Target Date Funds in Taxable Account

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BogleAlltheWay
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Target Date Funds in Taxable Account

Postby BogleAlltheWay » Tue May 16, 2017 11:09 am

Hi all,

Would my capital gains taxes be more, less or the same by holding a Vanguard Target Retirement Fund versus just copying underlying allocation?

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David Jay
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Re: Target Date Funds in Taxable Account

Postby David Jay » Tue May 16, 2017 11:28 am

If you truly matched the TR fund, you would have near daily sales of one asset class and purchases of another asset class. The TR fund can balance out a lot of that through the daily purchases and redemptions.

I don't know exactly how much higher your capital gains would be, but your paperwork would be interesting.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

DSInvestor
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Re: Target Date Funds in Taxable Account

Postby DSInvestor » Tue May 16, 2017 11:44 am

The tax on your TR fund's income would be higher if you held it in a taxable account. TR funds hold taxable bonds and the income from these are non-qualified dividend income (taxed as ordinary income). Qualified Dividend Income is taxed at lower tax rates (as low as 0%). The glide path of the TR fund will increase the bond allocation over time making it more tax inefficient. Something to consider if you're young today and expect higher income and higher tax bracket in 20-30 years. If you decide in 20 years that you'd prefer something more tax efficient, you'd have to sell this TR fund which may result in a large realized capital from the stock holdings.

If you hold separate funds, you can place funds for tax efficiency (i.e. hold tax efficient TSM and/or TISM in taxable) and place your taxable bonds in tax advantaged accounts. When the funds are placed this way, your taxable account gets mostly Qualified Dividend Income rather than Non-Qualified Dividend Income. Another option is to use a tax exempt bond fund in the taxable account if you need to hold bonds in taxable and are in high tax bracket.

BogleAlltheWay
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Re: Target Date Funds in Taxable Account

Postby BogleAlltheWay » Tue May 16, 2017 12:20 pm

Thanks for the replies.

@David Jay If I went the do it myself route I would re balance it a couple times a year. Would this causes more taxes than the target fund?


@DSInvestor
I like your idea. I am currently 33 so I do have a long time horizon. My 401k Target date fund has an ER of 1% so it makes more sense for me to use the Blackrock Index funds available (ER .11%-.14%) and the bond fund ER .37%. I am be able to hold the Bond portion of my allocation in my 401k and should be for a while. As you mentioned, if I need more Bonds I can take advantage of my state tax free muni bonds or tax exempt. Then I can throw tax efficient index funds in taxable. This makes more sense than holding a target retirement fund in taxable.

rkhusky
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Re: Target Date Funds in Taxable Account

Postby rkhusky » Tue May 16, 2017 2:02 pm

If you hold separate funds you can replace some, most, or all of Total Bond with something like Intermediate Tax Exempt.

BogleAlltheWay
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Re: Target Date Funds in Taxable Account

Postby BogleAlltheWay » Tue May 16, 2017 2:14 pm

From what I am gathering, the main issue with target funds in taxable, is that the bonds are taxable.

Assuming that I was able to get a target fund in a tax sheltered account, is the only benefit of the target fund that fact that it rebalances itself as opposed to having to doing it myself?

rkhusky
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Re: Target Date Funds in Taxable Account

Postby rkhusky » Tue May 16, 2017 3:11 pm

BogleAlltheWay wrote:From what I am gathering, the main issue with target funds in taxable, is that the bonds are taxable.

Assuming that I was able to get a target fund in a tax sheltered account, is the only benefit of the target fund that fact that it rebalances itself as opposed to having to doing it myself?

It also adjusts its asset allocation to become more conservative over time. Automated rebalancing and glide path adjustments are the two benefits of target date funds - all you need to do is supply the cash. Note that companies choose different methods to implement their target date funds.

BogleAlltheWay
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Re: Target Date Funds in Taxable Account

Postby BogleAlltheWay » Tue May 16, 2017 3:36 pm

Thanks again. I always noticed the Target funds ER was always higher than the funds that comprised it. Now I understand now that you are paying the extra ER for the convenience of having it automated.

