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
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
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!
Mutual funds clear in one day rather than three, right? So is it more advantageous to TLH with mutual funds?
Also do you think it’s worthwhile to get a margin account solely for the purpose of TLHing in one day?
Not really. Tax loss harvesting no more than once a week isn’t that big of a deal.
I have done the exact same thing over the last two years with similar terms on my loan.
Even with the tiny barrier to beat at 1.5 percent, I’ve lost money and wasted time vs just paying the debt.
You cant compare over a 2 year period, nor should you be watching it to justify it one way or the other. You have to let time do the heavy lifting. Do this at the end of your mortgage term and see how you’ve done. You shouldnt have lost any money unless you’ve sold something and permanently backed out of the market. This kind of inappropriate post hoc analysis is the kind that leads to poor reactionary behaviors.
Off topic but… Where did you find a 15y mortgage at 2.75%? I can’t find anything under 3%, with excellent credit/big income/similar sized mortgage? TIA
He found it probably 2 years ago when I did (although I beat him and have a 2.68% loan)
It was almost 4 years ago but rates haven’t moved that much since. Excellent credit, a non-jumbo amount, 20% down, and a willingness to play one lender off another can do surprising things some times. I’ve checked in a couple of times with lenders when rates were at a low, but it never made sense to refinance again.
2.65% here haha!
Mary, one of the lenders in my area was at 2.75% for the 15 yr 7 days ago (I suspect they are still there). I had a few clients at 3.5% on their 15 yr decide to pull the refinance trigger. This particular lender – Guardian Savings Bank – also has closing costs under $500. The catch is you have to have 25% equity to get these terms. For anyone with decent home equity, they are by far the lowest all-in cost lender in my town (Lexington KY). I suspect there are other lenders around the country just like them but you might have to ask around.
Interesting Vanguard rule about having to wait for the settlement date before buying the next ETF. In Canada, we can buy again immediately. I think of it that the brokerage can “see” that both trades will settle in 3 days time, so don’t care that the first trade hasn’t settled when you make the second one.
Another simpler way a of handling the mortgage vs investing issue, which I did when I had a mortgage, was that any funds in excess of what I normally saved for retirement and regular mortgage payments, were split between extra payments to the mortgage and investing for retirement. Also, in Canada, mortgage interest is not deductible, so that makes it less of an issue.
Splitting the difference is usually a reasonable thing to do. One issue with splitting the difference with a mortgage is that theoretically even if all you have is a $10K mortgage you could lose the house, so there is a dramatic reduction in risk when you make the final payment.
I have my accounts at Schwab and they ETF trades result in funds that are immediately available to buy a different ETF. Perhaps because they are in tax-advantaged accounts (Roth IRA, for instance)? Is this a Vanguard rule, or a US regulatory rule?
It’s a regulatory rule. It’s not the first trade, it’s the second that triggers it. I don’t think it would be any different in a Roth account, although I don’t know why you’d be buying and selling rapidly in a Roth.
Thanks for sharing your story, not sparing the details, and admitting a few mistakes. The ETF settlement business is new to me, but I’ve only dealt with mutual funds so far.
I had a similar goal and aimed to be debt-free by 40. I paid off the last of my student loans @ 37. I sold one former home @ age 38 and another @ 39, releasing me of my duties as unintentional landlord and becoming free of all debts. Financially, I might be better off with the low interest debt and more equity, but there is a very real psychological benefit (as you mentioned) when you owe nothing to nobody.
Tax Loss Harvesting is a great tool. I took $40,000 in losses last month with 2 simple exchanges in my Vanguard taxable account. There are, it seems, 101 ways to mess it up, but if you set up your portfolio in a way that minimizes the potential of a wash sale, it can be fairly straightforward. Like you, I don’t worry about the lower cost basis going forward. The 3 most likely destinations for this money are 1) donor advised fund, 2) sold in retirement when I’m in the 15% tax bracket, or 3) inherited in about 50 years, give or take a decade. Based on current law, there would be no capital gains due in any of the 3 scenarios.
Excessive trading will get you nowhere fast
He is not really trading. He is swapping. He sells one fund/etf and buys something similar to harvest the loss for taxes. It took me a while to really comprehend the concept. He stays invested the whole time and maintains his asset allocation.
Actually, there are about 5 minutes there where you’re not invested. I remember the market jumped a bit, perhaps 0.2-0.4% in that 5 minutes one time. Another issue with using ETFs. Of course, I think it went the other way once too so it can be a positive or a negative.
