Portfolio Review - Replacing Vanguard Target Retirement & Extra Cash

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k3vb0t
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Portfolio Review - Replacing Vanguard Target Retirement & Extra Cash

Post by k3vb0t » Wed Apr 11, 2018 10:36 am

This ended up being longer than I thought it would. Thanks in advance if you read the whole thing!

Me: 34, employed
Wife: 33, SAHM
2 kids (4 and 2)
  • Current Portfolio: ~$247k
  • Excess Cash Total: $85k ($45k earning 3% in several Penfed CDs until EOY)
  • Debt: Mortgage only, ~8-9 years left on a 15 year @ 3.25%, ~$108k remaining; home value ~$240k not including realtor fees
  • Annual Investments: Maxing out Roth IRA for me, Traditional IRA for her, ~$2k into my 401k/year
  • Emergency fund: 10-12 months if we didn't make drastic lifestyle changes (which we would if I lost my income); not included in excess cash amount above; earning 1-1.5% in reward checking/savings accounts
  • Life Insurance: Wife and I each have a 30 year term policy, 26 years remaining, each insured at $1.2M (~10-11x my annual income)
Portfolio:
  • $1,365 in VTI (Total Stock Market ETF)
  • $4,135 in Vanguard brokerage account waiting to be invested
  • remainder (~$241k) in VFORX
I opted for VTI with my wife's Traditional IRA deposit this week (as part of doing taxes; we had delayed decision until then) and thought I would DCA it in over 4 contributions in the coming months thus the $4k in cash and $1,365 invested in VTI. Was planning on doing full ETF switch, but then realized I could get Admiral shares.

Mentality:

I am okay with risk, but not as much as when we were a dual income family. We had a 6 month old when we locked up the money in the Penfed CDs in 2013. I've held excess cash in a mix of reward checking and online savings accounts average 1-2% over the last several years as extra buffer to our emergency fund. Part of that cash buffer is going to be used to remodel our master bath; let's estimate $10-15k for that. But I know holding the cash in very low interest rate accounts is dumb... we were just a little gun shy with a 6 month old and planning to go to single income. Now we're single income with 2 young kids I'm not looking to invest it in high risk investments, but I'd like to keep pace with inflation at minimum and earn excess return if possible with access to funds within say, 6 months (after burning through part of emergency fund).

We have separate saving categories in our budgets for major purchases: replacing cars at 10-15 years, major home repairs like roof and HVAC, etc. So those items don't factor into the use of the extra cash. It's just... extra. Good problem to have. (Those categories are also held in reward checking/savings accounts.)

Up until this year I had our investments in Target Retirement 2050. I would be 66. With the market having had such a rally without a major correction, my risk averseness kicked in and I switched us down to Target Retirement 2040 (VFORX) as it matched target bond allocation better than TR 2045. I've been comfortable with our bond percentage being 120 minus age and that seemed to fit better as well (currently about 14.3% in bonds).

With VFORX at 0.15% expense ratio and knowing low expenses and low taxes being the levers I can use to reasonably impact index fund performance, I wanted to see if moving to a mix of either Admiral-class mutual funds or Vanguard ETFs could reduce my costs further.

The math I've done to replicate VFORX in Admiral/ETFs:
  • VTSAX/VTI: 51.8% and 0.04% ER: $127,915
  • VTIAX/VXUS: 33.9% and 0.11% ER: $83,713
  • VBTLX/BND: 10% and 0.05% ER: $24,694
  • VTABX/BNDX: 4.3% and 0.11% ER: $10,618
If my math is correct this would drop my expense ratio from 0.15% to 0.0677%, saving $195 per year at current portfolio value.

Note: all funds held in a Vanguard Brokerage Account (since they just forced everyone to move over to that platform).