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CABob
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Re: Target Date Funds in Taxable Account

Postby CABob » Tue May 16, 2017 7:44 pm

BogleAlltheWay wrote:Thanks again. I always noticed the Target funds ER was always higher than the funds that comprised it. Now I understand now that you are paying the extra ER for the convenience of having it automated.

If you are discussing Vanguard TR funds its ER is the exact prorated ER of the Investor class shares of the funds contained. If you are comparing with Admiral shares you are correct that the TR fund would be higher.
Bob

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Re: Target Date Funds in Taxable Account

Postby BogleAlltheWay » Tue May 16, 2017 8:13 pm

I was comparing it to the admiral shares. I do think the extra cost is very reasonable. From what I have gathers it does not make sesne for me to have this is taxable.

rkhusky
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Re: Target Date Funds in Taxable Account

Postby rkhusky » Wed May 17, 2017 6:53 am

While Vanguard has a balanced fund that mixes US stocks with tax exempt bonds, they do not have a target retirement fund that does so. Probably because most investors invest via tax-advantaged accounts and they haven't seen a demand for it.

NiceUnparticularMan
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Re: Target Date Funds in Taxable Account

Postby NiceUnparticularMan » Wed May 17, 2017 8:54 am

I'll just note that I believe the behavioral risk associated with the DIY approach might significantly outweigh any tax savings. But all that depends on the individual investor.

BogleAlltheWay
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Re: Target Date Funds in Taxable Account

Postby BogleAlltheWay » Wed May 17, 2017 9:09 am

@ NiceUnparticularMan

What behavioral risks?

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Re: Target Date Funds in Taxable Account

Postby NiceUnparticularMan » Wed May 17, 2017 10:34 am

BogleAlltheWay wrote:@ NiceUnparticularMan

What behavioral risks?


Needing to rebalance your own funds requires you to keep track of what is happening with them and then take action. This is the core sort of information that tends to cause investors to depart from plan, because it triggers loss aversion. Such departures from plan can end up very damaging, and they can be as simple as failing to rebalance when planned, but could also involve making bigger changes in response to recent market events.

As I have pointed out before, to combat such issues, some people adopt larger bond allocations and such than would otherwise be financially optimal as a way of trying to avoid their personal loss aversion triggers. That sort of mechanism might be both much more costly and also less effective than simply letting a Target or balanced fund handle all this for you, and the difference in cost/benefits could be much larger than any tax efficiency gains from a DIY approach.

But if you, as an individual, don't experience much or any adverse loss aversion (beyond what is warranted for pure financial reasons), then none of this may matter. But if, say, you have ever contemplated holding more bonds as a way of combating loss aversion, I think you should strongly consider as a first step instead using a Target or balanced fund, notwithstanding any tax efficiency loss that may cause.

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Re: Target Date Funds in Taxable Account

Postby BogleAlltheWay » Wed May 17, 2017 11:03 am

Thanks. I won't have that problem. The issue for me would be moving all of my bonds into stocks if the market tanked. Only because I have 30 years till retirement.

NiceUnparticularMan
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Re: Target Date Funds in Taxable Account

Postby NiceUnparticularMan » Wed May 17, 2017 11:43 am

BogleAlltheWay wrote:Thanks. I won't have that problem. The issue for me would be moving all of my bonds into stocks if the market tanked. Only because I have 30 years till retirement.


I haven't been using them in accumulation and don't plan to, in part because I also see big stock drops just as "buying opportunities."

But I might change all that in withdrawal.

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Re: Target Date Funds in Taxable Account

Postby BogleAlltheWay » Wed May 17, 2017 12:07 pm

@NiceUnparticularMan Not using bonds?

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Re: Target Date Funds in Taxable Account

Postby NiceUnparticularMan » Wed May 17, 2017 12:15 pm

BogleAlltheWay wrote:@NiceUnparticularMan Not using bonds?


I actually meant I wasn't using Target funds, not that I wasn't using bonds--although depending on your definitions that happens to be mostly true as well.

Mostly our current asset allocation calls for stocks, REITs, and what I call super-cash, which in our case is fulfilled by a combination of a stable value fund and a cash-balance pension (at some point it will also include the TSP's G Fund). As necessary I'd also include CD ladders, short-term Treasury or government bond funds, and short-to-medium TIPs in this category. We also have a small allocation to a Real Return fund, and that in turn has an allocation to TIPs, some of which are longer than I would count as "super-cash," but that's very small as a percentage of our overall portfolio.

