Portfolio Allocation and 401k questions

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Topic Author
fastlane1051
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Joined: Sat Jul 12, 2014 2:37 pm

Portfolio Allocation and 401k questions

Post by fastlane1051 »

Hello everyone,

I'm new to the message board and was referenced here by a current member. I just graduated college with a degree in finance so many terms and topics I'm familiar with, though I still have a lot to learn. I've already learned quite a bit since visiting this site and I would like to personally thank everyone for contributing and sharing their knowledge, advice, and opinions. I would really appreciate anyone who can help me get started on the right track! I will try and be as specific as possible and provide all information that I can.

Emergency funds: My aim is for ~$4,500. I'm sitting at $1,500 right now and should be able to add another $750-1,000 over the next month, if not more (lease doesn't start until September).
Debt: No debt
Tax Filing Status: Single
Tax Rate: 25% Federal, 6.45% + $1,000 State, and 3-4% City
Location: New York City
Age: 23
Desired Asset allocation: 80-90% stocks / 10-20% bonds (after reading it seems the general consensus is at least 20% bonds)
Desired International allocation: 30% of stocks (this is another number I'm pretty unsure of)

I'm essentially starting from scratch with ~$1,000 in a previous 401k from an internship.

My current employer contributes 1.5% to my 6%. Initially I plan on contributing 10% of my income to investing until I'm settled in and my emergency fund is in order, and then bumping this to at least 12-15%. I think with the employer match I will have ~$5,000 in my 401k for my first year, assuming I only contribute the 6%. My understanding is that I should contribute up to the match in a traditional 401k, and what's left should be contributed to a Roth IRA. That said, being in NYC the taxes are high and I do not plan on spending my entire career there (I'm originally from the south). Would it make sense to contribute all to the traditional 401k to avoid the taxes in these circumstances? This is one of my biggest sticking points right now, and I'm having trouble determining how to approach this. Another key piece is the lack of good investing options in the 401k. They are as follows:

Name / Ticker / Net Expense Ratio

Artisan International Inv / ARTIX / 1.2%
Crm Small/Mid Cap Value Inv / CRMAX / 1.09%
Dodge & Cox Balanced / DODBX / 0.53%
Dodge & Cox Global Stock / DODWX / 0.65%
Dodge & Cox Income / DODIX / 0.43%
Dodge & Cox International Stock / DODFX / 0.64%
Dodge & Cox Stock / DODGX / 0.52%
Fairholme / FAIRX / 1.02%
Harbor Bond / HABDX / 0.53%
Jhancock Classic Value / JCVIX / 0.95%
Longleaf Partners / LLPFX / 0.92%
Munder Mic-Cap Core Growth A / MGOAX / 1.40%
Oakmark Equity & Income / OAKBX / 0.77%
Oakmark International / OAKIX / 0.98%
Osterweis / OSTFX / 1.01%
T Rowe Price Capital Appreciation / PRWCX / 0.71%
T Rowe Price Emerging Europe Fund / TREMX / 1.47%
T Rowe Price Emerging Markets Stock / PRMSX / 1.25%
T Rowe Price New Asia / PRASX / 0.93%
T Rowe Price New Era / PRNEX / 0.66%
T Rowe Price Real Estate / TRREX / 0.79%
Templeton Global Bond A / TPINX / 0.88%
Third Avenue Focused Credit / 0.91%
Third Avenue Value / TAVFX / 1.10%
Vanguard Long-Term Investment-Grade ADM / VWETX / 0.12%
Vangaurd Prime Money markt / VMMXX / 0.17%
Vanguard Short-Term Bond Index ADM / VBIRX / 0.10%
Vanguard 500 Index Admiral / VFIAX / 0.05%

What I would do is contribute all to the traditional 401k, with 80% going to VFIAX and 20% going to VWETX, but I'm not sure that is the best option. FWIW, I do not plan on being with this employer longer than 2 years.

Any advice/suggestions would be greatly appreciate and any other relevant information need just let me know. Thanks again!
Bob's not my name
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Re: Portfolio Allocation and 401k questions

Post by Bob's not my name »

fastlane1051 wrote:in NYC the taxes are high and I do not plan on spending my entire career there (I'm originally from the south). Would it make sense to contribute all to the traditional 401k to avoid the taxes in these circumstances?
Yes. Your 401k has awesome choices, which you've already figured out. Are you making $130,000/year so $65,000 in 2014? Or are you making $65,000 so $32,500 in 2014? The answer matters if you are eligible for an education credit in 2014 -- did you pay tuition in 2014? If you paid your last tuition bill before Jan 1 you are not.

The $2,000 Lifetime Learning Credit gets phased out if your Adjusted Gross Income exceeds $54,000. In the phaseout, your federal marginal rate is 45% so your total marginal rate is 55%. Obviously in that circumstance Roth IRA contributions cost more than twice as much as 401k contributions.
Topic Author
fastlane1051
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Joined: Sat Jul 12, 2014 2:37 pm

Re: Portfolio Allocation and 401k questions

Post by fastlane1051 »

Bob's not my name wrote:
fastlane1051 wrote:in NYC the taxes are high and I do not plan on spending my entire career there (I'm originally from the south). Would it make sense to contribute all to the traditional 401k to avoid the taxes in these circumstances?
Yes. Your 401k has awesome choices, which you've already figured out. Are you making $130,000/year so $65,000 in 2014? Or are you making $65,000 so $32,500 in 2014? The answer matters if you are eligible for an education credit in 2014 -- did you pay tuition in 2014? If you paid your last tuition bill before Jan 1 you are not.

