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  • zero-dividend investing in taxable account

    I have noticed that there are several threads on taxable accounts and tax efficiency (including outside articles by jfoxcpacfp and PoF).

    After reading Phil DeMuth's book (The Overtaxed Investor), it was with great interest that I watched this thread unfold on the Boglehead forum: https://www.bogleheads.org/forum/viewtopic.php?t=198334

    In short, the idea is holding a portfolio of individual stocks in your taxable account which do not pay a dividend.

    I admire the Bogleheads for their commitment to a particular dogma which serves most people best.  However, I felt that this thread on the Boglehead forum was limited by the ideology embraced by Bogleheads.

    I suspect the crowd here may be a little bit more open minded - would a reasonable person try something like this?

  • #2
    This reminds me of CPAs who tell their clients to spend a lot of money in December to save taxes, whether or not they need that shiny new piece of equipment costing $100k. By the way, what does a non-dividend-paying stock say about the management of the company? Can they not afford to pay? Are they miserly? Poor management? Or are they really putting aside that extra capital for needed expansion. Remember, you are buying a piece of a living, breathing business that should be throwing off profits and rewarding owners.

    How about bonds that don't pay interest? Let's see if we can reduce our income to zero. In for a penny, in for a pound.
    Working to protect good doctors from bad advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

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    • #3
      I would/do try to limit dividend paying in my taxable, using qqq or a similar low overall dividend fund works as does a market proxy company like Berkshire. That may have massive tax implications in the future if its ever broken up, spins off assets, etc...however. I mostly have muni funds in my taxable for now, and other things that are not fit for mentioning on this forum.

      Comment


      • #4


        This reminds me of CPAs who tell their clients to spend a lot of money in December to save taxes, whether or not they need that shiny new piece of equipment costing $100k. By the way, what does a non-dividend-paying stock say about the management of the company? Can they not afford to pay? Are they miserly? Poor management? Or are they really putting aside that extra capital for needed expansion? Remember, you are buying a piece of a living, breathing business that should be throwing off profits and rewarding owners. How about bonds that don’t pay interest? Let’s see if we can reduce our income to zero. In for a penny, in for a pound.
        Click to expand...


        With respect, companies like Berkshire Hathaway, Google, Amazon, Facebook, etc. don't have a problem hiring good management (look at the list of top businesses where Harvard MBAs want to work).  And yes, they are profitable and could pay dividends if they didn't have competitive ways to invest their profits in their own company.

        Dividends are great, but they = forced taxation.  If you knew you could receive a similar return with or without a dividend, you would never choose to have a dividend.  The dilema lies in achieving adequate diversification while avoiding a dividend.


        What would make you think that something you know is best for most isn’t best for you?
        Click to expand...


        Because I pay a lot more taxes than most - that answer was easy.


        You didn’t list a single legit reason or even lists sticks you would consider.
        Click to expand...


        Well, if you think about this for a while, there are a lot of reasons (I am sure you would have come up with many of these, your answer may have been somewhat impulsive).  Some of these are less significant for many, but some of these are a HUGE deal:

        1.  No annual Federal tax drag.

        2.  No annual State tax drag (this may change over the years if you retire to a different state).

        3.  No mutual fund expense ratios (even dirt cheap VTSAX/VTIAX add up if you are talking about using them as your primary tool for wealth accumulation over decades).

        4.  No taxes on the gains ever if you hold them until your death (even VTSAX/VTIAX if held to death would avoid LTCG, but you would have had forced taxation each year due to dividends).

        5.  Realizing LTCG only in years that you want (rather than having dividends in years when you are already in a high tax marginal tax bracket).

        6.  Your social security will be taxed less (muni bond interest doesn't save you here).

        7.  Your medicare premiums could be less (muni bond interest doesn't save you here).

        8.  More efficient tax-loss harvesting than holding mutual funds.

        Especially if you retire early:

        9.  You can realize less income in a year to qualify for ACA subsidies (this could effectively be a HUGE tax on your dividends).

        10.  You will have lower income, allowing for greater Roth conversions in post-retirement, pre-social security years (or, you could CHOOSE to realize LTCG during this time).

        I am sure their are plenty of other reasons that having control over your tax situation is better than not having control, but hopefully this can help open some people's eyes to the possibilities.

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        • #5




          With respect, companies like Berkshire Hathaway, Google, Amazon, Facebook, etc. don’t have a problem hiring good management (look at the list of top businesses where Harvard MBAs want to work).  And yes, they are profitable and could pay dividends if they didn’t have competitive ways to invest their profits in their own company.
          Click to expand...


