Taxable Brokerage Accounts: 5 Essential Optimization Strategies for High-Income Earners

Optimizing Your Taxable Brokerage Account: Key Strategies for Financial Independence

In this episode of The Retire Early Retire Now podcast, host Hunter Kelly, a certified financial planner and founder of Palm Valley Wealth Management, delves deep into the intricacies of optimizing taxable brokerage accounts. He outlines five crucial strategies for maximizing these accounts, emphasizing the importance of aligning investments with goals and time horizons, understanding the tax implications of trades, optimizing asset locations, focusing on low-cost funds, and planning for rebalancing and tax-loss harvesting. Hunter also provides real-life examples and actionable tips for investors at various stages, from beginners to seasoned investors. Tune in to learn how to make your taxable brokerage account work for you and help achieve financial independence.

00:00 Introduction to Taxable Brokerage Accounts
02:06 Clarifying Goals and Time Horizons
06:20 Understanding Tax Implications
11:18 Optimizing Asset Location
15:43 Managing Costs and Fees
17:23 Rebalancing and Tax Loss Harvesting
22:23 Conclusion and Final Thoughts

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Transcript

0:00

And welcome back to The Retire Early Retire Now podcast. I'm your host, hunter Kelly, certified financial planner and founder of Palm Valley Wealth Management. And today we're talking all things taxable brokerage accounts. I know I talk a lot about taxable brokerage accounts on this show, but we have not dove deep into taxable brokerage accounts in quite some time. So if you're a new listener. this could be a great, value add to you, especially if you are thinking about starting a brokerage account or, have already started one and want to make sure that you're optimizing this account, to as highest possible potential. And so this account gives you a ton of. Freedom and flexibility outside of your retirement accounts. And if you're a high income earner, it can supplement retirement as well. today we're gonna talk about five things that you should be thinking about, five items that you should, understand about your taxable brokerage account so that you can optimize it and make it work for you more than you working for it. Taxable brokerage accounts aren't just extra buckets. They're versatile tools for goals outside of retirement from funding kids college to maybe a second home, a boat, extra fun for trips. Whatever, your goals and desires and values are, this is going to give you the ultimate flexibility. But they come with some traps potentially, right? Taxes, misplaced assets and unnecessary costs that can erode returns. So today we'll cover five things you must know before you click buy in your brokerage account. And before we do that, if you know someone that is interested in starting a brokerage account or would like this information, share this with that friend and leave a five star review on your favorite podcasting app. I wanna spread this to as many people as possible, uh, because this podcast is all about helping people become financially independent and retiring early. So let's jump right in. Number one item, clarify your goals and time horizon. We talk about goals and values all the time on this podcast, and it is just as applicable in this. Episode as any episode that we have done. Why does it matter? Because aligning your objectives and your timeline dictates everything from security selection. So what ETFs, what mutual funds, what stocks that you want to, to purchase to tax planning, right? And so all these things matter when you talk about what do I wanna accomplish with this account? and what is my time horizon for the goals that I have? And so a couple things that you want to consider. What are some short-term goals? What are some long-term goals? So I think to a conversation with a friend I had a few weeks ago. he is wanting to purchase a new home, within the next probably year to three years. his kids are getting to the point where they're getting into grade school. they, their family has grown obviously. They have young kids and they want a little bit more room, and a better location for, the school that they'll be attending and things of that nature. he is currently saving and has a fund for a down payment knowing that this cash or this money is going to be used within the next one to three years. It would not make sense for him to go into something like an s and p fund or buy individual stocks. something like this would make more, something, that would make more sense for this account would be something like bond ladders. So utilizing treasuries or, with a given, interest rate market. it's something with short term duration or maybe even some CDs, right, more than using stocks. Or ETFs, things of that nature that have equities in them, because the volatility in those particular holdings can be great, right? So those particular holdings can go down 10, 20, sometimes 30%, in a short. Amount of time now they tend to recover. But if you need that cash in a short time period, you may not have it, to go out and buy that home in, in the case of my friend, or whatever large purchase that you need to make. So we wanna make sure that, We align our investments with our time horizon. So if you have a more long-term goal, maybe my friend, in a different scenario wanted to buy a house 10 or 15 years from now, right? maybe it's a second home or whatever, right? now because we have a longer time horizon, we can start to look at, individual holdings or, s and p fund type, ETFs where there's more equity, and things of that nature. And obviously you wouldn't just want to use the s and p, you would want to use other things, so you're a little bit more broadly diversified. But, the s and p it is the common holding that, that most people recognize, right? so obviously if you have a long. Time horizon. We want to use more equity, heavy, type investments. If we have a shorter time horizon, somewhere between three years or less, four years or less, we want to use something that is a little less volatile, maybe a little bit safer, like bond ladders or CDs, or maybe even a high yield savings