Simple solution to your settlement date is to simply make your taxable account a margin account. There is no good reason to have your hands overly tied. Ive never heard of not being able to trade with unsettled funds if you sell then buy, the trouble is if you sell, buy and sell/buy before the first trade settles, which they call a regulation T violation. Almost all brokerages give you a good faith loan for the first buy/sell so its weird that Vanguard was so touchy. Just make it margin and you’ll never have to worry about it.
Why do you have so much money in a metals and mining fund? Seems like an unnecessary concentration in a poor sector prone to major cyclical collapse, though you might have a good year this year.
The margin account is a good idea. I thought about that. I also thought about putting some of my e-fund in my MMF to avoid the issue too.
I’m not sure putting 1% of my net worth into any fund is a serious “concentration” of my portfolio. I certainly don’t regret it as its the only thing with a gain right now! But this fund is a bit of “play money” for sure. I don’t have serious money invested in precious metals or precious metal miners other than what is in broadly diversified index funds.
No, probably not, and it certainly has been crushed as of late so the timing is good. You’d think with all this cheap money and raw materials someone would build something. One can hope.
If you are worried about spreads just set a limit and let it hit when it hits. Itll happen unless youre reaching for something wild.
White Coat-Just do it! Pay off the mortgage. The benefits are HUGE–way more than just the numbers. Nothing like the sweet emotional boost when looking at the annual balance sheet with zero liabilities.
No debt for us–nothing, nada, zilch. Mortgage is far away in the rear view mirror. Like you am a BC, EM trained EP working in a democratic EM group at the same shop for decades. Love my job and part of the love stems from always having choices with FI for a long time. Have dialed back on many of the telomere shortening parts like late nights and overnights BECAUSE of flexibility. Living below your means and saving a lot with zero debt makes for INFINITE choices 24/7/365.
Thanks for communicating such a critical subject for all to read!
CB
I don’t think WCI is losing sleep about a $2450 mortgage given that he said that’s about 5% of what he’s grossing between medicine and WCI.com… That’d minimize the expected emotional benefit, surely.
Depends on your personal take on debt. I dont care at all about one side of the balance sheet or the other, I only care that it moves from negative to zero to positive. Net worth only sees one thing, positive or negative, whether its on the income or liabilities side doesnt make any bit of difference. That is if you have 10k extra, you can pay off 10k in debt or invest 10k, the overall effect is the same.
No need to overthink it or justify it beyond that, general direction is important. I for one dont care if I have debt as I see it simply as a tool. Give me the right terms and I’d take on a large debt, anyone would. It should always be relative to things like the risk free rate, inflation, etc….
I actually sleep a lot better at night knowing Im putting my money to work in the most efficient way possible, and the thought of paying off a loan at 0.9-2% early makes me cringe inside. ymmv
I’d be interested to see how Betterment’s Tax Loss Harvesting+ algorithm would have performed in this same scenario. It certainly would have been less effort, with the caveat that one couldn’t weight the portfolio to certain sectors as WCI has done.
Agreed! As a soon to be med school graduate (T-minus 2.5 months or so) I have been doing all I can to get things in order – meaning consolidating previous employers’ 401(k)s and IRAs and starting a budget on a projected PGY1 salary.
I chose to go with Betterment over Vanguard after some research, specifically with the automated Tax Loss Harvesting
Any experiences with Betterment, Toshi? Anyone else?
Are you doing Roth conversions? Probably would have been better to do them the last 3 years, but this year isn’t a bad time either.
Not sure I’d worry much about tax loss harvesting as an MS4. Do you have a taxable account? If so, it’ll probably be gone soon as you move it into tax protected accounts and it’ll be years before you should start one.
I just started this year – I was able to roll over an account from a former employer that turned into a SEP IRA as well my 401(b) where I dumped all my tutoring income my University paid me the past four years. I don’t know that I will be able to manage any other conversions anytime soon – we have two credit cards with interest free periods ending later this year that I am prioritizing first.
I should also be able to max out a Roth IRA for both me and my wife this year (between family members offering “matching graduation gifts” if I can contribute to a Roth and my extra income while on ADT orders as an HPSP student during this year). Working on a budget to make sure this happens the next four PGYs too.
Just discovered your book and website this past year – its forever changed my life already.
I’ve harvested some losses with Betterment. It seems to be working as planned. Some light reading, the first from yours truly before I signed up for Betterment myself:
1) https://www.whitecoatinvestor.com/betterment-tax-loss-harvesting/
2) http://www.mrmoneymustache.com/betterment-vs-vanguard/
3) http://www.madfientist.com/moving-my-money-to-betterment/
It was really the TLH+ Performance section of the third link that convinced me.
