Low fees vs. tax deferred bond allocations

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Gmen1144
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Low fees vs. tax deferred bond allocations

Post by Gmen1144 » Sun Mar 08, 2015 11:29 am

I am looking for advice with respect to re-balancing my existing investment portfolio. I am overweighted in US equity and am looking to reallocate into bond funds. However, my tax deferred investment choices for bond funds in my 401K, IRA and HSA do not include low cost funds/indexes, with the lowest cost being T.Rowe's New Income Fund (PRCIX) at 0.62%. So, do I swallow hard and invest my bond allocation in a tax deferred account in T.Rowe's New Income Fund or do I ignore the tax deferral benefit and invest my bond allocation in a taxable account where I can target Vanguard's Total Bond Mkt Index Adm at 0.08% or Vanguard's Short, Intermediate and/or Long Term Muni Fund, which may not be a great alternative as I am subject to AMT, at 0.20%. Thanks so much!

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Re: Low fees vs. tax deferred bond allocations

Post by donkey » Sun Mar 08, 2015 12:11 pm

Interested in the responses you get.
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goodenyou
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Re: Low fees vs. tax deferred bond allocations

Post by goodenyou » Sun Mar 08, 2015 7:03 pm

Depends on your tax bracket. You can allocate the bond portion of your (entire) portfolio in your taxable space in a tax-free bond fund. You can also allocate your bond portion in a Stable Value fund in your tax-advantage space, if you have that choice in your 401 (k). This is not such a bad idea in today's low interest rate environment. You won't have any interest rate risk in a Stable Value Fund, the er should be 0%, and you won't be giving up much performance. The problem is that your equity choices in your 401k plan are probably lousy as well. This is a common problem with 401k plans that involve glossy brochures and agents in suits.
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Gmen1144
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Re: Low fees vs. tax deferred bond allocations

Post by Gmen1144 » Sun Mar 08, 2015 7:34 pm

Thanks for the feedback.

I am in the highest tax bracket.

I have low cost, index options for both US and International equities, but not for bond funds.

Any other insights would be appreciated.

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Gmen1144
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Re: Low fees vs. tax deferred bond allocations

Post by Gmen1144 » Tue Apr 14, 2015 8:27 am

I thought I would refresh this post to see if any others have any insight having already crossed this bridge. Thanks in advance.

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BL
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Re: Low fees vs. tax deferred bond allocations

Post by BL » Tue Apr 14, 2015 8:53 am

Gmen1144 wrote:I am looking for advice with respect to re-balancing my existing investment portfolio. I am overweighted in US equity and am looking to reallocate into bond funds. However, my tax deferred investment choices for bond funds in my 401K, IRA and HSA do not include low cost funds/indexes, with the lowest cost being T.Rowe's New Income Fund (PRCIX) at 0.62%. So, do I swallow hard and invest my bond allocation in a tax deferred account in T.Rowe's New Income Fund or do I ignore the tax deferral benefit and invest my bond allocation in a taxable account where I can target Vanguard's Total Bond Mkt Index Adm at 0.08% or Vanguard's Short, Intermediate and/or Long Term Muni Fund, which may not be a great alternative as I am subject to AMT, at 0.20%. Thanks so much!
IRA could easily be moved to Vanguard to get the Total Bond Mkt fund. Maybe the HSA could be moved as well.

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Gmen1144
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Re: Low fees vs. tax deferred bond allocations

Post by Gmen1144 » Tue Apr 14, 2015 12:00 pm

Thanks, but I have already maxed out the low cost fund options available to my retirement dollars. The choices that I have remaining are to invest in bonds funds that have .62% of fees within my retirement/tax deferred accounts or to invest in low cost bond funds outside of my retirement/tax deferred accounts and deal with the tax liabilities, whether due to taxable income or AMT if I target municipals.

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ogd
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Re: Low fees vs. tax deferred bond allocations

Post by ogd » Tue Apr 14, 2015 12:19 pm

I would do the switch and use munis, provided you have low-cost stock funds to use in that tax-advantaged space.

Here's the rationale: the 0.5% extra fees are just about eating up a 25% tax saving on bonds yielding about 2%. The 25% level is special because it's roughly equal to the implied tax discount that we generally believe is priced in municipal bonds (everyone buying munis is getting a tax discount, and they are factoring it in when pricing them vs alternatives of the same risk).

In other words, you can use municipal bonds to limit your "tax bracket" for bonds held in taxable to 25%, even if you'd pay more on other bonds.

Since the fees make this roughly even, what's left is the fact that PRCIX is using up your tax advantaged space (a scarce resource) for no benefit. If you use it for stocks instead, you get some benefit, as long as you don't have a similar loss to fees in stock funds, in which case the location truly wouldn't matter.

The other factor is how much fixed income you're comfortable having in munis from a diversification perspective, since you could end up with 100% if none of the tax-advantaged accounts have good funds (see also suggestion about IRA above). Personally I limit it to 50% of total fixed income, and no more than 33% of total in a state-specific fund. If it ends up too much, another investment to consider is bank CDs, on which you pay full taxes but from 2.25% they still leave a decent yield considering it's no credit risk and very limited interest rate risk.

I would also add that I'm not particularly comfortable with PRCIX, they leave themselves too much freedom for my taste. There are incentives for bond managers that are not necessarily aligned with yours, for example to have a chance at being great as opposed to being consistently average. It's probably alright, but I would prefer even more conservative.

For a specific fund, use VWIUX or a state-specific fund. The Vanguard funds other than High Yield generally have little or no AMT exposure.

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Re: Low fees vs. tax deferred bond allocations

Post by DSInvestor » Tue Apr 14, 2015 12:23 pm

What are you holding in your IRA accounts and where are they held? If you have any stocks or stock funds in your IRAs, you can exchange stocks for bonds in the IRAs. If your IRAs are held at a firm that does not have low cost index funds, you can consider moving those accounts to Vanguard where you can get Admiral shares of index funds. Until then, you can consider using a Vanguard tax exempt bond fund like Vanguard Intermediate Term Tax exempt Investor VWITX or Admiral VWIUX (50K minimum initial investment).
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Re: Low fees vs. tax deferred bond allocations

Post by grabiner » Tue Apr 14, 2015 10:02 pm

With current low yields on bonds, there isn't that much tax difference between holding bonds or stocks in taxable. Thus, if your 401(k) has better stock than bond options (say, if it has a low-cost S&P 500 index), it's best to hold stocks there, and hold your bonds elsewhere, including a taxable account if necessary.
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max12377
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Re: Low fees vs. tax deferred bond allocations

Post by max12377 » Wed Apr 15, 2015 7:44 am

I've been pondering the same thing so I also appreciate the responses. My goal has been stocks in taxable and bonds in tax deferred and it's irritating that I have to pay more than I would like for my 403b bond funds. When the projected returns for bond funds are low to begin with, why pay more? To get around it I've been reversing my strategy and putting stocks in the 403b and muni bonds in taxable. I've often wondered if 'minimizing costs' would trump 'tax efficiency via the traditional, recommended asset location strategy'. I think if you have a large enough time horizon this may be true but there enough variables such that a rule of thumb might not be possible. In today's low bond yield environment I am under the impression that bond location strategies aren't as critical. So I'm comfy with my strategy -- for now....

..but then again I lose tax loss harvesting opportunities in my taxable account which argues against this strategy..

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