Using PP for part of allocation
Moderator: Global Moderator
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Brad243480
Using PP for part of allocation
Does anyone else use the PP for part of their allocation and then a stock index investing style for another part? Say half and half. About half of my investable assets are in tax-deferred accounts--if I were to employ this strategy, should I put all of the PP in the tax-deferred and have the 100% stock allocation in the taxable, or vice versa? Thank you.
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pplooker
Re: Using PP for part of allocation
I do that almost exactly, 50/50 except my VP has a fixed income component to it. Here's what I do, and it's not necessarily correct. First, count the indexing style side as your Variable Portfolio or VP. Also, I’m assuming it’s possible the VP isn’t necessarily all index funds per se, there could be some TIPS or a REIT or something like that in there too.
Second, try not to think of it as two portfolios for purposes of this exercise. Realize it's really one big portfolio that's a hybrid. For example if the PP slice is 25% gold and the VP slice is 0% gold, what you really have is one portfolio that's 12.5% gold, right? Similarly if your VP is 35% total stock market index and the PP is 25% TSM, the combined portfolio is 30% TSM.
This isn’t exactly what I do but it’s pretty close for all intents and purposes.
Example PP:
25% VTI 25% TLT 25% IAU 25% I bonds (for cash)
Example VP:
35% VTI 35% VEU 30% TIPS
Overall positions:
30% VTI
12.5% TLT
12.5% IAU
12.5% I bonds
17.5% VEU
15% TIPS
You probably have at least one component in common, IE the total stock market index fund or ETF and possibly whatever you use for cash.
I unfortunately do not have any problems at present tax sheltering all of it but I do go in order of tax efficiency. First, any TIPS or REITs must absolutely be tax sheltered. You don't have this problem but its useful to think about it for conceptual purposes. I wouldn’t even buy a TIPS outside of a tax advantaged account.
Then your fixed income.
The conventional wisdom then says cash, then stocks, but I don’t think that matters so much as putting the bonds (especially zero coupon bonds imho) and heinously inefficient things in first. I personally don’t bother with tax sheltering the cash because I use I bonds which are tax advantaged already, so I accomplish that via other means essentially.
Gold doesn’t pay any interest or dividends, so to be honest I don’t hold it in a tax advantaged space at all as I rarely sell. I could but for now I choose not to. If my gold allocation gets too far out of whack, I just shift my buying to the other slices for a while but if your portfolio is larger you probably can’t do that so easily as I can. Between that and the I bonds, I feel I have a significant portion of my portfolio immediately accessible without a withdrawal penalty or paperwork should I truly need it, and I like that. Others may feel differently.
In our example here I’d tax shelter things in this order:
TIPS – by far the least tax efficient thing here. This goes in first no matter what.
Then TLT second no matter what as our only other fixed income item.
At that point the stock ETFs with no priority given to one over the other. If you can’t shelter all the stocks, I’d just split the difference between them in the tax advantaged space and hold the rest in taxable accounts.
IAU would be next because it’s the lowest priority thing to shelter.
I bonds – take care of themselves and are left out of this analysis, but if instead I were using SHY for cash instead I would probably put that in ahead of the stock ETFs. I’ve noticed most PP investors really don’t use cash but rather short term bonds of some kind be it I bonds or short term treasuries. If I were using a money market account for cash I’d probably put that in ahead of the stocks as well if tax efficiency were my only consideration. While the yield is negligible right now, who knows in the future?
Does that make sense? Essentially what I’m doing is putting the tax help where it’s needed the most rather than worrying about one account being the PP and one being the VP. It makes for more difficult mental accounting of course, but I use a spreadsheet to put the whole thing in a presentation that reconciles it to the mindset that it’s two different portfolios.
Really there’s nothing wrong with thinking yet another way and having “tax diversification”?. Some people fear for good reason that they will be at a disadvantage keeping their wealth entirely in tax advantaged space. I don’t necessarily follow that, but I understand it.
If I were to buy into that, I’d keep the PP separate and in a taxable account but that’s just me because VPs tend to have the less tax efficient things or strategies in them.
Really both the PP and the index fund portfolio are relatively tax efficient already so long as you don’t have a very inefficient holding thrown in there. A “pure”? indexer likely uses total bond market or intermediate treasuries anyway, and it wouldn’t be the absolute end of the world to be taxed on that or your 30 year treasuries if the trade off is that you sleep better.
The exact instruments used will result in different "optimal" setups but the principles should be the same.
