About a year ago I published a post about my mortgage payoff scheme. I’ve had a number of readers ask for updates about how it is going throughout the year.  This post is that update.

The Scheme

Set for life insurance ad

I have a common dilemma among financially adept high-income professionals- I have a large amount of low-interest debt. Specifically, I have a 15 year fixed mortgage at 2.75%, where the effective after-tax interest rate is around 1.5%, or less than the rate of inflation. I’d like to be debt-free, both for psychological reasons as well as to reduce my required monthly outlay, but I can also do math, and expect much higher long-term returns out of my portfolio than 1.5%. So as a compromise, I am saving up an amount equal to the mortgage in a taxable account, at which point I may or may not pay off the mortgage, but will consider myself debt-free. I use the taxable account to tax-loss harvest and flush any capital gains out of the account by using highly appreciated shares for my annual charitable giving, adding a little boost to the returns in the account. Since my mortgage payment is very affordable (now down to something like 5% of monthly income) and because I have proved to myself that I can handle substantial short-term (shallow) equity risk, I invest in this account very aggressively-100% equity with a number of risky funds. It’s a little bit of play money that way, as it does not conform to my retirement asset allocation which I maintain fairly strictly.

The Update

So what have we done so far this year to reach this goal? Well, we finally sold our rental property, as discussed here, so that $91K debt was wiped out and the equity we got from the sale was moved into the side account.  In addition, we have made all the required monthly mortgage payments. So the mortgage amount on our home has dropped from $311,739 to $290,712. The loan was originally $391K in late 2010, then refinanced a couple of times, most recently in mid 2012 when the balance was $360K.

I spent the first half of the year funding tax-advantaged accounts, including two 401(k)s, a defined benefit/cash balance plan, two backdoor Roth IRAs, an HSA, and 529s (up to the amount on which we get a state tax credit.) However, by the second half of the year, especially with WCI doing so well financially thanks to my awesome business manager, I had some extra to invest in addition to the proceeds of the sale. Here’s what I’ve invested so far:

Cruising Heaps Canyon

Cruising Heaps Canyon

In September, I added $70,000 to the account and bought:

  • Vanguard Total Stock Market ETF: $19,976.22
  • Vanguard Total International Stock Market ETF: $19,980.50
  • Vanguard Emerging Markets ETF: $9991.08
  • Vanguard Energy ETF: $9956.80
  • Vanguard Health Care ETF: $10,060.05

In October, I added $20,000 to the account and bought:

  • Vanguard Precious Metals and Mining Fund: $20,679.08

In November, I added $40,000 to the account (some from the sale of the house) and sold:

  • Vanguard Precious Metals and Mining Fund: – 17,686.41

and bought:

  • USAA Precious Metals and Minerals Fund: 20,000.00
  • Vanguard Emerging Markets ETF: $19,983.22
  • Vanguard Total International Stock Market Index ETF: $17,701.88

Things were going pretty well up until that point, but that was all prior to the correction really getting going. I have not added any money to that account since November (because I preferred to make 2016 Roth IRA, HSA, and 529 contributions) but I have had lots and lots of opportunities to tax loss harvest.

Tax Loss Harvesting

My first TLH transaction occurred on November 6th.

  • I sold the Vanguard Precious Metals Fund and purchased the USAA Precious Metals Fund.

On December 10th.

  • I sold the Vanguard EM ETF and bought the IShares EM ETF.

On December 14th,

  • I sold the Vanguard Energy ETF and bought the SPDR Energy ETF.
  • I sold the Vanguard Total International ETF and bought the Vanguard FTSE All World Ex US ETF.
  • I sold the IShares EM ETF and bought the IShare Core EM ETF.

On January 8th,

  • I sold the Vanguard Total Stock Market ETF and bought the Vanguard Large Cap ETF.
  • I sold the Vanguard FTSE All World Ex US ETF and bought the Vanguard Developed Markets ETF.
  • I sold the IShares Core EM ETF and bought the Schwab EM ETF.

On January 13th,

  • I sold the Vanguard Precious Metals Fund

On January 14th,

  • I bought the USAA Precious Metals Fund

I had to wait a day for that due to some goofy Vanguard rules. It worked out well for me as I ended up selling relatively high and buying relatively low.

On January 15th,

  • I sold the Schwab EM ETF and bought the Vanguard EM ETF (4 step round trip complete.)
  • I sold the Vanguard Large Cap ETF and bought the Vanguard Total Stock Market ETF (2 step round trip complete.)
  • I sold the Vanguard Developed Markets ETF and bought the Vanguard Total International Stock Market ETF (3 step round trip complete.)
  • I sold the Vanguard Health Care ETF and bought the SPDR Health Care ETF.
  • I sold the SPDR Energy ETF and bought the Vanguard Energy ETF (2 step round trip complete.)

On January 19th,

  • I sold the Vanguard Total Stock Market ETF and bought the Vanguard 500 Index ETF.