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Re: Target Date Funds in Taxable Account

Postby BogleAlltheWay » Wed May 17, 2017 12:39 pm

Got it. Thanks. I plan on getting an REIT eventually as I am in the process of moving assets around.

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grabiner
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Re: Target Date Funds in Taxable Account

Postby grabiner » Wed May 17, 2017 10:27 pm

BogleAlltheWay wrote:From what I am gathering, the main issue with target funds in taxable, is that the bonds are taxable.


The problem isn't that the bonds are taxable (taxable bonds are fine in a taxable account in the 25% or lower bracket), but that in most tax brackets, it is better to hold bonds in a tax-deferred account and make your taxable account all stock.

The other issue is that the asset allocation is fixed. If you have TR 2020 in your IRA and decide you will keep working longer, you can switch to TR 2025 or 2030 with no tax cost. If you have it in your taxable account, you will have a capital gain if you switch. in contrast, if you hold the individual funds, you would be selling bond funds to buy more stock funds, so there would be little or no capital gain. Similarly, if you hold a balanced fund in your taxable account, and then move to NY, you would have a tax cost if you switch the bonds for NY tax-exempt bonds; if you hold separate bond and stock funds, you can sell your taxable fund and buy a NY muni fund.
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Re: Target Date Funds in Taxable Account

Postby BogleAlltheWay » Thu May 18, 2017 8:28 am

grabiner wrote:
BogleAlltheWay wrote:From what I am gathering, the main issue with target funds in taxable, is that the bonds are taxable.


The problem isn't that the bonds are taxable (taxable bonds are fine in a taxable account in the 25% or lower bracket), but that in most tax brackets, it is better to hold bonds in a tax-deferred account and make your taxable account all stock.

The other issue is that the asset allocation is fixed. If you have TR 2020 in your IRA and decide you will keep working longer, you can switch to TR 2025 or 2030 with no tax cost. If you have it in your taxable account, you will have a capital gain if you switch. in contrast, if you hold the individual funds, you would be selling bond funds to buy more stock funds, so there would be little or no capital gain. Similarly, if you hold a balanced fund in your taxable account, and then move to NY, you would have a tax cost if you switch the bonds for NY tax-exempt bonds; if you hold separate bond and stock funds, you can sell your taxable fund and buy a NY muni fund.


Thanks for the response. Funny I am from NY and in 25% bracket,so would it better for me to buy a bond fund in my tax deferred (Federated Total Return Bond Fund FTRBX ER .37%) or buy a tax-exempt NY Muni fund such as the Vanguard new york tax exempt (.09% ER) in taxable?

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Re: Target Date Funds in Taxable Account

Postby grabiner » Thu May 18, 2017 10:23 pm

BogleAlltheWay wrote:Funny I am from NY and in 25% bracket,so would it better for me to buy a bond fund in my tax deferred (Federated Total Return Bond Fund FTRBX ER .37%) or buy a tax-exempt NY Muni fund such as the Vanguard new york tax exempt (.09% ER) in taxable?


Since the bond funds in your 401(k) are more expensive than the stock funds, while the bond and stock funds in your taxable account have about equal costs, you should hold a bond fund in a taxable account.

I wouldn't recommend holding more than half your bonds in munis from your state. You could split evenly between Limited-Term Tax-Exempt and NY Long-Term Tax-Exempt; this would give you an intermediate-term duration with more than half your muni income exempt from NY state tax. Alternatively, since taxable bonds are OK in a 25% bracket, you might split evenly between NY Long-Term Tax-Exempt and TIPS, as the TIPS are also exempt from NY state tax.
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Re: Target Date Funds in Taxable Account

Postby BogleAlltheWay » Fri May 19, 2017 11:02 am

grabiner wrote:
BogleAlltheWay wrote:Funny I am from NY and in 25% bracket,so would it better for me to buy a bond fund in my tax deferred (Federated Total Return Bond Fund FTRBX ER .37%) or buy a tax-exempt NY Muni fund such as the Vanguard new york tax exempt (.09% ER) in taxable?


