placing investments in Roth vs traditional accounts

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rasputin
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placing investments in Roth vs traditional accounts

Post by rasputin »

an idea i'd like some feedback on -

there's a lot of talk here about portfolio allocation, stock vs. bonds, etc. however, i haven't seen much about what should be placed in Roth vs. traditional accounts.

roth gets taxed on the way in but not the way out. seems that "high growth" (stocks) would be best placed here.

traditional accounts get taxed on the way out. seems like the best place to keep more conservative investments (bonds, etc)

---

what do you think? is my idea flawed?
HIinvestor
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Re: placing investments in Roth vs traditional accounts

Post by HIinvestor »

Yes, have read that it's good to put items likely to highly appreciate in Roth accounts, like Total US and international stock index funds. It's good to put bond and any REIT index funds in tax advantaged accounts, because they are less tax efficient, so perhaps tIRAs. If you plan to have any individual stocks that nay gain other Lise, you may wish to hold in taxable, so you could have losses offset gains. There is a wiki about asset placement.
Johm221122
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Re: placing investments in Roth vs traditional accounts

Post by Johm221122 »

Try WIKI
http://www.bogleheads.org/wiki/Tax-adju ... allocation
Tax adjusted allocation, I don't use I'm trying to pay zero tax or close too zero tax on traditional ira
John
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CABob
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Re: placing investments in Roth vs traditional accounts

Post by CABob »

By traditional account I assume you mean traditional IRA or other tax deferred account. One of the reasons you don't see a lot on the subject is that the situation changes with the investor affected by availability of accounts, size of account types, etc.
What is generally recomended and seems to work in most cases is to rank your investments in order of tax efficiency then put your most tax inefficient investments (bonds, high turnover equities, etc.) in your tax deferred accounts. Put your most tax efficient investments (broad based index funds, munis, etc.) in your taxable accounts. The stuff in the middle goes into the Roth accounts. What is in the middle varies depending on circumstances.
I agree that high growth investments are "best" for Roth accounts especially high tax inefficient growth investments. Often this might be REIT since the dividends are taxed as ordinary income.
Bob
Johm221122
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Re: placing investments in Roth vs traditional accounts

Post by Johm221122 »

Here is article by bob's not my name
http://thefinancebuff.com/stocks-or-bonds-in-roth.html

John
d0gerz
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Re: placing investments in Roth vs traditional accounts

Post by d0gerz »

The wiki has good information on this: Principles of tax-efficient fund placement
Johm221122
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Re: placing investments in Roth vs traditional accounts

Post by Johm221122 »

d0gerz wrote:The wiki has good information on this: Principles of tax-efficient fund placement
The OP is talking about Roth and traditional ira(401)
There is no tax consequence in these accounts
From your WIKI link
" If your investments are all in tax-advantaged accounts, fund placement will not have a large impact on your returns. Tax-advantaged accounts include tax-deferred accounts, such as 401(k) and 403b, and tax-free accounts such as Roth IRA."

The choice of which funds to be put in Roth vs traditional is explained in the two links I provided
http://www.bogleheads.org/wiki/Tax-adju ... allocation
" Once you adjust for the after-tax value, it does not matter which assets you put in a traditional IRA or 401(k) and which you put in a Roth. If you are in a 25% tax bracket, investing $4,000 in the 401(k) or $3,000 in the Roth in the same investment will give you the same after-tax value."


John
Johm221122
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Re: placing investments in Roth vs traditional accounts

Post by Johm221122 »

I agree that high growth investments are "best" for Roth accounts especially high tax inefficient growth investments. Often this might be REIT since the dividends are taxed as ordinary income.
http://www.bogleheads.org/wiki/Tax-adju ... allocation
"Once you adjust for the after-tax value, it does not matter which assets you put in a traditional IRA or 401(k) and which you put in a Roth. If you are in a 25% tax bracket, investing $4,000 in the 401(k) or $3,000 in the Roth in the same investment will give you the same after-tax value."