The $2,000 Lifetime Learning Credit gets phased out if your Adjusted Gross Income exceeds $54,000. In the phaseout, your federal marginal rate is 45% so your total marginal rate is 55%. Obviously in that circumstance Roth IRA contributions cost more than twice as much as 401k contributions.
I'm making $65,000 so $32,500 this year and I probably made $7-8,000 as an intern. I made two payments to the school but they technically weren't tuition. One was a graduation fee and one was a facilities fee and a data fee. Not sure if that counts.

What your saying is my best bet right now is to contribute all to traditional for tax purposes? I'm not sure where the 45% you talking about is coming from.
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LAlearning
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Re: Portfolio Allocation and 401k questions

Post by LAlearning »

I would go 90% S&P, and 10% either Vanguard Long term or Dodge/Cox Income. The later is closer to TBM, and for personal reasons long term bonds just rub me the wrong way. At 10% of a few grand, I doubt either direction will amount to much.

And yes given NYC taxes I would just focus on the 401k for now.
I know nothing!
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Zabar
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Re: Portfolio Allocation and 401k questions

Post by Zabar »

fastlane1051 wrote:My understanding is that I should contribute up to the match in a traditional 401k, and what's left should be contributed to a Roth IRA. That said, being in NYC the taxes are high and I do not plan on spending my entire career there (I'm originally from the south). Would it make sense to contribute all to the traditional 401k to avoid the taxes in these circumstances? This is one of my biggest sticking points right now, and I'm having trouble determining how to approach this.
Welcome, fastlane1051. Let me give you a somewhat contrarian perspective to the idea that high NYC taxes should drive your decision. I'd do the 401(k) up to the match then fully fund a Roth IRA. Here's why:

1. You're young. That means that any investments you make now will have a lot of time to grow. You're a finance guy and thoroughly understand the rule of 72s.
2. While tax rates in NYC are high compared with the rest of the country, the absolute amount of money we're talking about in taxes is relatively small. (If you're feeling broke, you can always deliver pizzas or hustle up money some other way for a few weekends. Those pizzas will save you tens of thousands of dollars in future taxes!)
3. Starting a Roth now will give you tax diversification and the power that goes with it later on. When you retire, you'll better be able to control the marginal tax bracket you're in.
4. Part of your retirement savings will no longer have minimum required distributions.
Bob's not my name
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Re: Portfolio Allocation and 401k questions

Post by Bob's not my name »

fastlane1051 wrote: I'm not sure where the 45% you talking about is coming from.
That would be your marginal rate if you were eligible for the LLC and in the phaseout. It's a $2,000 credit that phases out over $10,000 of marginal income, so $2,000/$10,000 = 20%. Combined with your nominal 25% tax bracket that makes 45% -- for every additional $1,000 you make $450 goes to federal income taxes (and $100 to state and local income taxes and $76 to payroll taxes). Anyway, you're not in the phaseout so the issue is moot for you. I don't know if the fees you paid are eligible for the LLC but you can look that up at irs.gov.
Bob's not my name
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Re: Portfolio Allocation and 401k questions

Post by Bob's not my name »

Zabar wrote:1. You're young. That means that any investments you make now will have a lot of time to grow. You're a finance guy and thoroughly understand the rule of 72s.
Since the OP is a finance guy he'll also understand the commutative property of multiplication and understand that time period is irrelevant to the decision. Over any time period Roth and traditional produce the same result if the tax rate is the same at contribution and withdrawal. So tax rate is the key variable. The OP's current tax rate is 35% and in two years it will definitely be lower, so he should focus on the 401k now and wait for the lower tax rate year to start Roth IRA contributions. He could, of course, put his emergency fund in a Roth IRA.
Zabar wrote:the absolute amount of money we're talking about in taxes is relatively small.
At a 35% tax rate a $5,500 Roth IRA contribution consumes $8,500 of gross income, of which $3,000 is thrown away to taxes. Also, you generally don't want to use "absolute" and "relative" in the same argument :D
Topic Author
fastlane1051
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Re: Portfolio Allocation and 401k questions

Post by fastlane1051 »

Bob's not my name wrote:
Zabar wrote:1. You're young. That means that any investments you make now will have a lot of time to grow. You're a finance guy and thoroughly understand the rule of 72s.
Since the OP is a finance guy he'll also understand the commutative property of multiplication and understand that time period is irrelevant to the decision. Over any time period Roth and traditional produce the same result if the tax rate is the same at contribution and withdrawal. So tax rate is the key variable. The OP's current tax rate is 35% and in two years it will definitely be lower, so he should focus on the 401k now and wait for the lower tax rate year to start Roth IRA contributions. He could, of course, put his emergency fund in a Roth IRA.
Zabar wrote:the absolute amount of money we're talking about in taxes is relatively small.
At a 35% tax rate a $5,500 Roth IRA contribution consumes $8,500 of gross income, of which $3,000 is thrown away to taxes. Also, you generally don't want to use "absolute" and "relative" in the same argument :D

Thank you everyone, this helps me a lot.

