treating all of investments as one asset allocation pool

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OregonDucksFan
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treating all of investments as one asset allocation pool

Post by OregonDucksFan » Thu Sep 13, 2018 2:34 pm

Hello

Many people suggest treating all of investments as one asset allocation pool. In other words: if a person wants 60% stocks and 40% bonds, he or she could put 50% of 60% stocks in the taxable account and 10% more stocks in 401k and 40% bonds in 401k. Compare that to 60% stocks and 40% bonds in taxable account and 60% stocks and 40% bonds in 401k.

I am in the process of performing that shift so that bonds are mostly in 401k and most of equity are in taxable account, with some leftover equity allocation in 401k. I perform this by shifting bonds in taxable account to stocks, while making an equal and opposite shift from stocks to bonds in 401k. Since bonds' return are mostly in interest, there is very little capital gains. I calculate that I will save about $60k in taxes between now and 401k Required Minimum Distribution.

I intentionally still keep some bonds in taxable account because I don't feel comfortable having 100% stocks in taxable account even though my overall allocation is fine. I have 2 years' living expenses in cash..

I explained what I was doing to a friend, and he asked is there any risk to doing this? All I can think are two risks below. Is there any other risk for doing this?

1. It's possible the relative tax rates change over time. For example, qualified dividend is currently taxed at 20% maximum for federal income tax, whereas taxable bond interest is taxed at income tax rate, which is currently always higher than qualified dividend tax rate. But the relative tax rates might change, e.g., qualified dividend could be taxed at 50%, whereas bond interest is taxed at income rate (might be lower than qualified dividend rate). I am exaggerating at 50% for illustration purpose only.

2. It's possible that in an emergency, someone may have to sell stocks in taxable account while the stock market is down. But this is not an issue if he or she already has sufficient money put away in an emergency fund, or he or she maintains some bonds in taxable account (in the worst case, bonds go down less than stock could go down).

Thanks for your inputs.

delamer
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Re: treating all of investments as one asset allocation pool

Post by delamer » Thu Sep 13, 2018 4:37 pm

All investments for the same goal should have the allocation implemented across all accounts dedicated toward that goal.

It isn’t clear in your scenario if you are only talking about your retirement investments or you are including other goals too. For instance, you should not need the 2 years of cash in your taxable retirement accounts unless you are very close to retirement.

Thesaints
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Re: treating all of investments as one asset allocation pool

Post by Thesaints » Thu Sep 13, 2018 4:44 pm

Each goal comes with its own AA. Total AA is the (weighted) sum of all goals.
Following that, select where to keep your various investments in the most cost effective location and don't forget that some goals will likely be reached earlier than others.

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ruralavalon
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Re: treating all of investments as one asset allocation pool

Post by ruralavalon » Thu Sep 13, 2018 5:53 pm

Welcome to the forum :) .


OregonDucksFan wrote:
Thu Sep 13, 2018 2:34 pm
Hello

Many people suggest treating all of investments as one asset allocation pool. In other words: if a person wants 60% stocks and 40% bonds, he or she could put 50% of 60% stocks in the taxable account and 10% more stocks in 401k and 40% bonds in 401k. Compare that to 60% stocks and 40% bonds in taxable account and 60% stocks and 40% bonds in 401k.

I am in the process of performing that shift so that bonds are mostly in 401k and most of equity are in taxable account, with some leftover equity allocation in 401k. I perform this by shifting bonds in taxable account to stocks, while making an equal and opposite shift from stocks to bonds in 401k. Since bonds' return are mostly in interest, there is very little capital gains. I calculate that I will save about $60k in taxes between now and 401k Required Minimum Distribution.

I intentionally still keep some bonds in taxable account because I don't feel comfortable having 100% stocks in taxable account even though my overall allocation is fine. I have 2 years' living expenses in cash..

I explained what I was doing to a friend, and he asked is there any risk to doing this? All I can think are two risks below. Is there any other risk for doing this?

