Asset allocation and asset placement question?

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Buster65
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Asset allocation and asset placement question?

Post by Buster65 » Mon Mar 20, 2017 1:21 pm

Hypothetical round # investor has $5M of investments with $4M being in a taxable account and $1M being in a 401K / IRA. Vanguard seems to think that the allocation should be roughly 50% equities and 50% bonds given my risk profile but the entire 401K / IRA should be in bonds because you want to hold bonds in tax deferred vehicle if possible. I can't wrap my head around that. Isn't the tax savings between capital gains rate and ordinary rate less important than just growing the assets? An all bond 401K / IRA will never be as large as an all equity portfolio? What am I missing?

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elgob.bogle
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Re: Asset allocation and asset placement question?

Post by elgob.bogle » Mon Mar 20, 2017 9:50 pm

Putting your bonds in tax deferred allow you to take advantage of potentially lower capital gains taxes on your equities. If equities are in deferred accounts, you would pay ordinary income tax rates, which are usually higher.

elgob

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Dale_G
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Re: Asset allocation and asset placement question?

Post by Dale_G » Mon Mar 20, 2017 10:31 pm

And when it comes time to take RMDs, the amount you are required to take is likely to be larger if you have equities in the 401k/IRA than if you are invested wholly in bonds. The tax man would prefer that you keep bonds in the taxable account and equities in the tax deferred account.

Dale
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PaulF
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Re: Asset allocation and asset placement question?

Post by PaulF » Tue Mar 21, 2017 9:53 am

I cannot tell if you are really questioning the 50/50 ratio, or the placement of the bond portion. If you accept that you want 50% bonds, then the best place for them is in the tax-deferred space. If, instead, you think the potential for growth is paramount (and overrides downside potential), then you want to be in 100% equities in both tax-deferred and taxable. (I am not advocating that.)

bloom2708
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Re: Asset allocation and asset placement question?

Post by bloom2708 » Tue Mar 21, 2017 1:24 pm

If you only have two accounts (taxable and 401k/IRA), then your options for 50/50 are limited by the ratio of taxable to tax-sheltered.

Option 1 (using the funds from a 3 fund portfolio.)

Taxable:

Total US stock index
Total International stock index
Int-Term Tax-Exempt bond index

401k/IRA:

100% Total US bond index

Option 2

Taxable:

Total US stock index
Int-Term Tax-Exempt bond index

401k/IRA:

Total International stock index
Total US Bond index


You could also have each of the 3 funds in BOTH taxable and 401k/IRA. Use tax-exempt bonds in taxable (CA, NY, PA, OH have their own tax-exempt funds from Vanguard to also get state tax exempt interest beyond Federal tax exempt interest)

Int-Term Tax-Exempt in Taxable for bonds

Total US bond index in 401k/IRA for bonds

As mentioned, taxable bond interest is 100% ordinary income. Taxed at your marginal (highest) tax rate. That is why you place taxable bonds in tax-sheltered. But they did not mention you can use tax-exempt bonds in taxable. Many do (including me) if you are 25% or higher tax bracket.
"We are here not to please but to provoke thoughtfulness" Unknown Boglehead

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