Do you "Tax Adjust" your Asset Allocation (Pre vs Roth, etc)

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.

In your hypothetical account described in the post below, do you consider your AA:

50% Bond / 50% Stocks
45
64%
45% Bonds / 55% Stock
17
24%
Undecided
4
6%
Something Else for a concrete mathematical reason (please explain)
4
6%
 
Total votes: 70

Topic Author
Doc7
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Do you "Tax Adjust" your Asset Allocation (Pre vs Roth, etc)

Post by Doc7 »

I've asked similar questions in the past and just checking the current feelings around this:


For simplicity sake let us consider that you have a 2 fund portfolio. Total Bond and Total Stock. Both are available with the same ER and identical (zero) fees in your Vanguard Roth IRA, and your employers 401K which offers the same Vanguard shares (identical class).

You currently have $50,000 in your Roth IRA, and $100,000 in your 401k to which you contribute on a Pre-Tax basis (traditional).


Your Roth IRA is set up as follows:
$50,000 in Total Stock Market.

Your 401k is set up as follows:
$25,000 in Total Stock Market.
$75,000 in Total Bond.

You estimate your post-retirement marginal tax bracket will be 25%.

What is your asset allocation right now, for rebalancing purposes? Is it:

50% Bond / 50% Stocks (75K each)

or is it:

45% Bonds / 55% Stocks, because you discount the 401K balances of each by 25% and end up with Tax Adjusted dollars of $68,750 in Stocks and $56,250 in Bonds?

or is it something else altogether because I am doing the math wrong?


I rebalance my accounts using the latter method.

Thank you!
Last edited by Doc7 on Sun Jul 20, 2014 3:35 pm, edited 1 time in total.
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hoppy08520
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by hoppy08520 »

I voted 50/50, but that's partly because the way my accounts are configured, the theoretical tax-adjusted AA is about the same. I suppose that one who has all their bonds in tax-advantaged and all/most of their stocks in taxable might think a little differently.

There's a wiki page on this btw:

http://www.bogleheads.org/wiki/Tax-adju ... allocation

and if you search the archives, you'll see threads on this from time to time although these threads can be hard to find because there aren't really clear search terms to use that stand out from all the other posts.

From what I've read, the consensus is "don't fret too much about this" and that it's not as straightforward as a simple calculation.
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PriceOfFreedom
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by PriceOfFreedom »

I think your math may be incorrect. I compute it to be 55 stocks / 45 bonds ($68,750 stocks, $56,250 bonds). I always discount the value of my deferred tax holdings by the expected marginal tax rate at retirement (I consider the RMDs to be the "last dollars" added to my income). Of course, the latter is an estimate since tax rates will probably change over time.
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bertilak
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by bertilak »

50/50 because I look at it from a full portfolio view and consider the cash flow the portfolio needs to provide. The portfolio's AA has little or nothing to do with how I will spend the money (taxes vs the "good stuff"). It is only concerned about the risk/reward ratio and its ability to supply the needed cash flow.

Taxes are taken into account when I calculate how much cash flow I will need. They are just another expense (like mortgage payments). Just as I don't try to normalize my AA based on how much I will eventually spend on mortgage I also don't do so based on how much I will spend on taxes.

No matter where I take the money from (Roth or traditional) I will preserve the overall 50/50 AA.
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TimeRunner
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by TimeRunner »

What PriceOfFreedom said. Related thread of which I was OP: http://www.bogleheads.org/forum/viewtop ... 0&t=135649 , with some varying opinions.
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by mwm158 »

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Taylor Larimore
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by Taylor Larimore »

What is your asset allocation right now, for rebalancing purposes? Is it:

50% Bond / 50% Stocks (75K each)

or is it:

55% Bonds / 45% Stocks
Doc7:

I don't even know my best asset-allocation within 5%. I make no adjustments for (unknown) future taxes.

Strive for simplicity--not complexity.

Best wishes.
Taylor
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MrMatt2532
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by MrMatt2532 »

I didn't vote because you messed up the math a little bit. I would consider it 55% stocks, 45% bonds.
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Doc7
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by Doc7 »

Yes, I mixed up the math, and I am correcting it now. This makes my poll results very skewed and for that I apologize.