Questions:
  • Can I achieve greater return on our excess cash? If so, where?
  • Are there any downsides going from VFORX to a mix of Admiral-class funds and/or Vanguard ETFs? (Aside from having to manually adjust portfolio each year.)
  • Is there any upside or downside to going 100% of either Admiral-class funds or Vanguard ETFs? (Aside from only being able to buy full shares in ETFs versus partial shares with mutual funds -- at least that is my understanding)
  • Overall, how are we doing?
Thanks for the advice.

bloom2708
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Re: Portfolio Review - Replacing Vanguard Target Retirement & Extra Cash

Post by bloom2708 » Wed Apr 11, 2018 2:53 pm

I would use your cash to live on and put $16,500 (less the $2,000 you state you are putting in your 401k) into your pre-tax 401k.

You save the 22% (marginal tax rate) up front and lower your income. With one income, maxing your pre-tax 401k, a Traditional IRA for your spouse and perhaps an HSA can lower your income.

Your 4 fund strategy looks fine. Until you max out your 401k, it doesn't make sense to start a taxable account. Figure out the percent of your income that would max to $18,500 over the remaining paychecks (don't count any match). Your check will be smaller, but you won't be pay the tax. Then transfer $x from savings to make up for the lower paycheck.

You could do this in 2019 as well, etc. Giving up pre-tax 401k space is tough. Same as giving up Roth space. If you do this, you could switch to Roth IRA for your wife. The tax savings on $18,500 can help fund this. Or use more of your $85k cash to fund the Roth's for 2018. Fund your 2018 Roths with some of the $85k today.

You can possibly earn more by increasing your percentage of stocks to bonds. But that also adds risk.

For buy/hold investing, I use mutual fund versions. Some like ETFs. I don't need any incentive to trade more. Buy and hold. You could skip the international bonds. Total US bond is your safety side of your portfolio. A small percentage of international bonds doesn't add more safety.

Hopefully others add their thoughts.
"We are here not to please but to provoke thoughtfulness" Unknown Boglehead

k3vb0t
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Joined: Mon Jun 02, 2014 4:42 pm

Re: Portfolio Review - Replacing Vanguard Target Retirement & Extra Cash

Post by k3vb0t » Thu Apr 12, 2018 9:37 am

bloom2708 wrote:
Wed Apr 11, 2018 2:53 pm
...
Thanks for the response, bloom2708.

Another long response for you.

I see what you're saying -- we have enough liquid assets, and you can never go back to invest in your 401k/Roth/Traditional IRA after April 15th each year, so max those out while you can.

For some reason that makes me nervous, but I don't have a justifiable reason as to why.

I guess what I need to work out in my head is why I have felt the need to hold onto this money as cash. We already have an emergency fund at $30k. If we somehow burned through all of that we have Roth IRA contributions we could pull from (haven't checked but I'd estimate at least $80k). If I lost my job, my wife could go back into teaching fairly quickly (granted, at about 45% of what I make, but it would stop the bleeding for sure).

I suppose I should work that out and then even if I "only" invest a chunk of it, that's better than nothing. Quick spreadsheet calculation shows a $20k investment at 34 earning a consistent 7% turns into $116k at age 60. $50k turns into $290k.

Alternatively if we threw a big chunk at our mortgage we would pay it off a lot sooner, which frees up about $1200 in principal/interest payments per month, too. Only reason I mention this is because of the above -- we are just about at the point where itemized deductions aren't helping us. I've staggered our cash donations to every other year to maximize their tax usefulness, we won't have any this year and the interest we pay (something around $3-4k) won't help us if we itemize. So I'm not getting a mortgage interest write off. On the other hand, it's only a guaranteed 3.25% return into a very illiquid asset, and it isn't enough to fully pay it off so our monthly cashflow wouldn't change...

A question about the 22%. With our deductions (about $1,300 over the standard this year due to donations, should be standard next year, + Traditional IRA) and exemptions our taxable income dropped into the 12% bracket. So should I look at it this year as if any tax savings are at 12% instead of 22%?