The side account currently looks like this:

  • Vanguard Precious Metals Fund $25,094
  • Vanguard Energy ETF $8,456
  • Vanguard EM ETF $26,904
  • Vanguard 500 Index $18,654
  • Vanguard Total International ETF $32,918
  • SPDR Health Care ETF $8,947
  • Total $121,118

Tax Loss Harvesting Screw-ups

The careful observer will note three screw-ups I made during that flurry of tax-loss harvesting. The first two earned me a “naughty boy” call from Vanguard and the third one was a wash sale.

# 1 On December 14th I sold the Ishares EM ETF and bought the IShares Core EM ETF before the funds from the purchase of the IShares EM ETF on December 10th had settled.

# 2 On January 15th, I bought the Vanguard Total Stock Market ETF fund. Unfortunately, that was only 7 days after I sold it, not the requisite 30 days to prevent a wash sale. Not to mention I had bought it inside my HSA on January 7th, although it seems terribly unlikely that anyone but me will ever notice that. The following transaction (selling TSM and buying 500 Index ETF) was to recapture that loss. Unfortunately, that led to mistake # 3 and my phone call from Vanguard.

# 3 On January 19th, I sold the Vanguard Total Stock Market ETF and bought the Vanguard 500 Index ETF before the funds from the purchase of the Vanguard Total Stock Market ETF on January 15th had settled.

Mistake # 2 was just a dumb mistake that came from being in too much of a hurry that day. That was also my first time putting in trades using the Vanguard phone app during a break in a meeting. Mistakes # 1 and # 3 came as a result of this being my first time TLHing with ETFs. The last time I had to do this was in 2008 and I was using mutual funds, which was a little less complicated. At any rate, Vanguard’s settlement policy is that equity trades (like ETFs) require three business days to settle. So in December, trade date # 1 was December 10th. The 11th was day 1, the 12th and 13th were weekend days, the 14th was day 2 (trade date # 2,) and the settlement day for trade date # 1 was the 15th. In January, trade date # 1 was January 15th. The 16th and 17th were weekend days. The 18th was a holiday. So the 19th, four calendar days later, was only one business day later, again in violation of their policy and triggering their phone call as this was my strike # 2. They informed me that if I did it again before December 15th, 2016, that they would not allow me to trade using unsettled funds for one year. A slap on the wrist, no big deal. It is good to know I can apparently do this twice a year though!

Tax Loss Harvesting Success

There is also a great example here of just how beneficial tax loss harvesting can be. Consider the precious metals investment. In November, I booked a $3000 loss. In January I booked another $400 loss when I went back from the USAA fund to the original Vanguard investment. Overall, I’ve invested $23,000 in the investment, it’s worth $25,000, and I have a $3400 tax deduction. Although the basis is now $5000 lower than the value of the investment, I can later flush that gain out of the account through charitable giving.

The Bottom Line

So, how is the project going? Well, in January 2015 we owed $312K on one mortgage and $91K on the other and had nothing in the mortgage pay-off account. As of today, we owe $291K on one mortgage, nothing on the other, and have $121K in the pay-off account. That’s a difference of $403K-$291K-$121K= $233K, plus the tax benefits. Not bad for a single year. Obviously what we thought was going to be a five year project is probably going to be a two year project, especially if the market bounces back in the next year. So that’s fun.

What’s not fun, of course, is that, at least at this point, we would have been better off just sending those payments to the mortgage company rather than investing them. The side account declined to a low of $113K at one point, although it is now back up to $121K. So that’s a $9000 loss. It’s actually even more when you include a few months of saved interest. Even at 1.5%, that’s not insignificant on a $300K debt. It’s a good example of how stocks can make lousy short term investments. Over the long run it will probably still work out fine for us, and it is obviously an amount we can afford to lose, but there’s a lesson in there somewhere. We’re technically investing on margin, even if that margin is at a very low, fixed rate and is not callable.

The tax losses also help reduce the pain. In 2015, we booked $7,068 in losses. In 2016, we booked another $8,766. $3,000 per year of those losses can be used to offset my extremely highly taxed earned income. The remainder can be carried over to future years. Essentially, I’ve got a $3000 tax deduction for the next 5+ years. Given my marginal tax rate, that’s worth about $7000. If you add that to the $121K in the account, that’s not much of a loss.

But wait, you say, you now have a lower basis on the investments in the account. That’s true. We’ve now got about $5400 in unrealized gains. However, I don’t anticipate ever realizing those. The most appreciated shares will simply be used for our annual charitable giving rather than giving cash. We won’t be able to use them in 2016, since one has to hold appreciated shares for a full year before donating them, but we’ll use them eventually and flush those unrealized gains out of the taxable account.

 

What do you think? How are you doing at reaching your intermediate financial goals? Are you working on paying off your mortgage? What method are you using? Comment below!