Unexpected Home Purchase - Portfolio Impacts for Stock/Bond Ratio (also: Taxes!)

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Noobvestor
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Unexpected Home Purchase - Portfolio Impacts for Stock/Bond Ratio (also: Taxes!)

Post by Noobvestor »

I've been comfortably renting and/or owning my entire adult life (back and forth), though when owning: it has always been cheap (LCOL, between 5% and 10% of NW historically). Now I'm very likely about to buy a new home, bringing my home ownership percentage up to around 20% of NW. This wasn't planned - a unique opportunity just presented itself and it's what we've been looking for more or less for years. I have no 'house fund' for it, though.

Here's the thing: to do it, I need to sell taxable investments. And of those, the ones with the least capital gains (about 10%) are bonds. The stocks in taxable have massive gains (most are 50-150%). So I either take a tax hit, or let my portfolio tilt a lot more toward stocks, or adjust other things. For context: I'm 65/35 now, at the edge of a rebalancing target (my ideal is 60/40). So selling bonds only will further skew my stock/bond ratio. Also worth noting: I have a 6-figure income and live in a high-tax state that treats cap gains as ordinary income, so trying to reduce those if possible.

So ... what to do? (1) I could try to slowly rebalance with new funds for years to bring myself back to my target stock/bond ratio - this would likely result in my being closer to 70-75% stocks for a while, which isn't ideal, but, well, maybe OK. (2) I could realize larger capital gains on stocks to make it happen faster. (3) The only thing I can exchange within tax-advantaged is emerging markets for bonds -- those (EM) are supposed to be 25% of my stock portfolio, are already only 15%, and will have to go to 0% if I let stock/bond ratio trump sub-ratios within stocks. The upside of this is that it minimizes the shift in stock/bond ratio, but the downside is that my portfolio calls for (and I want to have) that EM exposure.

It's not a position I was really prepared for, so I'm curious as to what you would do. Accept the equity skew and treat the new home as a kind of 'bond' temporarily or indefinitely? Sell high-cap-gain stocks in taxable to speed things along? Ditch my high-conviction EM play to balance things out?

I confess I always was skeptical of treating real estate like a bond, but faced with it myself: I'm not sure if there's a *better* option than doing so in this case. If I treat the home as a bond, I'll be 65/35. If I sell off all EM (seems extreme) I could maybe stay close to 65/35. I have income coming in, but we're talking on the order of maybe 5% of my current portfolio per year, so that's not going to add up fast. Any ideas or perspectives welcome.

P.S. I could also take out a mortgage, but am inclined to pay cash for simplicity and to seal the deal more definitively and quickly.
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Re: Unexpected Home Purchase - Portfolio Impacts for Stock/Bond Ratio (also: Taxes!)

Post by pokebowl »

Well another option (option 4?) if your portfolio can easily cover the costs initially is explore a SBL/PAL (Securities Based Lending/Pledged Asset Line) style leverage against your portfolio. It doesn't have to be for the full value of the home but whatever portion helps with your rebalancing. It would allow you to dodge the capital gains tax hit initially as well as the rebalance issue and you can (depending on the lender) pay it back as you go. The risk with this is obviously the interest rates are not locked in, and depending on the value of the home if you are exceeding a safe margin factor you risk a margin call during times of economic stress if the underlying assets are extremely volatile. That said, it sounds your portfolio will safely absorb the cost and its just the rebalancing and initial withdrawal of funds that are your focus of concern.

If that sounds too much hassle and risk, and a traditional mortgage is also off the table, I would recommend the tax hit and deduct a portion from both bonds and stocks that allows you to maintain your desired IPS without losing sleep. :beer You may save some taxes by following option 1 and 3, but sounds like the change in AA won't allow you to sleep at night. If it were me I'd first explore what PAL-style options were available to me then if unsatisfactory move on to your option 2 in order to maintain my AA but take the tax hit for one year.
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Re: Unexpected Home Purchase - Portfolio Impacts for Stock/Bond Ratio (also: Taxes!)

Post by celia »

Could you sell what you need to in Taxable (for the least tax hit), and re-balance in tax-deferred and Roth to get back to your Asset Allocation?
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.
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Re: Unexpected Home Purchase - Portfolio Impacts for Stock/Bond Ratio (also: Taxes!)

Post by Noobvestor »

celia wrote: Wed Jun 16, 2021 10:44 pm Could you sell what you need to in Taxable (for the least tax hit), and re-balance in tax-deferred and Roth to get back to your Asset Allocation?
I could get close on the 'stock' front (overall as an asset class) but I'd basically have to get rid of emerging markets entirely within that. Right now, my tax-advantaged accounts are entirely bonds and EM, so any stock-to-bond rebalancing there involves selling EM specifically. It could be a bit of a sunk cost fallacy, but I'd hate to ditch EM after a decade of lower performance only to see it shine again after getting rid of it for this one-off purchase.