I do like Taylor's comment.
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by sunnyday »

I don't and based on this poll - http://www.bogleheads.org/forum/viewtop ... 0&t=131310 most Bogleheads do not

Taylor Larimore wrote:
What is your asset allocation right now, for rebalancing purposes? Is it:

50% Bond / 50% Stocks (75K each)

or is it:

55% Bonds / 45% Stocks
Doc7:

I don't even know my best asset-allocation within 5%. I make no adjustments for (unknown) future taxes.

Strive for simplicity--not complexity.

Best wishes.
Taylor
I always enjoy reading your advice Taylor. I find it refreshing because it's often a reminder that there's no need to over complicate things -- keep it simple and stay the course. Thank you for all of your contributions :beer
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by sambb »

I personally don't adjust asset location based on bonds/stocks, etc. In other words, contrary to several here, I don't put all my bonds in tax advantaged. So, hence, I maintain an equal allocation in all accts (roths, tax deferred, and taxable all are 60/40)

However, i would find it very interesting if there are people who do place all bonds in tax deferred, but then they do not account for taxes for asset allocation purposes. This seems paradoxical.
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by MrMatt2532 »

Frankly, I don't buy the "don't overcomplicate" argument here. A dollar in a roth is definitely worth more than a dollar in a traditional ira/401k. I agree that you shouldn't waste hours predicting future tax rates and guessing which bracket you are going to fall into, however, almost any correction is better than no correction.
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by letsgobobby »

Doc7,

If one concluded that his AA was 'actually' 55/45, rather than 50/50, how would that impact his decision-making?
Taylor Larimore wrote: Doc7:

I don't even know my best asset-allocation within 5%. I make no adjustments for (unknown) future taxes.

Strive for simplicity--not complexity.

Best wishes.
Taylor
I agree with Taylor 100% but I voted "something else altogether" because in addition to Taylor's excellent post, I just don't believe your future marginal tax rate will be 25%; or more to the point, I believe you that it could start out at 25% but is likely to fluctuate quite a bit and probably a lot lower in late retirement and based on all sorts of other factors such as inheritances and charitable giving and deductible health care expenses etc and for all of those reasons, even if I were to adjust my AA, it would not be by 5% but by some much smaller number like 2% and then we are right back to Taylor's comment which is, essentially, that it just doesn't matter in your hypothetical scenario, and my question, which is if it did matter, how does it matter?

I could imagine a scenario where it could matter, for someone who had a much less balanced portfolio, or had a weird asset location thing going on (like expects to be 50% marginal tax bracket in retirement and has $75k bonds in a 401k and $75k stocks in a Roth IRA) and then maybe a little adjusting would be warranted. I'm not saying one should never adjust. I'm asking to what end one needs to adjust; and proposing that for most people no adjustment is necessary or warranted because being off my 3% one way or another doesn't make a lick of difference in the end. Extreme investors, YMMV.
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by bertilak »

sambb wrote:I personally don't adjust asset location based on bonds/stocks, etc. In other words, contrary to several here, I don't put all my bonds in tax advantaged. So, hence, I maintain an equal allocation in all accts (roths, tax deferred, and taxable all are 60/40)

However, i would find it very interesting if there are people who do place all bonds in tax deferred, but then they do not account for taxes for asset allocation purposes. This seems paradoxical.
The portfolio (and its AA) does not know how much will be spent on taxes any more than how much will be spent on anything else. If the purpose of AA is to control the risk/reward ratio (per EMH, MPT, efficient Frontier or whatever) then it makes no difference how the money will ultimately be spent. All that risk, reward, correlation, volatility, etc. is happening with pre-spent money, be that pre-tax or pre-mortgage -- it's all the same in that it makes no difference. Same with expense ratios, advisor fees (AUM) or anything else you want to consider.
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by Kevin M »

Although I agree that mathematically it makes sense to tax-adjust, I'm too lazy to do it, so I voted 50/50 based on what I actually do. Similarly, I don't count part of my corporate bond (even high yield bond) allocation as equity. I just figure my portfolio is somewhat riskier than the unadjusted AA indicates, but since my stock allocation is only 30% of portfolio, that's probably OK.

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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by sunnyday »

MrMatt2532 wrote:Frankly, I don't buy the "don't overcomplicate" argument here. A dollar in a roth is definitely worth more than a dollar in a traditional ira/401k. I agree that you shouldn't waste hours predicting future tax rates and guessing which bracket you are going to fall into, however, almost any correction is better than no correction.
The bolded is not necessarily correct if you can convert a TIRA to roth and pay 0% in taxes. Also, any correction may not be better than no correction if the correction is an over estimate :) And how much of a difference in ones AA does it actually make -- close to nothing probably for most people.
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by gkaplan »

I don't tax-adjust my portfolio, because (1) I am math challenged to a great extent, and (2) It's too much trouble, at least for me.

