Does the ROTH IRA force us to rebalance in January?

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sabtastic
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Does the ROTH IRA force us to rebalance in January?

Post by sabtastic » Tue Jul 03, 2018 12:15 am

Every year I make a Roth IRA contribution. Current research suggests that dollar cost averaging is not the best practice, so naturally the best time to invest this "sideline cash" is as early as possible, which is January. In order to decide where the $$ go in the Roth, I have to look at the whole portfolio. This makes January a natural time to do my full rebalance. It struck me that I am probably not alone in doing this, which means this behavior could be predictable and therefore taken advantage of.

Does any one know if there is any research regarding this behavior? Part of me wants to change my timing and just start funding the ROTH later in the year, but I will be kicking myself the whole time for keeping hard earned $$ out of the market..

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Re: Does the ROTH IRA force us to rebalance in January?

Post by Noobvestor » Tue Jul 03, 2018 12:29 am

I don't contribute to a Roth in January. Probably a fair number of folks do it later in the year for various reasons - e.g. that's when they have money, or they're not sure if they'll be eligible. And then you have all the people contributing from paychecks, or to taxable accounts.

To further complicate things: I also rebalance throughout the year in different accounts depending on bands and cash flow and other factors.
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celia
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Re: Does the ROTH IRA force us to rebalance in January?

Post by celia » Tue Jul 03, 2018 1:48 am

No, you are never "forced" to re-balance, in January or any other month.

But some people think about it in January possibly because that is when they get the year-end balances for the previous year. (Many people never or rarely sign into their accounts.)

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Re: Does the ROTH IRA force us to rebalance in January?

Post by aristotelian » Tue Jul 03, 2018 6:13 am

Yes, if you do a lump sum, you are going from X/Y/Z plus $5500 cash to X/Y/Z.

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Re: Does the ROTH IRA force us to rebalance in January?

Post by bradpevans » Tue Jul 03, 2018 6:49 am

sabtastic wrote:
Tue Jul 03, 2018 12:15 am
Every year I make a Roth IRA contribution. Current research suggests that dollar cost averaging is not the best practice, so naturally the best time to invest this "sideline cash" is as early as possible, which is January. In order to decide where the $$ go in the Roth, I have to look at the whole portfolio. This makes January a natural time to do my full rebalance. It struck me that I am probably not alone in doing this, which means this behavior could be predictable and therefore taken advantage of.

Does any one know if there is any research regarding this behavior? Part of me wants to change my timing and just start funding the ROTH later in the year, but I will be kicking myself the whole time for keeping hard earned $$ out of the market..
Do you make other investments through out the year? Because the same logic would apply there..

If your Roth IRA is your only place for "sideline cash" then January might be reasonable.

Some hold the view that Roth is for your "high flyer" investments. For me i want all my investments to be such high flyers

Not sure what you mean by this part:

" which means this behavior could be predictable and therefore taken advantage of. "

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Tamarind
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Re: Does the ROTH IRA force us to rebalance in January?

Post by Tamarind » Tue Jul 03, 2018 7:07 am

sabtastic wrote:
Tue Jul 03, 2018 12:15 am
Every year I make a Roth IRA contribution. Current research suggests that dollar cost averaging is not the best practice, so naturally the best time to invest this "sideline cash" is as early as possible, which is January.
I actually disagree with your premise a bit, I think. The reason lump sum beats DCA is because the money is invested for longer. So one should actually be trying to never have "sideline cash" at all. Money should be working as soon as it is available.

Of course law prevents you from making a 2018 Roth IRA contribution before January 1, 2018, even if you have the cash on hand. But nothing is making you hold that money uninvested, especially if you routinely have extra cash flow even though you are maxing out everything you can contribute to via payroll deduction. I'm assuming here that the cash is only earmarked for Roth contribution and you are not tapping your emergency fund to make that contribution in January.

Why not invest the money intended for Roth in your taxable account? When the contribution window opens, sell in taxable and contribute to buy in Roth. Now you are not rebalancing, just shifting investments between accounts. You could combine this with tax loss or gain harvesting in late December.

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Re: Does the ROTH IRA force us to rebalance in January?

Post by rkhusky » Tue Jul 03, 2018 7:23 am

Just rebalance when your portfolio gets out of balance. If you believe that the stock market will generally rise over time, the earlier you invest, the better you will do on average.

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Re: Does the ROTH IRA force us to rebalance in January?

