Differential aggressiveness for ROTH vs 401K

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Finger123
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Differential aggressiveness for ROTH vs 401K

Post by Finger123 » Thu Apr 20, 2017 5:38 pm

Does anyone differentiate ROTH money from other tax advantaged moneys with regard to equities vs bonds?

One important caveat for this discussion should be stated up front... For this dicussion, assume that the ROTH portion of your retirement savings is a very small sliver....

I am fully aware of wanting dividend generating holdings in tax advantaged accounts..... but if you need to make a decision of where within the tax advantaged accounts to carry some stock holdings is there a consensus on how to do it?

My gut feeling is that ROTH money should be more in stocks than bonds (generally speaking) because it has the longest horizon (withdrawn last?) and because it has the best opportunity for growth. I am not sure but it might make sense to always/preferentially hold stocks in the ROTH (of course you need to glide down at some point when you are getting old)...

What do people think?

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Re: Differential aggressiveness for ROTH vs 401K

Post by retiredjg » Thu Apr 20, 2017 6:05 pm

You will hear varying opinions on this.

I think this decision is so far down the decision tree that is simply does not matter much. Other things are more important and should be give more consideration. For example...

    -how much you save in each account (filling tax-advantaged accounts first)

    -having the right stock to bond allocation

    -achieving your stock to bond allocation with the lowest costs possible (by picking the best funds available in the 401k)

    -attempting to be as tax-efficient as possible

If/when you get through all those things and still find that all things are equal....then ask what to put in Roth and maybe there is an argument for putting stocks there instead of bonds.

This topic receives a lot of discussion here at Bogleheads. I think it is rarely important enough to even wonder about such a decision because it is so rare that all the more important stuff results in "all things being equal". And when it does, the answer is not going to make much difference.

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Re: Differential aggressiveness for ROTH vs 401K

Post by Tyler Aspect » Thu Apr 20, 2017 6:08 pm

Finger123 wrote:Does anyone differentiate ROTH money from other tax advantaged moneys with regard to equities vs bonds?

One important caveat for this discussion should be stated up front... For this dicussion, assume that the ROTH portion of your retirement savings is a very small sliver....

I am fully aware of wanting dividend generating holdings in tax advantaged accounts..... but if you need to make a decision of where within the tax advantaged accounts to carry some stock holdings is there a consensus on how to do it?

My gut feeling is that ROTH money should be more in stocks than bonds (generally speaking) because it has the longest horizon (withdrawn last?) and because it has the best opportunity for growth. I am not sure but it might make sense to always/preferentially hold stocks in the ROTH (of course you need to glide down at some point when you are getting old)...

What do people think?


Since Roth IRA withdrawal is tax free after retirement age, then you would like Roth IRA to grow as much value as possible. On the other hand, you get a tax deduction on the traditional IRA, but any growth eventually gets taxed at the ordinary income tax rate, so you would like the traditional IRA to not grow as much, other factors being equal.
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Re: Differential aggressiveness for ROTH vs 401K

Post by Kevin M » Thu Apr 20, 2017 6:19 pm

With Roth as a small sliver of your portfolio, it does not matter. That is my situation.

If your Roth is a large portion of your portfolio, then you should think about after-tax risk and return, since that's what you eat. If you think in after-tax terms, then the risk and expected return are different after tax than before tax. If you adjust for this difference, then it does not matter whether you hold your stocks in tax-free or tax-deferred.

The exception is if your expected return variance could result in you being in a higher tax bracket if your realized return is at the high end of your expected return than if it's at the low end.

It does not matter for you from a practical perspective, but for more on this, see this Wiki article: Tax-adjusted asset allocation - Bogleheads

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Re: Differential aggressiveness for ROTH vs 401K

Post by ram » Thu Apr 20, 2017 10:19 pm

I keep bonds, small cap value and REITS in tax deferred.
Roth: REITS and SCV (expected higher return)
401 K: Bonds (expected lower returns)
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Re: Differential aggressiveness for ROTH vs 401K

Post by dn123 » Thu Apr 20, 2017 10:56 pm

Ill be doing what I think you are alluding to. Put your growth-iest bets into your Roth. Why not? It all tax free.

