Should I rebalance and other questions? Been 1.5 years.

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Topic Author
shootmenow
Posts: 29
Joined: Tue Feb 15, 2011 1:37 pm

Should I rebalance and other questions? Been 1.5 years.

Post by shootmenow »

Hello,

Thanks to this forums, I simplified, diversified, and lowered costs on my portfolio.

Emergency fund: 4 months
Debt: None (thinking about buying a house this year)
Tax Filing Status: Married filing jointly
Tax Rate: 25% federal, 5% state (IL)
Age: 31
Desired Asset allocation: 80% stocks/20% bonds
Desired International allocation: 50%

Our Income: 160k
Current Portfolio: 86k
Taxable: none

His Traditional IRA: Vanguard
Vanguard Total Market Index (VTSAX) - 29k

Her Traditional IRA: Vanguard
Vanguard Total Bond Market Index (VBTLX) - 22k

Her Roth IRA: Vanguard
Vanguard Total International Stock Index (VTIAX) - 30k

Her 401k with match:
Vanguard Small Capitalization Index Fund (NAESX) - 5k

Funds available in Her 401k:
ING Fixed Income Fund
Vanguard Inflation-Protect Sec Inv VIPSX
Vanguard Total Bond Mkt Index Inv VBMFX
Vanguard Growth Index Fund Inv VIGRX
Vanguard Small-Cap Index Fund Inv NAESX
Vanguard Total Stock Mkt Idx Inv VTSMX
Thornburg Intl Equity Fnd
Vanguard Total Intl Stock Ix Inv VGTSX

Current Allocation:
75% stock, 25% bond

Current Stock allocation:
International: 46%
Total US Market Index - 45%
Small US - 9%

Questions:
1. Should I convert part or all of my traditional to Roth?
2. Do I have the right mix of funds? Should I include REITs to diversify further?
3. Overall I have lost money in International, should I lower the percentage of target allocation in International from 50%?
4. Should I rebalance at this time?
5. Are we saving enough? Last year we maxed out our IRAs (10k), 5k in 401k, and 19k in cash (for house).
6. Current we don't have a house or kids but plan to have both in next 2 - 3 years. In the meantime, is there any tax strategy we should follow?

Thank you.
Last edited by shootmenow on Tue Jan 01, 2013 2:57 pm, edited 2 times in total.
jbran99
Posts: 65
Joined: Thu May 24, 2012 7:15 pm

Re: Should I reallocate and other questions? Been 1.5 years.

Post by jbran99 »

Based on your previous posts from Feb 2011, this is a significant improvement! Congratulations!
shootmenow wrote:1. Should I convert part or all of my traditional to Roth?
No. Your tax rate makes this unappealing.
2. Do I have the right mix of funds? Should I include REITs to diversify further?
3. Overall I have lost money in International, should I lower the percentage of target allocation in International from 50%?
4. Should I reallocate at this time?
5. Are we saving enough? Last year we maxed out our IRAs (10k), 5k in 401k, and 19k in cash (for house).
6. Current we don't have a house or kids but plan to have both in next 2 - 3 years. In the meantime, is there any tax strategy we should follow?
1. No. At your tax rate, leave it in a Traditional IRA.

2. What is the reasoning for holding NAESX in Her 401k? Did you intend to have a tilt toward small cap? I noticed that VTSMX is available in Her 401k, which basically matches His IRA, in case you did not want the small cap tilt. Regarding REITs: Some add them for diversification, some don't. They would (slightly) increase your diversification, but it comes at the cost of increased complexity and potentially (slightly) higher expenses.

3. Performance is not a good reason to change your AA. What was your reasoning behind having 50% Int'l in the first place? What has changed in that reasoning?

4. Do you mean rebalance? Many folks will rebalance when their actual holdings are 5% or more off from their target. You are right around that line (i.e. your bond allocation is ~5% above your target). I don't think you need to rebalance right now, but you may want keep an eye on that. You could easily exchange part of her VBTLX for VTSAX within her Trad'l IRA. Based on your income, I suspect you are contributing to Her Roth IRA, not Her Trad'l IRA. If that's the case, contributions to Her Roth IRA could take care of much of the rebalancing for you (since all your bonds are in Her Trad'l IRA, which does not have new contributions).

5. You are saving a little over 20% of your gross income. The house savings is a big part of that. Once you reach your target for that money, you should redirect that savings into your retirement accounts. Saving more is almost always better than saving less, so if you can increase your savings rate (into the 401k) you should.

6. Given your tax bracket, you may want to consider not contributing to Her Roth IRA (no current tax benefits) and instead raising the contribution to Her 401k (reduces taxable income). There may be other reasons for you to want to contribute to Her Roth IRA instead, but it's something you may want to consider. Also, what do you have for Health Insurance? You may want to consider a High Deductible Health Plan that would give you access to an HSA which would allow you to tax-shelter additional income.

