SCV Tilt to TSM, But How Much Additional SCV?

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Shaoya
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SCV Tilt to TSM, But How Much Additional SCV?

Post by Shaoya » Sun Sep 19, 2010 11:09 pm

Replies to my earlier BH posting on REIT's let me know that our Vanguard Limited-Term Tax Exempt (VMLTX) (0.20%) is incorrectly placed. It's currently in taxable, but it (or another bond substitute) should be in tax-advantaged.

Simultaneously, I'd like to tilt our portfolio to SCV. I'd like to exchange VMLTX for Vanguard Small-Cap Value Index Fund (VISVX) (0.28%) in our taxable, and then buy VMLTX or another bond in our tax-advantaged (by exchanging it for VWNFX & VTSMX). I can address both goals simultaneously, but I have a few questions on doing this.

1) We already have a tiny amount of small-cap exposure in our Total Stock Market holdings ~1.1% of total portfolio, per MS X-Ray, I believe. Exchanging the VMLTX, which is 7.9% of our portfolio in addition to the SCV in our Total Stock Market (~1.1% of our total portfolio) means that we'd immediately have 9% of our portfolio in small-cap value stocks?

Is 9% too much/not enough? Given our portfolio & situation (below), what exposure do you all think would be optimal? [Our Stock/Bond/Cash AA is 65/30/5.]

2)
retiredjg wrote: For low tax brackets, taxable bonds usually pay more, even after taxes.
Since, we're in a relatively low federal tax bracket (15%) yet in a high tax state (9%), what other VG bond fund, in place of VMLTX, would you all suggest?

Debt
Mortgage –30 year fixed at 4.75% (refi’d May 2009)
Credit card debt – none
Student – 1.6% fixed @ $130 a month.
Car – no debt
Emergency Fund – not included below

Tax Filing Status
Married Filing Jointly – 15% Fed in 2009; 9% Oregon (2009)
Age
Hers – 35
His – 37
Son (2008), Daughter (2010)

Stable jobs in local/state government with an annual income of ~$100K. Expect this to increase incrementally – not dramatically - relative to inflation later in our careers. Intend to stay in our current house/city indefinitely (“…’til they cart me out in a box”).

Portfolio

Taxable
28.5% Vanguard Total Stock Mkt Idx - Admiral (VTSAX) (0.08%)
8.7% Vanguard Total Stock Mkt Idx - Inv (VTSMX) (0.18%)
4.7% Vanguard PRIMECAP (VPMCX) (0.50)
16.7% Total Int'l Stock Index (VGTSX) (0.34%)
7.9% Vanguard Limited-Term Tax Exempt (VMLTX) (0.20%)

Tax-advantaged
IRA
10.7% Vanguard Inflation-Protect Sec (VIPSX) (0.25%)


Roth IRA
3.4% Vanguard FTSE All-World Except US (VFWIX) (0.40%)
5.3% Windsor II (VWNFX) (0.39%)
3.0% Vanguard Total Stock Mkt Idx Inv
1.8% Vanguard Short-Term Bond Index (VFSTX) (0.24%)

Her 457
6.3% Vanguard Total Bond Market Index Fund – Institutional Shares (VBTIX) (0.07%)

His 457
2.9% Intermediate Bond Option (0.09%)
0.2% Large Company Stock Option (0.39%)
100.0%

BTW - I've deferred a decision on REITS.
Last edited by Shaoya on Mon Sep 20, 2010 9:27 am, edited 1 time in total.

livesoft
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Post by livesoft » Mon Sep 20, 2010 6:45 am

Did you put VISVX into a M* X-ray all by itself? Did you notice that it is not 100% small-cap value stocks?

I think one could have as much as 50% of their US equity holdings in VISVX with the other 50% in VTSMX without any issues, but then no one can predict the future performance of these funds.

You may also wish to have up to half your international equities in small cap and value foreign equities as well.

Of your 65% in equities, then 16% in US small-cap value and 16% in foreign small cap value would be where my portfolio would be.

You may wish to read Rick Ferri's "All About Asset Allocation" or Larry Swedroe's "The Only Guide to a Winning Investing Strategy ..." where small-cap value tilt is discussed at length.

