Gyroscopic Investing

I've made a few posts regarding offsetting gold gains with as many capital losses as you can (ie, sell shares of VTI or TLT that are worth less than some previously purchased shares to have a capital loss to offset the gold gains, and then purchase some other reasonable substitute for VTI or TLT).  I've been pondering this, and I think I've been not seeing the forest through the trees.

In any given year, any capital losses you've obtained SHOULD be realized.  If you started investing in Yr 1 with $1000 in you stock portion, and it fell to $900 by year two, TAKE the loss, and reinvest in something similar (sell VTI and invest in the S&P 500 index).  The last part is to avoid the wash-sale rule, which tries to prevent people from doing exactly this but staying invested in the same fund.  If you expand this to, say, a $5,000 loss, one of the following will happen on your 1040:

1) You can offset up to $3,000 of ordinary income.  If you're in the top bracket (35%), and throw another 5% state on there, you'll save $1,200 in taxes any year you can do this. The other $2,000 will be forwarded to the following year, but could very well have the same effect.  This, in effect, takes a 40% deduction TODAY, and will give you a 20% (15% cap gain + 5% state) gain in the future... hopefully far into the future.

2) You will either offset gold gains that you were forced to realize (28%+5%=33%) or typical stock/bond capital gains (15%+5%=20%).  Either way, this will help you defer taxes into future years... yet another advantage of a portfolio with volatile pieces.

I'm surprised this thread doesn't have responses yet!

I had never thought about skirting the wash sale rule using that method before. Pretty brilliant really. I am hunting for a way to skirt the wash sale for the gold portion but I have had no luck. I'm guessing swapping GLD for IAU is a no-no. I bet GTU would work but I don't like the way it trades, I think it's because of the silver component.

I am also hunting for a safe swap for TLT. Maybe EDV blended with an intermediate term fund. This tax avoidance strategy has helped me see the benefit of a ladder. The IRS can't argue with selling a 28 year treasury and then immediately buying a fresh 30 year. Besides, we want the most duration we can get our hands on. Trading individual bonds isn't a smart choice with my brokerage set up right now though...

I did some research on exactly how close in securities you can purchase, and there isn't any bright line.  I, personally, tend to take somewhat aggressive tax positions where there is no bright line and my position seems reasonable.

I would say that TLT & EDV, as well as an S&P vs. TSM index are reasonable to say they are different securities.  I'm not sure about gold, though, though I'd be much less apt to try to take losses with gold, as you're giving yourself a possible 28% future gain as opposed to 15% with stocks/bonds.  Obviously you're still deferring and possibly reducing your taxes, though.

Also, be aware you may be subject to certain expenses by buying/selling more often. 

Luckily I get free equity/etf trades

Moda, if you ever find a good solution for the gold or treasuries please post here. Looking over EDV vs. TLT, it is too different for me, even if I were to only hold it for 30 days. This strategy gets me excited because I love free lunch!

I really think the PP shines in a taxable account because the PP can be used as a hyper-charged savings account. I put money into the PP that I may need in as a little as 5 years.

You could purchase LT treasuries directly.  EDV is different, but if you're only moving an amount for 1 month that would reap you a $3,000, maybe it wouldn't be all that much of your portfolio.

melveyr wrote: I had never thought about skirting the wash sale rule using that method before. Pretty brilliant really. I am hunting for a way to skirt the wash sale for the gold portion but I have had no luck. I'm guessing swapping GLD for IAU is a no-no. I bet GTU would work but I don't like the way it trades, I think it's because of the silver component.

GTU has no silver (perhaps you're thinking of CEF which is about 50/50 gold and silver).  If you're looking for a "wash free" way to realize losses in GLD, I think GTU is a pretty good bet - just make sure the premium isn't too high when you buy in.  The premium is currently -1.2%, i.e. $98.80 buys shares backed by $100 of assets - $97.10 of gold bullion, $1 of gold certificates, and $1.90 cash (see http://www.gold-trust.com/asset_value.htm).  Another alternative is PHYS which currently trades at a 0.87% premium.

Great stuff as usual, moda.  I've been trying to use a strategy similar to this myself but your reasoning and implementation approach is much more refined than mine.

The only "downside" that I can really think of is that you just need to schlep along this (potentially ever-growing, depending on how you add to the PP) capital loss from year to year on your tax returns.  But when you strike a rebalance band on gold, you'll be so glad to have it!

Come to think of it, I could see worries about a collectibles tax hit making a person hesitate (just ever so slightly) when it is time to sell some gold.  28% of your gains vanishing is nothing to sneeze at.  Having that capital loss available to cushion the blow seems smart.

