Asset allocation across accounts: Twist?

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football236
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Asset allocation across accounts: Twist?

Post by football236 » Mon Dec 04, 2017 3:58 pm

Hi everyone.

I've identified my asset allocation and am now implementing it across my many accounts (401k, IRA, Roth, 529s, taxable). I understand the concept of asset allocation across one's portfolio and tax-efficiency. However, I have one concern. Out of all of my accounts, only the taxable account allows for flexibility. The rest can't easily be touched until retirement or college. Assume I implement my asset allocation across my whole portfolio, but my taxable account ends up entirely in one asset class, and that asset class tanks. Though my portfolio as a whole would be balanced and otherwise healthy, my taxable account - the only one I can easily extract funds from if needed - would be greatly diminished.

Given that, should the taxable account get fully diversified per my asset allocation (i.e., touch all asset classes), and then the retirement accounts be the ones that don't mirror the asset allocation (i.e., don't touch each asset class), but as a whole, my portfolio reflects my desired asset allocation?

If so, that means bonds would end up in my taxable account, which contradicts the tax-efficiency point.

I read the multiple wiki articles (1, 2) and other posts about this subject but didn't see this specific question answered. Thanks for your help.

Here's some background info.
Investment horizon: 30+ years
Cash cushion: 6x monthly expenses in a cash/CD cushion separate from the AA below
My asset allocation:
  • Equities 90%
    • US 50%
      • Large cap 37%
      • Mid and small cap 13%
    • Non-US 40%
      • Large cap 32%
      • Mid and small cap 8%
  • Bonds 10%
    • US 7%
    • Non-US 3%
Last edited by football236 on Mon Dec 04, 2017 4:19 pm, edited 1 time in total.

iasw
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Re: Asset allocation across accounts: Twist?

Post by iasw » Mon Dec 04, 2017 4:08 pm

Would keeping a large enough cash cushion, in a high interest savings account or reasonable penalty CD help with this?

You can keep your AA and your cash separate.

Dottie57
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Re: Asset allocation across accounts: Twist?

Post by Dottie57 » Mon Dec 04, 2017 4:09 pm

I've put all stock in taxable in order to be tax efficient.

Roth has mostly stock but some bonds since I want the asset that will most like grow (tax free) to be in this account.

My ira and 401k have both bonds and stocks and also majority of my holdings.

iasw
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Re: Asset allocation across accounts: Twist?

Post by iasw » Mon Dec 04, 2017 4:10 pm

Or if I'm misunderstanding and you are saying it is difficult to change funds within your Roth or 529, Perhaps switch custodians so you can make changes as needed.

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eye.surgeon
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Re: Asset allocation across accounts: Twist?

Post by eye.surgeon » Mon Dec 04, 2017 4:19 pm

If your equities in taxable account diminish significantly due to a market crash, can't you simply rebalance within your tax advantaged accounts to match your desired asset allocation? You can rebalance within the various asset classes at-will in your IRA and 401k and 529 accounts.
"I would rather be certain of a good return than hopeful of a great one" | Warren Buffett

lazyjk
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Re: Asset allocation across accounts: Twist?

Post by lazyjk » Mon Dec 04, 2017 4:23 pm

For me, the AA I care about is only for funds earmarked for retirement. If you have money in taxable accounts that is for something other than retirement (car/house/etc) and would need to be withdrawn pre-retirement I wouldn't include those in my AA.

So if 40,000 out of 50,000 in a taxable account is in something like at 50/50 equity/bond fund but you are planning on using that for a house in 5 years, don't include that 40k in your AA calculations.

football236
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Re: Asset allocation across accounts: Twist?

Post by football236 » Mon Dec 04, 2017 4:29 pm

iasw, I forgot to mention my cash cushion and updated my original post: 6x monthly expenses in a cash/CD cushion separate from my AA. Assume I need the funds in the taxable account due to an unforeseen expense greater than the cash cushion.

iasw, no difficulty moving funds. Everything is in Vanguard owned by me and under my control.

eye.surgeon, this is getting to my point. Yes, I can rebalance within my tax advantaged accounts. Then, my overall portfolio would be back to my AA, but my concern is the other asset classes that did not suffer as much would not be in my taxable account, and the taxable account would be greatly diminished. If I then needed the money there (for an expense much greater than my cash cushion), my taxable account would be in no shape to withdraw from since it was consolidated in one asset class, and that asset class tanked.

