By Dr. James M. Dahle, WCI Founder
Lots of people understand investing theory (“I should buy and hold,” “I should use index funds,” and “I want an 80/20 stock/bond split”) but then get lost in the details. They get so overwhelmed that they rush out and hire an investment manager because they lack the ability to organize a portfolio. Or worse, they end up with a poorly thought-out collection of investments. Today, using our own portfolio, I'll give you a few management tips.
Start by Collecting Information
The most important thing to do is to write down what you want and what you actually have. You should probably use a spreadsheet, such as Microsoft Excel or Google Sheets. You will want all of the following information before you begin:
- Desired asset allocation, in detail
- Distribution of wealth between various accounts
- Your actual current holdings
- The cost basis of any holdings in a taxable account
Just collecting all of that represents a fair amount of work, but without doing it, nothing else here really matters. If you can't handle collecting and tracking all of that, you have no business as a do-it-yourself investor.
Our Information
Our desired asset allocation is:
60% stocks, 20% bonds, and 20% real estate
In detail, it looks like this:
60% stocks:
- 25% Total Stock Market Index Fund
- 15% Small Value Index Fund
- 15% Total International Stock Market Fund
- 5% Small International Stock Market Index Fund
20% bonds:
- 10% Nominal bonds
- 10% Inflation-protected bonds
20% real estate
- 5% Publicly traded REITs
- 10% Private equity real estate
- 5% Private debt real estate
That doesn't change over time. But everything else does. Currently, our division between accounts looks about like this:
Taxable 77%
- Various locations, mostly Vanguard
Tax-deferred 15%
- TSP 3%
- Practice 401(k) 5%
- Jim WCI 401(k) 4%
- Katie WCI 401(k) 3%
Tax-free 8%
- Jim Roth IRA 4%
- Katie Roth IRA 3%
- Practice Roth 401(k) <1%
- Jim WCI Roth 401(k) <1%
- Katie WCI Roth 401(k) <1%
More information here:
150 Portfolios Better Than Yours
Asset Location Concerns
As you can see, almost all of our investments are now in taxable. That trend has been going on for a few years. It wasn't that long ago that we didn't have a taxable account at all. It isn't that we stopped contributing to our tax-protected accounts. It's just the contributions to those have been dwarfed by the contributions to our taxable account in recent years. The ratio of taxable to tax-deferred to tax-free is not static for most people. It's usually going one way or the other. However, our shift was more violent than I think most people have to deal with. We have essentially had to move our investment holdings out of tax-protected accounts and into the taxable account one by one, asset class by asset class, as the shift occurred. Currently, the asset classes look like this:
Taxable 77%
- Total Stock Market Index Fund
- Total International Stock Market Index Fund
- Small International Stock Market Index Fund
- Equity real estate
- Most of our Small Value Index Fund
- Most of our debt real estate
- Some of our inflation-protected bonds
- Most of our nominal bonds
Tax-deferred 15%
- TSP 3%
- Nominal bonds
- Practice 401(k) 5%
- Inflation-protected bonds
- Jim WCI 401(k) 4%
- Inflation-protected bonds
- Debt real estate
- Katie WCI 401(k) 3%
- Inflation-protected bonds
- Small Value Index Fund
Tax-free 8%
- Jim Roth IRA 4%
- Publicly traded REITs
- Katie Roth IRA 3%
- Small Value Index Fund
- Practice Roth 401(k) <1%
- Small Value Index Fund
- Jim WCI Roth 401(k) <1%
- Publicly traded REITs
- Katie WCI Roth 401(k) <1%
- Publicly traded REITs
Whew! What can you learn from that process? I think there are a few things. First, when doing asset location work, you generally move tax-efficient asset classes out of tax-protected accounts and into taxable accounts first. We basically did this in the following order:
- Equity real estate
- Total Stock Market Index Fund
- Total International Stock Market Index Fund
- Small International Stock Index Fund
- Nominal bonds (munis)
- Small Value Stock Index Fund
- Inflation-protected bonds
The first four are now completely out of tax-protected accounts, and the next three are partially out. You can dicker about whether we did it all in the right order, but honestly, a lot of it happened so fast that it was mostly simultaneous. There is more to it than just tax-efficiency, however. There is also availability. For example, the G Fund is only available in the TSP, a tax-protected account. So, if we want it, we have to have it there. That's why we still have some nominal bonds in tax-protected accounts. We have a similar issue with inflation-protected bonds. They would be one of the last asset classes for me to move out of tax-protected, but given the incredible I bond yields in 2022, we added those in individual and trust accounts. We're almost surely going to end up with individual TIPS bought at TreasuryDirect, too, so we've started that process.