I think that smart tax planning (while sticking to the PP guidelines) may be the "last frontier" in effectively implementing the Permanent Portfolio.  The 4x25 works really well and probably doesn't need a lot of improving.  Proper tax planning, though, is kind of an ever-evolving beast and can vary a lot from person to person.

I agree that tax-planning is huge.  It is different for everyone though, you are correct.  I also find "FAFSA Planning" to be very closely joined at the hip with tax planning, especially after recent posts made in the Saving for College thread.

28% is a hard one to swallow.  That's why it's nice if you have enough income coming in to contribute to the laggards and avoid hitting a rebalance point.  If you really were looking at it in a mathmatical way, you maybe would have the gold upper band be slightly higher than the rest, or allow your bands some wiggle room depending on your tax loss-carryover situation.  For instance:

If you go all in to the PP in a given year, and 1 year later, you've hit your 35% gold band.  You could say to yourself "I'm at 35%, so I must sell," or you could say, "Well it looks like I'm at 35%, but if I sell, they've taken 28% (+5% state (estimate)) of the gains, which means that there is a built in piece of my 35% that's not really mine, but the IRS'... so I'm not going to rebalance this until MY tax-free piece of gold ownership is 35%, or when the whole thing is 38%, or whatever.  Meanwhile, somone with a fat carryover loss should look at rebalancing gold differently than someone without that loss.  It may seem wrong to allow your bands to move (since that puts you in a position of timing the market), but as long as you kept it scientific based on tax factors, I think it's completely legit.

The "shlepping along" isn't really a  downside, since you wouldn't even be getting these losses to begin with.  Like I said, your loss with either:

1) offset $3,000 of ordinary income (up to 35%+5% state)
2) offset a gold gain (28%+5%)
3) offset a capital gain (15%+5%)
4) "shlep" along to next year... yeah, we'd all rather have it offset gains, but it's not really a "downside"

If you've captured the loss with bonds or stocks, you've given yourself a future capital gain at what could be a realized ordinary or collectibles reduction in income today.  It's really win/win.  Also, think about this regarding rebalancing bands.  If you're selling/rebalancing you could very well be dealing with 40% or more of your sale being capital gain if it's in a taxable account.  If 1/3 of your gain is taxed, then you're looking at 13% of your sale being confiscated.  So you're effectively saying, "I'm going to sell $100 worth of gold so I can buy $87 worth of stocks & bonds."  Obviously, being too far out of balance can cause bigger problems, but this should, at least, make tax-deferred accounts look much more attractive when you start to think about having to make some of these decisions.

moda0306 wrote: The "shlepping along" isn't really a  downside, since you wouldn't even be getting these losses to begin with. 

I completely agree.  Sorry for being unclear.  To be more specific, I only meant that you have to make sure you properly carry over losses from previous years when you fill out your tax returns.  It's nothing more than a small additional bookkeeping step.  A very small price to pay, considering that the rest is all upside!  (I mention it only because I've heard people complain about it when I talk about the idea of tax loss harvesting.  "Too much work", "That's confusing", etc.)

Speaking of tax-deferred accounts: once you start examining how powerful tax deferred accounts are, it gives you some hint as to how important it is to not pay taxes unnecessarily when a little tweaking could let you keep more of your investment income!

Tax planning seems like the best place to invest spare "tinkering energy" one might have left to burn if the 4x25 leaves them with too much time on their hands. 

One more idea:

Maybe the bands should stay the same, but in your taxable accounts you impliment a "partial rebalance" in that when you hit the 35/15 bands, you rebalance to 30/20.

This probably hasn't proven to be problematic, historically, and would keep you in the proper PP "risk zone" while deferring taxes to a greater degree.  I really like this idea.... MT & Craigr, I'd love your opinions on if this should be a revision on the "suggested PP strategy" for taxable accounts.

When combined with proper use of retirement accounts, capturing losses and avoiding the wash-sale rule, and using individual security identification to "pick and choose" your smallest gain purchases, I think making a slight tweak to the rebalance bands in your taxable account would further help one defer taxes and improve their returns.

ROTH IRA's

Since this thread is getting some attention, I thought I'd reiterate the flexibility given to roth IRA's.  Unlike traditional IRA's, you get to pull your contributions out after 5 years tax/penalty free.  This can create huge flexibility later in life in the form of hundreds of thousands of dollars of accessible (but still tax deferred until you pull it out) funds.  I hope people realize this before they decide that "maxing out is just too much money that I can't touch until retirement."  This is techinically possible with Roth 401(k)'s as well, but is often prohibited by a company retirement plan. 