Given most of the responses in this thread, however, perhaps I should have a more aggressive allocation, since my rollover IRA consists entirely of fixed income.
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Kevin M
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by Kevin M »

gkaplan wrote:I don't tax-adjust my portfolio, because (1) I am math challenged to a great extent, and (2) It's too much trouble, at least for me.

Given most of the responses in this thread, however, perhaps I should have a more aggressive allocation, since my rollover IRA consists entirely of fixed income.
If your rollover IRA is a traditional IRA, and your other investments are in Roth and taxable accounts, then I think the idea is that you already have a "more aggressive" (i.e., riskier) allocation than you may think. This is because accounting for the taxes you are likely to pay on the tIRA distributions essentially lowers the amount you actually have in fixed income in your tIRA (the "your share, government's share" paradigm).

Perhaps this is what you meant, but saying "should have" sounds like changing your AA to make it riskier than it already is.

But you also have to tax-adjust taxable account holdings if you follow this approach, so the difference may not be as large with just tax-deferred and taxable accounts (i.e., no Roths). I think that Roth and any other truly tax-free accounts are the only accounts that don't warrant any tax adjustment.

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Doc
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by Doc »

Kevin M wrote: But you also have to tax-adjust taxable account holdings if you follow this approach, so the difference may not be as large with just tax-deferred and taxable accounts (i.e., no Roths). I think that Roth and any other truly tax-free accounts are the only accounts that don't warrant any tax adjustment. Kevin
The tax adjustment for a taxable account is likely much smaller than for a tIRA/401k. You only need to adjust for the potential capital gains on unrealized appreciation. Not only is the tax rate lower but it also applies to only a portion of the account balance not the whole thing.

Often the taxable account is not a lot different from a ROTH if you have done any significant tax loss (or gain) harvesting during your investment lifetime.
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by Kevin M »

Doc wrote:
Kevin M wrote:<snip> so but the difference may not be as large with just tax-deferred and taxable accounts (i.e., no Roths).
The tax adjustment for a taxable account is likely much smaller than for a tIRA/401k.
Yes, that's what I was getting at (I edited my quote to say what I meant); thanks for adding the clarifying details.

Kevin
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MathWizard
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by MathWizard »

I don't for two reasons:

Age may have something to do with it. For a younger person #1 may not apply.
1) The ROTH is small relative to tax deferred, so the adjustment would not change things much.

I've been contributing to tax deferred for much longer than the ROTH has been available. ROTH max limits
started out at just $2K, and so the low max contribution limits have meant that my tax deferred is much larger
than the ROTH even though I've max out ROTH almost every year. Even now, my tax deferred gains alone exceed
the max ROTH contribution for both my wife and I. Thus adjusting for the R

2) My expected average tax rate in retirement is going to be small after age 70. Much of it (maybe all) will be at the 0% federal.
E.g Assume at age 70 you have $40K in SS. Then SS is not taxed at all until your income from tax-deferred + $20K exceeds
32K (for MFJ filing status). This means if you take $12K from tax-deferred, and have no non-taxable munis,
none of the SS is taxable, and neither is any ROTH withdrawals, so you have an AGI of $12K.
After Standard Deduction and 2 personal exemptions, this means a taxable income of $0.
So you'd have $52K annual income and pay zero federal income tax.
You could add say $8K from a $200K ROTH (4%WR) and have $60K/yr.federal income tax free. Now
you may have state income taxes to consider.

At at much higher withdrawal from tax deferred, this may mean you will pay taxes. RMDs would be really important
to consider in that respect.
I'm planning on filling up the 15% federal tax bracket between retirement and 70, converting as much as can to ROTH
before I turn 70.
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by placeholder »

Not at all because I just include an estimate of future tax in the required income stream so I no more adjust my accounts for that than I do for housing expenses.
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by MathWizard »

I should add that since my 403b charges a higher ER than equities in my Vanguard ROTH, I place equities
in the ROTH, and have all the bond/fixed income in my 403b.

I expect greater growth in equities, so the lower ER should mean lower expenses.