Post by mbasherp » Tue Jul 03, 2018 7:26 am

Tamarind wrote:
Tue Jul 03, 2018 7:07 am

Why not invest the money intended for Roth in your taxable account? When the contribution window opens, sell in taxable and contribute to buy in Roth. Now you are not rebalancing, just shifting investments between accounts. You could combine this with tax loss or gain harvesting in late December.
I've been thinking a lot about this, since this is first full year I have enough in taxable to take this approach. The benefits are clear when tax loss harvesting. But what about when I have only gains in taxable and I want to fund my Roth? Is it better to skip it (front-loading) those years and just fund the Roth from new income?

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Re: Does the ROTH IRA force us to rebalance in January?

Post by vineviz » Tue Jul 03, 2018 7:50 am

Tamarind wrote:
Tue Jul 03, 2018 7:07 am
....nothing is making you hold that money uninvested, especially if you routinely have extra cash flow even though you are maxing out everything you can contribute to via payroll deduction. I'm assuming here that the cash is only earmarked for Roth contribution and you are not tapping your emergency fund to make that contribution in January.

Why not invest the money intended for Roth in your taxable account? When the contribution window opens, sell in taxable and contribute to buy in Roth. Now you are not rebalancing, just shifting investments between accounts. You could combine this with tax loss or gain harvesting in late December.
+1 to this. Invest the money SOMEWHERE as soon as you have it, then transfer to the Roth when you can.
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Re: Does the ROTH IRA force us to rebalance in January?

Post by AlohaJoe » Tue Jul 03, 2018 7:54 am

mbasherp wrote:
Tue Jul 03, 2018 7:26 am
The benefits are clear when tax loss harvesting. But what about when I have only gains in taxable and I want to fund my Roth? Is it better to skip it (front-loading) those years and just fund the Roth from new income?
I don't understand what you think the problem is in this scenario. Can you elaborate more on the problem you see and how much money you think it would cost you?

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Re: Does the ROTH IRA force us to rebalance in January?

Post by sabtastic » Tue Jul 03, 2018 8:04 am

Tamarind wrote:
Tue Jul 03, 2018 7:07 am
Why not invest the money intended for Roth in your taxable account? When the contribution window opens, sell in taxable and contribute to buy in Roth. Now you are not rebalancing, just shifting investments between accounts. You could combine this with tax loss or gain harvesting in late December.
FWIW, this is exactly what I do. I have enough in taxable to fund a few year's worth of ROTH, so I usually sell in late dec and buy right back in early Jan. Since both are with vanguard almost all of the time this is going from VTSAX in taxable to VTSAX in ROTH. I guess my concern was the predictability of this behavior. If most investors are doing this same thing it could result in some volatility, but I haven't noticed anything obvious. I haven't been able to find any statistics on this anywhere, either.

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Re: Does the ROTH IRA force us to rebalance in January?

Post by vineviz » Tue Jul 03, 2018 8:47 am

sabtastic wrote:
Tue Jul 03, 2018 8:04 am
Tamarind wrote:
Tue Jul 03, 2018 7:07 am
Why not invest the money intended for Roth in your taxable account? When the contribution window opens, sell in taxable and contribute to buy in Roth. Now you are not rebalancing, just shifting investments between accounts. You could combine this with tax loss or gain harvesting in late December.
FWIW, this is exactly what I do. I have enough in taxable to fund a few year's worth of ROTH, so I usually sell in late dec and buy right back in early Jan. Since both are with vanguard almost all of the time this is going from VTSAX in taxable to VTSAX in ROTH. I guess my concern was the predictability of this behavior. If most investors are doing this same thing it could result in some volatility, but I haven't noticed anything obvious. I haven't been able to find any statistics on this anywhere, either.
A) I feel confident that "most" investors aren't doing anything like this.

B) As long as the money is invested SOMEWHERE, there is no longer any need to make the taxable>>Roth transfer happen at the beginning of the year. You could pick a random day any time during the year (John Bogle's birthday is May 8th) and do it then.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

mbasherp
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Re: Does the ROTH IRA force us to rebalance in January?

Post by mbasherp » Tue Jul 03, 2018 9:09 am

AlohaJoe wrote:
Tue Jul 03, 2018 7:54 am
mbasherp wrote:
Tue Jul 03, 2018 7:26 am
The benefits are clear when tax loss harvesting. But what about when I have only gains in taxable and I want to fund my Roth? Is it better to skip it (front-loading) those years and just fund the Roth from new income?
I don't understand what you think the problem is in this scenario. Can you elaborate more on the problem you see and how much money you think it would cost you?
If I have only gains in my taxable and I choose to sell there to move the money over to my Roth, am I realizing an unnecessary capital gain? If I simply leave my taxable as is when I don't have opportunities to TLH, I'm keeping more totally invested (no self-generated loss to taxes), and I fill the Roth with all new investment contributions in each new year. Once the Roth is full, I move to taxable again for the remainder of the year.