I started a similar plan about 6 months before you and have similar numbers. At this point, no extra money is going to the taxable account in anticipation of selling in 1 year at long-term cap gains. Now, just need the market to cooperate. And if not, I wait another year or two. Talk about first world problems.
I read your initial post about paying off the mortgage by funding a side investing account with interest as I have become very interested in paying off our own mortgage. I appreciate the update. However, due to strictly psychological factors, I decided to simply send in extra payments rather than trying to get clever with investments. 🙂 I have to say, even if I had been able to do better with side investments, bringing my mortgage down from ~380K to ~260K in a year has felt amazing. Far more amazing than that amount of money sitting in an investment account (and we do have $1M plus in investment accounts).
Why not take the investment money and pay off the mortgage then?
The investment money is in 401(k)s. I don’t think I need to explain more as to why we don’t want to access it at this time. We also own two rental properties outright (use of inheritance money) and that has been more of a dilemma–purchased both of them back before I really started reading about FI. One thought has been to reach FI sooner by selling one. On the other hand, why not prepay the mortgage down to zero and keep the rental property cash cows?
I use the transfer function to tax loss harvest on the vanguard website. It seems to get done on the same day. Shoul be selling and waiting a few days to buy.
You’re doing that with mutual funds, not ETFs, right?
Yup, with mutual funds.
Then exchange works fantastically.
WCI – I don’t understand why you can’t use unsettled funds. It’s not been a problem for me, and as far as I know I don’t have a margin account. I usually sell first and buy second. Back in 2015 I had to note how much the sale netted, and then I would buy using slightly less than that amount, a few minutes later. In 2016, Vanguard actually updates the net sale number to the “available” funds, so I don’t have to do the math myself. Both in 2015 and in 2016, there is a pop up that says “warning you are using unsettled funds, it’s a violation of federal law if you don’t have funds by the time trade settles” or some such, I click ok. I was concerned the first time it popped up though. I think I may have even called Vanguard to check on this the first time.
Then, normally the proceeds from the sale settle same day as the money is needed to settle the purchase. So I never got harassed by Vanguard for doing something improperly. I would hate to be out for 3 days, with the volatility. I hope that what I’m doing is actually ok, and that my account doesn’t have some sort of a glitch that makes them think it’s a margin account…
But it was truly 3 days when I had to sell some mutual funds, then wait to settle, then get ETFs. In my experience, the 3 days were needed when going between mutual funds and ETFs and I assume vice versa, but not when trading the same type (ETF to ETF, or mutual fund to mutual fund).
My other thought about your choices for taxable – how tax efficient Healthcare, Energy, and Mining funds are (or aren’t). I have both Healthcare and some Energy in my Roth, but taxable is very broad funds, and also mostly international, and for domestic, I try to stick to growth funds to hopefully minimize dividends and get foreign tax credit. You don’t want to have things in taxable that are spitting out more dividends than the absolute minimum tolerated – that goes into the marginal tax bracket. Ouch. Unless you are really looking forward to Energy and Mining recovering a huge percent, and that taking out the sting from their dividends… I obviously didn’t research them for a taxable account for myself, but I somehow ended up with some pre-formed opinion (which could be wrong) that Energy tends to be generous with dividends…
As Zaphod explained, it isn’t the first purchase with unsettled funds that gets you in trouble. It’s the second one. So if you sell and then buy on day one, no problem. But if you then sell and buy again on day two, that’s an issue.
I appreciate your concerns about the tax-efficiency of the sector funds in this play money account. Absolutely some of those funds are less tax-efficient than a TSM or TISM. Lots of value stocks in the energy ETF for sure. Bear in mind that the net effect of taxes on my taxable accounts has been negative due to tax-loss harvesting and donation of appreciated shares. I’m not that worried about paying some taxes on dividends. I was mostly looking for very volatile funds with high-expected long-term returns. The volatility is beneficial to me, as it allows me to book losses while avoiding paying for gains. It would be nice if none of them ever paid out dividends, but it’s tough to find funds like that and I’m not willing to do the individual stock thing. And keep in mind what we’re talking about here-TSM has a yield of 2.12%. Energy’s yield is only 3.33% and Health Care’s is actually less at 0.94% (lots of growth stocks there I guess.) The precious metals fund is sitting on tons of losses and its yield last year was also less than TSM- 1.7%. Hard to get really worked up about tax efficiency there.
I understand now. I didn’t have any churning in my taxable account that frequently, so I never ran into that issue.