Since the bond funds in your 401(k) are more expensive than the stock funds, while the bond and stock funds in your taxable account have about equal costs, you should hold a bond fund in a taxable account.

I wouldn't recommend holding more than half your bonds in munis from your state. You could split evenly between Limited-Term Tax-Exempt and NY Long-Term Tax-Exempt; this would give you an intermediate-term duration with more than half your muni income exempt from NY state tax. Alternatively, since taxable bonds are OK in a 25% bracket, you might split evenly between NY Long-Term Tax-Exempt and TIPS, as the TIPS are also exempt from NY state tax.


Thanks grabiner for the advice.
I forgot to add another caveat. My 401k charges me a .5% allocation fee per year. So by keeping the higher growth stock funds, I will have to pay more allocation fees. I did some math

10k bonds in my 401k for 30 years at 2.7% (accounting for the .3% extra ER) = 19.1k (22.2K with no fee)
10k S&P 500 in my 401k for 30 years at 6.93 % would get me to about = 59K (75k with no fee)

10k bonds in taxable for 30 years at 3% = 24.2
10k S&P 500 in taxable for 30 years at 7% = 76.1k

Bonds in taxable and stocks in 401k = 18k(25% tax) + 44k(25% tax) = 62K
Bonds in 401k and stocks taxable = 14k(25% tax) + 64k(15% capital gains) = 78k

Is this right?

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grabiner
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Re: Target Date Funds in Taxable Account

Postby grabiner » Fri May 19, 2017 9:03 pm

BogleAlltheWay wrote:I forgot to add another caveat. My 401k charges me a .5% allocation fee per year. So by keeping the higher growth stock funds, I will have to pay more allocation fees.


That is a percentage cost, so you should just treat it as a higher expense ratio. In the 401(k), you will pay 0.59% on stocks and 0.87% on bonds.

Another way to look at this is that your plan provider owns 15% of your 401(k) (if you stay for 30 years); $10,000 invested in the 401(k) will be equivalent to $8500 in an IRA no matter how you invest it. Given this understanding, there is no reason to prefer stocks in one account or the other.

This is the same issue as Tax-adjusted asset allocation. If you have $10,000 in a traditional IRA and $7500 in a Roth IRA, and you will retire at a 25% marginal tax rate, it doesn't matter which account holds the stocks; you will get the same value either way. If you have $10,000 in a traditional IRA and $10,000 in a Roth IRA, you will get a higher expected return putting stocks in the Roth, but you are also taking more risk, as you will lose more if stocks fall.

I did some math

10k bonds in my 401k for 30 years at 2.7% (accounting for the .3% extra ER) = 19.1k (22.2K with no fee)
10k S&P 500 in my 401k for 30 years at 6.93 % would get me to about = 59K (75k with no fee)

10k bonds in taxable for 30 years at 3% = 24.2
10k S&P 500 in taxable for 30 years at 7% = 76.1k

Bonds in taxable and stocks in 401k = 18k(25% tax) + 44k(25% tax) = 62K
Bonds in 401k and stocks taxable = 14k(25% tax) + 64k(15% capital gains) = 78k


Besides the risk issue, you do not have the correct tax costs. Your effective tax rate on bonds in a taxable account is probably close to 25%, since most of your bond income would be from NY munis, which I would assume earn 75% as much as taxable bonds of comparable risk. But in a taxable account, you will pay 20%, not 15%, on your capital gains (23% if you live in NYC), counting 3/4 of the NY income tax since you deduct it from federal tax. And you will lose more than just the capital gains on your stocks, since the dividends will be taxed every year.
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Re: Target Date Funds in Taxable Account

Postby BogleAlltheWay » Sat May 20, 2017 12:13 am

grabiner wrote:
BogleAlltheWay wrote:I forgot to add another caveat. My 401k charges me a .5% allocation fee per year. So by keeping the higher growth stock funds, I will have to pay more allocation fees.


That is a percentage cost, so you should just treat it as a higher expense ratio. In the 401(k), you will pay 0.59% on stocks and 0.87% on bonds.

Another way to look at this is that your plan provider owns 15% of your 401(k) (if you stay for 30 years); $10,000 invested in the 401(k) will be equivalent to $8500 in an IRA no matter how you invest it. Given this understanding, there is no reason to prefer stocks in one account or the other.