account depending on, your specific goal or need. And so the tip here is. Write down your goals. Write down the amount that you would need or that you think you would need, and then this will help you choose. the investments that would fit your goal and time horizon. those are some action items, items to take. So maybe you've already started, a brokerage account and you're just kind of investing. You don't really have, a rhyme or reason. sit back and think, or am I just saving this money to save and I wanna be uber aggressive with it'cause I don't have a time horizon on it? Or is there a specific reason why you opened this account that you have something in mind that you want to use this money for? And maybe that will change what you actually have invested in it currently. maybe you wanna be more aggressive or maybe you wanna be more conservative because that time horizon, is actually fairly close. Or vice versa. Maybe it's longer, so we'd be a little bit more aggressive. The biggest thing that IP think people, don't understand with brokerage accounts is how their investments are going to be impacted from a tax standpoint. Everyone is fairly familiar with, their 4 0 1 ks or traditional IRAs, maybe a Roth IRA, knowing that. Those accounts are deferred on taxes. So any trades that you do, no matter how many trades, you could do, hundreds of thousands of trades, there will be no tax implications while the, that money is in those retirement accounts. Now, on the back end, depending if it's Roth or traditional, there may be some, some taxes owed on the backend, but while that money is in that account, there'll be no taxes owed. Right? And so that is not the case for. These brokerage accounts. you can either have a short-term gain or loss, or you can have a long-term gain or loss. So depending on which is. Which, especially on the gain side depends on the tax rate that you'll use. So gains held for less than one year are tax at ordinary income gains that are held for a year and a day or longer will, have a long-term capital gains rate. And so the long term capital gains rate is. Generally much more favorable than short term, because short term is going to be your ordinary income. So if you're in a 24% tax bracket, a 35% tax bracket, or maybe even the highest at 37 and a half, your Your ordinary income would be much higher than, let's say the 15 or the 20% long-term capital gains rate. So things that you want to consider is maybe you, picked an individual stock and you felt good about it. You've been holding this stock for a few months, and it goes gangbusters. It goes extremely high, very quickly, and. You wanna start thinking about taking gains off of this? Well, if you're close to that one year mark and it makes sense, it. It might be worth holding it until you get to that year mark to save on those taxes. Now, there's, there's all kinds of reasons why you might wanna sell before that. if people are selling and taking their gains as well, and you're losing that profit, maybe you would want to, it would make more sense to sell before that year. but if you can, waiting until that. year and a day would make more sense from a tax standpoint, at the very least. and so you wanna consider that. And so that'll also, dictate how many trades you wanna make each year, whether that be to capture gains or capture losses. rebalance, things of that nature. So you wanna be very aware of, okay, do I have a short term gain or do I have a long term gain here? what are the tax implications to this trade that I'm considering? Right? the other thing to consider is dividends and interest. qualified dividends get preferential rates, and then ordinary dividends and bond interest do not. So high yield, bond funds and REITs generally have a tax rate at ordinary income. And so you need to understand what you own, and we'll talk about that here in just a second. With optimizing our asset location, that's a fancy term that we use in the business, and we'll talk about that here in a second. But, we wanna know what we own and we want to try our best if we're receiving dividends to have what's called qualified dividends because they get a better rate. they get the long term capital gains rate versus, ordinary dividends get, ordinary income. So just consider that as well. And, and just to reiterate, we wanna make sure that we have tax bracket awareness. So strategically realizing gains in years with lower income, can help you save. So again, if you have, a significant amount of gains, actually working with a prospective client right now where he has. Done the, investment management himself. And he's getting to a point where, he just doesn't have the time, and the know-how to, to continue to manage that, portfolio himself. And so we have to look at, hey, how are we gonna, sell some of these, particular holdings? That he is very much overweight at this point'cause he's hit big on a couple holdings. and so how do we realize that? And so maybe there will be a case where he has some years of lower income or, some losses that he can utilize. to capture some of those gains. Or maybe we just have to rip the bandaid off, every so often, and take some, some gains, reinvest in, something else or maybe something similar, whatever that may be. You just wanna be aware of when you're making these trades, what is your tax implication gonna be? Because it's obviously very unlike what you would normally experience in, an IRA or 401k, things of that nature where you can trade all day and there's really no tax implication until the back end and you start taking distributions, right? That leads me into, something called asset location. And all this really means, it's a fancy way of saying where should our investments be held? so core principle, right? Hold tax inefficient assets. So things like, high yield bonds that may spit out ordinary income and give you an ex extra amount of tax that maybe you, you wouldn't. Really want to pay or didn't need to pay, hold those types of holdings in your tax advantage accounts. So your high yield savings bonds or, high yield bond funds you may want in your, your. Traditional type accounts. So 4 0 1 Ks and traditional IRAs where we want to keep our tax efficient investments