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Re: Differential aggressiveness for ROTH vs 401K

Post by tarheel » Fri Apr 21, 2017 5:35 am

Don't lose sleep over it.

Ideally, assets with larger expected return in Roth - in my Roth I only have small-cap international.

But I don't overthink it.

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Re: Differential aggressiveness for ROTH vs 401K

Post by Kevin M » Fri Apr 21, 2017 1:10 pm

dn123 wrote:Ill be doing what I think you are alluding to. Put your growth-iest bets into your Roth. Why not? It all tax free.

Because you are not adjusting your AA for after-tax return and risk. If you do so, it doesn't matter where you put your "growth-iest" bets.

You increase your portfolio expected return by putting higher risk / higher expected return assets in Roth because you increase your after-tax risk. In other words, you are increasing your after-tax allocation to the riskier assets. You could accomplish the same thing by increasing your before-tax allocation to your riskier assets, and holding them in tax-deferred accounts.

tarheel wrote:Ideally, assets with larger expected return in Roth - in my Roth I only have small-cap international.

Same misunderstanding.

If you disagree, read the Wiki article I linked to, and come back with an argument defending your position against what it explains.

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Re: Differential aggressiveness for ROTH vs 401K

Post by dn123 » Fri Apr 21, 2017 3:36 pm

Hi Kevin, thanks for that link, because I was reading https://www.bogleheads.org/wiki/Tax-eff ... _placement

If all else is equal (and it often isn't, because you may have different options in your 401(k) and your Roth IRA), it is slightly better to have the fund with the highest expected return in your Roth, because the Roth is free from Required Minimum Distributions (RMDs), [note 6] is not counted as income for making Social Security taxable, and probably is less subject to the risk of changing tax rates. [note 7]


But that is a different page than you refer to and the reasons listed are a bit different. Let me study your page and let it sink in. Thanks for pointing this out.

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Re: Differential aggressiveness for ROTH vs 401K

Post by Ketawa » Fri Apr 21, 2017 3:56 pm

dn123 wrote:Hi Kevin, thanks for that link, because I was reading https://www.bogleheads.org/wiki/Tax-eff ... _placement

If all else is equal (and it often isn't, because you may have different options in your 401(k) and your Roth IRA), it is slightly better to have the fund with the highest expected return in your Roth, because the Roth is free from Required Minimum Distributions (RMDs), [note 6] is not counted as income for making Social Security taxable, and probably is less subject to the risk of changing tax rates. [note 7]


But that is a different page than you refer to and the reasons listed are a bit different. Let me study your page and let it sink in. Thanks for pointing this out.


The tax-efficient fund placement wiki article is addressing whether to put something in taxable vs tax-advantaged. Tax-advantaged includes both Roth (tax-free) and Traditional (tax-deferred). Accounting for taxes correctly, Traditional and Roth accounts are basically the same, so there is no need to worry about what to put in which for tax efficiency reasons.

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Re: Differential aggressiveness for ROTH vs 401K

Post by inbox788 » Fri Apr 21, 2017 4:09 pm

I've been putting international into Roth thinking it has the biggest risk and potential to outperform in the long run, but that's been a mistake. I'm considering going 50/50 us/international and just giving up on any outperformance expectations.

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Re: Differential aggressiveness for ROTH vs 401K

Post by Kevin M » Fri Apr 21, 2017 4:47 pm

dn123 wrote:Hi Kevin, thanks for that link, because I was reading https://www.bogleheads.org/wiki/Tax-eff ... _placement

If all else is equal (and it often isn't, because you may have different options in your 401(k) and your Roth IRA), it is slightly better to have the fund with the highest expected return in your Roth, because the Roth is free from Required Minimum Distributions (RMDs), [note 6] is not counted as income for making Social Security taxable, and probably is less subject to the risk of changing tax rates. [note 7]

But that is a different page than you refer to and the reasons listed are a bit different. Let me study your page and let it sink in. Thanks for pointing this out.

