"Tax-Adjusted Asset Allocation: Is It Necessary?"

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Taylor Larimore
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"Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by Taylor Larimore » Thu Apr 26, 2018 7:36 pm

Bogleheads:

One of decisions investors must make is whether or not to adjust the asset-allocation of our IRAs, 401Ks, and other tax-advantaged accounts (Roth's are a major exception), into their after-tax value.

Our wiki has a lengthy discussion here:

Tax Adjusted Asset-Allocation

The Wall Street Physician has written an excellent article on the subject here:

Tax-Adjusted Asset-Allocation: Is It Necessary?

What do you think?

Best wishes.
Taylor
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Re: "Tax-Adjusted Asset Allocation: Is It Necessary"

Post by dbr » Thu Apr 26, 2018 7:44 pm

Saying that something like this is "necessary" is a strong statement that requires a strong justification. The answer is that it is certainly not necessary. What purpose is served that it is necessary for an investor to serve by doing this?

A different question is whether it is even helpful. I have yet to see an explanation other than the one in a certain paper of Reichenstein's that explains why a person would even do this, and I don't think Reichenstein's approach is how most people here do that problem. That is before one looks at the practical consequences which, as explained in the paper above, don't amount to anything most people would worry about.

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by nps » Thu Apr 26, 2018 8:45 pm

The article seems to confuse marginal and effective tax rates:
The retirement tax rate is most commonly 22%, but this obviously can change with new tax laws).

For example, the tax-adjusted value of a $100,000 401(k) is $78,000 after the government takes its 22% cut on withdrawals.

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by Khanmots » Thu Apr 26, 2018 8:58 pm

I value monies in my Roth more than other locations when figuring out if I'm at my allocation. The other types of accounts I assume it's close enough to a wash and don't worry about.

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by Kevin M » Thu Apr 26, 2018 8:59 pm

It may not be necessary, but I think it's useful to understand the concept.

I think it's better to think in terms of tax-adjusted risk than tax-adjusted account value. This makes it easier to think about taxable accounts, for example, since the government may not own any of your account if you don't have any unrealized capital gains, but they still share 15% of the risk if you will pay 15% long-term capital gain tax.

Clearly you are taking more risk with stocks in a Roth IRA or 401k than with stocks in a traditional IRA or 401k, assuming you will pay income tax on distributions from the latter. You take 100% of the risk in the Roth, but only part of the risk in traditional. So your expected return is higher with stocks in Roth, but your risk also is higher. People seem to think only about the former and not the latter. You may not need to do the actual tax adjustment calculation, but hopefully you don't make bad decisions about asset location because you don't think clearly about the after-tax risk.

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by Pigeye Brewster » Thu Apr 26, 2018 9:18 pm

I track my tax-adjusted asset allocation. In my case, the difference is not significant.

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by bling » Thu Apr 26, 2018 9:20 pm

it's not "necessary" but people with high incomes and/or living high tax states should definitely take it into consideration.

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by ofckrupke » Thu Apr 26, 2018 9:22 pm

Kevin M wrote:
Thu Apr 26, 2018 8:59 pm
It may not be necessary, but I think it's useful to understand the concept.

I think it's better to think in terms of tax-adjusted risk than tax-adjusted account value. This makes it easier to think about taxable accounts, for example, since the government may not own any of your account if you don't have any unrealized capital gains, but they still share 15% of the risk if you will pay 15% long-term capital gain tax.
Agree completely on both points and admire their succinct expression above.

Like Pigeye my raw and tax-adjusted equity allocations don't differ by much. But I wouldn't know this if I hadn't taken the trouble once upon a time to add a couple of columns and cell formulae to my worksheet.

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by AlohaJoe » Thu Apr 26, 2018 9:49 pm

I think it isn't necessary primarily because precision isn't important in asset allocation and the impact of tax adjustments isn't actually that big in most cases. Let's say your "desired asset allocation" is 60/40. How much difference does it actually make if you accidentally end up at 50/50 or 70/30?

Image

Over a 30+ year period being wrong on the most important part of your asset allocation by 10% adds up to:
  • CAGR +/- 0.4%
  • Stdev +/- 1.4%
  • Best year +/- 2%
  • Worst year +/- 4%
  • Max drawdown +/- 5%
  • Sharpe ratio +/- 0.05
I'd argue those are trivial differences that no real world person is going to notice or care about. Are you really going to be okay if your portfolio drops -30% but lose your marbles if it drops -36%? Are you going to be overwhelmed with regret if your portfolio goes up by 27% instead of 28.7%?

We like to pretend that we have finely tuned our risk tolerance but that is self-deception. How do I actually know that 60/40 is right for me and not 55/45 or 65/35? I'm almost certainly just picking a round number that is massively influenced by the opinions of the people around you. Being wrong by +/- 10% is not noticeable except with the benefit of decades of hindsight. Heck, even going from 50/50 to 70/30 is a much smaller change in results than you'd probably expect given the fairly substantial change in asset allocation.

So by all means understand the impact of taxes on asset allocation & risk. But I consider that more of an academic "huh, that's interesting" kind of thing rather than something that makes a material difference.

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by inbox788 » Fri Apr 27, 2018 2:37 am

Necessary, no, but important to understand. Your future tax liability may be zero in Roth, 15% in taxable, and 25% in tax deferred. You’ll have some lower tax brackets to fill, so the effect is muted, but that lump sum cash car payment can mean liquidating $30k vs. $40k in stocks depending on tax status of account.

I’m somewhat diversified, so I do a little mental accounting, but no formal adjustments. Plus most is in tax deferred, so expecting to be taxed on everything is conservative. If you have lots in Roth and taxable, you can use a lower rate closer to capital gains tax rate.

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by dbr » Fri Apr 27, 2018 7:36 am

Before adopting a tax adjusted "virtual" asset allocation you also have to know how to decide the correct allocation for such assets, which would not necessarily follow the same logic as arriving at an asset allocation for actual assets. Just because you decide that you want 50/50 for actual assets does not mean 50/50 is the right number for your virtual assets. The only place I have seen that fact addressed is in Reichenstein's paper.

