The basics still apply

No dramatic changes foreseen in terms of investment advice. Our experts recommend looking closely at your bond investments in this low-interest-rate environment, rebalancing your asset allocation, and maximizing after-tax returns. Otherwise, basic principles like broad diversification and low-cost investing still hold.

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Talli Sperry: We’ll go back to one of our presubmitted questions; and I’m going to take this one from David. And, Tony, I’m going to ask you this, which is, “What portfolio changes should investors be considering in light of the new tax structure?” because I’m sure that’s exactly on your mind right now.

Tony Giordano: It’s a great question. And unlike the tax in the estate planning front, I don’t see things changing all that much from Vanguard’s perspective in terms of our investment advice.

Talli Sperry: That’s comforting.

Tony Giordano: Yes. I do see a tremendous opportunity for clients to take a look. Jackie had put up a slide earlier that talked about the rates, the marginal tax brackets. And just about everybody’s going to be in a different marginal tax bracket going forward; albeit, they’ll probably be in a close marginal tax bracket than what they are today or what they were in 2017. It will be different, so I think it’s a great opportunity for investors to look primarily at the bond portion of their portfolio.

We continue to be in a very low interest rate environment, so it’s important to really maximize your after-tax returns. So, again, I think it’s a good opportunity to do an apples-to-apples comparison of what does it look like, where are you at in the tax bracket, where do you fall in the new marginal tax bracket, and then do an apples-to-apples comparison to see do municipal bonds provide a greater after-tax value for you or does being in a taxable bond portfolio provide that greater value?

Talli Sperry: That’s a really important question we should probably be assessing sooner rather than later, right?

Tony Giordano: Yes, being at the beginning of the year, you want to be able to maximize that. So, you know, the way our bond funds work, they pay a dividend on the last business day of each year, so we’re already kind of midway through January, so the sooner that decision is made the better.

And some of our core principles, some of the things that we believe in like broad diversification—not only just U.S. but global diversification—low cost investing, those things still hold. We’re not making any changes from that perspective. We still think that that’s, obviously, really going to be even more important going forward because a lot of firms are projecting that returns could be a little bit lower than historical averages going forward.

Talli Sperry: So it’s nice to know that amidst a lot of change, some things remain very consistent. That’s great.

Tony, I have a follow-up question for you, and it’s a live question. So Bruce is asking, “In a taxable account, what is the strategy for rebalancing asset allocations when the tax basis of your assets is essentially zero and one has substantial gains in all asset classes?” So maybe if you were going to start out by defining tax basis and then walk us into that so all of our viewers can be with us.

Tony Giordano: Sure, so it’s a great question. It’s coming up quite often with a lot of my clients. As the equity markets have drifted higher, we’re asking a lot of people to consider rebalancing at this time, you know, selling some of their stocks and going into bonds.

But to answer your question, in terms of establishing cost basis in a taxable account, that’s essentially what you paid for the security or the underlying mutual fund or individual security. So just as an example, if you put $10,000 into one of our mutual funds, and that $10,000 has now grown to $100,000, you now have that established cost basis of $10,000; and now the question is, “If I’m going to rebalance the portfolio, I’ve got that delta, that $90,000 differential, and I’ve got to probably pay some capital gains tax to do that.”

So one of the ways that we recommend doing that, it doesn’t move the dial all that much, but we could redirect dividends.

Talli Sperry: Interesting.

Tony Giordano: So you could take the dividends from the stock funds, you could start redirecting them into the bond portion of the portfolio. That’s a way to do it. You’re going to pay taxes on the dividend regardless, whether you reinvest it back into the mutual fund or whether you distribute it to a new fund or if you take it in cash. You’re going to pay taxes on it anyway.

So that’s one way again; albeit, it’s not going to move the dial all that much, but it will start to gradually shift that investor a little bit more conservative without having to necessarily incur the capital gains tax.

Having said that, the capital gain rates are pretty low, so we’re historically, when you look at capital gain rates—Jackie could probably talk to this even more historically—but if you’re not in the top marginal tax bracket, your federal rate is 15%. So it’s not the end of the world to pay a little bit of taxes. You did make money along the way, so and we do think that the overall asset allocation is really the driving force behind the investment strategy. So we do think that clients should rebalance, and if they have to pay a little bit of taxes, so be it.

Important information

All investing is subject to risk, including the possible loss of the money you invest. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income. Diversification does not ensure a profit or protect against a loss.

Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer’s ability to make payments.

Investments in bonds are subject to interest rate, credit, and inflation risk.

Although the income from municipal bonds held by a fund is exempt from federal tax, you may owe taxes on any capital gains realized through the fund’s trading or through your own redemption of shares. For some investors, a portion of the fund’s income may be subject to state and local taxes, as well as to the federal Alternative Minimum Tax.

This webcast is for educational purposes only. We recommend that you consult a tax or financial advisor about your individual situation.

Advice services are provided by Vanguard Advisers, Inc., a registered investment advisor.

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