Is this asset allocation correct?

[FBN2014]

I am rather disappointed in this portfolio's returns for 2016. I am trustee for a trust beneficiary. I am required to make a 3% distribution each year paid out monthly. The trust assets have a target allocation of 40/60. The stock portion returned 11.4%, bond portion -2.4%. The portfolio is managed by a low cost RIA who uses index funds and ETFs. Here is the current portfolio breakdown with percentage weightings:

Stocks (41%):
US Stocks(72%):
ISHARES S&P SMALL-CAP 600 VALUE INDEX ETF (IJS) 24%
VANGUARD TOTAL STOCK MARKET INDEX ETF (VTI) 76%

International Stocks (28%):
DFA EMERGING MARKETS CORE STOCK FUND (DFCEX) 24%
DFA INTERNATIONAL SMALL CAP VALUE FUND (DISVX) 20%
VANGUARD FTSE EUROPE INDEX ETF (VGK) 27%
VANGUARD FTSE PACIFIC INDEX ETF (VPL) 29%

Bonds (58%):
VANGUARD INTERMEDIATE-TERM TAX-EXEMPT FUND (VWIUX) 100%

Cash (1%)

I chose the 40/60 allocation due to the trust beneficiary's age of 59, my fiduciary duty to invest conservatively, and the portfolio record of low volatility in the crash of 2008-2009 (lost approx. 16%). The bond portion is invested in intermediate munis (5-7 year maturities) to avoid generating lots of taxable income that would be taxed at higher trust tax rates if not distributed since I am only required to distribute 3% each year but have discretion to distribute more as beneficiary needs dictate. I am concerned that if interest rates continue to rise then the bonds will be a drag on performance and I would at least like to get a 3%+ return. I want to have a third party manager involved to avoid any possible legal exposure of being sued for mismanagement since I am not an RIA or CFP. Thoughts? Recommendations?

[mhalley]

The portfolio seems fine to me. To get the cheapest fa, you could go with vanguard pas, fidelity go, or schwab intelligent portfolio. I don't think you will achieve 3% on your bond fund right now. You could try shortening the duration, but that will decrease the yield. Plus, I don't think vanguard has a short term muni fund, you might need to go with an etf if you really want munis.
http://www.schwab.com/public/schwab/nn/ ... Rates-Rise
http://etfdb.com/type/bond/municipal-bo ... asc&page=1

[Nate79]

According to M* total return for VWIUX for 2016 was 0.19%. Not negative. What am I missing that you had a negative return?

[FBN2014]

According to M* total return for VWIUX for 2016 was 0.19%. Not negative. What am I missing that you had a negative return?

The account was opened near the end of April 2016 so I imagine that accounts for the lower return on the bonds.

[retiredjg]

The portfolio is managed by a low cost RIA who uses index funds and ETFs.

Just how low is this "low cost"?

[KyleAAA]

There is no such thing as a "correct" asset allocation. 40/60 seems overly conservative for the average 59 year old but other than that, the allocation looks quite good for what you're trying to accomplish. What return did the portfolio earn and what return would you have expected? There's some tilting going on so you should expect significant tracking error.

[livesoft]

I like this portfolio a lot for a taxable account. I would not have (and don't have) the exact same funds, but I still like it a lot.

But I am about the same age and for myself, I would and do have a 60/40 asset allocation and intend to have that the rest of my life.

[FBN2014]

The portfolio is managed by a low cost RIA who uses index funds and ETFs.

Just how low is this "low cost"?

.37%

[livesoft]

If you haven't managed to watch the 4 videos on "Managing Expectations" linked in this post: viewtopic.php?t=205911

I expect they would be well worth your time watching.

[harmony]

There were some political theories given for the performance in muni bonds around the election of 2016. You can find several articles by googling. I won't link to any of them here because politics is off topic, but it might help you understand it all better.

You provide a good idea for using munis to keep trust taxes down. Thanks for the tip. While VWIUX may be well-diversified, muni bonds themselves make up less than 10% of the U.S. bond market. I understand why you are using tax-exempt munis though.

Would having some I-bonds offset some muni bond fund risk? It would take a few years to get much moved over with the $10,000 annual limit. It's not tax-exempt, of course, but the I-bond tax-deferred interest could help you control when interest would become taxable and in a year like 2016 it could buffer muni losses. If muni bonds were doing well, you could take the income from munis that year and distribute it to the beneficiary. If munis and stocks didn't have great returns, you could distribute the accrued interest from an I-bond. Accrued I-bond interest could also be distributed in a year when the beneficiary had unusually high expenses.

