I don't understand which accounts to place investments in

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EPCOTCenter1982
Posts: 29
Joined: Mon Sep 03, 2018 4:49 pm

I don't understand which accounts to place investments in

Post by EPCOTCenter1982 » Sun Jun 23, 2019 3:26 pm

I have a t401K and a Roth IRA as my two main vehicles for investing.

I am able to max out the Roth IRA every year, but I cannot max out my t401K.

I want to do the three fund portfolio, but I don't understand which fund makes the most sense for which type of investment.

Do I put the same three funds across these two accounts?

livesoft
Posts: 66918
Joined: Thu Mar 01, 2007 8:00 pm

Re: I don't understand which accounts to place investments in

Post by livesoft » Sun Jun 23, 2019 3:28 pm

I would not and do not. I try to invest tax efficiently because I have income taxes to pay. If you don't pay income taxes, then it probably doesn't matter what you do.
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EdLaFave
Posts: 394
Joined: Fri Dec 26, 2014 2:31 am

Re: I don't understand which accounts to place investments in

Post by EdLaFave » Sun Jun 23, 2019 4:44 pm

I figured a quick explanation of account types may be in order...

At the highest level you have tax advantaged accounts (401k, IRA, HSA, etc.) and taxable accounts.

When you own a fund in a taxable account it will generate distributions (dividends and capital gains) based on the stocks the fund holds and/or sells. A portion of the distribution will be qualified (which means it is taxed as a capital gain) and a portion will be unqualified (which means it is taxed as ordinary income). So long story short, every year you have to pay taxes on the distributions you received within your taxable account. The other way you pay tax is if you sell shares of a fund at a gain. If you held those shares for a year or more then they’ll be taxed as a capital gain, otherwise they’ll be taxed as ordinary income.

Tax advantaged accounts on the other hand shield you from having to pay taxes on distributions or from selling shares at a gain. Within the world of tax advantaged accounts you can choose from Traditional and Roth.

With a Traditional account you can earn money, invest it without paying taxes, let it grow tax free, and then every dollar you eventually withdraw is treated as ordinary income. So that equation looks like this: $1 * (1 + Growth) ^ N_Years * (1 - TaxRate).

With a Roth account you can earn money, pay taxes, let it grow tax free, and then withdraw it tax free. That equation looks like this: $1 * (1 - TaxRate) * (1 + Growth) ^ N_Years.

As you can see these two equations have many of the same terms, but the tax rates will likely be different. With a Roth you are paying tax at your highest tax bracket. With a Traditional, you’ll get to fill up deductions, credits, and the lower tax bracket. This gets complex, but I think Traditional is best for most people.

The other common tax advantaged account is an HSA. The HSA is quite similar to the Traditional Tax Advantaged accounts, except if you keep track of your medical spending, you’ll be able to withdraw that money tax free. So this account gives you the ability to avoid taxes when you earn money, while the investment grows, and again when you withdraw the money.

Having said all of that, if your analysis is truly limited to what investments should go on a Traditional vs a Roth then the answer can be found in how those accounts are taxed. Since the Roth account will not be taxed it makes sense to hold the investments with the highest expected return in the Roth. In practice, that means stocks in Roth and bonds in Traditional.

It is worth noting that these topics can get quite complex depending on your specific circumstances (which you didn’t lay out for us). For example if you had to pay 4% to own a bond fund in your Traditional account but you could buy a stock fund for 0.04% in your Traditional then there is no way you should buy the bond fund in Traditional. I’ve tried to give the most general information without completely overwhelming you with every dirty detail or possibility.

retiredjg
Posts: 36745
Joined: Thu Jan 10, 2008 12:56 pm

Re: I don't understand which accounts to place investments in

Post by retiredjg » Sun Jun 23, 2019 5:05 pm

EPCOTCenter1982 wrote:
Sun Jun 23, 2019 3:26 pm
I want to do the three fund portfolio, but I don't understand which fund makes the most sense for which type of investment.
It depends on things you have not told us, but this is an idea that works for many people.

401k
500 index or other large cap value fund
bond fund

roth IRA
more US stocks if needed
international stocks

See how that works out for you. If the answer is not clear, you need to post your information in the format designed to help people with their portfolio questions. See link below.

MotoTrojan
Posts: 4881
Joined: Wed Feb 01, 2017 8:39 pm

Re: I don't understand which accounts to place investments in

Post by MotoTrojan » Sun Jun 23, 2019 5:15 pm

Until/unless you have significant taxable assets I wouldn’t hesitate to use a Target Retirement in both the t401k and Roth, assuming the 401k expense ratio isn’t unreasonable, in which case there’s a stronger reason to manually control a 3 fund.

rkhusky
Posts: 6748
Joined: Thu Aug 18, 2011 8:09 pm

Re: I don't understand which accounts to place investments in

Post by rkhusky » Sun Jun 23, 2019 9:07 pm

401k's have more limited choices. Look at the funds with the lowest expense ratios (er's).

If there is a reasonably priced total bond fund, place it in the 401k.
Put either US or International in 401k.
Put US and International in Roth IRA.

Rebalance between stocks and bonds in 401k.
Rebalance between US and International stocks in Roth IRA.

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