## Grok Tip 15 You're doing it wrong: Figuring stock/bond split

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grok87
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### Grok Tip 15 You're doing it wrong: Figuring stock/bond split

Grok’s Tip #15: You’re doing it wrong: Figuring your stock/bond split

Figuring your asset allocation or stock/bond split may seem like pretty simple math. Let’s say your investment accounts total \$100 k with \$60 k in stocks and the other \$40 k in bonds/cash. So your stock/bond split is just 60/40 right? Not so fast. To better calculate your TRUE stock/bond split I would argue for considering these 3 things:
1) Tax deferred vs. taxable (i.e. after-tax) accounts
2) Social Security

1) Tax-deferred vs. taxable (i.e. after-tax) accounts. Let’s say the \$60 k in stocks is in a taxable account whereas the \$40 k in bonds is in a traditional 401k. The trouble is the \$40 k in bonds are pre-tax funds whereas the \$60 k in stocks was created out of after-tax funds. So if you had to liquidate everything today and your tax rate was 25% then you would net \$90 k after tax, with \$60 k from stocks (assuming no capital gains were realized) and \$30 k from bonds (i.e. \$40,000*75%). That works out to a 67/33 stock/bond split.

So the idea is to put all your accounts on the same tax basis. Personally I like to work with pre-tax figures so I gross up my taxable accounts to a pre-tax basis. Staying with the above example the \$60 k taxable stock account is really \$80 k (=\$60k/75%) on a pre-tax equivalent basis. The adjusted total is then \$120 k of which \$80 k stocks and \$40 k bonds, giving the same 67/33 split. I like working on a pre-tax basis for 2 reasons:

a) It’s easier to compare the amounts to your salary (which is of course pre-tax)
b) I think for most people, most of their money is in pre-tax accounts.

Now some may argue that it is your future tax rate in retirement that should be used and that this is too uncertain to estimate. It’s a valid concern. But be aware that just adding up your accounts ignoring their tax basis is equivalent to assuming you will have a 0% tax rate in retirement-that hardly seems realistic.

The wiki has some perspective on this as well:

2) Social Security: Many (young) investors decide to simply ignore social security. It is too far off and they think the trust fund may be depleted by then anyway. But older investors often find Social Security to be a very meaningful part of their retirement picture. Let’s say you are in mid-career with retirement on the horizon and you want to start factoring social security into your asset allocation- what should you do? Well the idea is to somehow estimate the present value of your future social security benefits and count that towards your bond allocation (pre-tax).

It sounds tricky but this is one of those issues that I think just being in the ballpark is good enough-at least for mid-career asset allocation purposes. Here's a quick and dirty way to factor in Social Security: Just add up your (and your employers) contributions over your working career to date. The basic assumption here is that the current value of your earned social security benefit is equivalent to the government having invested these contributions over time at a 0% nominal return. That may be pessimistic, but then again it may be realistic and it certainly makes the math easy!

It used to be easy to find your contribution history when SS mailed you a statement every year. If you have an older SS statement to work from you can keep the total up to date by looking at your more recent W2s. In case you can't find the info easily or can’t be bothered, here is a table by age of what the contributions would total assuming: 1) you started work at age 22, and 2) you earned the maximum social security wage each year (\$113.7 k for 2013).

As of 7/1/2013
Age…start work year….Sum of Max SS contributions through end 2013 (\$k)
25……2010……………………\$40.55 k
30……2005……………….……103.45
35……2000…………………….156.74
40……1995…………………….199.56
45……1990…………………….235.31
50….…1985……………………262.72
55……1980………………….…282.08

Most people would want to make 2 adjustments to use this table. First: interpolate based on your age or year you started work. Say you are 42.5 years old. Then you would average the figures for 40 and 45 and get \$217.4 k. Or say you are 45 now but didn’t start work till age 26, i.e. in 1994. Then you would interpolate between the \$199.56k and \$235.31k figures to get \$206.7k [=199.56 + (235.31-199.56)*(1/5)].

Second: estimate what percentage, on average, your salary has been relative to the maximum taxable social security wage. You can find the historical maximums here:

http://www.ssa.gov/planners/maxtax.htm
(note: in working out this average you shouldn’t take any credit for the years your salary is above the max). So again if you are now 42.5 and figure your salary over your career has been roughly 60% of the social security max salary then your estimated contributions (including those of your employer) would be 60%*217.4 or \$130.4k

3) Mortgage: Opinions vary on how to figure your mortgage into your asset allocation. Some argue to ignore it all together and some to treat it like a negative bond. My position is more middle of the road- basically I think its usually safe to ignore it early in life but as you get close to retirement you should start treating a mid-to-large mortgage like a negative bond. So how do we translate that intuition into a working rule of thumb? Let's lay out some assumptions and then work some examples:

Assumptions:
a) goal: payoff or defease mortgage before you retire. Let’s assume the (now) standard SS retirement age of 67 & then drop that to age 64 to build in a 3 year margin of safety(note: if you are targeting early retirement for other than health reasons, you may have less of a need to build in a margin of safety).

b) house to be paid off pro-rata over a 30 year period (i.e. standard mortgage period)
c) assume you just bought your house yesterday at fair market value (check Zillow http://www.zillow.com/).

So let’s look at some examples:

d) Let’s say you bought a house 3 years ago for \$400k. It’s now worth \$500k and you are age 40. Your current mortgage balance is \$275k. So basically your house is 45% paid off (again you calculate using the current \$500 k market value, and thus the unpaid amount is \$275k/\$500k = 55%). Your goal is to pay off your house prorata over the 30 years before age 64. So based on that, since you have 24 years to go, you would need to have only 20% of your house paid off (= 1 -24/30). So you are ahead of the game and your mortgage can be safely ignored. Note that according to the logic here, the \$400k purchase price and the fact that you bought your house 3 years ago are basically irrelevant. Only the current market value of the house, your age, and your mortgage balance matter.

e) Now let’s tweak that example and say that instead you are aged 55. So now you have only 9 years to go until the target payoff age of 64. So your house should be 70% paid off (=1-9/30) but as before your house is only 45% paid off. So you are 25% short or in dollar terms \$125k (=25%*\$500k). I would argue you should treat that \$125k as a negative bond in your asset allocation. And moreover that \$125k shortfall is an after-tax amount. Pre-tax it is \$167 k (again assuming a 25% tax rate).