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goingup
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Re: Portfolio Review - Replacing Vanguard Target Retirement & Extra Cash

Post by goingup » Thu Apr 12, 2018 9:55 am

Just a quick observation. You may have a tendency to overthink things. A Target Fund is a fantastic solution for investors who tend to do this. If I were you I would not change. :wink:

bloom2708
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Location: Fargo, ND

Re: Portfolio Review - Replacing Vanguard Target Retirement & Extra Cash

Post by bloom2708 » Thu Apr 12, 2018 10:39 am

I don't know if 12% or 15% or 22% (pre-tax) makes much difference. We can't know what the tax rates will be 20-30 years ahead. They could be higher or lower or the same. Whatever the savings now, gives your paycheck a boost and defers the tax. Plus, you save the money to grow for 20-30 years.

I understand. I'd like to have $85k cash, pay down the mortgage and etc etc. I'm not a fan of debt of any kind, so paying down the mortgage would be just fine with me. Others might say to not do it and get it invested. Inflation (too much cash, not earning enough) is a risk too.

I know that only putting $2k in your pre-tax 401k is "not enough". It maybe doesn't make sense now. Your 50 year old self wants you to max the pre-tax 401k and Roth IRAs.

Many paths through this journey.
"We are here not to please but to provoke thoughtfulness" Unknown Boglehead

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BL
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Re: Portfolio Review - Replacing Vanguard Target Retirement & Extra Cash

Post by BL » Thu Apr 12, 2018 2:12 pm

Agree to max your 401k at $18.5k and both Roth IRAs. The Roth can be a back-up emergency fund if really needed, as contributions (only) can be withdrawn without tax or penalty.

Agree that your new Target Date is just fine. So is breaking it down, but it does lead to temptations. If I did break it down, I would skip the foreign bonds and possibly lower the international, but no one knows the future or what will turn out best. Search for the long thread and also the Wiki page for the 3-fund portfolio. Maybe 55/30/15% would be good enough. I like round numbers. Actually, 15% bonds is pretty aggressive; (that might be why you like to have more cash on hand).

I see Ally online bank often mentioned for savings/CD rates. Bankrate.com lists others.

Your child tax credit should double to 2k each starting this year. That is a reduction off taxes, not income.
Your exemptions disappear while SD is up to 24k.

I don't know your income, but you might want to check to see if you are eligible for savers credit or earned income credit with 18.5k in 401k or whether putting her into trad. IRA is worth it if it gets you into those credit territories. If not, doing some Roth instead might make sense. It might take a tax program or calculator to get it right. You might even decide to do as in first paragraph this year, and fine tune next year when there will be more calculators available. Remember most folks just do what they do, and pay whatever the tax happens to be for that!

k3vb0t
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Re: Portfolio Review - Replacing Vanguard Target Retirement & Extra Cash

Post by k3vb0t » Fri Apr 13, 2018 9:18 am

BL wrote:
Thu Apr 12, 2018 2:12 pm
Agree to max your 401k at $18.5k and both Roth IRAs. The Roth can be a back-up emergency fund if really needed, as contributions (only) can be withdrawn without tax or penalty.

Agree that your new Target Date is just fine. So is breaking it down, but it does lead to temptations. If I did break it down, I would skip the foreign bonds and possibly lower the international, but no one knows the future or what will turn out best. Search for the long thread and also the Wiki page for the 3-fund portfolio. Maybe 55/30/15% would be good enough. I like round numbers. Actually, 15% bonds is pretty aggressive; (that might be why you like to have more cash on hand).

I see Ally online bank often mentioned for savings/CD rates. Bankrate.com lists others.

Your child tax credit should double to 2k each starting this year. That is a reduction off taxes, not income.
Your exemptions disappear while SD is up to 24k.

