What should I use my taxable account for?

[mtntigger]

I've had my account for about 10 months now and am struggling with determining what my purpose is for it. Originally I was buying stocks and holding them, but now I’m leaning more toward trying to find short-term profitable trades. So far, I’ve done ok and have learned quite a bit, but I know I could get into trouble and I want to avoid that. Plus, I am finding myself watching the stock market more than I should during the day.

Some background info… I’m going to be 40 this year (ack!), I’m maxing out both my 401K and ROTH (so my retirement should be set), I'm a typical cheap engineer with just a house mortgage as debt, I only have to worry about me, and just “extra” money is finding the way into the account ($5K last year and a projected $8K-ish this year). In other words, I'll make my current goals regardless of what happens in this account, although I'm getting tired of "playing" with this account and want to actually use it to make money instead of a learning tool.

If you have to do it over again or were in my place, what would you recommend my strategy to be (follow the index or a couple of sectors, 50% buy and hold + 50% trading, look into options, buy dividend stocks and get back to work, etc.)?

[rovo]

Could you give us some info about the holdings in the 401K and Roth?

I ask this because I always like to look at the entire picture. Typically a 401K holdings can only be changed quarterly and tend to be mutual funds with a longer term outlook. The Roth can be traded or not as they are usually self directed and of course there are no tax ramifications for giant gains in the Roth.

[ModE98]

SBS, there is no easy answer as most of us have their own investment philosophy and style. Eventually you must settle down and adopt your own, which would be comfortable to you.
So, you are turning 40 and will have approximately 25 years to build a comfortable retirement age portfolio to supplement SS, and your other funds. That's good.
I am sure you will be getting some fine advice from smarter people than me. The only thing I would say is to accumulate top quality, well established, wide moat type stocks and just build a very sound portfolio over the time you have. Good investing, and above all, good luck!

[2kids10horses]

It depends upon your goals.

If you want to avoid taxes, then use a buy and hold strategy. If you want to grow your account, and your selected strategy requires some trading that creates taxible gains, so be it, just be prepared to pay the taxes.

Some people want to do both. So, they "trade" in the IRA accounts, and buy and hold in the taxible accounts.

As you know, the tax advantaged accounts (IRA and 401Ks) are more limited in what they can invest in. But, there are things you can do... most IRAs will let you sell covered calls, but not short stocks or buy options directly. You probably can buy inverse ETFs, or leveraged ETFs in your IRA. You may or may not in your 401k.

But, taxes should not be the primary reason for making (or not making) a trade. If you trade, and have gains, and have to pay taxes, that's good. A lot better than trading, and losing, and having tax write-offs!

[burger]

I take the philosphy that 2kids mentions. I tend to buy and hold (well, I try to at least) in my taxable account. I'm more of a trader in my Roth IRA. Capital gains aren't necessarily a bad thing...it means you are making money at least! It's just a little less painful if you can make them long term vs. short term.

[mtntigger]

Could you give us some info about the holdings in the 401K and Roth?

401K: Approximately $190K now. Right now, my 401k is all over the place and I really need to look into the different holdings. My company has recently switched providers and the new company website is much harder to navigate plus I've had various changes of heart and lots of remnants over the years; the fees are probably killing me. About 1/2 of the $ is in FIDELITY FREEDOM 2030 FUND; about 15% is in PRUDENTIAL JENNISON SMALL COMP; about 20% is in a self-directed account; and the rest are a smattering of different funds. I have on my list of things-to-do to consolidate those before the beginning of the next quarter. None of the selections are that exciting. In the self-directed account, the majority is still in FCNTX FIDELITY CONTRAFUND and the rest are in dividend stocks. For the 401K, I'm a pretty much set it and forget it type person.
ROTH: Uggghh! Changing these have been on my list to do too. I'm in USCGX and USCRX... both are through USAA and I haven't been able to break my loyalty to them.

SBS, there is no easy answer as most of us have their own investment philosophy and style. Eventually you must settle down and adopt your own, which would be comfortable to you.

I know, but I've done the lazy-azz way for way too long and I need to start concentrating on how to get my money to actually work harder than I do. Oh, and I do not ever expect to get anything from SS. I love getting the annual statement from them that says "You are qualified to get $X, but unfortunately, the system is going to be broke by that time."

If you want to avoid taxes, then use a buy and hold strategy.

That was my original plan... buy and hold for at least a year to avoid the taxes.

If you trade, and have gains, and have to pay taxes, that's good.

... and that is my current plan. That, however, takes time, so I'm trying to find a happy medium.

[Deleted]

When are you planning on retiring? If you plan on retiring before 55 then your taxable account needs to act as a bridge until you can access your 401k.

Looks like DH's contract ends 5 months before he turns 55. So he's not going to be able to access his 401k until 59.5. So I'm glad we have taxible accounts plus my 457 to bridge those 5 years.