Bob's not my name
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Re: SCV Tilt to TSM, But How Much Additional SCV?

Post by Bob's not my name » Mon Sep 20, 2010 7:48 am

Shaoya wrote:Replies to my earlier BH posting on REIT's let me know that our Vanguard Limited-Term Tax Exempt (VMLTX) (0.20%) is incorrectly placed. It's currently in taxable, but it (or another bond substitute) should be in tax-advantaged.

I'd like to buy VMLTX or another bond in our tax-advantaged.

Since, we're in a relatively low federal tax bracket (15%) yet in a high tax state (9%), what other VG bond fund, in place of VMLTX, would you all suggest?
I may be misunderstanding your post, but you appear to believe that tax considerations matter for which bond fund you choose in your IRA. IRA investment income is not taxed.

retiredjg
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Re: SCV Tilt to TSM, But How Much Additional SCV?

Post by retiredjg » Mon Sep 20, 2010 11:56 am

Replies to my earlier BH posting on REIT's let me know that our Vanguard Limited-Term Tax Exempt (VMLTX) (0.20%) is incorrectly placed. It's currently in taxable, but it (or another bond substitute) should be in tax-advantaged.
Not quite. All of your bonds should be in tax-advantaged if possible. But they should be taxable bonds, not tax-exempt bonds. Holding tax-exempt bonds in a tax-advantaged location would be like wearing a raincoat inside the house.

The only time you have to decide between taxable bonds and tax-exempt bonds is if you must hold some bonds in your taxable account. This does not apply to you since you can hold all of your bonds in the tax-advantaged locations. For bonds in your IRA, consider Vanguard's Total bond Market VBMFX.

Some thoughts:

1) Since you want to tilt to small cap and value, it does not make sense to me to sell Windsor II which is a value fund.

2) It also does not make sense to me to keep the Primecap fund since that is a growth fund - the opposite of a value fund - as it will offset your value tilt.

3) However, it does make sense to me to move the FTSE International fund from the Roth IRA to taxable because the international fund is eligible for the foreign tax credit if it is held in taxable.

4) Consider holding less Small Cap Value since you are unsure if 7.9% might be too much.

Here is a suggestion:

Taxable
28.5% Vanguard Total Stock Mkt Idx - Admiral (VTSAX) (0.08%)
8.7% Vanguard Total Stock Mkt Idx - Inv (VTSMX) (0.18%)
4.7% Vanguard PRIMECAP (VPMCX) (0.50) <--sell this and replace it with small cap value
16.7% Total Int'l Stock Index (VGTSX) (0.34%)
7.9% Vanguard Limited-Term Tax Exempt (VMLTX) (0.20%) <--sell this and replace it with international and total stock market, about half and half

Tax-advantaged
IRA
10.7% Vanguard Inflation-Protect Sec (VIPSX) (0.25%)


Roth IRA
3.4% Vanguard FTSE All-World Except US (VFWIX) (0.40%) <--sell this and buy total bond market
5.3% Windsor II (VWNFX) (0.39%)
3.0% Vanguard Total Stock Mkt Idx Inv <--sell this and buy total bond market
1.8% Vanguard Short-Term Bond Index (VFSTX) (0.24%)

Her 457
6.3% Vanguard Total Bond Market Index Fund – Institutional Shares (VBTIX) (0.07%)

His 457
2.9% Intermediate Bond Option (0.09%)
0.2% Large Company Stock Option (0.39%)

Your portfolio as reported above is currently 70.5% stocks/29.6% bonds. If you do the things I said, it will be about 72% stocks/28.1% bonds. Not to worry - just direct more of your contributions to bonds for a little while and it will return to your desired allocation of 65% stocks/35% bonds.

This idea will give you a bit of a small cap tilt and a little more of a value tilt. However, it is moderate and should not be "too much" for most people.

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grabiner
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Re: SCV Tilt to TSM, But How Much Additional SCV?