Also, before having children or buying the house, I would strongly suggest you both acquire 25- or 30-year term life insurance (if you don't already).
Topic Author
shootmenow
Posts: 29
Joined: Tue Feb 15, 2011 1:37 pm

Re: Should I reallocate and other questions? Been 1.5 years.

Post by shootmenow »

Thank you for looking at my situation and answering my questions. I really appreciate it. Cheers. :sharebeer
jbran99 wrote:2. What is the reasoning for holding NAESX in Her 401k? Did you intend to have a tilt toward small cap? I noticed that VTSMX is available in Her 401k, which basically matches His IRA, in case you did not want the small cap tilt. Regarding REITs: Some add them for diversification, some don't. They would (slightly) increase your diversification, but it comes at the cost of increased complexity and potentially (slightly) higher expenses.
After using Morningstar X-Ray, I noticed only 6% was in small cap and thought adding NAESX would diversify my portfolio further. How much exposure is recommended in small cap?

I think I will stay out of REITs for simplicity's sake. Thanks.
jbran99 wrote:3. Performance is not a good reason to change your AA. What was your reasoning behind having 50% Int'l in the first place? What has changed in that reasoning?
Original thinking in international was for diversification away for US economy. My thought process was that I live and work in US, so I am already very dependent on it, so 50% international would protect me better if something major happened in the US over the next 40 years or so. However it seems the rest of the world is very dependent on the US economy too, so I am not sure how much it helps. But you are right, not much has changed in the reasoning, so I should keep it at 50%.

jbran99 wrote:4. Do you mean rebalance? Many folks will rebalance when their actual holdings are 5% or more off from their target. You are right around that line (i.e. your bond allocation is ~5% above your target). I don't think you need to rebalance right now, but you may want keep an eye on that. You could easily exchange part of her VBTLX for VTSAX within her Trad'l IRA. Based on your income, I suspect you are contributing to Her Roth IRA, not Her Trad'l IRA. If that's the case, contributions to Her Roth IRA could take care of much of the rebalancing for you (since all your bonds are in Her Trad'l IRA, which does not have new contributions).
Yes, I meant rebalance, thanks for pointing it out. I think I will rebalance at this time and remove NAESX and contribute accordingly. It should simplify things further.


jbran99 wrote:5. You are saving a little over 20% of your gross income. The house savings is a big part of that. Once you reach your target for that money, you should redirect that savings into your retirement accounts. Saving more is almost always better than saving less, so if you can increase your savings rate (into the 401k) you should.
jbran99 wrote:6. Given your tax bracket, you may want to consider not contributing to Her Roth IRA (no current tax benefits) and instead raising the contribution to Her 401k (reduces taxable income). There may be other reasons for you to want to contribute to Her Roth IRA instead, but it's something you may want to consider. Also, what do you have for Health Insurance? You may want to consider a High Deductible Health Plan that would give you access to an HSA which would allow you to tax-shelter additional income.
Hmm...I expect our household income to keep increasing and we might hit the Roth IRA cutoff in 5 years. So I thought I should keep contributing to Roth while I can even though I don't get the tax benefit now. Seriously though, it is so complicated (at least for me) to figure out whether I should contribute to Roth vs Traditional that I just decided to do half and half.

HDHP plan is not offered by either of our employers.

jbran99 wrote:Also, before having children or buying the house, I would strongly suggest you both acquire 25- or 30-year term life insurance (if you don't already).
I should have done this before turning 30 because I have heard rates go up once you hit that number. I definitely need to get term.
jbran99
Posts: 65
Joined: Thu May 24, 2012 7:15 pm

Re: Should I reallocate and other questions? Been 1.5 years.

Post by jbran99 »

shootmenow wrote:After using Morningstar X-Ray, I noticed only 6% was in small cap and thought adding NAESX would diversify my portfolio further. How much exposure is recommended in small cap?
If you own Total Stock Market, you own Small Caps. You also own Mid Caps, Large Caps and everything in between - that's the beauty of Total Stock Mkt. You own those classes in the same ratios that exist in the market as a whole. Therefore, holding NAESX (in addition to the Total Stock Mkt) will cause you to hold a higher ratio of Small Cap than exists in the market as a whole. It will not give you more diversification because you already hold Small Caps as part of Total Stock Mkt.
shootmenow wrote:Original thinking in international was for diversification away for US economy. My thought process was that I live and work in US, so I am already very dependent on it, so 50% international would protect me better if something major happened in the US over the next 40 years or so. However it seems the rest of the world is very dependent on the US economy too, so I am not sure how much it helps. But you are right, not much has changed in the reasoning, so I should keep it at 50%.
If you are comfortable at 50%, that's fine. I believe the general guidelines are 20-50% in International. As a comparison, the Vanguard Target Retirement 2030 fund is approximately 80/20 (much like your AA). That funds hold just over 30% of stocks in Int'l.
shootmenow wrote:Seriously though, it is so complicated (at least for me) to figure out whether I should contribute to Roth vs Traditional that I just decided to do half and half.
There are certainly worse reasons. If taking this approach helps you simplify things and helps avoid big mistakes, that's good.
Grt2bOutdoors
Posts: 25625
Joined: Thu Apr 05, 2007 8:20 pm
Location: New York

Re: Should I reallocate and other questions? Been 1.5 years.