1. It's possible the relative tax rates change over time. For example, qualified dividend is currently taxed at 20% maximum for federal income tax, whereas taxable bond interest is taxed at income tax rate, which is currently always higher than qualified dividend tax rate. But the relative tax rates might change, e.g., qualified dividend could be taxed at 50%, whereas bond interest is taxed at income rate (might be lower than qualified dividend rate). I am exaggerating at 50% for illustration purpose only.

2. It's possible that in an emergency, someone may have to sell stocks in taxable account while the stock market is down. But this is not an issue if he or she already has sufficient money put away in an emergency fund, or he or she maintains some bonds in taxable account (in the worst case, bonds go down less than stock could go down).

Thanks for your inputs.
Your plan looks okay in my opinion. I would still not hold any part of the bond allocation in a taxable account, when there is space for the bond allocation in tax-advantaged accounts. However I don't know your particular job situation, and the allocation plan needs to be comfortable for you.

Two years of expenses for emergencies is a large emergency fund. A large taxable account can also function as an emergency fund.

I don't see any additional risks. I think the risk is very small that you might need to sell a stock fund from your taxable account unless you have a prolonged job loss.
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link:Getting Started

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Phineas J. Whoopee
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Re: treating all of investments as one asset allocation pool

Post by Phineas J. Whoopee » Thu Sep 13, 2018 7:34 pm

Hi OregonDucksFan, and welcome to the forum.

You might want to read this article from our wiki: Placing cash needs in a tax-advantaged account.

PJW

OregonDucksFan
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Re: treating all of investments as one asset allocation pool

Post by OregonDucksFan » Thu Sep 13, 2018 9:44 pm

Thanks. This is all very helpful. It seems reasonable for my situation to put all stock allocation in taxable account and ROTH IRA, and bonds allocation in 401k. Side note: I have included existing I bonds as the only bonds in taxable account for asset allocation (I keep them since they pay 4%-6% from 2000-2004). Thanks again

Dandy
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Re: treating all of investments as one asset allocation pool

Post by Dandy » Fri Sep 14, 2018 8:05 am

I like the idea of having tax advantaged accounts mostly fixed income heavy and taxable accounts mostly equity heavy. By having this structure you can often rebalance without creating a taxable event. The good news/bad? news is that over time your equities in the tax advantaged accounts should have large capital gains. So, there will be a cost if you need to sell in order to take money out or reconfigure your equities. Tax loss harvesting will likely be not available. I have this condition so I direct my taxable equity distributions to a money market fund rather than automatically reinvest.

My TIRA is fixed income heavy. So taking my RMDs will deplete my fixed income assets while the taxable equities will likely continue to grow (faster over time than my fixed income heavy TIRA). The effect of this will be to pressure my overall allocation to an increasing equity allocation in retirement. Not the allocation approach I desire in retirement.

I can't complain since I received a nice tax deduction with my TIRA contributions and had tax advantages. I wish I had more opportunity to contribute to Roth or would have done more Roth conversions in early retirement. Having a nice percentage of assets in a Roth gives you more options to avoid rebalancing expenses and to be able to adjust your overall allocation without expense and avoid or moderate a rising equity pressure.

OregonDucksFan
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Re: treating all of investments as one asset allocation pool

Post by OregonDucksFan » Tue Sep 18, 2018 10:28 pm

I would appreciate inputs on three more questions.

1. If bonds addition is needed to satisfy asset allocation and 401k is already 100% bonds, is ROTH IRA or taxable account a better place for adding bonds for rebalancing to satisfy asset allocation?

2. does the below order of withdrawal priority make sense to satisfy living expenses in retirement for before RMD and after RMD??
background on taxes: I will be in 22% federal and 15% federal LT capital gains / qualified dividend tax rate. 9.3% for all state taxes.