Post by grabiner » Mon Sep 20, 2010 5:36 pm

Shaoya wrote:2)
retiredjg wrote: For low tax brackets, taxable bonds usually pay more, even after taxes.
Since, we're in a relatively low federal tax bracket (15%) yet in a high tax state (9%), what other VG bond fund, in place of VMLTX, would you all suggest?
If you must hold bonds in the taxable account, you should use Treasuries (possibly TIPS), which are exempt from the high state tax. However, you should still prefer to hold stocks in the taxable account if possible, because you pay federal tax on qualified dividends at a rate of 5% (if the 2003 tax cuts are extended).
Wiki David Grabiner

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Shaoya
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Post by Shaoya » Tue Sep 21, 2010 8:29 am

Thank you all; your thoughts are insightful.
retiredjg wrote: Holding tax-exempt bonds in a tax-advantaged location would be like wearing a raincoat inside the house.
Yes, of course. Duh. I got fixated on avoiding that 9% OR tax!
retiredjg wrote: 4) Consider holding less Small Cap Value since you are unsure if 7.9% might be too much.
Well, actually, it's not that I'm unsure that 7.9% would be too much; I don't know whether it would be too much/too little/just right vis-a-vis our portfolio - I'm simply soliciting opinions!
livesoft wrote: You may wish to read Rick Ferri's "All About Asset Allocation"
Yes, the 2nd Edition is what got me thinking about a small-cap tilt.....
Last edited by Shaoya on Tue Sep 21, 2010 9:08 am, edited 2 times in total.

Flashes1
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Post by Flashes1 » Tue Sep 21, 2010 8:48 am

Ah, I missed the thread about Vanguard Limited Term Tax Exempt fund that shouldn't be in Taxable......is it because you still pay State taxes on the interest? Just to confirm? Interest from this fund is exempt from Fed taxes, yes?

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Shaoya
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Post by Shaoya » Tue Sep 21, 2010 9:09 am

What do others think of the suggestions given here?

livesoft
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Post by livesoft » Tue Sep 21, 2010 9:11 am

I think the suggestions to read the books are the best! :)

dbr
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Post by dbr » Tue Sep 21, 2010 9:18 am

Shaoya wrote:What do others think of the suggestions given here?
The comments about bonds seemed appropriate and you agree.

There is no computation of what is an appropriate degree of SCV tilt. The votes fall from none among the total market crowd to the example given by Livesoft of about half in some generally total market and about half in SCV. In previous discussions nobody seemed to think the volatility of a 100% SCV allocation would be tolerable or advisable, nor of one much more than 50% SCV.

Since the game is all about increasing the expected return from the portfolio, have you estimated a target expected return you think you want? If you don't have that, it would seem that planning a portfolio around increasing the return from what it would be with a different allocation doesn't have a rationale.

I would be interested in comments from the SCV tilting crowd about that point.

retiredjg
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Post by retiredjg » Tue Sep 21, 2010 9:24 am

Flashes1 wrote:Ah, I missed the thread about Vanguard Limited Term Tax Exempt fund that shouldn't be in Taxable......is it because you still pay State taxes on the interest? Just to confirm? Interest from this fund is exempt from Fed taxes, yes?
I think you misunderstood. A tax-exempt fund does belong in taxable.

But it is best not to hold any bonds in taxable if there is space to hold them in tax-advantaged. This poster has plenty of tax-advantaged space to hold all his bonds. Therefore, he has no need to hold any bonds (exempt or not) in his taxable space.

The Wizard
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Post by The Wizard » Tue Sep 21, 2010 9:26 am

If everybody tilted to SCV, then guess what?
Prices would be bid up considerably and it would be a DISadvantageous holding.
I presently hold both MidCap Growth and MidCap Value funds in the same family.
MCG is up 12.14% YTD.
MCV is up 7.24% YTD.
So where exactly is my value premium?

dbr
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Post by dbr » Tue Sep 21, 2010 9:30 am

livesoft wrote:I think the suggestions to read the books are the best! :)
Yes, me too on that one!

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Shaoya
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Post by Shaoya » Wed Sep 22, 2010 11:20 pm

dbr, you bring up an excellent point about the rationale for portfolio planning!
Thank you all, again, for your input. - Shaoya

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