Further, young healthy people should be using the HSA instead of traditional insurance, and contributing to those (you avoid the payroll taxes as well, in addition to your fed/state income taxes... plus they can be used for medical expenses for life).

Tax planning is now where a lot of my "tinkering energy" goes.  Also, getting my dad to put his funds into something like the PP (he'll never leave a stock-heavy portfolio) is where my energy goes.

If the stock market crashes, though, I will be eternally grateful to those on this forum for probably saving my dad's retirement (indirectly).  He is one of the most selfless, hard working, responsible guys I know but he feels like he has to invest in stocks for his lack of savings (I know... yikes!).

What of the pros/cons of converting a nondeductible IRA to a Roth IRA in, I believe, a 28% tax bracket living in New York, Moda? Any thoughts on that? I like the idea of having nontaxable withdrawals later but do not like the idea of paying taxes on it now. I am 54 years of age if that helps.

It really comes down to tax brackets.  If you think tax brackets will be higher when you pull the money out, you'll benefit from converting now.  If they'll be lower, then you'll have unnecessarily paid taxes.

I'm not sure of the the RMD rules of a n/d IRA, but at 28% in NY I'd hesitate to do the conversion... planning on retiring in Florida or Arizona by chance?

Thank you for the reply. It is not an easy choice so I'll probably opt to not pay the taxes up front. As far as your question goes, I'll probably end up snow-birding shortly. Which will bring me to another dilemna...buying or renting. But that's for another forum and another day.

I've been thinking of the tax efficiency of the PP, and it really is great, as most other traditional "safe" assets are a combination of tax-unfavored and/or extremely low in return:

Muni-rates: Pathetically low for an asset that doesn't perform like a treasury bond in years like 2008.
ST Corporate/savings account/cd: Taxed as ordinary income at federal and state level, whether you reinvest or not.

PP:

1/4 of the portfolio isn't taxed until you sell, and is taxed at the lower of 28% or your ordinary rate, and normal state rates.
1/4 of the portfolio maybe pays out 1% in taxable income, but it's mostly growth not taxed until sold, and either way they are given preferred tax treatment.
1/4 of the portfolio throws out federal taxable interest, but it's not taxed at the state level, and its volitile price results in capital gains (again, preferred treatment) when the asset really goes to work for you.
1/4 of the portfolio is throwing out federal taxable interest if you stick with treasuries... but the purpose of this 1/4 is to retain its value, not produce amazing returns.

In many of the contributing years of your life, you won't even NEED to sell any of the assets as you can contribute enough cash to other assets to keep from triggering a rebalance, so the deferral is a bigger piece than initially thought.  Further, if you use some careful tax planning tricks (see previous posts), you avoid/defer taxes even more.  In 2010, a 4x25 PP grew 14.5% about, but only resulted in about 1.875% ((4.5%+2%+1%)/4) of the return being subject to an immediate tax.  The dividends are either non-taxable or 15%, depending on your bracket, and the rest are not subject to state income tax (big for me in MN, it's 1/3 of my marginal tax rate).  This would result in an after-tax return (assuming 25% ordinary bracket, 5% state) of pert-near 14%.  If paid out in interest, it would take 20% pre-tax interest (same brackets) to produce that return.

Now, yes, there is some built in future tax to capital gains, but at least this money is all yours for now to grow with until you sell.  This all makes tax-deffered accounts, and their inherant disadvantages (illiquidity or penalty), much less necessary.  I'm not saying don't use them, but you don't have to shove every red cent into a your IRA & 401(k) because taxes are so burdensome.  Also, putting interest producing assets into your deferred accounts, while keeping stocks/gold as your liquid assets, is a great way to have your cake and eat it too.

I just sold TLT to realize a nice loss, I split the proceeds and bought VGLT and EDV 50% each, in 31 days I plan on buying TLT back.  Just a note the  “wash sale”?  rule applies to purchases made within 31 days before a sale, too. If you have dividends reinvested that amount could be a wash sale if it is within 31 days.

Cool Steve... I haven't started using that one yet, but I say use every opportunity the tax code gives you, even if its kind of gaming the system... cuz the system's gaming you, too.

You ever think of only bumping down to 30/20 on rebalances to avoid some gain recognition but still stay within bands?  Do you use individual security selection method for basis recognition?

Where do you keep your money to keep your trading costs down?

I use Vanguard, I use individual security selection method for basis recognition, this give me additional advantages. As far as rebalance bands go I do not have a hard fast rule. I may rebalance around 30/20 or 35/15 or somewhere in between,  I start to think about rebalancing and take a look at where I stand when it gets close to 30/20. Only after the fact could you see which rebalance band would have given better results.