in our taxable bucket, right? So tax efficient, investments would be like broad market ETFs or index funds, tax managed mutual funds, which, again, we wanna stay probably away from usual ones as much as we can. in our brokerage accounts, but there are some mutual funds that are a little bit more tax managed, things of that nature. Or maybe your, your income bracket is at such a place where it doesn't necessarily matter. but we wanna keep those tax efficient investments inside of our brokerage accounts and our tax efficient. So things like active bond funds, active, mutual fund managers, high turnover, type. Funds, things like that. We wanna keep those in our retirement accounts because again, you can trade as much as you want, and you're not gonna realize those taxes, each year. just an extra example here. Put your US large cap index funds in a taxable, account. Hold your high yield municipal bonds and your IRA. Or 401k because again, those will spit out, ordinary income, or taxes. And we can avoid that by putting those in our IRAs. So really with tax or with asset location, we just wanna make sure, okay, here's our portfolio. From a 10,000 foot view, maybe we have a million dollars, across a few different accounts. An IRAA brokerage account, Roth, IRA, and So we have a million dollars over, three different accounts. So traditional IRA, Roth IRA and brokerage account. And so from there our, we have some sort of portfolio allocation, whether that be a, an aggressive allocation or a conservative allocation depending on your specific, risk tolerance and time horizon and things of that nature. and so from there. We just wanna say, okay, if I'm going to be an aggressive, aggressive by nature, right? or because my time horizon allows me to be more equity heavy and go after growth. Well, based off the holdings I need to have. With my million dollars, where can I place those things to be most tax efficient? That's really what we're looking at here, right? And so with our high growth, low dividend or no dividend, we want to try to keep that in our brokerage account because. Those are not gonna spit out, dividends and, and taxes essentially each year. Right. And those, those, investments. But maybe we do have a little bit of fixed income for whatever reason, that's spitting out interest. We would want to keep those in our IRAs. Because, we're not gonna experience those taxes each year, along the way. that's kind of a 10,000 foot view on that. but that's something we can do, right? We can. We can run what's called a holdings report. Again, if you have that million dollars over those, couple of different accounts, three different accounts, we can run a holdings report and look at, okay, well based off my holdings in each account, am I really optimizing this? And this is something that we can do at Palm Valley Wealth Management and something we do all the time when we're working with prospective clients. We go, okay, based off your portfolio, maybe you have a good, allocation. From the 10,000 foot view, but let's drill in and go, okay, well instead of holding these bonds in this brokerage account, let's hold. Why are we holding them there? Oh, I don't really know. Well, we can be a little bit more tax efficient, here in this traditional IRA, whatever the case may be. Right? And so that's something you'd want to do. You wanna run that holdings report every, probably once a year, or. once every few years and go, okay, is there a way that I can be a little bit more tax efficient? And how do I, how do I go about doing that? Right? and that's again, something we do for clients, here at Palm Valley Wealth Management. So number four, mine the cost and choose low cost funds. So expense ratios matter more in taxable counts since fees are not tax deductible, every basis point counts, right? so really here, if you're, investing in ETFs as your main kind of holding in your brokerage accounts, just make sure that. You are not, choosing something that you can get for a lower cost, just do the analysis and go, okay, is this s and p fund the lowest cost s and p fund I can find, right? Or is this mid-cap fund the most value for what I'm paying for? Right? And so just have, it's not the end all, be all. Fees are not the end all, be all, but. We wanna make sure that we do our due diligence, avoid, try to avoid hidden fees like transaction fees, short term redemption, redemption fees, things of that nature. And so most custodians have gotten away from transaction fees, but every so often they do apply to certain trades and things of that nature. And so we just wanna be cognizant of what we're paying. if you're in an active mutual fund, can I get something similar? That maybe might be a ETF or index fund that can get a similar rate of return, but cut the cost in half or, dramatically lower that cost. And then essentially just. Increase my return because now I'm not paying as high of fees. Right? And so again, fees are not the end all be all, but they certainly can be a drag on your, portfolio. And so we wanna make sure that we are certainly getting the value of what we're paying for. Right? Number five, plan for rebalancing and tax lost harvesting. You are gonna need a lot more thought and consideration when you're rebalancing and thinking about tax loss harvesting inside of your, brokerage account. So why do we rebalance? This keeps your target risk and tax. So what that means is if you have a 80 20 portfolio, you have 80% equity, the 20% bonds, it's. Over a period of time, whether that be a quarter, two quarters, a whole year, over a period of time, you're gonna have, that portfolio move, right? Whether that's the portfolio is growing or maybe there's a pullback in the market, whatever that may be, and you're, the balance of your portfolio is going to deviate from what your ideal portfolio construction is gonna be, right? A year, like this year where there's a lot of volatility in the market upfront. And now we start to see the trend of the market kind of recovering, hitting new highs again. likely, if you have not touched your portfolio since then, it's at a different spot than it was 6, 7, 8 months ago. Right. And so often we need to go, okay, well I am not, within, my