So I guess you could say I Expense Adjust the placement of my asset allocation
among my ROTH and tax deferred.
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by Garco »

"About 50-50" is good enough for me. And in fact I have "about 50%" in equities. I have a number of different types of account, and I hold more than just "stocks and bonds." Trying to make any more exact calculations of the effective AA would just be a waste of my time.
Last edited by Garco on Mon Jul 21, 2014 10:05 am, edited 1 time in total.
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by Doc »

placeholder wrote:Not at all because I just include an estimate of future tax in the required income stream so I no more adjust my accounts for that than I do for housing expenses.
Asset allocation is not about an income stream it is about the risk in your portfolio. That's why firms like Vanguard have a number of Target Retirement Funds which change your AA automatically as you age. If you are not using one of these funds many recommend other balancing schemes like age in bonds for example.

Adjusting your AA for taxes is just acknowledging that some of the balance in your accounts is accrued taxes that belong not to you but to the guv. In a 401k as much as 40% of that balance represent taxes that have to be paid in the future while in a ROTH the accrued tax is zero. If you don't recognize that much of what you think is yours really belongs to someone else you have no idea of what your AA is and how it may change not because the stock market is up or down but because you are maxing your 401k and spending much of what is in your taxable account on your new girl friend.

Many people ignore tax adjusting because it is too hard or they can't estimate their future tax rate so they ignore it or just have the same AA in every type of account. Well multiplying your 401k balance by (1-15%) is not rocket science. Keeping the same AA in all accounts ignores tax efficiency which could be costing you 30 bps or more every year. Regarding it's too hard to estimate future tax rates I suggest that your current tax rate is a lot closer than a zero tax rate which is what you are effectively using if you can't estimate any better.

Every one should do a tax adjustment calculation every five years or so and find out if the the result is meaningful to their situation and react accordingly. Some will find it makes little difference and others will say "Oh Sith! I better pay more attention".
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by kenyan »

If my account balances were as above, I might tax-adjust my AA. However, my balances are much higher in my Traditional accounts than in my Roth accounts, and I don't bother with it.

edit: If I did, it would change my stock/bond split by one percent. Within the noise, hence not worth it IMO.
Last edited by kenyan on Mon Jul 21, 2014 10:21 am, edited 1 time in total.
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by sscritic »

This one is easy for me: I don't have a Roth and I don't have an AA. I have stuff. The stuff is in taxable, two IRAs, and three 403(b)s. When I need money, I take it from taxable. When I hit my RBD, I will take my RMDs as the law specifies. I pay my taxes every year. That will continue after my RBD.
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by rkhusky »

Traditional account withdrawals will only be taxed at your marginal rate if you have other sources of income, like a pension (unless your marginal rate is zero). You really need to estimate the average tax rate on your traditional account withdrawals. Depending on your situation, it may or may not make a difference. A useful exercise in any case.
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by asif408 »

Taylor Larimore wrote:
What is your asset allocation right now, for rebalancing purposes? Is it:

50% Bond / 50% Stocks (75K each)

or is it:

55% Bonds / 45% Stocks
Doc7:

I don't even know my best asset-allocation within 5%. I make no adjustments for (unknown) future taxes.

Strive for simplicity--not complexity.

Best wishes.
Taylor
I agree with Taylor. I think it is complicated enough balancing multiple accounts. For example, I have 5 different accounts (IRA, Roth IRA, HSA, 457b, & Treasury Direct account for I-bonds). Even following a basic 3 fund portfolio with a REIT tilt I have 7 funds across 4 accounts, not including the HSA that I will eventually start investing in. I see tax adjustment as about #100 on my list of worries in my investing life.

I think the Bogleheads principles are far more important: http://www.bogleheads.org/wiki/Getting_started. I occasionally look back at these when I start to think about complicating my portfolio and investing life.
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by sscritic »

When I think about tax adjusting, not only do I need to know my own tax rate in the future, I need to know what my kids' tax rates will be when I die. I think that today one is in a higher bracket and one is in a lower bracket than I am. On the other hand, when I die and they have to start taking RMDs, they can stop working and be in a lower tax bracket.

At least that's my current excuse for not following iORP's suggestion that I convert $1 million to Roth in the next three years and pay $428,880 in additional taxes now. Of course the real reason is that I am too lazy, but blaming it on my kids' tax rates when I die sounds more rational, like I actually thought about it.
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by Doc »

sscritic wrote:When I think about tax adjusting, not only do I need to know my own tax rate in the future, I need to know what my kids' tax rates will be when I die.
I don't think future tax rates are that important. If you are tax adjusting to keep your risk constant by maintaining a desired AA you are concerned with the risk in the near future not some 20 or 30 years hence. And most of us can estimate what their current marginal tax rate is within 5% or so. Again most of us have an age progression in their AA and it is easy to change the estimate of that tax rate as we change our AA. We also don't need a lot of precision. There is probably little difference between 50/50 or 45/55 but the difference between 50/50 and 65/35 is another matter.

