"Asset Placement" Market Timing

[TripleB]

I'd like to propose a strategy that may or may not have been discussed previously. I think this strategy is only something possible in recent years, so maybe it is in fact "new" or maybe I just re-thought of something someone else here already has.

The theory is that most investors have limited tax-sheltered space and must make decisions on which assets place within sheltered accounts, and which assets to place within taxable, non-sheltered accounts. This decision has historically been made by tax-efficiency, whereby people would place equities in taxable accounts first, due to (a) a lower preferred capital gains tax (b) deferring tax until time of asset sale (c) ability to donate appreciated equity positions for a bonus tax break.

The theory continues in that cash gives all of it's earnings in the form of dividends that are immediately taxable at your marginal tax rate. Since long-term treasury bonds have some earnings from long-term capital gains of principal appreciation (or ability to writeoff losses of principal loss), it makes more sense to "protect" cash within the tax-shelter, then LT bonds. Nothing new so far in this thread, just summarizing the historical "best practices."

My idea is to constantly shift around what you are holding within your taxable accounts based on market conditions. I do not propose deviating from the traditional 4x25% PP ratios. I only propose making decisions on where to place those assets based on market timing.

Now that cash is yielding ~0% it seems silly to place it in tax-sheltered vehicles. You are essentially sheltering nothing.

An additional consideration that I've used for a long time is total tax liability. If you have a portion of your money in Roth IRAs, a portion in Traditional Deferred IRA/401ks, and a portion in taxable savings, then it makes sense to place the highest earning asset class within the Roth IRA, because those earnings will never be taxed. Historically equities have been the highest earning position, and while that may not be the case going forward, I like the idea of keeping equities within Roth IRAs as much as possible, to shelter future tax liability. I believe tax rates will rise in the future, long-term capital gains preferred rates will be discontinued due to mountain debt pressures over the next few decades, and as such, the Roth IRA seems to be the best place for equities.

There are costs associated with moving things between sheltered and non-sheltered accounts. Primarily in the form of taxes due on any capital gains on the taxable asset you are shifting. Let's examine some possibilities.

Scenario 1) You are using the traditional format of equities and perhaps gold coins in taxable, and cash and bonds in sheltered. Interest rates are dropping on the cash. This is caused by government intervention to try to cause the stock market to recover. I believe anytime interest rates on cash are falling, it's likely because the stock market is doing bad. Thus investors are "flocking" to the "safety" of cash, and also governments lower interest rates to make cash less attractive and encourage stock buying.

In this example, your taxable equities have lost money, and now you have cash in the tax-shelter earning 0%. You sell the stocks in taxable, get a nice tax-break, and repurchase them in the tax-shelter with your cash. Then you keep the stocks sold within the taxable account as cash. Basically keeping the same AA% but shifting the location while recognizing a tax break.

In the future, cash interest rates rise as the stock market recovers. You then do another reversal where you buy stocks in taxable, and trade stocks for cash within the shelter. You have no net cost here, because when you "sold" the cash within taxable, there is no capital gains realized.

The additional benefit is that since the stock market has "recovered" there's a decent chance that the stock market will correct itself and drop again. In other words, consider two separate situations:

a) Stock market raises 10%
b) Stock market drops 10%

It's more likely that situation A will result in a subsequent stock market drop, than situation B. Anything is possible, however, and being "wrong" here does no harm. I only outline an additional benefit, in that in this scenario, the market recovers so you shift taxable cash back into stocks, and if the market declines again, you can do tax-loss harvesting on your higher cost-basis stock holdings, as compared to if you never did this cash-to-stock location switch, and kept the older low cost-basis of the stock position.

Scenario 2) You have limited tax-sheltered space and have used 100% of the shelter for cash because it's the most tax inefficient.

It's 2005 and interest rates are dropping. My strategy would advocate tactically shifting the long-term treasury bonds into the tax shelter, and the cash into taxable. Since interest rates are dropping, it means that the bonds are experiencing principal growth. This growth will be taxable. If you switch the bonds into a Roth IRA before the growth has occurred, you can avoid ever paying taxes on this growth.

Since interest rates are falling, having the cash in the taxable account is less bad because you aren't paying much or any taxes on the dividends.

The obvious fallacy here is knowing whether interest rates are dropping or rising. If you're wrong, and interest rates rise, then you just shifted bonds into the Roth IRA, and have reduced the relative capacity of your tax-shelter because the value dipped. You also suffered a tax-hit on the capital gains experienced in the bond that you had to sell in order to shift it into the Roth IRA. Thus, you lost money, too.

Scenario 2 seems like a risky method of using a tactical placement strategy. Scenario 1 seems less riskier. I imagine we can speculate on a few other scenarios of market situations that could be good or bad to use this idea on.

[Gumby]

You sell the stocks in taxable, get a nice tax-break, and repurchase them in the tax-shelter with your cash. Then you keep the stocks sold within the taxable account as cash. Basically keeping the same AA% but shifting the location while recognizing a tax break.

I believe the IRS will consider this a "wash sale" if you repurchase the same asset in your IRA, within a 30 day period. It's an interesting idea though.

[TripleB]

You sell the stocks in taxable, get a nice tax-break, and repurchase them in the tax-shelter with your cash. Then you keep the stocks sold within the taxable account as cash. Basically keeping the same AA% but shifting the location while recognizing a tax break.

I believe the IRS will consider this a "wash sale" if you repurchase the same asset in your IRA, within a 30 day period. It's an interesting idea though.

The IRS will consider this a "wash sale" if you repurchase the same, or a significantly similar asset within a 30 day period. However, if I sell TSM fund from taxable and re-buy SP500 Index Fund in the IRA, there is no wash sale. I can then wait 30 days and shift SP500 back into TSM within the IRA, and since it's in an IRA, even if the SP500 had a gain in the 30 days, there's no taxable event. If I wanted to be technical, I could buy 80% SP500 index fund and 20% Extended Market Index fund within the IRA, and essentially be identical to the TSM I tax-loss harvested, but remain in the same market position, and avoid wash sale rules.