4) Putting it all together: Let’s stay with part 3e) above and put that together with the info from 1) and 2). To sum up:

Taxable stocks = \$60 k = \$80 k pre-tax
401k bonds = \$40 k = \$40 k pre-tax
SS (est.) = \$282 k pre-tax bonds (assuming your salary was at the yearly SS max taxable salary on average)
Mortgage = negative \$125 k = negative \$167 k pre-tax bonds

So putting it all together, on a pre-tax basis you have:

Stocks = \$80 k
Bonds = \$40 k + \$282 k - \$167 k = \$155 k
Total pre-tax = \$235 k
Stock/bond split = 34/66
--------------------------
This Tip is part of a series of investment tips
Last edited by grok87 on Thu Oct 17, 2013 10:27 pm, edited 2 times in total.
RIP Mr. Bogle.
nyblitz
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

Grok,

You have done a great job with your Tip series. They are fun to read.

I'll play with my spreadsheets and see how your pretax idea changes the numbers.

Would you place high student loan debt similar to your thoughts on mortgage debt? That it can be ignored if you are on track to pay it off by retirement?

Thanks.
davidlukewilcox
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

Grok,

It seems like to be fair, if we're going to start calculating things like living expenses (mortgage) as part of our asset allocation (which I agree it should be to be realistic), we should also estimate other expenses like groceries, etc as part of this negative bond. If I spend \$100 per month on groceries, you could see that as a \$100 in perpetuity bond that I have to pay to the grocer to live. You can determine the present value of this bond given you have a discount rate. This is just like if I pay \$700 to the bank every month in the form of a mortgage, then we should count that as a negative bond.

However, also to be fair, we should count your job as a bond. A lot of people may be surprised about how exactly conservatively allocated they are when they do the math this way.
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

As noted earlier, grok87's tips are in the wiki: Grok's tips (now includes this tip)

While everything said here is accurate, I want to put this in perspective. We normally tell new investors to track asset allocations to the nearest 5%, as there's not that much difference in performance and tracking to more precise tolerances (like to the nearest 1%) is a lot more work.

Adding tax management and Social Security (especially when retirement is a long way off) adds another level of complexity. Discussions of what counts as a bond (human capital, mortgage, etc.), adds a few more moving parts to the picture.

My concern is that new investors may be intimidated by all of the extra work and may stop dead in their tracks. Rather, I think your tip is for experienced investors who want to fine-tune their portfolio.
To some, the glass is half full. To others, the glass is half empty. To an engineer, it's twice the size it needs to be.
Topic Author
grok87
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

nyblitz wrote:Grok,

You have done a great job with your Tip series. They are fun to read.

I'll play with my spreadsheets and see how your pretax idea changes the numbers.

Would you place high student loan debt similar to your thoughts on mortgage debt? That it can be ignored if you are on track to pay it off by retirement?

Thanks.
Thanks nyblitz,
I'm not an expert on the ins and outs of student loan debt. It seems to me that there are 4 issues that make it different than a mortgage:
1) It may not be tax deductible
2) it cannot be discharged in bankruptcy.
3) A house is generally an appreciating asset (not always to be sure) whereas student loans rely on your earning power which may go up for a while but ultimately will go down
4) the interest rate may be rather high on certain types of student loans

so i don't know. If it is at a low rate, tax deductible and you have a good secure job, i would probably not be in a rush to pay it off.
RIP Mr. Bogle.
Topic Author
grok87
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

davidlukewilcox wrote:Grok,

It seems like to be fair, if we're going to start calculating things like living expenses (mortgage) as part of our asset allocation (which I agree it should be to be realistic), we should also estimate other expenses like groceries, etc as part of this negative bond. If I spend \$100 per month on groceries, you could see that as a \$100 in perpetuity bond that I have to pay to the grocer to live. You can determine the present value of this bond given you have a discount rate. This is just like if I pay \$700 to the bank every month in the form of a mortgage, then we should count that as a negative bond.

However, also to be fair, we should count your job as a bond. A lot of people may be surprised about how exactly conservatively allocated they are when they do the math this way.
David,
I agree completely with your point. In fact I wrote a Tip on this a while back, Tip #8

Re job as a bond, I think it depends. Many folks have commented thought about the issue. I think someone put it this way. If you have a secured university tenured type position, then you could think of that like a bond. if you work on Wall street, where folks are habitually laid off at the worst possible time (recessions, etc.) then your job is more like a stock.
cheers,
RIP Mr. Bogle.
Topic Author
grok87
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

LadyGeek wrote:As noted earlier, grok87's tips are in the wiki: Grok's tips (now includes this tip)

While everything said here is accurate, I want to put this in perspective. We normally tell new investors to track asset allocations to the nearest 5%, as there's not that much difference in performance and tracking to more precise tolerances (like to the nearest 1%) is a lot more work.

Adding tax management and Social Security (especially when retirement is a long way off) adds another level of complexity. Discussions of what counts as a bond (human capital, mortgage, etc.), adds a few more moving parts to the picture.

My concern is that new investors may be intimidated by all of the extra work and may stop dead in their tracks. Rather, I think your tip is for experienced investors who want to fine-tune their portfolio.
RIP Mr. Bogle.
stlutz
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

Regarding parts 2 & 3: income and expenses are not bonds. Income, whether that comes from social security, a job etc. simply reduces the amount of assets you will need; more expenses increases the amount of assets you will need. It makes sense to factor these into a consideration of how much one should save and when one can stop working; they do not "count" as a particular type of investment, however.

Regarding part 1, this shows how much simpler it is to replicate at least your desired stock/bond split in each investment account. It saves you from all of these calculations and it makes rebalancing easier (even automatic in many 401Ks).

Perhaps the larger point is that asset allocation is actually an approximate decision, not a precise one. 64/36 is not somehow better because it has less round numbers than 60/40.
My concern is that new investors may be intimidated by all of the extra work and may stop dead in their tracks. Rather, I think your tip is for experienced investors who want to fine-tune their portfolio.
I disagree. "Fine tuning" has a way of morphing into return chasing, changing allocations based on the latest thread on bogleheads etc. Investors who do the best generally do less fine tuning; in fact, they generally don't even check on the value of their portfolios that often.