For me an asset allocation that is 50/50 in actual assets produces a 55/45 allocation in virtual assets, but I also know that 55/45 is the right allocation after tax adjustment, so I would not make any changes in the actual distribution of actual dollars.

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by IlliniDave » Fri Apr 27, 2018 7:58 am

I don't bother. Asset allocation to me is not a precision sport. I tend to think more like, for example, "about half" rather than 50.000 +/- 0.001%. I already crunch numbers far more than is probably healthy for me, last thing I need is one more level of refinement to stew about. Neither taxes nor risk-adjusted returns are constants, so in the end trying to dial things in perfectly strikes me as a hopeless time sink. YMMV, of course.
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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by KlangFool » Fri Apr 27, 2018 8:10 am

Taylor Larimore wrote:
Thu Apr 26, 2018 7:36 pm
Bogleheads:

One of decisions investors must make is whether or not to adjust the asset-allocation of our IRAs, 401Ks, and other tax-advantaged accounts (Roth's are a major exception), into their after-tax value.

Our wiki has a lengthy discussion here:

Tax Adjusted Asset-Allocation

The Wall Street Physician has written an excellent article on the subject here:

Tax-Adjusted Asset-Allocation: Is It Necessary?

What do you think?

Best wishes.
Taylor
Taylor,

1) My tax-deferred portfolio is around 500K and I plan to early retire. It is too small for me to tax-adjust since I will be paying little to no tax on my withdrawal.

2) I hope there should be something in the WiKi that indicates someone should only worry about this issue when their tax-deferred accounts are big enough.

3) Please correct me if my understanding is wrong.

KlangFool

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by dwickenh » Fri Apr 27, 2018 8:20 am

I make the assumption that they are my assets until I have to pay taxes. My intent is to never have to pay taxes. I don't see the value in adjusting my asset allocation based on taxes when my allocation addresses risk of loss. Only counting 78% of an IRA as mine indicates I have given up on all tax planning.

Just my 2 cents worth,

Dan
The market is the most efficient mechanism anywhere in the world for transferring wealth from impatient people to patient people.” | — Warren Buffett

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by dbr » Fri Apr 27, 2018 8:27 am

KlangFool wrote:
Fri Apr 27, 2018 8:10 am

2) I hope there should be something in the WiKi that indicates someone should only worry about this issue when their tax-deferred accounts are big enough.

KlangFool
On the contrary the Wiki contains a strong warning that tax adjustment might have (presumably large) unintended consequences. A more common consensus here on the forum has been that no matter the theoretical justifications there isn't enough effect to go to the trouble.

In my opinion it is an excellent piece of academic finagling that creates just a little more anxiety among those prone to too much anxiety to start with and is ignored by everyone else.

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by triceratop » Fri Apr 27, 2018 8:37 am

dbr wrote:
Fri Apr 27, 2018 8:27 am
KlangFool wrote:
Fri Apr 27, 2018 8:10 am

2) I hope there should be something in the WiKi that indicates someone should only worry about this issue when their tax-deferred accounts are big enough.

KlangFool
On the contrary the Wiki contains a strong warning that tax adjustment might have (presumably large) unintended consequences. A more common consensus here on the forum has been that no matter the theoretical justifications there isn't enough effect to go to the trouble.

In my opinion it is an excellent piece of academic finagling that creates just a little more anxiety among those prone to too much anxiety to start with and is ignored by everyone else.
On the other hand Taylor has mentioned that the only reason he owns 0% international stocks is because of how his withdrawals have interplayed with his asset allocation. Depending on how international stocks perform going forward there is the potential for quite an important impact on returns.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by KlangFool » Fri Apr 27, 2018 8:38 am

dbr wrote:
Fri Apr 27, 2018 8:27 am
KlangFool wrote:
Fri Apr 27, 2018 8:10 am

2) I hope there should be something in the WiKi that indicates someone should only worry about this issue when their tax-deferred accounts are big enough.

KlangFool
On the contrary the Wiki contains a strong warning that tax adjustment might have (presumably large) unintended consequences. A more common consensus here on the forum has been that no matter the theoretical justifications there isn't enough effect to go to the trouble.

In my opinion it is an excellent piece of academic finagling that creates just a little more anxiety among those prone to too much anxiety to start with and is ignored by everyone else.
dbr,

I might be nitpicking. The warning should include if your tax-deferred portfolio is small, don't worry about it in the first place.

KlangFool

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by dbr » Fri Apr 27, 2018 8:44 am

triceratop wrote:
Fri Apr 27, 2018 8:37 am
dbr wrote:
Fri Apr 27, 2018 8:27 am
KlangFool wrote:
Fri Apr 27, 2018 8:10 am

2) I hope there should be something in the WiKi that indicates someone should only worry about this issue when their tax-deferred accounts are big enough.

KlangFool
On the contrary the Wiki contains a strong warning that tax adjustment might have (presumably large) unintended consequences. A more common consensus here on the forum has been that no matter the theoretical justifications there isn't enough effect to go to the trouble.

In my opinion it is an excellent piece of academic finagling that creates just a little more anxiety among those prone to too much anxiety to start with and is ignored by everyone else.
On the other hand Taylor has mentioned that the only reason he owns 0% international stocks is because of how his withdrawals have interplayed with his asset allocation. Depending on how international stocks perform going forward there is the potential for quite an important impact on returns.
Can you expand on what that has to do with the idea that one should tax adjust one's asset allocation?

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by dbr » Fri Apr 27, 2018 8:49 am

KlangFool wrote:
Fri Apr 27, 2018 8:38 am
dbr wrote:
Fri Apr 27, 2018 8:27 am
KlangFool wrote:
Fri Apr 27, 2018 8:10 am

2) I hope there should be something in the WiKi that indicates someone should only worry about this issue when their tax-deferred accounts are big enough.