Before RMD.
a. dividends and capital gains distributions from funds in taxable account and I bonds as they mature
b. ROTH IRA [0% tax]
c. sell stock investments in taxable account [15% + 9.3% tax]
d. sell I bonds before maturity [22% + 9.3% tax]
e. 401k before RMD [22% + 9.3% tax]

After RMD.
a. dividends and capital gains distributions from funds in taxable account and I bonds as they mature
b. 401k after RMD [22% + 9.3% tax]
c. ROTH IRA [0% tax]
d. sell investments in taxable account [15% + 9.3% tax]
e. sell I bonds before maturity [22% + 9.3% tax]

3. What criteria should be used to sell investments in taxable account? After shifting bonds to 401k and keep mostly stock funds in taxable account, I have all stock funds other than Target Retirement 2020 (6% of taxable account) and I Bonds (14% of taxable account).
a. Capital gain tax amount per dollar being sold?
b. Whether the fund is active or passive (I have only one active fund)?
c. Other considerations?

Thank you

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grabiner
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Re: treating all of investments as one asset allocation pool

Post by grabiner » Thu Sep 20, 2018 6:01 pm

OregonDucksFan wrote:
Tue Sep 18, 2018 10:28 pm
I would appreciate inputs on three more questions.

1. If bonds addition is needed to satisfy asset allocation and 401k is already 100% bonds, is ROTH IRA or taxable account a better place for adding bonds for rebalancing to satisfy asset allocation?
Usually Roth IRA.
2. does the below order of withdrawal priority make sense to satisfy living expenses in retirement for before RMD and after RMD??
background on taxes: I will be in 22% federal and 15% federal LT capital gains / qualified dividend tax rate. 9.3% for all state taxes.

Before RMD.
a. dividends and capital gains distributions from funds in taxable account and I bonds as they mature
b. ROTH IRA [0% tax]
c. sell stock investments in taxable account [15% + 9.3% tax]
d. sell I bonds before maturity [22% + 9.3% tax]
e. 401k before RMD [22% + 9.3% tax]
No, this does not make sense. The IRS and Oregon own 31.3% of your 401(k), so $6870 in your Roth IRA and $10,000 in your 401(k) are equivalent as long as you stay in the same tax brackets. You don't gain any extra benefit by tax-deferring further growth in the 401(k), because you will lose the same 31.3% of that growth.

By withdrawing from the Roth or 401(k), you can control your taxable income, to avoid going up a tax bracket and increasing your taxes. The Roth also has the advantage that it is free of RMDs.

Selling stocks in the taxable account is usually best, because you will pay the 24.3% tax on only a portion of your gains, and that portion will increase the longer you hold the stocks.

I-Bonds are exempt from state tax, which gives you an incentive to hold them longer.

Thus, my suggested order, both before and after RMDs:

1, dividends, capital gain distribution, matured bonds, and anything else that can be sold at no tax cost
2. taxable stock
3. I-bonds before maturity
4. 401(k) up to top of current tax bracket if necessary
5. Roth IRA
3. What criteria should be used to sell investments in taxable account? After shifting bonds to 401k and keep mostly stock funds in taxable account, I have all stock funds other than Target Retirement 2020 (6% of taxable account) and I Bonds (14% of taxable account).
a. Capital gain tax amount per dollar being sold?
b. Whether the fund is active or passive (I have only one active fund)?
c. Other considerations?
The active fund may be worth selling now, switching to an index, as it will generate more taxable gains if you keep it.

If the current capital gain on the active fund is enough to be worth waiting to sell, it's still probably the first thing you should sell when you need the money. Among index funds, minimizing the capital-gains tax per dollar makes sense.
Wiki David Grabiner

OregonDucksFan
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Re: treating all of investments as one asset allocation pool

Post by OregonDucksFan » Fri Sep 21, 2018 1:39 pm

Thanks for the detailed thinking process. It's helpful for me to go off to calculate. It's still years off, but I can calculate at any time while trading off how close to i bonds maturity and to 59.5/RMD.

1, dividends, capital gain distribution, matured bonds, and anything else that can be sold at no tax cost

2. I-bonds before maturity
  • I Bonds (50% of value in accumulated interest at income tax rate 22%. Pay $11 in taxes for every $100 sold)

no state income tax on i bond interest

3. taxable stock
  • Primecap Core (71% capital gains at LT capital gains rate 15% + 9.3%. pay $17 in taxes for every $100 sold).
4. 401(k) up to top of current tax bracket if necessary
  • 401k (100% taxable at income tax rate 22% + 9.3%. Pay $31.3 taxes for every $100 sold)
5. Roth IRA
  • Not taxable
Last edited by OregonDucksFan on Sun Sep 23, 2018 1:22 am, edited 1 time in total.