My thought is that realizing gains when I don't need to is sub-optimal. Either way, every dollar is invested immediately. The only downside I can think of is that a market surge in the first few months of the year would be better captured in a Roth than taxable. But that is probably really splitting hairs and would vary every year depending on market performance.

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Re: Does the ROTH IRA force us to rebalance in January?

Post by livesoft » Tue Jul 03, 2018 9:20 am

mbasherp wrote:
Tue Jul 03, 2018 9:09 am
If I have only gains in my taxable and I choose to sell there to move the money over to my Roth, am I realizing an unnecessary capital gain?
Anybody who has money to contribute to a Roth at the first of the year has to be keeping that money somewhere. If it is under the mattress, then I can see why there might not be any taxes to move it to a Roth, but most people would have the money some place else such as a savings account.

If the money has been held in a savings account, then it presumably has earned interested which gets taxed. It is foolish to believe that gains in a savings account or CD or the like are taxed any differently than short-term capital gains.

Of course, if one has a taxable account, there is a chance of other things besides short-term capital gains, interest, dividends: One can have long-term capital gains and qualified dividend income --- or one can have losses. All of these other things would result in lower tax rates.

No one would call a savings account that paid 10% "sub-optimal", would they?
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Re: Does the ROTH IRA force us to rebalance in January?

Post by H-Town » Tue Jul 03, 2018 9:27 am

sabtastic wrote:
Tue Jul 03, 2018 12:15 am
Every year I make a Roth IRA contribution. Current research suggests that dollar cost averaging is not the best practice, so naturally the best time to invest this "sideline cash" is as early as possible, which is January. In order to decide where the $$ go in the Roth, I have to look at the whole portfolio. This makes January a natural time to do my full rebalance. It struck me that I am probably not alone in doing this, which means this behavior could be predictable and therefore taken advantage of.

Does any one know if there is any research regarding this behavior? Part of me wants to change my timing and just start funding the ROTH later in the year, but I will be kicking myself the whole time for keeping hard earned $$ out of the market..
It doesn't really matter. Where there is a buyer, there's typically a seller. Your trade partner could be a retiree who withdrew 5,500 to fund monthly expenses.

There are many researches out there but the most powerful one would tell you to stop thinking about your portfolio. Set automatic contributions, invest any extra cash inflows, and forget about it.

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Re: Does the ROTH IRA force us to rebalance in January?

Post by House Blend » Tue Jul 03, 2018 9:29 am

mbasherp wrote:
Tue Jul 03, 2018 9:09 am
My thought is that realizing gains when I don't need to is sub-optimal. Either way, every dollar is invested immediately.
Agreed. Realizing capital gains when you have enough cash flow to eventually max out the Roth IRA would be a mistake IMO. (Exception if you pay 0% tax on LT cap gains.)

Note that you should not auto-reinvest dividends from taxable accounts. Manual reinvesting increases cash flow and gives you the option to contribute the divs to your IRA.

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Re: Does the ROTH IRA force us to rebalance in January?

Post by H-Town » Tue Jul 03, 2018 9:44 am

livesoft wrote:
Tue Jul 03, 2018 9:20 am
mbasherp wrote:
Tue Jul 03, 2018 9:09 am
If I have only gains in my taxable and I choose to sell there to move the money over to my Roth, am I realizing an unnecessary capital gain?
Anybody who has money to contribute to a Roth at the first of the year has to be keeping that money somewhere. If it is under the mattress, then I can see why there might not be any taxes to move it to a Roth, but most people would have the money some place else such as a savings account.
What about the money from 12/31 paycheck?

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Re: Does the ROTH IRA force us to rebalance in January?

Post by Tamarind » Tue Jul 03, 2018 10:06 am

thangngo wrote:
Tue Jul 03, 2018 9:44 am
livesoft wrote:
Tue Jul 03, 2018 9:20 am
mbasherp wrote:
Tue Jul 03, 2018 9:09 am
If I have only gains in my taxable and I choose to sell there to move the money over to my Roth, am I realizing an unnecessary capital gain?
Anybody who has money to contribute to a Roth at the first of the year has to be keeping that money somewhere. If it is under the mattress, then I can see why there might not be any taxes to move it to a Roth, but most people would have the money some place else such as a savings account.
What about the money from 12/31 paycheck?
Unless it's a very very large paycheck (so large that direct Roth contributions would probably not be an option), that person wouldn't be funding their Roth IRA all in a lump sum in early January. They'd be contributing from cash flow either each month or at at least for the first few paychecks. Which is a completely valid way to avoid having sideline cash.

