What Tax Losses?
Jonathan Clements | Sep 30, 2015
AFTER A TURBULENT few months for stock prices and with 2015 winding down, talk will soon turn to tax-loss harvesting. The notion: You sell losing stocks in your taxable account, and then use the realized capital losses to offset realized capital gains and up to $3,000 in ordinary income, thus trimming your 2015 tax bill. Sound like a smart strategy? If you trade individual stocks actively or you’re a really bad investor, tax-loss harvesting might make sense. What about the rest of us, who sit quietly with a handful of mutual funds and exchange-traded index funds, and perhaps also own a few long-term individual stock holdings? Most of the time, there won’t be any losses to harvest. Yes, if you’re a long-term investor, you might get the chance to realize losses in the first few years that you own a fund or an individual stock. But soon enough, your investments will likely be above your cost basis, and the chance to benefit from tax losses is probably gone forever. Instead, you’ll face an entirely different problem: How do you rebalance your holdings without getting whacked with big capital-gains tax bills? The upshot: If you’re a sensible investor, I wouldn’t spend too much time worrying about tax losses, and instead focus your efforts on two far more important tax-minimization strategies. First, make sure you keep tax-inefficient investments in your retirement account. That list would include taxable bonds, actively managed mutual funds, stocks you plan to trade and real estate investment trusts. Second, aim to hold tax-efficient investments in your taxable account, including stock index funds, tax-managed stock funds and individual company stocks you plan to hold for the long haul. These investments might generate dividends each year, but you shouldn’t pay much in capital-gains taxes, unless you opt to sell. You might…
Read more » Tips for Grads
Jonathan Clements | May 7, 2015
THIS IS GRADUATION season at colleges across America. Got a kid heading into the workforce this year? Here are three pieces of advice you might pass along. First, deal with your financial goals concurrently, not consecutively. In other words, don’t save for the house down payment in your 30s, the kids’ college in your 40s and then turn your attention to retirement in your 50s. If you do that, it will be almost impossible to amass enough for a comfortable retirement. Instead, even as you put aside money for other goals, make saving for retirement a priority from the day you enter the workforce. Second, strive to keep your fixed living costs low. In particular, look for inexpensive housing. The lower your fixed monthly costs, the more money you’ll have for discretionary “fun” spending, the less financial stress you’ll suffer and the easier you will find it to save. Third, think carefully about which investments you buy for your taxable account. If you purchase an actively managed stock fund that proves to be a lackluster performer or you make a big, undiversified bet on individual stocks, correcting that mistake could trigger a hefty tax bill. Instead, I’d favor broadly diversified stock-index funds with low annual expenses. These funds shouldn't produce performance surprises or generate big annual tax bills, so you should be happy to hold them for many decades—and perhaps for the rest of your life. [xyz-ihs snippet="Donate"]
Read more » Low Fidelity
Jonathan Clements | Aug 11, 2018
WE HAVE FINALLY HIT rock-bottom. Last week, Fidelity Investments announced that it was introducing two index funds with zero annual expenses, while also slashing expenses on its other index funds and dropping the required minimum investment on all funds, both actively managed and indexed. All of this raises five key questions. 1. Why is Fidelity doing this? I view Fidelity’s move as both bold and borne of desperation. When I started writing about mutual funds in the late 1980s, Fidelity’s swagger bordered on nauseating, as it relentlessly pedaled a slew of star fund managers, notably Magellan’s Peter Lynch. But like almost everybody who plays the market-beating game, the odds eventually caught up with the Boston behemoth. Today, its reputation for minting winners is all but forgotten. The upshot: After decades of pooh-poohing index funds, Fidelity has clearly decided they’re its best bet for getting new investor dollars in the door. 2. Is this a bait-and-switch? When Fidelity, iShares and Charles Schwab started slashing expenses on their broad market index funds to compete with Vanguard Group, I initially feared that they were looking to lure unsuspecting investors into their funds and then, once the funds were bloated with assets, they'd jack up the fees. It wouldn’t be the first time this has happened. We've seen it before with both money-market funds and S&P 500-index funds. That’s still a risk, especially if we got a long, brutal bear market that puts pressure on profit margins at fund management companies. But today, I find I’m less concerned. With so many major fund companies engaged in this price war, any company that backtracked on its expense cuts would be tarred and feathered for betraying the trust of fund shareholders—and deservedly so. Instead, investors need to be leery of a subtler bait-and-switch. Fidelity’s zero- and minimal-cost index funds are open-end…
Read more » Spending Deferred
Jonathan Clements | Jun 30, 2018