We inherited a fair amount of blue chip stock. But if we hadn't I think we would be totally invested in various index funds. I'm smart enough to know I'm too dumb to beat the market.

[mtntigger]

When are you planning on retiring? If you plan on retiring before 55 then your taxable account needs to act as a bridge until you can access your 401k.

I don't think I will ever "retire" per say. My house should be paid off by 2018; after that, everything is negotiable. In general, I enjoy my job, but am bored stiff. So, I do see a possibility of changing careers around then.

[yclept]

I don't distinguish between plays in taxable versus Roth accounts. It's true that the taxable is taxable (duh), so if I was inclined to buy municipal bonds and such (which I am not), I would put them in the taxable account.
In the past I've seen a lot of gains evaporate in the taxable account while trying to wait for them to go long-term, and if I had to guess, I'd say I lost more doing that than I would have paid in taxes on the earlier gain. When a stock needs to be sold, it needs to be sold -- taxes be damned! At least that's the conclusion I've come to. For that matter, I've still got carry-over losses from the financial crash to be applied against some yet-to-be profits. Lucky me!
Over time I've become convinced that any investment decisions I make based primarily on tax considerations are going to prove to be wrong.
I think it would be wise to be more aggressive with the funds in the Roth. It's true that time is the one irreplaceable ingredient in successful investing, but it's also true that one needs to take some risk in order to attain decent returns. I'm sure it sounds simplistic, but it's the combination of time and the return achieved over that time that creates wealth. One can keep a lot of money under the mattress for a long time to no good purpose.
I always hated the choices available in the 401k plans at places I worked -- talk about a pig in a poke -- I could never tell where my money was really invested (and I didn't even know about "window dressing" at the time), but I can say the returns were less than optimal. Still, one has to do that at least up to the point where one captures the full company match. Whenever I changed jobs, I was quick to roll those plans into an IRA, and later I converted them all to Roth. Since my tax rate is lower now that I'm retired, I'm not sure the Roth conversions were worthwhile, but it's still nice to know that I'm never going to have to deal with the IRS with respect to any of those funds -- so far I haven't had to take anything out of them. And I'm sure my heirs will love it when I kick the bucket!
Money is fungible. Use it all to get the best return you can. Pay the taxes on the categories where taxes are due, and be happy about it. That's my advice.
Turning 40 is no big deal -- I'm only now finding (64) that some of most physically exerting stuff I used to do is getting harder. I was thinking about another boat awhile ago, but remembering the work to keep one up and wrestling with spinnakers and such has abated my desire somewhat. I don't ski anymore -- too much money and too much work. I don't scuba dive anymore (wet-suit, tanks, weights, ugh), though when I go places with warm water I'll still do some free diving.

[mtntigger]

I tend to buy and hold (well, I try to at least) in my taxable account. I'm more of a trader in my Roth IRA.

I'm glad I asked; I didn't even think about this.

In the past I've seen a lot of gains evaporate in the taxable account while trying to wait for them to go long-term, and if I had to guess, I'd say I lost more doing that than I would have paid in taxes on the earlier gain.

That's what I've seen too in the last 10 months. Although, it has been an easy year to get profits from the market.

I think it would be wise to be more aggressive with the funds in the Roth.

I do too and it's dang embarrassing that I'm watching three or four of the stocks in the taxable account on a consistent basis and yet have been ignoring my ROTH and my 401K selections for so long. I can excuse myself for doing that initially, but I've definitely have known better for the last two years at least.

Turning 40 is no big deal.

Logic plays no part in turning 40!

[phil5185]

I would use the Freedom 2050 rather than the 2030, the 2030 has over 20% bonds - at your age you need to be more agressive to build wealth. (You can adjust the age goal to tailor to your risk level).

I would get rid of the USAA funds and stay with the Freedom 2050, it is fully diversified, a one-stop-shop - and real time reallocation to match your age.

As '2kids' said, keep unmanaged index funds in your Taxable Fund. There is almost no trading so you won't pay annual taxes, the fund will grow tax deferred - and it will get the favored cap gains rate when/if you sell some. It is your pre-59 1/2 wealth - a fallback EF, rental house money, early retirement bridge money, car money, small business, yada.

And if you want to do some trading, do it inside one of the qualified funds - your schedule D will be way easier to manage. (Many years ago, before 401k's were invented, some of us had 3 or 4 page Schedule D's)

In general, you diversify your tax status just as you diversify your investments. You don't want to reach age 65 and find yourself 100% wrong - eg, 100% in Roth only to learn that the US Code switched to a 30% Sales Tax and rendered Roth money to be fully taxed. We cannot predict Code 25 yrs ahead, so you protect yourself by diversification. But skew toward the one that helps you - as an engineer, you get hammered on Fed Tax so the 401k deferral is a big benefit.

But the key metric for all 3 account types - taxable, posttax, pretax - is the return. Eg, you $190k for 25 yrs will be $2,600,000 at 11%/yr - but only $725,000 at 5.5%/yr. (the function is nonlinear).