....Unless they are also holding too much cash in their checking account such that they can "skip" most of a paycheck.

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Re: Does the ROTH IRA force us to rebalance in January?

Post by Tamarind » Tue Jul 03, 2018 10:10 am

sabtastic wrote:
Tue Jul 03, 2018 8:04 am
Tamarind wrote:
Tue Jul 03, 2018 7:07 am
Why not invest the money intended for Roth in your taxable account? When the contribution window opens, sell in taxable and contribute to buy in Roth. Now you are not rebalancing, just shifting investments between accounts. You could combine this with tax loss or gain harvesting in late December.
FWIW, this is exactly what I do. I have enough in taxable to fund a few year's worth of ROTH, so I usually sell in late dec and buy right back in early Jan. Since both are with vanguard almost all of the time this is going from VTSAX in taxable to VTSAX in ROTH. I guess my concern was the predictability of this behavior. If most investors are doing this same thing it could result in some volatility, but I haven't noticed anything obvious. I haven't been able to find any statistics on this anywhere, either.
Glad this is how you do it rather than having cash on the sidelines.

Doing this on the last/first trading days off the year, and buying in Roth the same thing that you sell in taxable, you aren't really contributing to volatility or price changes in that fund. Just adding a little more volume.

If it makes you feel better to wait until the second week of January, go ahead, you aren't losing much time. But I think you're overthinking it (and the tax cost of harvesting gains, unless you are right at the top of your marginal bracket).

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Re: Does the ROTH IRA force us to rebalance in January?

Post by drk » Tue Jul 03, 2018 10:14 am

Tamarind wrote:
Tue Jul 03, 2018 10:06 am
Unless it's a very very large paycheck (so large that direct Roth contributions would probably not be an option), that person wouldn't be funding their Roth IRA all in a lump sum in early January. They'd be contributing from cash flow either each month or at at least for the first few paychecks. Which is a completely valid way to avoid having sideline cash.

....Unless they are also holding too much cash in their checking account such that they can "skip" most of a paycheck.
You've set this up as a dichotomy, but it's not. Some of us know in January that we'll have to use the backdoor Roth.

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Tamarind
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Re: Does the ROTH IRA force us to rebalance in January?

Post by Tamarind » Tue Jul 03, 2018 11:10 am

drk wrote:
Tue Jul 03, 2018 10:14 am
Tamarind wrote:
Tue Jul 03, 2018 10:06 am
Unless it's a very very large paycheck (so large that direct Roth contributions would probably not be an option), that person wouldn't be funding their Roth IRA all in a lump sum in early January. They'd be contributing from cash flow either each month or at at least for the first few paychecks. Which is a completely valid way to avoid having sideline cash.

....Unless they are also holding too much cash in their checking account such that they can "skip" most of a paycheck.
You've set this up as a dichotomy, but it's not. Some of us know in January that we'll have to use the backdoor Roth.
You're right. Funding Roth or non-deductible tIRA.

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Re: Does the ROTH IRA force us to rebalance in January?

Post by AlohaJoe » Tue Jul 03, 2018 11:15 am

mbasherp wrote:
Tue Jul 03, 2018 9:09 am
AlohaJoe wrote:
Tue Jul 03, 2018 7:54 am
mbasherp wrote:
Tue Jul 03, 2018 7:26 am
The benefits are clear when tax loss harvesting. But what about when I have only gains in taxable and I want to fund my Roth? Is it better to skip it (front-loading) those years and just fund the Roth from new income?
I don't understand what you think the problem is in this scenario. Can you elaborate more on the problem you see and how much money you think it would cost you?
If I have only gains in my taxable and I choose to sell there to move the money over to my Roth, am I realizing an unnecessary capital gain? If I simply leave my taxable as is when I don't have opportunities to TLH, I'm keeping more totally invested (no self-generated loss to taxes), and I fill the Roth with all new investment contributions in each new year. Once the Roth is full, I move to taxable again for the remainder of the year.
If you invest monthly in your Roth then your expected return is $5,773.
If you invest lump sum then your expected return is $6,012, for a difference of $239.

