitable hobby, but if it's not a hobby you're interested in, you won't be tax-loss harvesting like you should.
Option # 2 Do it yourself but balance investing simplicity with tax simplicity
You're actually doing pretty great and already following some good principles. However, there are a number of principles of simplification you are NOT following, which you could apply relatively easily to your taxable investing account.
12 Principles for Simplifying Your Taxable Investing Account
Principle # 1 Max out tax-protected accounts
Whether you choose tax-free (Roth) or tax-deferred (most retirement accounts,) both are almost always better than taxable in the long run, from an investing return standpoint, a tax standpoint, an asset protection standpoint, and a simplicity standpoint. Far too many doctors are investing in taxable simply because they don't know about all the accounts available to them, such as individual 401(k)s, defined benefit/cash balance plans, backdoor Roth IRAs, and stealth IRAs (Health Savings Accounts.)
Principle # 2 Follow a regular savings and investing plan
You have a written asset allocation, are saving an adequate amount, and are following your plan. In the long run, that matters far more than a few bucks in taxes and how much hassle your account requires.Principle # 3 Use tax-efficient funds in the taxable account
Although there is significant debate about asset location, whether you choose to hold bonds, stocks, or both in taxable, it is best to choose very tax-efficient funds there. That means broadly diversified stock index funds and muni bond funds. While individual bonds are also tax-efficient and reasonable to use, they certainly introduce additional hassle and are expensive to tax-loss harvest.
Principle # 4 Simplify holdings at every opportunity possible
As you go through the years, there are often ways to simplify and consolidate your various tax lots. Take advantage as you go along. Tax-loss harvesting is one of the best ways to do this.
For example, imagine if you have 8 lots of shares of an index fund, and in a bear market, the price of that fund falls below the price of the lowest tax lot. Just sell all 8 of them, and consolidate them into one tax lot as you tax loss harvest. If you have mistakenly bought investments you really don't want for the long term, and you have a taxable loss in them, here's your chance! You may wish to do this even if your shares have small gains, just for the sake of simplicity.
One simplifying idea that is probably NOT worth doing is waiting 30 days to reinvest. I think it is better to find a tax-loss “partner” and buy it at the same time you sell the shares with the loss. That way if the market takes off on you in the next month, as it often does, you're not selling low and buying high.
Principle # 5 Donate appreciated shares
One of the best ways to simplify things, if you give regularly to charity anyway, is to simply donate appreciated shares to the charity instead of cash. Not only do you get the itemized deduction, but neither you nor the charity has to pay the capital gains taxes.
You can then turn around and use the cash you would have donated to buy those shares back immediately with a higher tax basis. You get to flush those taxable gains right out of your portfolio. Plus, it gives you another opportunity to simplify holdings. By giving some tax lots (or investments you didn't want to hold for the long run) away, you have fewer tax lots.
Principle # 6 Save regularly but invest less frequently
Just because you pull money out of your pay every two weeks to invest, doesn't mean you have to buy funds with it. You can just stick the money into a high-yield savings account and invest once a month, or even once a quarter. If you're buying 4 times a year instead of 24 times a year, you're going to have a lot fewer tax lots.
Principle # 7 Buy one investment at a time
Along those same lines, if you have $2000 to invest (or maybe $12,000 if you decide to do it once a quarter), you can just put that entire $12,000 into the same fund instead of into all four funds. Sure, your asset allocation will be a little off, but that doesn't matter much, especially as the years go by and new contributions become tiny compared to the size of your portfolio.
Each quarter just choose the holding whose asset allocation is the lowest compared to the target allocation, and lump sum the whole contribution into that fund. There will be fewer opportunities to tax loss harvest, but you won't have to watch hundreds of tax lots over the years. You may also save commissions depending on your brokerage and investments.
Principle # 8 Hold bonds in taxable
Wherever you fall in the bonds vs stocks in taxable debate, there is no doubt that you can worry a lot less about tax-loss harvesting if you just hold muni bond funds in taxable. Consider the Vanguard Intermediate tax-exempt fund. The current price is $14.43. Over the last fifteen years, the price has basically stayed between $13 and $14.50 (except for one very brief excursion down to $12.11 in the 2008 bear market.) So basically, you only had a significant opportunity to tax loss harvest one time in 15 years, and that was only an 8% drop. That's not so bad.
Equity funds, on the other hand, are far more volatile. You get 8% drops a couple of times a year for most years. Again, you're balancing a desire for simplicity with maximizing the benefits of investing in a taxable account where Uncle Sam will share in your losses. All bonds in taxable give you maximum simplicity. All stocks in taxable give you maximum opportunities for tax-loss harvesting.