Since sscritic says "This one is easy for me: I don't have a Roth and I don't have an AA. I have stuff" he doesn't have to worry about what his AA is but if his risk is much higher than he thinks maybe his kids should worry a little. :D
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by YDNAL »

Doc7 » Sun Jul 20, 2014 2:55 pm wrote:Your Roth IRA is set up as follows:
$50,000 in Total Stock Market.

Your 401k is set up as follows:
$25,000 in Total Stock Market.
$75,000 in Total Bond.....

What is your asset allocation right now, for rebalancing purposes? Is it:

50% Bond / 50% Stocks (75K each)

or is it:

45% Bonds / 55% Stocks, because you discount the 401K balances of each by 25% and end up with Tax Adjusted dollars of $68,750 in Stocks and $56,250 in Bonds?
Are you willing to do this in the 401K?:

Code: Select all

	      TSM	      TBM	     TOTAL
Roth	 50,000 	     -   	 50,000 
401K	 16,500 	 83,500 	 100,000 
TAX	 (4,125)	 (20,875)	 (25,000)
	     62,375 	 62,625 	 125,000
Split	 49.9%	   50.1%

Unless you do it -- in order to maintain and rebalance Stock risk -- then mental exercises are simply what they are !!!!!
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by bertilak »

Doc wrote: Asset allocation is not about an income stream it is about the risk in your portfolio.
...
Adjusting your AA for taxes is just acknowledging that some of the balance in your accounts is accrued taxes that belong not to you but to the guv.
I see a contradiction in the above. I agree AA is all about risk management and that is why I disagree with he last statement. Your portfolio does not know how much belongs to you or how much is accruing to the government. Its risk factors therefore have nothing to do with how much will eventually be paid out in taxes. Dollars are dollars. Stocks are stocks. Bonds are bonds. They are no different no matter who gets them in he end.

Now it does make sense to account for taxes in judging how much you will need in order to eventually produce the cash flow you need. It doesn't make sense in judging the risk of your portfolio. (Assuming the difference in "how much" isn't so vast as to make a difference in having "won the game" or not.)

Even if the government owned the whole portfolio the risk would still be based on the actual AA.
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by Ketawa »

bertilak wrote:Even if the government owned the whole portfolio the risk would still be based on the actual AA.
I wouldn't care about the portfolio's risk if the government owned the whole portfolio, since it's not my risk. If I had one account subject to a 99% tax rate and another with a 0% tax rate, putting all my stocks in the taxed account would make practically zero difference to my asset allocation if the pre-tax dollar values were equal. I'm not taking that risk, the government is.

So which matters, how much risk only you are taking, or how much you and the government are taking combined? I think the answer is pretty clear, and I chose the 55/45 option.
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by Doc »

bertilak wrote:Now it does make sense to account for taxes in judging how much you will need in order to eventually produce the cash flow you need.
I agree with this statement but its irrelevant. The AA in the Modern Portfolio Theory or CAPM is about risk not the amount of money you will have some time in the future. In its simplest terms risk is the ratio of stocks to bonds. We re-balance to keep our risk constant not to make more money.

From one of Vanguard's retirement fund's product summary: "The funds continue to adjust for approximately seven years after that date until their allocations match that of the Target Retirement Income Fund."

If you are trying to match this on your own and all your bonds are in a 401k and all your stocks are in taxable you need to take account of the fact that the some of the balance in the 401k represent accrued taxes and you need to make an adjustment. The fund does not need an adjustment because it is subject to a single tax rate.

If you need to take on more risk because of future taxes then you may need to save more or take on more risk but taking on more risk does not affect the calculation of your AA. The taxes only affect that you may want a higher AA if you can't save more.
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by Dale_G »

In my case "tax adjustment" doesn't amount to a whole lot from the risk perspective. My equity allocation is 62.7% without any tax adjustment, and 69.7% after tax adjustment.

The fly in the ointment however, is that tax adjustment also accounts for capital gains in the taxable account. Under present law, I don't expect anyone to pay taxes on the capital gains. Neglecting those gains, my equity allocation would be higher still.