Thanks for looking up the yields – I may consider putting Healthcare into my taxable, I’ve run out of Roth space for it. I was concerned it would not be tax efficient, but that does not seem to be the case.
I cant seem to make myself do TLH. Concept is simple just no desire. I already have enough loses to give me that 3K a year benefit for 15 years.
The only way TLHing will help me if I was to sell some of my appreciated apple/google shares and move the money into index funds.
What else situations will I get capital gains where doing TLH may be beneficial?
There is no sense in doing it if the gains are truly useless to you. You’re right that the law of diminishing returns starts kicking in after $3000 of losses.
I see no reason not to TLH. Every year, you should have short-term and long-term gains that can be offset by TLH losses in addition to the 3k from ordinary income.
I did the math and paid off my house in 2010, 11 years after the mortgage originated and with a few refinances in between.
While theoretically one could make more money investing and keeping the mortgage, the reality is, as WCI has experienced, the return on paying off your mortgage is guaranteed while investment returns are not.
When I was a young, whippersnapper out of training, a wise senior partner told me that one could withstand a significant amount of financial hardship if one’s house is owned free and clear.
Another way of looking at it is that if you are paying a mortgage, your entire life is financed by debt. You paid cash for your car? Well, actually, if you still have a mortgage, that car is essentially being financed. So is your trip to Hawaii, your kids’ private school, your wife’s new necklace, or your husband’s new tool set.
Sound advice for most
History has proven that actual / real business and thus stock market return are around 5 % (based on business growth / dividend). Rest of it is pure speculation (game played by “experts” with our money (both retail investors and institutions). In the 1990’s / 2000’s the mantra was that you must shift large amount of your money to emerging markets. Well, how that turned out?
Here is my advice:
1. Pay off your debts
2. I have never had more then 30 – 40% of money in stocks (even when I was much younger), rest in bonds (even now) and rebalance once every year. I made money even in 2008. I can state without hesitation that I have done better then most, with a lot less risk.
I have never lost money, so really don’t need to care about tax loss harvesting. For most part I am capturing 85 – 90% returns provided by stocks, and at times have beaten stocks without any drama. I rebalance once every year (using tax favored accounts), buy investment when I need to without worrying about market conditions b/ I know my principal will be safe. If stocks crash 30%, then my treasuries rally hard and overwhelm stock losses. If treasuries go down like 2009 and 2011, stocks counterbalance by rallies of their own. Poetry in motion.
Please, please and pretty please, do learn the difference b/ arithmetic and geometric returns before refuting what I am saying. Also, I only invest in treasuries (mostly 10 yr). Do not tell me about rising rates and all that nonsense. I have been hearing that for years. 2009 / 2011 were the worst years for treasuries in more then 100 yrs, and still made money.
People forget that treasuries will pay (100% guarantee), and stock which can fly much high then true value due to speculation, cannot break free of gravitational forces applied by debt market
I’m a believer in paying off debts, as I mentioned in my comment above. I’m also not going to argue against your asset allocation. If it works for you, it’s right for you.
I don’t understand your disregard for tax loss harvesting, however, unless you have no earned income. An exchange of similar funds resulting in a $3000 loss (on paper) results in a $3000 reduction in taxable income, which can be $1200 to $1500 in your pocket if you are in a high marginal tax bracket. The tradeoff is a lower cost basis, which can be irrelevant depending on what you plan on doing with the money. It’s worth investigating further IMHO.
I have nothing against TLH. It is akin to life gave you a lemon so might as well make lemonade. Trick to true wealth accumulation over the years is to benefit from compounding. In order for compounding to work its magic, you need to reduce volatility. In our economic system, it can only be done by mixing stocks / treasuries (not just any bonds, or gold or commodities etc).
Not to sound condescending, but do you know difference between geometric vs. returns? This can really help one assess true risk tolerance.
I understand the concept. Losing 50%, then gaining 50% doesn’t get you back to square one (i.e. you’re still down 25%). The compound annual growth rate will be lower than the arithmetic mean, and the higher the volatility, the greater the difference. I’m willing to live with higher volatility if the end result is a higher CAGR.
“I’m willing to live with higher volatility if the end result is a higher CAGR.”
Just couple of additional points:
On long term basis volatility absolutely doesn’t result in higher CAGR. Volatility is byproduct of speculation and not business fundamentals. Additionally, volatility can move in either direction. Recent examples include MLP’s, Gold, commodities, emerging markets.
Additionally, you maybe able to tolerate 20% – 30% decline while you haven’t amassed significant amount of wealth, and have plenty of time to earn income. However, it isn’t as easy when you have saved and invested for over twenty yrs and market corrects, as it always does.