" If all else is equal (and it often isn't because of limited 401(k) options), it is slightly better to put assets with higher expected returns in the Roth. "

John
Here is another thread, which describes OP question
http://www.bogleheads.org/forum/viewtop ... h#p2051602
Here is poll"Do you tax adjust"
http://www.bogleheads.org/forum/viewtop ... 0&t=131310
d0gerz
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Re: placing investments in Roth vs traditional accounts

Post by d0gerz »

With regards to asset location both wiki pages have similar advice. For instance the last sentence you quoted is also found here: http://www.bogleheads.org/wiki/Principl ... tock_funds
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max12377
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Re: placing investments in Roth vs traditional accounts

Post by max12377 »

I had 100% stocks in my Roth until about a month ago. Then I realized I could get a much lower ER Total Bond Fund in my Roth (.08) than in my 403b (.46). So I've been buying some bonds (Vanguard Total Bond) in the Roth as a result (and selling the PIMCO in the 403b). I hate paying more for a similar fund just because it's in my 403b. Plus, the returns on Bond funds are so low I feel that the higher ER bond funds will slowly eat away at the measly return.

Given that $x in a Roth is likely 'worth more' than $x in a 403b because the 403b will be taxed upon withdrawal, you could tax-adjust to make the swap roughly even. For example, the equivalent of $1 in a Roth is, say, $1.2 in a 403b. It's imprecise because you won't know exactly what your tax rate will be in retirement, but you can approximate.

In my case I didn't bother too much with the tax adjustment. By ignoring the tax adjustment I was effectively doing a little re-balancing, which I was overdue for anyways.

This is also covered in the wiki. One of the tenets of 'bogleheadism' is to control one of the few thing you can with investing - costs. So fund placement should also take into account where you can buy the least costly funds.
Bob's not my name
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Re: placing investments in Roth vs traditional accounts

Post by Bob's not my name »

For most people the primary consideration is lowering costs.

For some people the emergency fund consideration is important, too. If you are relying on your Roth IRA as an emergency fund you should keep bonds there. If you are relying on your 401k loan program as an emergency fund you should keep bonds there. These two sentences are not incompatible -- your tiered emergency fund may include both your Roth IRA and your 401k loan program, so you may want some bonds in each, depending on the size of each. For example, I have an old 401k that allows loans to former employees. I have only about $130,000 in it, and the maximum $50,000 loan is available as long as my balance is at least $100,000. So even though I can get TSM there at 0.02% ER, I keep about half of the 401k in bonds to make sure that in a crisis (which might occur during a stock market crash) I have the full loan amount available to me.

As discussed in my article, which John kindly linked, I don't think any other arguments hold water.

An interesting (to me) tangential question is whether it matters what you locate in your inherited Roth IRA, which has immediate untaxed RMDs.
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rasputin
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Re: placing investments in Roth vs traditional accounts

Post by rasputin »

I have an emergency fund of 3 months cash plus another 5 months in federal tax free bonds which resides in my taxable vanguard account.

seems best to me not to rely on IRA/401k for emergency funds.
Bob's not my name
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Re: placing investments in Roth vs traditional accounts

Post by Bob's not my name »

My marginal tax rate is almost 50%. If I give half of my emergency fund to the government will they give it back to me when I have an emergency?
Topic Author
rasputin
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Re: placing investments in Roth vs traditional accounts

Post by rasputin »

Bob's not my name wrote:My marginal tax rate is almost 50%. If I give half of my emergency fund to the government will they give it back to me when I have an emergency?
I have no idea what you're getting at.
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Re: placing investments in Roth vs traditional accounts

Post by livesoft »

Heading back to the original question, please consider this:

The riskiest investments are expected to drop the most and potentially lose the most money. Do you want assets that lose the most to be in your Roth IRA?
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Topic Author
rasputin
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Re: placing investments in Roth vs traditional accounts

Post by rasputin »

livesoft wrote:Heading back to the original question, please consider this:

The riskiest investments are expected to drop the most and potentially lose the most money. Do you want assets that lose the most to be in your Roth IRA?
I suspect that for many people the answer is "no", however I'm very confident that i'll never need to take a loan from my Roth IRA. So my answer is "sure, why not?"
Johm221122
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Re: placing investments in Roth vs traditional accounts

Post by Johm221122 »

d0gerz wrote:With regards to asset location both wiki pages have similar advice. For instance the last sentence you quoted is also found here: http://www.bogleheads.org/wiki/Principl ... tock_funds
The one part that WIKI link fails to mention if you use Roth for stocks or "high growth"stocks if you don't tax adjust your portfolio will be more risky
John
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Re: placing investments in Roth vs traditional accounts

Post by Atgard »

There are really 3 buckets: Roth IRA, traditional IRA, and taxable.

Most articles/Wiki talks about taxable vs. "retirement."

