I’m skipping a couple steps on the path we have taken to start retirement so far, but given the week the stock market had, I think it appropriate to do so.
To catch up on retirement, or attempt FIRE, it is necessary for one to learn about taxable investing. Full disclosure up front – we aren’t experts. Learning about taxable accounts is part of our journey. And so, we decided last year that we would attempt a start with taxable accounts in January 2018. So what did we choose to do?
Maybe it’s best if we quickly mention what we chose to avoid. We decided to skip money market accounts or savings accounts. We’ve had these in the past, but the best rates we can currently find earn around 1.5% (when we originally looked, we could only find 1.3%). It’s not that we don’t like those kinds of accounts – we’ve had them in the past. The problem is that inflation in the U.S. is over 2%. So while money market and savings accounts are FDIC insured, and earning something is better than nothing, we can’t help but look at those accounts as losing money. The Fed will likely raise rates again this year, so we may have better yields with these accounts in the near future. For the time being though, they are non-starters.
Our starting strategy is two-fold. The first prong is to have a “safe” taxable account. Safe in this sense means low risk, and something we wanted to manage ourselves. For this account, we are learning about Maryland municipal bonds. This will be the subject of another post.
The second prong of our strategy, and the subject of this post, was our choice in an “aggressive” taxable account. There were a couple criteria in choosing our strategy for this account. Those were as follows:
- Well-balanced (aggressive) portfolio
- Be as hands-off as possible – we want auto-withdrawals from our checking account and we want it auto-invested in our portfolio as appropriate
- Fees need to be at an absolute minimum
- We only have a small initial investment
- Be conscious of taxes
Taking note of those criteria, our search for something to fit that bill led us to TD Ameritrade’s Essential Portfolios. I want to be clear, we have no affiliation with TD Ameritrade, and this is not an advertisement or sponsored post. Rather, it is something we chose to try on our own, and I want to describe what it is, why we chose it, and ultimately our experience with tax loss harvesting.
So, what are Essential Portfolio’s? It is a “robo” service that runs on its own automatically. It invests in 6 ETFs that give a diversified portfolio matching the level of risk with which we were comfortable. Once one puts money into the account, the “robo” service automatically invests it in the 6 ETFs in the appropriate proportion. So right off the bat, this service fit our first two criteria – we could choose the portfolio risk we wanted, and it’s hands off.
Next, it has a management fee of 0.3%. I had been paying attention to management fees for mutual funds last year, and found they range from 0.04% (FUSVX) to 1.96% (BGRXS) with the average probably somewhere around 0.6% or 0.7%. With Essential Portfolios, one still has to pay for fees related to the ETFs in the account, but with ETF fees generally lower than mutual fund fees, I figured by the time all was said and done the overall fees would be comparable to an average mutual fund. We found this acceptable enough to try, and it ticked off our requirement for low fees.
We are beginning investors, which is to say we don’t have a lot to invest. I figured we could maybe stretch to start with $10,000, but less was preferable. I find it hard telling a broker or bank that we only have a couple thousand dollars to start with. I imagine that they deal with clients with a lot more money, and that subconsciously we are judged as not being important. Maybe that is the reality of things, but this was about getting outside our comfort zone and we pressed on. We liked the Essential Portfolios because the minimum was $5,000 and that was something we could do. Moreover, it seems intended for beginning investors, so it helped me feel a bit more comfortable.
The last requirement is to be conscious of taxes, and that is what really got us interested in Essential Portfolios. It advertises the ability to do tax loss harvesting. I will admit, I had never heard of that. TD Ameritrade has an entire page and video dedicated to describing tax loss harvesting – so I won’t belabor the details. The important things to know are that it’s not proprietary to TD Ameritrade – it’s a legitimate investing strategy that can be used to lower taxes. I describe it now as letting Uncle Sam subsidize losses in the stock market. The whole idea is to realize losses when available to ultimately lower one’s taxable income. There are limits of course, but even that has advantages (maximum write off of $3,000 a year, and any extra can be carried over to future years).
So with all that said, we decided to jump in and try it out. We opened an account with the minimum necessary – $5,000 in January. We added another $2,500 at the beginning of February for a total of $7,500. We had wanted to see tax loss harvesting in action early so that if something horrible went wrong, then we wouldn’t have much money committed. After all, it is a “robo” service, and I think there is a personal comfort level that must be earned with that.
Well, we didn’t have to wait long to see tax loss harvesting in action. The stock market took a big tumble the week of February 5-9. During that week, three instances of tax loss harvesting occurred in our account. Let’s take a close look at what happened.
- ITOT – Sold for a realized loss of $187.56 (it then bought VTI)
- VWO – Sold for a realized loss of $52.72 (it then bought IEMG)
- VEA – Sold for a realized loss of $103.06 (it then bought IEFA)
That is a total realized loss of $343.34. There aren’t any realized gains yet, so we should be able to deduct that full amount from our taxes (and it is well beneath the $3,000 limit). In deducting that from our taxes, how much money do we get back? Well, it depends on one’s tax bracket. And, in checking this out, it is a demonstration on how, even the new Tax Cuts and Jobs Act (TCJA) bill in 2018, benefits the rich . I’ve pulled the 2018 tax brackets from the Tax Foundation and pasted below:
|Rate||For Unmarried Individuals, Taxable Income Over||For Married Individuals Filing Joint Returns, Taxable Income Over||For Heads of Households, Taxable Income Over|
What’s important is the percentage. The $343.34 realized loss, which becomes a deduction, translates to the following back in taxes for each of the tax brackets.
- 10%: $34.33
- 12%: $41.20
- 22%: $75.53
- 24%: $82.40
- 32%: $109.86
- 35%: $120.16
- 37%: $127.03
So, someone in the lowest tax bracket would get back $34.33 for a realized loss of $343.34, while someone in the highest bracket would get back $127.03 for the same realized loss from Uncle Sam. Interesting, and maybe not fair, but it is indeed how tax loss harvesting appears to work.
On a positive note, everyone gets something back, and something is better than nothing. I think one has to itemize deductions to get this advantage. Regardless, it appears the tax loss harvesting advertised with Essentials Portfolio is working, and my confidence level in it has increased a bit. I’d call it a successful check on our requirement to be tax conscious, and with it done, we’ll be able to see any effect it has on our 2018 taxes.