It is absolutely a lie told by financial advisors / fund managers and brokerages that you can afford to take risk while you are young and make it up later. Math argues against this nonsensical statement.
I have stated this before somewhere on this board that talking heads due to raging bull markets of 1980 and 1990’s were advising even people in their 60’s to have larger portion of funds in stocks. however, the money they need in 2 yrs should be in cash or bonds. Then the tech bubble in early 2000’s ruined many people, and financial advisors recommended to only put money in stocks if they have long time horizon of 5 yrs. Then 2008 -9 happened. Many folks got ruined, and talking heads had following recommendations, don’t put any money in stocks that you may need in 10 yrs, work longer and postpone your retirement, and be more frugal. All along they collected their fees
Just to be fair, I did say that CAGR will be lower than arithmetic mean, and the higher the volatility, the greater the difference. I think we have the same understanding of how that works.
I think we have different risk tolerances and that’s perfectly OK. 2008-09 only ruined people who sold at the bottom. The stock market bounced back in a couple years. That dip was great for me. I invested on the way down, at the bottom, and along the way back up. I now have many more shares than I would have had in a flat market, thanks to dollar cost averaging. Someone who retired in 2007 and had no cash or fixed income to ride out those couple years would rightfully feel differently about it.
It looks like you have embarked on this suicide mission with eyes wide open. Just kidding around. It looks like you know what you are doing, so good luck
To each his own. Cheers and good luck to you as well!
-PoF
Sam, regardless of volatiltity, given that stocks have an expected return of about 10% and bonds 5-6% (over the long term), the higher allocation to stocks you have in a portfolio, the higher returns you will over most time periods longer than about 5 years, especially if you are adding money at regular intervals along the way. In choppy and down markets, certainly you may get some benefit from rebalancing out of bonds into stocks, but not so in a steadily rising bull market.
Here are actual numbers:
1972 – 2015 1981 – 2015 91 – 15 200 – 2015
!00% stocks: 10.15% 10.68 9.95 4.46
100% treasuries: 8% 9.41 7.85 7.4
50/50 9.6% 10.63 9.65 6.98
———————————————————–
WORST YEAR
STOCKS: – 40.61 (Had birrger losses on rolling basis)
Treasuries – 13. 03
50/50 – 11.6
More risky and volatile the portfolio, less likely the investor will earn fair share of returns.
I’m not sure what you mean by the investor earning a “fair share of returns”. You can only earn what the market gives. From 1926 to 2015 treasuries returned 5% and stocks returned 10%. Volatility is a different issue. Shorter periods of time the numbers will differ, but over most periods of time greater than 5, and more so 10 years, stocks outperform bonds, and a 50/50 mix. With a 50/50 mix, the ride will be smoother and the risk adjusted returns (Sharpe ratio) will be better, but you can only eat returns, not risk adjusted returns.
I think he’s talking about average returns. You’re more likely to get the average return for a less volatile asset class over a short period of time.
He was also nice and used a 50/50 portfolio, a 60/40 portfolio would do even better. Diversification is your friend. I made a post about this in the forum, I was a 100% stocks “true believer” for a while too, but its simply not true in any real persons investing time frame. I dont know about you but I do not have a 50 year time horizon before I start drawing it down some.
If you follow the link in that post you will see a diversified portfolio has never had a loss of purchasing power over any time period while all stocks have. You dont want your investing horizon to unfortunately coincide with that era.
With diversification the whole is greater then the sum of it s parts.
The above statement cannot be refuted when it comes to diversification, the only free lunch in investing.
Diversification doesn’t mean large cap vs. small cap vs. emerging market or gold and corporate bonds. In western economic system it means treasuries (gold standard) vs. all other asset classes
By “fair share” I mean that if you want to capture what the market is willing to give you then not only do you need to participate in the market but also stay in it when times are tough.
Finally, above dada is CARG (compound annual growth rate), the best way to calculate true / pocketable value of your portfolio.
No,
Forgive me fellas, I am on a roll today
Grant also writes “but you can only eat returns, not risk adjusted returns.”
without managing risk and volatility you may have little or nothing to eat when you need it the most.
Sam, interest rates have been falling for the last 30 years or so, so most of that time bonds have performed well compared to stocks. I don’t think bonds can perform as well compared to stocks going forward from this point in time. Interest rates may not be going up any time soon, but they can’t keep going down as much as they have in the last 30 years.