Principle # 9 Don't tax loss harvest tiny losses
As a general rule, unless you're exchanging from a less-preferred fund to a more-preferred fund, wait until you have a significant loss to tax loss harvest — as defined by dollar amount, not a percentage amount. There are costs to buying and selling, even if you're not paying commissions.
ETFs are particularly handy for tax-loss harvesting (since you can capture intra-day losses). When you buy and sell ETFs there are bid-ask spreads you eat every time you make a transaction. While a fund doesn't see that, there may be other fees associated with the transaction.
If you have a bunch of $500 lots, you're not going to want to harvest 8% drops, much less 4% drops. But on a $15K lot, a 4% drop is $600, and probably $300 off this year's tax bill. That's worthwhile to me. And a 10% drop on a $40K lot? That a $4000 loss and $2000 off my taxes. That's definitely worth a bid-ask spread.
Principle # 10 Use ETFs, especially if commission-free
As mentioned above, you can capture intra-day losses with ETFs. It's more of a pain to have to put in the buy and sell orders manually, but probably worth it in the long run. If the asset class you're interested in has a good ETF, might as well use it. ETFs, by virtue of their structure, can be slightly more tax-efficient than even a highly-tax efficient index fund, although the Vanguard funds with ETF share classes get that free ride too.
I prefer traditional mutual funds in tax-protected accounts, but I like ETFs in taxable. On a related note, use only high volume ETFs with tiny bid-ask spreads. I've seen spreads as high as 2%. That's not something you want in taxable when you can get ETFs with spreads of 1 or 2 basis points.
Principle # 11 Don't reinvest dividends in taxable
Want to create a big tax pain? Reinvest your dividends in taxable. Now every quarter every holding you have has another tiny little tax lot. Better to just direct them all into your sweep account and throw them into your next big transaction. Yes, it will be time out of the market for those dollars, but I think it's worth it to save the hassle. That's just one more way in which taxable investing is inferior to tax-protected investing.
Principle # 12 Remember tax loss harvesting is done in the beginning
After you have held a fund for a year or two, chances are good it is NEVER going back below the price you bought it at. So typically, you're only tax loss harvesting tax lots you bought in the last year. Maybe in a big bear market you might sell something you bought three or four years ago. But if you're not flushing out gains with charitable donations, you will likely end up with tax lots you bought a decade or three ago. Eventually, you are just spending distributions and holding on until your heirs get the step-up in basis at death. If you need to sell shares, you'll be selling shares purchased more recently anyway. So the point is, even if you have dozens or hundreds of tax lots, you don't have to watch them all.
Applying these principles should allow you to tax loss harvest while still being able to keep your portfolio as simple as possible. The main principle is that if you don't want to manage a large number of tax lots, don't buy a large number of tax lots and consolidate the ones you have at every opportunity either through tax-loss harvesting or donation of shares to charity.
What do you think? How do you manage your taxable account? ETFs or traditional mutual funds in taxable? How much do you let your asset allocation drift from month to month in order to avoid tax hassle? Comment below!
Posts like this are exactly why I keep coming back to this blog for more and more. Practical, efficient, and clearly communicated. Well done, as always, WCI.
I believe TLH is the best cure for loss aversion. It feels really good to share my losses with the taxman.
The best use of capital losses is the $3000 offset against regular income.
Booked capital losses could keep you in a lower tax bracket.
I have multiple funds at Vanguard and have no problem moving small amounts between my tax loss fund “pairs.” I pay no fees so the transaction is frictionless.
Check for losses when the Market drops.
The boglehead: “livesoft” is the master of TLH.
I want to make a comment regarding tax lots.
Who cares if you have 3 tax lots or 300. When I do my taxes, TurboTax logs into my account, pulls in all the trades, and I am done. Takes about 10 seconds to do, and another minute or 2 to go over. Although minimizing tax lots was good advice 10-15 years ago, todays technology has made it completely unnecessary.
Therefor by as many lots as you like. I add funds to my taxable account every month and distribute it to get as close as possible to my asset allocation. But then again, I enjoy playing with my asset allocation spreadsheet.
Yes, I also love that feature in Turbotax. You’re right that it isn’t as big a deal if it’s done automatically. Still some additional complexity though.
For the man with the question, principle #7 is pertinent advice. Rather than buying 4 funds two times every month, make one lump sum purchase. Rotate which fund you purchase if you must to keep your asset allocation in balance. That’s what I do.