One additional point I realized is that if the taxable is in one asset class, and that asset class outperforms as opposed to underperforms (opposite of my original scenario), I'd need to sell within my taxable account to bring that asset class back to my AA, which means I'd have a taxable event. Instead, if the taxable account mirror my AA, I'd have more flexibility to not sell and thus avoid a taxable event by simply adding new money to the underperforming asset classes.

Any thoughts on this? I think I'm going in the direction of having my taxable account mirror my AA but wanted to hear the wisdom of the (educated) crowd.

football236
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Re: Asset allocation across accounts: Twist?

Post by football236 » Mon Dec 04, 2017 4:33 pm

lazyjk, thanks for your reply. The funds in my taxable account aren't earmarked for anything as of now, but they are my wealth outside of my retirement accounts, 529s, and cash cushion. Thus, it's unknown whether the funds will be needed over the next ~30 years prior to retirement, or whether the funds will stay invested during that time without being needed for anything specific.

Jermbo
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Re: Asset allocation across accounts: Twist?

Post by Jermbo » Mon Dec 04, 2017 4:53 pm

If the equities take a dip and that's all you have in your taxable account, and then you needed to access funds in taxable account, even if you sell equities at a loss in taxable you can sell bonds in tax deferred and buy the very cheap priced equities in tax deferred. It's pulling from one place and replacing it in the other so technically you are back to where you were. Also you get an added benefit of tax loss harvesting. If you have bonds in taxable and you sell those in taxable while equities are taking a dip. You are in effect adjusting AA but now you might have taxable gains because fixed income could have appreciated while equities are declining.

With the flipside, equities are appreciated and you need the money for some reason above and beyond your ER fund, well you might just have to take some gains. Having bonds in taxable while equity has appreciated can help a bit to curb your tax gain but how much bonds do you really want to hold in a taxable account? I'd prefer to have higher return on bonds being sheltered and just rebalance in tax deferred when needed depending on taxable account activity (which ideally is rarely ever tapped if ER fund can hold you over). If bonds in taxable is your second tier emergency fund, i wouldn't keep it as part of your asset allocation. I'd also prefer a CD to bonds as second tier emergency fund. Short term/intermediate term bonds are what some choose though too.

iasw
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Re: Asset allocation across accounts: Twist?

Post by iasw » Mon Dec 04, 2017 4:55 pm

football236 wrote:
Mon Dec 04, 2017 4:29 pm


One additional point I realized is that if the taxable is in one asset class, and that asset class outperforms as opposed to underperforms (opposite of my original scenario), I'd need to sell within my taxable account to bring that asset class back to my AA, which means I'd have a taxable event. Instead, if the taxable account mirror my AA, I'd have more flexibility to not sell and thus avoid a taxable event by simply adding new money to the underperforming asset classes.

Is this because there just isn't enough room right now to say, go all bond in your 401k (or wherever) to preserve your AA across your entire portfolio, if your taxable went up significantly?

In that scenario, you could sell some in taxable, or you could direct new money to buying a bond fund or something within taxable. Of course, the bonds in the taxable fund wouldn't be tax-friendly, so you'd just have to weigh that all out at the time.

iasw
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Re: Asset allocation across accounts: Twist?

Post by iasw » Mon Dec 04, 2017 5:01 pm

One idea I had:

In your OP, you mentioned your desired AA includes large cap, mid and small, 2 types international, and 2 types of bonds for 6 funds total (I'm assuming 6 here -- correct me if I'm mistaken).

Would it help right now to do fewer funds, say, 3 and do total domestic, total international, and total bond? Or are your options limited?

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jhfenton
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Re: Asset allocation across accounts: Twist?

Post by jhfenton » Mon Dec 04, 2017 5:13 pm

My overall allocation is fairly complex, with 6 equity asset classes, five bond funds in various accounts, 80/20 equity/fixed income, 55/45 intl/US (at the moment), heavily tilted small and value.