When it comes to asset allocation, I don't see how these types of complex formulas will really lead to better results than picking something that makes good sense and getting on with life.
Dutch
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

stlutz wrote:Regarding part 1, this shows how much simpler it is to replicate at least your desired stock/bond split in each investment account. It saves you from all of these calculations and it makes rebalancing easier (even automatic in many 401Ks).
Not disagreeing with the larger point you're making in your post, but this particular quote is simply bad advice. Tax efficient placement of investments is very important.
Dutch
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

grok87 wrote:Grok’s Tip #15: You’re doing it wrong: Figuring your stock/bond split

Figuring your asset allocation or stock/bond split may seem like pretty simple math. Let’s say your investment accounts total \$100 k with \$60 k in stocks and the other \$40 k in bonds/cash. So your stock/bond split is just 60/40 right? Not so fast. To better calculate your TRUE stock/bond split I would argue for considering these 3 things:
1) Tax deferred vs. taxable (i.e. after-tax) accounts
2) Social Security
I definitely agree with your first point of accounting for tax status.

While I don't necessarily disagree with your second and third point, I wonder how actionable that is (or should be) when it comes to ones asset allocation. Generalizing: the mortgage would be higher at a younger age and the built-up "value" of social security would be higher, later in life.

If you were to act on that, wouldn't that have you buying lots of (real) bonds when young(er) and lots of stocks when older?
stlutz
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

Not disagreeing with the larger point you're making in your post, but this particular quote is simply bad advice. Tax efficient placement of investments is very important.
But the best placement varies through time.

For example, right now TSM yields 1.79%; IT Treasury yields 1.38%. On TSM, I pay tax of Federal at 15%+ state at 5%= 20%. So, I give up .3864% in taxes now. With any capital gains I'll give up another 20% whenever I happen to sell.

With IT Treasury, I pay 28% in federal tax, meaning I give up .358% in taxes.

Not much difference for this year's taxes *(.03%). Longer term, I'm better off with TSM in, say a Roth. Of course, using munis in taxable makes bonds in taxable even more advantageous.

All of that said, dividend yields, interest rates, and tax rates will all change in the future. So, my calculations are good for now, but not for all of eternity.

I definitely agree that one can pick up a bit of extra return by optimizing for taxes, but be aware that the rules for such optimization will vary through time. Don't fool yourself into thinking that because you have optimized for this year that the best way to do it will be the same a few years from now.

More on the topic:

http://thefinancebuff.com/tax-efficienc ... olute.html
market timer
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

I agree with the idea of adjusting for taxes on retirement accounts--personally prefer using after-tax dollars that I spend as a numeraire rather than pre-tax that I earn, but this is a minor detail. A more important point is that you should also adjust for the value of tax deferral. If you do this, you might find \$1 in a traditional IRA/401K is worth the same or even more than \$1 in taxable, despite the future tax liability.
nedsaid
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

Agree or disagree, Grok always gives you food for thought.

1) I like that he is considering Social Security as part of his asset allocation. I don't do this myself, but I agree that all investors need to take this into account.

2) Grok also points out that balances in tax deferred accounts are inflated. We should give thought to what these account balances are after tax.

3) Some folks just a few years from retirement carry large mortgage balances. I am glad that Grok brings this issue up. I don't figure this into asset allocation though. Mortgage payments for me are just a part of the cost of living. Unless I live in a 100% paid for home, I will make payments on a mortgage either on my own or chances are on someone else's if I rent.

My approach is a bit simpler than that for figuring asset allocation. I just figure what is age appropriate for me. These factors Grok mentions are factored into my retirement planning though.
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

Included in tax-deferred accounts are pensions. Most pensions are taxable, therefore most folks should be taking into account the erosive tax effects on it - especially if pension is taxed at a higher rate than capital gains at time of realization.
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Doc
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

Dutch wrote:
stlutz wrote:Regarding part 1, this shows how much simpler it is to replicate at least your desired stock/bond split in each investment account. It saves you from all of these calculations and it makes rebalancing easier (even automatic in many 401Ks).
Not disagreeing with the larger point you're making in your post, but this particular quote is simply bad advice. Tax efficient placement of investments is very important.
There is a relatively simple way to accomplish your tax efficient placement and yet simplify the calculations.

First calculate your AA on a tax adjusted basis. Place your assets in the most efficient way. With this placement calculate your "unadjusted" AA. Use the unadjusted AA to do you rebalancing. You are going to be close enough. As mentioned previously AA is only an approximation and +/- 5% is not important.

When your taxable / tax advantage ratio occurs a large change repeat the calculation. Except for those whose annual contributions are a large percentage of their total portfolio you should only have to recalculate once every several years. And many of those who don't meet that criteria will be young and have a high equity AA in which case the exact calculation is not that important.
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.
less
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

Ask what your AA objective is. To me it is to allow me to earn the maximum returns without subjecting my gut to so much emotional turmoil that I act rashly and fail to realize the return potential. Under this objective, the existence of a pension or SS sometime in the future would have no impact ..... unless I was 100% certain it would exist and cover all my needs until death (which IMO is not a reasonable assumption). I probably would not be saving \$\$ and investing if that were true. So I am against including SS and pensions in the calculation.

Also the treatment of mortgages still allows for owing debt and owning debt at the same time .... adding risk and creating net losses. This AA methodology effectively promotes leverage of risky assets.
Angst
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

Hi Grok,

I always enjoy reading your tips. From my perspective though, I'm not really interested in going into such minutiae as this one entails. I use prospective social security benefits and employer's pension as a baseline from which I consider what minimum amount of money/income in addition that I need to survive. My AA follows through from there. I have a mix of Roth and Trad IRA savings as well as taxable. Future tax rates are unknown and I anticipate managing my withdrawals in ways to minimize the impact of taxes. I just can't imagine going into such detail as you are suggesting. But I can see people who enjoy this kind of detail doing so, I just don't think it is necessary for most people, at least not me!
grok87 wrote:It used to be easy to find your contribution history when SS mailed you a statement every year. If you have an older SS statement to work from you can keep the total up to date by looking at your more recent W2s.
Btw, you can still get these statements at http://www.ssa.gov/myaccount/ I agree that they are very useful and you can go here and get the exact same statements in pdf form that we used to get in the mail. Enjoy!

Angie
BrandonBogle
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

Interesting thought about adjusting for equivalent tax-basis across your accounts. I wonder if it hasn't bothered me in my own portfolio as I am planning to retire between 50-55. So I expect a number of years at effectively 0% doing Traditional -> Roth conversions and living off taxable.