Four funds might be more than is necessary. I only buy into two in my taxable account (Total Stock Market and Total International), and I own some older shares of S&P 500 which is my TLH partner for Total Stock Market. If you like muni bonds in taxable, that could be another class to own here.
Best,
-PoF
WCI, could you please expand on not reinvesting dividends in taxable? I always thought that Bogleahead way to automatically reinvest?
Reinvest, yes. Automatically reinvest, no.
If you set each fund to automatically reinvest dividends & capital gains, you can inadvertently create a wash sale if you engaged in TLH within the last month, or want to do so within the next month.
I set my funds to direct dividends to a Vanguard Money Market Fund. I then manually reinvest to the mutual fund of my choice.
Exactly. As POF said above, you do reinvest, just in a different way than you might in your Roth IRA. I have it done automatically in my Roth IRA. But in my taxable account, the dividends all go into the sweep account. They aren’t spent. They’re reinvested. But they’re reinvested in a tax-efficient and simple way.
Thanks for the informative article. If one does not practice TLH, is there any reason to avoid automatic dividend reinvestment in taxable? I realize it’s more complex but the tax lots are dealt with automatically.
Do you ever plan to sell the shares or die with them?
I plan on selling at some point. I thought the tax issues were taken care of on the 1099 and by tax software.
I think it’s worth not reinvesting the dividends automatically to reduce complexity, especially with regards to TLHing. Fewer lots to track.
When I TLH and have a bunch of lots, I just click one at a time for the ones that gave a negative symbol, and then convert them to their analogous fund.
The complexity is insignificant.
I prefer not to auto reinvest dividends because I need that cash to kinda rebalance through monthly contributions.
I have always been confused with the relationship between funds in tax-advantaged accounts vs taxable accounts, with respect to TLH. For instance, if I TLH my “total stock market” fund in my taxable account, and my total stock market fund in my Roth happens to do an automatic dividend reinvestment during the wash sale window, does this disqualify my TLH? If so, how do you guys get around this?
Technically it probably does, but the likelihood of the IRS noticing is probably awfully close to zero. I don’t think they put much effort, if any at all, into enforcing TLHing rules. It is a very tiny percentage of investors who actually worry about this stuff.
I just try to be careful. Remember you only tax loss harvest in corrections and bear markets for the most part, so it’s not like you have to be watching this stuff every day.
still a firm believer of buy, hold, and rebalance yearly
with my individual muni bonds one can tlh but you are paying 1-2% out and 1-2% in
KEEP IT SIMPLE and invest immediately-no reason to leave money in a MM paying zero
Paying $8 to reinvest a $30 dividend immediately instead of waiting until your next paycheck (or whenever you invest next) is not only expensive, but also introduces unnecessary complexity. That’s the point of the post.
I’m not sure where I fall on the TLH issue. I see the points made here which are good ones. I also see points to the contrary which seem good.
What are your feelings on this stance by Evanson on TLH?:
http://www.evansonasset.com/?Page=56
I’m with Evanson here. When you look at the details, it’s hardly worth the hassle, unless you really enjoy the process of doing it.
I also disagree, but each person will be different. As I donate shares, I never have to pay taxes on the difference and get to enjoy the deduction. Also, since I don’t have any transaction costs, it’s even better.
As hard as doctors look for a small deduction, this one is an easy 3K every year, not insignificant.
Disagree with Evanson asset for several reasons:
1) One can plan to tax gain harvest in early retirement.
2) Many may pass on part of their taxable account to heirs or die with a taxable account and their heirs will receive the step-up basis. This possible can not just be discounted.
3) Saving 39.6% plus state tax off ordinary income now still beats paying cap gains tax later. Can’t beat a negative interest loan.
4) Faulty assumption that cap gains rate will be higher in future. Who knows but I’d bet lower and possible also a larger standard deduction. Tax reform by both parties tends to help the “poor” which also benefits low income early retirees looking to tax gain harvest.
I disagree also. In my view, it’s worth it JUST for the $3K deduction every year. That’s something like $1400 off my taxes. I also get to offset any capital gains taxes from gains thrown off by my funds during the year. That could be a few thousand more. Then, assuming I don’t EVER pay those taxes back from charitable giving/step-up in basis at death, I still get the use of that money for decades, an additional arbitrage to subtract regular taxes and pay capital gains taxes, and potentially an arbitrage between LTCG rates now and later. Is it tens of thousands a year? Probably not. But it’s worth it to me for a couple thousand bucks a year or so.