But I would also rather have something that will grow faster in a Roth, as it can grow to seventeen gazillion dollars and I still won't owe a cent in taxes.

If instead I had put some bonds in there, big whoop, my $100K grew to $200K and I don't pay taxes on the $100K gain.

But if my $100K in a riskier investment grows over 40 years to $4,000,000, then I have $3,900,000 of tax-free gains.

So I would say a Roth is ideal for things that are tax inefficient, but still likely to appreciate at a decent rate, like REITs.

Traditional is better for tax-inefficient things that are charged at ordinary income rates anyway, like bonds.

Stocks are decent in taxable because (a) you choose when you sell and pay the gains, and (b) it's at long-term capital gains rates. BUT they have the best chance to increase a lot in value and would therefore be nice in a Roth.

Most would say put stocks in taxable and bonds in a Roth. But, assuming 40 years, 10% return for stocks and 4% for bonds, 15% cap gains rate and 25% average tax rate:

If you start with $100K stocks in taxable and $100K bonds in a Roth, you could end up with $4,500,000 in taxable ($3,825,000 after taxes) and $480,000 in the Roth (tax free); total = $4,305,000.

If you instead do $100K bonds in taxable and $100K stocks in the Roth, you could end up with $480,000 in taxable ($360,000 after taxes) and $4,500,000 in the Roth (tax free); total = $4,860,000.

Obviously, the exact numbers are subject to tax rates and return rates, etc. But I'm not convinced that "bonds into Roth" is always a good idea.
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Re: placing investments in Roth vs traditional accounts

Post by Johm221122 »

Atgard wrote:There are really 3 buckets: Roth IRA, traditional IRA, and taxable.

Most articles/Wiki talks about taxable vs. "retirement."

But I would also rather have something that will grow faster in a Roth, as it can grow to seventeen gazillion dollars and I still won't owe a cent in taxes.

If instead I had put some bonds in there, big whoop, my $100K grew to $200K and I don't pay taxes on the $100K gain.

But if my $100K in a riskier investment grows over 40 years to $4,000,000, then I have $3,900,000 of tax-free gains.

So I would say a Roth is ideal for things that are tax inefficient, but still likely to appreciate at a decent rate, like REITs.

Traditional is better for tax-inefficient things that are charged at ordinary income rates anyway, like bonds.

Stocks are decent in taxable because (a) you choose when you sell and pay the gains, and (b) it's at long-term capital gains rates. BUT they have the best chance to increase a lot in value and would therefore be nice in a Roth.

Most would say put stocks in taxable and bonds in a Roth. But, assuming 40 years, 10% return for stocks and 4% for bonds, 15% cap gains rate and 25% average tax rate:

If you start with $100K stocks in taxable and $100K bonds in a Roth, you could end up with $4,500,000 in taxable ($3,825,000 after taxes) and $480,000 in the Roth (tax free); total = $4,305,000.

If you instead do $100K bonds in taxable and $100K stocks in the Roth, you could end up with $480,000 in taxable ($360,000 after taxes) and $4,500,000 in the Roth (tax free); total = $4,860,000.

Obviously, the exact numbers are subject to tax rates and return rates, etc. But I'm not convinced that "bonds into Roth" is always a good idea.
If you use stocks in Roth and don't tax adjust you are taking more risk(which is ok as long as you want it)
If you tax adjust your portfolio return will be the same, no matter were you put risky assets
John
Topic Author
rasputin
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Re: placing investments in Roth vs traditional accounts

Post by rasputin »

thanks for all the help on this. my portfolio is a lot more solid now.
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ogd
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Re: placing investments in Roth vs traditional accounts

Post by ogd »

Atgard wrote:If you start with $100K stocks in taxable and $100K bonds in a Roth, you could end up with $4,500,000 in taxable ($3,825,000 after taxes) and $480,000 in the Roth (tax free); total = $4,305,000.

If you instead do $100K bonds in taxable and $100K stocks in the Roth, you could end up with $480,000 in taxable ($360,000 after taxes) and $4,500,000 in the Roth (tax free); total = $4,860,000.
Atgard: the second portfolio is significantly more riskier than the first. It becomes so from the very first year, as you don't reinvest the taxes you paid back into bonds. Or consider the end state: 88% stock vs 92% stock. Also, your numbers aren't quite right because bond income taxes get paid every year, further reducing the weight of bonds in taxable.

