Last week we covered how to cut your expenses by cutting your phone bill in half with Google’s Project FI. Today we’ll jump back into the world of investing with Part 5 of The Investment Buckets of FI series, covering the Taxable Account (AKA Brokerage Account, AKA Post Tax Account).
If you’re new to this site, you can catch up with parts 1 through 4 here:
The Investment Buckets of FI – Part 1: 401k
The Investment Buckets of FI – Part 2: INDIVIDUAL 401K/SOLO 401K
The Investment Buckets of FI – Part 3: Roth IRA
The Investment Buckets of FI – Part 4: Traditional IRA
What is a Taxable Account?
Much like the other “buckets” we’ve explored, a taxable account is simply another container that holds your investments such as Index Funds (US or International) and Bonds. The defining characteristic of a Taxable account, as you may have guessed, is that it’s taxable. It doesn’t have any tax deferring methods such as a 401k or IRA. The contributions are similar to a Roth IRA in that the money you put in is “Post Tax”, meaning you’ve already paid taxes on it. However unlike the Roth, it does not grow tax free. Because a Taxable Account is not strictly for retirement savings, the funds inside can be taken out at any time with not penalty.
Taxes in a Taxable Account / Tax Efficiency
In a Taxable Account you’ll pay taxes on dividends (A portion of a company’s profits paid out to shareholders), interest (think the yields that bonds pay out) and capital gains (profit you take when selling an investment – change in value since you originally bought the asset). Because of these 3 factors you’ll want to carefully consider exactly which assets you place in your Taxable account, focusing on which are most TAX EFFICIENT. This means avoiding those assets that naturally generate returns that are taxable, and instead focus on CAPITAL APPRECIATION (The value of the fund(s) increasing).
What to Put in a Taxable Account
Lucky for us INDEX FUNDS such as VTSAX (Vanguard Total Stock Market Index Fund) is very tax efficient and a perfect fit for a Taxable Account. Because it’s just tracking the overall market there’s not a lot of buying and selling (generating capital gains taxes from sales), and it only pays out a small taxable dividend. Personally I keep my international assets (VGTSX VTIAX) in my Taxable account which are also fairly tax efficient.
What NOT to Put in a Taxable Account
You’ll want to avoid putting TAX INEFFICIENT assets in your Taxable account. These include things that kick off a lot of dividends, interest and capital gains. One example are mutual funds that focus on stocks that pay high dividends. If you want these funds, keep them in a tax deferred account. Another example are actively traded mutual funds. These funds are generally doing a large volume of trading (buying and selling) trying to beat the market (which most fail to do). All this trading creates taxable events, generating capital gains taxes for the fund holder (you). I would avoid actively traded funds all together, but if you insist, they’d also be better off in a tax deferred account.
You’ll also want to avoid holding funds in a Taxable Account that generate interest. This includes your Bond Funds such as Vanguard Total Bond Market Index Fund (VBTLX), which consistently pays out interest which will be taxed. Another big one which we haven’t talked about yet is REITs (Real Estate Investment Trusts – pronounced ‘reets’). We’ll explore these more in a later post, but basically they’re funds that are made up of real estate investments allowing investors to get exposure to real estate without actually owning property. However one of their defining characteristics is that they pay out a large percentage of income back to investors as a dividend. And as we’ve been learning, large dividends and Taxable Accounts don’t mix. So again, you’ll want to keep Bonds and REITs in tax deferred/tax sheltered accounts.
Why have a Taxable Account?
I’ll admit Taxable accounts don’t sound great when compared to the 401k and Roth IRA. There’s no specific incentive to use them. I try to think of them as a BONUS BUCKET, when trying to get as much money into the market as possible. Once you’ve maxed out your 401k and Roth IRA, and already have a fully stocked emergency fund start putting the excess cash into a Taxable Account. .For those of us looking to pursue FIRE (Financial Independence Retire Early), the Taxable Account can serve as a great ‘bridge’ account funding your life between early retirement and age 59 ½ when you can start tapping into traditional retirement accounts.
How to open a Taxable Account?
As always I’d recommend going with Vanguard. You can set it up online or over the phone. It won’t say ‘Taxable Account’, so look for General Investing/Individual Brokerage Account. If you’re new to investing, I’d recommend getting on the phone with Vanguard, letting them know you want to establish a TAXABLE BROKERAGE ACCOUNT (non-retirement) and have them walk you through the setup.
Once you have your new taxable account setup, Vanguard enables you set up automatic contributions. For example I have a small amount going in every week. This makes it easy to invest without thinking about it. Plus because you’ll be consistently putting money into the market you’ll be taking advantage of DOLLAR COST AVERAGING, spreading out the volatility of stock prices by buying both at points of high and low prices.
Please share any of your tips for taxable investing in the comments. Keep filling those buckets!
Please share any Project FI experiences, recommendations or data saving tricks in the comments below.
DISCLAIMER: The information on this site is for entertainment and informational purposes only. I’m a graphic designer. I’m NOT a financial advisor. There are not official sounding initials after my name. I’m just interested in investing and hope to get you interested as well. Know that THERE IS RISK IN ALL INVESTING. Please fully inform yourself, and consult with your accountant or other financial professionals before you make any financial decisions.