KlangFool
On the contrary the Wiki contains a strong warning that tax adjustment might have (presumably large) unintended consequences. A more common consensus here on the forum has been that no matter the theoretical justifications there isn't enough effect to go to the trouble.

In my opinion it is an excellent piece of academic finagling that creates just a little more anxiety among those prone to too much anxiety to start with and is ignored by everyone else.
dbr,

I might be nitpicking. The warning should include if your tax-deferred portfolio is small, don't worry about it in the first place.

KlangFool
My point is that the warning seems to be a silly one. If someone is really serious about it, the Wiki needs a section on what the supposed hazards are.

On the other hand, I tend to agree with you that the appropriate warning might be more to the effect that people need not bother.

None if this means that anticipating taxes in one's financial planning is not important. The question is whether or not the mere act of tax adjusting an asset allocation is either necessary or sufficient or even helpful to manage that issue.

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by Peter Foley » Fri Apr 27, 2018 8:51 am

IMHO doing the calculation once is prudent. Once an investor has an idea as to how much the pre-tax and post tax calculations diverge he/she can judge whether it is something worth monitoring long term. My pre-tax bond allocation is about 5% higher than my post tax bond allocation. Some of this is due to age, Roths weren't available until very late in my working years and then had income limits, and some divergence is due to employing the tax efficient asset allocation strategy of placing bonds in tax deferred.

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by dbr » Fri Apr 27, 2018 9:05 am

Peter Foley wrote:
Fri Apr 27, 2018 8:51 am
IMHO doing the calculation once is prudent. Once an investor has an idea as to how much the pre-tax and post tax calculations diverge he/she can judge whether it is something worth monitoring long term. My pre-tax bond allocation is about 5% higher than my post tax bond allocation. Some of this is due to age, Roths weren't available until very late in my working years and then had income limits, and some divergence is due to employing the tax efficient asset allocation strategy of placing bonds in tax deferred.
And what change to the actual disposition of invested dollars did that incline you to make. It should have caused you to sell bonds and buy stock on the grounds that your portfolio after taxes is not a large as you were imagining it to be and that you should now take more risk to get the return you need. You don't say what the size of your after tax portfolio is nor your financial after tax needs. Keep in mind that after tax needs require not only tax adjusting assets but also tax adjusting income that is not related to investments.

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by KlangFool » Fri Apr 27, 2018 9:14 am

dbr wrote:
Fri Apr 27, 2018 8:49 am
KlangFool wrote:
Fri Apr 27, 2018 8:38 am
dbr wrote:
Fri Apr 27, 2018 8:27 am
KlangFool wrote:
Fri Apr 27, 2018 8:10 am

2) I hope there should be something in the WiKi that indicates someone should only worry about this issue when their tax-deferred accounts are big enough.

KlangFool
On the contrary the Wiki contains a strong warning that tax adjustment might have (presumably large) unintended consequences. A more common consensus here on the forum has been that no matter the theoretical justifications there isn't enough effect to go to the trouble.

In my opinion it is an excellent piece of academic finagling that creates just a little more anxiety among those prone to too much anxiety to start with and is ignored by everyone else.
dbr,

I might be nitpicking. The warning should include if your tax-deferred portfolio is small, don't worry about it in the first place.

KlangFool
My point is that the warning seems to be a silly one. If someone is really serious about it, the Wiki needs a section on what the supposed hazards are.

On the other hand, I tend to agree with you that the appropriate warning might be more to the effect that people need not bother.

None if this means that anticipating taxes in one's financial planning is not important. The question is whether or not the mere act of tax adjusting an asset allocation is either necessary or sufficient or even helpful to manage that issue.
dbr,

My effective tax rate while I am working is less than 5%. I won't worry about my tax at all when I am retired. If I have to pay a lot of taxes when I am retired, I am a very lucky person.

KlangFool

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by aristotelian » Fri Apr 27, 2018 9:35 am

I prefer to set up my portfolio and withdrawal strategy so that I will not have to worry significantly about taxes. I plan to retire early, delay SS, and convert the 401k to Roth.

If you have the majority of your portfolio in your 401k and a high spending rate in retirement, you definitely need to plan for it.

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by House Blend » Fri Apr 27, 2018 9:39 am

Kevin M wrote:
Thu Apr 26, 2018 8:59 pm
It may not be necessary, but I think it's useful to understand the concept.

I think it's better to think in terms of tax-adjusted risk than tax-adjusted account value. This makes it easier to think about taxable accounts, for example, since the government may not own any of your account if you don't have any unrealized capital gains, but they still share 15% of the risk if you will pay 15% long-term capital gain tax.

Clearly you are taking more risk with stocks in a Roth IRA or 401k than with stocks in a traditional IRA or 401k, assuming you will pay income tax on distributions from the latter. You take 100% of the risk in the Roth, but only part of the risk in traditional. So your expected return is higher with stocks in Roth, but your risk also is higher. People seem to think only about the former and not the latter. You may not need to do the actual tax adjustment calculation, but hopefully you don't make bad decisions about asset location because you don't think clearly about the after-tax risk.
+1.

The irony here is that those who don't grasp this [the blue portion] and view stocks in a Roth as a free lunch probably end up better off anyway. They end up with a higher risk portfolio, more dollars after tax, and smaller RMDs, than they would have otherwise.

So ignorance is bliss in the same sense that an 80/20 portfolio is "better" than a 60/40 portfolio. (And 100% stocks in both Roth *and* tax-deferred would be "better" still.)
Last edited by House Blend on Fri Apr 27, 2018 10:07 am, edited 1 time in total.

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by dbr » Fri Apr 27, 2018 10:06 am

I would like to see some people step forward with real life examples how failing to tax adjust their asset allocation did or would have produced a bad investment decision somehow. That doesn't happen in my case and it is a lot of work to try to figure out hypotheticals that may not be realistic anyway. A corollary would be examples where the dreaded unintended consequences develop.

Note that somehow being stupid that taxes would have to be paid at all does not count.

