Talli Sperry: Hi, I’m Talli Sperry, and welcome to tonight’s live webcast, “Wealth management resolutions—getting ready for 2019.”
As we make the transition into a new year and another tax season, it’s always a good practice for investors to take stock of their overall financial picture. Our lives and circumstances evolve from year to year, and there are a number of factors that may be bearing on our investment strategy. That’s why it’s important to check in on your own or with the help of an advisor and take some time to establish your financial priorities for the year ahead. So that’s what we’re here to talk about tonight and with the help of our expert guests.
Among the topics we’ll address are revisiting your asset allocation to ensure you’re on track, making sure your portfolio is tax-efficient, and considering any recent or upcoming life events that may affect your strategy.
Before we dive in, if you need to access technical help, it’s available by selecting the blue widget, and that’s on your left. And you can learn more about Vanguard’s services by clicking the green Resource List, and that’s on the far right of the player, where you can view webcast replay or listen to a recent podcast episode.
We’d like to thank those of you who submitted questions in advance, and we encourage all of you to keep sending in questions as you’re watching. If there’s something you’d like us to address further, we’ll get to as many of them as possible; just let us know. These conversations are designed to support and connect with the Vanguard community of investors, so we definitely want to hear from you.
We’ve got two terrific and knowledgeable guests here tonight who’ll be taking your questions and sharing their insights. So Maria Bruno is head of the U.S. Wealth Planning Research at Vanguard. She’s a retirement strategist, and she’s also the cohost of our podcast series, The Planner and the Geek. Maria, welcome.
Maria Bruno: Thank you, good to be here.
Talli Sperry: Thank you. And also with us is Bryan Lewis. He’s a senior financial advisor with Vanguard Personal Advisor Services®. Bryan provides financial planning and advice to high-net-worth clients, and he’s been with Vanguard since 2006. So welcome as well, Bryan.
Bryan Lewis: Thank you,Talli.
Talli Sperry: Thanks. So before we get started, Bryan, I thought it might be useful for you to share some of your perspective and what you’re hearing from clients that you’re working with at this time of year.
Bryan Lewis: Sure. When you think about some of the trends that we’ve been seeing, some of the themes and conversations that we’ve been having with our clients, I don’t think it’s going to come as a surprise that market volatility is, I think, certainly probably the biggest topic that we’re talking about—what’s going on overseas, even over here in the United States. But I think when you take a step back and look at some of the things that you should be thinking about as you step into this year, and really any year, it’s probably more or less a checklist that you should start thinking about. And the conversations that I have with my clients really relate to, where is the portfolio today versus your overall financial plan? So I think it’s critical that investors have a financial planning.
Really what I mean by that is that investors need to be able to identify their goals and objectives, their risk tolerance, what is their saving strategy or really their rebalancing strategy, create a budget to track your income and expenses. So when you think of that financial plan, I think of it as a roadmap or more or less a blueprint as you help to navigate through some of the twists and turns, particularly when the market is volatile like we saw in the fourth quarter, specifically in December.
But when you think of this financial plan and take a step back and look at, all right, maybe for this year has anything really changed that would warrant maybe an adjustment to that overall financial plan? So think of maybe what I call life events. Did you retire? Did you have a child or a grandchild? Was there an inheritance? So a certain event that would warrant a change to the overall financial plan.
If nothing’s really changed, I think the next step would be to look at your asset allocation. Where is your current mix of stocks, bonds, and cash versus your target? If you’re within 5% of that, well, maybe you don’t have to do anything. But as the market goes up and down and somewhat what we saw in the fourth quarter, that actually presented opportunities for us to do some rebalancing, which I know we’ll talk more about this evening.
But when you start thinking about, all right, I have my overall plan, nothing’s really changed or things have changed, let’s start planning ahead. So some of the things I’m helping my clients with is, do you think about how much cash do you have currently? Do you have too much cash? Maybe you should start saving and investing that money. Or if you’re somebody who’s in retirement and spending from the portfolio, well, maybe you should actually start and raise your cash for that entire year. So start thinking ahead throughout the year, and then use this as an opportunity maybe to do some rebalancing.
And then as you step into tax season—it’s hard to believe it’s February already—there are things that you need to be mindful of. And I think one of the themes that I notice with clients is, it’s just human nature, we tend to wait till the last minute to do things. Where I think what I try to be is very forward-thinking and try to think ahead about, for example, how did the recent tax reform impact me in 2018? Am I in a lower tax bracket now? Well, maybe I should actually start to change my saving strategy. So maybe historically I’ve been in a higher tax bracket; now I’m in a lower tax bracket so maybe I should save into a Roth IRA or a Roth 401(k) versus a pre-tax IRA. So there’s a number of things that you should look at, and these are things that I think are critical really at the beginning of any year, but especially after you saw the market. And as volatile as it was, I think it’s crucial that we really start to plan ahead.
And when you think of some of the things that went into effect with the tax reform, things have changed. So an example would be that standard deductions went up versus people might actually find that they can’t itemize their deductions anymore. Or if you own a small business, there’s something called a qualified business income deduction. So these are all crucial components to start thinking about, because the timing is key.
Talli Sperry: Wow! I’m glad we’re here tonight because that’s a lot to think about as we start the year. Maria, would you add anything?
Maria Bruno: I would. I think, Bryan, those are all really good points. A couple of things that I would add would be from a financial housekeeping standpoint, maybe some of those things that we don’t tend to really look at on a regular basis. And I would look at things like insurance. Are you adequately covered from a disability standpoint or life insurance or even car insurance, things like that, beneficiary planning? To just take a look at that and just make sure that those financial housekeeping things are in order, and does it reflect what your overall plan is?
I guess the other thing I would add when we think about the tax reform and the things that we may be seeing as a result of the changes last year, and we’ll probably talk about that a little bit more from a retirement standpoint, to really look at if the tax picture has changed, there may be some tax-planning opportunities to take advantage of in terms of creating tax diversification, which I’m sure we’ll probably talk about tonight. But things like with Roth conversions, there was one change in terms of you cannot recharacterize a conversion. So with the conversion, it’s a distribution from a traditional IRA into a Roth IRA, and it creates a taxable event.