I'd also hate to pay taxes on cap gains in taxable since my income is still fairly high and could well be lower in a few years (company was acquired so some bonus and RSU things going on bumping me up higher than usual, plus I might move to a lower-tax state later, retire early, etc...).
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Re: Unexpected Home Purchase - Portfolio Impacts for Stock/Bond Ratio (also: Taxes!)

Post by qwertyjazz »

I would ignore your signature block on diversification and go with the Boglehead thesis of costs matter. Minimize taxes. No one knows what an optimal AA. No one knows whether EM will help or hurt a portfolio.
I do know paying taxes is real money. Then with real new money (more of it as you are paying less in taxes) over time shift to whatever portfolio you want. Theory is fine until it hurts actual costs.
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Re: Unexpected Home Purchase - Portfolio Impacts for Stock/Bond Ratio (also: Taxes!)

Post by celia »

You could always get a short-term loan, say against a 401K where you pay yourself back, from a credit union, if you're already a member, or a rich uncle. It doesn't have to be a "mortgage" per se. Pay it back next January after you have diverted some of this year's income to pay it off. Then in January, you can also sell something in taxable to spread the tax hit over two years.

The way I wrote this sounds convoluted, but it is just a short term loan.
JustGotScammed
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Re: Unexpected Home Purchase - Portfolio Impacts for Stock/Bond Ratio (also: Taxes!)

Post by JustGotScammed »

Drop the bonds, buy the house, and add bonds back to your comfort level through future savings and perhaps redirecting dividends from your stockholdings.
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Re: Unexpected Home Purchase - Portfolio Impacts for Stock/Bond Ratio (also: Taxes!)

Post by mortfree »

Seems like the mortgage might be the simplest route.

Was your offer accepted and contract signed?
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Re: Unexpected Home Purchase - Portfolio Impacts for Stock/Bond Ratio (also: Taxes!)

Post by RickBoglehead »

Get a mortgage, because rates are low. Don't have a mortgage contingency, just a settlement date that meets that timing. Or get a short term loan to cover any weeks you need to.
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Re: Unexpected Home Purchase - Portfolio Impacts for Stock/Bond Ratio (also: Taxes!)

Post by simplesimon »

Noobvestor wrote: Wed Jun 16, 2021 10:02 pm P.S. I could also take out a mortgage, but am inclined to pay cash for simplicity and to seal the deal more definitively and quickly.
Based on your post is paying cash really that simple?

When you say seal the deal more definitively are you worried about not being able to get a mortgage?
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Re: Unexpected Home Purchase - Portfolio Impacts for Stock/Bond Ratio (also: Taxes!)

Post by grabiner »

If you pay cash for your home, your risk tolerance has increased, because your home is now providing part of your standard of living. When you rented, if you lost 20% of your portfolio, your standard of living would decline by 20%. But now, if you lose 20% of your portfolio, your home will still provide just as much housing.

Therefore, it is reasonable to sell bonds for the home purchase, as long as you can still sleep at night with the new allocation.

When I bought my home, I changed my allocation from 90% stock to 100% net stock. If I had paid cash, I would have sold all my bonds. I chose to take out a mortgage because I got a low rate, deductible interest, and avoided a huge capital gain on stock sales. At 100% net stock, I held bonds in my employer plan equal to my mortgage balance. (And when I paid off the mortgage early, I sold bonds, keeping the same stock exposure.)
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Re: Unexpected Home Purchase - Portfolio Impacts for Stock/Bond Ratio (also: Taxes!)

Post by sandan »

Noobvestor wrote: Wed Jun 16, 2021 10:02 pm I've been comfortably renting and/or owning my entire adult life (back and forth), though when owning: it has always been cheap (LCOL, between
I confess I always was skeptical of treating real estate like a bond, but faced with it myself: I'm not sure if there's a *better* option than doing so in this case. If I treat the home as a bond, I'll be 65/35. If I sell off all EM (seems extreme) I could maybe stay close to 65/35. I have income coming in, but we're talking on the order of maybe 5% of my current portfolio per year, so that's not going to add up fast. Any ideas or perspectives welcome.

P.S. I could also take out a mortgage, but am inclined to pay cash for simplicity and to seal the deal more definitively and quickly.
I think either or both options are fine.
-EM is going to be correlated enough with the total stock market and the housing market.
-A temporary shift of 10% decrease in bonds is no biggie. This is especially true in the sense that you are adding tangible/homestead assets into your portfolio. Here is a quick google of homestead laws by state. https://www.assetprotectionplanners.com ... -by-state/

A mortgage seems silly to me, especially in a LCOL. That's just a guaranteed loss in fees and less leverage in negotiation.
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Re: Unexpected Home Purchase - Portfolio Impacts for Stock/Bond Ratio (also: Taxes!)