In your case since the VP is all stock, you’d just put in the treasury bonds first, then possibly the cash depending on what you use for cash or what your needs are, and then as much of the stock as will fit. Basically you’ll have to decide if it’s better to shelter the stocks or the cash first, so shelter one and then the other before moving on. Recall in my example I use I bonds so I don’t have to worry about this decision amd it's stocks by default. Then if there’s any room for gold, the gold.
It also may matter if you have some kind of tax loss harvesting system in place how I'd advise allocating it. I personally don't bother as my unique tax situation wouldn't benefit from it.
Second, try not to think of it as two portfolios for purposes of this exercise. Realize it's really one big portfolio that's a hybrid. For example if the PP slice is 25% gold and the VP slice is 0% gold, what you really have is one portfolio that's 12.5% gold, right? Similarly if your VP is 35% total stock market index and the PP is 25% TSM, the combined portfolio is 30% TSM.
This isn’t exactly what I do but it’s pretty close for all intents and purposes.
Example PP:
25% VTI 25% TLT 25% IAU 25% I bonds (for cash)
Example VP:
35% VTI 35% VEU 30% TIPS
Overall positions:
30% VTI
12.5% TLT
12.5% IAU
12.5% I bonds
17.5% VEU
15% TIPS
You probably have at least one component in common, IE the total stock market index fund or ETF and possibly whatever you use for cash.
I unfortunately do not have any problems at present tax sheltering all of it but I do go in order of tax efficiency. First, any TIPS or REITs must absolutely be tax sheltered. You don't have this problem but its useful to think about it for conceptual purposes. I wouldn’t even buy a TIPS outside of a tax advantaged account.
Then your fixed income.
The conventional wisdom then says cash, then stocks, but I don’t think that matters so much as putting the bonds (especially zero coupon bonds imho) and heinously inefficient things in first. I personally don’t bother with tax sheltering the cash because I use I bonds which are tax advantaged already, so I accomplish that via other means essentially.
Gold doesn’t pay any interest or dividends, so to be honest I don’t hold it in a tax advantaged space at all as I rarely sell. I could but for now I choose not to. If my gold allocation gets too far out of whack, I just shift my buying to the other slices for a while but if your portfolio is larger you probably can’t do that so easily as I can. Between that and the I bonds, I feel I have a significant portion of my portfolio immediately accessible without a withdrawal penalty or paperwork should I truly need it, and I like that. Others may feel differently.
In our example here I’d tax shelter things in this order:
TIPS – by far the least tax efficient thing here. This goes in first no matter what.
Then TLT second no matter what as our only other fixed income item.
At that point the stock ETFs with no priority given to one over the other. If you can’t shelter all the stocks, I’d just split the difference between them in the tax advantaged space and hold the rest in taxable accounts.
IAU would be next because it’s the lowest priority thing to shelter.
I bonds – take care of themselves and are left out of this analysis, but if instead I were using SHY for cash instead I would probably put that in ahead of the stock ETFs. I’ve noticed most PP investors really don’t use cash but rather short term bonds of some kind be it I bonds or short term treasuries. If I were using a money market account for cash I’d probably put that in ahead of the stocks as well if tax efficiency were my only consideration. While the yield is negligible right now, who knows in the future?
Does that make sense? Essentially what I’m doing is putting the tax help where it’s needed the most rather than worrying about one account being the PP and one being the VP. It makes for more difficult mental accounting of course, but I use a spreadsheet to put the whole thing in a presentation that reconciles it to the mindset that it’s two different portfolios.
Really there’s nothing wrong with thinking yet another way and having “tax diversification”?. Some people fear for good reason that they will be at a disadvantage keeping their wealth entirely in tax advantaged space. I don’t necessarily follow that, but I understand it.
If I were to buy into that, I’d keep the PP separate and in a taxable account but that’s just me because VPs tend to have the less tax efficient things or strategies in them.
Really both the PP and the index fund portfolio are relatively tax efficient already so long as you don’t have a very inefficient holding thrown in there. A “pure”? indexer likely uses total bond market or intermediate treasuries anyway, and it wouldn’t be the absolute end of the world to be taxed on that or your 30 year treasuries if the trade off is that you sleep better.
The exact instruments used will result in different "optimal" setups but the principles should be the same.
In your case since the VP is all stock, you’d just put in the treasury bonds first, then possibly the cash depending on what you use for cash or what your needs are, and then as much of the stock as will fit. Basically you’ll have to decide if it’s better to shelter the stocks or the cash first, so shelter one and then the other before moving on. Recall in my example I use I bonds so I don’t have to worry about this decision amd it's stocks by default. Then if there’s any room for gold, the gold.
It also may matter if you have some kind of tax loss harvesting system in place how I'd advise allocating it. I personally don't bother as my unique tax situation wouldn't benefit from it.