Automating and Managing Investments for Stress-Free Wealth

Achieving financial success and independence is not a pipe dream: it’s a well-planned journey that requires discipline, smart strategies -- and takes advantage of modern technology like automation. As a member of the U.S. military, you've got the discipline to do it, and with the Military Wealth Coach you're learning the strategies you need to make sure you don't get left behind.

Over on the Service and Wealth Podcast we've been talking about how to build an optimal strategy that you can set up today. When you invest in low-cost mutual funds that invest in the S&P 500 and the C Fund in your Thrift Savings Plan, you will achieve some life-changing financial results:

1. 10.8% annual return on money invested over 10 years
2. Easy and efficient diversification in 500 companies across 11 sectors of the U.S. economy
3. Low risk: index funds with a "beta" of 1.0 have no extra risk or volatility
4. Passive rebalancing: the S&P each year adds successful stocks and kicks out the losers
5. A total portfolio return of at least 8% adjusted for inflation when combined with your cash savings in High Yield Savings Accounts (HYSA) earning 4.5-5.5% interest

This strategy won't make you rich overnight, but it will help you create life-changing and lifelong wealth, and achieve Financial Freedom. Even better is it's simple and an easy Do-It-Yourself (DIY) strategy, so you don't need to pay some Financial Advisor $1,000s every year to do it for you. The only thing left is how to manage your portfolio year-in and year-out, with a focus on automation.

Today, we’ll explore how to manage your investment portfolio effectively, ensuring you’re on track to reach your financial goals. The core pillars of smart portfolio management include:

• Automating investments
• Investing consistently
• Optimizing tax considerations
• Planning the withdrawal strategy

Automating Deposits and Investments

One of the most powerful tools at your disposal is automation, and you can do it for your Thrift Savings Plan (TSP) and your "after-tax" brokerage with E*Trade, Vanguard, Schwab, TDAmeritrade, or Robinhood. By automating your deposits and investments, you remove the human element of hesitation and inconsistency. Here’s how you can get started:

1. Automating Deposits: Set up automatic payroll deductions through DFAS MyPay directly into your Thrift Savings Plan (TSP). This ensures a portion of your income is consistently directed towards your investments before you even see it. Try to deposit $575 per month every month. (NOTE: divide $575 by your monthly pre-tax Base Pay to calculate the percent to enter into MyPay for your monthly deposit. Change this each year to stay on track.)
2. Automating Investments: To ensure you aren't trapped by TSP's default investment of your deposits into the Lifecycle Funds, which do NOT accomplish your investment return goals because TSP includes underperforming F, G, S, and I Funds in it, log into TSP and ensure you allocate 100% of new contributions to the C Fund. (NOTE: if you previously had investments in the Lifecycle, F, G, S, or I Funds, you can also tell TSP to transfer those funds now. Since the trade occurs in your retirement account it is considered a "sweep" and is not taxable.)

Do the same thing for your after-tax brokerage account. In most of those you simply link your checking account to the brokerage, and then set up automatic monthly investments. Once you have made an initial investment, you can simply tell the brokerage to directly buy more with every deposit. Some brokerages may require a two-step process to automate the deposit and then automate the investment. If that is the case for your account, just make sure to set up the investment automation 2-3 days after the automatic deposit to make sure your funds are "settled" and your investment goes through.

Automatic Dividend Reinvestment

Another automation to set up when managing your investments is to reinvest dividends. Dividends are a share of profits paid each quarter or year to investors who own shares of that company's stock, and pass through to mutual fund and Exchange-Traded Fund (ETF) owners, too. The S&P 500's dividend yield is about 1.7%, and this extra 1.7% is what ensures you are getting that magical 10-11% annual return, or 8-9% adjusted for inflation, per year. If you withdraw your dividends instead of reinvesting, in the long run you will be lucky to just barely reach 8% -- and may come in lower.

Most brokerage accounts and the TSP offer automatic dividend reinvestment plans (DRIPs). In fact, you won't even need to worry about this in your retirement accounts like the TSP, because you can't live on any profits or dividends without paying a penalty. TSP automatically does it. So you only need to remember to set this up for your after-tax brokerage.