Post by MBB_Boy »

pokebowl wrote: Wed Jun 16, 2021 10:34 pm Well another option (option 4?) if your portfolio can easily cover the costs initially is explore a SBL/PAL (Securities Based Lending/Pledged Asset Line) style leverage against your portfolio. It doesn't have to be for the full value of the home but whatever portion helps with your rebalancing. It would allow you to dodge the capital gains tax hit initially as well as the rebalance issue and you can (depending on the lender) pay it back as you go. The risk with this is obviously the interest rates are not locked in, and depending on the value of the home if you are exceeding a safe margin factor you risk a margin call during times of economic stress if the underlying assets are extremely volatile. That said, it sounds your portfolio will safely absorb the cost and its just the rebalancing and initial withdrawal of funds that are your focus of concern.

If that sounds too much hassle and risk, and a traditional mortgage is also off the table, I would recommend the tax hit and deduct a portion from both bonds and stocks that allows you to maintain your desired IPS without losing sleep. :beer You may save some taxes by following option 1 and 3, but sounds like the change in AA won't allow you to sleep at night. If it were me I'd first explore what PAL-style options were available to me then if unsatisfactory move on to your option 2 in order to maintain my AA but take the tax hit for one year.
+1. You think mortgage rates are low? Look at margin loans

Otherwise, sell the bonds
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Re: Unexpected Home Purchase - Portfolio Impacts for Stock/Bond Ratio (also: Taxes!)

Post by Noobvestor »

I have follow-up question, plus some responses below. What happens if the seller wants to defer the closing? Apparently they're building a new house they expect to have done in October (my agent told me). That's inconvenient but not unworkable for me. But he also mentioned the date was 'TBD' and I'm trying to figure out how nebulous that really is, what it means for locking into this deal (or not). I'm worried about two things: (1) in this crazy building environment, they could have delays, (2) I want this settled soon so I can make plans either way (buy or move on). Thoughts/experiences welcome!
mortfree wrote: Thu Jun 17, 2021 2:43 am Was your offer accepted and contract signed?
To clarify: the deal isn't signed/sealed though I had my agent reach out to see what they think about a cash offer - it's a condo in a slower-turnover building where other properties have sat for weeks or months (so I'm not terribly worried about competing bids). At my agent's request, I already handed over some screenshots (with account numbers removed) to show that I do indeed have the cash to buy.
mortfree wrote: Thu Jun 17, 2021 2:43 am Seems like the mortgage might be the simplest route.
I could get a mortgage, but if the money effectively would be in lower-rate bonds, I wonder: why bother? Like if I got a mortgage at something like 2.75% (what my agent thought I could get, more or less), but then put that money in Treasuries/TIPS yielding significantly less, well, it seems silly, no?
grabiner wrote: Thu Jun 17, 2021 9:55 pm If you pay cash for your home, your risk tolerance has increased, because your home is now providing part of your standard of living. When you rented, if you lost 20% of your portfolio, your standard of living would decline by 20%. But now, if you lose 20% of your portfolio, your home will still provide just as much housing.

Therefore, it is reasonable to sell bonds for the home purchase, as long as you can still sleep at night with the new allocation.

When I bought my home, I changed my allocation from 90% stock to 100% net stock. If I had paid cash, I would have sold all my bonds. I chose to take out a mortgage because I got a low rate, deductible interest, and avoided a huge capital gain on stock sales. At 100% net stock, I held bonds in my employer plan equal to my mortgage balance. (And when I paid off the mortgage early, I sold bonds, keeping the same stock exposure.)
I'm inclined to split the difference somewhat - let my stock allocation go a bit higher, but sell some EM too. I think the biggest thing is a variant of the sunk cost fallacy - basically, I'd hate to sell EM now more than ever after it's had a terrible decade, but it is what it is.

With my luck of course EM will completely devastate the competition this decade after I held it through a rough decade :oops:
MBB_Boy wrote: Fri Jun 18, 2021 9:14 am
pokebowl wrote: Wed Jun 16, 2021 10:34 pm Well another option (option 4?) if your portfolio can easily cover the costs initially is explore a SBL/PAL (Securities Based Lending/Pledged Asset Line) style leverage against your portfolio. It doesn't have to be for the full value of the home but whatever portion helps with your rebalancing. It would allow you to dodge the capital gains tax hit initially as well as the rebalance issue and you can (depending on the lender) pay it back as you go. The risk with this is obviously the interest rates are not locked in, and depending on the value of the home if you are exceeding a safe margin factor you risk a margin call during times of economic stress if the underlying assets are extremely volatile. That said, it sounds your portfolio will safely absorb the cost and its just the rebalancing and initial withdrawal of funds that are your focus of concern.

If that sounds too much hassle and risk, and a traditional mortgage is also off the table, I would recommend the tax hit and deduct a portion from both bonds and stocks that allows you to maintain your desired IPS without losing sleep. :beer You may save some taxes by following option 1 and 3, but sounds like the change in AA won't allow you to sleep at night. If it were me I'd first explore what PAL-style options were available to me then if unsatisfactory move on to your option 2 in order to maintain my AA but take the tax hit for one year.
+1. You think mortgage rates are low? Look at margin loans

Otherwise, sell the bonds
This is entirely new to me but I'm going to look into it more - thanks!
"In the absence of clarity, diversification is the only logical strategy" -= Larry Swedroe
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