You're welcome.

Yes, there are second-order effects that could slightly favor risky assets in Roth vs. tax-deferred. You'll see another one listed in the tax adjusted AA article. But, these are not the arguments that people usually make, so I think it's important for people to understand the first-order effect: after-tax risk and return is different than pre-tax risk and return. Since your AA depends on your assessment of risk and expected return, and how it fits your ability, willingness and need to take risk, it's more rational to consider your AA on an after-tax basis, since this is what matters in terms of the risk to your purchasing power.

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Re: Differential aggressiveness for ROTH vs 401K

Post by Alto Astral » Fri Apr 21, 2017 6:17 pm

I do. I have vanguard total bond index in our ROTHs. The hope is that thw value will be somewhat stable if i need to withdraw any contributions. Needed to do it once before. I was using the ROTH as emergency fund and kept it all in prime money market.

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Re: Differential aggressiveness for ROTH vs 401K

Post by Finger123 » Fri Apr 21, 2017 7:43 pm

[/quote]
Same misunderstanding.

If you disagree, read the Wiki article I linked to, and come back with an argument defending your position against what it explains.

Kevin[/quote]

Kevin, I think I disagree with you for the following reason. When you talk about risk you need to include the concept of long term vs short term risk. I agree that short term risk is high for equities but long term risk is still fairly low. The reason this is important in the ROTH is that is has the advantage of tax free growth and tax free withdrawal unlike a 401k of which the govt owns a significant fraction upon withdraw.

Put simply....

Equities value is in their valuation growth rather than divends which is taxed at long term capital gains, which is why they should be in taxable accounts

Bonds value is in the dividends they produce which is taxed at marginal rate which is why they should be in tax advantaged accounts.

But if you have money that will never again be taxed, it makes sense to have it populated by the highest possible growth potential (also high short term risk) which is equities. Holding these long term (with no age based mandated withdrawal) mitigates the short term risk.

That is my argument. Point out the errors that you see....

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Re: Differential aggressiveness for ROTH vs 401K

Post by Ketawa » Fri Apr 21, 2017 8:03 pm

I'm not Kevin, but regardless...

Finger123 wrote:
Kevin M wrote:Same misunderstanding.

If you disagree, read the Wiki article I linked to, and come back with an argument defending your position against what it explains.

Kevin


Kevin, I think I disagree with you for the following reason. When you talk about risk you need to include the concept of long term vs short term risk. I agree that short term risk is high for equities but long term risk is still fairly low. The reason this is important in the ROTH is that is has the advantage of tax free growth and tax free withdrawal unlike a 401k of which the govt owns a significant fraction upon withdraw.


Agreed, so the alternative isn't simply to hold the same amount of equities in a Traditional account as you would have held them in a Roth. To make the accounts equal after tax, you would hold more equities in Traditional and less bonds in Roth. This is the example that the wiki gives. It doesn't matter how long the time period is, the adjustment still works.

Finger123 wrote:Equities value is in their valuation growth rather than divends which is taxed at long term capital gains, which is why they should be in taxable accounts

Bonds value is in the dividends they produce which is taxed at marginal rate which is why they should be in tax advantaged accounts.


This is an issue of tax-efficient placement of assets. You should put bonds in tax-advantaged accounts (Roth or Traditional) because they generally have a higher tax cost than equities. However, the tax cost in Traditional accounts is not something to consider for tax-efficient placement of assets, because both equities and bonds are affected the same.

Finger123 wrote:But if you have money that will never again be taxed, it makes sense to have it populated by the highest possible growth potential (also high short term risk) which is equities. Holding these long term (with no age based mandated withdrawal) mitigates the short term risk.

That is my argument. Point out the errors that you see....