As for counting your job or SS as a bond (I expect to pay off my house before early retirement), I have a pretty stable Engineering job, but it's a private enterprise that could always lay me off. I feel secure in my job, but you never know. SS I have always discounted that it won't be there (at least in any shape like it looks currently) when I retire. I am currently 30.
Rodc
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

Lots of threads on SS as a bond and mortgage as a negative bond and many disagree with your approach.

SS is clearly not a bond. You can twist up some logic if you want to make it kind of a little bit like a bond, but it is still not a bond. It is a stream of income that will reduce your need to produce income from your investments. Better to just treat it as such IMHO. Because it reduces the income you need to produce you might save less, you might decide to target higher returns via higher risk, you might decide you can target lower returns and lower risk. The consequences are all over the map depending on your goals and aspirations.

If one wants to consider a mortgage as a negative bond, which it is isn't, you have to include the associated stream of "income", otherwise it is like only considering the price of a bond but ignoring the interest paid. Should also include some estimate of growth in value. But then you need to consider a whole host of benefits and costs from imputed rent to taxes etc. Likely far too complicated to do well and too little benefit in the end from doing so.

No one knows their optimal stock-bond split to even +/- 10%. There is no need or likely any benefit for most people to turn this into rocket science, IMHO.
Last edited by Rodc on Fri Oct 18, 2013 12:10 pm, edited 1 time in total.
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

LadyGeek wrote:As noted earlier, grok87's tips are in the wiki: Grok's tips (now includes this tip)

While everything said here is accurate, I want to put this in perspective. We normally tell new investors to track asset allocations to the nearest 5%, as there's not that much difference in performance and tracking to more precise tolerances (like to the nearest 1%) is a lot more work.

Adding tax management and Social Security (especially when retirement is a long way off) adds another level of complexity. Discussions of what counts as a bond (human capital, mortgage, etc.), adds a few more moving parts to the picture.

My concern is that new investors may be intimidated by all of the extra work and may stop dead in their tracks. Rather, I think your tip is for experienced investors who want to fine-tune their portfolio.
Thanks Grok, I do appreciate your Tips and contributions, but I have to agree with ladygeek on this one. I think the added complexity of adding in what seems to me to be extraneous factors in the AA decision doesn't do anything but artificially skew the AA and the risk profile.

I don't see any advantage in including SS. I guess you could say it increases one's capacity to take risk, but at the same time it lowers the need and the withdrawal rate. Same with taxes--some portion of investible assets does not belong to the government unless we believe that the government will make up for any additional losses we incur on their portion of the portfolio It doesn't belong to the government until the taxes are paid. My withdraws always include enough extra to cover taxes and that's the end of it. Nothing there to suggest I should modify my AA. Using a mortgage in the AA calculation may throw the home into the risk pool and that's not an option I want.

Having made a case for not complicating the AA, I know that some investors prefer to use your method and that's fine, and I will say you've done a very nice job of presenting it. So I guess I'm really just trying to say is OK if you don't do it that way.

Paul
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Peter Foley
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

I'm in agreement with a couple others who stated that calculating the tax relative to asset placement provides a more realistic assessment of one's AA. I would tend to stop there because IMHO one's AA is a risk/reward indicator. I think one of its purposes is to reflect risk tolerance while the other is for investors to plan for a retirement "number". If one is 20/80, for example, that retirement number would need to be reached almost entirely by savings, not investment returns.

I think adding mortgage, SS, pensions, job security and the like overly complicates the calculation without providing the investor with much more useful guidance in either the accumulation or withdrawal phase.

Now I'm going to go back and recalculate my AA based on suggestion number 1. Thanks for the insight Grok.

Edit: Reporting back on the recalculation based on applying suggestion #1.

Methodology: I'm in the 15% bracket but would move to the 25% bracket if moved everything to taxable or Roth over a period of a few years. I took 85% of value of taxable capital gains and 100% of the rest of taxable. I used 75% of all deferred accounts and 100% of all Roths.
Net: AA changed from 44% to 46% equities. Not as much as I had anticipated.

My conclusion is that the mix of assets among tax deferred, tax free and taxable will impact this calculation as will the ratio of investment cost to capital gains in taxable.
Last edited by Peter Foley on Fri Oct 18, 2013 4:09 pm, edited 1 time in total.
Dutch
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

market timer wrote:I agree with the idea of adjusting for taxes on retirement accounts--personally prefer using after-tax dollars that I spend as a numeraire rather than pre-tax that I earn, but this is a minor detail. A more important point is that you should also adjust for the value of tax deferral. If you do this, you might find \$1 in a traditional IRA/401K is worth the same or even more than \$1 in taxable, despite the future tax liability.
I'm trying to understand what you mean by your last two sentences. Could you elaborate on this a bit more?

Are you referring to the value of deferral at the initial contribution moment, or the ongoing deferral of investment returns? And how would you approach a present value calculation/estimate?
FFFollower
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

I have taken your advise and here are my results just on including SS:

Age: 34
Current View of Investment AA: 77/23
After including SS: 57/43

By including SS i go from Age-11 in bonds to Age+9. That is a HUGE swing. Very eye opening. But at the same time, I am not going to do anything about it. I am not going to reduce my bond exposure. I guess I just have to wait for my portfolio to grow into the traditional age in FI allocation.
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

I think there are a number of different purposes for asset allocation numbers, each of which needs a different calculation in order to make it as relevant to the situation as possible.

For example, if you are looking to build a portfolio that takes advantage of diversification and MPT, then I think the best metric is simply the raw dollar assets invested in various asset classes. This is simply because that is what you are going to find in the research on the topic. However to understand the portfolio value variance for different allocation strategies THEN you will need to correct the research results for the tax liabilities. Inclusion of amounts other than the actual investments in this calculation can be misleading because they aren't going into the assets that are part of the portfolio.

Pensions and SS I think really don't need to be considered at all when calculating asset allocation. These are not investments, really they are much more like annuities. Their real effect is to reduce the amount of expenses that your investments have to cover after retirement. So suppose you figure that your expenses will be \$100K p/a after retirement, and you have \$50K in SS and \$30K in non-COLA'd pensions. Estimate a tax (say 25%) on the SS+pensions and then subtract the result over time from the expenses. This is what you need to make up, either from investments or by reducing expenses. This is really where tax estimation becomes important.