What are the restrictions on withdrawing from a Roth if I were to put my emergency fund into one? I'll dig and see what I can find, but if anyone has a good link/article that would be great!
Bob's not my name
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Re: Portfolio Allocation and 401k questions

Post by Bob's not my name »

You can withdraw your contributions, but not your earnings, at any time for any reason, penalty-free. Read the wiki.
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Zabar
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Re: Portfolio Allocation and 401k questions

Post by Zabar »

Bob's not my name wrote:
Zabar wrote:1. You're young. That means that any investments you make now will have a lot of time to grow. You're a finance guy and thoroughly understand the rule of 72s.
Since the OP is a finance guy he'll also understand the commutative property of multiplication and understand that time period is irrelevant to the decision. Over any time period Roth and traditional produce the same result if the tax rate is the same at contribution and withdrawal. So tax rate is the key variable. The OP's current tax rate is 35% and in two years it will definitely be lower, so he should focus on the 401k now and wait for the lower tax rate year to start Roth IRA contributions. He could, of course, put his emergency fund in a Roth IRA.
It's not so much an issue of commutation as it is a Type I vs Type II error problem: which way would he rather be wrong? Marginal federal income tax rates are at an all-time low right now. While he may think that he'll move in a couple of years, he doesn't really know. He's working in a field that pays well, which means that his marginal federal tax rate will be going up, even if the current marginal rates remain (which I think is unlikely, given the size of the federal deficit.) Also, the lack of RMDs on a Roth IRA has a future value, as does the potential to leave a "stretch" Roth as an inheritance. How much those latter two are worth will depend on a person's future situation. As I said, this is a contrarian view. :twisted:
Bob's not my name
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Re: Portfolio Allocation and 401k questions

Post by Bob's not my name »

He'll need to almost double his income and stay single to move from a 25% to 28% federal rate. The 3% difference will definitely be offset, probably more than offset, by a move to another location. His income will have to more than triple to put him in the 33% bracket, which would still be break even with his current rate if he can escape NYC taxes.

Total marginal rates are exceptionally high right now due to high state and local taxes and federal AGI-based phaseouts. Marginal rates may stay level while total tax burdens increase. No young person should give up a third of his money to taxes to get a Roth IRA.
pingo
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Re: Portfolio Allocation and 401k questions

Post by pingo »

For what it's worth, I'm siding with Bob's not my name. 401k all the way. :D

That said, the emergency fund makes moot the debate between the 401k and Roth IRA, at least for a while. Using the Roth to hold emergency savings also uses emergency savings to save in a Roth, which hopefully makes both not-Bob and Zabar happy.

There are no target/lifecycle funds in the 401k? You mentioned using VFIAX and VWETX exclusively. Bob's-not appears to agree (?) and LAlearning is thinking along those same lines, with possibly using DODIX. That results in a solid portfolio with a weighted expense ratio of 0.06% to 0.13%, depending on whether you use VWETX or DODIX. Here's my $0.02:
fastlane1051 wrote:Desired Asset allocation: 80-90% stocks / 10-20% bonds (after reading it seems the general consensus is at least 20% bonds)
Desired International allocation: 30% of stocks (this is another number I'm pretty unsure of)
Translation: 56% US Equities / 24% International Equities / 20% Bonds

U.S. Equities: You absolutely should use the Vanguard 500 Fund - Admiral (VFIAX) ER 0.05% for your U.S. stocks. It holds Large and Mid Cap stocks and it does a darn good job of tracking the entire U.S. market. Regardless, there don't appear to be any small cap alternatives to "complete" your U.S. exposure, if that's even necessary.

International Equities: Purists may say that you're better off, or no worse off, if you forget the 401k's international options and simply put this money into VFIAX also. There's nothing' wrong with that. Your 401k Dodge & Cox International Stock (DODFX) ER 0.64% does have a solid international option from a great firm with an exceptional investment culture. While Mr. Bogle's tolerance for risk does not include non-U.S. markets, he has written and stated that he highly regards Dodge & Cox and would have no problem investing with them as a firm. Since the second order of diversification is the ratio of U.S.- International and adding DODFX brings your portfolio's weighted expense ratio to a mere 0.20%, I think it's worth the diversification benefit.

Bonds: The usual target for average bond duration, especially for new investors, is in the intermediate range (~5 years). Longer than that should come from serious thought and study. Most Bogleheads prefer the Vanguard Short-Term Bond Index Fund - Admiral (VBIRX) ER 0.10% over Vanguard's Long-Term Investment-Grade Fund -Admiral (VWETX) 0.12% because it's simpler to use bonds for safety and stocks for the higher risk/return. (Long bonds can see large losses in a rising interest rate environment.) There are arguments in favor of long-term bonds for high-stock portfolios because of periods when the long bonds moved in the opposite direction of stocks, creating negative correlation, thus lower risk, thus higher returns via rebalancing, however I would encourage further study before going that route.

Here are alternatives for your bond allocation:

1. Fill the entire allocation with Vanguard Short-Term Bond Index Fund - Admiral (VBIRX) ER 0.10% all short bonds. If you want more than just short bonds or don't like the low risk/low return characteristics of short bonds…
2. Use Dodge & Cox Income (DODIX) 0.43% or Harbor Bond (HABDX) 0.53%, which are good intermediate-term bond funds. BTW Harbor Bond is Pimco's lesser known (and often less expensive) clone of the Pimco Total Return Bond Fund. Using a VFIAX-DODFX-DODIX portfolio lands you with a weighted ER of 0.27%. (Hardly spectacular, but still respectable.) If the expense ratio is still bothersome (we are Bogleheads, after all) …
3. To Manage Risk Well, Use a Barbell of your two inexpensive bond funds, inspired by CFA and forum member grok. I'm just spit balling, but I'd say that a 3:1 ratio of Long:Short bonds puts your average duration at 5.14 years and your weighted expense ratio remains at 0.20%.