Grant, you are probably right, but rising interest rate may also impact stock returns. Rising interest rate also increase treasury total return over time. During the 30’s treasuries did bad, but portfolio of treasuries and stocks kept you from jumping out of your window. It took couple of decades to recoup losses from stock market, even though stocks posted double digit gains for couple of decades after the great depression.
Intrest rates went through the roof during mid 70’s and early 80’s. Stocks and treasuries did pretty bad. Still, portfolio of stocks / treasuries beat both stocks and treasuries.
Now, what happened in the 80’s and 90’s when stocks went crazy was amazing. I hope my kids have opportunity to participate in such bull run in their life time. Unique period in human history. New technologies / freedom and introduction of capitalist if not democratic principals in large parts of the world. Government incentivizing retail investors to pour money in retirement accounts, and wall street putting these funds in stocks. If you lived through that time you know how good it was, until it wasn’t.
Even in those years (1981 – 2000) when one would expect stocks to to destroy treasuries, stocks CAGR was 14.69 % vs. 12.99 % for stock/treasury portfolio (40/60).
You can’t time the market. You can’t predict interest rates. You can’t earn more then what market has to offer you non consistent basis without taking risks. All you can do is to stay invested in order to capture you fair share of market returns. Reducing volatility helps you do that, and even beat the market when it corrects.
1981-2000, whether intentionally chosen or not, is perhaps the best possible 20 year period for treasury returns in history. Interest rates in 1980-1981 were in the mid teens.
Well, I think you missed the point / points. 1980 – 2000 were very good years for treasuries, and even better for stocks. For comparison also mentioned 1930’s and 1970’s as well.
I will say as I always do. You cannot use a straight up comparison of simple and compound interest and call one a guaranteed return and the other not. You can buy a guaranteed return for a better rate than your mortgage in treasuries. Then you can bring in term lengths as well, which is another huge plus for investing.
Thinking about everything else in your life as being financed by debt and allowing that to hold you back from anything is a poor and incorrect way to do things. Doing whatever makes you feel better is fine, but it almost always seems things like this make you feel better because of a misunderstanding of the math or all in reasoning.
You do not have more flexibility with a paid off home vs. one thats not unless youre only concern in life is paying the tax/insurance bill. You have to remove liquidity which is actual flexibility from your life in order to pay off a mortgage.
Debt, and money are just tools, they are neither good nor bad, it is what you do with them that matters. If many of us never took on loans we wouldnt be doctors, that was an investment and seemingly good use of debt. Similar with many companies, access to capital markets and debt allows them to grow, Apple has like 60 Billion in debt, and 218 Billion in cash, why arent they paying it off? Yes, debt has also taken people and companies down, but it wasnt the debts fault it was the abject irresponsible use of a tool not the tool itself. Like anything else, it can be good or bad depending on how its used.
If Apple goes bust due to too much debt, nobody ends up moving into mom and dad’s basement. Corporate debt and personal debt are not necessarily analogous.
I’m not sure what you’re getting at with simple and compound interest either. Paying down a mortgage compounds just as much as investing in a bond fund does.
Investing might provide more flexibility, but reducing require payments improves cash flow, which also has its advantages, even if it costs flexibility.
Mortgage paydown is not compound interest, investing in an equity index fund is, agree about bonds. Paying down your mortgage doesnt reduce your monthly payments until you refinance, reamortize or pay it down completely, so you have actually reduced your cash flow until one of those events occurs. The amortization of a mortgage gives the appearance of compounding, but its really a compounding of your principal more than how one would normally think of it.
Of course no one should have too much debt and be irresponsible. Base case here is the people are already responsible and with about the highest job security in the world, but with so much discretionary income after maxing out retirement, etc…they pay down other things quickly. If that was not the case then downsizing or renting are more topical than investing.
Bottom line is a mortgage is a exceedingly low rate tax advantaged debt, and one of physicians only write offs. It seems like most people do the mortgage pay down thing because thats what is preached on most financial websites and shows. This is one of the least efficient uses of your investable monies, and imo, doctors that come to this site should be able to think about it as a roi of those funds and in a more nuanced manner. No guarantee you stay in that house, no guarantee you get any of that cash back, only guarantee is its gone unless tapped by a heloc/sell, which is an extra step from a taxable. If you are upside down or without a cushion on your equity, totally different matter.
A mortgage is a currency hedge and shorting the dollar. You will have put in dollars at a time when they were most valuable to save yourself from having to pay them in a couple decades when it would turn out to be a pittance. The FV calculation and opportunity cost on this trade off is bad. I would bet the majority doing this will not stay in these places forever anyway, and putting in more cash just reduces any profit (if there was any to be had). Now, if you’re truly concerned about being able to pay your mortgage or your job stability, you have bigger problems and probably shouldnt have a mortgage. Point being, all the usual reasons why people put forth to pay down a mortgage are not the same level of concern to a physician as many other people and we should acknowledge such.