As far as mortgages go I'm firmly in the camp that treats housing as an expense. If you plan to downsize after retirement I suppose an estimate of the capital freed up by downsizing can go into the total assets available for investment post-retirement. But I would not include it in an estimate of the asset allocation for your current portfolio.
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grok87
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

stlutz wrote:Regarding parts 2 & 3: income and expenses are not bonds. Income, whether that comes from social security, a job etc. simply reduces the amount of assets you will need; more expenses increases the amount of assets you will need. It makes sense to factor these into a consideration of how much one should save and when one can stop working; they do not "count" as a particular type of investment, however.
Hi stlutz,
William Bernstein, in his book "the Intelligent Asset Allocator", recommends estimating the net present value of a pension/annuity and factoring it into your asset allocation:

With apologies to Warren Bufffet (he had a similar triad re employee stock options):

If an annuity is not a series of fixed income payments, then what is it?
If a series of fixed income payments is not a financial asset, then what is it?
If a financial asset shouldn't be included in your asset allocation, then where in the world does it go?

cheers,
RIP Mr. Bogle.
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

Fresh off the Bogleheads 12 convention, the very topic of "should I include Social Security in my bond allocation?" was extensively discussed in the Expert Panel Q & A session.

There were some disagreements, but I believe the majority opinion is that Social Security is like a defined benefit (pension) - it's an income source.

How you call it (stock, bond, fixed income, etc.) is not important. The point is to consider both income sources and your portfolio as one complete picture. You want to maximize your return to match your liability (expenses needed for retirement). Use your income streams first, then your portfolio to make up the difference.

I would not include Social Security or other income sources as part of asset allocation.

(Please correct me if I misunderstood the discussion.)
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archbish99
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

grok87 wrote:d) Let’s say you bought a house 3 years ago for \$400k. It’s now worth \$500k and you are age 40. Your current mortgage balance is \$275k. So basically your house is 45% paid off (again you calculate using the current \$500 k market value, and thus the unpaid amount is \$275k/\$500k = 55%). Your goal is to pay off your house prorata over the 30 years before age 64. So based on that, since you have 24 years to go, you would need to have only 20% of your house paid off (= 1 -24/30). So you are ahead of the game and your mortgage can be safely ignored. Note that according to the logic here, the \$400k purchase price and the fact that you bought your house 3 years ago are basically irrelevant. Only the current market value of the house, your age, and your mortgage balance matter.

e) Now let’s tweak that example and say that instead you are aged 55. So now you have only 9 years to go until the target payoff age of 64. So your house should be 70% paid off (=1-9/30) but as before your house is only 45% paid off. So you are 25% short or in dollar terms \$125k (=25%*\$500k). I would argue you should treat that \$125k as a negative bond in your asset allocation. And moreover that \$125k shortfall is an after-tax amount. Pre-tax it is \$167 k (again assuming a 25% tax rate).
So the other way to look at this is a "maximum" amount of desired leverage in your housing:
• Up to age 34: 100%
• Age 40: 80%
• Age 50: 47%
• Age 60: 13%
By that logic, anyone under age 34 should ignore their mortgage entirely, and anyone with 20% down before age 40 is ahead of the game. Is that a fair interpretation? Do you also advocate considering equity in advance of this "ideal" burndown line as a bond allocation?
I'm not a financial advisor, I just play one on the Internet.
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grok87
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

Dutch wrote:
grok87 wrote:Grok’s Tip #15: You’re doing it wrong: Figuring your stock/bond split

Figuring your asset allocation or stock/bond split may seem like pretty simple math. Let’s say your investment accounts total \$100 k with \$60 k in stocks and the other \$40 k in bonds/cash. So your stock/bond split is just 60/40 right? Not so fast. To better calculate your TRUE stock/bond split I would argue for considering these 3 things:
1) Tax deferred vs. taxable (i.e. after-tax) accounts
2) Social Security
I definitely agree with your first point of accounting for tax status.

While I don't necessarily disagree with your second and third point, I wonder how actionable that is (or should be) when it comes to ones asset allocation. Generalizing: the mortgage would be higher at a younger age and the built-up "value" of social security would be higher, later in life.

If you were to act on that, wouldn't that have you buying lots of (real) bonds when young(er) and lots of stocks when older?
Not sure about buying lots of real bonds when younger. Maybe buying more stock when you're older I guess.
Not sure if you caught my idea on the mortgages. Archbish99 sums it up nicely below. I think the amount of leverage you have in your house should decline as you age. Not exactly a revolutionary idea- but I have a formula! ("we have charts!")
RIP Mr. Bogle.
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grok87
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

market timer wrote:I agree with the idea of adjusting for taxes on retirement accounts--personally prefer using after-tax dollars that I spend as a numeraire rather than pre-tax that I earn, but this is a minor detail. A more important point is that you should also adjust for the value of tax deferral. If you do this, you might find \$1 in a traditional IRA/401K is worth the same or even more than \$1 in taxable, despite the future tax liability.
Interesting statement. Care to back it up?
RIP Mr. Bogle.
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

Agree or disagree, Grok always gives you food for thought.
Part-Owner of Texas | | “The CMH-the Cost Matters Hypothesis -is all that is needed to explain why indexing must and will work… Yes, it is that simple.” John C. Bogle
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grok87
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

nedsaid wrote:Agree or disagree, Grok always gives you food for thought.

1) I like that he is considering Social Security as part of his asset allocation. I don't do this myself, but I agree that all investors need to take this into account.

2) Grok also points out that balances in tax deferred accounts are inflated. We should give thought to what these account balances are after tax.

3) Some folks just a few years from retirement carry large mortgage balances. I am glad that Grok brings this issue up. I don't figure this into asset allocation though. Mortgage payments for me are just a part of the cost of living. Unless I live in a 100% paid for home, I will make payments on a mortgage either on my own or chances are on someone else's if I rent.

