Invest Your Taxable Account Thoughtfully

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Jonathan Clements was a longtime personal finance columnist for The Wall Street Journal, and he offers great advice at the best price you can get (free) on his blog Humble Dollar. Here is one piece of advice from his site:

INVEST YOUR TAXABLE ACCOUNT THOUGHTFULLY. If you purchase the wrong investments in your taxable account, you may be reluctant to sell, because you’ll trigger capital gains taxes. A good choice: low-cost U.S. and international total stock market index funds, which should be tax-efficient—and which shouldn’t ever lag far behind the market averages.”

For those of us in the military, investing in a taxable account comes into play in a few scenarios…

Scenario #1 – You and your spouse (if you have one) have filled your Thrift Savings Plan (TSP) and all other retirement accounts available including IRAs, yet you want to save more for retirement. In this case, you put the rest in a taxable account with the investment company of your choice (Vanguard, Fidelity, Schwab, etc.). This is what I do when all of my retirement accounts are full, and just like Jonathan mentions I invest purely in broad, low-cost index funds at Vanguard. The only taxable holdings I have are the Vanguard U.S. and international total stock market index funds.

Scenario #2 – You are saving for a financial goal that is not related to retirement, such as a downpayment on a home or for a new car. If you’re saving for college, you’d use a 529 plan, but for just about anything else you could use a taxable account. For example, you could put your emergency money and extra spending money in a money market fund among your taxable accounts. The alternative to this is to use a bank and invest in a high-yield savings account (which is what I do), a certificate of deposit (CD), or a money market account. will show you the best rates for each of these reasonable alternatives.

If you are using a taxable account, there are a few things to consider. If you are investing in bonds, you may want to invest in municipal bonds in your taxable account due to the tax benefits. If you are a fan of target date funds, you may not want to use them in a taxable account because the bond portion will kick off income that is taxed at your full marginal tax rate. This is less of an issue with bond yields being low right now, but most experts feel that bonds are better placed in a tax-advantaged retirement account unless you are using municipal bonds.

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