If equities are less risky in the long term, why not be 100% equities? (They're not less risky in the long term.) You can achieve the same goal by holding more equities in a Traditional account and bonds in Roth, and this is the example in the wiki.

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Re: Differential aggressiveness for ROTH vs 401K

Post by Kevin M » Fri Apr 21, 2017 8:05 pm

Finger123 wrote:Kevin, I think I disagree with you for the following reason. When you talk about risk you need to include the concept of long term vs short term risk. I agree that short term risk is high for equities but long term risk is still fairly low.

I am talking about long-term risk, or risk over whatever time period is relevant to you. If you think stocks are not risky given a certain length of time, then you should own 100% stocks for any time horizon beyond that. In this case, asset location is a non-issue. Many people on this forum do indeed believe that stocks are not risky in the long term, and own 100% stocks for the long term.

Also, short-term risk is relevant in terms of willingness to take risk. Read posts on this forum from late 2008 and early 2009--there was lots of talk about "plan B", which is what to do when stocks drop so much that you feel your financial security is in danger. It doesn't do any good to think you believe that stocks are not risky in the long run if you freak out when you see your portfolio drop by 50% in value, and you really don't know how long it will take to recover. I bet lots of people who thought they had a high risk tolerance sold their stocks during the financial crisis.

The reason this is important in the ROTH is that is has the advantage of tax free growth and tax free withdrawal unlike a 401k of which the govt owns a significant fraction upon withdraw.

Assuming a constant tax rate, the government owns a significant portion of your 401k right now. That's exactly why you should think about your after-tax risk and return. If stocks fall 50%, you take the entire hit in a roth, but only (1-tax rate) * 50% in your 401k (so down 37.5% for a 25% tax rate).

Again, if you don't think stocks are risky in the long run, then own only stocks for the long run and don't worry about asset location.

Equities value is in their valuation growth rather than divends which is taxed at long term capital gains, which is why they should be in taxable accounts

Some disagree, but even if you believe this, this is a tax-efficiency consideration, not an after-tax risk/return consideration.

Bonds value is in the dividends they produce which is taxed at marginal rate which is why they should be in tax advantaged accounts.

Ditto. Some disagree though. Google: bonds in taxable.

But if you have money that will never again be taxed, it makes sense to have it populated by the highest possible growth potential (also high short term risk) which is equities. Holding these long term (with no age based mandated withdrawal) mitigates the short term risk.

Already addressed.

That is my argument. Point out the errors that you see....

Done.

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Re: Differential aggressiveness for ROTH vs 401K

Post by powermega » Fri Apr 21, 2017 8:43 pm

We allocate in our accounts like this. Our Roth accounts are most aggressively allocated, and on the other end is an inherited traditional IRA that is most conservatively allocated. In between are the 401ks. The bond heavy inherited tIRA is offset by the equity heavy rIRA accounts.
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Re: Differential aggressiveness for ROTH vs 401K

Post by grabiner » Fri Apr 21, 2017 8:50 pm

Finger123 wrote:
Same misunderstanding.

If you disagree, read the Wiki article I linked to, and come back with an argument defending your position against what it explains.

Kevin


Kevin, I think I disagree with you for the following reason. When you talk about risk you need to include the concept of long term vs short term risk. I agree that short term risk is high for equities but long term risk is still fairly low. The reason this is important in the ROTH is that is has the advantage of tax free growth and tax free withdrawal unlike a 401k of which the govt owns a significant fraction upon withdraw.


The long-term risk still matters. If it doesn't matter to you, then you are free to put 100% of both your Roth and traditional accounts in stock, and hold them for the long term; many young investors do this. (I don't recommend this unless you know that the long-term risk is all that matters to you; that is, you have a secure job, and you know how you will react to a bear market because you already lived through one.)

And even then, tax-adjusted asset allocation is still relevant. If you have $4000 in US stock in your traditional account and $3000 in foreign stock in your Roth account, your effective allocation is 50% US stock, not 58%.