My approach is a bit simpler than that for figuring asset allocation. I just figure what is age appropriate for me. These factors Grok mentions are factored into my retirement planning though.
Thanks nedsaid. Your point 3) about the folks near retirement with large mortgage balances is a good one. That does worry me. That's one of the main reasons i wrote this tip, to try to give folks some benchmark about whether their mortgage was on track. So many people have refinanced, etc. it seems like its easy to lose track.
RIP Mr. Bogle.
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grok87
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

Grt2bOutdoors wrote:Included in tax-deferred accounts are pensions. Most pensions are taxable, therefore most folks should be taking into account the erosive tax effects on it - especially if pension is taxed at a higher rate than capital gains at time of realization.
agree. pensions can be tricky to value because high value pensions have some credit risk- i.e. the PBGC only guarantees up to a certain level
RIP Mr. Bogle.
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grok87
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

Doc wrote:
Dutch wrote:
stlutz wrote:Regarding part 1, this shows how much simpler it is to replicate at least your desired stock/bond split in each investment account. It saves you from all of these calculations and it makes rebalancing easier (even automatic in many 401Ks).
Not disagreeing with the larger point you're making in your post, but this particular quote is simply bad advice. Tax efficient placement of investments is very important.
There is a relatively simple way to accomplish your tax efficient placement and yet simplify the calculations.

First calculate your AA on a tax adjusted basis. Place your assets in the most efficient way. With this placement calculate your "unadjusted" AA. Use the unadjusted AA to do you rebalancing. You are going to be close enough. As mentioned previously AA is only an approximation and +/- 5% is not important.

When your taxable / tax advantage ratio occurs a large change repeat the calculation. Except for those whose annual contributions are a large percentage of their total portfolio you should only have to recalculate once every several years. And many of those who don't meet that criteria will be young and have a high equity AA in which case the exact calculation is not that important.
Thanks Doc, that's an interesting idea.
RIP Mr. Bogle.
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grok87
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

less wrote:To add to LadyGeek's argument against including pensions and SS ...
Ask what your AA objective is. To me it is to allow me to earn the maximum returns without subjecting my gut to so much emotional turmoil that I act rashly and fail to realize the return potential. Under this objective, the existence of a pension or SS sometime in the future would have no impact ..... unless I was 100% certain it would exist and cover all my needs until death (which IMO is not a reasonable assumption). I probably would not be saving \$\$ and investing if that were true. So I am against including SS and pensions in the calculation.

Also the treatment of mortgages still allows for owing debt and owning debt at the same time .... adding risk and creating net losses. This AA methodology effectively promotes leverage of risky assets.
Thanks less. I like your phrase "owing debt and owning debt at the same time"
So I take it you are in the "a mortgage should always be treated like a negative bond" camp?
RIP Mr. Bogle.
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grok87
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

Angst wrote:Hi Grok,

I always enjoy reading your tips. From my perspective though, I'm not really interested in going into such minutiae as this one entails. I use prospective social security benefits and employer's pension as a baseline from which I consider what minimum amount of money/income in addition that I need to survive. My AA follows through from there. I have a mix of Roth and Trad IRA savings as well as taxable. Future tax rates are unknown and I anticipate managing my withdrawals in ways to minimize the impact of taxes. I just can't imagine going into such detail as you are suggesting. But I can see people who enjoy this kind of detail doing so, I just don't think it is necessary for most people, at least not me!
grok87 wrote:It used to be easy to find your contribution history when SS mailed you a statement every year. If you have an older SS statement to work from you can keep the total up to date by looking at your more recent W2s.
Btw, you can still get these statements at http://www.ssa.gov/myaccount/ I agree that they are very useful and you can go here and get the exact same statements in pdf form that we used to get in the mail. Enjoy!

Angie
Thanks Angie and thanks for the link. That looks very useful.
(Go Birds!)
cheers,
RIP Mr. Bogle.
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grok87
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

BrandonBogle wrote:Interesting thought about adjusting for equivalent tax-basis across your accounts. I wonder if it hasn't bothered me in my own portfolio as I am planning to retire between 50-55. So I expect a number of years at effectively 0% doing Traditional -> Roth conversions and living off taxable.

As for counting your job or SS as a bond (I expect to pay off my house before early retirement), I have a pretty stable Engineering job, but it's a private enterprise that could always lay me off. I feel secure in my job, but you never know. SS I have always discounted that it won't be there (at least in any shape like it looks currently) when I retire. I am currently 30.
Thanks BrandonBogle,
That's an interesting idea about how to achieve a 0% tax rate in retirement. Can you explain how it works?
RIP Mr. Bogle.
Doc
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

grok87 wrote:If an annuity is not a series of fixed income payments, then what is it?
If a series of fixed income payments is not a financial asset, then what is it?
If a financial asset shouldn't be included in your asset allocation, then where in the world does it go?
The problem is that you cannot sell the SS annuity. And a financial asset is typically thought of as something that can be bought and sold.

With that in mind SS is an income stream and should not be included in your AA.

But that makes me rethink the mortgage. I always though of a mortgage as a housing expense and therefore not a financial asset. But I can pay off that mortgage (buy it) or refinance (sell it) so it does fit the negative bond definition and maybe should be considered in ones AA.

Thankfully my mortgage is paid off. But does that mean I have a "bond" (with a zero coupon) equal to 80% of my home value. Or is it a bond with a "coupon" equal to what I would have to pay for rent? Aaarrgghhh.
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

LadyGeek wrote:Fresh off the Bogleheads 12 convention, the very topic of "should I include Social Security in my bond allocation?" was extensively discussed in the Expert Panel Q & A session.

There were some disagreements, but I believe the majority opinion is that Social Security is like a defined benefit (pension) - it's an income source.

How you call it (stock, bond, fixed income, etc.) is not important. The point is to consider both income sources and your portfolio as one complete picture. You want to maximize your return to match your liability (expenses needed for retirement). Use your income streams first, then your portfolio to make up the difference.

I would not include Social Security or other income sources as part of asset allocation.

(Please correct me if I misunderstood the discussion.)
This is what makes sense to me as well. You consider pensions when setting your asset allocation, as opposed to them being part of your asset allocation.

These are great tips, and I really agree with all of them. I was actually just discussing the inflated value of tax-deferred investments in a Canadian context here.