          Then the question should be if you should buy stocks only of companies with great track records that don't pay dividends. That's a totally different perspective. Your list is nice (maybe you should write a post - seriously) but it merely highlights the need for a comprehensive financial plan.

          The point of planning is to clarify goals, resources, and opportunities in order to accomplish those goals. Limiting yourself to only non-dividend paying stock is not really different than limiting yourself to only dividend-paying stocks. It is one-dimensional, like writing a symphony using only one note.

          Tax-reduction is only a tactic, not a plan or even a meaningful goal. It's easy to reduce taxes: work less and donate more. But what are the overall results in the context of achieving your goals? All of the moving pieces play their part, not simply taxes.

          And by the way, my original response was not directed at you personally but at the idea. I apologize for causing you offense.
          Working to protect good doctors from bad advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

          Comment


          • #6
            I prefer a low-dividend taxable account for all the reasons you've outlined. I actually recently bought some shares of Berkshire Hathaway (my only individual stock), liking the no-dividend history, but it's less than 1% of my taxable account.

            I'm able to keep tax drag pretty low by investing in passive index funds, and it should be more tax-efficient if I have low enough income as an early retiree. I think if you focus only on individual stocks without dividends, your return may vary from the market's return by more than the tax savings you've realized.

            I do think the dividend-focused PF blogs are missing the point, though. Total return matters. For high earners like us, dividends aren't welcomed so joyously. There was some similar discussion in this recent thread.

            Best,

            -PoF

             

             

            Comment


            • #7



              This is also a good way of looking at the costs: https://www.bogleheads.org/wiki/Tax-efficient_fund_placement#Appendix:_comparison_of_h ypothetical_tax_costs

              If the cost of holding TSM in taxable is 0.48% per year in federal taxes (not counting state taxes, expense ratio, or later optimized timing of LTCG), and the cost of TISM is 0.43% (+ the other stuff), it is easy to see how much this adds up to over a few decades.

              This only matters for people who save a lot in taxable each year.  I haven't implemented this idea at all yet, I still only invest in VTSAX/VTIAX every month in taxable.

              If future returns are expected to be lower than historical norms, then costs become even more important than they have been in the past - and the largest cost is taxes.  I'm a spreadsheet guy.  I know some of you are also.  Play with that 0.48% federal + 0.05% expense ratio + your state tax rate over a few decades or the rest of your life and see if you think this is worth talking about.

              I came to the conclusion that it is.

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              • #8






                This is also a good way of looking at the costs: https://www.bogleheads.org/wiki/Tax-efficient_fund_placement#Appendix:_comparison_of_h ypothetical_tax_costs

                If the cost of holding TSM in taxable is 0.48% per year in federal taxes (not counting state taxes, expense ratio, or later optimized timing of LTCG), and the cost of TISM is 0.43% (+ the other stuff), it is easy to see how much this adds up to over a few decades.

                This only matters for people who save a lot in taxable each year.  I haven’t implemented this idea at all yet, I still only invest in VTSAX/VTIAX every month in taxable.

                If future returns are expected to be lower than historical norms, then costs become even more important than they have been in the past – and the largest cost is taxes.  I’m a spreadsheet guy.  I know some of you are also.  Play with that 0.48% federal + 0.05% expense ratio + your state tax rate over a few decades or the rest of your life and see if you think this is worth talking about.

                I came to the conclusion that it is.
                Click to expand...


                I agree, which is why I dont hold any tax free dividend/distribution fund in taxable. Its all muni funds and indexes/etfs that dont have a dividend, etc...For the record I dont see too much risk aside from what I mentioned earlier about BRK, breakup risk, and even then you'd know beforehand. BRK is basically an index fund that mimics the market but has no dividend and is technically a single stock. Its huge and there are many many businesses contained within it, its more diverse than many factor etfs likely which people are comfortable with.

                Even though muni fund returns are lower than market indexes, their distribution is much higher and when you track them inflation adjusted theyre very very close, so I chose to go heavy munis and a couple other factors, no taxable dividends for me right now.

                Comment


                • #9
                  I read Demuths book on taxes too.  In a perfect world assuming no changes to future tax law it could make sense to invest in no dividend stocks.  However the world is not perfect.  If you have been investing for a while you already have assets in a taxable account that are paying dividends and you would incur large LTCG by selling.  Figuring out good stocks with no dividends seems to be individual stock picking and market timing.  It is simply impossible to legally avoid all taxes.  I think it is a good position to be in having to worry about the taxes your taxable account is throwing off because that means you have done a good job in the accumulation phase.