I don't know your income, but you might want to check to see if you are eligible for savers credit or earned income credit with 18.5k in 401k or whether putting her into trad. IRA is worth it if it gets you into those credit territories. If not, doing some Roth instead might make sense. It might take a tax program or calculator to get it right. You might even decide to do as in first paragraph this year, and fine tune next year when there will be more calculators available. Remember most folks just do what they do, and pay whatever the tax happens to be for that!
I hadn't considered the Roths as a potential emergency fund source. That does help me feel better about deploying the excess cash, as we're sitting on about $90-100k in Roth contributions.

Question: do I need to worry about capital gains any of our accounts (Roth, Traditional, 401k) from making this switch?

I see what you're saying about temptations, but I am confident once I have my percentages setup for each fund and automatic contributions setup, I'll go back to doing my annual rebalancing and that be it. I think it's a fair risk. If someone offered me $150 today and every year after today (plus additional as portfolio grows), I would gladly take it.

Thanks for the heads up on the tax changes, I hadn't considered that. Not eligible for savers or EITC, unfortunately, at least based on what I'm seeing online.

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BL
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Re: Portfolio Review - Replacing Vanguard Target Retirement & Extra Cash

Post by BL » Fri Apr 13, 2018 10:48 pm

There are no tax consequences for exchanging funds within tax-advantaged accounts, as long as they stay within the account.

I would try to stay within the 12% tax bracket by using the tax-deferred 401k, at least as much as it takes to keep it there. Since the CTC reduces taxes but does not change the bracket, there could be some possible considerations there on whether to use some Roth 401k if all trad. 401k is not needed to keep tax low. It may be a judgement call. A tax estimator program would really help to play "what if" trials. Maybe one will show up mid-year or so.

k3vb0t
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Re: Portfolio Review - Replacing Vanguard Target Retirement & Extra Cash

Post by k3vb0t » Mon Apr 16, 2018 3:56 pm

BL wrote:
Thu Apr 12, 2018 2:12 pm
I don't know your income, but you might want to check to see if you are eligible for savers credit or earned income credit with 18.5k in 401k or whether putting her into trad. IRA is worth it if it gets you into those credit territories. If not, doing some Roth instead might make sense. It might take a tax program or calculator to get it right. You might even decide to do as in first paragraph this year, and fine tune next year when there will be more calculators available. Remember most folks just do what they do, and pay whatever the tax happens to be for that!
Okay, now that I've read more about the 2018 changes it seems the Savers Credit is just out of reach, but I'd like someone to check me to make sure I'm not calculating wrong.

My understanding of Saver's Credit is it is based off your AGI. In the Married Filing Joint column here you get a 10% credit between $41,001 - $63,000.

Using round numbers, we're right at $100k in gross income (wages + interest + small biz income).

$100k
- 18.5k 401k
- 11,000 tIRA x2
= $70.5k

Which means we would miss out because the standard deduction is after that?

Also -- 70.5k - 24k = $46.5k taxable income = $5,199 in tax - $4,000 in child tax credits = $1,199 in net tax owed?

That's crazy low!

If we do 1 Roth and 1 tIRA we're still just out of the 22% bracket, but with more tax in "hopes" that rates are higher than 12% in retirement.
Last edited by k3vb0t on Mon Apr 16, 2018 4:06 pm, edited 1 time in total.

dbr
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Re: Portfolio Review - Replacing Vanguard Target Retirement & Extra Cash

Post by dbr » Mon Apr 16, 2018 4:04 pm

The simple answer to the excess cash is you can get more return on it by investing it in the stock market. If you don't want to take that risk, then it probably isn't helpful to worry about it. The point of this comment is that risk and return are properties of your portfolio as a whole and that is mainly determined by the riskiness of your asset allocation between stocks and bonds.

The suggestions that in effect amount to just having less cash are fine. To try to earn meaningfully more than current CD rates on cash or short bonds amounts to niggling around in the market for bits of change, not that there is anything wrong with that, but I don't have a suggestion.

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