I am confused as to why I should treat the .5% allocation fee as the same as stocks and bonds. They charge the .5% allocation fee on the total balance I have in the 401K: "Fees for Investment related services to the Plan of 0.5% of participant balances will be allocated pro rata based on
participant account balances to participant accounts. A portion of this fee will be charged to participant accounts quarterly"

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Re: Target Date Funds in Taxable Account

Postby grabiner » Sat May 20, 2017 10:31 pm

BogleAlltheWay wrote:
grabiner wrote:
BogleAlltheWay wrote:I forgot to add another caveat. My 401k charges me a .5% allocation fee per year. So by keeping the higher growth stock funds, I will have to pay more allocation fees.


That is a percentage cost, so you should just treat it as a higher expense ratio. In the 401(k), you will pay 0.59% on stocks and 0.87% on bonds.

Another way to look at this is that your plan provider owns 15% of your 401(k) (if you stay for 30 years); $10,000 invested in the 401(k) will be equivalent to $8500 in an IRA no matter how you invest it. Given this understanding, there is no reason to prefer stocks in one account or the other.


I am confused as to why I should treat the .5% allocation fee as the same as stocks and bonds. They charge the .5% allocation fee on the total balance I have in the 401K: "Fees for Investment related services to the Plan of 0.5% of participant balances will be allocated pro rata based on
participant account balances to participant accounts. A portion of this fee will be charged to participant accounts quarterly"


You don't want to minimize fees; you want to optimize after-fee returns (and similarly after-tax returns) across all your accounts. If you have $1M when you retire, you don't care whether you lost $50K or $100K to the plan provider, or whether you paid $100K or $200K to the IRS, compared with what you would have earned without expenses and taxes.

And that is why the fee should be ignored in deciding which funds are better to hold in the 401(k). If you hold the fund for 30 years, you will lose 14% (not 15% because of compounding) compared to what you would get fee-free. Thus you should invest $10,000 in the 401(k) with the fees exactly as you would invest $8603 without the fees; the returns will be the same either way.
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Re: Target Date Funds in Taxable Account

Postby BogleAlltheWay » Sun May 21, 2017 1:26 am

grabiner wrote:
BogleAlltheWay wrote:
grabiner wrote:
BogleAlltheWay wrote:I forgot to add another caveat. My 401k charges me a .5% allocation fee per year. So by keeping the higher growth stock funds, I will have to pay more allocation fees.


That is a percentage cost, so you should just treat it as a higher expense ratio. In the 401(k), you will pay 0.59% on stocks and 0.87% on bonds.

Another way to look at this is that your plan provider owns 15% of your 401(k) (if you stay for 30 years); $10,000 invested in the 401(k) will be equivalent to $8500 in an IRA no matter how you invest it. Given this understanding, there is no reason to prefer stocks in one account or the other.


I am confused as to why I should treat the .5% allocation fee as the same as stocks and bonds. They charge the .5% allocation fee on the total balance I have in the 401K: "Fees for Investment related services to the Plan of 0.5% of participant balances will be allocated pro rata based on
participant account balances to participant accounts. A portion of this fee will be charged to participant accounts quarterly"


You don't want to minimize fees; you want to optimize after-fee returns (and similarly after-tax returns) across all your accounts. If you have $1M when you retire, you don't care whether you lost $50K or $100K to the plan provider, or whether you paid $100K or $200K to the IRS, compared with what you would have earned without expenses and taxes.

And that is why the fee should be ignored in deciding which funds are better to hold in the 401(k). If you hold the fund for 30 years, you will lose 14% (not 15% because of compounding) compared to what you would get fee-free. Thus you should invest $10,000 in the 401(k) with the fees exactly as you would invest $8603 without the fees; the returns will be the same either way.


Thanks again for the answer.
I do understand that the point is to maximize money as opposed to fees. I I am still missing something. If they only took .5% fee off of each deposit, I would get it.

Let's consider this case(maybe this doesn't apply):
10k in 401k
10K in traditonal IRA

Bonds in 401k go up to 11K and stocks in IRA go up to 15K after 1 year : I will have 26K - $55 of fee(11k *.5%)
Bonds in IRA go up to 11K and stocks in 401 go up to 15K after 1 year : : I will have 26K - $75 of fee (15k *.5%)

I would love that return, but I don't understand how they are the same.

