Placement of Funds in All Tax advantaged accounts

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bjames310
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Placement of Funds in All Tax advantaged accounts

Post by bjames310 »

Between my wife and I, we have two 401ks, two Roth IRAs, and an HSA. We're aiming for an 80/20 asset allocation (which thanks to everyone here for help, we know what we'll invest in).

We don't have any taxable accounts. We will open one within the next 12-18 months after we've saved enough for a down payment.

My question is this: since all our accounts are tax advantaged, shouldn't we put our higher risk, higher reward funds (which will be a split between Vanguard Total Stock Market, an S&P 500 index fund, and Vanguard's Extended Markets fund) first in the HSA and Roths, then the remaining of the 80 percent stocks in the 401k, and then the bonds in the 401ks?

My thinking is that since we won't be taxed on the Roths and HSA in retirement in 35 years, but we will be taxed later on with the 401ks, we'll maximize our returns by having the higher earning funds in Roth and HSA.

Also, we have enough cash to cover and medical emergencies, so we don't plan on touching the HSA.

Thanks!
mcraepat9
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Re: Placement of Funds in All Tax advantaged accounts

Post by mcraepat9 »

I think your strategy is sound.
Amateur investors are not cool-headed logicians.
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flamesabers
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Re: Placement of Funds in All Tax advantaged accounts

Post by flamesabers »

Are you able to invest in a Roth 401k?

I agree with your strategy of putting higher risk accounts in retirement accounts. Since you won't be retiring for a few decades, you can afford to ride out the peaks and valleys in the market. I'm not so sure about having your HSA in a high-risk account. You say you don't plan on touching the HSA, but if you have to it would be quite unfortunate if you had to withdraw money when the fund is doing poorly and you incur a capital loss.

Out of curiosity, where are you keeping your cash reserves? If it's in a checking or savings account, do you need to keep 100% of it immediately accessible? If not, you may want to consider moving some of it to an account that will get you slightly better returns, like I-Bonds or CDs.
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bjames310
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Re: Placement of Funds in All Tax advantaged accounts

Post by bjames310 »

flamesabers wrote:Are you able to invest in a Roth 401k?

I agree with your strategy of putting higher risk accounts in retirement accounts. Since you won't be retiring for a few decades, you can afford to ride out the peaks and valleys in the market. I'm not so sure about having your HSA in a high-risk account. You say you don't plan on touching the HSA, but if you have to it would be quite unfortunate if you had to withdraw money when the fund is doing poorly and you incur a capital loss.

Out of curiosity, where are you keeping your cash reserves? If it's in a checking or savings account, do you need to keep 100% of it immediately accessible? If not, you may want to consider moving some of it to an account that will get you slightly better returns, like I-Bonds or CDs.
Roth 401k -- it's an option under my plan, not hers. But I'm still limited to $18,000 a year in contributions for either type. And I already maxed out my contributions for re year.

HSA -- I just started doing it this, so at this point it's not a lot of money. But I completely understand your point.

Cash -- it's all in GS Bank right now, 1.05 percent interest. We have enough for an adequate down payment but we want to be able to put down more than 20 percent when we purchase next year, so we have lower monthly payments. So while we don't immediately need the money, there is a chance we see something we like now and could pull the trigger on it.

Are you referring to buying individual I-bonds?
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flamesabers
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Re: Placement of Funds in All Tax advantaged accounts

Post by flamesabers »

bjames310 wrote:
flamesabers wrote:Are you able to invest in a Roth 401k?

I agree with your strategy of putting higher risk accounts in retirement accounts. Since you won't be retiring for a few decades, you can afford to ride out the peaks and valleys in the market. I'm not so sure about having your HSA in a high-risk account. You say you don't plan on touching the HSA, but if you have to it would be quite unfortunate if you had to withdraw money when the fund is doing poorly and you incur a capital loss.

Out of curiosity, where are you keeping your cash reserves? If it's in a checking or savings account, do you need to keep 100% of it immediately accessible? If not, you may want to consider moving some of it to an account that will get you slightly better returns, like I-Bonds or CDs.
Roth 401k -- it's an option under my plan, not hers. But I'm still limited to $18,000 a year in contributions for either type. And I already maxed out my contributions for re year.

HSA -- I just started doing it this, so at this point it's not a lot of money. But I completely understand your point.

Cash -- it's all in GS Bank right now, 1.05 percent interest. We have enough for an adequate down payment but we want to be able to put down more than 20 percent when we purchase next year, so we have lower monthly payments. So while we don't immediately need the money, there is a chance we see something we like now and could pull the trigger on it.

Are you referring to buying individual I-bonds?
Yes, I am referring to buying individual I-bonds.