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by triceratop » Fri Apr 27, 2018 11:15 am

dbr wrote:
Fri Apr 27, 2018 8:44 am
triceratop wrote:
Fri Apr 27, 2018 8:37 am
dbr wrote:
Fri Apr 27, 2018 8:27 am
KlangFool wrote:
Fri Apr 27, 2018 8:10 am

2) I hope there should be something in the WiKi that indicates someone should only worry about this issue when their tax-deferred accounts are big enough.

KlangFool
On the contrary the Wiki contains a strong warning that tax adjustment might have (presumably large) unintended consequences. A more common consensus here on the forum has been that no matter the theoretical justifications there isn't enough effect to go to the trouble.

In my opinion it is an excellent piece of academic finagling that creates just a little more anxiety among those prone to too much anxiety to start with and is ignored by everyone else.
On the other hand Taylor has mentioned that the only reason he owns 0% international stocks is because of how his withdrawals have interplayed with his asset allocation. Depending on how international stocks perform going forward there is the potential for quite an important impact on returns.
Can you expand on what that has to do with the idea that one should tax adjust one's asset allocation?
Taylor sold his international stocks because the shares had the lowest unrealized gains. If Taylor tax-adjusted his asset allocation I do not think this would happen and he wouldn't have made that asset allocation decision. Am I wrong?

Are you counting Taylor's case under the "Note that somehow being stupid that taxes would have to be paid at all does not count." umbrella?
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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by nedsaid » Fri Apr 27, 2018 11:18 am

Definitely, one should not ignore the effect of taxes upon their investments.

Two schools of thought on this. One is allocate taxable, tax free, and tax deferred portfolios the same. The other school of thought is to place asset classes into the type of account where they are most tax efficient. TIPS and REITs are thought of as tax inefficient, so the standard advice is to place them in tax deferred accounts. Given that favorable tax treatment is given for qualified dividends and for capital gains, it makes sense to put stocks in taxable accounts. You lose the foreign tax credit in tax free and tax deferred accounts so it makes sense to put International Stocks in taxable accounts as well. If you have a large taxable fixed income portfolio, depending upon your tax bracket, it might make sense to consider municipal bonds.

My thoughts on this are this: If you have both large taxable and tax deferred portfolios, tax efficient placement makes sense. Pretty much, make your taxable accounts stock heavy and the tax deferred accounts more bond heavy. Many people are like me, they have the bulk of their investments in their tax deferred retirement plans, in this case I recommend investing for maximum return in retirement accounts. I have cautioned that one doesn't want to doom their retirement accounts to low returns by overloading such accounts with bonds.

So pretty much, this depends upon the individual situation. Too often, I get the sense that people let the tax tail wag the investment dog. Sometimes, the best tax shelter is just to pay the tax. That being said, investors need to be aware how investments and investment accounts are taxed and to work out the numbers for themselves. It is hard here to give one size fits all advice.
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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by dbr » Fri Apr 27, 2018 2:38 pm

triceratop wrote:
Fri Apr 27, 2018 11:15 am


Taylor sold his international stocks because the shares had the lowest unrealized gains. If Taylor tax-adjusted his asset allocation I do not think this would happen and he wouldn't have made that asset allocation decision. Am I wrong?

Are you counting Taylor's case under the "Note that somehow being stupid that taxes would have to be paid at all does not count." umbrella?
I don't see how selling something rather than something else because it is a way to withdraw at the lowest tax cost is an example of anything having to do with asset allocation tax adjusted or not. Doing that might cause an asset allocation problem, tax adjusted or not, by depleting the allocation to international because one could not properly rebalance due to tax costs. I also see no relationship to anything about understanding that taxes have to be paid but rather the opposite.

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by triceratop » Fri Apr 27, 2018 3:04 pm

Okay. I see it differently.
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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by Artsdoctor » Fri Apr 27, 2018 3:56 pm

IlliniDave wrote:
Fri Apr 27, 2018 7:58 am
I don't bother. Asset allocation to me is not a precision sport. I tend to think more like, for example, "about half" rather than 50.000 +/- 0.001%. I already crunch numbers far more than is probably healthy for me, last thing I need is one more level of refinement to stew about. Neither taxes nor risk-adjusted returns are constants, so in the end trying to dial things in perfectly strikes me as a hopeless time sink. YMMV, of course.
This is pretty much my philosophy as well. You can wind up with a lot of spreadsheets which turn out to be meaningless in the end. I think the most important thing is awareness of what effect taxes may have.

The concept that a Roth dollar is worth more than a 401k dollar is clear. But trying to calculate how much more or less is an exercise in futility. It's important to have tax diversification and in the ideal world, you'd have taxable accounts, tax-deferred accounts, HSAs, and Roths. But if you're going to have to get into specific numbers, you're going to have to consider AGI, MAGI, NIIT, capital gains tax, carryover losses, IRMAA, SS tax, and state tax.

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by DaftInvestor » Fri Apr 27, 2018 4:00 pm

I started down this path a couple of years ago but then got caught up in analysis-paralysis and deleted all the calculations (had different models based upon different potential tax-rates in retirement).
All stock in taxable - lowered stock allocation slightly as I got older and decided this was "good enough" so as not to worry about it.

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by Kevin M » Fri Apr 27, 2018 4:11 pm

dwickenh wrote:
Fri Apr 27, 2018 8:20 am
I make the assumption that they are my assets until I have to pay taxes. My intent is to never have to pay taxes. I don't see the value in adjusting my asset allocation based on taxes when my allocation addresses risk of loss. Only counting 78% of an IRA as mine indicates I have given up on all tax planning.

Just my 2 cents worth,

Dan
Dan, if you don't expect to pay taxes on traditional IRA (or 401k) distributions, then you would not count 78% as yours. You would count 100% as yours, and it would be the same risk as holding the assets in a Roth. Assuming you got a tax deduction on contributions to traditional IRA (or 401k), you have a super-IRA--benefit of traditional on the contributions, benefit of Roth on the distributions. This is why traditional IRA can be superior to Roth IRA for some people, even in low tax brackets when contributions are made.