But check the wiki article again, and consider the math involved. If you are going to withdraw in a 25% tax bracket, then $4000 in a traditional account and $3000 in a Roth account are equivalent. Either one will have the same after-tax value if invested in stocks, whether stocks go up or down. The Roth has the advantage of tax-free growth, but the traditional account has the advantage of being 33% larger, and that exactly cancels out the fact that you will lose 25% of it to taxes.
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Re: Differential aggressiveness for ROTH vs 401K

Post by markcoop » Fri Apr 21, 2017 9:42 pm

One point I have seen mentioned in the past is looking at the dispersion of possible outcomes. If the risk does not show up long term, then I understand that having stocks in the ROTH makes sense. However, look at the other side. If the risk does show up long term, then stocks in the ROTH is not preferential. Although bad returns from stocks is unlikely long term, it certainly is possible. So not having stocks in the ROTH is a middle of the road strategy - Stocks do well, I therefore can afford to have more taken out for taxes. Stocks don't do well, I better position my portfolio by paying less in taxes.
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Re: Differential aggressiveness for ROTH vs 401K

Post by dn123 » Sat Apr 22, 2017 12:40 am

Kevin M wrote:
dn123 wrote:Hi Kevin, thanks for that link, because I was reading https://www.bogleheads.org/wiki/Tax-eff ... _placement

If all else is equal (and it often isn't, because you may have different options in your 401(k) and your Roth IRA), it is slightly better to have the fund with the highest expected return in your Roth, because the Roth is free from Required Minimum Distributions (RMDs), [note 6] is not counted as income for making Social Security taxable, and probably is less subject to the risk of changing tax rates. [note 7]

But that is a different page than you refer to and the reasons listed are a bit different. Let me study your page and let it sink in. Thanks for pointing this out.

You're welcome.

Yes, there are second-order effects that could slightly favor risky assets in Roth vs. tax-deferred. You'll see another one listed in the tax adjusted AA article. But, these are not the arguments that people usually make, so I think it's important for people to understand the first-order effect: after-tax risk and return is different than pre-tax risk and return. Since your AA depends on your assessment of risk and expected return, and how it fits your ability, willingness and need to take risk, it's more rational to consider your AA on an after-tax basis, since this is what matters in terms of the risk to your purchasing power.

Kevin



Hi Kevin. So I read through your BH link and I stand corrected and thanks again for pointing this out. I now understand what you are talking about and feel a bit stupid for not realizing this. However, in my defense, even Rick Ferri's "All About Asset Allocation" book doesn't mention this (or at least I didn't find it expressed like on the wiki page. There is a section on page 306 of the 2010 edition of his book that talks about asset placement, but its referring to tax placement strategies in terms of minimizing the running tax drag on the portfolio, not in terms of reflecting the ratios in consideration of the tax rates. Rick, if you are reading this and its in the book, my apologies).

So I have been trying to go back to the case where someone has X in post tax, and Y in pretax 401k and has maxed out their 401k and now have Z more dollars to invest for long term, and would want to max that return using some high risk stock selections. Using the post tax 401k mega backdoor, that could be rolled into a Roth401k or alternately could just be put into a post tax account. Now here is where I would be saying that, well in this case I would rather have the Roth option. Your counter argument to this would be, if you select Roth option, all that really means is that in order to keep your stock/bond ratio the same, you would have to adjust your existing pre and post tax holdings to maintain the fixed stock/bond ratio, and I would have to agree after reading the aforementioned web page. The problem that I have here is that I have to kind of know my expected returns on this high risk option to know how much to tweak my current allocations, to compensate, which is going to be hard. In this case, I would just like to have a separate aspirational portfolio for this.

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Re: Differential aggressiveness for ROTH vs 401K

Post by tadamsmar » Sat Apr 22, 2017 12:01 pm

If there were no RMD and one unchanging tax rate, then it would be a wash.