Before, individuals had the flexibility to recharacterize that in terms of whether they found they wanted to reverse that and make a change. That window has been eliminated, so to be really thoughtful in terms of what that taxable income picture looks like for the year before making those types of decision-making. So those are things that maybe you can look at the income tax for last year but really be thoughtful of what 2019 looks like before you actually make those types of decisions.
Bryan Lewis: I think that’s crucial too. That actually is an argument to actually wait maybe toward the end of the year. You have a better picture of what your income will be from an employment’s perspective, you have a better sense of what your portfolio has generated from distributions, and then you can use that and be more thoughtful about, all right, maybe I have a $20,000 to $30,000 window before I go into another tax bracket. Well maybe I should do a partial Roth conversion, which I know we might talk a little bit more about this evening.
Talli Sperry: I think this is really helpful for setting the stage for tonight’s discussion and just reminding us it’s good to pause and reevaluate year by year even though we think life might just keep moving forward. So this is really helpful. Thank you.
Before we dive into your questions, we’d like to ask our viewers a question. On your screen now you’ll see our first poll question, and that says, “Have recent or anticipated life events—retirement, children, wedding, grandchildren, etc.—made you rethink about revising your investing goals?” So, “Yes,” “No,” or “Not yet but likely in the near future.” Those are your answer choices, and please respond now and we’ll share your answers in just a few minutes.
So, Bryan, in the meantime, why don’t we answer our first submitted question. This is from Steve from Southampton, who says he’s retired but now has a grandchild. He wants to help there, maybe establish a trust, help with college, etc. How does he juggle it all?
Bryan Lewis: Yes, it’s exciting, so congratulations first and foremost. And this is an example of a life event, as I was alluding to earlier, where you may actually need to change or want to change your overall strategy. So it’s very common. I have a lot of clients who, as they get older, they may have more than enough to support their own needs. They actually start to take on more risk. And what I mean by that is they start to actually increase their stock allocation over time. So I actually have clients in their 80s and 90s who are taking more risk from a stock perspective than some of my 30- and 40-year-old clients.
Talli Sperry: Interesting.
Bryan Lewis: So when you start to look at a situation like this, it can add a layer of complexity as well, depending upon the different accounts that you have. And I think you need to be thoughtful about the types of accounts that you might be establishing for your grandchildren. So what I mean by that is, you need to think about, all right, maybe I want to earmark this investment or this gift for college. Well, then you can maybe look at 529 plans. Or do you want more control over that, or do you want more flexibility on how that money can be used? So you can start looking at custodial accounts or trust accounts.
You have to be careful. As a grandparent, when you set up a 529 plan, there can actually be financial aid implications when your grandchildren go to school. There are some rules that had changed a couple years ago, where if you’re applying for financial aid, when you take a distribution, when a grandparent owns the 529, it’s actually considered income to the beneficiary. So the strategy with that would be to delay using the 529 plan until their junior and senior year. You might say, “Why junior and senior year?” The idea with that is there’s a two-year look back. So if you’re smart about that, it would have less of an impact on their financial aid, or you just name your son or daughter to be the owner of the 529.
Talli Sperry: This is why I’m grateful for you both. These are really helpful tips.
Bryan Lewis: And then you can start looking at other types of accounts. There are pros and cons to each. I mentioned custodial accounts; you have to be aware of what’s called “kiddie tax.” You also have to be aware that if you predecease the beneficiary of the custodial account, it could be clawed back into your estate. There are a lot of different components to it, but, ultimately, if you want flexibility, that’s where a trust potentially could be beneficial, because you can use it not only for education, but you might be able to use it for support and maintenance for the grandchild. So there are pros and cons to each, and these are the types of dialogues that we have with our clients.
Talli Sperry: That’s really, really helpful. So before we continue on with our questions, I’d love to check our poll responses. And it looks like our audience is split. It looks like about 65% of you are not reevaluating due to life events, about 25% are, and then we’ve got a small margin that is kind of in the “not yet but in the near future” perspective.
Bryan, is that consistent with what you see from clients?
Bryan Lewis: I think it is. Even if there’s no life event, you also have to be aware of, maybe my goal has always been retirement. Well, you may want to reevaluate your plan as you get closer to retirement; we call it a glide path. So maybe you’re further away, you have a higher percentage in stocks, but every few years you might want to consider reducing stocks as you get closer to retirement. So that doesn’t come as a surprise to me, but there’s still ways just to be mindful. Again, kind of we’re looping it back to the overall financial plan to see if there’s anything that needs to be changed.
Talli Sperry: That’s helpful. I wonder if sometimes we don’t consider the things that are really life events, life events that could cause us to take a look at our investments. So that’s helpful.
Would you add anything, Maria?
Maria Bruno: Yes, when you think about the different phases of retirement, interests and things might change, priorities might change, so your plan needs to be flexible and adapt as well. Maybe earlier in retirement you might want to do more travel, for instance, but maybe later in retirement you want to spend more time with the grandkids, perhaps. So reevaluate that and just make sure that your plan is aligned, even though that’s not necessarily a major life event.
Talli Sperry: That’s helpful. Great.
So let’s ask our audience another poll question. And so, audience, this one is for you. Our question is, “How likely are you to make changes to your portfolio based on changing economic, market, or political conditions?” And so the answers are, “Very likely,” “Somewhat likely,” or “Not likely.” So please, respond now, and we’ll get back to your results in just a few minutes. But let’s take another question that was submitted before the webcast.
So, Maria, I’ll move this one to you. And this is Sunil from Mertztown, Pennsylvania, is asking, “Is Vanguard recommending any significant change in asset allocation strategy to reflect the new economic environment?” So thank you.
Maria Bruno: That’s a good question. We get that a lot with the changing market environments or the outlooks. I think what we’re dealing with, we saw some market volatility late last year into earlier this year, so that normally can make us stop and think like, do I need to make any changes? And I don’t think there’s any better way to answer that question than to quote Jack Bogle, our founder, who was “Stay the course.” And that doesn’t necessarily mean doing nothing, but it means doing everything that Bryan had talked about—making sure that your financial plan is sound, your asset allocation is sound.