Post by Grt2bOutdoors »

shootmenow wrote:
jbran99 wrote:Also, before having children or buying the house, I would strongly suggest you both acquire 25- or 30-year term life insurance (if you don't already).
I should have done this before turning 30 because I have heard rates go up once you hit that number. I definitely need to get term.
Don't fret - rates do go up, but not as much as if you were 40 or 50. What's important is to gauge how much you need - what expenses you want to have covered in the event of untimely demise. Figure things like mortgage, childcare, child's college education, any remaining debts you may have.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions
bdpb
Posts: 1622
Joined: Wed Jun 06, 2007 3:14 pm

Re: Should I rebalance and other questions? Been 1.5 years.

Post by bdpb »

shootmenow wrote: Hmm...I expect our household income to keep increasing and we might hit the Roth IRA cutoff in 5 years. So I thought I should keep contributing to Roth while I can even though I don't get the tax benefit now.
You are still a bit away from not being eligible for Roth contributions. The start of the phaseout is a MAGI of 178k. With gross income of 160k minus a 17.5k 401k contribution and other typical MAGI reductions of around 5k, you're about 40k under today. The phaseout is adjusted for inflation, so you'll have to grow your income by over 40k above inflation before you're no longer eligible for the full deduction.

The state of IL does not tax IRA withdrawals or conversions at any age. So, if you have any plans to withdraw from or convert IRAs or 401k while in the state of IL, you should probably be contributing the max to deductible IRAs and 401k before contributing to Roths.

This second point is the reason you should probably be contributing to deductible accounts before Roth even if you expect to lose the ability to directly contribute to Roth because you can convert to Roth some time down the road and not pay IL state tax. Today, you are paying IL state tax on your Roth contributions.
Topic Author
shootmenow
Posts: 29
Joined: Tue Feb 15, 2011 1:37 pm

Re: Should I rebalance and other questions? Been 1.5 years.

Post by shootmenow »

bdpb wrote:
shootmenow wrote: Hmm...I expect our household income to keep increasing and we might hit the Roth IRA cutoff in 5 years. So I thought I should keep contributing to Roth while I can even though I don't get the tax benefit now.
You are still a bit away from not being eligible for Roth contributions. The start of the phaseout is a MAGI of 178k. With gross income of 160k minus a 17.5k 401k contribution and other typical MAGI reductions of around 5k, you're about 40k under today. The phaseout is adjusted for inflation, so you'll have to grow your income by over 40k above inflation before you're no longer eligible for the full deduction.

The state of IL does not tax IRA withdrawals or conversions at any age. So, if you have any plans to withdraw from or convert IRAs or 401k while in the state of IL, you should probably be contributing the max to deductible IRAs and 401k before contributing to Roths.

This second point is the reason you should probably be contributing to deductible accounts before Roth even if you expect to lose the ability to directly contribute to Roth because you can convert to Roth some time down the road and not pay IL state tax. Today, you are paying IL state tax on your Roth contributions.

bdqb, you just saved me 5% tax on future contributions. Makes total sense now. Thank you so much.
STC
Posts: 415
Joined: Wed Nov 14, 2012 8:22 am

Re: Should I rebalance and other questions? Been 1.5 years.

Post by STC »

Your retirement savings rate is ~10%. This is very low.
Topic Author
shootmenow
Posts: 29
Joined: Tue Feb 15, 2011 1:37 pm

Re: Should I rebalance and other questions? Been 1.5 years.

Post by shootmenow »

STC wrote:Your retirement savings rate is ~10%. This is very low.
Yes, I need to squeeze more savings out. My situation is that I paying mortgage and utilities for my parent's house for last 6 years because my Dad's business is not doing well and so my parents barely have any income. And now I am trying to save for my own house too. The choice is basically between buying a house or saving more for retirement and renting.
Default User BR
Posts: 7502
Joined: Mon Dec 17, 2007 6:32 pm

Re: Should I rebalance and other questions? Been 1.5 years.

Post by Default User BR »

In accumulation mode, especially with relatively small balances, rebalancing is best done through new contributions.


Brian
Topic Author
shootmenow
Posts: 29
Joined: Tue Feb 15, 2011 1:37 pm

Re: Should I rebalance and other questions? Been 1.5 years.

Post by shootmenow »

Default User BR wrote:In accumulation mode, especially with relatively small balances, rebalancing is best done through new contributions.

Brian
Thanks Brian.

If I switch all current and future contributions in 401k to International and switch all future His and Her IRA contributions to Total Stock, then at the end of 2013 I will be near the 80/20 stock/bond split and 50% stock in international.

It also means I will not be investing in bonds this year.
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