If the tax rate was 25% then you could think of your 401k as 75% Roth and 25% Uncle Sam's.

Differential aggressiveness would only matter to Uncle Sam.

But there are RMDs and other considerations.

My question is:

Are there any scenarios where putting the Roth in the investment with a lower return would be a good idea?
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Re: Differential aggressiveness for ROTH vs 401K

Post by Ketawa » Sat Apr 22, 2017 12:03 pm

tadamsmar wrote:My question is:

Are there any scenarios where putting the Roth in an investment with a lower return would be a good idea?


If the only good fund in a 401k was an S&P 500 index fund, and a Roth IRA had to be used for the bond allocation.

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Re: Differential aggressiveness for ROTH vs 401K

Post by retiredjg » Sat Apr 22, 2017 1:14 pm

tadamsmar wrote:Are there any scenarios where putting the Roth in the investment with a lower return would be a good idea?

A couple of people have reported over the years that they don't want their Roth space to shrivel during times of market upheavel. I think one puts both stocks and bonds in Roth and one filled his Roth with a TIPS fund if I recall correctly.

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Re: Differential aggressiveness for ROTH vs 401K

Post by Finger123 » Sat Apr 22, 2017 2:32 pm

You increase your portfolio expected return by putting higher risk / higher expected return assets in Roth because you increase your after-tax risk. In other words, you are increasing your after-tax allocation to the riskier assets. You could accomplish the same thing by increasing your before-tax allocation to your riskier assets, and holding them in tax-deferred accounts.



Keven I think u are using risk is the wrong way. The risk of someone else (govt) taking your money does not necessarily translate to better returns. For example, if you marriage is on the rocks and your spouse might take half of your money, this does not mean that you should expect better returns on that money. Risk related invest performance only translates if the risk is related to the investments themselves.

No?

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Re: Differential aggressiveness for ROTH vs 401K

Post by Kevin M » Sat Apr 22, 2017 3:45 pm

Finger123 wrote:
You increase your portfolio expected return by putting higher risk / higher expected return assets in Roth because you increase your after-tax risk. In other words, you are increasing your after-tax allocation to the riskier assets. You could accomplish the same thing by increasing your before-tax allocation to your riskier assets, and holding them in tax-deferred accounts.



Keven I think u are using risk is the wrong way. The risk of someone else (govt) taking your money does not necessarily translate to better returns. For example, if you marriage is on the rocks and your spouse might take half of your money, this does not mean that you should expect better returns on that money. Risk related invest performance only translates if the risk is related to the investments themselves.

No?

No.

The risk isn't that the government will take your money. If distributions from your tax-deferred account will be taxed at 25%, the government already owns 25% of the account, is taking 25% of the risk, and will get 25% of the return. Therefore, the simplest way to think about it is that 75% of your tax-deferred account is a tax-free account, and so whatever you have in the tax-deferred account is equivalent to 75% of that in a Roth.

The risk is related to the investment itself. All we are saying is that it's the after-tax risk and return that matter.

And it's not just me. Note the other posters in this thread who understand the math and have posted in support of viewing your asset allocation in tax-adjusted terms. And read the Wiki article on it.

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Re: Differential aggressiveness for ROTH vs 401K

Post by grabiner » Sat Apr 22, 2017 9:15 pm

tadamsmar wrote:If there were no RMD and one unchanging tax rate, then it would be a wash.

If the tax rate was 25% then you could think of your 401k as 75% Roth and 25% Uncle Sam's.

Differential aggressiveness would only matter to Uncle Sam.

But there are RMDs and other considerations.

My question is:

Are there any scenarios where putting the Roth in the investment with a lower return would be a good idea?


Yes. Suppose that you are on the boundary of a decrease in marginal tax rate, such as the top of the Social Security phase-in; your marginal tax rate is 27.75% up to the top of the phase-in, and 15% above it. You would prefer to have riskier investments in the traditional account, as the IRS would take 15% of your gains but give back 27.75% of your losses. (Even if some of the gains are taxed at 25%, you would still come out ahead.)