When comparing Roth vs traditional, a stocks-in-traditional portfolio is less risky because the final tax payment reduces the volatility of stocks by X%. After that adjustment by X (an X which is unknown, but nevertheless exists and can be guessed), there is no bottom line difference between traditional and Roth.

The slight recommendation for stocks in Roth has to do with withdrawal mechanics, that is RMDs, and their effect on tax bracket if traditional grows too high. It is by no means a slam dunk like you make it sound.

On the other hand, I keep reading this from livesoft and don't understand it:
livesoft wrote:The riskiest investments are expected to drop the most and potentially lose the most money. Do you want assets that lose the most to be in your Roth IRA?
Can you clarify, livesoft? Surely if the higher Roth is preferable then the higher expected returns of stocks win the other side of the argument? Yes, volatility needs to be accounted for, but only linearly and not as an all or nothing thing. To me, Traditional and Roth space are equally precious (that is, after adjustment); it's true that I benefit from the option of Roth 401k so I could rebuild Roth at the cost of Traditional easily. The main reason both are precious is that I don't pay taxes in the interim.
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Re: placing investments in Roth vs traditional accounts

Post by retiredjg »

rasputin wrote:...however, i haven't seen much about what should be placed in Roth vs. traditional accounts.
Perhaps you have been interested in other threads and just missed it. This gets discussed all the time and opinions are all over the place.

Some people say to place your highest expected performers in Roth. So say to protect your Roth space by holding bonds there. Some say to have both stocks and bonds there. Etc.

I don't think this question is meaningless, but I do believe it is way far down the line in the decision making tree and a lot of people never even get that far. If you get to that decision and it appears that all other things are equal, just do what makes sense to you.
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Re: placing investments in Roth vs traditional accounts

Post by spaddlewit »

If I have a Roth IRA, and Traditional 401k/403b, and Taxable account, where should I put my REITs/Bonds?

From the discussion in this thread, it seems to suggest that the Traditional 401k/403b should hold the bonds.
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Re: placing investments in Roth vs traditional accounts

Post by CABob »

spaddlewit wrote:If I have a Roth IRA, and Traditional 401k/403b, and Taxable account, where should I put my REITs/Bonds?

From the discussion in this thread, it seems to suggest that the Traditional 401k/403b should hold the bonds.
As indicated in prior responses it depends on many factors, but, as a general recommendation you are correct.
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retiredjg
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Re: placing investments in Roth vs traditional accounts

Post by retiredjg »

spaddlewit wrote:If I have a Roth IRA, and Traditional 401k/403b, and Taxable account, where should I put my REITs/Bonds?

From the discussion in this thread, it seems to suggest that the Traditional 401k/403b should hold the bonds.
This will depend on what you have available in the 401k/403b. And the costs of those choices. And the relative sizes of the accounts.

Best guess is to hold bonds in the 401k/403b and REIT in Roth IRA. But if there is a low cost REIT fund available in the 401k/403b, that would be fine there too. If there is space....
Atgard
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Re: placing investments in Roth vs traditional accounts

Post by Atgard »

ogd wrote:To me, Traditional and Roth space are equally precious (that is, after adjustment); it's true that I benefit from the option of Roth 401k so I could rebuild Roth at the cost of Traditional easily. The main reason both are precious is that I don't pay taxes in the interim.
To start at the end, I don't consider traditional and Roth space as equally precious. At inception, it is. But a Roth account comes with no immediate benefit, but a very positive end result (anything in there is sheltered from all taxes no matter how large it grows), so I want as much as possible in there when I retire.

On the other hand, after the initial benefit, a Traditional IRA in isolation is a kinda crappy account: it converts cap gains & dividends to ordinary income (taxed at a higher rate), and has penalties and RMDs associated with it. But of course you get a very strong immediate up-front benefit for putting money in it. But after you get your tax deduction, most of the benefit (aside from deferring taxes on realized gains, if any) is gone.

With a traditional IRA, the benefit is based on how many dollars you put in. With a Roth, the benefit is based on how many dollars come out tax-free at the end.

As for re-balancing, that doesn't change the main point. So you want 50/50 stocks/bonds. Let's say you have $100K of Roth space you can use. You have 2 choices:

1.) Start with $100K in stocks in your Roth, $100K in bonds in your taxable. As they grow, rebalance with new money and buy bonds in your taxable account so you end up with $4,500,000 stocks in Roth and $4,500,000 bonds in taxable, 50/50. So you end up with $4,500,000 (Roth) + $3,375,000 (taxable after 25% taxes) = $7,875,000.