Investment income is not taxed at trust tax rates unless the income stays in the trust beyond the year that it is earned. It is possible to distribute net income to the trust beneficiary via the 1041 and Schedule K-1, so that the beneficiary (instead of the trust) pays taxes at his lower individual tax rate. You would first reduce trust income with various trust expenses, i.e. your trustee fee and maybe the FA's fees. Net income to the beneficiary is further reduced by his own standard deduction and personal exemption. You may already know this since you are gearing up to complete the 1041. (I'd be interested in learning how that goes for you.)

I am still learning about muni bond funds and trusts too. If anyone can correct my understanding, please do so.

[retiredjg]

.37%

Well, I guess that is not the problem then.

[FBN2014]

harmony, the loss on the muni bond part of the portfolio is only a paper loss unless I decided to sell. As the bonds come due the full issue value would be credited to the account and then gets reinvested in bonds with higher interest rates if rates continue to rise. The Vanguard intermediate muni fund has over 6000 bonds in it I believe. Vanguard also has a total bond market index fund that includes corporate and munis.

[retiredjg]

Vanguard also has a total bond market index fund that includes corporate and munis.

They do?

[FBN2014]

VBTLX

[retiredjg]

I'm pretty sure the Vanguard Total Bond Market index does not contain munis.

[FBN2014]

I'm pretty sure the Vanguard Total Bond Market index does not contain munis.

https://personal.vanguard.com/us/funds/ ... IntExt=INT

[jhfenton]

I'm pretty sure the Vanguard Total Bond Market index does not contain munis.

https://personal.vanguard.com/us/funds/ ... IntExt=INT

Vanguard Total Bond does not include tax-exempt muni bonds.

[retiredjg]

Sorry. I was equating "muni" with "tax-exempt" although I've read that there are a small number of municipal bonds that are not tax-exempt. Can't say I would recognize a municipal bond that is not tax-exempt. Any examples come to mind?

[FBN2014]

I believe that munis are only tax exempt for the investor if he/she lives in the state where they are issued although some states may have reciprocal agreements not to tax bondholders who may live elsewhere. Of course if you live in a state that has no income tax then it doesn't matter.

[rkhusky]

You could try shortening the duration, but that will decrease the yield. Plus, I don't think vanguard has a short term muni fund, you might need to go with an etf if you really want munis.

Vanguard does have a short term muni fund (VWSTX, VWSUX).

[jhfenton]

Sorry. I was equating "muni" with "tax-exempt" although I've read that there are a small number of municipal bonds that are not tax-exempt. Can't say I would recognize a municipal bond that is not tax-exempt. Any examples come to mind?

The taxable muni bond market is pretty small. The ones I've seen are various state and local agency bonds for stadiums or pension under-funding.

From reading my alumni news, I know that Harvard has issued both tax-exempt (through the Massachusetts Development Finance Agency) and taxable bonds through the muni market. Here's an article from October.

Here's a WSJ article from June 5, 2013: Should You Buy Taxable Muni Bonds? (It mentions Harvard too.)

[jhfenton]

You could try shortening the duration, but that will decrease the yield. Plus, I don't think vanguard has a short term muni fund, you might need to go with an etf if you really want munis.

Vanguard does have a short term muni fund (VWSTX, VWSUX).

Correct. They also have a Limited-Term Tax Exempt (VMLTX, VMLUX) with an average duration of 2.5 years. The Short-Term Tax Exempt fund has a duration of only 1.2 years.

[retiredjg]

The taxable muni bond market is pretty small. The ones I've seen are various state and local agency bonds for stadiums or pension under-funding.

Hard to see why bonds like this would be included in a total bond index. But I'm not going to look through the thousands of bonds on the index to find out!

[jhfenton]

The taxable muni bond market is pretty small. The ones I've seen are various state and local agency bonds for stadiums or pension under-funding.

Hard to see why bonds like this would be included in a total bond index. But I'm not going to look through the thousands of bonds on the index to find out!

Me either. I have no idea whether Total Bond includes any taxable munis. I would guess that the Aggregate Bond Index it follows doesn't, because including taxable munis would require dealing with a entirely separate bond market just for the sake of a completely insignificant segment of investment grade taxable bonds.