I dont really care what people do, obviously thats their business, it just seems to come from a place of misunderstanding which generates an emotional aspect to it that guarantees people are less likely to do whats best or what they otherwise might do if fully appreciating the costs. We all understand, look down upon and even switch funds due to what are trivial differences in expense ratios, and then people turn around and toss full integers of percentage points away. When assessing the trade, I see over and over comparing the savings over 30 years to performance over a much shorter time to justify it one way or the other which doesnt make sense.
It doesn’t reduce your payment (until paid off), but the amount of that payment going to principal each month increases in a compound interest not a simple interest way.
The money paid toward a mortgage isn’t “gone” in any way shape or form. Less accessible? Yes. But not gone. It has directly reduced my debt. Before I paid $1000 toward a mortgage I had $1000 and a mortgage of (say) $100,000. After paying it, I have $0 and a mortgage of $99,000.
Your analysis of this being a “bad tradeoff” reflects your values. I’m not sure I entirely disagree with them. As I said in the post, I can do math and that’s the reason I’m investing instead of paying it down. So far, that’s been the wrong decision!
That is of course a reflection of my values and comfort levels. I will quasi agree/disagree with the interest part, as it is simply more complicated than we can quickly put into a sentence due to amortization. It is better than simple, true.
I already know, mostly because you’ve explicitly stated so you think along the same lines I do. However, if I dont periodically argue other points I cant clarify my thinking, spot errors and be corrected, or learn new things from the discourse.
At the moment, Public Enemy Number 1 is educational debt, and will most likely be the main focus in terms of being debt free over the next few years. I was literally discussing mortgages with a co-resident today as he is about to join a practice and unfortunately think the temptation of life-style inflation at the moment is too much for him to resist.
Youre not investing on margin. In no way shape or form is this margin, not even pretend margin. You are taking discretionary money and investing it.
You did not “lose” 9k, the market fluctuates, thats the only thing its guaranteed to do. Changes on a daily basis that are not taken out are gained/lost, they are unrealized until realized.
I disagree about the loss. I lost the money. No doubt about it. Pretending I didn’t lose it because I didn’t sell is just mental accounting. Likewise, if the account goes up to $140K over the next year, I will have gained $19K. Playing the mental game of “you didn’t lose (or gain) until you sell” is just a mental trick to keep people from panicking in down markets. Unrealized losses are losses too, even if you don’t report them on your taxes for that year.
By that reasoning your house value also changes over time, its just difficult to see real time. It is an incorrect comparison to assume a guaranteed return on one side because its not simple to see the daily value fluctuation and attribute a loss to another vehicle where it is more obvious simply because of the transparency. This is an oversimplification that will lead to inaccurate conclusions.
No one worries or talks about their home value “loss” from one month to the next, it does not matter until its realized. You can track it on Zillow which is not something to take as totally accurate or anything, but it certainly fluctuates over time.
This is simply an approach and process perspective.
Will agree its somewhat “lost” as if you accessed it you would have less purchasing power, but it should be in the context of your time frame of course, which obviously doesnt bother yourself.
This is always my dilemma with strict buy and hold philosophies, at the best time to buy your purchasing power outside of new contributions is really low. Havent finished glossing the old crystal ball yet though, so no great conclusions, just a conundrum.
I agree, it’s just a different way to look at it. But as you might imagine, I agree that my house changes in value every single day. I just don’t mark it to market every day. When my house goes down in value, I truly do lose money.
There is some grey in regards to the wash sale rules and using ETF’s and Mutual Funds to TLH. The big question is what is substantially identical?
The obvious example is the exact same individual stock, ETF or Mutual Fund – selling then buying back within 30 days is an obvious wash sale violation. But what about swapping out the Vanguard S&P 500 ETF with the IShares S&P 500 ETF? Or what about swapping the Vanguard Total Market fund w/ the Fidelity Total Market Fund? To me those also seem like obvious violations – though not quite as obvious as swapping the exact same security.
It seems there is no clear line in the sand defining what is substantially identical – or not one I know of.
I don’t think those are obvious violations at all. I see the Vanguard and Fidelity TSM funds as substantially different. They have different securities and even follow different indices.
Besides, I have NEVER heard of anyone getting in trouble for any TLHing that wasn’t the exact same security. Have you? I don’t think this is particularly high on the IRS’s list of things they worry about.