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Re: Target Date Funds in Taxable Account

Postby grabiner » Sun May 21, 2017 8:41 am

BogleAlltheWay wrote: Let's consider this case(maybe this doesn't apply):
10k in 401k
10K in traditonal IRA

Bonds in 401k go up to 11K and stocks in IRA go up to 15K after 1 year : I will have 26K - $55 of fee(11k *.5%)
Bonds in IRA go up to 11K and stocks in 401 go up to 15K after 1 year : : I will have 26K - $75 of fee (15k *.5%)

I would love that return, but I don't understand how they are the same.


The difference is that these two do not have the same effective allocation. Suppose that the stock market crashes instead of booming, and the stocks go to $5K instead of $15K. Now you will lose $55 of fees if the bonds are in the 401(k), and $25 if the stocks are in the 401(k). So putting stocks in the 401(k) reduced your risk, as well as your return, because the fund provider owns a piece of the 401(k).

The way I prefer to look at it is the following:

$10,000 in 401(k)
$9950 in traditional IRA

Bonds in 401(k): Bonds worth $11,000 less $55 fee. Stocks worth $14,925 in boom, $4975 in crash. Total $25,880 in boom, $14,930 in crash.

Stocks in 401(k): Stocks worth $15,000 less $75 fee in boom, $5000 less $25 fee in crash. Bonds worth $10,945. Total $25,880 in boom, $14,930 in crash.

Now, this is assuming that you have the same funds. With the bond fund in the 401(k) costing an extra 0.28%, you will be $31 worse off with bonds in the 401(k) because of the expense loss, no matter what the markets do.
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Re: Target Date Funds in Taxable Account

Postby BogleAlltheWay » Sun May 21, 2017 12:39 pm

grabiner wrote:
BogleAlltheWay wrote: Let's consider this case(maybe this doesn't apply):
10k in 401k
10K in traditonal IRA

Bonds in 401k go up to 11K and stocks in IRA go up to 15K after 1 year : I will have 26K - $55 of fee(11k *.5%)
Bonds in IRA go up to 11K and stocks in 401 go up to 15K after 1 year : : I will have 26K - $75 of fee (15k *.5%)

I would love that return, but I don't understand how they are the same.


The difference is that these two do not have the same effective allocation. Suppose that the stock market crashes instead of booming, and the stocks go to $5K instead of $15K. Now you will lose $55 of fees if the bonds are in the 401(k), and $25 if the stocks are in the 401(k). So putting stocks in the 401(k) reduced your risk, as well as your return, because the fund provider owns a piece of the 401(k).

The way I prefer to look at it is the following:

$10,000 in 401(k)
$9950 in traditional IRA

Bonds in 401(k): Bonds worth $11,000 less $55 fee. Stocks worth $14,925 in boom, $4975 in crash. Total $25,880 in boom, $14,930 in crash.

Stocks in 401(k): Stocks worth $15,000 less $75 fee in boom, $5000 less $25 fee in crash. Bonds worth $10,945. Total $25,880 in boom, $14,930 in crash.



Why only $9950 in the the traditional IRA? I think that is part the confusion. I understand that that they are the same if the allocation fee is taken out when I first deposit the money or at the end. Considering, I have a long way to go until retirement, I am going under the assumptions that stocks will greatly outperform bonds over the next 30 years.

In the above example, what happens in year 2? For arguments sake lets say I get 0 return on both

Bonds in 401(k): Total $25,880 - ~ $55 fee on the ~ 11k of Bonds
Stocks in 401(k): Total $25,880 ~ $75 fee on the ~15K of stocks

Won't I be $25 ahead in after year 2?
Now, this is assuming that you have the same funds. With the bond fund in the 401(k) costing an extra 0.28%, you will be $31 worse off with bonds in the 401(k) because of the expense loss, no matter what the markets do.