                  Comment


                  • #10


                    I agree, which is why I dont hold any tax free dividend/distribution fund in taxable. Its all muni funds and indexes/etfs that dont have a dividend, etc
                    Click to expand...


                    If you read through the referenced boglehead thread on zero dividend investing, you will see that there are many "modified AGI's" that include income from muni bond funds.  I think what you are doing is much better than most, but I think there may still be room for improvement.


                    For the record I dont see too much risk aside from what I mentioned earlier about BRK, breakup risk, and even then you’d know beforehand. BRK is basically an index fund that mimics the market but has no dividend and is technically a single stock
                    Click to expand...




                    As I mentioned before IF I did this I’d use Berkshire but it isn’t a broad index fund or any index fund for that matter. Using it is buying a stock with all pros and minuses of single stock purchases.
                    Click to expand...


                    I think BRK would almost certainly be a part of any meaningful implementation of this plan, but I don't think it could reasonably be the only holding.  I understand the breakup risk, I understand the single stock risk... I don't understand the risk related to their financial or insurance operations (and 2008-2009 made me rationally/irrationally fearful of the possibilities).

                    Comment


                    • #11




                      I read Demuths book on taxes too.  In a perfect world assuming no changes to future tax law it could make sense to invest in no dividend stocks.  However the world is not perfect.  If you have been investing for a while you already have assets in a taxable account that are paying dividends and you would incur large LTCG by selling.  Figuring out good stocks with no dividends seems to be individual stock picking and market timing.  It is simply impossible to legally avoid all taxes.  I think it is a good position to be in having to worry about the taxes your taxable account is throwing off because that means you have done a good job in the accumulation phase.
                      Click to expand...


                      I have no plans to incur any LTCG to reduce my current TSM/TISM in taxable.  I will always pay some tax from dividends in taxable (my dividend-related tax bill will be several thousand this year).

                      I am thinking about the future, and I am not as fatalistic about my future tax bill as you seem to be.

                      Truthfully, I do have some concerns about implementing this in a way that shields me from the investing sins of stock picking and market timing.  I also realize that I would have to live with some (positive or negative) tracking error by giving up the near perfect diversification of index funds for this portion of my portfolio.

                      Comment


                      • #12
                        Was just reading Larry Swedroe's piece:

                        http://www.cbsnews.com/news/does-a-high-dividend-strategy-help-or-hurt-returns/

                         

                        In short, a high-dividend strategy creates returns that are explained by a slight value-tilt.  The 'dividend' factor is subsumed by the 'value' factor.

                        Does this mean that a zero-dividend strategy leads to a growth-tilt?  In this case, a small tax savings (compared to low turnover index funds) may not make up for lower returns.

                        Comment


                        • #13
                          Yes I think it does tilt to growth.  High growth tech companies are classics for zero dividend stocks.  After they have been around awhile they start paying dividends.  The classic example of this is apple.  When I bought it initially it was a high growth stock that paid no dividend.  It starting paying a dividend and became a blend and is now considered a value stock on my asset allocation tool

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                          • #14
                            So... I still only have VTSAX/VTIAX in taxable (along with their tax-loss-harvesting partners VLCAX/VFWAX).

                            At the WCI conference 2018, William Bernstein MD mentioned in his talk a couple of times about how close BRK's performance has been to S&P500 over the last 10-15 years.  After his talk, I asked him "since you are in a room full of people paying the highest taxes of their life right now, and BRK and S&P500 have very similar returns, is there a roll for holding this in taxable to minimize tax liability during these high tax years?"

                            His response was basically:

                            1.  Warren Buffet is pretty old, and won't live forever

                            2.  What BRK does with taxes is nearly criminal

                            3.  Just because you can avoid taxes now with BRK doesn't mean it will always be so

                            That is going from memory, but I think it is mostly accurate.

                            I didn't ask him about this strategy in general, only about BRK because he mentioned it in his talk - I am sharing it because I thought those of us interested/intrigued/curious with this idea might also be interested in his opinion.

                            Comment


                            • #15




                              That is going from memory, but I think it is mostly accurate.
                              Click to expand...


                              Your memory serves you well--I was there listening to his response as well. A lot of folks are worried/curious about what will happen to BRK after Buffett/Munger are out of the picture.

                              I think like many things the idea of a dividend-free taxable account sounds appealing when considered in isolation. However, the market operates as the market operates and the issues others have referenced are at play. Definitely an interesting thought exercise and I second Johanna's suggestion that it would make a good post. Perhaps as a back-and-forth pro/con post?

                              In other news, Zaphod is such a tease with his mysterious portfolio.

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