Bond Fund Placement: Tax Efficiency vs. Lower ER's

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Bond Fund Placement: Tax Efficiency vs. Lower ER's

Postby stilts1007 » Thu Feb 07, 2013 2:11 am

Am I correct in assuming that the tax advantages of holding bonds in tax-advantaged accounts would typically outweigh the drawback of a higher expense ratio? The only bond fund that my 401(k) offers is PIMCO Total Return Instl Index (PTTRX, ER 0.46%). I have room to move all of my bond allocation there, but I like Vanguard's Total Bond Market Index Fund nice low expense ratio (0.10%). The math I am doing says the tax benefits outweigh the small extra expense by a ton, am I right?
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Re: Bond Fund Placement: Tax Efficiency vs. Lower ER's

Postby Johm221122 » Thu Feb 07, 2013 10:05 am

You could also consider I bonds, EE bonds and municipal bonds.But yes in long run taxes would become a problem in taxable account with bonds even with higher exspence ratio
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Re: Bond Fund Placement: Tax Efficiency vs. Lower ER's

Postby grabiner » Thu Feb 07, 2013 11:23 pm

stilts1007 wrote:Am I correct in assuming that the tax advantages of holding bonds in tax-advantaged accounts would typically outweigh the drawback of a higher expense ratio?


Not with current yields; you don't lose much by holding a taxable bond fund with a 2% yield, or a municipal fund with a 1.5% yield as an alternative to the taxable fund. If your 401(k) has better stock options than bond options, and you don't have enough room in your IRA for all your bonds, then you should hold bonds in taxable (munis in most tax brackets).

If bond yields go back to a more normal 5%, you will want to switch back, selling your taxable bonds (probably at a capital loss) to hold stocks in taxable, and using a decent bond fund such as the PIMCO fund in your 401(k).
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Re: Bond Fund Placement: Tax Efficiency vs. Lower ER's

Postby stilts1007 » Fri Feb 08, 2013 1:13 am

Thanks for the thoughts!
My 401(k) has Vanguard index funds available for most asset classes, so as of now I have 2 similar-looking portfolios in terms of allocation, 1 in a taxable account and 1 in my 401(k). It sounds like in today's market, moving bonds into 401(k) isn't super imperative, but assuming yields improve in the future, bonds would be better served in 401(k), even at a slightly higher ER
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Re: Bond Fund Placement: Tax Efficiency vs. Lower ER's

Postby grabiner » Fri Feb 08, 2013 7:56 pm

stilts1007 wrote:My 401(k) has Vanguard index funds available for most asset classes, so as of now I have 2 similar-looking portfolios in terms of allocation, 1 in a taxable account and 1 in my 401(k). It sounds like in today's market, moving bonds into 401(k) isn't super imperative, but assuming yields improve in the future, bonds would be better served in 401(k), even at a slightly higher ER


This is correct. However, you can wait to switch; if bond yields increase, bond funds will lose value, so you can sell bonds in your taxable account for a capital loss to buy stocks, and sell an equal amount of stocks to buy bonds in your 401(k).
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