The main asset class we're currently moving out of tax-protected and into taxable are small value stocks. As you can see, they're currently all over the portfolio: in a Roth IRA, in a couple of places in 401(k)s, and in taxable. A year or two from now, given current trends, they'll all be in taxable. Going the other direction, our least tax-efficient asset class with a high return is real estate debt funds. This is a great asset class to have in a tax-protected account, but it's kind of a pain to get them in there as they are private investments and require true self-directed retirement accounts. We've got one fund in there, and we will work to get some of the ones we currently have in taxable in there if we can. It would not surprise me if we got to the point where our entire tax-protected account space was filled up with this asset class eventually.
More information here:
Managing a Taxable Account Efficiently
Over the years, I've learned a lot about managing a taxable account efficiently. There are three principles that seem appropriate to mention here. The first is to use your taxable brokerage account for your charitable giving. While a good general principle is to never buy anything in a taxable account that you don't want to hold forever—because tax considerations may force you to do so—that's not necessarily the case if you give a lot to charity. If you end up with something you're not thrilled with but you have a big gain on it and have owned it for a year, you just give it to charity in place of cash. A Donor Advised Fund (DAF) makes it really, really easy and even anonymous.
The second principle is to tax-loss harvest pretty much any time you have a loss. Now, you don't need to do it frenetically. I used to tax-loss harvest like a madman. Every time stocks went down, I was swapping the fund for another one. I remember once going through four or five different funds to maximize the amount of losses I had captured. I still do it, but I don't do it more than every couple of months. Trust me, that's plenty. More than that, and you're just increasing your work. At any rate, tax losses are super useful. Think of all the great stuff you can do with them:
- Offset up to $3,000 per year in ordinary income
- Erase any capital gains distributions from your mutual funds
- Offset any capital gains from shares you sold to live on
- Offset any capital gains from shares you sold to rebalance
- Offset capital gains of real estate investments you sold
- Offset capital gains of your residence if your gain exceeds the $250,000 ($500,000 MFJ) exemption
- Offset the sale of a practice or other business
The losses can be carried forward indefinitely. All you have to do is swap from one investment with a loss to an investment that is not exactly the same but which has high correlation with the original investment (and which you'd be content to hold long-term.)
The third principle is to simply identify two acceptable options for every asset class in your taxable account. Why two? You're only going to tax-loss harvest every couple of months. That prevents any wash sales (the 30-day rule). It also prevents any dividends from being changed from qualified to non-qualified (the 60-day rule). If you wait 60 days, you never need more than one tax-loss harvesting partner.
How does that shake up in my portfolio? It looks like this:
Total Stock Market Index Fund
- Primary holding: VTI (Vanguard Total Stock Market Index ETF)
- Tax-loss harvesting partner: ITOT (iShares Total Stock Market Index ETF)
Right now, the ratio between those is about 1:5, but that will change as we donate appreciated shares of ITOT and direct new contributions toward VTI. And if the market really drops, we'll tax-loss harvest back from ITOT to VTI. These holdings have a ridiculously high correlation with each other, and they are both well-run, low-cost ETFs. Perfect partners.
