diversification and taxes

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diversification and taxes

Post by Cn2012 »

I am relatively new to investing but I have read and enjoyed the Boglehead books. I have a question on diversification in my taxable and tax deferred accounts.
Currently I max out a 403b and 457b both of which are going into vanguard target retirement funds set near the age I retire. I like the diversification of these funds and like the idea of my asset allocation adjusting as I get closer to retiring.
My question comes more for my taxable account. I like the idea of the three fund portfolio, but I know having bonds within my taxable account is not the most efficient. However, I also want the diversification that comes with bonds. Is it ok to have a total bond market fund in my taxable account? Or should I rethink how I structure my accounts.
Thanks for the help.
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Re: diversification and taxes

Post by GMCZ71 »

CD's, I bonds or high yield savings will work for the taxable side. Remember to look at all your accounts as whole to keep things in balance.
Last edited by GMCZ71 on Tue Jun 15, 2021 7:08 am, edited 1 time in total.
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Re: diversification and taxes

Post by Cyclesafe »

At these low interest rates, having taxable bonds in taxable isn't such a big deal. If you're in the 24% or above federal bracket, you might consider a muni fund, however. But again, it might not make a meaningful difference.
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Re: diversification and taxes

Post by mesaverde »

OP, awesome job maxing out the 403b plus 457b and investing in taxable... you're well on your way to financial independence. I do the same.

I imagine you are aware of the benefits of investing in target retirement funds, which include:
1. hands off simplicity (following the KISS principal)
2. less temptation to tinker with your investments at the wrong time (Vanguard recently did a study which revealed that those with target retirement funds were much less likely to tinker with their investments during the market downturn in spring 2020).

But the question you raise is a downside, especially if you continue to invest more and more in your taxable account (only you can estimate how much you might invest in taxable in the future). For that reason you might consider breaking your target retirement up into the three funds so that you hold all of your bonds in tax-deferred and one (or both) of the stock index funds in taxable.

Another reason for using the three funds (as opposed to target retirement fund) is the premium you pay for the simplicity of using the target retirement fund. I suggest calculating how much extra you will pay over the years ahead by figuring out your average expense ratio if you break into the three funds, and use an expense ratio calculator like this one: https://www.begintoinvest.com/expense-ratio-calculator/
and/or this one:
You may find that the premium you pay for the target retirement fund is not trivial, which is the main reason I choose to invest in the 3 funds (as opposed to target retirement fund). For example, the expense ratio for Vanguard Target Retirement 2030 is .12%. If you break that up into the funds the expense ratio would be approx. .06%, half the cost. Paying 100% more in expense ratio can equate to thousands of dollars over many years.
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Re: diversification and taxes

Post by dbr »

In general once one accumulates significant taxable investments it does not work so well to stick to target retirement or other balanced funds. Most likely you want to hold stocks in taxable and add some bond holdings in tax deferred (not Roth). You can also use TR funds that hold more in bonds. Those funds should be chosen for asset allocation rather than date of retirement anyway. The TR fund glide path also complicates this. It can still be that if your 401k does not have good fund choices or a directed brokerage option that some TR fund is a choice and you will just have to finagle around it.
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Re: diversification and taxes

Post by sycamore »

GMCZ71 wrote: Mon Jun 14, 2021 6:50 am CD's, I bonds or high yield savings will for the taxable side. Remember to look at all your accounts as whole to keep things in balance.
+1 to look at accounts as a whole.

I think the choices above are all reasonable for a taxable account, with pros and cons to each. Note that CD's and HYSA are just as tax-inefficient as bonds (they all generate taxable income). But with I Bonds you can choose to defer the income until later or report the income each year.
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Re: diversification and taxes

Post by retired@50 »

Cn2012 wrote: Sun Jun 13, 2021 9:55 pm Is it ok to have a total bond market fund in my taxable account? Or should I rethink how I structure my accounts.
Thanks for the help.
I'm a fan of the target date funds too, although they were created long after I started investing, so I didn't really get to take advantage of them.

Anyway, here's an idea. For your taxable account, try sticking with just a US Stock index fund and an International Stock index fund. The bonds will be missing from the taxable account. But, to make up for that, you could hold more bonds in your retirement account. Either by buying a pure bond index fund in the retirement account, or by changing the date (2040 or whatever) of your target retirement fund.

So, in the end, each account may be slightly off-kilter from your desired asset allocation, but you, overall, as an investor, will have the right asset allocation to suit your needs. It's not really essential that each account hold the exact same asset allocation, since you own all the accounts, it's really more about what you own in total.

Oh, and welcome to the forum. :happy

This is one person's opinion. Nothing more.
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