JBTX
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Re: treating all of investments as one asset allocation pool

Post by JBTX » Fri Sep 21, 2018 2:13 pm

As I've mentioned elsewhere, from my own calculations, the bonds in tax advantaged strategy is greatly overrated, unless you are in a very high tax bracket (and it still may be overrated), or you expect interest rates to increase substantially.

In general, I have found that in moderate growth and moderate interest rate scenarios, while the tax rate on interest is higher, one would expect gains on stocks to be higher - and the net impact is they mostly cancel each other out.

The "risk" of having bonds in tax advantaged, is if Stocks have very high returns relative to bonds, and you missed out on that tax deferred growth and end up paying capital gains that could have been avoided. Also, if you have the opportunity to do future Roth conversions at low rates, you would have more that you could convert with stocks in tax advantaged. Of course, if stocks went down or were very low return, they would be better off in taxable.

jayhawkerbeef
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Re: treating all of investments as one asset allocation pool

Post by jayhawkerbeef » Fri Sep 21, 2018 2:18 pm

I’m non-boglehead on this. Believe it was Rick Ferri, could be wrong, had a comment about this too. Just do a search. However, I repeat the same allocation in each account pre-tax. Taxable all stock and only what I’m willing to risk above emergency fund. This suits me, which is most important to me.

OregonDucksFan
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Re: treating all of investments as one asset allocation pool

Post by OregonDucksFan » Fri Sep 21, 2018 4:02 pm

These are the calculations I used, in case they're helpful to others. The levers are these, which will greatly impact the decision.
  • dollar amount in bonds
    federal state income tax rate (0% if using municipal bond fund)
    state income tax rate (0% if using state municipal bond fund)
    federal LT capital gains tax rate
    state LT capital gains tax rate
    number of years until withdrawal from 401k
I have been using municipal bond fund in taxable account, but due to drop in tax rate with retirement coming soon, municipal bond fund no longer makes sense (relative to total bond market index fund). After evaluation using these calculations and knowing I have very little capital gains when I sell bond funds in taxable account (California municipal intermediate bond and total international bond), I find quite a chunk in tax saving. So, it was an easy decision to go ahead with this.

I did the same calculation for a friend (the same friend I mentioned in the initial post asked me about the risks of shifting bonds to 401k / stocks to taxable account), it didn't make sense for him to do this. He has less in bonds and uses municipal bond funds already and plans to work for some more years (such that municipal bond makes sense relative to total bond market)

tax saving = A - B

A = amount in bonds in taxable account being shifted to 401k * bond interest rate * (federal + state income tax rate) * number of years until withdrawal from 401k

B = same amount in stocks in 401k being shifted to taxable account * stock dividend rate * (LT capital gains rate federal + state) * number of years until withdrawal from 401k

OregonDucksFan
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Re: treating all of investments as one asset allocation pool

Post by OregonDucksFan » Fri Sep 21, 2018 4:12 pm

PS: having to sell in taxable account is a very valid point. That would be another lever to consider.

In my case, I do not anticipate withdrawing any money from taxable account beyond fund distributions in the form of dividends and capital gains. There is virtually no capital gains distributions from taxable account funds if most are index funds.

alex_686
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Re: treating all of investments as one asset allocation pool

Post by alex_686 » Fri Sep 21, 2018 4:13 pm

The primary benefit is that you don't use "Mental Accounting", a cognitive defect. You should be able to build a portfolio with a higher return and lower risk by combining your goals and risk tolerance into a unified structure. So kudos for you.

The problem is a higher cognitive load. Doing this is more complex. For example, as you state, what happens in a emergency. Rationally one would be to add a "emergency fund" goal and integrate that. I do this - I have taxable stock and a HELOC designated for such things. Both are doing double duty. But it does mean more balls in the air.

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