This part I understand. This is situation is not my case, since the funds aren't going to be in a traditional IRA, but I prefer to fully understand the situation. Once, I do then, I will decide between the options you recommend( I addded below). Minus the allocation fee in my 401K, I do understand why you recommend my bonds in taxable. The benefits of my tax sheltered 401K are weighed down by the extra expense ratio of my bond fund, causing my overall return to be maximized by having the bonds taxable. ( I will pay more taxes this way, but I will have higher returns that more than offset the extra taxes)

I wouldn't recommend holding more than half your bonds in munis from your state. You could split evenly between Limited-Term Tax-Exempt and NY Long-Term Tax-Exempt; this would give you an intermediate-term duration with more than half your muni income exempt from NY state tax. Alternatively, since taxable bonds are OK in a 25% bracket, you might split evenly between NY Long-Term Tax-Exempt and TIPS, as the TIPS are also exempt from NY state tax.




Thanks again for your patience.

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Re: Target Date Funds in Taxable Account

Postby grabiner » Sun May 21, 2017 5:18 pm

BogleAlltheWay wrote:The way I prefer to look at it is the following:

$10,000 in 401(k)
$9950 in traditional IRA

Bonds in 401(k): Bonds worth $11,000 less $55 fee. Stocks worth $14,925 in boom, $4975 in crash. Total $25,880 in boom, $14,930 in crash.

Stocks in 401(k): Stocks worth $15,000 less $75 fee in boom, $5000 less $25 fee in crash. Bonds worth $10,945. Total $25,880 in boom, $14,930 in crash.



Why only $9950 in the the traditional IRA? I think that is part the confusion.[/quote]

Because, for a one-year investment, that is the amount which creates an equivalent investment. If you actually have $20,000 in the traditional IRA, then you can put the other $10,000 in your 50/50 allocation. If the 401(k) is in stock and $5025 of the IRA is in stock, this is equivalent to having the 401(k) in bonds and $14,975 of the IRA in stock.

[/quote] I understand that that they are the same if the allocation fee is taken out when I first deposit the money or at the end. Considering, I have a long way to go until retirement, I am going under the assumptions that stocks will greatly outperform bonds over the next 30 years.

In the above example, what happens in year 2? For arguments sake lets say I get 0 return on both

Bonds in 401(k): Total $25,880 - ~ $55 fee on the ~ 11k of Bonds
Stocks in 401(k): Total $25,880 ~ $75 fee on the ~15K of stocks

Won't I be $25 ahead in after year 2? [/quote]

Yes if the stock market goes up, and no if it goes down. Therefore, for a two-year investment, the portfolios are no longer equivalent. Now, $10,000 in the 401(k) is equivalent to $9900 in the traditional IRA, because now you will lose two years' fees, and if you do the math with this pair of investments, you will find that you get the same return whether the stock market goes up or down. If you will be stuck with the 401(k) for 30 years, $10,000 in the 401(k) is equivalent to $8603 in the traditional IRA.
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Re: Target Date Funds in Taxable Account

Postby BogleAlltheWay » Sun May 21, 2017 9:16 pm

Yes if the stock market goes up, and no if it goes down.


Isn't it better to have the stocks in the traditional IRA considering they are more likely to rise?

Therefore, for a two-year investment, the portfolios are no longer equivalent. Now, $10,000 in the 401(k) is equivalent to $9900 in the traditional IRA, because now you will lose two years' fees, and if you do the math with this pair of investments, you will find that you get the same return whether the stock market goes up or down. If you will be stuck with the 401(k) for 30 years, $10,000 in the 401(k) is equivalent to $8603 in the traditional IRA.


I get the equivalents but why does it matter if I already have 10k in the traditional IRA?

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Re: Target Date Funds in Taxable Account

Postby grabiner » Sun May 21, 2017 10:44 pm

BogleAlltheWay wrote:
Yes if the stock market goes up, and no if it goes down.


Isn't it better to have the stocks in the traditional IRA considering they are more likely to rise?


Not necessarily. You have a risk tolerance, which is the reason that you hold some bonds and some stocks. If you prefer 5.5% expected returns and a 25% loss in a bear market to 6% expected return and a 30% loss in a bear market, then you prefer 50% stock to 60% stock.

But the effect of gains and losses is based on your effective asset allocation, not the reported dollars. If holding stocks in your IRA instead of your high-cost 401(k) increases your expected return and your loss in a bear market, then it has the same effect as moving some money from bonds to stocks in one account and leaving other accounts unchanged.