Setting Up Specific ID Cost Basis

While you're logged in this first time, you'll also want to set the "cost basis" on your account. When you eventually sell your shares, you will have to consider the profits earned for taxes. In your Roth TSP, this is not an issue -- but for your after-tax brokerage it is critical. If you let the brokerage sell the shares by their method, it can be very costly, so you've got to keep total control so you can choose which shares to sell. There are four different "basis" methods that can be used:

1. Average Cost. Treats all shares sold in one trade as having the same average value.
2. First-in, First-out (FIFO). Automatically sells the first shares you bought first.
3. Last-in, First-out (LiFO). Automatically sells the last shares you bought first.
4. Specific ID (SpecID). Allows you to view all shares owned and select which ones to sell.

Among these, FIFO is most likely going to result in large profits, or Capital Gains, that result in potentially owing taxes. For that reason you should avoid FIFO cost basis. Average Cost isn't much better as it still allows the brokerage to sell shares, and has a similar tax effect. LiFO most probably will sell shares with the least profit and minimize your tax burden -- but again, you are not in control.

By choosing Specific ID, you get to choose which shares to sell. If you need some extra cash and sell some stock from your brokerage, you want to make sure you aren't going to have to pay taxes on the sale, which would require selling even more shares to cover the tax. With Specific ID, you can select the shares that have zero profit and zero tax liability. 

It also allows you to do something called "tax-loss harvesting." If you are sitting on the edge of a tax bracket, you can sell shares that have lost money using Specific ID and deduct up to $3,000 per year as "Capital Losses," reducing your taxable income. Single filers making $61,750 per year in Base Pay (so every O-2, W-3, and E-7) can take advantage of this to lower their taxes. You should also do this in years you accept Reenlistment Bonuses or Continuation Pay to offset those lump-sum payments.

Consistently Investing for Dollar Cost Averaging

When you manually invest every month, you might get intimidated or hesitant based on what's happening in the stock market at that time. This historically results in missed opportunities and lower returns in the long-run. Consistency is key.

Dollar Cost Averaging (DCA) is a strategy in which you invest a fixed amount of money at regular intervals, regardless of the market conditions. This helps to average out the ups and downs of prices in the stock market, reducing the impact of volatility. In fact, from 1993 to 2013 when the S&P 500 returned an average of 9.2% per year despite two major stock market crashes thanks to DCA; on the other hand, the average retail investor averaged only 2.6% per year because of hesitation and second-guessing. If they had stuck to consistent DCA investing, they also could have averaged 9.2%!

Automating Stop-Loss Limit Orders

While there's no sense panicking over a 5% or even 10% drop in the stock market, every decade there seems to be a major crash of 20% or more. Early in your investing life, you again can weather the storm and recover, but this can be catastrophic if it occurs in the 3-5 years before you plan to retire on your TSP, or retire early with your brokerage income.

To protect your investments from significant losses, consider setting up automated "stop-loss limit orders" by setting a predetermined price at which your stocks will be sold to prevent further loss.

• Example: If you buy a stock at $100, you might set a stop-loss order at $80. This means if the stock price falls to $80, it will automatically be sold, limiting your loss to 20%.
• Example: Set a price alert for every 10% gain in your investment, and then update your limit price. Once the stock hits $110, reset your stop-loss to $90 so you still have about a 20% loss prevention in place. Leaving it at $80 would increase your potential loss to nearly 30%. 

To see how to do this, search for a video specific to your brokerage on YouTube to see the settings and familiarize yourself with the options and process.

Taking Profits in a Tax-Optimized Way

When it comes time to take profits, you have to understand the different types of profits you'll get and how they are taxed, as Long-Term Capital Gains, Ordinary Income, or "return of principal."

For the Roth TSP and other Roth retirement accounts, every dollar you get out is non-taxable, so as long as your retirement savings are in Roth accounts, it's no worry. But if you have retirement savings in the Traditional TSP or other Traditional retirement accounts, all profits are considered Ordinary Income and will be taxed at the 10%, 12%, 22% or higher Federal Income Tax rate. All matching contributions made by your service under the Blended Retirement System (BRS) are to a Traditional account, so you must convert these to Roth before you retire. (More on that in a future post -- or you can check out our book Service and Wealth on Amazon to learn more!)

In your after-tax brokerage, which you use to build wealth that you can spend before age 59 1/2, such as for Early Retirement, the money you get back when you sell shares will be one of four different types for tax purposes:

1. Return of Principal. The amount you originally paid, and non-taxable.
2. Capital Gains. The profit on the sale price, taxed as a Capital Gain.
3. Qualified Dividends. Taxed at Capital Gains tax rates in the year you earned them.
4. Non-Qualified Dividends. Taxed as Ordinary Income in the year you earned them.

