Rebalancing from IRA

[RandyAdams1978]

I'm not getting something, and I hope you folks can straighten me out.

The Holy Trinity of Bogle-ism seems to be Asset Allocation, Rebalancing, and Asset Location. I've read the wiki on Asset Location, and understand the advantage of stuffing tax inefficient investments into an IRA.

What I don't get is this: If you have a tax-advantaged account stuffed with only tax inefficient investments(let's say it's VBMFX), and a taxable account full of only tax efficient investments(call it VTSMX), ..... how can you re-balance? Doesn't that get messy? Is it even possible?

I've read threads here where some folks admit they have TSM in a Roth IRA, then they get blasted by the group (well, mildly chided, anyway) for having Total Stock Market in a tax-advantaged account. My take-away from these types of threads (and maybe this is my mistake), is that some of the true Bogleheads have nothing but FI investments in their IRA's.

As an example: Taxable account A is all TSM, and 70% of a portfoilio. IRA account B is all Total Bond Market, and 30% of a portfolio. If stocks fall 20% and bonds go up 5%, you now have a 64/36 AA. How do you rebalance that?

I don't get it. What am I missing?

[JustinR]

1. Rebalance with new money.

or

2. Buy a second group of TSM in your IRA, and/or Bonds in your taxable.

Why would people get chided for putting TSM in tax-advantaged space? (genuinely curious)

[RandyAdams1978]

I can't find the exact thread now. But I definitely got the feeling that the veteran Boglehead was questioning the wisdom of TSM in an IRA.

[livesoft]

We have seem some posters confuse the tax-efficiency issue. There is a a difference between these two statements:
a. Put tax-efficient investments in a taxable account.
b. Put tax-efficient investments only in a taxable account.

The harder part is when one's tax-advantaged accounts are 100% fixed income and one needs more fixed income which then could only go into taxable account. One has to decide how to be tax-efficient with fixed income in taxable. This is not that hard to do either, but it is harder for some folks.

[JustinR]

I can't find the exact thread now. But I definitely got the feeling that the veteran Boglehead was questioning the wisdom of TSM in an IRA.

There's nothing wrong with putting TSM in your IRA:

http://www.bogleheads.org/wiki/Principl ... _Placement

Step 5: Place tax efficient funds last

Tax-efficient funds are fine in any account. Regular rebalancing of your stock/bond ratio is particularly easy if you have enough room in your tax-advantaged accounts to hold some of your tax-efficient stock fund, because the stocks and bonds can be exchanged without tax consequence. Rebalancing in a taxable account is often best done by investing new money so that capital gains can be avoided.

It doesn't matter where you put your tax-efficient funds, like TSM.

[kenyan]

Overlap is generally required somewhere in order to maintain desired asset allocations. Your various account balances should not force your hand in asset allocation - this is true whether discussing a split between taxable and tax-advantaged, or simply between various retirement accounts. The "dog" is your desired asset allocation, the "tail" is asset location. Let the dog wag its tail.

If someone happens to have a 60/40 portfolio of stocks and bonds and a 60/40 ratio of taxable/IRA, there is nothing wrong with having the IRA partly in stocks and the taxable partly in tax-efficient bonds.

[RandyAdams1978]

Thanks gang. I'm back on track now.

[BrianOB]

RandyAdams1978: No useful contribution from me here but I was going to ask the exact same question however, you asked it better. Thanks!

[RandyAdams1978]

To BrianOB: Glad to be the sacrificial lamb. I figure I can't possibly be the only one thinking what I'm thinking.

[Artsdoctor]

Randy,

Taylor is famous for his "There's more than one road to Dublin" comment, and that comment is so appropriate here, too.

Location is definitely important and the wiki here will help a great deal. The concept is not too hard: if you wind up shoveling in all those equity funds to your tax-deferred accounts, you will eventually have to take them out. When you do, you'll pay income tax on everything you take out. If you keep those equity funds in a taxable account, you'll only have to pay capital gains when you liquidate that money. Hopefully, capital gains tax will always be less than income tax rates. Likewise, if you put your fixed income in your taxable account, you'll pay income tax on the monthly proceeds whereas if you put fixed income in your tax-deferred account, you simply "defer" those taxes.

Overall, this is just smart and, as a rule, it's the right way to manage to biggest chunks of your investment accounts. But you don't have to be so rigid! Say the stock market really tanks. There is no problem whatsoever selling some fixed income in your IRA to buy equities; in fact, it's a good move. You can start feeding new money into equities on the taxable side but you've not generated in capital gain but selling in the IRA. You can rebalance later when the market allows: you can start selling back those equities in your IRA to buy FI when your asset allocation allows.

And things aren't quite as "efficient" as they once were either. Munis are only for taxable accounts and they've become even more valuable, at least to me. But equity dividends aren't "free" and are currently higher than a lot of bond fund dividends (for example, even for the tax-efficient TSM, I'm going to be getting about 2% dividends but paying 15% [federal] plus 3.8% [Medicare surtax] plus 12.3% [state tax].)

Also, there are some 401k's where the fixed income funds have expense ratios of over 0.75%, sometimes even more. With fixed income, that's deadly so you might have to think outside the box.

Everyone's situation is different, the guidelines here are pretty common sense, but there's plenty of room for maneuvering.

Artsdoctor

[grabiner]

I'm not getting something, and I hope you folks can straighten me out.

The Holy Trinity of Bogle-ism seems to be Asset Allocation, Rebalancing, and Asset Location. I've read the wiki on Asset Location, and understand the advantage of stuffing tax inefficient investments into an IRA.

What I don't get is this: If you have a tax-advantaged account stuffed with only tax inefficient investments(let's say it's VBMFX), and a taxable account full of only tax efficient investments(call it VTSMX), ..... how can you re-balance? Doesn't that get messy? Is it even possible?

Everything is relative: you want to fill up your tax-deferred account with tax-inefficient assets first. If your target bond allocation doesn't fit in your tax-deferred account, then you should hold bonds in taxable, and rebalance by selling taxable stock (or using new money and dividends to buy bonds). Conversely, if your target bond allocation is smaller than your tax-deferred account, you may well have tax-efficient stock index funds in your tax-deferred account.

[Jeff7]

What I've gathered is that the short-and-sweet reason for placing the tax-efficient funds in taxable accounts is to reserve what precious tax-advantaged space you are permitted for tax-inefficient fund types. But, this assumes that you're able to fill your entire available tax-advantaged space, and that you are left with investable "overflow" money. So if your income isn't high enough to max out both an IRA and 401k, then tax-efficient/inefficient fund placement isn't critical, since you can keep it all in tax-advantaged locations. Have I got that right?

[grabiner]

What I've gathered is that the short-and-sweet reason for placing the tax-efficient funds in taxable accounts is to reserve what precious tax-advantaged space you are permitted for tax-inefficient fund types. But, this assumes that you're able to fill your entire available tax-advantaged space, and that you are left with investable "overflow" money. So if your income isn't high enough to max out both an IRA and 401k, then tax-efficient/inefficient fund placement isn't critical, since you can keep it all in tax-advantaged locations. Have I got that right?

Yes, this is correct. Tax efficiency is irrelevant in a tax-sheltered account, as it is taxed the same no matter what you put in it; a Roth IRA is tax-free, and a traditional IRA or 401(k) will be taxed at your full tax rate upon withdrawal.