Great post. Answers a lot of practical questions. TLH and wash sale rule are new to me. Have 2 questions, may sound silly to the pros:
1. If i sell vanguard total stock market index fund (VTSAX) today and buy vanguard small cap value index (VISVX) within 30 days of selling, does that constitute wash-sale because VTSAX has some small cap stocks too? Does the answer change if it is in a tax protected vs a taxable account.
2. If i want to avoid washsale violation in my tax-protected account due to selling and buying similar funds in taxable account, would you recommend not reinvesting dividends automatically in the tax protected accounts too?
1. Keep in mind that the IRS has not spelled all this stuff out in the detail you’re looking for, but most authorities would not consider that a wash sale.
2. No. # 1 because nobody is looking that closely and # 2 because I love the concept of reinvesting dividends automatically as long as it doesn’t create a tax mess. As a general rule, tax loss harvesting is something done fairly rarely. So if you hold the same stuff in taxable as in a tax protected account, I guess you could turn off automatic reinvestment of dividends that month.
I treat my taxable and tax protected accounts as one large portfolio. When I rebalance, I decide what to do as if it’s one big account. My actual trades occur in a way which incurs no taxes (for example, I never sell anything in the taxable account unless it’s for a loss.)
So, to facilitate rebalancing, I never automatically reinvest dividends. Instead, I use cash balances to buy whatever my rebalance spreadsheet says I’m under allocated on. When I do tax loss harvest, I make sure not to rebuy the exact same ETF in any of the accounts with 30 days (prior or after.) for every ETF I’ve selected, I have an alternative that’s similar (but not exactly the same.)
Does the argument for simplicity in your taxable account suggest that the benefit from Dollar-Cost-Averaging isn’t worth the extra hassle of the increasing number of tax lots to manage?
Yes. Besides, DCAing (actually periodic investing, not DCAing since you never had a lump sum) once a quarter or once a year is still DCAing. Nobody says you have to do it once a week to get the benefits.
What are your thoughts on an all in one in taxable. Two years from retirement at 55 and just got hit with a large inheritance so deciding what to buy. Want it really simple and don’t care about tax loss harvesting. Considering buying vanguard lifestrategy mod growth (60/40). Only income in early retirement will be dividends and cap gains from this fund so I think I’m correct in saying tax efficiency is less of a concern?
If “really simple” is your goal, then yes, that would work fine. That’s Mike Piper’s only investment. You can do much, much worse than Life Strategy Moderate Growth. There are a few issues with it:
1) The tax efficiency issue you noted
2) No admiral shares, so higher expenses
3) No tilts, if you believe in that sort of thing.
4) Perhaps rebalanced more frequently than is optimal
Do you know what fees the charity pays to receive donated shares? The organization I want to donate to has a UBS account and was told there would be a transaction fee was based on “stock market volatility and several other factors” but would agree to charge 1% of the donation amount instead. Is this typical?
That’s news to me, but I’ll be honest that I don’t know what a charity would pay for that service, if anything.
Can you elaborate on this part from the post about ETFs?
“ETFs, by virtue of their structure, can be slightly more tax-efficient than even a highly-tax efficient index fund, although the Vanguard funds with ETF share classes get that free ride too.”
I am about to open my first taxable account and want to hold Vanguard Total Stock Market and Vanguard Total International Stock Market. Both funds have an ETF. The post suggests choosing ETFs over mutual funds in a taxable but are you suggesting that is not necessary with Vanguard? Why or why not?
This was a VERY helpful post for me as I venture into the taxable world for the first time. Thanks!
No. It is not necessary as both share classes are extremely tax efficient investments and those who hold the mutual fund shares benefit from the additional tax efficiency created by the ETF shares.
I am just beginning to build a portfolio and one question I have is what is the difference, advantages, and disadvantages of index funds, ETFs, mutual funds, and no load mutual funds? Which one is preferred for someone like me just starting to invest?
Thanks for all the helpful articles. I have read almost every post on WCI and it has changed my life!
Most index funds are no load mutual funds.
No sense in using a load fund.
If you’re going to buy mutual funds, you probably ought to use index funds.
ETFs are just another form of a mutual fund.
https://www.whitecoatinvestor.com/vanguard-etfs-vs-mutual-funds-friday-qa-series/
My husband and I are both in the final year of our MD/PhD program, and have started a taxable savings account since we are have not been eligible to open tax-protected accounts without a W2. This year, we’ve gotten small side hustles and can open Roth IRAs and Roth 403(b)s. Would it be worth paying taxes on selling what’s currently in the taxable savings account to open and fund new Roth IRAs and Roth 403(b)s at this point, or should we just keep the taxable savings account as-is and open and fund Roth IRAs and Roth 403(b)s when we begin residency and our salaries ~double in a year?