In my view, your asset allocation is plenty aggressive, so stick with the short bonds for the following portfolio:

56% Vanguard 500 Fund - Admiral (VFIAX) .05
24% Dodge & Cox International (DODFX) .64
20% Vanguard Short-Term Bond (VBSIX) .10

Weighted ER = 0.20%

All the best!

:beer
Last edited by pingo on Mon Jul 14, 2014 4:19 pm, edited 2 times in total.
Bob's not my name
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Re: Portfolio Allocation and 401k questions

Post by Bob's not my name »

I agree on the short term bond fund. For stocks, I don't think international matters at this early stage.
Topic Author
fastlane1051
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Re: Portfolio Allocation and 401k questions

Post by fastlane1051 »

pingo wrote:For what it's worth, I'm siding with Bob's not my name. 401k all the way. :D

That said, the issue of the emergency fund makes moot the debate between the 401k and Roth IRA. Using the Roth to house emergency savings also uses emergency savings to save in a Roth, which should make both not-Bob and Zabar happy.

There are no target/lifecycle funds in the 401k? You mentioned using VFIAX and VWETX exclusively. Bob's-not appears to agree (?) and LAlearning is thinking along those same lines, with possibly using DODIX. That results in a solid portfolio with a weighted expense ratio of 0.06% to 0.13%, depending on whether you use VWETX or DODIX. Here's my $0.02:
fastlane1051 wrote:Desired Asset allocation: 80-90% stocks / 10-20% bonds (after reading it seems the general consensus is at least 20% bonds)
Desired International allocation: 30% of stocks (this is another number I'm pretty unsure of)
Translation: 56% US Equities / 24% International Equities / 20% Bonds

U.S. Equities: You absolutely should use the Vanguard 500 Fund - Admiral (VFIAX) ER 0.05% for your U.S. stocks. It may only hold Large and Mid Cap stocks, but it does a darn good job of tracking the entire U.S. market. Regardless, there don't appear to be any small cap alternatives to "complete" your U.S. exposure, if that's even necessary.

International Equities: Purists might say that you're better off, or at least no worse off, if you forget the 401k's international options and simply put this money into VFIAX also. Nothin' wrong with it. Your 401k Dodge & Cox International Stock (DODFX) ER 0.64% is a solid international holding from a great firm with a exceptional investment culture. While Mr. Bogle's tolerance for risk does not include non-U.S. markets, he has written and stated that he highly regards Dodge & Cox and would have no problem investing with them as a firm. Since the second order of diversification is the ratio of U.S.- International and adding DODFX brings your portfolio's weighted expense ratio to a mere 0.20%, I think it's worth the diversification benefit.

Bonds: The usual target for average bond duration, especially for new investors, is in the intermediate range (~5 years). Deviation from that should probably come from serious thought and study. I'm almost certain that most Bogleheads would prefer the Vanguard Short-Term Bond Index Fund - Admiral (VBIRX) ER 0.10% over Vanguard's Long-Term Investment-Grade Fund -Admiral (VWETX) 0.12% because investing is simpler if we use bonds for relative safety while using stocks for our higher risk/return objectives. (Long bonds can see large losses in a rising interest rate environment.) There is some argument in favor of long-term bonds for high-stock portfolios because of some periods when the long bonds moved in the opposite direction of stocks, creating negative correlation, thus lower risk, and thus higher returns via rebalancing, however I would encourage further study and consideration before going that route.

Here are some alternatives to consider for your bonds:

1. Use all short bonds. If you want more than just short bonds or don't like the low risk/low return characteristics of short bonds…
2. Use Dodge & Cox Income (DODIX) 0.43% or Harbor Bond (HABDX) 0.53%, which are intermediate-term bond funds of the highest calibre. BTW Harbor Bond is Pimco's lesser known (and often less expensive) clone of the all-time great Pimco Total Return Bond Fund. Using a VFIAX-DODFX-DODIX portfolio lands you with a weighted ER of 0.27%. (Still respectable.) If the expense ratio is still bothersome (we are Bogleheads, after all) …
3. To Manage Risk Well, Use a Barbell of your two inexpensive bond funds, inspired by CFA and forum member grok. I'm just spit balling, but I'd say that a 3:1 ratio of Long:Short bonds puts your average duration at 5.14 years and your weighted expense ratio remains at 0.20%.

In my view, you're plenty aggressive in your asset allocation, so I'd stick with the short bonds for the following portfolio:

56% Vanguard 500 Fund - Admiral (VFIAX) .05
24% Dodge & Cox International (DODFX) .64
20% Vanguard Short-Term Bond (VBSIX) .10

Weighted ER = 0.20%

All the best!

:beer

Very informative post!

How did you decide on 56/24 for domestic/international stock?

I read the post on barbelling and it was extremely interesting. With your 3:1 ratio you're saying 15% in the long bonds and 5% in the short bonds correct?

EDIT:

I just thought of more questions.

1. I have $1,100 from a previous employer 401k. I was setting up a Vanguard Roth and I was wondering if I could roll that amount over into the IRA and help supplement my emergency fund?