So when you think about our market outlook, for instance, uncertainty is, I think, probably the best word that we can think about in terms of investing, perhaps some muted economic growth forecasts, anticipated market volatility. So what we’re seeing is not uncommon. We just haven’t seen it for the past 9+ years, so we may not be comfortable with it.
So my guidance there would be not to make reflex reactions but make sure your goals are clear and your asset allocation reflects those goals, your risk tolerance, and then just make sure you rebalance, because over the past 9+ years, the markets have been on such a positive growth trajectory that you might think, for instance, maybe if your target asset allocation was 60% stocks, you may well be into 70%+ stock territory. And that means you may be overexposed, knowingly or unknowingly, so it’s time to rebalance that portfolio and make sure that you maintain that risk-return profile. That way, then, you feel more confident when there is some market volatility that you’re well globally diversified.
Talli Sperry: That’s helpful. I really like your comment about making sure you’re staying the course doesn’t mean inaction. And I think our poll results are interesting. I definitely feel our Vanguard audience here because most of them, 60%, said, “Not likely to make changes.” Whereas we had 32% “Somewhat likely,” and about 6% “Very likely.” So I think it’s an interesting mix. My guess, it’s what we see with our clients normally. Bryan?
Bryan Lewis: Yes, and that’s pretty consistent, I think. Yes, even when the market was as volatile as it was in December, I had clients who were calling me; and that’s really my role, to help them kind of navigate through some of these challenging markets. But some investors—they knew what I was going to say. They just needed to hear me say it, so that doesn’t come across as a surprise to me.
Talli Sperry: Yes, our position’s comforting, I think. Yes, that’s great. So as always, we’ve gotten a lot of great questions submitted in advance. And some of them are fairly broad, and others are focused on specific financial planning scenarios.
So I thought we could take a few minutes to maybe dive a little deeper into some of the specifics, the situations that are complex, that our clients face, and get a feel for what some of our investors are thinking about as they make their plans for this year and beyond. So we’ll go through a set of questions on that now.
I’m going to kick this to you, Bryan. This is from John from West Hartford, Connecticut, who’s talking about those volatile markets. He’s asking should he increase the cash portion of his portfolio to reduce risk?
Bryan Lewis: Yes, that’s a question that we certainly have been receiving and, I think, we’ll probably continue to receive. So the short answer’s no, we wouldn’t want you to just move to cash just because you’re worried about what the market’s going to do. Nobody has really an idea of what’s going to happen with at least any certainty. There’s no way to know. If I sell and time this, get out of the market, move to cash, and then reinvest that cash, it’s very difficult to time the market because you have to be right twice. You have to known when to get out and when to get back in.
And when you think about cash, it’s really meant for savings. It’s not truly a long-term investment. So when you look at yields, they’ve started to go up, which is good for somebody who’s saving. But when you look at the best way to mitigate risk, in Vanguard’s opinion, it’s bonds. We view bonds more or less as that safety net, so I think of it as a shock absorber from the stock market. So depending upon what your risk tolerance is will dictate how much exposure you do have to bonds, but bonds are truly the best way to diversify, in our opinion, to reduce the risk within the stock market; and we try to encourage clients to try to avoid the temptation to try to market-time.
Talli Sperry: I think that’s helpful, and it gets to a live question we have from Didier, who’s saying, “How can I be immune to daily fluctuations of the market?” And I think that’s precisely what you’re getting at. Would you like to add anything, Maria?
Maria Bruno: Yes. The thing to reinforce too is, there’s an opportunity cost to not be invested. So you might think as an investor that you might pull more into cash and that you’re playing it safe. Well, if you have a short-term goal, that’s very prudent because principal preservation is paramount there. But if you don’t, the portfolio then does not have the opportunity to grow on an inflation-adjusted basis. So you’re basically trading off market volatility for shortfall risk down the road. So it really is a balancing act. And that’s the concern with having overexposure to cash in a long-term portfolio.
Bryan Lewis: Exactly. And when you look at December, those that sold in December and moved to cash missed out in January. So that’s an extreme example, but it’s just another reason to reinforce to try to avoid those temptations as best as you can.
Talli Sperry: Yes, because we’ve seen them before in other markets, right? Yes.
I think our conversation about grandchildren kicked off something with our viewers, so I want to go to another grandchildren question. And this says, “Please discuss using qualified charitable distributions,” so we call those QCDs, “to help fund grandchildren’s college cost.” Any thoughts on that?
Maria Bruno: Now that’s an interesting question. Let’s talk a little bit first around defining a QCD.
Talli Sperry: That’d be helpful.
Maria Bruno: So that’s a qualified charitable distribution. And what that means is that individuals can take a distribution from their IRA up to $100,000 or typically for RMDs; anyone who is age 70 or older can take a distribution if they’re charitably inclined. That distribution is paid directly to a charity, a qualified charity. So as an account owner, I never take possession of that distribution. It goes straight to the charity, and that’s one of the prerequisites to meeting that.
The benefit to that is, because I never take possession of that distribution, it does not get factored into my adjusted gross income for the tax year. So, again, when you take a required minimum distribution or a distribution from a traditional IRA, that amount, that pretax balance, is added as an income in the year of distribution. So taking that out of the tax picture altogether reduces your taxable income for the year but then also other things that could be triggered from your taxable income figure. So there’s a big benefit there, plus the charity gets the full benefit of the distribution.
In this situation, I think the question might be around using that distribution toward a college or a college payment. That can get a little tricky, and I think that’s where it’s probably best to actually work with someone, either a tax advisor who’s much more qualified in terms of the mechanics of that.
Bryan Lewis: Yes, because you have to do the distribution out of the IRA. If it’s going to an institution, it’s going to be taxable to you, the owner of the IRA. If you’re taking that out as a charitable distribution to a qualified charity, it does get a little more tricky. But when you’re looking at funding different colleges, this is where you need to get into more of a broad estate plan, and it can get pretty complicated.
Maria Bruno: And if it’s not done correctly, then you could be triggering a taxable event. So my suggestion would be if you’re working with a financial planner or advisor, or if you have questions, just give us a call and perhaps we might be able to troubleshoot that one a little bit more.
Talli Sperry: Yes, I think this is a great deeper-dive question, isn’t it? All right. Well, thank you so much for defining that for us and helping us set the stage there.