YOU MAY BE SAVING and investing for retirement. But what you’re really doing is buying future income. How much income? That brings us to a little number crunching, which I hope will illuminate five key financial ideas. Let’s start with the numbers. Imagine stocks notch 6% a year, but inflation steals two percentage points of that gain, so you collect an after-inflation annual return of 4%. If you socked away $1,000, what would it be worth in retirement? We’ll look at the value as of age 70—and not just the sum accumulated, but also how much income it would generate each year thereafter, assuming a 4% portfolio withdrawal rate. If your parents socked away $1,000 for you when you were born, you would have more than $59,000 at age 70, thanks to seven decades of 6% annual returns. But seven decades of inflation would also take their toll, so your $59,000 would be worth $15,572 in today’s dollars. That would generate $623 in annual income—again, figured in current dollars. That's a pretty good tradeoff: In return for your parents’ onetime decision not to spend $1,000, you get to spend $623 every year in retirement, with money likely left over for your heirs. If you put away $1,000 from your summer job at age 16, you’d have an inflation-adjusted $8,314 at age 70. You could then spend that lump sum or draw it down slowly using a 4% withdrawal rate, which would give you $333 in annual retirement income. If you saved $1,000 when you entered the workforce at age 22, you’d have an inflation-adjusted $6,571 at age 70, which would then kick off $263 in income, assuming a 4% annual portfolio drawdown rate. The $1,000 you save at age 40 would be worth $3,243 at 70, figured in today’s dollars. That should…
Read more » Lean Against the Wind
Jonathan Clements | Dec 23, 2023
AT THE RISK OF CAUSING readers to think too much on a Saturday morning, let me start by offering a pair of seemingly contradictory statements: The financial markets are efficient, but occasionally go stark, raving mad. Nobody knows what stocks are worth, but they have fundamental value. My contention: There’s a payoff to be had from grappling with these two apparent contradictions—a payoff that takes the form of greater calm in the face of market turmoil and improved long-run portfolio performance. Measuring up. Many HumbleDollar readers, and perhaps most, are fans of indexing, and with good reason. We all know how difficult it is to pick winning stocks and to forecast the financial markets’ short-term direction. Statistics tell us that even professional money managers struggle to outwit the markets, especially once their investment costs are factored in. Beating the market, of course, would be far easier if we could figure out what stocks were truly worth. But as I’ve come to realize after almost four decades of writing about investing, valuation metrics like price-earnings ratios, book value and dividend yield give only a rough idea of what stocks are truly worth, and they certainly aren’t a reliable guide to short-term performance. Why aren’t these market yardsticks more helpful? There’s a host of reasons. Stocks’ fair value rises when interest rates fall, and it falls when rates climb. Investors’ appetite for risk has grown over time, and that means typical stock valuations have also trended higher. Valuing corporations based on the assets they own has become trickier as companies focus on building intangible assets like brand names and intellectual property. Meanwhile, valuation measures that look at earnings have drifted upward as the market has come to be dominated by fast-growing technology firms. Because it’s so difficult to figure out whether stocks…
Read more » Get an Attitude
Jonathan Clements | Jun 12, 2021
WHAT DOES IT TAKE to manage money prudently? Yes, we should save diligently, favor stocks, diversify broadly, hold down investment costs, buy the right insurance and so on. But all these smart financial moves stem from key assumptions we make about our lives and the world around us. What assumptions? I believe prudent money management starts with five core notions—which, as you’ll discover below, sometimes contradict one another: 1. We’ll live a long life. For our hunter-gatherer ancestors, life was nasty, brutish and short. Many folks continue to behave as though that’s still the case. They spend too much today and save too little for tomorrow. They impulsively borrow money, only to struggle with the resulting debt payments. They claim Social Security early and eschew immediate annuities that pay lifetime income. But if we’re to manage money prudently, we need to keep our gaze firmly fixed on the future, including the very distant future. That means assuming we’ll make it to retirement and saving accordingly, and then—once we reach retirement—plan on living into our 90s and perhaps beyond. This might sound like a prescription for constantly deferred gratification. But in truth, focusing on the distant future from the time we enter the workforce is not only a recipe for a plump nest egg that’ll make for a more comfortable retirement, but it’ll likely also mean far less financial stress than that suffered by those who focus solely on today and end up living paycheck to paycheck. 2. Death could come at any time. Even as we manage our money as though we’ll one day be age 95 or 100, we should also behave as though the next bus has our name on it. For those who have young children and a spouse who depend on them financially, that means getting…
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