2. How should I allocate the emergency fund? Should I view this as part of my entire portfolio, or as its own thing? I know I want something safe for this.
pingo
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Re: Portfolio Allocation and 401k questions

Post by pingo »

fastlane1051 wrote:How did you decide on 56/24 for domestic/international stock?
I didn't. You did. :wink:

80% Stock Allocation x 30% of stocks for International equities = 24% of the portfolio.
fastlane1051 wrote:I read the post on barbelling and it was extremely interesting. With your 3:1 ratio you're saying 15% in the long bonds and 5% in the short bonds correct?
Yes, but even so I now regret complicating things with all that talk. I agree with not-Bob: just put your bonds in the short-term bond fund.
fastlane1051 wrote:I have $1,100 from a previous employer 401k. I was setting up a Vanguard Roth and I was wondering if I could roll that amount over into the IRA and help supplement my emergency fund?
I don't have a firm opinion of what you should do. You can always reverse the decision and roll the money over to your current 401k if you don't like having that little speck of an account floating around while the other ones get big. Because of the small dollar amount, the only place for that money at is a Vanguard Target Retirement Fund (only $1,000 minimum). Doing so puts the money at risk, so it wouldn't be reliable for emergencies. Otherwise VG Target Funds are great vehicles for retirement.
fastlane1051 wrote:How should I allocate the emergency fund? Should I view this as part of my entire portfolio, or as its own thing? I know I want something safe for this.
Right. You would not count it as part of your retirement allocation until/unless you get to the point of having more in the Roth than you need for the emergency fund. However, once you reach your desired amount for emergencys, you should probably increase your 401k contributions rather than put extra money into your Roth.

So, you'd put the Roth emergency fund money into the Vangaurd Prime Money Market Fund (earning nothing) or the Vanguard Short-Term Bond Index Fund which increases your risk a little, but it'll earn you a modest dividend. OR, don't open the Roth at Vanguard; instead find a competitive CD rate and open the Roth at that institution. I'd tell you to do it at Sallie Mae for their 5 year CD at 2.10% APY (6 month interest penalty for early withdrawal), but I can't find anything that says they do Roth accounts.
Last edited by pingo on Mon Jul 14, 2014 2:09 pm, edited 1 time in total.
Bob's not my name
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Re: Portfolio Allocation and 401k questions

Post by Bob's not my name »

pingo wrote:
fastlane1051 wrote:I have $1,100 from a previous employer 401k. I was setting up a Vanguard Roth and I was wondering if I could roll that amount over into the IRA and help supplement my emergency fund?
I don't have a firm opinion of what you should do. You can always reverse the decision roll the money over to your current 401k if you don't like having that little speck of an account floating around while the other ones get big. Because of the small dollar amount, the only place for that money at is a Vanguard Target Retirement Fund (only $1,000 minimum). Doing so puts the money at risk, so it wouldn't be reliable for emergencies. Otherwise VG Target Funds are great vehicles for retirement.
If this is a traditional 401k you're proposing to do a Roth conversion. The five-year rule on Roth conversions is confusing, but I believe it applies here and thus this would not make a good emergency fund.
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Re: Portfolio Allocation and 401k questions

Post by Bob's not my name »

fastlane1051 wrote:$32,500 this year and I probably made $7-8,000 as an intern.
Sorry, I should have recognized this earlier. You're in the 15% federal bracket this year, not the 25%. Your taxable income will be under $30,000. You don't break into the 25% bracket until you hit $36,900. The 15%-25% step is the biggest wide-impact break in the tax code. The 10% difference means that you can sensibly choose a Roth IRA contribution in 2014. Another option is to hold your cash and contribute the maximum $17,500 to your 401k in 2015, when the contributions will avoid a 35% total tax rate. It might otherwise be hard for you to max your 401k in 2015, since it's over a quarter of your gross income and your NYC cost of living is high.

On bogleheads we often assume the "saturated" scenario, in which you max all your tax-advantaged space every year. Very few people can or want to do this. Maxing both your 401k and a Roth IRA in 2015 will require 40% of your gross income.

If you're not saturating your tax-advantaged space, then it makes sense to consider your multi-year tax-situation and time your 401k contributions to save the most in taxes. This requires the discipline to save your money now and contribute it in 2015.

The guaranteed 10% tax advantage more than offsets what gain you might reasonably make on the investment in the waning months of 2014. However, that trade-off isn't even necessary. You can contribute to a Roth IRA in 2014 and invest the money, and then in 2015 you can withdraw the Roth IRA contribution and contribute an equal increment to your 401k. I believe this is an unnecessary complication, but it counters the argument that you shouldn't wait to invest.

To muddy things even more, note that you might flirt with the 15% bracket next year, too. Assuming you have no pre-tax health insurance premiums withheld from your pay because you're still riding on your parents' health insurance, your AGI will be $17,500 less than your gross if you max your 401k. That's $47,500. Your 2015 standard deduction and personal exemption (both inflation-adjusted) will drop you to the threshold of the 15% bracket (also inflation-adjusted).
pingo
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Re: Portfolio Allocation and 401k questions

Post by pingo »

fastlane1051 wrote:I have $1,100 from a previous employer 401k. I was setting up a Vanguard Roth and I was wondering if I could roll that amount over into the IRA and help supplement my emergency fund?
pingo wrote:I don't have a firm opinion of what you should do. You can always reverse the decision roll the money over to your current 401k if you don't like having that little speck of an account floating around while the other ones get big. Because of the small dollar amount, the only place for that money at is a Vanguard Target Retirement Fund (only $1,000 minimum). Doing so puts the money at risk, so it wouldn't be reliable for emergencies. Otherwise VG Target Funds are great vehicles for retirement.
Bob's not my name wrote:If this is a traditional 401k you're proposing to do a Roth conversion. The five-year rule on Roth conversions is confusing, but I believe it applies here and thus this would not make a good emergency fund.
Thanks for catching that, Bob's not my name!