Conversely, if you might hit the boundary of an increase in marginal tax rate, you would prefer riskier investments in the Roth.
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Re: Differential aggressiveness for ROTH vs 401K

Post by tadamsmar » Sun Apr 23, 2017 8:26 am

retiredjg wrote:
tadamsmar wrote:Are there any scenarios where putting the Roth in the investment with a lower return would be a good idea?

A couple of people have reported over the years that they don't want their Roth space to shrivel during times of market upheavel. I think one puts both stocks and bonds in Roth and one filled his Roth with a TIPS fund if I recall correctly.


But is that a good idea? Seems at best neutral.

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Re: Differential aggressiveness for ROTH vs 401K

Post by retiredjg » Sun Apr 23, 2017 8:44 am

tadamsmar wrote:
retiredjg wrote:
tadamsmar wrote:Are there any scenarios where putting the Roth in the investment with a lower return would be a good idea?

A couple of people have reported over the years that they don't want their Roth space to shrivel during times of market upheavel. I think one puts both stocks and bonds in Roth and one filled his Roth with a TIPS fund if I recall correctly.

But is that a good idea? Seems at best neutral.

No opinion. Just reporting some comments I remember. These were both people whose opinions I respect so I thought it was at least worth wondering about.

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Re: Differential aggressiveness for ROTH vs 401K

Post by grabiner » Sun Apr 23, 2017 8:45 am

tadamsmar wrote:My question is:

Are there any scenarios where putting the Roth in the investment with a lower return would be a good idea?


Another example: you may be using the Roth before 59-1/2, such as withdrawing the money to make a down payment on a house. You can withdraw contributions, plus $10,000 of earnings for a home purchase, free of tax and penalty. If market declines reduce the earnings below $10,000, you have to take the money from somewhere else, and taking it out of a traditional account while you are still working may have a high tax cost.
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Re: Differential aggressiveness for ROTH vs 401K

Post by midareff » Sun Apr 23, 2017 9:05 am

Have started my 6th year of retirement and next B-day will be 70. Roth is roughly 6% of total portfolio and is all stock funds. I have always used it for sector plays @ Fidelity (very un-Bogleish) and have simply been lucky :mrgreen: with that over a very long term. The other 94% is invested very Boglehead's style. I also use a higher WR for the Roth than I do for the balance of the portfolio and adjust the $ withdrawn quarterly to match the %. FWIW, my first years of retirement I converted $ up to the top of the 15% tax bracket into the Roth and with RMD starting next year that's over. Only a winning lottery ticket is more attractive than tax free income.

cherijoh
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Re: Differential aggressiveness for ROTH vs 401K

Post by cherijoh » Sun Apr 23, 2017 12:10 pm

dn123 wrote:Ill be doing what I think you are alluding to. Put your growth-iest bets into your Roth. Why not? It all tax free.

Because you are not adjusting your AA for after-tax return and risk. If you do so, it doesn't matter where you put your "growth-iest" bets.[/quote]

Kevin,
I understand what you are saying, but if "it doesn't matter" then there is nothing wrong with what dn123 is doing either. IMO you are wasting time projecting future tax rates to set tax-adjusted asset allocations - there is no way to know these things a priori. Just pick an AA with which you are comfortable and stick with it - or rather stick with whatever glide path that you have mapped out. If the Roth is a very small amount of the total portfolio, then the "increased risk" you reference is negligible anyway.

I view it as a personal preference. Whether it will turn out to be the best decision from a return standpoint will only be known after the fact. (That's the same issue for higher order questions like "should my AA be at 85/15 or 80/20?"). FWIW, I have all my bond funds in my rollover IRA and in my 401K, primarily because they are by far the largest portion of my tax-advantaged accounts and it makes it simpler not to have bonds in a third account.