I myself have started buying I-Bonds. I intend to build up a collection of I-Bonds to act as a reserves in case my typical cash flow is unable to cover my expenditures. Even though the fixed rate is currently 0%, the variable rate is currently more favorable. As I see it, if the official rate of inflation goes up, I'm much more likely to get an increase in interest rate from my I-Bonds than from the typical checking/savings account. Also I like how I-Bonds are exempt from state/local taxes and the federal tax can be deferred until redemption/maturity.
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grabiner
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Re: Placement of Funds in All Tax advantaged accounts

Post by grabiner »

bjames310 wrote:My question is this: since all our accounts are tax advantaged, shouldn't we put our higher risk, higher reward funds (which will be a split between Vanguard Total Stock Market, an S&P 500 index fund, and Vanguard's Extended Markets fund) first in the HSA and Roths, then the remaining of the 80 percent stocks in the 401k, and then the bonds in the 401ks?[

My thinking is that since we won't be taxed on the Roths and HSA in retirement in 35 years, but we will be taxed later on with the 401ks, we'll maximize our returns by having the higher earning funds in Roth and HSA.
There isn't actually a benefit here. If you put the same number of dollars in stock in the Roth and HSA rather than the 401(k), you will increase your expected return, but also your risk. If you adjust for the fact that the IRS owns 25% of your 401(k) (if you retire in a 25% bracket), then putting $4000 in stock in the 401(k) or $3000 in stock in the Roth has the same return and risk.

See Tax-adjusted asset allocation on the wiki.
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masha12
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Re: Placement of Funds in All Tax advantaged accounts

Post by masha12 »

If you check out Pet Peeve #2 in this blog post: http://whitecoatinvestor.com/my-two-ass ... et-peeves/, you will find a good explanation of asset placement in tax-deferred versus tax-free.

In a nutshell, a tax-free account has one basket, while a tax-deferred account has two baskets: one for you and one for the government's share of delayed taxes. If you put all your high risk assets in tax-free, you are taking more risk than if if the same dollar amount was in tax-deferred because part of that investment will go to the government in the form of taxes.

The article helped me look at asset location in a way I never had before.
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bjames310
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Re: Placement of Funds in All Tax advantaged accounts

Post by bjames310 »

Still not sure if I understand the two above posts of how it makes no difference what account I put the money in. Maybe this is a simplistic way of looking at it, but let's assume two different scenarios where (A) I have $100,000 in my Roth/HSA accounts, and (B) that money instead is in my 401k. Let's also assume that I invest in the Total Stock Market fund for both accounts. To keep the math simple for me, let's also assume I withdraw 100% of the money when I hit age 65 and let's also assume that I am in the 25% tax bracket.

In Scenario A, I get $100% of the $100,000 when it's withdrawn since it's all tax free.

In Scenario B, I get 75% of the $100,000 when it's withdrawn, since the government is entitled to 25% of it.

I don't understand how it doesn't make a difference what account the money is in, or how there is more risk of putting the money is Scenario A.
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grabiner
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Re: Placement of Funds in All Tax advantaged accounts

Post by grabiner »

bjames310 wrote:Still not sure if I understand the two above posts of how it makes no difference what account I put the money in. Maybe this is a simplistic way of looking at it, but let's assume two different scenarios where (A) I have $100,000 in my Roth/HSA accounts, and (B) that money instead is in my 401k. Let's also assume that I invest in the Total Stock Market fund for both accounts. To keep the math simple for me, let's also assume I withdraw 100% of the money when I hit age 65 and let's also assume that I am in the 25% tax bracket.

In Scenario A, I get $100% of the $100,000 when it's withdrawn since it's all tax free.

In Scenario B, I get 75% of the $100,000 when it's withdrawn, since the government is entitled to 25% of it.

I don't understand how it doesn't make a difference what account the money is in, or how there is more risk of putting the money is Scenario A.
What you have shown is that it is better to have $100,000 in a Roth account than in a 401(k), which is clearly true.

But here is the correct comparison. Suppose you have $100K in your Roth IRA, and $100K in your 401(k). You can spend $175K in retirement. Now, suppose you invest one of the accounts entirely in stock. If it is the Roth IRA and the stock market doubles, you gain $100K. If the stock market loses half its value, you lose $50K. If the stock is in the 401(k) and the stock market doubles, you gain $75K. If the stock market loses half its value, you lose $37.5K. Thus, by putting stock in the Roth IRA, you got higher returns when the stock market rose, but higher losses when it fell; this is taking more risk.

Now suppose you have $75K in your Roth IRA, and $100K in your 401(k). You can spend $150K in retirement. If you hold stock in either account and the stock market doubles, you gain $75K. If you hold stock in either account and the stock market loses half its value, you lose $37.5K. Stock in the Roth IRA is thus no better or worse than stock in the 401(k); it just gives you more return and more risk per dollar.
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