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by 9-5 Suited » Fri Apr 27, 2018 4:19 pm

Has the government locked in the marginal tax rates and capital gains rates for 2046 when I start drawing from my accounts? :) If not, it's pretty unclear how useful such an exercise would be.

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by Kevin M » Fri Apr 27, 2018 4:20 pm

House Blend wrote:
Fri Apr 27, 2018 9:39 am
Kevin M wrote:
Thu Apr 26, 2018 8:59 pm
It may not be necessary, but I think it's useful to understand the concept.

I think it's better to think in terms of tax-adjusted risk than tax-adjusted account value. This makes it easier to think about taxable accounts, for example, since the government may not own any of your account if you don't have any unrealized capital gains, but they still share 15% of the risk if you will pay 15% long-term capital gain tax.

Clearly you are taking more risk with stocks in a Roth IRA or 401k than with stocks in a traditional IRA or 401k, assuming you will pay income tax on distributions from the latter. You take 100% of the risk in the Roth, but only part of the risk in traditional. So your expected return is higher with stocks in Roth, but your risk also is higher. People seem to think only about the former and not the latter. You may not need to do the actual tax adjustment calculation, but hopefully you don't make bad decisions about asset location because you don't think clearly about the after-tax risk.
+1.

The irony here is that those who don't grasp this [the blue portion] and view stocks in a Roth as a free lunch probably end up better off anyway. They end up with a higher risk portfolio, more dollars after tax, and smaller RMDs, than they would have otherwise.

So ignorance is bliss in the same sense that an 80/20 portfolio is "better" than a 60/40 portfolio. (And 100% stocks in both Roth *and* tax-deferred would be "better" still.)
Interesting perspective. The key qualification is "probably".

The problem is I often see statements like, "I hold stocks in Roth because they will generate higher returns, I won't pay taxes on those higher returns, and my RMDs from traditional will be smaller". My counterpoint to this is that if you're sure stocks will generate higher returns if you hold them long enough, then you should be 100% stocks in traditional, IRA and taxable for all assets with an investment horizon longer than whatever period you are sure stocks will generate higher returns than fixed income, and the asset location problem does not exist for you.

You could accomplish basically the same thing by holding stocks in traditional and bonds in Roth, and just increasing your stock allocation. Either way you are increasing expected return and risk. But your point is that stocks in Roth is a way for people to fool themselves into getting higher expected returns without realizing that they are taking higher risk, and chances are that this will work out to their benefit.

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by Peter Foley » Fri Apr 27, 2018 10:41 pm

dbr » Fri Apr 27, 2018 9:05 am

Peter Foley wrote: ↑Fri Apr 27, 2018 8:51 am
"IMHO doing the calculation once is prudent. Once an investor has an idea as to how much the pre-tax and post tax calculations diverge he/she can judge whether it is something worth monitoring long term. My pre-tax bond allocation is about 5% higher than my post tax bond allocation. Some of this is due to age, Roths weren't available until very late in my working years and then had income limits, and some divergence is due to employing the tax efficient asset allocation strategy of placing bonds in tax deferred."

And what change to the actual disposition of invested dollars did that incline you to make. It should have caused you to sell bonds and buy stock on the grounds that your portfolio after taxes is not a large as you were imagining it to be and that you should now take more risk to get the return you need. You don't say what the size of your after tax portfolio is nor your financial after tax needs. Keep in mind that after tax needs require not only tax adjusting assets but also tax adjusting income that is not related to investments.
I don't want to stray too far from the original question, but I sincerely believe that may wife and I are representative of early Baby Boomers in that our tax deferred is by far the largest part of our portfolio (2/3 of our savings). We have been retired for almost 6 years and have been spending down taxable while doing Roth conversions. That being said, near the end of 2017 our pre-tax AA was 51% equities. Except for a few I-bonds all our bonds are in tax deferred. Our tax adjusted AA near the end of 2017 was 57.7% equities. My plan calls for a 50/50 AA with 5% bands. So in real. spendable money terms, we were exceeding our bands by 2.7%. Not a lot, certainly. I did some minor rebalancing in tax deferred in late December to bring us into line. This may be the first time I've had to sell and buy to rebalance since changing our AA about a year prior to retirement.

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by dbr » Sat Apr 28, 2018 8:05 am

Peter Foley wrote:
Fri Apr 27, 2018 10:41 pm
dbr » Fri Apr 27, 2018 9:05 am

Peter Foley wrote: ↑Fri Apr 27, 2018 8:51 am
"IMHO doing the calculation once is prudent. Once an investor has an idea as to how much the pre-tax and post tax calculations diverge he/she can judge whether it is something worth monitoring long term. My pre-tax bond allocation is about 5% higher than my post tax bond allocation. Some of this is due to age, Roths weren't available until very late in my working years and then had income limits, and some divergence is due to employing the tax efficient asset allocation strategy of placing bonds in tax deferred."

And what change to the actual disposition of invested dollars did that incline you to make. It should have caused you to sell bonds and buy stock on the grounds that your portfolio after taxes is not a large as you were imagining it to be and that you should now take more risk to get the return you need. You don't say what the size of your after tax portfolio is nor your financial after tax needs. Keep in mind that after tax needs require not only tax adjusting assets but also tax adjusting income that is not related to investments.
I don't want to stray too far from the original question, but I sincerely believe that may wife and I are representative of early Baby Boomers in that our tax deferred is by far the largest part of our portfolio (2/3 of our savings). We have been retired for almost 6 years and have been spending down taxable while doing Roth conversions. That being said, near the end of 2017 our pre-tax AA was 51% equities. Except for a few I-bonds all our bonds are in tax deferred. Our tax adjusted AA near the end of 2017 was 57.7% equities. My plan calls for a 50/50 AA with 5% bands. So in real. spendable money terms, we were exceeding our bands by 2.7%. Not a lot, certainly. I did some minor rebalancing in tax deferred in late December to bring us into line. This may be the first time I've had to sell and buy to rebalance since changing our AA about a year prior to retirement.
But you didn't establish that the correct asset allocation for the after tax virtual portfolio is still 50/50. It isn't logical that the two asset allocations should be the same. The virtual portfolio should be more aggressive because it is smaller and needs earn more return.