Total International Stock Market Index Fund
- Primary holding: VXUS (Vanguard Total International Stock Market Index ETF)
- Tax-loss harvesting partner: IXUS (iShares Total International Stock Market Index ETF)
Our ratio here is much better. It's now 10:1. We have little in IXUS, because I recently tax-loss harvested a bunch of shares back to VXUS and we donated a bunch of really appreciated IXUS shares for our charitable contributions last year. These holdings also have a ridiculously high correlation with each other and, they are both well-run, low-cost ETFs. Again, perfect partners.
International Small Stock Index Fund
- Primary holding: VSS (Vanguard FTSE All-World ex-US Small Cap Index ETF)
- Tax-loss harvesting partner: SCHC (Schwab International Small Cap Equity ETF)
The ratio here is about 1:1 currently. This is one of my least favorite partners because SCHC doesn't include emerging markets stocks like VSS does, but it seemed to be the best ETF option.
Small Value Stock Index Fund
- Primary holding: VBR (Vanguard Small Cap Value Stock Index Fund ETF)
- Tax-loss harvesting partner: VIOV (Vanguard S&P Small Cap 600 Value ETF)
Some people may not like my small cap value holdings because they're not the smallest or the most value-y. They don't employ any sort of additional profitability screens either. But they are very cheap, very diversified, very liquid, and very similar to one another. They have a long track record too, particularly VBR. I've owned it or its fund equivalent for many years. The ratio here is currently 1:0 after recent tax-loss harvesting.
Muni Bonds
- Primary holding: VWIUX (Vanguard Intermediate Term Tax-Exempt Bond Fund)
- Tax-loss harvesting partner: VTEAX (Vanguard Tax-Exempt Bond Index Fund)
The partner has a slightly longer duration, but otherwise, these are both top-notch muni bond funds run by Vanguard. After recent tax-loss harvesting, the ratio here is currently 1:13, and it may not change any time soon. Good thing I'm happy with either. Interestingly, these are both funds, not ETFs. I really like Vanguard bond funds, but it only has one muni bond ETF. By using the traditional funds, I can have two good partners right at Vanguard at no additional cost. I actually prefer tax-loss harvesting using funds because you never have to worry about the market going up between selling the first and buying the second. You only have to put in one order, too.
The taxable account currently has nine ETFs. It seems unnecessarily complex until you realize the purpose behind having two funds in each asset class. We don't do any tax-loss harvesting of our real estate holdings (the transaction costs are too high and liquidity is too low). We haven't yet done any for inflation-protected bonds either. Actually, I'd never tax-loss harvested bonds before 2022, so I don't think the opportunity really comes up very often to get significant losses from bonds.
I hope explaining the nuts and bolts behind our investing accounts helps you to manage yours more effectively.
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Featured Real Estate Partners
What do you think? How many holdings do you have in your taxable account? Which ones and why? Comment below!
Thanks for this. I’m wondering where you recommend a primary residence in an ideal asset allocation? My family lives on the West Coast so our house is a sizable percentage.
I’d leave it out completely.
Jim, if I want to switch over all my Vanguard mutual funds into their ETF counterparts, is it doable, simple, and not a big taxable event?
And if that’s not possible, is it possible to tax loss harvest from a mutual fund (i.e., VTSAX) directly into another company’s ETF (i.e, ITOT) using Vanguard’s website?
Maybe a better question for Speakpipe if you’d rather I go that route. Thank you kindly.
Not all Vanguard funds have an ETF counterpart, but otherwise, yes it’s easy and not taxable.
Depends on what you mean by “directly”. The mutual fund sells at 4 pm and you can buy the ETF the next morning. Whether you can put an order in to buy the ETF at 3:55 pm that same day I’m not sure. Maybe you can since you have a couple of days to get the money in there and you’d have it in there a few minutes later. I think I’d probably try it and it would probably work but I’ve never actually done that.