My plan for the house is this: Since I had an allocation that made sense before buying the house, initially I am going to stick with that allocation, and consider both the house and mortgage part of it. (House is a RRB, mortgage a negative bond. If I wanted to be really technical I could look at the saved rent and interest rates on RRBs to set the house value, but I figure a conservative market value is close enough.) Once a significant chunk of the mortgage is paid off, I'll shift my asset allocation to take into account the fact that I own a house (and so my income needs are lower), and will then only take into account the mortgage as part of my AA, until it's paid off completely.
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grok87
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

Rodc wrote:
If one wants to consider a mortgage as a negative bond, which it is isn't, you have to include the associated stream of "income", otherwise it is like only considering the price of a bond but ignoring the interest paid. Should also include some estimate of growth in value. But then you need to consider a whole host of benefits and costs from imputed rent to taxes etc. Likely far too complicated to do well and too little benefit in the end from doing so.
Thanks- that's an interesting point. So I guess the other way to do it would be to treat the full value of your mortgage as a negative bond and then (somehow) add in the market value of your house into your asset allocation. That approach would seem to have a lot of issues though...
RIP Mr. Bogle.
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

Hi stlutz,
William Bernstein, in his book "the Intelligent Asset Allocator", recommends estimating the net present value of a pension/annuity and factoring it into your asset allocation:
That hardly makes it right and certainly does not make it at all required.

If one is careful they can sensibly count a pension as a bond. In fact if twin A in otherwise identical circumstances as twin B counts his pension as a bond and his brother counts it as an income stream and they have the same desire, interest, etc in risk and income they should come to the same asset allocation.

For this reason I think it is a waste of time to do something artificial like pretend a pension is a bond, and in inexpert hands might cause more problems that it solves. If someone wants to do this fine, but I think it is wrong to tell people it is some important thing to do and if they don't they are doing it wrong, as you are doing in the OP. You greatly overstate the case for pretending a pension is something it is not.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

grok87 wrote:
Rodc wrote:
If one wants to consider a mortgage as a negative bond, which it is isn't, you have to include the associated stream of "income", otherwise it is like only considering the price of a bond but ignoring the interest paid. Should also include some estimate of growth in value. But then you need to consider a whole host of benefits and costs from imputed rent to taxes etc. Likely far too complicated to do well and too little benefit in the end from doing so.
Thanks- that's an interesting point. So I guess the other way to do it would be to treat the full value of your mortgage as a negative bond and then (somehow) add in the market value of your house into your asset allocation. That approach would seem to have a lot of issues though...
It does have a lot of issues, but if you are going to add it in your asset allocation either do it well or don't do it. Personally for this reason, difficulty of rebalancing my house etc. I choose to leave it out of asset allocation considerations but do keep it in net worth.
We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.
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grok87
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

Doc wrote:
grok87 wrote:If an annuity is not a series of fixed income payments, then what is it?
If a series of fixed income payments is not a financial asset, then what is it?
If a financial asset shouldn't be included in your asset allocation, then where in the world does it go?
The problem is that you cannot sell the SS annuity. And a financial asset is typically thought of as something that can be bought and sold.

With that in mind SS is an income stream and should not be included in your AA.

But that makes me rethink the mortgage. I always though of a mortgage as a housing expense and therefore not a financial asset. But I can pay off that mortgage (buy it) or refinance (sell it) so it does fit the negative bond definition and maybe should be considered in ones AA.

Thankfully my mortgage is paid off. But does that mean I have a "bond" (with a zero coupon) equal to 80% of my home value. Or is it a bond with a "coupon" equal to what I would have to pay for rent? Aaarrgghhh.
Well again if you take my approach, i'm pretty sure that in your situation (retired) no adjustment would be needed (since your mortgage is paid off). But if you for some reason took out a new mortgage then I would argue to treat it like a negative bond.
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

ClosetIndexer wrote:These are great tips, and I really agree with all of them. I was actually just discussing the inflated value of tax-deferred investments in a Canadian context here.
I think you raise a point of distinction. Grok87 is discussing how to modify your asset allocation based on taxation. Take a look at the top of the article: Put Your Assets in Their Place

There's an entire subject on doing just that; it's called asset location. From the article:
Asset location refers to the type of account you use to hold the stocks, bonds, cash and real estate in your portfolio. It’s important because the growth and income from your investments are treated in different ways by the taxman.
The Bogleheads wiki touches on the subject: Tax basics (under "External links") which goes to the forum archives: Asset Location ( ---> Wiki) (Feb 23, 2007)

Asset allocation (percentages) and asset location (categories) are intertwined. The idea is to minimize taxes (location) simultaneously with risk (allocation). Which is more important? Allocation is higher priority than taxes. I believe grok87 assumes that you have everything in the right location first, then consider taxes.

See: Principles of tax-efficient fund placement (US), Tax-Efficient Investing (Canadian)

===========================
Definitions of TFSA, GIC, RRSP, etc. can be found in finiki, the Canadian financial Wiki.
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grok87
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

pkcrafter wrote:
Thanks Grok, I do appreciate your Tips and contributions, but I have to agree with ladygeek on this one. I think the added complexity of adding in what seems to me to be extraneous factors in the AA decision doesn't do anything but artificially skew the AA and the risk profile.

Paul
Thanks for the kind words Paul,
Well i think the "artificially skew the AA and the risk profile" can be played both ways.
Consider this example:
Let's say that a married couple is near retirement. They have house with no mortgage worth \$400 k and \$500 k in taxable savings with a 50/50 stock/bond split.
They decide to move to the coast and buy a similar house for \$400 k but this time take out a mortgage for \$320 k. So now they have to figure out what to do with the \$320 k in cash that they netted from their move. Do they invest it 50/50 in stocks/bonds? That seems like a bad idea to me- they effectively would be making a leveraged investment in stocks (borrowing money against their house to invest in stocks). I would argue that they should put it all in bonds. This is what I meant by defeasing the mortgage
http://financial-dictionary.thefreedict ... defeasance
i.e. matching the amount of the mortgage with an equivalent amount of bonds set aside in their portfolio.
So I guess my point is that if a married couple close to retirement ignores a large mortgage on their house (i.e. does not factor it into their asset allocation), then THAT is artificially skewing their asset allocation and their risk profile.
cheers,
RIP Mr. Bogle.
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grok87
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

Peter Foley wrote:I'm in agreement with a couple others who stated that calculating the tax relative to asset placement provides a more realistic assessment of one's AA. I would tend to stop there because IMHO one's AA is a risk/reward indicator. I think one of its purposes is to reflect risk tolerance while the other is for investors to plan for a retirement "number". If one is 20/80, for example, that retirement number would need to be reached almost entirely by savings, not investment returns.

I think adding mortgage, SS, pensions, job security and the like overly complicates the calculation without providing the investor with much more useful guidance in either the accumulation or withdrawal phase.

