Perspicacious Perplexity

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AUTHOR: billehart on 7/04/2024

I wrote recently about my attempts to improve my asset location. Now, I’ve even consulted an AI chatbot, Perplexity, on the subject, and it produced a surprisingly good answer—it even knew I was asking about taxes when I forgot to use the word tax in my question.

As part of the plan I wrote about, I’m preparing to buy another stock ETF for my taxable account from the proceeds of a Treasury bill maturing soon. I will sell an identical amount of a stock holding in a Traditional IRA and place the proceeds in bonds. The net result would be lower taxes, as qualified dividends are taxed at the capital gains rate instead of the ordinary income rate. I would still have access to the bonds in an emergency, such as job loss, because I’m over 59 and a half.

But from that taxable account, I’ve been drawing interest, dividends and mutual fund capital gains yearly to max out my Roth IRA. (I also save to a Roth 4011(k) from my paychecks.)

I wanted to know if it mattered, tax-wise, whether I invested in a high-dividend stock ETF or an ETF with lower dividends, such as a total market index ETF or a growth-stock ETF. (For comparison purposes, you need to assume identical total returns for each investment, as Perplexity was artificially intelligent enough to point out.)

Psychologically, I seem happier diverting dividends to fund the Roth IRA. I’m loath to sell shares for that purpose, though in reality, it makes little difference. It’s just one of my psychological tics.

Without further ado, below is the question I posed Perplexity, and its verbatim answer. (Note: I got a completely wrong answer from a different chatbot.)

You won’t be able to see here the sources of Perplexity’s answer, though they are helpfully footnoted by the chatbot. They include Investopedia, the r/dividends sub on Reddit and a site called SmartAsset, which describes itself as a service to link consumers to financial advisors.

What do you think of Perplexity’s answer, and the topic in general? Are you ready to replace your financial advisor with AI?

“Mathematically, is there a difference between paying 15% on steady dividends versus paying 15% when you sell?”

“Mathematically, there is no significant difference between paying 15% tax on steady dividends versus paying 15% capital gains tax when you sell shares, assuming the same total return. However, there are some nuanced differences to consider:

  1. Timing of taxation: Dividends are typically taxed in the year they are received, while capital gains taxes are only incurred when you sell shares. This gives you more control over the timing of your tax liability with selling shares.
  2. Tax deferral: With a strategy of selling shares, you can potentially defer taxes longer, allowing your investments to grow tax-free for a more extended period
  3. Flexibility: Selling shares allows you to choose exactly how much income you need, whereas dividends are paid at set amounts and intervals determined by the company
  4. Reinvestment opportunities: When receiving dividends, you have the option to reinvest immediately, potentially compound your returns. However, this can also be achieved by not selling shares in a growth strategy.
  5. Impact on investment value: Dividend payments typically result in a corresponding decrease in share price, while selling shares directly reduces your ownership stake
  6. Long-term growth potential: Companies that reinvest profits instead of paying dividends may have higher growth potential, which could lead to greater long-term returns

While the 15% tax rate may be the same in both scenarios, the overall impact on your investment strategy and long-term returns can differ. The choice between dividend investing and a total return approach often depends on individual financial goals, tax situation, and risk tolerance.”

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