2.) Or, we do what you suggest, and put $100K in bonds in your Roth, and $100K in stocks in taxable. As they grow, you buy more bonds in your taxable account (it's not like you get to add an extra few million to your Roth due to contribution limits, you only get X amount of Roth space to play with). At the end, you have $480,000 (Roth) + $3,825,000 (taxable stocks after 15% cap gains) + $3,015,000 (taxable bonds after 25% tax) = $7,320,000.

Re-balancing doesn't change the main point: you only get so much Roth space, $5,500 a year. The $5,500 you put in this year can either grow to 45x that amount (stocks), or it can grow to 5x that amount (bonds). In the former case, you have 9x as much Roth space at the end. So you have 9x the benefit, even though that benefit (avoiding 15% cap gains) is only roughly half as valuable dollar-for-dollar as avoiding 25% ordinary income taxes.

So, if I start with $X in a Roth and $X in taxable, I'd rather have $45X tax free and pay 25% taxes on $5X, than have $5X tax free and pay 15% taxes on $45X.
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ogd
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Re: placing investments in Roth vs traditional accounts

Post by ogd »

Atgard wrote:1.) Start with $100K in stocks in your Roth, $100K in bonds in your taxable. As they grow, rebalance with new money and buy bonds in your taxable account so you end up with $4,500,000 stocks in Roth and $4,500,000 bonds in taxable, 50/50. So you end up with $4,500,000 (Roth) + $3,375,000 (taxable after 25% taxes) = $7,875,000.

2.) Or, we do what you suggest, and put $100K in bonds in your Roth, and $100K in stocks in taxable. As they grow, you buy more bonds in your taxable account (it's not like you get to add an extra few million to your Roth due to contribution limits, you only get X amount of Roth space to play with). At the end, you have $480,000 (Roth) + $3,825,000 (taxable stocks after 15% cap gains) + $3,015,000 (taxable bonds after 25% tax) = $7,320,000.
Atgard, you have a point which I agree with below, but in the math above the devil is in the details. Specifically, bonds get taxed every year while stocks get deferred until the end; the deferral works out to be worth over half of that 15% rate even leaving aside the possibility of donating them away or deftly harvesting losses at income tax rates (something that even the buy and holders among us will tell you happens more than you'd think).

Add to that the fact that I don't think you contributed the same in both scenarios, nor are they equally risky at the end as can me seen from comparing the ratios 4500 / 3375 vs 3825 / 3495. What matters is the ratios after tax since the money that goes to tax are not really mine but the govt's, so I mind the risks less.

Anyway, there are spreadsheets working this out in detail including in the tax allocation Wiki and a monster thread from last year that wanted the Wiki deleted. It very much depends on your tax rates before and after and the deferral opportunities.
Atgard wrote:Re-balancing doesn't change the main point: you only get so much Roth space, $5,500 a year. The $5,500 you put in this year can either grow to 45x that amount (stocks), or it can grow to 5x that amount (bonds).
This is true and the expansion of space is something that gets ignored in all but the more detailed treatments. I've said it before here that it leads at the current interest rates to the conclusion that tax placement often doesn't matter unless you pay huge tax rates.

However, beware of using this line of reasoning for the Roth vs Traditional argument (instead of taxable); the proper comparison is $5500 Roth vs $5500 Traditional PLUS the tax savings invested in taxable. Hint: the Roth loses this one under many scenarios. TFB has a (still) good treatment: http://thefinancebuff.com/roth-401k-for ... e-max.html .
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ogd
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Re: placing investments in Roth vs traditional accounts

Post by ogd »

Also, let me address this point separately:
Atgard wrote:With a traditional IRA, the benefit is based on how many dollars you put in. With a Roth, the benefit is based on how many dollars come out tax-free at the end.
This argument is often given, but often wrong. If you don't max out either account (which is the case with many people with 401k's), the benefit is a multiplicative factor into your returns. Because multiplication is commutative, it doesn't matter if you pay it before or after. What's far, far more important is your projection of contribution tax rates (note: marginal) vs withdrawal tax rates (note: holistic, as in you fill the low tax brackets too).

If you do max out at least the Traditional, things change as per TFB's post for example, but still under some scenarios the initial tax savings, invested, will earn more than the additional Roth space is worth, balanced out by often-reduced tax rates at withdrawal.
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