I don't want to reproduce all of that in taxable, but I want a bit of diversity. So I keep taxable fairly straightforward and pick one representative of each major asset class: 1/3 each in VOHIX (Vanguard Ohio Long-Term Tax Exempt), VWO (Vanguard Emerging Markets ETF), and VIOV* (Vanguard S&P 600 Small Cap Value). All three are fairly tax efficient. All three perform very differently, providing a high degree of diversification in the account, both for smoothing overall returns and maximizing the potential for tax-loss harvesting.

* I use VSIAX (Vanguard Small Cap Value) in tax-advantaged, but it is not tax-friendly, so I go with VIOV in taxable. It also avoids problems with TLHing. If I want to TLH VWO, I'll have to time it with my purchases of VEMAX in tax-advantaged.

retiredjg
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Re: Asset allocation across accounts: Twist?

Post by retiredjg » Mon Dec 04, 2017 5:53 pm

Eye.surgeon and Jermbo are giving you the right answer. You can hold only stocks in taxable and still be fine even in a crash even if you have to use the money.

If you have to sell stocks at a loss, that's OK. You simply rebalance into stocks by selling bonds in a tax-advantaged account and buying stocks at a very attractive price. This will get you back to your stock to bond ratio.

If you don't believe it, look at the problem from the other direction. What if you could magically sell the bonds in your 401k and use that money instead. If you sell enough bonds your portfolio will be out of whack and you would need to sell stocks and buy bonds to re-establish your stock to bond ratio. Its backwards but it is the same thing. Either way, you are selling stocks "at a loss".

But you are worried that in a crash your taxable account will not take care of an expense larger than your cash cushion. That will still be true if you mirror your AA and put 10% bonds in your taxable account. If you are 100% stocks, the taxable account might drop 50%. If you are 90% stocks, the taxable account might drop 45%..... These are estimates and guesses, but you get the idea. Putting 10% bonds in your taxable account is not going to make a great deal of difference if your cash cushion is exceeded. It will only help a tiny bit.

If you are worried about exceeding your "cash cushion", maybe it is not large enough.


This link helps explain it more. https://www.bogleheads.org/wiki/Placing ... ed_account


By the way, I'm not sure your 529s should be at the same stock to bond ratio as your retirement money. Might be OK. Might not if the time horizons are very different.

JBTX
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Re: Asset allocation across accounts: Twist?

Post by JBTX » Mon Dec 04, 2017 6:24 pm

While tax efficiency is a big factor in how you allocate your assets between account categories (traditioal, Roth, taxable) I would also say duration until withdrawal is also a factor. If I thought I was going to need the funds in the taxable account within 5 years, or 10 years etc, I would probably tend to invest those with an allocation appropriate for that time frame. Within 5 years it is mostly going to be in cash and cash equivalents. 10 years maybe some short term bonds, and possibly a small allocation of conservative equity or a balanced fund. Those are not the most tax efficient, but tax efficiency would be a primary criteria only if I assumed I would be holding the taxable funds until retirement/pre retirement.

football236
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Re: Asset allocation across accounts: Twist?

Post by football236 » Tue Dec 05, 2017 11:37 am

Thanks everyone. Here are my replies:

Jermbo and retiredjg: I understand that I'll always be able to reestablish my AA by buying elsewhere in my portfolio. That's not my concern. My concern is my taxable account diminishing too far due to no diversification. It's not so much that I want a second emergency fund. For emergencies, I'm comfortable with the cash cushion I set aside. I'm more thinking long term. I have ~30 years before retirement. One's taxable account is the storage location of almost all non-tax-advantaged wealth across their pre-retirement lifetime. I may need those funds not just for emergencies but other possibilities, such as some other investments, buying property, starting a business, etc. If my taxable account is in one asset class, it's more at risk for being diminished. If it was spread across other asset classes, I'd have some protection via diversification.

iasw: No, plenty of room to do bonds elsewhere. I can very much put my taxable funds in one asset class or across all and still accomplish my AA for my entire portfolio.

iasw: No issue with accomplishing my AA due to the number of funds. I'm using five funds.
Vanguard 500 Index Fund VFIAX 37%
Vanguard Extended Market Index Fund VEXAX 13%
Vanguard Total International Stock Index Fund VTIAX 40%
Vanguard Total Bond Market Index Fund VBTLX 7%
Vanguard Total International Bond Index Fund VTABX 3%

retiredjg: Thanks for your concern about the 529s. Our kids are 17 years away from college so I have the 529s in an aggressive, 100% equity composition right now. I'll adjust over the years to be more and more conservative.