[mtntigger]

Ok, my ROTH IRA $ is now in a ROTH brokerage account. Now, I really have to pay attention.
Thanks for the help!

[rovo]

I have great disdain for these targeted funds such as the Freedom 2030 fund. Most 401Ks allow for quarterly updates and this hampers the nimbleness one has with regards to the 401K account. That said, the best one can do is to rotate between stock funds, bond funds, and Money Market Funds. If one was to only follow the macro trends I believe the returns would be much better than using a targeted fund. Sure, there would always be up to 3 month delays in the rotation but you would not be burdened with a percentage of the holdings being in an out of favor investment. Going forward, as far as I can see, bonds are dead.

[mtntigger]

My new 401k provider doesn't like targeted funds either and it is no longer a choice. I have the Freedom Fund 2030 now only because it's grandfathered in; once I get out of it, that would be it.
Phil - I did have the Freedom Fund 2040 and 2050 as selections once, but the 2030 achieved better results for the 9 months or so that I was comparing them in 2009.

[yclept]

One other thought. You have shown in the weekly contest that you can do a better job of picking stocks than the results most funds (of any flavor) attain. With rare exceptions, the hottest funds this quarter will be the worst ones next quarter. In any case, the fund manager will be driving the Porsche or BMW that the clients bought for him/her -- the fund manager is the one guaranteed winner! Why would you want to pay to have someone else pick investments that in all probability are not as good as the ones you can pick yourself?

[phil5185]

I did have the Freedom Fund 2040 and 2050 as selections once, but the 2030 achieved better results for the 9 months or so that I was comparing them in 2009.

Yes, and that would make sense. In 2009 bonds did well, stocks didn't (the 2030 fund has more bonds). Then in 2010, bonds did OK, but stocks returned 15.1% for the yr so the 2050 Fund was be the winner.

That shows the futility of analyzing long term products via short term results.

The SP500 index has a Std Deviation of about 15%. That tells you that the predicted outcome for a yr is 11% +/- 30%, 19 yrs out of 20 (and #20 would be an outlier). That info is pretty useless, you already knew that the Market will probably be in the -20% to +40% window except for when it has a really good/bad year? LOL. However if you have a statistically significant set of data points (often stated to be 33) you will see the probable outcome converge on 11%. With a fair degree of mathematical certainty.

You can probably find confidence levels here -
www.statpac.com/statistics-calculator/sampling.htm
Also in the old MIL-STD-105 procurement methods.

[mtntigger]

Why would you want to pay to have someone else pick investments that in all probability are not as good as the ones you can pick yourself?

Because I'm American, dagnabit, and I have to have someone else to blame.
Actually, if it wasn't for my relative success in the stock picking game, I would not even contemplate doing my own ROTH brokerage account despite what the books say. As it is, I think I'll be dumping the majority of it in SPY or QQQQ tomorrow until I figure out what I want to do with it.

[rovo]

SPY and QQQQ are OK for the time being but I think you ought to consider TBT (-2X bonds) for at least 10% of the Roth. TBT isn't a long shot any more if you look at the chart but bonds are just beginning a multi-year trip to the trash pile. I just added more TBT today and I'm expecting 50% to 100% from here till it peaks.

[phil5185]

I think I'll be dumping the majority of it in SPY or QQQQ tomorrow until I figure out what I want to do with it.

Good! I used SPY for many years. And the Q's when there were only 3 of them.
If you want to spice it up with a small portion, use the super spyders (SSO). They are SPY but leveraged 2 to 1. Eg, today SPY went up 0.63% and SSO went up 1.12%. Of course, it's only fun when they are in an uptrend, they also go down twice as fast.
And it is only useful as a shortterm play - over a longer term the overhead cuts your gain - ie, you pay interest on the half of the money that is being borrowed to complete the lever.

[rovo]

I checked with my son in reference to his 401K holdings and they are as follows:

25% MACGX Morgan Stanley Mid Cap Growth
25% VFINX Vanguard 500 Index Fund
50% PRSVX T. Rowe Price Small-Cap Value Fund

He is very pleased with the performance of 401K. Both MACGX and PRSVX have out paced the S&P500.

Just some food for thought.

[yclept]

Rovo,

TBT is 2X short, not 3X. From Profunds website:


UltraShort 20+ Year Treasury
ProShares UltraShort 20+ Year Treasury seeks daily investment results, before fees and expenses and interest income earned on cash and financial instruments, that correspond to twice (200%) the inverse (opposite) of the daily performance of the Barclays Capital 20+ Year U.S. Treasury Index.

We wouldn't want to appear to be madmen!

[rovo]

Yclept, I knew that. Why I type 3X is beyond me. I'll change the previous to reflect the correct leverage factor. My fingers must have just gone out of control.

[mtntigger]

We wouldn't want to appear to be madmen!

Way, way too late!

[yclept]

Watch yourself youngster or we won't allow you into the "over 40 senility club".