My spreadsheet calculates the after tax number without complaint, but I pay no attention to it. I count the entire IRA as mine until I have to withdraw from it and send a quarter of it off to the feds, so I go by the pre-tax number (It's mine - it's mine).

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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by placeholder »

Doc wrote:Adjusting your AA for taxes is just acknowledging that some of the balance in your accounts is accrued taxes that belong not to you but to the guv.
You are free to do it that way but again all I do is account for future tax payments in outgoing income stream estimates and I believe to be a reasonable and much simpler way to do it.
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by bertilak »

Doc wrote:If you are trying to match this on your own and all your bonds are in a 401k and all your stocks are in taxable you need to take account of the fact that the some of the balance in the 401k represent accrued taxes and you need to make an adjustment.
That's the part I simply don't agree with (or perhaps don't follow what you are saying).

There is no reason to take taxes into account when you are talking about AA. The risk is determined by the AA and the AA is unaffected by what will eventually become of some portion of the assets. The AA is what it is and nothing more or less. I don't see the "why" of needing to take taxes into account -- as far as the AA is concerned. As I said above there are other reasons to take taxes into account but they are beside the point when we are discussing AA, the topic of this thread.

Perhaps my assumption is that the portfolio as a whole, regardless of how it is split across various accounts, is what matters. One can readjust the proportions of assets inside the individual accounts and maintain the same overall AA so it seems beside the point what the split happens to be at any given time. It could just as well be different.

EDIT:

Doc WAIT! I think I might agree with you, given the situation you describe!

If you have "locked away" assets in a taxable account (can't liquidate without immediate tax consequences) they may NOT be fungible with assets in the tax-advantaged account. You therefore are NOT free to readjust your asset split across accounts. This puts a constraint on things. I need to mull this over a bit.
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by celia »

I voted 50-50 since withdrawals/conversions from the 401k may incur taxes that are paid from other sources just as the Roth taxes that were already paid.

We expect some of our assets to be distributed to our heirs who all have different tax rates. Am I supposed to account for that too?
A dollar in Roth is worth more than a dollar in a taxable account. A dollar in taxable is worth more than a dollar in a tax-deferred account.
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by Doc7 »

YDNAL wrote:
Doc7 » Sun Jul 20, 2014 2:55 pm wrote:Your Roth IRA is set up as follows:
$50,000 in Total Stock Market.

Your 401k is set up as follows:
$25,000 in Total Stock Market.
$75,000 in Total Bond.....

What is your asset allocation right now, for rebalancing purposes? Is it:

50% Bond / 50% Stocks (75K each)

or is it:

45% Bonds / 55% Stocks, because you discount the 401K balances of each by 25% and end up with Tax Adjusted dollars of $68,750 in Stocks and $56,250 in Bonds?
Are you willing to do this in the 401K?:

Code: Select all

	      TSM	      TBM	     TOTAL
Roth	 50,000 	     -   	 50,000 
401K	 16,500 	 83,500 	 100,000 
TAX	 (4,125)	 (20,875)	 (25,000)
	     62,375 	 62,625 	 125,000
Split	 49.9%	   50.1%

Unless you do it -- in order to maintain and rebalance Stock risk -- then mental exercises are simply what they are !!!!!
You tell me, here is the spreadsheet I have been using to rebalance twice a year for the last 3 years. It takes me 5-10 minutes, the longest portions of which are gathering X-Ray Data for the "Morningstar Data" Tab and my updated account balances.

I suspect I may need to adjust my tax rate down based on the discussion above but that is a trivial matter of changing cell C46.


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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by Doc »

bertilak wrote:There is no reason to take taxes into account when you are talking about AA. The risk is determined by the AA and the AA is unaffected by what will eventually become of some portion of the assets.
Let's try this though process. Suppose you and I form a 50/50 partnership to invest in a super safe government bond with a face value of $1,000,000 and good interest rate. It matures in ten years and either of us can dissolve the partnership on three days notice in which case we will sell the bond and divide the assets. (We did this because neither of us had a million to invest in this special bond.) Would you say you had $1,000,000 in fixed income from this partnership when you calculated your AA? No, you would say you had $500,000 or 50% of whatever the market value of the bond was today. Now if you change Doc's name to Guv all of a sudden you have $1,000,000 of fixed income from this partnership when you calculate your AA?

"That does not compute."

When you compare the value of assets in various accounts you need to do them on a consistent basis. Market price minus any margin debt. Market price of a bond vs. market price of a CD (not the face value). Market value minus accrued taxes.