Are you buying a tips ladder of individual tips held to maturity? You are rich enough not to bother as I’m sure your portfolio withdrawal rate is 2% or less with only 20% in tax deferred (and since you’ve been maximizing your 401k x 20 years that gives a good idea of your portfolio size). You would be old enough though to start buying new issue 30 years tips held to maturity to be spent in your 70s.
We actually did start buying some individual TIPS at Treasury Direct in the last year. I wouldn’t call our collection a ladder yet though. It’s not that organized. Most of our TIPS allocation is still in retirement accounts in SCHP.
Nice general primer. As we don’t presently have any heirs, why would we want to tax loss harvest now? It would only lower our tax basis for the future, when the gains might be larger and also the tax rates higher than in early retirement? What are we missing?
The deferred tax still has value, plus you can use $3K a year against ordinary income. But you’re right that it is less valuable for you than some others like me.
It’s interesting how quickly things change. There were a few weeks in between when I wrote this article and when it was published. As of today, the day it was published, the ratios look like this:
VTI:ITOT- 4:1
VXUS:IXUS-1:30
VBR:VIOV- 1:4
VSS: SCHC- 1:0
VWIUX:VTEAX- 1:0
The investment in a couple of those small tax-protected accounts changed from SV to REITS in the last month too.
Very illustrative of the fact that a portfolio is a living, growing, flowing thing.
Nice read! I Always enjoy your work. Question : Concerning tax loss harvesting, aren’t those funds too similar to exchange? VTI and ITOT are about as close to identical as you can get. Ditto for VXUS and IXUS. The differences are nearly insignificant. If audited (which sounds like it might become a more frequent occurrence…. Don’t get me started on that), I doubt an IRS agent would see those funds as significantly different. And trust me, the IRS isn’t your friend (my profit sharing pension is currently under audit and it’s been a complete nightmare).
# 1 I don’t know of anybody who knows of anybody who’s been audited on this point. So no, I have zero fear that I will be the first. If the IRS cares, they need to define “substantially identical” more clearly. The working definition right now seems to be the same CUSIP number.
# 2 My argument if I were audited on this point is that the two funds follow different indices, have different numbers of stocks, and actually hold different stocks. They’re put together by two different companies, have different amounts of embedded capital gains etc. The top ten holdings aren’t even in the same order. VXUS and IXUS have different amounts of qualified dividends too. Lots of differences to talk about. Heck, I’d pursue this one right into tax court so there would at least be some cases to look at. But I highly doubt that’s going to happen.
If you’re worried about it, use something else. Doesn’t bother me. But I don’t think you need to.
1. Well, now you do!
2. I see your point, but with all due respect I think you would lose if that were to ever go to court. Best of luck to you on that but as for me I’ll be choosing funds that are more measurably dissimilar. As someone who is actually going through the IRS audit process, believe me when I tell you that your ability to contest the IRS is limited and only applies to black and white issues. This is about as gray as one can get.
Hold on, you’re saying you or someone you know is being audited over tax loss harvesting and what is substantially identical? That’s what you’re implying with “1. Now you do!”
You’re being audited about your tax loss harvesting? Really? You might be the only one in the country. If that is true, you have no idea how interested I (and many others) are in the results of this audit. Are you willing to do a guest post or podcast interview about it once it’s wrapped up?
I never said my audit was over tax loss harvesting. I have no idea where you got that. What I did say is that my profit sharing pension is being audited. And, seeing as this is a medium to share ideas and experiences (it is, right?) I took the liberty of sharing that with you. Granted, that is a tax deferred account and obviously tax loss harvesting doesn’t apply to it. What does apply is my experience of dealing with an IRS auditor (my first) and I can tell you it isn’t something you’d wish on anyone. You are guilty until proven innocent and you want to be able to show irrefutable proof on every issue. Sure, you can employ a tax attorney to fight the government but it will cost you many thousands of dollars and in the end you’ll probably lose or settle. So, to your point, if my taxable accounts were ever audited, I’m simply saying that I wouldn’t want to be in the position of trying to prove definitively that my tax loss harvesting was valid because I exchanged one total market index fund for another. That sounds like bad advice to me.
