Difference between revisions of "User talk:LadyGeek/Principles of tax-efficient fund placement"

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(Tax efficiency table now in main article.)
(Discussion on low-yielding bonds)
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This table of tax efficiency lists low-yielding bonds as a 3% yield. In the current environment, I'd categorize low-yielding bonds at something <2%.
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--[[User:Assumer|Assumer]] 03:46, 21 November 2013 (CST)
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Propose this change to the ranking:
 
Propose this change to the ranking:
  

Revision as of 05:46, 21 November 2013

This table of tax efficiency lists low-yielding bonds as a 3% yield. In the current environment, I'd categorize low-yielding bonds at something <2%. --Assumer 03:46, 21 November 2013 (CST)

Propose this change to the ranking:

Very Efficient

   Money market and short-term bond funds
   Tax-managed stock funds
   Large-cap and total-market stock index funds 
   Muni bond funds

Efficient

   Balanced funds
   Small-cap or mid-cap index funds
   Value index funds

Moderately inefficient

   Total-market bond funds
   Active stock funds 

Very inefficient

   Real estate or REIT funds
   High-turnover active funds
   High-yield bonds

Tfb 19:59, 19 November 2013 (CST)

If you hold munis, they should be in taxable accounts, but putting them at the top of the list creates the incorrect impression that munis are good choices for your taxable account; usually, holding munis in taxable leads to about the same cost as holding corporate bonds of comparable risk.

And the real distinction is not short-term versus total-market bond funds, but the actual yields. When I first started thinking about asset location, short-term bonds yielded 5%, and even though stock dividends were taxed at your full tax rate (28% for me at the time), that was only on 2% yields with capital gains taxed well in the future at 20%. How about:

   Very efficient: bond funds with extremely low yields
   Efficient: bond funds with an after-tax yield less than stock yields
   Moderately inefficient: bond funds with an after-tax yield higher than stock yields
   Very inefficient: high-yield bonds

Grabiner 20:09, 19 November 2013 (CST)

It's not just the yield. The eventual capital gains matter too unless we all only invest for charity and heirs. Tfb 20:23, 19 November 2013 (CST)

I know that the capital gains matter; it turns out that the capital gains tend to approximately cancel out the fact that bond yields are non-qualified. The estimates in the article give about the same total tax cost for munis yielding 2% (2.67% taxable equivalent) as for stocks yielding 2% qualified held for 30 years.Grabiner 20:51, 19 November 2013 (CST)

Cash is missing.

Efficient

   Balanced funds
   Small-cap or mid-cap index funds
   Value index funds
   Cash

--LadyGeek 20:27, 19 November 2013 (CST)

Proposed tax efficiency ranking

Table is located in Template:Tax efficiency ranking of major asset classes. Insert the proposed changes in the table below.

Approximate Tax Efficiency Ranking for Major Asset Classes (4 buckets)
Most Tax Efficient

Place Anywhere
Tax Efficient Fund Placement - Arrow.png
Least Tax Efficient
Place in Tax-Free
or Tax-Deferred

Assets

Very Efficient

  • Money market, cash, short-term bond funds
  • Tax-managed stock funds
  • Large-cap and total-market stock index funds
  • Muni bond funds

Efficient

  • Balanced index funds
  • Small-cap or mid-cap index funds
  • Value index funds

Moderately inefficient

  • Total-market bond funds
  • Active stock funds

Very inefficient

  • Real estate or REIT funds
  • High-turnover active funds
  • High-yield corporate bonds
Approximate Tax Efficiency Ranking for Major Asset Classes (3 buckets)
Most Tax Efficient

Place Anywhere
Tax Efficient Fund Placement - Arrow.png
Least Tax Efficient
Place in Tax-Free
or Tax-Deferred

Assets

Efficient

  • Money market, cash, short-term bond funds
  • Tax-managed stock funds
  • Large-cap and total-market stock index funds
  • Muni bond funds
  • Balanced index funds
  • Small-cap or mid-cap index funds
  • Value index funds

Moderately inefficient

  • Total-market bond funds
  • Active stock funds

Very inefficient

  • Real estate or REIT funds
  • High-turnover active funds
  • High-yield corporate bonds

I assume "High-yield bonds" means High-yield bonds and not a bond with a high yield?

--LadyGeek 20:37, 19 November 2013 (CST)

Wiki already said the exact ordering within the categories, and between "Efficient" and "Very Efficient" are unclear. Maybe we should use just three buckets or even only two buckets and not worry about small differences which drift by person and over time.

Tfb 20:41, 19 November 2013 (CST)

Cash is entered twice, first as money market funds and then as cash.--Blbarnitz 20:52, 19 November 2013 (CST)

I missed that. To help new investors who may not realize cash and money markets are similar, I kept cash alongside money markets.

I created 2 tables side-by-side to visualize how 4 (original) vs. 3 buckets would look. I prefer the 3 buckets, as the subsequent examples (steps) in the main article only draw from the top or middle of the table. I don't think 2 buckets would work as it implies that the top is "good" and the bottom is "bad". You need a middle choice (neutral), which I think helps from a behavioral perspective. --LadyGeek 21:07, 19 November 2013 (CST)

Is there any significance to the order within each bucket? The arrow implies an ordered sequence (best to worst); do the fund rankings align in a similar fashion? --LadyGeek 21:51, 19 November 2013 (CST)

For the most part, the ordering is roughly correct. (The tables are sortable, set the tables from highest tax cost to lowest tax cost to get an idea of tax costs, and remember to include the range of eventual capital gains taxes that the stock funds incur upon sale). The major adjustment in the ordering is in the fixed income segment where current money market and bond yields are substantially lower than those assumed in the table; thus the elevation of money markets and short term bond funds in the hierarchy. One quibble is the position of balanced funds; active balanced funds are likely to be less tax efficient than indexed balanced funds. I tweaked the descriptions in the charts.--Blbarnitz 05:10, 20 November 2013 (CST)

The proposed tax efficiency table is in the main article for forum review. Replace Template:Tax efficiency ranking of major asset classes with the updated contents when complete. The example figures will need to be updated. --LadyGeek 20:04, 20 November 2013 (CST)