We’re going to jump to a question from Jim from Verona, Wisconsin, who says, “We are in the sweet spot of pre-RMD retirement.” Congratulations. “And we are trying to think about how to take advantage of moving traditional IRA dollars to Roth IRA dollars. What do we need to think about?”
Maria Bruno: Okay. I’ll start that one. I love taking Roth questions.
Talli Sperry: That’s great, we love it! It’s good to know people who love Roths.
Maria Bruno: So we just touched upon required minimum distribution, so beginning at age 70½. The benefit of IRAs is that you’ve deferred these monies, but at age 70½, you have to start taking these distributions. For many individuals who have deferred, these required minimum distributions could be quite hefty and could potentially bump someone into a higher marginal bracket. So that could come as a little bit of a surprise during the retirement years.
What that opens to is, maybe preretirement, some strategies in terms of either drawing down those assets, taking those distributions or withdrawing from the IRA sooner, or doing a series of Roth conversions. We had talked about this earlier, where you take a distribution from the traditional IRA and then put the monies into a Roth IRA.
The benefit to that is, you’re creating tax diversification; different types of accounts are treated differently from a tax perspective. So, basically, what you’re doing then is, you’re balancing that out and potentially lowering your traditional IRA balances, which then later potentially reduce your RMDs as well. So you’re accelerating a tax liability, but you’re doing it potentially to lower tax rate for the benefit of smoothing out that tax liability throughout retirement. So Roth IRAs, there are no lifetime distributions, so you don’t have to take mandated distributions during your lifetime either, so there are lots of benefits there.
Talli Sperry: That’s helpful to think about—a short- and long-term mindset in that perspective, isn’t it? Bryan, would you add anything?
Bryan Lewis: Yes, those are all critical points, and I think maybe a reason why you don’t want to do Roth conversions, number one, you have to pay tax on whatever you move from the traditional over to the Roth. Generally, you want to pay the tax outside of the Roth conversion so, say, like a joint account. If you don’t have cash to do that, well, then argue probably, maybe it doesn’t make sense. But when you look at converting into a Roth IRA, to Maria’s point, around tax diversification, so for somebody who’s maybe on the cusp of going into a higher tax bracket, maybe they’re in retirement and they want to manage their taxes better, well, you might be able to leverage that Roth IRA to use that small portion of it to spend from.
But, for example, if a charity is designated as a beneficiary for an investor, well, that actually could be an argument not to do a Roth conversion. So there are a lot of different variables into that, and it could be on a case-by-case basis, but it’s something that investors should be thinking about, especially as you get closer to retirement. And if your income’s gone down, you think about the tax reform that went into effect, it’s actually scheduled to sunset at the end of tax year 2025, meaning starting on January 1, 2026, it’s going to go back to the old tax rates. So somebody who’s in that sweet spot, it actually possibly makes sense to do these Roth conversions now with basically the assumption that your tax rates are probably going to go up in the future.
Talli Sperry: Really helpful. Very comprehensive between the two of you. It’s great.
So, Bryan, my guess is that this question relates back to the conversation about bonds that you had regarding them being safe. So Dilip is saying that, unfortunately, bonds are safe when you can hold them to maturity, but with bond mutual funds in Vanguard, bond portfolios go up and down, although not as much as stock mutual funds. So he’s feeling that cash seems to be safer than bonds when the interest rate is now 3.5%. Any commentary there?
Bryan Lewis: Yes, as interest rates are going up—it might be helpful just for the audience to understand the relationship. As interest rates go up, the price of your bond will go down. As a result of the price going down, the yield or your income will start to go up. The benefit of using a mutual fund, say, over an individual bond would be that you could have a single bond mutual fund that has hundreds if not thousands of bonds within it. And, arguably, when you have these huge bond funds that Vanguard has, you have new capital that goes into the funds, you have bonds that mature. So what the portfolio managers can do is go out and reinvest that at a higher yield. So they start to take advantage of these higher yields.
And I look at it as, these bonds are potentially things that you’re going to hold onto the rest of your life. So if you’re using a mutual fund, you don’t have to worry about laddering a bond. The common theme that I see with individual bonds is that it’s just human nature, we don’t always catch if a bond’s called or as the bond matures; you have to go out and reinvest it.
Talli Sperry: It’s a lot to monitor.
Bryan Lewis: It is. But over time, the way we view it is, generally, there’s less correlation or similarities between stocks and bonds. Certainly, cash won’t fluctuate, but Maria mentioned earlier, you have a hidden cost, which is inflation. That’s the loss of your purchasing power. And when you try to go into cash, do that for a few months, it doesn’t always work out. Sometimes it may work in your favor and other times it generally won’t.
Talli Sperry: I think that goes back to our point of this webcast on effectively and focused planning for 2019, so being intentional about what you need from the year and years ahead. Great.
So we’re going to continue with our presubmitted questions. Please keep sending in your questions. These are great. They’re good, meaty questions, so thank you.
This is from Tom from California, and he’s asking, “Do the tax law changes impact any way conventional wisdom around optimal allocation of different asset classes between taxable and tax-deferred accounts?” So, clearly, taxes are on our minds. Maria, I might send this one to you.
Maria Bruno: I think that’s an evergreen topic. When I think about tax diversification, as we had mentioned earlier, first and foremost, is having the different types of accounts within your portfolio. So that ranges from having tax-advantaged accounts—these encompass 401(k)s, IRAs, 529s that we had mentioned earlier; I’d also throw health savings accounts into that as well—and then also tax-deferred accounts—so within that window, whether it’s a Roth or a traditional deferred account—and then nonretirement accounts, which are taxable accounts. So holding a portfolio, first and foremost, that is diversified among account types is important. But then, what that does is allow for how to strategically implement your asset allocation. So the general guidelines would be to focus any tax-inefficient investments within tax-advantaged accounts.
And simply what that means is, any assets that generate current income—whether they be bonds, mutual funds that, for instance, pay monthly dividends—anything that’s dividend-oriented, that’s taxable, it’s best to shelter those generally within tax-advantaged accounts. That way they’re sheltered. You’re not actually having to pay taxes on that income. Or anything that, you know, funds that might have lots of turnover—perhaps actively managed funds, those types of things—shelter those within tax-advantaged accounts. And then within taxable accounts, nonretirement accounts, focus on efficient investments such as broad market index funds, for instance, highly tax-efficient and cost-effective stock investments, and then municipal bond funds as well. So that creates a good balance for across accounts, but then also within accounts.
