Changing a Piece of the Puzzle

In the most recent dividend income report, I mentioned that I had adjusted my automated deposit that was originally setup to purchase the Vanguard Total Stock Market Index Fund (VTSAX) to now be directed towards additional purchases of the Vanguard High Dividend Yield ETF (VYM).

The impetus for this change was primarily because my overall portfolio already has plenty of coverage with index funds, and the purpose of my dividend growth portfolio should truly be with dividends in mind.

I’ll admit that the inclusion of VTSAX initially was because old habits die hard.

My core retirement portfolio is constructed of index funds, and will continue to be aligned to that strategy. However, the goal of my DGI portfolio is to supplement our early retirement income with a passive income stream provided by quality dividend paying companies.

I appreciated that holding VTSAX was not truly aligned to that goal.

To realign my DGI portfolio to that goal, I will be executing the following three steps to transition my taxable VTSAX holding over to VYM.

Step 1 :: Adjust Automated Purchase

The change to the automated monthly purchase of VTSAX is the first step in the process, as obviously it would not make sense to continue making regular investments if my plan is to move those funds over to VYM.

This step has already been completed.

July was the first month where this change was implemented, and despite the more manual process–as an ETF cannot be automatically purchased with a set contribution amount like you can with an index fund–all went smoothly.

Step 2 :: Adjusting the Reinvestment of Dividends

The next step is to adjust my settings at Vanguard that specify the dividends from VTSAX should be reinvested automatically.

Again, with the intent to close out the VTSAX position in my taxable account, I don’t want to continue having new shares purchased with new capital or with dividends.

I’ve completed this step earlier this week.

These first two steps really are interchangeable, and the order that I’ve approached them was simply because I had the next monthly contribution scheduled earlier than the next dividend payout from VTSAX.

Step 3 :: Wait, and then Sell

With the first two steps completed, now I am playing the waiting game before I sell my current holding in VTSAX. While I certainly could make the change right now and liquidate my position, my plan is to hold until at least the beginning of 2019 and possibly until I’ve reached the long-term capital gains.

Why? Taxes.

This year has been an unusual year for me, and as a result our income is considerably higher than the average year. While my current gain in VTSAX is not earth-shattering, liquidating now will certainly cost me more than if I wait until January and a new tax year.

One of the risks with this approach is certainly that the market can turn down, and the unrealized gains that I have today in VTSAX could evaporate. I consider this risk to be a matter of when, not if, however my current perspective is one where I value minimizing my tax impact at a higher priority.

Once January arrives, nearly half of the current unrealized gain will be long-term capital gains.

At that point I will likely liquidate the entire position, as our income will be back to our normal range and the tax implications will be less than they would be now. The entire position will be eligible for long-term gains by June of next year, so I may reevaluate as time goes on and liquidate lot by lot depending on how VTSAX is performing.

Summary

In large part, my rationale for initially purchasing VTSAX in what I have earmarked as my dividend growth portfolio was based out of old habits as well as a touch of fear that I could be making a mistake by changing from my strategy of being purely in index funds.

While I don’t want to pretend that I have all the answers, I have grown more confident that I have established a portfolio of quality dividend paying companies.

With regard to the old habits of being an index fund investor, one can argue that is still being maintained by holding VYM; however, VYM certainly has a better dividend yield than VTSAX and is therefore more aligned to the goal of this portfolio. Over time I may look to reduce VYM as well, however for now I value the additional diversification it offers me beyond my individual holdings.

As we have talked about before, change is difficult but in this case I think the change aligns better to my goals and should pay dividends (like the pun?).