If you make $1000 a week and there is $200 of withholding you only have $800 to spend. And that $800 is less than the $1000 in your checking account which you put in there after paying the taxes. You compare them on an equal basis - an after tax is usually easier but not a requirement.
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by bertilak »

Doc wrote:
bertilak wrote:There is no reason to take taxes into account when you are talking about AA. The risk is determined by the AA and the AA is unaffected by what will eventually become of some portion of the assets.
Let's try this though process. Suppose you and I form a 50/50 partnership to invest in a super safe government bond with a face value of $1,000,000 and good interest rate. It matures in ten years and either of us can dissolve the partnership on three days notice in which case we will sell the bond and divide the assets. (We did this because neither of us had a million to invest in this special bond.) Would you say you had $1,000,000 in fixed income from this partnership when you calculated your AA? No, you would say you had $500,000 or 50% of whatever the market value of the bond was today. Now if you change Doc's name to Guv all of a sudden you have $1,000,000 of fixed income from this partnership when you calculate your AA?

"That does not compute."

When you compare the value of assets in various accounts you need to do them on a consistent basis. Market price minus any margin debt. Market price of a bond vs. market price of a CD (not the face value). Market value minus accrued taxes.

If you make $1000 a week and there is $200 of withholding you only have $800 to spend. And that $800 is less than the $1000 in your checking account which you put in there after paying the taxes. You compare them on an equal basis - an after tax is usually easier but not a requirement.
I see your point, but let's think about the following....

In your though experiment my AA was 0/100. Even if I discount ALL of my half of those bonds the AA is still 0/100! The AA hasn't changed and it's the AA we are talking about.

I am thinking of the case where my half of that big bond is part of a larger portfolio. Lets say that larger portfolio is 75/25 stocks/bonds that says I have $500K in bonds and $1MIL in stocks (75/25 AA). If I want to take $500K out of the portfolio 75% will come from stocks and 25% from that bond, assuming I can sell part interest to someone. My AA was 75/25 to start with and I will deliberately keep it at 75/25 when I withdraw money since I intend to keep my AA constant, as any good BH should do.

Now I WILL need to pay taxes on a bunch of stuff. In taxable only on cap gains (I've been paying on the income all along). In tax-advantaged I'll pay straight income on all money taken out. When I originally set my AA none of that made any difference since the difference occurs AFTER the money is taken out. And the AA started at 75/25 STILL hasn't changed. I'm right back where I started except I have less money invested. AA of 75/25 unaffected all the way through.
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by Peter Foley »

While I keep a tab on my portfolio spreadsheet to estimate pretax versus Roth + Taxable, I do not use it to adjust my asset allocation. There are just too many factors involved - including potentially different rates for IRA withdrawals and long term capital gains - to make such an exercise precise enough to be worthwhile. Note: I am retired and in the withdrawal phase - I might feel differently about this if I were still accumulating.
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by grabiner »

Your Roth IRA is set up as follows:
$50,000 in Total Stock Market.

Your 401k is set up as follows:
$25,000 in Total Stock Market.
$75,000 in Total Bond.

You estimate your post-retirement marginal tax bracket will be 25%.

What is your asset allocation right now, for rebalancing purposes?
The reason I discount the 401(k) by 25% is that I consider asset allocation as a measure of risk. If the stock market drops by 20%, I will lose $10,000 of spendable value in the Roth IRA, and $3750 of spendable value in the 401(k), a total of $13,750. If I switched the stock and bond funds (so that the Roth was all bonds), then the same stock market decline would cost $11,250 of spendable value, which would be 9/11 as much risk.
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by grabiner »

bertilak wrote:
Doc wrote: Asset allocation is not about an income stream it is about the risk in your portfolio.
...
Adjusting your AA for taxes is just acknowledging that some of the balance in your accounts is accrued taxes that belong not to you but to the guv.
I see a contradiction in the above. I agree AA is all about risk management and that is why I disagree with he last statement. Your portfolio does not know how much belongs to you or how much is accruing to the government. Its risk factors therefore have nothing to do with how much will eventually be paid out in taxes. Dollars are dollars. Stocks are stocks. Bonds are bonds. They are no different no matter who gets them in he end.
I get the opposite conclusion from the same logic.