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by Doc » Sat Apr 28, 2018 9:34 am

dbr wrote:
Sat Apr 28, 2018 8:05 am
But you didn't establish that the correct asset allocation for the after tax virtual portfolio is still 50/50. It isn't logical that the two asset allocations should be the same. The virtual portfolio should be more aggressive because it is smaller and needs earn more return.
If I have $100 in my tIRA and am in the 25% tax bracket only $75 in that tIRA a is mine. The other $25 belongs to the Guv and some day I will have to pay that along with interest that is equal to the return on my tIRA.

In the meantime if I have $100 in my taxable account most of it is mine except for the tax on unrealized cap gains which is going to be small compared to the $25 in taxes I owe on the tIRA balance.

So if my AA is to control my risk why should I include the Guv's $25 in my AA. Do I have any reason at all to care about the Guv's risk?

If my tIRA is all bonds and my taxable is all stock my AA is 57/43 not 50/50.

If my tax rate changes as I age I'm going to recalculate my tax adjusted AA but I'm going to change my AA with age anyway and am going to rebalnce regularly so there is no need to try to predict my future tax rate.

If you think there is no difference in risk between 57/43 and 50/50 it is not necessarily to tax adjusted your AA. :shock:
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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by dbr » Sat Apr 28, 2018 9:43 am

Doc wrote:
Sat Apr 28, 2018 9:34 am
dbr wrote:
Sat Apr 28, 2018 8:05 am
But you didn't establish that the correct asset allocation for the after tax virtual portfolio is still 50/50. It isn't logical that the two asset allocations should be the same. The virtual portfolio should be more aggressive because it is smaller and needs earn more return.
If I have $100 in my tIRA and am in the 25% tax bracket only $75 in that tIRA a is mine. The other $25 belongs to the Guv and some day I will have to pay that along with interest that is equal to the return on my tIRA.

In the meantime if I have $100 in my taxable account most of it is mine except for the tax on unrealized cap gains which is going to be small compared to the $25 in taxes I owe on the tIRA balance.

So if my AA is to control my risk why should I include the Guv's $25 in my AA. Do I have any reason at all to care about the Guv's risk?

If my tIRA is all bonds and my taxable is all stock my AA is 57/43 not 50/50.

If my tax rate changes as I age I'm going to recalculate my tax adjusted AA but I'm going to change my AA with age anyway and am going to rebalnce regularly so there is no need to try to predict my future tax rate.

If you think there is no difference in risk between 57/43 and 50/50 it is not necessarily to tax adjusted your AA. :shock:
I didn't say there is no difference in risk. I said you need to rethink what the risk should be for the virtual portfolio. You can't do this problem without first understanding how to determine what the risk should be. How did you arrive at 50/50 and if you think that is right for actual assets why would you think it is still right for the virtual assets. Reichenstein, by the way, addresses that problem directly by implementing a method to calculate an asset allocation for tax adjusted assets that optimizes an after tax utility function. No one else here seems to actually know how to arrive at any asset allocation actual or virtual, as far as I can tell. My case is similar to yours and I have determined that the correct asset allocation for actual assets is 50/50 and for adjusted assets is a "riskier" 57/43. My method is personal. Note I can conceive of an approach to asset allocation where the after tax allocation should perhaps be less risky than the actual asset allocation. In your case that could mean that your 57/43 should be adjusted down to 45/55 or something like that. One can't know until one knows how to arrive at an asset allocation.

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by Doc » Sat Apr 28, 2018 10:44 am

dbr wrote:
Sat Apr 28, 2018 9:43 am
I didn't say there is no difference in risk. I said you need to rethink what the risk should be for the virtual portfolio. You can't do this problem without first understanding how to determine what the risk should be. How did you arrive at 50/50 and if you think that is right for actual assets why would you think it is still right for the virtual assets. Reichenstein, by the way, addresses that problem directly by implementing a method to calculate an asset allocation for tax adjusted assets that optimizes an after tax utility function. No one else here seems to actually know how to arrive at any asset allocation actual or virtual, as far as I can tell
I don't know what you mean by virtual assets. Is this the future after tax value of your portfolio assuming you liquidated at some point and paid all the taxes due at that time? If so I have no idea how to calculate that because the future tax is unknown and any attempt to calculate it is so packed with what if's that it is virtually useless in my opinion.

As far as an AA being "right" is also indeterminate. The point of an AA is to control risk. Whatever the "value" of that risk is is even more fruit with difficulties. If the price/book goes from 16/1 to 22/1 is your portfolio more risky if you maintain a constant AA over that period. Yea, probably. Do I account for it someway. No. I'd have to go back and look at historical data and then use that to predict the future.

What I want to do is to keep my risk constant in some way. I don't think changing my risk level because I owe the Guv more or less money is relevant to that risk. I can change my risk level by having more or less equities that I own not the ones that partly belong to some else whether that someone is the Guv or the DBR Payday Loan Company. :D

There have been posts that say that equities in a 401k are less risky than in a taxable account becaue the Guv shares some of your risk. I don't buy that argument.
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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by Taylor Larimore » Sat Apr 28, 2018 10:52 am

1) My tax-deferred portfolio is around 500K and I plan to early retire. It is too small for me to tax-adjust since I will be paying little to no tax on my withdrawal.
KlangFool:

I would not bother tax-adjusting.

There is more than one road to Dublin.