Talli Sperry: I think that’s helpful that you just clarified that we can kind of think of as a trigger in our mind if an investment produces income, we should think about the end relation to tax and where it belongs. That’s great. Good. Good little tip.
So Steve from Las Vegas, Nevada, is asking, “Bryan, could you please review the changes to the tax law for charitable contributions?”
Bryan Lewis: Sure, so these are certainly areas that you need to be aware of, and this is where you need to be on top of some of these changes. So I think it’s worth noting that the standard deductions for tax filers—they increased. So, for example, a joint tax filer in 2019 is $24,400. What we find is investors, as they go through and prepare their tax returns this year, 2018 is the first year with the new tax reform, is that you may not be able to itemize just because you don’t have enough itemized deductions, so you have to take the standard deduction. So that can impact your charitable giving strategy. So an idea would be, instead of giving these smaller yearly charitable gifts, maybe you bundle those charitable gifts every other year or every couple of years to make a larger gift so that you can then deduct that on your tax return.
And when you start thinking about, “I want to start giving cash and securities,” well, it depends on what your income is. You can give away as much as you want to charities. It’s more of a question of what you can deduct on your tax return.
And one of the changes is, if you give to a public charity cash, it used to be 50% of your income. It’s now 60%. So there was a slight change with that, but that is where we do an analysis with our client and say, “All right, maybe we do a combination of appreciated stock with cash and then also a Roth conversion, and just try to think of ways to take advantage of the new tax laws and use that in your favor.”
Maria Bruno: I was just going to add, Bryan, you throw Roth conversions in there because that actually increases your income, which then increases the cap of how much you can contribute to charities.
Bryan Lewis: Exactly.
Maria Bruno: Yes.
Talli Sperry: Yes, this is why I’m thankful for advisors in our Personal Advisor Services. This is a lot to keep track of, so if you also have questions about Vanguard Personal Advisor Services, we do have a link in the widget since I just mentioned it. So thank you, guys, for that.
So Jaymin from Buffalo Grove, Illinois, is asking you, Maria, “As someone’s wealth increases and they have enough bonds and cash for emergency reserves for a few years, should they have a higher percentage of wealth in equities, meaning a more aggressive portfolio?” So, Bryan, I think you were leaning in this direction earlier, so maybe we can dive in.
Maria Bruno: We used an extreme example early on, so that’s good. Yes, I think it depends. It really depends how you want to use those portfolio dollars and what your goals are. You need to think about how you’re using the money. If it is something where you’re balancing current spending with legacy planning, for instance, maybe some intergenerational planning, for instance, then, yes, being more aggressive with those dollars can be prudent. You want to be comfortable that you can handle the market volatility that goes along with that.
The flip side is, some clients may not be inclined to take the risk if they don’t have to. So I think what that really goes down to, what is your goal, and then what is your risk tolerance? And then allocate accordingly. But I think it’s a good way to think about it in terms of, can I afford to or do I want to afford to take more risk, more growth opportunities for a longer-term investing?
Talli Sperry: Great, Bryan, do you see clients playing with this?
Bryan Lewis: Yes, so this is something that, back to that financial plan, it’s very fluid. These things can change over time, and I think of it as, if you’re just using this to support your lifestyle, well, you can make the argument, “Well, maybe I don’t need to take the risk or I haven’t saved enough. I need to take on more risk.” And if you’ve saved enough and you’re starting to think ahead about this idea of legacy planning, I think of it as, if you’ve won the race, why go out and run the mile if you can walk the mile? Meaning, don’t take any unnecessary risk unless you have to. And if you’re using this to support your lifestyle, that could be an argument to be more conservative if you have enough. But if you start thinking about, “Oh, I want to start growing this for my children and grandchildren,” well then that could be an argument to, again, increase the stock allocation.
Talli Sperry: There’s some good wisdom there, good little tips.
So we have a live question. It’s a little bit unrelated to the discussion, but I think it’s a good one; and it does make me want to draw us back to noting that our Vanguard 2019 market and economic outlook is in your Resource List widget. That’s got some really great insights for the flavor of questions that we’re discussing tonight.
This one is from Ron, and he’s asking, “What are your thoughts on staying invested in Vanguard Ultra-Short-Term Bond Fund versus Vanguard Total Bond Market Index Fund to avoid a bond price decline due to the Fed raising interest rates, i.e., keep your fund a short duration?” Who wants to take that one?
Bryan Lewis: I’ll comment on it. When you buy a bond, what you need to look for is the average duration within, for example, a bond fund. So what you want to look for when you’re buying that bond fund is, “Is my investment horizon at least equal to if not longer than the average duration?” So an example would be, let’s say a bond fund has a 5-year average duration, interest rates go up 1%, which is very unlikely, but in a simple example, if they go up 1%, then you lose 5% on your principal, or the price of the bond.
So when you look at the Fed, and when they start increasing rates, well, they impact short-term rates, not intermediate- and long-term. The markets are going to adjust for the intermediate- and the long-term rates for interest rates as well as inflation. So you’re moving into that area where the Fed is impacting the most.
Arguably, you will get some additional price stability in the short term, but you’re also giving up yield, or your monthly income. So if you’re somebody who’s in retirement, for example, and you’re basically living off these dividends, you’re going to miss out on some of that income. And you get most of your return from the yield with a bond, so I would caution investors from doing that. We’ve seen that, but over a long period of time, having that balance with short-, intermediate-, and some long-term bonds makes a lot of sense; and the numbers over time help to prove that.
Talli Sperry: Really helpful. Great. Thanks, Bryan.
So this is from Jeffrey from Plano, Texas, and he’s asking to “Please explain the concept of building a tax-efficient portfolio.” So, Maria, this feels like a question for you.
Maria Bruno: I think we talked about it already in terms of making sure your portfolio’s diversified across account types and then within.