I mis-read OP's statement. I was thinking that the Previous 401k would to be rolled over in its original state and merely become a Rollover IRA, not a Roth conversion. My frame of reference was that perhaps a Rollover IRA might serve as additional emergency backup in it's original, tax-deferred state. It's also why I considered it to be an easily "reversible" decision because if OP changes his/her mind, a Rollover IRA can be rolled into the 401k.

fastlane1051, please sure to (re)read my last post with the above in clarification/correction in mind.

The 5 year restriction on Roth conversions makes converting the Previous 401k into a Roth a poor option for emergency purposes. Tax-wise, it is as Bnmn says.
Topic Author
fastlane1051
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Joined: Sat Jul 12, 2014 2:37 pm

Re: Portfolio Allocation and 401k questions

Post by fastlane1051 »

pingo wrote:
fastlane1051 wrote:How did you decide on 56/24 for domestic/international stock?
I didn't. You did. :wink:

80% Stock Allocation x 30% of stocks for International equities = 24% of the portfolio.
fastlane1051 wrote:I read the post on barbelling and it was extremely interesting. With your 3:1 ratio you're saying 15% in the long bonds and 5% in the short bonds correct?
Yes, but even so I now regret complicating things with all that talk. I agree with not-Bob: just put your bonds in the short-term bond fund.
fastlane1051 wrote:I have $1,100 from a previous employer 401k. I was setting up a Vanguard Roth and I was wondering if I could roll that amount over into the IRA and help supplement my emergency fund?
I don't have a firm opinion of what you should do. You can always reverse the decision and roll the money over to your current 401k if you don't like having that little speck of an account floating around while the other ones get big. Because of the small dollar amount, the only place for that money at is a Vanguard Target Retirement Fund (only $1,000 minimum). Doing so puts the money at risk, so it wouldn't be reliable for emergencies. Otherwise VG Target Funds are great vehicles for retirement.
fastlane1051 wrote:How should I allocate the emergency fund? Should I view this as part of my entire portfolio, or as its own thing? I know I want something safe for this.
Right. You would not count it as part of your retirement allocation until/unless you get to the point of having more in the Roth than you need for the emergency fund. However, once you reach your desired amount for emergencys, you should probably increase your 401k contributions rather than put extra money into your Roth.

So, you'd put the Roth emergency fund money into the Vangaurd Prime Money Market Fund (earning nothing) or the Vanguard Short-Term Bond Index Fund which increases your risk a little, but it'll earn you a modest dividend. OR, don't open the Roth at Vanguard; instead find a competitive CD rate and open the Roth at that institution. I'd tell you to do it at Sallie Mae for their 5 year CD at 2.10% APY (6 month interest penalty for early withdrawal), but I can't find anything that says they do Roth accounts.
I think I will be fine on my emergency fund so what I'm gathering is just to roll it over into my current employer's 401k and call it a day?
Bob's not my name wrote:
fastlane1051 wrote:$32,500 this year and I probably made $7-8,000 as an intern.
Sorry, I should have recognized this earlier. You're in the 15% federal bracket this year, not the 25%. Your taxable income will be under $30,000. You don't break into the 25% bracket until you hit $36,900. The 15%-25% step is the biggest wide-impact break in the tax code. The 10% difference means that you can sensibly choose a Roth IRA contribution in 2014. Another option is to hold your cash and contribute the maximum $17,500 to your 401k in 2015, when the contributions will avoid a 35% total tax rate. It might otherwise be hard for you to max your 401k in 2015, since it's over a quarter of your gross income and your NYC cost of living is high.

On bogleheads we often assume the "saturated" scenario, in which you max all your tax-advantaged space every year. Very few people can or want to do this. Maxing both your 401k and a Roth IRA in 2015 will require 40% of your gross income.

If you're not saturating your tax-advantaged space, then it makes sense to consider your multi-year tax-situation and time your 401k contributions to save the most in taxes. This requires the discipline to save your money now and contribute it in 2015.

The guaranteed 10% tax advantage more than offsets what gain you might reasonably make on the investment in the waning months of 2014. However, that trade-off isn't even necessary. You can contribute to a Roth IRA in 2014 and invest the money, and then in 2015 you can withdraw the Roth IRA contribution and contribute an equal increment to your 401k. I believe this is an unnecessary complication, but it counters the argument that you shouldn't wait to invest.

To muddy things even more, note that you might flirt with the 15% bracket next year, too. Assuming you have no pre-tax health insurance premiums withheld from your pay because you're still riding on your parents' health insurance, your AGI will be $17,500 less than your gross if you max your 401k. That's $47,500. Your 2015 standard deduction and personal exemption (both inflation-adjusted) will drop you to the threshold of the 15% bracket (also inflation-adjusted).
I'm sorry I haven't responded sooner. I've been thinking and running numbers all day. To make sure I'm understanding correctly, this year I can contribute 6% to traditional 401k to receive the match, and what's left over, contribute to a Roth IRA. Next year, I would contribute the maximum to my 401k (hopefully higher than the $17,500), and use what I contributed to the Roth this year as supplemental income, and hopefully dropping down to the 15% income tax bracket. Is that correct? If so, here's the numbers I've run (hopefully they're easy to follow):

I believe I will be able to save $600-800 a month for July-Dec giving me somewhere around ~$4,000. I also have a sign on bonus to contribute taking me close to the $5,500. Year end, I expect a gross bonus of $5,000 netting roughly $3,100, giving me a total emergency fund/savings of ~$8,000-10,000 depending on how aggressively I can save. This amount of money I can use to supplement next years income, though the year end bonus will be paid in January, thus contributing to 2015 income.