A side hustle shouldn’t make you eligible for a 403(b). You need to be an employee of an employer offering one.
But yes, in general it is worth it to move assets from a taxable account to a tax-protected/asset protected account, especially when you’re not in your peak earnings years yet. Is there even a tax cost to selling those appreciated assets? You might be in the 0% LTCG bracket.
I’m a 2nd year attending about to open my first taxable account. I visited Boglehead’s and got some great advice toward simplifying the mess I created in residency. The last dilemma is where to open my taxable account and I’ve settled on either Vanguard with their mutual funds (for ease of use and widespread familiarity) or Merrill Edge with Vanguard ETFs (mainly for the Platinum Honors benefits).
Information seems to vary between “there really is no difference between ETFs and mutual funds (oversimplifying – I know ETF is traded like a stock whereas mutual funds have a set price)” to “ETFs are more of a hassle and time intensive.” If I plan on contributing twice a year to my taxable account and turn off automatic reinvesting, what would be the time intensive hassle I would face with ETFs? I apologize if it’s a redundant question!
It wouldn’t be a big deal if you prefer the ETFs. It’s really dealer’s choice and it sounds to me like you’d like to try the ETFs so I say go for it. I’ve done both and (very) slightly prefer traditional mutual funds when given the choice.
When selling stock lots, don’t forget to check if they’re long term or short term. If you need to sell and take a tax gain (maybe you are withdrawing money) you typically want to sell long term lots. However, you’d should understand your tax rate because if you have a small short term gain then that might have less absolute taxes than a very long long term gain.
If you have some short term losses in taxable accounts , make sure to take those losses before they become long term (assuming the tax benefit exceeds trading commissions.)
Check your brokers account options for how tax lots are chosen when selling a security that has many lots. Some broker’s options are very simplistic (high or low price) but others (I.e. Fidelity) have more sophisticated features which will favor larger long term losses over small short term losses because your end up better in taxes.
Depending on broker, you may be able to select exactly which lots to sell at time of trade OR correct them after the fact (up to 3 days post trade)
Long term losses are plenty useful. I wouldn’t feel like you necessarily want to sell only short term ones. But honestly, you should tax loss harvest most losses and most of the time they’ll be short term.
Hi Jim and all,
After maximizing my 403b, 457, Roth, 529, I’ve decided to open a taxable account.
Wondering if this allocation makes sense (in regard to turnover (range here is 0-24%), fees (range is .04-.17 ER), and anything else I may have missed to be thinking about.
30% VTSAX Vanguard Total Stock Market Index Fund Admiral Shares
20% VEXAX Extended Market Index Admiral Shares
20% VSGAX Small-Cap Growth Index Admiral Shares
10% VTMGX Developed Markets Index Admiral Shares
10% VEMAX Vanguard Select Funds Emerging Markets Stock Index Admiral Shares
10% VNYTX NY Muni Bond
Thanks!
Why the SCG tilt? That has classically been a corner of the market that has been tilted away from, not toward, especially with such a large tilt.
Good point. Uncertain. I could bring it down to 10% and add more to total stock. Otherwise seems like a good blend?
Larry Swedroe considers small growth the black hole of investing. You should read his arguments about it before deciding to tilt toward it at all.
OP seems to have index funds in taxable account. Would you suggest something similar (sans small cap) for tax efficiency?
Index funds, especially total market index funds, are very tax-efficient and thus make for good taxable account holdings. But what you put in your account depends on your available space and desired asset allocation.
What is your thought on using mutual fund only if you have taxable in Vanguard?
I see advantages in using mutual fund over ETF if you plan on keeping everything at Vanguard.
1) You already get the tax advantage based on Vanguard’s unique MF structuring.
2) You can immediately switch MF to TLH partner by switching funds, whereas if you use ETF, you have to sell ETF first, wait 2-3 days until settlement fund comes in, then buy ETF’s TLH partner. I think there is high change of market changes in those 2-3 day wait-time until settlement fund settles, unlikelMF you can swap immediately without any lag time.
You don’t have to wait 2-3 days for money to settle before using it to buy another ETF. Stop doing that
But it is nice that there is no bid ask when your two funds swap at 4 pm. I kind of like that.