Any reason to have different allocation in ROTH?

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McCharley
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Any reason to have different allocation in ROTH?

Post by McCharley » Sun Jan 29, 2012 8:41 pm

Hi, Folks,

I'm rolling over a 401(k) and part of it is ROTH. Is there any reason to make this AA different from the rest of the portfolio?

The whole portfolio is about $330k and the ROTH portion is only about $26k. I'm thinking I don't want to totally mirror the larger portion because I'd like to keep Admiral shares. But other than that I can't think why I'd put one fund type (e.g. REIT) in the ROTH account vs. another.

Thank you!

Bob's not my name
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Re: Any reason to have different allocation in ROTH?

Post by Bob's not my name » Sun Jan 29, 2012 8:42 pm

Short answer: doesn't matter.

Long answer: http://www.bogleheads.org/forum/viewtopic.php?t=66960

PB
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Re: Any reason to have different allocation in ROTH?

Post by PB » Sun Jan 29, 2012 9:20 pm

I'm not an expert, but if your horizon is long-term, my thinking is this:

- Include your ROTH fund(s) in your overall asset allocation, but:
- Hold equities in the ROTH.

Presuming equities will perform better than cash or bonds in the long run, the return on those ROTH equities will be completely tax free. In contrast, you'll have to pay taxes on your non-ROTH equity returns.

Maybe I'm missing something, but that's my thinking.

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Toons
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Re: Any reason to have different allocation in ROTH?

Post by Toons » Sun Jan 29, 2012 9:21 pm

Don't think it matters
"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee

beareconomy
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Re: Any reason to have different allocation in ROTH?

Post by beareconomy » Sun Jan 29, 2012 9:27 pm

Maybe it depends on what the capitol gains tax rate will be in the future. If it is going to be higher, it would be good to have stocks in the roth. If it going to stay low at 15%, maybe it would be better to have them in a taxed account. But as a previous poster mentioned, you have to figure out what will grow more, stocks or bonds, so really the question depends on predicting the future which is difficult to do. Maybe a shifting strategy that looks at taxes each year may be the best way to go. But like I said, I think you need to figure out how much greater stocks will grow than bonds if at all. I would say tough question, but things to think about.

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Re: Any reason to have different allocation in ROTH?

Post by larryswedroe » Sun Jan 29, 2012 10:09 pm

Here is what the literature on subject says
a) prefer to first hold bonds in tax advantaged accounts, then other tax inefficient asset classes like REITS and commodities (though if cannot hold them in tax advantaged accounts probably best to avoid unless in lowest brackets), then least efficient equities especially international due to loss of FTC
b) between Roth and traditional hold highest expected return in Roth to minimize RMDs

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McCharley
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Re: Any reason to have different allocation in ROTH?

Post by McCharley » Mon Jan 30, 2012 12:42 am

not Bob -- thanks for the link!

I am inclined to bias my Roth account to those parts of my portfolio that may make more money -- like emerging markets (eg VMAX). That's certainly where the value of the Roth is best: in accounts which have gained a lot. :greedy

tpm871
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Re: Any reason to have different allocation in ROTH?

Post by tpm871 » Mon Jan 30, 2012 12:53 am

I put the higher expected return funds in my Roth IRA, due to the fact that no taxes will ever be owed. Given a choice of having my biggest gains in my Roth IRA or my Trad IRA, I'd pay fewer taxes if my Roth IRA has the bigger gains.

I have had these in my Roth IRA:
1. REITs
2. Emerging Markets
3. Small Value
4. International Small Cap

But recently I've considered adding a Treasury bond fund, since it would provide rebalancing benefits to these (these funds are a bit too correlated in their movements).

Bob's not my name
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Re: Any reason to have different allocation in ROTH?

Post by Bob's not my name » Mon Jan 30, 2012 4:00 am

A traditional IRA or 401k has a magical property that is a well-guarded secret: it can save you from a market downturn. This is why you should hold stocks in traditional and bonds in Roth.

Suppose you have $1,000 of stocks in a TIRA and $1,000 of bonds in a Roth. Now suppose the stock market tanks by 50% just when you've retired. Say bonds rise 10% because of flight to safety. Now you have $500 in your TIRA and $1,100 in your Roth. You withdraw both and pay $125 (25%) tax on the TIRA withdrawal, leaving you with $1,475 total.

Now suppose you make the terrible mistake of holding stocks in your Roth. Now you have $500 in your Roth and $1,100 in your TIRA. You withdraw both and pay $275 tax on the TIRA withdrawal, leaving you with $1,325 total, way less.

The argument is even more compelling when you consider RMDs. When you hold stocks in your Roth you have a bigger TIRA, meaning you are forced to make larger withdrawals. That’s terrible.

The reason behind this little miracle is that arcane details in the tax code require that the TIRA environment provide soothing lighting, groovy mood music, and pixie dust to help soften a stock market collapse. I know, I get a little teary about it, too, thinking about those congressional aides working late into the night to fashion laws that protect us from the evil grip of Wall Street.

Seriously: What I just wrote is baloney. If you can spot the fallacy in my little math model, you’ll know to look for the same fallacy in the stocks-in-Roth arguments.

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Re: Any reason to have different allocation in ROTH?

Post by ObliviousInvestor » Mon Jan 30, 2012 9:21 am

Unless your entire portfolio is in tax-advantaged retirement accounts and you have low-cost investment choices in each asset class in each account, then you probably do not want to use the same allocation in each account. In other words, implementing your desired allocation at the portfolio level rather than in each account often creates cost saving opportunities.
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Zephyr120
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Re: Any reason to have different allocation in ROTH?