JBTX: I hear you, except that the concern I'm posing is that there is no known need right now or potentially ever. It's more that my taxable account is the storage location of my wealth prior to retirement.

jhfenton: Your point is the direction I'm going in, that the taxable account should be the one account that has some semblance of your entire asset allocation, to provide diversification to prevent the balance from getting wiped out. Is that why you have multiple asset classes in your taxable account?

jhfenton: How do you assess tax efficiency? Is there a ratio stated somewhere? For example, here is the details page for VSIAX. Does it state its tax efficiency?

Thanks everyone.

retiredjg
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Re: Asset allocation across accounts: Twist?

Post by retiredjg » Tue Dec 05, 2017 12:05 pm

football236 wrote:
Tue Dec 05, 2017 11:37 am
If it was spread across other asset classes, I'd have some protection via diversification.
Do you think a 90/10 portfolio will shrink significantly less than 100%/0? The difference will not be much.

itstoomuch
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Re: Asset allocation across accounts: Twist?

Post by itstoomuch » Tue Dec 05, 2017 12:15 pm

Depends :oops:
Rev90517; 4 Incm stream buckets: SS+pension; dfr'd GLWB VA & FI anntys, by time & $$ laddered; Discretionary; Rentals. LTCi. Own, not asset. Tax 25%. Early SS. FundRatio (FR) >1.1 67/70yo

MWormwood
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Re: Asset allocation across accounts: Twist?

Post by MWormwood » Tue Dec 05, 2017 12:29 pm

football236 wrote:
Tue Dec 05, 2017 11:37 am
I may need those funds not just for emergencies but other possibilities, such as some other investments, buying property, starting a business, etc. If my taxable account is in one asset class, it's more at risk for being diminished. If it was spread across other asset classes, I'd have some protection via diversification.
Here you're saying you want to use this taxable funds for things other than retirement. Earlier you said you wanted to save it for retirement. I think this is really the crux of the issue. If the money is truly earmarked for retirement, then it's fine for the taxable portion to be 100% equities so long as your overall retirement asset allocation is on track.

If the money is intended for another purpose, you should set the asset allocation appropriately for that purpose. The timeline is shorter, so fewer equities probably makes sense. How much less? Depends on your timeframe. But for me, I wouldn't want to have money I was counting on for a down payment w/in 5 years to be mostly equities, for example.

One side note: If your retirement accounts are in Roth, you can actually withdraw the *contributions* tax-free at any time. Not that I'd recommend that if you don't have to, but if you need to access the money it's an option.

football236
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Re: Asset allocation across accounts: Twist?

Post by football236 » Tue Dec 05, 2017 1:08 pm

MWormwood: You raise a good point. For someone in their 30s, what is the purpose of the funds in one's taxable account? Clearly the funds in one's 401k, IRA, and Roth are for retirement. The funds in one's taxable account could be for retirement if not used prior to then, or could be used for some other purpose across one's life, without knowing upfront that there will be a specific need. Without knowing or even suspecting a specific need, should I apply a more conservative AA to my taxable account than my tax-advantaged accounts? I personally don't want to do that because I'd be reducing expected returns (and risk) without a sufficiently high probability of an event that would warrant that. I'm curious what others do/did for this bucket of funds.

MWormwood: Yup, thanks for the reminder (about Roth contributions being withdrawable). I'm aware that the various tax-advantaged accounts allow for withdrawals with penalties or otherwise, depending on the account. In general, I try to think of tax-advantaged funds as "locked up" until 59.5.

Tramper Al
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Re: Asset allocation across accounts: Twist?

Post by Tramper Al » Tue Dec 05, 2017 2:02 pm

It is all really just mental accounting, unless you do plan to use substantial funds in one location (taxable) before they are even accessible in another (IRA). But as others have said, that's a separate issue. And it's clearly very inefficient to duplicate portfolios everywhere or otherwise flip your locations without a good reason.

In practice, the sort of "problem" you run into is when an equities asset class does so well that you can't easily rebalance out of it any further without realizing huge taxable gains, as you've already sold everything in that class from your tax-favored locations. A good problem to have, obviously.