So as long as the capital gains tax paid is $238 or less, it makes sense to realise the capital gains. $238 at a short term capital gains tax rate of 24% means $991 in capital gains. Having $991 in capital gains on a $5,500 investment over ~3 months would be the equivalent of an annualised return of over 40%. It is possible but seems unlikely.

If you have less than $991 in capital gains then you should realise the capital gains and invest on January 1st.

I'm sure you can build your own model that takes into account your own personal tax situation for a more accurate answer. But it should be clear that simply saying "realising capitals gains is inefficient" doesn't really offer guidance on what to do. And it seems that one's default intuition should be "more money is better" not "do anything to avoid paying any taxes".

mbasherp
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Re: Does the ROTH IRA force us to rebalance in January?

Post by mbasherp » Tue Jul 03, 2018 2:18 pm

AlohaJoe,
Thanks for the analysis, although I think I'm not understanding it fully. Is it just me or does it ignore the existence of the (still invested) taxable account? What concerns me is the total ending values across all accounts, not just the Roth.

Scenario #1: Pull funds from taxable Dec 31, max Roth Jan 1, incur short/long term capital gains taxes. Invest monthly during the new year in taxable.

Scenario #2: Leave taxable account alone; no taxes due. Invest monthly in Roth until it is maxed, then invest in taxable.

Both scenarios have the exact same amount of principle invested across 2 accounts (with identical returns, lets assume), minus the capital gains taxes I've paid in #1. So how can #1 possibly be better?

Truly not being difficult; I'd like to understand this by the end of the year. :oops:

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Re: Does the ROTH IRA force us to rebalance in January?

Post by Tamarind » Wed Jul 04, 2018 6:29 am

mbasherp wrote:
Tue Jul 03, 2018 2:18 pm
AlohaJoe,
Thanks for the analysis, although I think I'm not understanding it fully. Is it just me or does it ignore the existence of the (still invested) taxable account? What concerns me is the total ending values across all accounts, not just the Roth.

Scenario #1: Pull funds from taxable Dec 31, max Roth Jan 1, incur short/long term capital gains taxes. Invest monthly during the new year in taxable.

Scenario #2: Leave taxable account alone; no taxes due. Invest monthly in Roth until it is maxed, then invest in taxable.

Both scenarios have the exact same amount of principle invested across 2 accounts (with identical returns, lets assume), minus the capital gains taxes I've paid in #1. So how can #1 possibly be better?

Truly not being difficult; I'd like to understand this by the end of the year. :oops:
Some thoughts, though I am not AlohaJoe.

Neither of these scenarios involves sidelined cash anymore, which was the big issue in the plan as originally stated, so we can drop the lump sum vs DCA considerations. Now you are right that situation 1 and 2 are very similar.

If you've been doing taxable investing for a while, no reason ever to take a short term gain.

Perhaps you could do scenario 1 if you have harvestable losses and scenario 2 if you don't?

mbasherp
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Re: Does the ROTH IRA force us to rebalance in January?

Post by mbasherp » Wed Jul 04, 2018 8:53 am

Tamarind wrote:
Wed Jul 04, 2018 6:29 am
mbasherp wrote:
Tue Jul 03, 2018 2:18 pm
AlohaJoe,
Thanks for the analysis, although I think I'm not understanding it fully. Is it just me or does it ignore the existence of the (still invested) taxable account? What concerns me is the total ending values across all accounts, not just the Roth.

Scenario #1: Pull funds from taxable Dec 31, max Roth Jan 1, incur short/long term capital gains taxes. Invest monthly during the new year in taxable.

Scenario #2: Leave taxable account alone; no taxes due. Invest monthly in Roth until it is maxed, then invest in taxable.

Both scenarios have the exact same amount of principle invested across 2 accounts (with identical returns, lets assume), minus the capital gains taxes I've paid in #1. So how can #1 possibly be better?

Truly not being difficult; I'd like to understand this by the end of the year. :oops:
Some thoughts, though I am not AlohaJoe.

Neither of these scenarios involves sidelined cash anymore, which was the big issue in the plan as originally stated, so we can drop the lump sum vs DCA considerations. Now you are right that situation 1 and 2 are very similar.

If you've been doing taxable investing for a while, no reason ever to take a short term gain.

Perhaps you could do scenario 1 if you have harvestable losses and scenario 2 if you don't?
You're correct, these scenarios don't have any sidelined cash. I agree with you on harvestable vs non harvestable losses dictating which to do. While AlohaJoe's analysis looks right, my gut keeps telling me that we aren't accounting for the growth of the other non Roth money. That would lean things toward scenario 2 except for losses or very small gains.

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