Including that year end bonus, I estimate my annual income to be ~$69,500 best case, ~$63,000 worse case. I also have a unique benefit that allows me to pay for transit with pre-tax dollars which I estimate to be $1350 for the year. If I max the 401K and take into account the transit benefit, that leaves me with a range of $45,650 - 50,650 for taxable income. I feel like this will be over the 15% threshold will it not? Could I contribute to a traditional Roth to take my taxable income down farther? I think with the supplemental income from this year I would have enough to cover my expenses based on the projections I'm running.

Hopefully this was all clear. Again, thanks for taking the time to help me out.
Bob's not my name
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Re: Portfolio Allocation and 401k questions

Post by Bob's not my name »

fastlane1051 wrote:I estimate my annual income to be ~$69,500 best case, ~$63,000 worse case. I also have a unique benefit that allows me to pay for transit with pre-tax dollars which I estimate to be $1350 for the year. If I max the 401K and take into account the transit benefit, that leaves me with a range of $45,650 - 50,650 for taxable income. I feel like this will be over the 15% threshold will it not? Could I contribute to a traditional [IRA] to take my taxable income down farther?
$69,500 gross income
- $17,500 401k
- $1,350 transit benefit
- $0 health, dental, and disability insurance premiums
- $0 health FSA contributions
---------------
$50,650 AGI, which is NOT taxable income, but it does determine that you're eligible for deductible TIRA contributions
- $4,000ish personal exemption (it's $3,950 in 2014, but it's inflation-adjusted)
- $6,400ish standard deduction (it's $6,200 in 2014, but also inflation-adjusted)
---------------
$40,250 taxable income --> In 2014 the 15% bracket tops out at $36,900. It's also inflation-adjusted.

So your top end estimate may put you just into the 25% bracket. Remember that it's only the marginal income that's taxed at 25%. I would still go Roth IRA even if you're just into the 25% bracket.
Topic Author
fastlane1051
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Joined: Sat Jul 12, 2014 2:37 pm

Re: Portfolio Allocation and 401k questions

Post by fastlane1051 »

Bob's not my name wrote:
fastlane1051 wrote:I estimate my annual income to be ~$69,500 best case, ~$63,000 worse case. I also have a unique benefit that allows me to pay for transit with pre-tax dollars which I estimate to be $1350 for the year. If I max the 401K and take into account the transit benefit, that leaves me with a range of $45,650 - 50,650 for taxable income. I feel like this will be over the 15% threshold will it not? Could I contribute to a traditional [IRA] to take my taxable income down farther?
$69,500 gross income
- $17,500 401k
- $1,350 transit benefit
- $0 health, dental, and disability insurance premiums
- $0 health FSA contributions
---------------
$50,650 AGI, which is NOT taxable income, but it does determine that you're eligible for deductible TIRA contributions
- $4,000ish personal exemption (it's $3,950 in 2014, but it's inflation-adjusted)
- $6,400ish standard deduction (it's $6,200 in 2014, but also inflation-adjusted)
---------------
$40,250 taxable income --> In 2014 the 15% bracket tops out at $36,900. It's also inflation-adjusted.

So your top end estimate may put you just into the 25% bracket. Remember that it's only the marginal income that's taxed at 25%. I would still go Roth IRA even if you're just into the 25% bracket.
The bolded quote was a piece I was missing as well as the marginal tax rate part, but I see what you're saying now.

So what you're recommending is 6% to traditional 401k, then contribute to Roth IRA until maximum is met, and what's left over back into 401k for both 2014 and 2015?

How does the tIRA come into play here?
Topic Author
fastlane1051
Posts: 8
Joined: Sat Jul 12, 2014 2:37 pm

Re: Portfolio Allocation and 401k questions

Post by fastlane1051 »

pingo wrote:
fastlane1051 wrote:I have $1,100 from a previous employer 401k. I was setting up a Vanguard Roth and I was wondering if I could roll that amount over into the IRA and help supplement my emergency fund?
pingo wrote:I don't have a firm opinion of what you should do. You can always reverse the decision roll the money over to your current 401k if you don't like having that little speck of an account floating around while the other ones get big. Because of the small dollar amount, the only place for that money at is a Vanguard Target Retirement Fund (only $1,000 minimum). Doing so puts the money at risk, so it wouldn't be reliable for emergencies. Otherwise VG Target Funds are great vehicles for retirement.
Bob's not my name wrote:If this is a traditional 401k you're proposing to do a Roth conversion. The five-year rule on Roth conversions is confusing, but I believe it applies here and thus this would not make a good emergency fund.
Thanks for catching that, Bob's not my name!

I mis-read OP's statement. I was thinking that the Previous 401k would to be rolled over in its original state and merely become a Rollover IRA, not a Roth conversion. My frame of reference was that perhaps a Rollover IRA might serve as additional emergency backup in it's original, tax-deferred state. It's also why I considered it to be an easily "reversible" decision because if OP changes his/her mind, a Rollover IRA can be rolled into the 401k.

fastlane1051, please sure to (re)read my last post with the above in clarification/correction in mind.