Unfortunately, even IRS hasn’t clarified topic of substantially identical securities when it comes to mutual funds / etc /etn. Even brokerages don’t have all the answers and are working on set of assumptions because IRS won’t issue white paper rulings so law abiding citizens can do what is right.
Zaphod, by “all stocks” do you mean the S&P500? It’s true in the period 1965-1981 (from Ben Carlson’s post you linked in your post), there was a loss of purchasing power of the S&P 500. I note that in that time period the other two asset classes mentioned, 5 year treasuries and long corporates, also lost purchasing power. It would be interesting to see the returns of a globally diversified small value tilt portfolio of stocks in that same period. I’d be surprised if that 100% stock portfolio had a loss of purchasing power.
‘I’d be surprised if that 100% stock portfolio had a loss of purchasing power.”
That maybe true, but many people did lose their mind as well as shirts off their backs trying to stay invested in 100% small cap tilted stocks as they aged toward retirement.
I just don’t get this nonsense of being 100% invested in stocks. “I have high risk tolerance”. “I am young and have long investment time horizon”. when even billionaires / large endowments / governments buy and invest in treasuries. I would imagine yale and harvard endowments as well as USA and republic of china have a longer life span then you guys. Japanese and every other government, as well as insurance companies and warren buffet are real stupid, because they can triple their money by selling debt and buying stocks.
Sam, you seem to be talking about risk tolerance. People only lost their shirts because they made “the big mistake” and sold, or in retirement failed to have enough cash/bonds to deal with sequence of return risk. The market always has gone on to new highs, and probably always will. Nothing wrong with having an allocation to bonds, but with lower volatility comes lower returns over most time periods. Eg. This based in Canada portfolio shows with increasing allocations to stocks comes increasing returns, over all time periods back 20 years, and this in a time very favourable to bonds (falling interest rates) and two times equities were cut in half.
http://canadiancouchpotato.com/wp-content/uploads/2016/01/CCP-Model-Portfolios-Vanguard-2015.pdf
The loss of purchasing power is after considering your true return, meaning it factors in taxes and inflation. During the time period where stocks lost purchasing power the nominal gains were actually not bad, but inflation was epic, so most people would not have looked at their statements and thought theyve done poorly, even though they had. Same thing in the depression and why it didnt take 20+ years to get back to level, the massive deflation made it so you could be back to even after 5-7 years.
The reason those entities dont do that kind of investing is because they understand the math and can get the same return with less volatility. Its simply unnecessary.
I basically followed Ramsey’s 7 baby steps. I became debt free in my thirties and never looked back. Life is simple and freeing. All money flows to me, not away. If I ever want a mortgage I can go get one, but NO THANK YOU!
It is part of what allowed me to become FI. I could maintain my current lifestyle without working but fortunately I love my work and have no plans to quit.
Putting the money aside to pay the mortage off in a lump if you wish shows good discipline and gives time to decide where funds will work best for you.
On the other hand, the gyrations involved in the tax harvesting seem a bit over complex and almost hyperactive in the speed. Maybe it’s becuase I like to plan, think and then execute which can take some calendar time or becuase we set buy/sell targets before purchasing in the first place which heads off spurts of frantic activity.
Last, why are you treating ETF’s like penny stocks? This is a big and worrisome mystery/
Just booking losses before the losses disappear. I assure you I don’t move anywhere near as quickly when I have gains (as I do now). But there really is no point at all in sitting on losses if you can legally TLH them.
I might be confused but in your article you mentioned you would give your gains from the taxable account to charity to avoid having to pay the capital gains tax. Wouldn’t it be more advantageous to give to charity from your earned income since you would certainly be in a higher tax bracket with a doctors income unless you are giving a huge amount of your salary. For example you give a gain of 10K to charity from your stock capital gain and save 20% verses saving maybe 35% from 10K of your earned income so the TLH wouldn’t be as advantageous as just giving from your earned income. Now I know you will get to take 3K from that TLH each year until it is used up so I guess it is a wash but that is only if you continue to earn a very high income for the next 5 years.
You’re missing the beauty of this strategy. When you donate appreciated shares, not only do you avoid paying capital gains taxes but you get to deduct the full value of the donation on schedule A. You get BOTH. Cool huh? You also seem to be bringing in tax losses which are unrelated to this. Totally separate concept. For example, I booked $7K in tax losses last year. That allowed me to not pay any capital gains taxes on a $4K capital gain I had plus deduct $3K against my regular income.
Ah now I get it. Thanks for the clarification.