Therefore, for a two-year investment, the portfolios are no longer equivalent. Now, $10,000 in the 401(k) is equivalent to $9900 in the traditional IRA, because now you will lose two years' fees, and if you do the math with this pair of investments, you will find that you get the same return whether the stock market goes up or down. If you will be stuck with the 401(k) for 30 years, $10,000 in the 401(k) is equivalent to $8603 in the traditional IRA.


I get the equivalents but why does it matter if I already have 10k in the traditional IRA?[/quote]

Anything beyond the equivalent amount is independent of the decision.

This is easier to see if there aren't value complications. Suppose that you have $10K in a 401(k), and $20K in an IRA with identical expenses. You can treat $10K of the IRA as independent from any asset location decisions; if you split that $10K 50/50, then you can get a 50/50 effective allocation by putting all the 401(k) in stock and the remaining $10K in the IRA in bonds, or vice versa.

Now, look at the same situation in which you have $10K in a 401(k) which will lose 13.97% to expenses over 30 years, and $10K in an IRA. You can treat $1397 of the IRA as independent from any asset location decisions; if you split that $10K 50/50, they you can get a 50/50 effective allocation by putting all the 401(k) in stock and the remaining $8603 in the IRA in bondsm or vice versa.

Consider the following four portfolios with $10K in each account, again assuming that 30 years of higher expenses will reduce the 401(k) by 13.97%.

A. 401(k) all in bonds, IRA all in stock
B. 401(k) all in bonds, $1397 of IRA in bonds and $8603 in stock
C. 401(k) all in stock, IRA all in bonds
D. 401(k) all in stock, $8603 of IRA in bonds and $1397 in stock

You are trying to compare portfolios A and C. Do you prefer A or B? Do you prefer C or D? These are both simpler decisions; do you want to have more stock?

Ignoring the difference between the options in the different accounts, either of these questions answers the question of whether you prefer A or C. Portfolios B and C are equivalent, as are A and D. Thus, if you prefer A to B, then you prefer A to C (and D to C, and D to B).

Now, add your own situation in which the bond fund in the IRA is inferior. You should therefore prefer D to A, and C to B. A cannot be the right portfolio; if you prefer the asset allocation of A to that of B, you should use D, which will come out ahead after fees.
David Grabiner

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Re: Target Date Funds in Taxable Account

Postby BogleAlltheWay » Mon May 22, 2017 10:01 am

A. 401(k) all in bonds, IRA all in stock
B. 401(k) all in bonds, $1397 of IRA in bonds and $8603 in stock
C. 401(k) all in stock, IRA all in bonds
D. 401(k) all in stock, $8603 of IRA in bonds and $1397 in stock


Lets assume 3% for bonds and 7% for stocks for 30 years
A: 20,883.78 + 76,122.55 = 97006.33
B: 20,883.78 + 3,390.89 + 65,488.23 = 89762.87
C: 65,494.64 + 24,272.62 = 89767.26
D: 65,494.64 + 20,881.74 + 10,634.32 = 97010.7

I see why it doesn't matter where I put my investments. When I have stocks in the 401k I pay more in fees, but I also have a higher return due to the fact I own more stocks. I just have to adjust the percentages to get the allocation I want.

Now, add your own situation in which the bond fund in the IRA is inferior. You should therefore prefer D to A, and C to B. A cannot be the right portfolio; if you prefer the asset allocation of A to that of B, you should use D, which will come out ahead after fees.


Now that I understand this, I actually have a Roth IRA space.
You had mentioned early that Bonds are OK in taxable the 25% tax bracket. They would be better in taxable because of the higher ER in my 401K How did you calculate that bonds are better in taxable in my case?

Am I correct in saying that even with the extra .3% ER and my .5% 401k allocation fee, it is still better to have bonds in the 401k than taxable? (I can max out my 401k until I get the bonds in)? Does this still apply to NY tax free munis?

Is there a website that has information about how to decide what to put where? https://www.bogleheads.org/wiki/Tax-efficient_fund_placement has helped alot , but I am in a different situation with the ER difference in my 401k and the benefit of being able to buy tax free ny munis.

Thanks again. You have been super helpful.


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