I think one thing that I would add to that, as well as—I guess two things. One would be, when you’re looking at returns, it’s always important to look at the after-tax returns. So it’s not so much how much you pay in taxes, but what is the after-tax return of the fund? Because your goal there would be to look at returns from an after-tax basis, even if you’re paying taxes but your after-tax return might be higher. These are numbers and figures that are quoted on vanguard.com, so you can look at a fund and you can see after-tax returns historically, so that gives you a sense of how tax-efficient a fund can be.
The other thing I would add, as we have been talking tonight about individuals with different types of goals, would be, when you’re thinking about tax efficiency, you want to think about it on an annual basis for your own situation but then also with the goals of the assets. And I specifically point to beneficiary planning, that if you are earmarking certain types of accounts, maybe it’s Roth accounts, and you’re looking at those for beneficiary planning, think about it in terms of not so much your tax bracket but those of the beneficiary. So sometimes with decision-making, with financial planning as well, “What’s my tax rate now versus when I’m in retirement, for instance?” But if the goals for those assets are actually to pass through to another generation, you want to be forward-looking instead of going, “Well, actually, it’s not my tax bracket in the future but my beneficiary’s.” And that may help think through whether you want to earmark Roth or traditional assets, for instance.
So a couple of thoughts there in terms of how you think about your portfolio, both now and then down the road.
Talli Sperry: I think those are really good, specific thoughts for our Flagship Select clients, because many of them are thinking about generational wealth transfers. So for all of you who are in that mindset, that’s a really key section to start to consider, so thank you.
All right, so this question is from Mike, and he’s asking for us to please explain how to tax efficiently rebalance a portfolio, and when does he do it? So I think it’s the “when” that’s the big key part that’s unique here, Bryan.
Bryan Lewis: I agree. So when you kind of loop it back to that financial plan, this is where you—all right, if you have a balanced portfolio, let’s say, for example, it’s 50% stocks/50% bonds, ideally what we want is to ensure that you stay within 5% of your target asset allocation at all times. So if it goes as high as 55% or as low as 45% in stocks, well maybe you don’t have to rebalance the portfolio. But as the market continues to go up and down, let’s say stocks went down in December, maybe you’re at 44% in stocks, well that is a reason to go in and rebalance the portfolio.
So we look at it from a 5% threshold, plus or minus. When you look at for somebody who’s saving, that could be a great way to invest cash maybe in the asset class that you’re underweighted in, meaning if stocks are down, you can add to stocks or vice versa with bonds. And then if you’re spending, that’s another great way to look at the rebalancing aspect of it as well as maybe look within, let’s say I’m heavy in stocks, look within my options that I have. And what I’ll do for investors is look within those options to see what’s going to create the least amount of tax implications. So we do what’s called tax-loss harvesting, so look for opportunities that maybe have losses to offset those gains.
But kind of looping it back to the 5% threshold, we also look at—well, I mentioned earlier the glide path. So as you get closer to retirement, as an example, maybe it’s a reason to go in and rebalance.
But from a tax efficiency perspective, even building off an actively managed fund, or if you’re heavy in stocks and you’re sensitive to selling an investment, you could redirect dividends and capital gains from those investments. I would say at a minimum that’s what you’d want to do. So instead of reinvesting back into an actively managed fund, you would take those dividends and those capital gains, maybe move those into a more tax-efficient index fund.
So there’s ways around that, even for charitable giving or gifting to your family members. You could start using that as a way to rebalance. So gift appreciated stock. Maybe you’re heavy in stocks, so that’s what you would focus on. So there’s ways that we work within that to do that tax efficiently.
Talli Sperry: That’s helpful and, Bryan, did I hear you mention that Vanguard Personal Advisor Services does tax-loss harvesting? Is that correct?
Bryan Lewis: Yes.
Talli Sperry: Is that correct? Okay, so that’s something you would regularly do for your clients?
Bryan Lewis: Yes, so that’s what we’ll look at. And for the audience, it’s really where you look for—all right, maybe I sold an investment because the client needed cash, and it triggered a taxable event. What we would do throughout the year is look for opportunities to identify any losses that we could capture to bring down that tax liability. So you have to be careful. There’s a lot of rules around it. You have to be careful of what’s called a wash sale, but those are things that as an advisor we’re looking at, really any opportunity to minimize tax and what the client owes.
Talli Sperry: Okay, that’s great. Thanks for clarifying that. I appreciate that. So thank you for continuing to send in live questions. We’ve got another one right here. So we’ll go to Dan’s question. He says, “Given the run-up in stocks over the last 10 years, I now have large capital gains, which I’ll have to pay if I rebalance.” We hear this one often. And so he’s asking, how does he determine whether it’s worth it to rebalance or not? Bryan, I’m sure you deal with this all the time.
Bryan Lewis: I do, especially for older clients that have been investing for 20 or 30 years, and you have large gains within this. So we don’t want that to be the only reason you don’t rebalance is the tax implications. Obviously, it’s easy for me to say that. I’m not the one paying the tax. But when you look at the reason you want to rebalance, it’s to manage the risk. So if you’re not rebalancing, well then your portfolio’s potentially taking on more risk than maybe what you’re comfortable with.
Talli Sperry: That’s a great point.
Bryan Lewis: And when you see a market decline like we saw in December, that could be an uneasy feeling, and the market just adjusted the portfolio for you.
So there’s ways to reduce your taxes. You can look at, I mentioned this earlier, charitable giving. You can gift that money away. Maybe gift to children who are in a lower tax bracket. You could use that as a way for funding your gifting. But there’s ways within, for example, it depends on what cost basis method you’re using, but you might be able to identify lots within all those holdings that have smaller gains or losses. So there are a couple of different levers that we can pull to try to minimize that tax.
Talli Sperry: Great. Maria, would you add anything?
Maria Bruno: Yes, I would echo what you said earlier in terms of, you don’t want the tax implications to drive the investment decisions.
Bryan Lewis: Exactly.
Maria Bruno: So first and foremost, you want to make sure that you understand where you need to be and then think strategically how to get there.
Talli Sperry: Great.
Maria Bruno: And then, you mentioned some really good tactics in terms of how to do that tax efficiently. The other thing I will add is capital gains rates, so when you sell assets at a capital gain, those rates currently are lower than ordinary income tax rates, so that’s another consideration.