The 5 year restriction on Roth conversions makes converting the Previous 401k into a Roth a poor option for emergency purposes. Tax-wise, it is as Bnmn says.

I didn't quite understand this all the first time but it makes sense now that I'm somewhere quiet and can focus more.

There's $1,058 in a Roth 401k which would make rolling it over into a Roth IRA easy correct? The bad news is there's an extra $43.61 that was put into a traditional before I made the switch.

Is it possible to roll the $1,058 Roth 401k over into an IRA and roll the $43.61 over into my current employer's 401k plan?
Bob's not my name
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Re: Portfolio Allocation and 401k questions

Post by Bob's not my name »

fastlane1051 wrote:So what you're recommending is 6% to traditional 401k, then contribute to Roth IRA until maximum is met, and what's left over back into 401k for both 2014 and 2015?

How does the tIRA come into play here?
No, I'm not recommending that. I'm recommending that in 2015, when you have a 35% marginal rate (federal, state, local) that you max your 401k before contributing to a Roth IRA. And then I'm saying that you'll likely have dropped just into the 15% federal bracket (25% total marginal rate including state and local), or very nearly, and you should contribute to a Roth IRA if you can afford it without living like a monk. You'll be eligible for deductible TIRA contributions, but I'm recommending you go Roth for your IRA. Keeps it simple and gives you some diversification at the more reasonable 25% tax cost.

Maxing your 401k and a Roth IRA will consume $25,000 of gross income. Payroll taxes will take another $5,000. You have to live on what's left over.
pingo
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Re: Portfolio Allocation and 401k questions

Post by pingo »

fastlane1051 wrote:How does the tIRA come into play here?
It doesn't anymore, mostly for reasons specified by Bob's not my name, and because we didn't know that the previous 401k is actually a Previous ROTH 401k.
fastlane1051 wrote:I think I will be fine on my emergency fund so what I'm gathering is just to roll it over into my current employer's 401k and call it a day?
You had not specified that the Previous 401k is a ROTH 401k, so the assumption on our side WAS that it's a Traditional 401k (it usually is). A ROTH 401k CAN be rolled into a Roth IRA, so it is not a conversion for the $1,058. (No tax consequences.) Converting the $43.61 is fine given your 2014 tax situation. A Roth conversion is restricted from withdrawal for 5 years, but, hey, it's $43.61. I'm just assuming that the original contributions of the $1,058 may be accessible for emergencies without penalty, but you'd have to figure out the amount of those original contributions. Honestly, I'd rather not have to figure that stuff out, and I like to keep things clean, so I would not even consider it for emergency withdrawal. I'd only consider future Roth IRA contributions to fill emergency purposes because you'll have a clear contribution history going forward.

And if you don't want/need the Previous Employer Rollover Roth 401k for emergencies, the Previous Employer Rollover Roth 401k can be rolled over to Vanguard and invested in the Vanguard Target Retirement 2035 (VTTHX) ER 0.18%, which has a fund minimum of only $1,000. VTTHX has an asset allocation of 84% Stocks, 16% Bonds, with 30% of stocks in International markets. It'll be 80% stocks in 2-3 years because it gradually moves to a more conservative allocation as time passes.
fastlane1051 wrote:Year end, I expect a gross bonus of $5,000 netting roughly $3,100 ... the year end bonus will be paid in January, thus contributing to 2015 income.
It seems to me that towards the end of 2014 you'll want to change your 401k contributions so that the higher contibution rate begins by January 2015. That way you keep more of that bonus. Check with your HR department and/or 401k Plan Document/Website, but it could take up to 6 weeks or 2 to 3 payroll periods for your new 401k contributions pulled from your paychecks. In November or December 2014, you may have to set the 401k as desired for 2015, so that your January 2015 pay stubs reflect the new contribution rate in time for your bonus to be taxed less.



Now, if I'm clear on what's happening (and I'm not sure of that):

1. Do not open a Roth right now.
2. Non-401k savings stay in the bank (not a Roth account) until 2015.
3. In 2015, set 401k for maximum contributions.
4. If your net pay isn't enough to meet your needs, spend down Non-401k savings as necessary. (Money is fungible. You are effectively transferring low-tax non-401k savings into the 401k when the tax benefit is greatest.)
5. If you can manage not-spending all the non-401k savings, or even saving some extra bucks in 2015, by all means, put non-401k savings into a Roth IRA invested in cash or short-term bonds for emergencies. If that time comes before the April 2015 tax deadline, make select the option to make 2014 Roth contributions; after mid-April 2015, you'll have no other choice than to make 2015 contributions. (The only difference is that you'll leave more Roth space open to be filled for as long as possible, in case things go swimmingly in 2015.)

Bob's not my name, did I get it right, or did I just make it worse?
Last edited by pingo on Wed Jul 16, 2014 10:25 pm, edited 11 times in total.
Bob's not my name
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Re: Portfolio Allocation and 401k questions

Post by Bob's not my name »

I agree with your advice.
Topic Author
fastlane1051
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Joined: Sat Jul 12, 2014 2:37 pm

Re: Portfolio Allocation and 401k questions

Post by fastlane1051 »

You two have been awesome. Thanks so much for getting me on the right track.
pingo
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Re: Portfolio Allocation and 401k questions

Post by pingo »

:thumbsup
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