Suppose that you own 100% of one account, and you own 75% of another account with your uncle owning the other 25%. Your uncle lets you manage the joint account freely, and you don't care how much he gets. Therefore, you should consider $4000 in the joint account to be equivalent to $3000 in the individual account for all purposes; if you move $4000 from stocks to bonds in the joint account and $3000 from bonds to stocks in the individual account, you will still have the same amount of money no matter what the stock market does.

This is how it actually works, with Uncle Sam the uncle who owns 25% of your 401(k).
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by YDNAL »

Doc7 wrote:
YDNAL wrote:
Doc7 » Sun Jul 20, 2014 2:55 pm wrote:Your Roth IRA is set up as follows:
$50,000 in Total Stock Market.

Your 401k is set up as follows:
$25,000 in Total Stock Market.
$75,000 in Total Bond.....

What is your asset allocation right now, for rebalancing purposes? Is it:

50% Bond / 50% Stocks (75K each)

or is it:

45% Bonds / 55% Stocks, because you discount the 401K balances of each by 25% and end up with Tax Adjusted dollars of $68,750 in Stocks and $56,250 in Bonds?
Are you willing to do this in the 401K?:

Code: Select all

	      TSM	      TBM	     TOTAL
Roth	 50,000 	     -   	 50,000 
401K	 16,500 	 83,500 	 100,000  <<<
TAX	 (4,125)	 (20,875)	 (25,000)
	     62,375 	 62,625 	 125,000
Split	 49.9%	   50.1%

Unless you do it -- in order to maintain and rebalance Stock risk -- then mental exercises are simply what they are !!!!!
You tell me, here is the spreadsheet I have been using to rebalance twice a year for the last 3 years. It takes me 5-10 minutes, the longest portions of which are gathering X-Ray Data for the "Morningstar Data" Tab and my updated account balances.

I suspect I may need to adjust my tax rate down based on the discussion above but that is a trivial matter of changing cell C46.
<< snip >>
Here's what I'm willing to "tell you."
  • 1. IF the 50/50 AA is a risk-management decision/tool, and we wish to account for some future event (tax), then we should allocate what we "supposedly" own.
    2. Anyone that claims to own 75% of a 401K, then (s)he owns 75%, should use the 75% 401K value to allocate the overall portfolio.
All else are a mental exercises.

Good day!
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by Doc7 »

YDNAL - I hope you didn't take my response as snarky because I didn't mean it as such.
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by Beliavsky »

Peter Foley wrote:While I keep a tab on my portfolio spreadsheet to estimate pretax versus Roth + Taxable, I do not use it to adjust my asset allocation. There are just too many factors involved - including potentially different rates for IRA withdrawals and long term capital gains - to make such an exercise precise enough to be worthwhile.
If you think the range of tax rates you will face is 10% to 30%, it does not make sense to throw up your hands in the face of uncertainty and assume a 0% tax rate. Use your best guess, say 20%. We don't know how long we are going to live in retirement, either, but we make plans based on expected life expectancy rather than assuming that years in retirement will be zero.
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by Beliavsky »

The estimated volatility of your portfolio should also be computed on a post-tax basis. If your tax rate on long term capital gains is 20%, and if you have a fund in a taxable account with large unrealized gains, the after-tax volatility of this fund is effectively reduced by 20%. I include the "large unrealized gains" qualifier because only $3000 of capital losses can be deducted against ordinary income.
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Re: Do you "Tax Adjust" your Asset Allocation (Pre vs Roth,

Post by YDNAL »

Doc7 wrote:YDNAL - I hope you didn't take my response as snarky because I didn't mean it as such.
No, I responded to your post.
  • 1. IF you are convinced that you own only 75% of the 401K, the AA to manage risk should reflect it.
    2. Meaning that you need to rebalance out of Equities into Fixed Income (per "for instance" in your original post last Sunday).

    Code: Select all

             TSM         TBM        TOTAL
    Roth    50,000         -       50,000 
    401K    16,500     83,500     100,000  <<< originally 25,000/75,000
    TAX    (4,125)    (20,875)    (25,000)
            62,375     62,625     125,000
    Split    49.9%      50.1%
    3. And, it doesn't matter if Roth is 100% TSM or 100% TBM (or something in between).

    Code: Select all

             TSM         TBM        TOTAL
    Roth       -       50,000      50,000 
    401K    83,500     16,500     100,000  <<< originally 75,000/25,000
    TAX    (20,875)    (4,125)    (25,000)
            62,625     62,375     125,000
    Split    50.1%      49.9%
Landy | Be yourself, everyone else is already taken -- Oscar Wilde
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