Talli Sperry: So a lot to weigh there. I think our clients are taking us up on our focus for specifics for 2019. So, Maria, I’m going to give this question to you because it’s another one around asset allocation. And this one is from Michael in New York, and he’s asking, “How does he plan if he’s thinking of a significant cash need in a year or 2?”
Maria Bruno: Well, that’s a good question. Bryan had mentioned earlier when we think about the role of cash in the portfolio, it’s really around principal preservation. So if you know you have a need within a short time horizon, within a year or 2, then that is where cash really can come into play.
So certainly make sure that when you think about your spending, or maybe a spending fund, or how you take your RMD, for instance, if you’re retired, keep that into a cash reserve type of account so that money is there if you have a known need.
Otherwise, if you incur an unexpected need, then pull from the portfolio as tax efficiently as possible to meet that need. But if you know you have a short time horizon, then certainly earmark or try to get to that cash position so that you have those funds available.
Talli Sperry: Great. Bryan, do you see clients dealing with this issue regularly? How do they use you as an advisor to think this through?
Bryan Lewis: Yes, so I think as you prepare for 2019, even every year, the comment we made earlier is crucial. You need to make sure you have enough cash on hand for any emergency and any expenses that you may have coming up. So somebody who’s still working, for example, maybe 3 to 6 months’ worth of cash is sufficient. But for somebody who’s in retirement, where you’re living off maybe the assets that you’ve accumulated, look at maybe a year’s worth of cash. So if you spend $100,000 a year, maybe you have $100,000 in a savings account that would be earmarked for those expenses. It’s stable. It’s not exposed to the market. But these are things that we commonly talk about, and rates are still relatively low. But interest rates have gone up, so it’s helped some of those retirees in that regard. But it’s still something you want to make sure that you don’t have too much cash or too little.
Talli Sperry: Great, really helpful.
All right, so this question is from Harry from Addison, Texas. And he’s asking a question about international allocation. And so I might want to hear from both of you on this one, if that’s okay. But, Bryan, we’ll start with you.
So, “How much should be allocated to developed as compared to emerging markets, and what should the allocation be for active versus index, for both domestic and international?” So big, meaty questions, so thank you very much.
Bryan Lewis: Yes, that’s a great question. When you look at building your portfolio, you look at it in 2 different sections. One would be first look at your stocks. So Vanguard would recommend that you have anywhere from 30% to 50% of your stocks invested outside of the United States, more or less 40% is the sweet spot. Ideally no less than 20%.
Talli Sperry: And can you share why?
Bryan Lewis: Yes, so over time we’ve done a lot of research; we’ll continue to do this. It helps to reduce risk. It sounds counterintuitive. If you look at international investing, the immediate thought that I hear, and counter to my argument, would be, well, it’s riskier to invest overseas. Well, when you look at that in addition to what you have in the United States, it actually has proven to reduce risk. What I mean by that is getting from point A to point B with a smoother portfolio return. So there are benefits to international investing. You think of the different sector allocations, so comparing U.S. versus the international markets, they’re not allocated the same. Health care, consumer services, they just have different weightings. And there are large companies outside the U.S. that are domiciled, that if you primarily are looking at these multinationals, you’re not getting that exposure and you’re also not getting that additional currency exposure that we want you to have on the stock side. So within the stocks, ideally right around 85%, 80% in developed markets, and then the rest would be in emerging markets.
If you flip it and look at the bonds, it’s quite different. We view bonds, and I mentioned this earlier, as more of that safety net, shock absorber. So when you look at investing in developed markets versus emerging markets, first you’d want to have around 20% to 30% of your taxable bonds invested in international bonds. And then within that you’d have around, actually pretty much primarily all developed markets as far as the bond exposure.
The reason for that is emerging markets, there’s more risk associated with it. So think of the bonds, as again, more of that shock absorber. The stocks are where I would take the risk; but in the grand scheme of things, over a long period of time, the benefits of international investing, we found, actually, it proves to have that.
Now it hasn’t worked when you look at performance. So over the last decade, the international has underperformed relative to the domestic stocks. And when you look at Vanguard’s, you mentioned our market and economic outlook, that we actually think developed markets have the opportunity to outperform relative to the U.S. markets. So I don’t like to try to time the market, but for somebody who is maybe light on international stocks, it could be a good opportunity to get into them.
Talli Sperry: That’s great, and you can read again about our Vanguard economic and market outlook. The 2019 version is in the Resource List widget.
So we’ve got a live question that I’d love to get to. Maria, I think we’d love your thoughts on this one. And it’s from A. Cransley, who’s saying, “How do you consider estate taxes on rebalancing equity funds that trigger a tax where no tax would be due in an estate?”
Maria Bruno: So how do I, I’m going to repeat the question.
Talli Sperry: It’s a meaty one. Do you want me to repeat it?
Maria Bruno: Please. So how do I think about estate taxes—
Talli Sperry: —on rebalancing equity funds that trigger a tax where no tax would be due in an estate?
Bryan Lewis: I can answer that. So this is a question we get from time to time.
Talli Sperry: How interesting.
Bryan Lewis: When you look at—for somebody who passes away, there’s something called a step up in basis. So you could say, “You know what? I don’t want to deal with the tax of selling this investment. I’m going to wait for my heirs to inherit that. They’re not going to pay any tax on it.” Or you can look at basically selling portions of it to chip away at it, and then you’re responsible for the tax.
So when you look at the pros and cons of that, it depends, I guess, as far as how much of this holding represents your overall portfolio. If it’s an individual stock that represents a huge portion of the portfolio, well, we would say you’d want to diversify. It’s worth paying the tax. But it’s a cost-benefit analysis. You have to look at the pros and cons of that.
Talli Sperry: That’s helpful. Would you add anything?
Maria Bruno: No, I think that you want to balance that out and what the goals for those monies are. Absolutely, yes.
Talli Sperry: Okay, that’s helpful. Good. All right, so this question is for you, Maria. And so this is from John from Naples, Florida, who’s saying that he’s considering reducing his 40% allocation if we go into a recession in order to free up money to buy equities at a discounted price. And he’s asking you to comment on that proposed strategy.