target. Portfolio. So now I need to do what's called rebalancing. And what's you're gonna, what's gonna happen when you rebalance, likely you're going to sell the big winners, especially if the market's running up. You're gonna sell those winners and you're going to buy the ones that either have lost, or have not won as much. So you're gonna sell high and buy low. That's the whole goal of investing, right? and so when we do this, In a brokerage account, we want to be aware of taxable events. So very similar to what we've been talking about in this entire podcast episode. we want to be aware of, well, if I sell this, what are my tax implications? And so if you're one of those people that have individual holdings or a number of ETFs, this can get complicated really quickly. And so how do I determine, which one to sell? Which one to. Buy back into all because of these taxable ben events, right? And so what we want to do is, one, we also want to look for tax loss harvesting, opportunities. So we want to sell losers to offset gains. So again, if you have multiple holdings, It's going to be ra very rare that all the holdings are gonna win all the time or going to gain all the time, right? And so there may be, situations where you have losses. And now if you have a significant loss, you can sell that particular holding, buy something, similar but not substantially identical. So you could buy, you could have a s and p 500 fund. Maybe you have a law in it for whatever reason. You can sell that those shares that are at a loss and buy something like the Russell 2000 or something similar but not substantially identical to the s and p. And you can hold that fund for as long as you want, or at the very least, for 31 days, and get back into your s and p fund and lock in that loss. And so those are some opportunities that you want to look for when you're rebalancing, so that if you do have some winners. that you want to sell and rebalance, then you can minimize those tax implications when, you sell those winners. trim. An underperforming, ETF to generate, let's say$10,000 in losses and then that will offset$10,000 in gains. So maybe you have another winner somewhere else and now you can offset, rebalance, or just use, save those losses for something later on down the road. And again, we wanna try to avoid that wash cell rule, which is you gotta wait 31 days. to buy back into that, same holding, so that you don't, negate those losses that you have sold off, right? one of the things that my custodian does really well is this rebalancing and tax loss harvesting. that they're looking for those opportunities on a daily basis. And so again. tax loss harvesting opportunities are going to be more plentiful when the market is volatile. a year, like this year earlier on in Q1 and early Q2, where the market was extremely volatile, it was not uncommon for my custodian to, start capturing losses for my clients, especially the ones that I've just bought in. and now they're able to use those losses. Moving forward. whether that is to capture some gains of some, low cost basis holdings that they have, or, using them moving forward, maybe they'll need to sell at some point, to, to purchase something or use that cash for whatever number of reasons. and they can use those, those losses to offset those gains. Those are five things that you would want to consider, if you're using or thinking about starting a brokerage account. really it's understanding your goals and your time horizon. That will, that will help you create a portfolio, that will fit your needs. And so sometimes you have multiple goals, right? and you will, want to create maybe two different portfolios. You can say, Hey, I'm gonna sift, a portion of the money that I'm contributing to this account to more short term. Type investments. So bond lighters or CDs. and then maybe I have a more long-term vision for something else, whether that's early retirement, buying a second home, a new car, whatever that may be, and I can be a little bit more aggressive With equities and ETFs and things of that nature. And, and so once you have that down, then it's just getting into minutia of how do I best understand my tax implications, whether that be from a, a capital gain standpoint or optimizing where you have your investments from an asset location, should I have these investments in my IRA and not in my brokerage account? what's the most efficient way to do that? And the best way to, understand that is just run a holdings report across all of your accounts of your investible assets, and then you can start optimizing from there. And again, that's something we do at Palm Valley Wealth Management. And then from there, understanding your plan for rebalancing and tax loss harvesting because. Again, taxes are going to be, a big weight on these accounts, especially if you're a high income earner. And so once you start optimizing these, then it is fairly straightforward to just keep contributing, let the, the money work for you, and go from there. And again, if you like this podcast, if you thought it was useful, if you want more of this type content where we're diving a little bit more into the minutia and strategy. let me know. There's a text me button on the podcast description, show notes. shoot me a text, let me know what you want to hear. And if you liked this podcast, please leave a five star review on your favorite podcasting app. Again, trying to get this podcast out to, as many people as possible so that they can become financially independent and hopefully retire early. but if you're confused about your brokerage account and your. Not sure where to start, or you've been investing and you don't know you're, you're kind of in a spot where you're stuck and you're overwhelmed a little bit. Go to my website, palm Valley wm.com. I would love to have a conversation with you, see if there's anything I can do to help. and, we can, we can certainly do that. until next time, have a great week. This podcast is for educational purposes only. It is not meant to be financial or investment advice. Please do not make decisions solely based on this podcast alone. Please seek financial or professional help when making decisions about your specific situation.