Hey everyone, it’s Finance Fridays again. Just like I promised I’m going to kick off my new Finance Fridays series talking about Taxable Accounts.

Stock Photo from: Pixabay

Why has it taken you so long to discuss this?

It was all on purpose actually. I wanted to make sure before you went down this road, that everyone had already prioritized the other things on The Checklist.

While it may seem amazing to some, there are still those who do this step first, wayyyyy before maximizing their 401k/403b and, if available, 457. There are people who like to talk about how they made $1000 or something in the last week because they bought and sold Apple or Amazon or whatever. However, those same people haven’t maximized their 401k/403b/457, are paying the minimum on their Student Loans, and even carry Credit Card Debt.

Their priorities are backwards.

For that reason, I didn’t want to bring it into the picture until the other things are the Checklist were all over this little blog of mine.

Why not? Did you not trust me (us)?

Well… no. But don’t feel bad – I don’t even trust myself – when it comes to taxable accounts.

Like I’ve said before, I tend to tinker, and that is the worse possible thing to do when saving for retirement. It’s a slippery slope, especially for physicians.

Sweeping Generalization Starts

As physicians we have always tried to “shoot for the top”.

Need to get straight As. Have to ace the MCAT. Get into the best medical school. Need to ace Step 1. Have to get into the best residency.

Have to be the best. Got to be the best. Need to be the best.

Sweeping Generalization Ends

This mindset has served us well for the majority of our careers. However, it is absolutely horrible when it comes to investing.  The well-ingrained idea that you can get more by working harder – doesn’t work, when it comes to investing. It’s the most difficult principle to teach in the Boglehead style of investing.

Don’t just do something… stand there!

This is a rearrangement of the more common quote: “Don’t just stand there, do something.” However, its meaning is very deep. In a time of stress or crisis, the initial, and often emotional reaction is to do something.

Sometimes the best course of action is no action.

The Boglehead style of investing is designed to not do anything or do as little as possible.

To be honest, this is also an important phrase to keep in the back of your mind when it comes to medicine. Sometimes the best treatment is no treatment. 

I see, so it was to “protect” us?

Well, kind of. It was more to protect me from myself — and you from myself.

Like I’ve said numerous times, I love to tinker. The prototypical physician investor above who believes that they can “get more by working harder” is definitely me. I am well aware of my own tendencies and for that reason I have put off on writing these kinds of posts. When I research new things, I tend to want to try them out, like what happened with my 529.

A little bit of knowledge can be dangerous, especially in the hands of a novice.

Let me reiterate again before continuing.

Knowing more does not necessarily give you an edge – when it comes to investing.

Ok, I think I’ve got my own tendencies in check now, can we move on?

Ok.

However, this part is kind of boring. It’s just more of the same.

In my opinion, after The Checklist, the money you put into your taxable account should simply be an extension of your retirement account. It should mirror the same asset allocation that your retirement accounts have.

For example, if your 401k is a three fund portfolio with an 80/20 split, then your taxable account should be the same thing, or the closest approximation.

There is some discussion as to whether you should consider your 401k/403b/457/Roth IRA and your taxable account as separate entities. Some prefer to see it as all parts of the same pie and balance accordingly. Others like to balance their retirement accounts at a certain allocation and their taxable accounts as a different allocation. To be honest, it probably doesn’t make a huge difference overall.

Here is an important point to consider.

Are you able to achieve your financial goals without the taxable account?

For example, you and your spouse are able to put away $53k a year each as you are both partners in your respective practices. You were both very lucky to stay at these jobs from early in your career and didn’t waste too many years on Temporary First Jobs. Also, you’ve been doing your Backdoor Roth IRA every year like clockwork. With your current budget your house will be paid off by retirement as well as your student loans. In this scenario, without a taxable account you are both pretty much set for a normal retirement.

However, if this same couple wants to retire early, then most likely they will want to need to make use of a taxable account in order to pay for the years before age 59, because of the early withdrawal penalties of retirement accounts.

Could they still probably withdrawal early despite the penalty and be ok? Maybe.

However, a 10% penalty is a bitter pill to swallow. So then, when planning to retire early, it’s probably a good idea to have money that you can access before needing to take a penalty. Other ways to do this would be downsizing by selling their house and renting or buying a smaller house or having money saved in other areas. Ideally, if you had some way to obtain passive income, that would be an ideal way to help you retire early.

Ok, well let’s say I can only achieve my financial goals with a taxable account, what then?

Well then, it’s probably in your best interest to stay the course and treat your taxable account like an extension of your retirement account.

Is this efficient? No, however, it’s what is available to you. There are other places to invest of course, like real estate, etc. However, this post is about taxable accounts.

Is there a way to be more tax efficient with this taxable account?

Yes. However, it requires understanding of your marginal income tax bracket and alternative minimum tax. You also will need to understand which particular assets are tax efficient versus inefficient. In general, you’d prefer tax inefficient items to be in your retirement accounts (tax exempt) and the tax efficient items to be in your taxable accounts. However, it’s not always that easy because most likely the majority of your assets will be in the retirement account relative to your taxable account.

Going over this would require a whole other post (or even series of posts) to discuss further.

What about tax loss harvesting?

I’ve mentioned tax loss harvesting before when I did my post about Roboadvisors. Speaking of which, I should probably update that post because a few changes have occurred.

Tax loss harvesting is when you sell a security and then accept its loss. You then buy a similar security. This helps to offset taxes on the gains and income. How much this helps remains to be seen. However, it’s one the major selling points for Roboadvisors currently:

• Betterment suggests 0.77% gain from tax loss harvesting from January 2000 to December 2013.
• Wealthfront suggests “Between 2000 and 2011, our research shows Tax-Loss Harvesting would have increased your after-tax returns by more than 1.55% a year.”

But one might ask, why did they choose those particular time periods? I’m going to guess because they included the financial crisis of 2007-2008.

What would the difference be for January 2000 to January 2008 during the bull market? Can Tax-Loss Harvesting consistently provide enough to offset the management fee? I’m not sure.

In my opinion, tax loss harvesting isn’t all that easy to do without it being automated for you, unless you are keeping tabs on things yourself. I may do a full post on this at some point as well, if those are interested.

What if I can achieve my financial goals without a taxable account, what then?

Well then, you are probably allowed to be more aggressive than your normal retirement allocation.

For example, you can go 90/10 or even 100% stocks if you want. That’s probably reasonable.

However, only gamble with money you are ok losing, remember?

Or if you want to be a stock picker, you could try your hand at buying and selling Apple or Amazon or whatever. Just remember, you’re gambling.

I see, so more of the same if it’s for retirement. But gambling is still gambling?

Yup!

Next week I’ll talk about Dividend Stocks.

TL;DR

Everything before this series of posts was to make sure we keep our own tendencies in check (mine included).

A taxable account should be an extension of your retirement if it is required for your retirement goal.

Taxable accounts can be made more tax efficient, but this is whole other post.

Tax loss harvesting can be helpful, but may prove difficult for some, unless you are using a Roboadvisor.

Do the benefits of Roboadvisors outweigh their management costs? It may for some, but not for others.

If it is not required, then you are significantly more flexible.

However, gambling is still gambling. Only gamble with money you are ok losing.

-Sensei

Agree? Disagree? Questions, Comments and Suggestions are welcome.

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