Now I'm going to go back and recalculate my AA based on suggestion number 1. Thanks for the insight Grok.

Edit: Reporting back on the recalculation based on applying suggestion #1.

Methodology: I'm in the 15% bracket but would move to the 25% bracket if moved everything to taxable or Roth over a period of a few years. I took 85% of value of taxable capital gains and 100% of the rest of taxable. I used 75% of all deferred accounts and 100% of all Roths.
Net: AA changed from 44% to 46% equities. Not as much as I had anticipated.

My conclusion is that the mix of assets among tax deferred, tax free and taxable will impact this calculation as will the ratio of investment cost to capital gains in taxable.
Peter,
you're welcome. Interesting how it worked out in your case. I agree with your conclusion. I suspect you've got a bunch of bonds in your Roth.
cheers,
Last edited by grok87 on Fri Oct 18, 2013 8:10 pm, edited 1 time in total.
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

grok87 wrote:...Do they invest it 50/50 in stocks/bonds? That seems like a bad idea to me- they effectively would be making a leveraged investment in stocks (borrowing money against their house to invest in stocks). I would argue that they should put it all in bonds. This is what I meant by defeasing the mortgage
http://financial-dictionary.thefreedict ... defeasance
i.e. matching the amount of the mortgage with an equivalent amount of bonds set aside in their portfolio.
Is this similar to liability matching, which is in the wiki as: Matching strategy?
To some, the glass is half full. To others, the glass is half empty. To an engineer, it's twice the size it needs to be.
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grok87
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

FFFollower wrote:I have taken your advise and here are my results just on including SS:

Age: 34
Current View of Investment AA: 77/23
After including SS: 57/43

By including SS i go from Age-11 in bonds to Age+9. That is a HUGE swing. Very eye opening. But at the same time, I am not going to do anything about it. I am not going to reduce my bond exposure. I guess I just have to wait for my portfolio to grow into the traditional age in FI allocation.
Thanks FFFollower.
RIP Mr. Bogle.
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grok87
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

Ged wrote:I think there are a number of different purposes for asset allocation numbers, each of which needs a different calculation in order to make it as relevant to the situation as possible.

For example, if you are looking to build a portfolio that takes advantage of diversification and MPT, then I think the best metric is simply the raw dollar assets invested in various asset classes. This is simply because that is what you are going to find in the research on the topic. However to understand the portfolio value variance for different allocation strategies THEN you will need to correct the research results for the tax liabilities. Inclusion of amounts other than the actual investments in this calculation can be misleading because they aren't going into the assets that are part of the portfolio.

Pensions and SS I think really don't need to be considered at all when calculating asset allocation. These are not investments, really they are much more like annuities. Their real effect is to reduce the amount of expenses that your investments have to cover after retirement. So suppose you figure that your expenses will be \$100K p/a after retirement, and you have \$50K in SS and \$30K in non-COLA'd pensions. Estimate a tax (say 25%) on the SS+pensions and then subtract the result over time from the expenses. This is what you need to make up, either from investments or by reducing expenses. This is really where tax estimation becomes important.

As far as mortgages go I'm firmly in the camp that treats housing as an expense. If you plan to downsize after retirement I suppose an estimate of the capital freed up by downsizing can go into the total assets available for investment post-retirement. But I would not include it in an estimate of the asset allocation for your current portfolio.
Thanks Ged. Good point about the downsizing scenario.
RIP Mr. Bogle.
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grok87
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### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

LadyGeek wrote:Fresh off the Bogleheads 12 convention, the very topic of "should I include Social Security in my bond allocation?" was extensively discussed in the Expert Panel Q & A session.

There were some disagreements, but I believe the majority opinion is that Social Security is like a defined benefit (pension) - it's an income source.

How you call it (stock, bond, fixed income, etc.) is not important. The point is to consider both income sources and your portfolio as one complete picture. You want to maximize your return to match your liability (expenses needed for retirement). Use your income streams first, then your portfolio to make up the difference.

I would not include Social Security or other income sources as part of asset allocation.

(Please correct me if I misunderstood the discussion.)
Thanks LadyGeek. Sounds like it was a great convention.
RIP Mr. Bogle.
Topic Author
grok87
Posts: 9161
Joined: Tue Feb 27, 2007 9:00 pm

### Re: Grok Tip 15 You're doing it wrong: Figuring stock/bond s

archbish99 wrote:
grok87 wrote:d) Let’s say you bought a house 3 years ago for \$400k. It’s now worth \$500k and you are age 40. Your current mortgage balance is \$275k. So basically your house is 45% paid off (again you calculate using the current \$500 k market value, and thus the unpaid amount is \$275k/\$500k = 55%). Your goal is to pay off your house prorata over the 30 years before age 64. So based on that, since you have 24 years to go, you would need to have only 20% of your house paid off (= 1 -24/30). So you are ahead of the game and your mortgage can be safely ignored. Note that according to the logic here, the \$400k purchase price and the fact that you bought your house 3 years ago are basically irrelevant. Only the current market value of the house, your age, and your mortgage balance matter.

e) Now let’s tweak that example and say that instead you are aged 55. So now you have only 9 years to go until the target payoff age of 64. So your house should be 70% paid off (=1-9/30) but as before your house is only 45% paid off. So you are 25% short or in dollar terms \$125k (=25%*\$500k). I would argue you should treat that \$125k as a negative bond in your asset allocation. And moreover that \$125k shortfall is an after-tax amount. Pre-tax it is \$167 k (again assuming a 25% tax rate).
So the other way to look at this is a "maximum" amount of desired leverage in your housing:
• Up to age 34: 100%
• Age 40: 80%
• Age 50: 47%
• Age 60: 13%
By that logic, anyone under age 34 should ignore their mortgage entirely, and anyone with 20% down before age 40 is ahead of the game. Is that a fair interpretation? Do you also advocate considering equity in advance of this "ideal" burndown line as a bond allocation?
Hi archbish,
I agree with your interpretation. That's a good way to think about it.
On your last question, yeah that thought has crossed my mind. That if you are ahead of target on paying down your mortgage then maybe you can think of that as a positive bond allocation. But I guess I would advise against it. The trouble is you may not be able to tap into that money when you need it. Your house is an illiquid asset. And you may not be able to take money out (via a HELOC) when you need it if you have lost your job etc.

cheers,
RIP Mr. Bogle.