Now the question, do you account for taxes at all in the relative valuation of your taxable and tax-favored locations? That is to say, if you are systematically locating one asset (stocks) in taxable and another (bonds) in tax-favored, is your AA really what you think it is?

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Re: Asset allocation across accounts: Twist?

Post by Gauntlet » Tue Dec 05, 2017 2:49 pm

Tramper Al wrote:
Tue Dec 05, 2017 2:02 pm
Now the question, do you account for taxes at all in the relative valuation of your taxable and tax-favored locations? That is to say, if you are systematically locating one asset (stocks) in taxable and another (bonds) in tax-favored, is your AA really what you think it is?
This is the reason I have my 401k money have the same allocation as my roth ira and taxable money. I still look at all my accounts as one portfolio but since some of the money in my 401k is the governments (taxes) it doesn't seem right to pretend it is all mine. For example, if I want my overall portfolio to be 50/50 and I have 50k bonds in my 40k and 50k stocks in my roth ira, am I really 50/50? I would argue no because some of the 50k bonds is owed to the government. I'll add that I'm fortunate because I have good options in my 401k.

Tramper Al
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Re: Asset allocation across accounts: Twist?

Post by Tramper Al » Tue Dec 05, 2017 3:01 pm

Gauntlet wrote:
Tue Dec 05, 2017 2:49 pm
Tramper Al wrote:
Tue Dec 05, 2017 2:02 pm
Now the question, do you account for taxes at all in the relative valuation of your taxable and tax-favored locations? That is to say, if you are systematically locating one asset (stocks) in taxable and another (bonds) in tax-favored, is your AA really what you think it is?
This is the reason I have my 401k money have the same allocation as my roth ira and taxable money. I still look at all my accounts as one portfolio but since some of the money in my 401k is the governments (taxes) it doesn't seem right to pretend it is all mine. For example, if I want my overall portfolio to be 50/50 and I have 50k bonds in my 40k and 50k stocks in my roth ira, am I really 50/50? I would argue no because some of the 50k bonds is owed to the government. I'll add that I'm fortunate because I have good options in my 401k.
I agree with you re the government's money. And your (complete duplication) method while it may have drawbacks for most (due to fund availability, tax inefficiency, complexity, etc.) has the advantage that you don't actually need to specify what the tax effect is!

football236
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Re: Asset allocation across accounts: Twist?

Post by football236 » Thu Dec 07, 2017 11:42 am

Thanks everyone for your input. Just to close out this thread in case it helps others in the future, I decided to mirror my AA in my taxable account, whereas my tax-advantaged accounts are not mirrored.

For the bonds portion of my taxable account, I went with jhfenton's suggestion of using a tax-exempt bond fund for my state, as opposed to Vanguard Total Bond Market Index Fund (VBTLX), which is my US bond fund in general. jhfenton, thanks for that suggestion. I didn't think of that.

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grabiner
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Re: Asset allocation across accounts: Twist?

Post by grabiner » Fri Dec 08, 2017 10:48 pm

football236 wrote:
Mon Dec 04, 2017 3:58 pm
Hi everyone.

I've identified my asset allocation and am now implementing it across my many accounts (401k, IRA, Roth, 529s, taxable). I understand the concept of asset allocation across one's portfolio and tax-efficiency. However, I have one concern. Out of all of my accounts, only the taxable account allows for flexibility. The rest can't easily be touched until retirement or college. Assume I implement my asset allocation across my whole portfolio, but my taxable account ends up entirely in one asset class, and that asset class tanks. Though my portfolio as a whole would be balanced and otherwise healthy, my taxable account - the only one I can easily extract funds from if needed - would be greatly diminished.
How much would you need to take out of the taxable account? If you are holding stock in a taxable account and you might use it for some purpose (such as a home down payment), your taxable account should be double the amount you might need. This allows you to weather a crash and still have the money. (And if you then don't have any taxable money to spare, you can sell the stock for a capital loss, keep the taxable account in bonds, and move bonds to stock in another account.)

You can also take contributions from the Roth IRA, and conversions if they were made at least five years ago or were made with post-tax money (such as backdoors). And many major financial needs will fit into one of the exemptions from the 10% penalty for early withdrawals from a traditional IRA.
David Grabiner

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