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Kevin M
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Re: Differential aggressiveness for ROTH vs 401K

Post by Kevin M » Sun Apr 23, 2017 1:42 pm

cherijoh wrote:
dn123 wrote:Ill be doing what I think you are alluding to. Put your growth-iest bets into your Roth. Why not? It all tax free.
Because you are not adjusting your AA for after-tax return and risk. If you do so, it doesn't matter where you put your "growth-iest" bets.

Kevin,
I understand what you are saying, but if "it doesn't matter" then there is nothing wrong with what dn123 is doing either.

The problem is that dn123 is not adjusting for after-tax risk (you left out the "if you do so" in your quote), so putting "growth-iest bets" is just skewing the AA to higher risk (and higher expected return) than the pre-tax AA would suggest. I'm not saying that there's anything wrong with that, but just that it's no different than increasing risk and expected return by holding a higher allocation to the "growth-iest bets" in a tax-deferred account.

IMO you are wasting time projecting future tax rates to set tax-adjusted asset allocations - there is no way to know these things a priori.

Well, I'm not wasting any time on it, because my Roth accounts are such a tiny portion of my portfolio that it doesn't have enough impact to bother adjusting. But, I disagree that it's a waste of time for someone for whom Roth accounts make up a significant portion of one's portfolio. Whether I estimate my marginal tax rate at 28% or 25% (or even 15%) when I start taking RMDs, I think the chances of it being 0% are slim to none. So if I had significant Roth assets in addition to significant tax-deferred assets, I'd at least pick some positive tax rate to estimate how much the government shares in the risk and return of my tax-deferred accounts.

You might as well say that you are wasting time projecting future returns, since there is no way to know these things apriori. And if you think there's as good a chance that your RMDs will be taxed at 0% as at 25%, then there's no reason to worry about asset location with respect to traditional vs. Roth accounts.

Just pick an AA with which you are comfortable and stick with it - or rather stick with whatever glide path that you have mapped out.

But we should think clearly about what makes us comfortable with a particular AA. Say we use the common rule of thumb that we should be able to handle a 50% drop in stocks. We are comfortable with a 25% drop in portfolio value, so we pick a 50/50 AA.

But if we think about it in after-tax terms, which is what really matters, then preferring Roth over traditional for stocks is riskier than preferring traditional over Roth for stocks. If we have equal Roth and traditional space, then holding all stocks in the Roth would give us the 25% drop in portfolio value we decided we are comfortable with if stocks drop 50%. But with stocks all in tax-deferred at a 25% tax rate, our portfolio loss would only be 18.75% after tax, so we really should be comfortable with a 67/33 AA with all stocks in tax-deferred.

If the Roth is a very small amount of the total portfolio, then the "increased risk" you reference is negligible anyway.

Exactly, which is why this discussion isn't relevant to those of us in this situation. But then the benefit of higher after-tax returns, which everyone focuses on without considering the higher-risk piece of the equation, is also negligible, and it doesn't matter much what you hold in Roth.

I view it as a personal preference. Whether it will turn out to be the best decision from a return standpoint will only be known after the fact. (That's the same issue for higher order questions like "should my AA be at 85/15 or 80/20?").

Whether you locate stocks in Roth or traditional is the same order, or even higher, as whether your pre-tax AA is 85/15 or 80/20. Going back to the rule of thumb, if you decided on your 80/20 AA because you think you would be comfortable with a 40% loss in portfolio value, then even with 100% stocks all in tax deferred at a 25% tax rate, a 50% drop in stocks is only a 37.5% drop after taxes, so you really should be 100% stocks instead of only 80% stocks. If you could do so, you should be leveraged and hold 107% stocks if you are comfortable with a loss of 40%.

FWIW, I have all my bond funds in my rollover IRA and in my 401K, primarily because they are by far the largest portion of my tax-advantaged accounts and it makes it simpler not to have bonds in a third account.

Simplicity is a valid consideration, and as you and I agree, with a relatively small Roth holding, the tax adjustment is not very relevant.

Kevin
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