By reinvesting your dividends, you "dilute" this share of your profits over 10, 20, or 30 years, paying small amounts of taxes each year. Thus when they're reinvested to buy even more shares, they become "principal" and in the future when you sell will not be taxed. The only taxable part of your sale will be the profit, or Capital Gain. Capital Gains Taxes are lower than ordinary income taxes, so your goal is to get most or all your future income from Capital Gains, not dividends. For example:

• Over 10 years, you invest $10,000 per year or $100,000, meaning there is $100,000 in principal
• You earn a total of $20,000 in dividends over 10 years, but on average received $2,000 each year, paid taxes, and reinvested them; this now makes your non-taxable principal $120,000
• You sell all the shares for $260,000, meaning $140,000 is taxed as a Long-Term Capital Gain

If this $260,000 was your only income for the year and you were married, your tax situation would be:

• Reported income = $140,000, 100% as Capital Gains (the principal is not income!)
• Subtract your standard deduction ($29,200) = $110,800 taxable income
• Capital Gains 0% tax limit = $94,050; $0 tax paid on those gains
• 15% tax paid on remaining $16,750 (15% tax bracket) = $2,512.50

That's not terrible, and if you took that from a Traditional retirement account, the entire $110,800 would be taxed as ordinary income, leaving you with a tax bill of $15,321. Clearly having investments in non-retirement brokerage accounts that can be taxed as Capital Gains is an essential strategy for future passive income and for planning retirement income.

An even better strategy, assuming you needed all of that $260,000, would be to sell half in December and half in January, splitting your profits across two tax years. This would lower your tax bill to $0 as the split would be reported as only $40,800 in Capital Gains each year, all at the 0% tax rate.

Maximizing Annual Income from After-Tax Brokerage Accounts

The previous example showed a "bulk withdrawal", but the reality is that you'll eventually want to start withdrawing income from your brokerage to either glow up your lifestyle -- or even to fund an Early Retirement. To maximize the value of your Roth and TSP income, you'll delay withdrawals from your retirement accounts until age 70; to minimize taxes in retirement, you'll want avoid taking too much from non-retirement accounts from age 75 when the Required Minimum Distributions (RMDs) kick in for non-Roth savings.

So on the one hand, you once again need to convert all that Traditional TSP, IRA, and 401(k) money to Roth as soon as you can. On the other hand, if you forgot, you'll want to burn through some brokerage investment income before age 75: once RMDs start, all that Traditional retirement income will count as ordinary income and add to capital gains income. You could quickly find yourself in the 22%, 24% or higher tax bracket.

This means you should focus on maximizing income from after-tax brokerage accounts up until age 70, and then backwards plans to the age at which you can start and sustain the income until 70. I'll spare you the math, but if you want to get about $130,000 annual income tax-free (or almost tax-free), the following account balances provide the corresponding number of years of withdrawals:

• $1 million = 11 years of withdrawals of $130,000 = retire at age 60
• $1.2 million = 15 years of withdrawals of $130,000 = retire at age 55
• $1.4 million = 20 years of withdrawals of $130,000 = retire at age 50

This strategy involves building a substantial brokerage account balance by age 50, allowing you to draw income from these investments. Using Specific ID you can sell investments to ensure the amount that is Capital Gains stays at or below the cutoff for the 0% tax rate, keeping your income tax-free.

Of course this requires serious strategy and dedication to saving and investing in your 20s, 30s, and 40s. But there aren't a lot of Americans earning $130,000 per year tax-free. To create that for yourself by age 50 buys you 20 years of Financial Freedom, and will save you $100,000s in taxes over the course of your lifetime. And so long as you've built yourself this runway -- and made sure to convert all your Traditional TSP, IRA, and 401(k) retirement savings to Roth accounts -- you can allow your Roth savings to continue growing in the background, quadrupling by age 70.

This is the formula to getting six figures of passive investment income for the rest of your life, tax-free.

Conclusion

Automating and managing your investment portfolio is not just about setting up a plan—it's about sticking to it with discipline and leveraging smart strategies to maximize your returns. By automating deposits and investments, staying consistent, avoiding market timing, and using tax-optimized strategies, you can achieve financial success and independence. Remember, the key is to start early, stay disciplined, and let the power of compounding work in your favor. With these strategies, you can stand atop the mountain of financial success and enjoy the view.