Sorry, it wasn’t clear if that’s what you were saying or not. It would have been very interesting if so. But if not, my argument remains the same (and quite strong.)
I’m sorry you’re getting audited, but let’s be honest, most returns are not audited and this issue, as far as I know, has never been audited. I’m more than willing to not only be audited on it (if I have to be, obviously nobody wants that),and if I were to lose the audit, I’d take it to tax court.
What is your reason for not investing in Vanguard’s Total Bond Market Index Fund and Total International Bond Index Fund?
I keep my bonds very high quality and relatively short term, taking my risk on the equity side. For a long time my only nominal bond holding was the TSP G fund. Now I’ve had to put them in taxable so I use a muni bond fund. I don’t own corporate bonds or mortgage backed bonds.
I haven’t seen that international bonds add enough value to add yet another asset class to an already complicated portfolio.
What do you put in your HSA and 529 plans?
Thanks
HSA: 100% TSM
529: 50% TISM, 25% Vanguard SV, 25% DFA SV
Thanks!
Just to confirm:
TSM= Total US stock market?
TISM=Total International Stock Market?
SV=Small Value
DFA=Dimensional Funds?
Yes.
Jim awesome post as always and I always learn something new everytime you post. That’s interesting that you have chose US small cap value, but only International small cap with no value tilt. Any reason why? Was it b/c the cost of investing in international small value outweighed the premium you would get from investing in these factors? Or was it because international small value funds didn’t really exist when you chose your asset allocation? If that was the reason Avantis now has an international small cap value index you are interested in AVDV.
In the end doesn’t seem to matter much, you’re killin it!
When I started my portfolio more than 15 years ago there was no good international small fund available to me. So when Vanguard came out with one, I split my TISM into TISM and SI. If Vanguard came out with an international small value fund/ETF, I might swap into it. There are some ISV ETFs out there now, but I haven’t gone to any of them yet. Entirely possible I might in the future. Avantis and DFA both have ISV ETFs now. Avantis (AVDV) has an ER of 0.36%. DFA (DISV) has an ER of 0.42%. By comparison, VSS has an ER of 0.07%. That’s probably what has made me hesitate to change so far.
Thank you so much for the transparent article on your portfolio. It certainly helps to reaffirm the teachings in your book and podcasts.
Maybe a silly question, but did you actually move monies from the tax protected/deferred accounts into the taxable account and pay taxes on the distributions etc.; or did you only sell and reinvest into another asset class in the tax protected accounts?
Also, any reason why you are using the ETFs instead of mutual fund accounts (e.g. VTI instead of VTSAX)? Thanks again for all your contributions. Be well.
Thank you so much for the transparent article on your portfolio. It certainly helps to reaffirm the teachings in your book and podcasts.
Maybe a silly question, but did you actually move monies from the tax protected/deferred accounts into the taxable account and pay taxes on the distributions etc.; or did you only sell and reinvest into another asset class in the tax protected accounts?
Also, any reason why you are using the ETFs instead of mutual fund accounts (e.g. VTI instead of VTSAX)? Thanks again for all your contributions. Be well.
Second person to ask that “silly question.” No, I didn’t move money out of tax-protected. I sold one asset class in tax protected and bought another, then bought the first one in taxable. I’m moving asset classes out, not actual dollars.
The main reason I’m using ETFs is that there are more and better tax loss harvesting partners for the ETFs. Vanguard only has one total stock market fund, but iShares also has one. Both are free at Vanguard. But if my TLHing partner were a Schwab or Fidelity traditional mutual fund, I’d have to pay a big fee to buy and sell it. And otherwise, my partner becomes large cap index or 500 index, which really isn’t quite as much the same thing as another TSM fund.
But I can’t care all that much as my parents portfolio, including a taxable account, is all funds. It really doesn’t matter much when you’re using Vanguard funds. ETF. Traditional fund. Same same.