The nuts and bolts of investing

By Bill Jackson February 10, 2023 19 mins read 286 Views

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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

Backdoor Roth IRA Millionaire

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

nuts and bolts of investing

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:

The New WCI 401(k)

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.

If you're interested in pursuing real estate investing and working with some of the WCI-vetted partners that I invest with, here are some of the best companies in the business.

Featured Real Estate Partners

Wellings Capital

Type of Offering:

Fund

Primary Focus:

Self-Storage / Mobile Homes

Minimum Investment:

$50,000

Year Founded:

2014

Type of Offering:
Fund

Primary Focus:
Self-Storage / Mobile Homes

Minimum Investment:
$50,000

Year Founded:
2014

The Peak Group

Type of Offering:

REIT

Primary Focus:

Single Family

Minimum Investment:

$25,000

Year Founded:

2000

Type of Offering:
REIT

Primary Focus:
Single Family

Minimum Investment:
$25,000

Year Founded:
2000

37th Parallel

Type of Offering:

Fund / Syndication

Primary Focus:

Multi-Family

Minimum Investment:

$100,000

Year Founded:

2008

Type of Offering:
Fund / Syndication

Primary Focus:
Multi-Family

Minimum Investment:
$100,000

Year Founded:
2008

DLP Capital

Type of Offering:

Fund

Primary Focus:

Multi-Family

Minimum Investment:

$200,000

Year Founded:

2008

Type of Offering:
Fund

Primary Focus:
Multi-Family

Minimum Investment:
$200,000

Year Founded:
2008

Mortar Group

Type of Offering:

Syndication

Primary Focus:

Multi-Family

Minimum Investment:

$50,000

Year Founded:

2001

Type of Offering:
Syndication

Primary Focus:
Multi-Family

Minimum Investment:
$50,000

Year Founded:
2001

Origin Investments

Type of Offering:

Fund

Primary Focus:

Multi-Family

Minimum Investment:

$50,000

Year Founded:

2007

Type of Offering:
Fund

Primary Focus:
Multi-Family

Minimum Investment:
$50,000

Year Founded:
2007

MLG Capital

Type of Offering:

Fund

Primary Focus:

Multi-Family

Minimum Investment:

$50,000

Year Founded:

1987

Type of Offering:
Fund

Primary Focus:
Multi-Family

Minimum Investment:
$50,000

Year Founded:
1987

Southern Impression Homes

Type of Offering:

Turnkey

Primary Focus:

Single Family

Minimum Investment:

$65,000

Year Founded:

2017

Type of Offering:
Turnkey

Primary Focus:
Single Family

Minimum Investment:
$65,000

Year Founded:
2017

* Please consider this an introduction to these companies and not a recommendation. You should do your own due diligence on any investment before investing. Most of these opportunities require accredited investor status.

What do you think? How many holdings do you have in your taxable account? Which ones and why? Comment below!

The post The Nuts and Bolts of Investing appeared first on The White Coat Investor - Investing & Personal Finance for Doctors.

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By: The White Coat Investor
Title: The Nuts and Bolts of Investing
Sourced From: www.whitecoatinvestor.com/the-nuts-and-bolts-of-investing/
Published Date: Fri, 10 Feb 2023 07:30:31 +0000

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