Maria Bruno: Okay. That’s an interesting one because when you think about it, we can’t predict exactly what’s going to happen. There are some fears around a potential recession. If you look at Vanguard’s market and economic outlook, we don’t necessarily share that concern, but it is at the forefront, and it is a possibility as well.
We’ve done some research—again, it’s in this economic outlook as well—that actually shows that a diversified portfolio actually overall fairs better. The thing I would caution is, when you think about trying to react to concerns around what could happen in either the markets or in the economy, that ventures into market-timing because that may or may not happen, and you’re altering your portfolio, which could have short-term and long-term implications to it as well.
So I would go back to what we would recommend in terms of having a globally diversified portfolio. And it doesn’t necessarily ensure against a loss, but it’ll help diversify and make sure that you’re diversified across. That could help minimize the impact of losses within the portfolio.
Talli Sperry: Okay, that’s great. That’s really helpful.
Maria, I’d like to keep you in the hot seat for a minute if you’re up for it. So this is from G.R. from East Lyme, Connecticut, and he’s asking, “For someone with substantial rollover IRA holdings, the RMD might force him into a higher tax bracket,” and so he’s asking, “Are there situations where withdrawing from the IRA ahead of the RMDs might make sense?”
Maria Bruno: Yes, it really can. It’s on a case-by-case basis, but as we had mentioned earlier, many retirees today are probably holding larger traditional IRA balances than Roth assets. So a couple ways to help mitigate those RMDs could be to draw those assets down or to do a series of partial conversions in those earlier years. I think those could be prudent strategies to think through.
So I would evaluate it probably on a case-by-case basis and on an annual basis, but I often encourage retirees to think about RMDs well before age 70. It sounds kind of counterintuitive. Once you reach age 70½, your options are limited. You’re mandated to take those distributions. There may be some tactics to help minimize the tax implications, but the options are much more limited at that point.
I would, though, encourage that individuals that are looking at that, and typically it’s between the age 60 and 70 window, to really think through that; and this is where I think an advisor or a financial planner can actually add value in terms of figuring out how much to either draw down or convert.
Bryan Lewis: Yes, because you could be, obviously, retired and you’re spending. That could be a good way, maybe you spend from the retirement account. Generally Vanguard would suggest you use your nonretirement accounts first. As long as you can, delay those distributions from the IRAs until you’re required at age 70½.
But there could be situations where it makes sense to spend from your IRA, or if you have a goal of passing on assets to your children or grandchildren, that’s when you could start chipping away, doing Roth conversions. But this is where you have to be sensitive to, all right, if I’m doing a Roth conversion that’s taxable income to me, what other impacts will it have on, for example, your Medicare premiums? So there’s other tax implications. This is where we partner with a client’s accountant and think through some of these big-picture items, just because you need to know exactly what you’re getting into just because you can’t recharacterize, basically what I call a mulligan, where you can’t undo that Roth conversion anymore, so you have to make sure it makes sense.
Talli Sperry: Okay, really helpful.
So I’m going to ask a question to both of you here, and so you guys can decide who answers first. This is from Scott from Dartmouth, Massachusetts, who’s asking, “What are the most important investment tasks for individuals as we move into 2019?” This is a great question, very timely. So, Maria?
Maria Bruno: Well, I would start by, it may not sound glamorous, but really look at that 2018 tax return, whether it’s already done or whether you’re doing it. I think we can learn a lot from that, because 2018 is the first year that we’re going through the new tax reform package. So Bryan had mentioned earlier in terms of standard deductions going up, the personal exemptions gone away, the brackets have changed, there are some limitations in terms of the ability to deduct state taxes and local taxes.
So my suggestion would be, take a look at that 2018 tax return, either if you did it yourself take a look at it or with your accountant or your advisor, to really understand what the tax picture looks like and if there’s anything that’s going to be different in 2019, and proactively think about that now, not later in the year, so that you can think about whether you can take advantage of any tax-planning opportunities throughout that year.
Talli Sperry: Great.
Bryan Lewis: Yes, I think that’s a great point, and thinking out of other topics with estate planning, so the federal exclusion amount is $11.4 million per person, so this is actually scheduled to go away in what’s called sunsetting at the end of tax year 2025. So it’s going to go back to the $5.5 million plus inflation, unless things change.
So some people are waiting to do anything. This is where I think being, I mentioned earlier, forward-looking, and trying to think of how are these decisions I’m making now going to impact me later. And that’s where I think of myself as a CFO, so somebody’s chief financial officer, as I navigate them through some of these twists and turns. But thinking ahead about some of these decisions that they’re going to be making and what the broad impact will be.
Talli Sperry: Yes, I think those are great final thoughts for us tonight because they really draw us back to thinking short- and long-term, even as we start to look at 2019, so thank you both.
I’m sure we could keep talking tonight, but it does look like we’ve run out of time. So thank you guys so much for sharing your thoughts and your insights tonight. It’s really helpful.
So as we cover a lot of important material tonight, we are really grateful for the expertise of Maria and Bryan, and thank you members of the Vanguard community and those who may be new to our webcast for joining us tonight.
We really hope this conversation has been helpful to you as you think about your own financial planning for 2019. If you would be generous enough to share just a few more seconds of your time, we’d be grateful if you can select the red Survey icon. It’s the second from the right at the bottom of your screen. We really do value your feedback on tonight’s webcast, and we welcome your suggestions for future topics you’d like us to cover.
In the next few weeks we’ll send you an email with a link to review the replay of tonight’s webcast, as well as links to some highlights of tonight’s discussion, and we’ll also include transcripts for your convenience.
And be sure to check out our new podcast series, The Planner and the Geek, and it’s featuring Vanguard’s own Maria Bruno, who is with us tonight. You guys crack me up when I listen to that.
Maria Bruno: I’m the Planner, not the Geek.
Talli Sperry: Right. Okay, good to clarify. See, she makes me laugh even now. So if you guys want to go to the first link on the green Resource List to listen to a recent episode, you’ll hear Maria.
We’re so glad you spent your evening with us, and we do sincerely hope you benefitted from the program. We encourage you to continue the conversation with Vanguard communities through our social channels, so that’s facebook.com/vanguard and on Twitter by going to @vanguard_group.
On behalf of our panelists and all of us here at Vanguard, thank you and goodnight.
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