Best wishes.
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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by dbr » Sat Apr 28, 2018 10:56 am

Doc wrote:
Sat Apr 28, 2018 10:44 am
dbr wrote:
Sat Apr 28, 2018 9:43 am
I didn't say there is no difference in risk. I said you need to rethink what the risk should be for the virtual portfolio. You can't do this problem without first understanding how to determine what the risk should be. How did you arrive at 50/50 and if you think that is right for actual assets why would you think it is still right for the virtual assets. Reichenstein, by the way, addresses that problem directly by implementing a method to calculate an asset allocation for tax adjusted assets that optimizes an after tax utility function. No one else here seems to actually know how to arrive at any asset allocation actual or virtual, as far as I can tell
I don't know what you mean by virtual assets. Is this the future after tax value of your portfolio assuming you liquidated at some point and paid all the taxes due at that time? If so I have no idea how to calculate that because the future tax is unknown and any attempt to calculate it is so packed with what if's that it is virtually useless in my opinion.

Virtual assets are the tax adjusted assets (asset values) we are discussing in this thread. Keep in mind I am no enthusiast for doing this as I think the rationale for it is spacey and the practical effect would be of little consequence for most investors.


As far as an AA being "right" is also indeterminate. The point of an AA is to control risk. Whatever the "value" of that risk is is even more fruit with difficulties. If the price/book goes from 16/1 to 22/1 is your portfolio more risky if you maintain a constant AA over that period. Yea, probably. Do I account for it someway. No. I'd have to go back and look at historical data and then use that to predict the future.

That is one good reason for not getting involved in trying to alter one's actual asset allocation based on after tax nuances. It isn't a parameter that is precise enough or meaningful enough at the margins to justify such a treatment. That is what I thought I said by provoking people to explain exactly how one comes up with asset allocations in such a definite, systematic, and exact way as to justify this tax adjustment process.

What I want to do is to keep my risk constant in some way. I don't think changing my risk level because I owe the Guv more or less money is relevant to that risk. I can change my risk level by having more or less equities that I own not the ones that partly belong to some else whether that someone is the Guv or the DBR Payday Loan Company. :D

The advocates of tax adjusted asset allocation are saying just exactly that you should consider only the risk of your adjusted asset allocation but doing so without telling us how to arrive at an asset allocation at all. Reichenstein does not fall afoul of that miss-step.

There have been posts that say that equities in a 401k are less risky than in a taxable account becaue the Guv shares some of your risk. I don't buy that argument.

Well, exactly. I made the same point that if actual assets are allocated at 50/50 and the asset allocation of adjusted assets is 57/43, then so what.

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by Doc » Sat Apr 28, 2018 11:24 am

dbr wrote:
Sat Apr 28, 2018 10:56 am
The advocates of tax adjusted asset allocation are saying just exactly that you should consider only the risk of your adjusted asset allocation but doing so without telling us how to arrive at an asset allocation at all. Reichenstein does not fall afoul of that miss-step.
I think I looked at the Reichenstein argument years ago when this idea was hashed out thoroughly. I don't remember all the arguments.
If you have accounts with different tax treatment (taxable, traditional IRA or 401(k), Roth IRA or 401(k)), equal dollar amounts in those accounts have different after-tax values. Therefore, if you want to optimize the after-tax value of your portfolio, you should base your asset allocation on the after-tax value of the accounts.
https://www.bogleheads.org/wiki/Tax-adj ... allocation

There are several links to Reichenstein's work in that Wiki article.

I don't have a dog in this fight. Our "non-converter" traditional IRA's are down to just over $1000 and I'm keeping that just to have access to the broker's website for research purposes.
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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by dbr » Sat Apr 28, 2018 11:35 am

Doc wrote:
Sat Apr 28, 2018 11:24 am
dbr wrote:
Sat Apr 28, 2018 10:56 am
The advocates of tax adjusted asset allocation are saying just exactly that you should consider only the risk of your adjusted asset allocation but doing so without telling us how to arrive at an asset allocation at all. Reichenstein does not fall afoul of that miss-step.
I think I looked at the Reichenstein argument years ago when this idea was hashed out thoroughly. I don't remember all the arguments.
If you have accounts with different tax treatment (taxable, traditional IRA or 401(k), Roth IRA or 401(k)), equal dollar amounts in those accounts have different after-tax values. Therefore, if you want to optimize the after-tax value of your portfolio, you should base your asset allocation on the after-tax value of the accounts.
https://www.bogleheads.org/wiki/Tax-adj ... allocation

There are several links to Reichenstein's work in that Wiki article.

I don't have a dog in this fight. Our "non-converter" traditional IRA's are down to just over $1000 and I'm keeping that just to have access to the broker's website for research purposes.
I have no idea what "optimize the after-tax value of your portfolio" actually means as no method of optimization is suggested. In the case of value of a portfolio the obvious meaning would be that optimize means maximize and to do that you would invest in the highest expected after tax return possible. I am unable to perceive how setting the asset allocation based on tax adjusted values is helpful to do that as to start with one's entire investment portfolio would be 100% stocks adjusted or not, in order to maximize return. If some other utility function is what is in mind for "optimize" then the article would be more useful if what this is was made clear.

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by dbr » Sat Apr 28, 2018 12:08 pm

Here's another question I have on this topic.

It seems to me that tax adjusting an asset allocation really amounts to capitalizing the net present value of a future (negative) income stream. I am just wondering how often that is considered a useful technique in academic finance for doing financial analysis.

There is an interesting parallel with respect to the idea of capitalizing pensions, annuities, and SS as a fixed income asset based on NPV of future cash flows and then sticking that NPV into the asset allocation. Posters on this forum tend to be reluctant to do that. The parallel to this with regard to taxes is to account for taxes as future expenses rather than negative NPV assets.

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by Lynette » Sat Apr 28, 2018 12:13 pm

I am not taking this into account in planning my AA as I've had 60/40 allocation and see no reason to change. However in tax planning don't forget Medicare IRMAA especially if most of your money is in tax deferred and you do not have low income years to do Roth conversions. I worked into my seventies, have two pension, SS and have to take RMDs. Most of my money is in tax-deferred and its not worth doing Roth conversions. So I'm stuck with additional tax - Medicare IRMAA - for life.

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by golfCaddy » Sat Apr 28, 2018 12:17 pm

It depends on what taxes you expect to pay in retirement. I expect my effective tax rate, federal plus state, on future tax deferred withdrawals to be 25%+. In my situation, it would be foolish not to tax-adjust the asset allocation for planning purposes. In other tax situations, the effective tax rate might be small enough that ignoring it makes little difference.

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by dbr » Sat Apr 28, 2018 12:19 pm

golfCaddy wrote:
Sat Apr 28, 2018 12:17 pm
It depends on what taxes you expect to pay in retirement. I expect my effective tax rate, federal plus state, on future tax deferred withdrawals to be 25%+. In my situation, it would be foolish not to tax-adjust the asset allocation for planning purposes. In other tax situations, the effective tax rate might be small enough that ignoring it makes little difference.
There are many ways to take taxes into account in planning than tax adjusting the asset allocation. This is not a debate about whether it is ok to ignore the existence of taxes altogether.

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by inbox788 » Sat Apr 28, 2018 12:25 pm

dbr wrote:
Sat Apr 28, 2018 9:43 am
I didn't say there is no difference in risk. I said you need to rethink what the risk should be for the virtual portfolio. You can't do this problem without first understanding how to determine what the risk should be. How did you arrive at 50/50 and if you think that is right for actual assets why would you think it is still right for the virtual assets. Reichenstein, by the way, addresses that problem directly by implementing a method to calculate an asset allocation for tax adjusted assets that optimizes an after tax utility function. No one else here seems to actually know how to arrive at any asset allocation actual or virtual, as far as I can tell. My case is similar to yours and I have determined that the correct asset allocation for actual assets is 50/50 and for adjusted assets is a "riskier" 57/43. My method is personal. Note I can conceive of an approach to asset allocation where the after tax allocation should perhaps be less risky than the actual asset allocation. In your case that could mean that your 57/43 should be adjusted down to 45/55 or something like that. One can't know until one knows how to arrive at an asset allocation.
You know the expression being on the same page? I'm thinking we're not even on the same starting line, so even if we followed the same path, we may not wind up in the same place. When someone says they want a 50/50 AA (however they arrived at that number), we generally equate that with actual assets, but for some, it's already an approximation for the ideal after tax spendable amount that's difficult to compute, the virtual portfolio as I understand it. Which is the cart and which is the horse? Figuring this out in part depends on whether you factored in taxes in your spending. Some folks do, but I seldom see taxes on the budget line. So this tax-adjustment can go either way. Pension plans that aim for 80% of working years income work because you no longer need to save for retirement during retirement (or shouldn't have to), and with reduced income comes a lower tax burden. This works much of the time, but if you haven't been saving for retirement and don't pay much taxes, 80% may not cut it.

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by dbr » Sat Apr 28, 2018 12:29 pm

inbox788 wrote:
Sat Apr 28, 2018 12:25 pm
dbr wrote:
Sat Apr 28, 2018 9:43 am
I didn't say there is no difference in risk. I said you need to rethink what the risk should be for the virtual portfolio. You can't do this problem without first understanding how to determine what the risk should be. How did you arrive at 50/50 and if you think that is right for actual assets why would you think it is still right for the virtual assets. Reichenstein, by the way, addresses that problem directly by implementing a method to calculate an asset allocation for tax adjusted assets that optimizes an after tax utility function. No one else here seems to actually know how to arrive at any asset allocation actual or virtual, as far as I can tell. My case is similar to yours and I have determined that the correct asset allocation for actual assets is 50/50 and for adjusted assets is a "riskier" 57/43. My method is personal. Note I can conceive of an approach to asset allocation where the after tax allocation should perhaps be less risky than the actual asset allocation. In your case that could mean that your 57/43 should be adjusted down to 45/55 or something like that. One can't know until one knows how to arrive at an asset allocation.
You know the expression being on the same page? I'm thinking we're not even on the same starting line, so even if we followed the same path, we may not wind up in the same place. When someone says they want a 50/50 AA (however they arrived at that number), we generally equate that with actual assets, but for some, it's already an approximation for the ideal after tax spendable amount that's difficult to compute, the virtual portfolio as I understand it. Which is the cart and which is the horse? Figuring this out in part depends on whether you factored in taxes in your spending. Some folks do, but I seldom see taxes on the budget line. So this tax-adjustment can go either way. Pension plans that aim for 80% of working years income work because you no longer need to save for retirement during retirement (or shouldn't have to), and with reduced income comes a lower tax burden. This works much of the time, but if you haven't been saving for retirement and don't pay much taxes, 80% may not cut it.
I would raise the suspicion that most comments and articles regarding tax adjusting the asset allocation don't have a starting line or even know what a starting line looks like. "The government owns x% of my assets." looks like a starting line, but it certainly is not, as clever as it sounds.

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Re: "Tax-Adjusted Asset Allocation: Is It Necessary?"

Post by Doc » Sat Apr 28, 2018 12:49 pm

There is a big problem in this whole discussion.

The whole reason for picking an asset allocation is to maintain a desired risk in one's portfolio. How much risk each of us want to take is based on our individual need/ability/willingness to take risk. Those are non-quantitative factors that we put into a metric that we call AA. Whether we complicate the situation by adding tax consequences just adds to the problem.

We have heard of appropriate values of AA of which the most common is perhaps age in bonds. This is based on things like the return and variance of something that happened in the past based on the different stock/bond ratios. But I doubt that in any of those past opinions was tax ever a consideration.

We should have a consistent method of computing an AA. Past studies of equity/bond portfolios apply to all of us in the same way. If we now add tax to the equation the result becomes different for each of us and all that past data becomes worth very little.

Our tax rates change over time. Likewise do our individual ratios of taxable and tax advantaged accounts. The only data we have for the past is based on data without tax considerations. It only makes sense if we are going to use that past data choose an AA we should also put our calculation on a tax equivalent basis. From the Wiki that is an after tax basis but even then the question of current or future tax rates is left open.
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