Post by Zephyr120 » Mon Jan 30, 2012 9:15 pm

I mostly agree with placing high return equities in the Roth, as several others advise. My one reservation is to hold stable investments in a Roth as an emergency fund - there being no tax impact on withdrawing it. Also lower risk of it losing value when there is an emergency. This would apply only in retirement with increased risk of health problems.

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Re: Any reason to have different allocation in ROTH?

Post by madbrain » Mon Jan 30, 2012 11:01 pm

Bob's not my name wrote:A traditional IRA or 401k has a magical property that is a well-guarded secret: it can save you from a market downturn. This is why you should hold stocks in traditional and bonds in Roth.

Suppose you have $1,000 of stocks in a TIRA and $1,000 of bonds in a Roth. Now suppose the stock market tanks by 50% just when you've retired. Say bonds rise 10% because of flight to safety. Now you have $500 in your TIRA and $1,100 in your Roth. You withdraw both and pay $125 (25%) tax on the TIRA withdrawal, leaving you with $1,475 total.

Now suppose you make the terrible mistake of holding stocks in your Roth. Now you have $500 in your Roth and $1,100 in your TIRA. You withdraw both and pay $275 tax on the TIRA withdrawal, leaving you with $1,325 total, way less.

The argument is even more compelling when you consider RMDs. When you hold stocks in your Roth you have a bigger TIRA, meaning you are forced to make larger withdrawals. That’s terrible.

The reason behind this little miracle is that arcane details in the tax code require that the TIRA environment provide soothing lighting, groovy mood music, and pixie dust to help soften a stock market collapse. I know, I get a little teary about it, too, thinking about those congressional aides working late into the night to fashion laws that protect us from the evil grip of Wall Street.

Seriously: What I just wrote is baloney. If you can spot the fallacy in my little math model, you’ll know to look for the same fallacy in the stocks-in-Roth arguments.
Let me try. You only need a given net amount to cover your expenses. It's either $1325 or $1475, but not both. You would work in reverse from the dollar amount you need, and make withdrawals from either your Roth or your Traditional to net that amount.

If you have high RMDs in your traditional IRA, you would just take that and then withdraw less or nothing from the Roth IRA.

But I think in some cases, your net from RMDs might still be higher than your expenses. In that case it probably means your equities are actually doing well and you are actually selling high. Though, if the 50% crash happened on January 1, you might still be hosed and forced to sell some of your equities low due to the RMDs. However that problem should be temporary, only for one yea - the next year your RMDs should be less. Unless the market somehow consistently doubles on December 31 and halves on January 1.

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Re: Any reason to have different allocation in ROTH?

Post by baw703916 » Mon Jan 30, 2012 11:08 pm

tpm871 wrote:I put the higher expected return funds in my Roth IRA, due to the fact that no taxes will ever be owed. Given a choice of having my biggest gains in my Roth IRA or my Trad IRA, I'd pay fewer taxes if my Roth IRA has the bigger gains.

I have had these in my Roth IRA:
1. REITs
2. Emerging Markets
3. Small Value
4. International Small Cap

But recently I've considered adding a Treasury bond fund, since it would provide rebalancing benefits to these (these funds are a bit too correlated in their movements).
I have my Roth allocated similarly. About a year and a half ago I decided to add EDV (zero coupon Treasuries) and LTPZ (long-duration TIPS) to try to offset all those high risk equities. I'm very glad I did.

Brad
Most of my posts assume no behavioral errors.

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rob
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Re: Any reason to have different allocation in ROTH?

Post by rob » Mon Jan 30, 2012 11:13 pm

tpm871 wrote:I put the higher expected return funds in my Roth IRA, due to the fact that no taxes will ever be owed. Given a choice of having my biggest gains in my Roth IRA or my Trad IRA, I'd pay fewer taxes if my Roth IRA has the bigger gains.

I have had these in my Roth IRA:
1. REITs
2. Emerging Markets
3. Small Value
4. International Small Cap

But recently I've considered adding a Treasury bond fund, since it would provide rebalancing benefits to these (these funds are a bit too correlated in their movements).
It does not really matter but I see what your aiming at..... The rub there is that "EXPECTED" word..... what if it was worse because of having the risk show up.
| Rob | Its a dangerous business going out your front door. - J.R.R.Tolkien

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Re: Any reason to have different allocation in ROTH?

Post by RustyShackleford » Tue Jan 31, 2012 12:23 am

A lot of people repeat the line that bonds should be in tax-advantaged accounts.

My notion is that Roth money is precious, because of the tax-free status of any growth and earnings. Therefore it should have an AA similar to my entire portfolio (because, after all, that also is precious). So I tend to go for something like a 50/50 equity/FI split in my Roth.

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Re: Any reason to have different allocation in ROTH?

Post by Bob's not my name » Tue Jan 31, 2012 4:35 am

madbrain wrote:
Bob's not my name wrote:A traditional IRA or 401k has a magical property that is a well-guarded secret: it can save you from a market downturn. This is why you should hold stocks in traditional and bonds in Roth.

Suppose you have $1,000 of stocks in a TIRA and $1,000 of bonds in a Roth. Now suppose the stock market tanks by 50% just when you've retired. Say bonds rise 10% because of flight to safety. Now you have $500 in your TIRA and $1,100 in your Roth. You withdraw both and pay $125 (25%) tax on the TIRA withdrawal, leaving you with $1,475 total.

Now suppose you make the terrible mistake of holding stocks in your Roth. Now you have $500 in your Roth and $1,100 in your TIRA. You withdraw both and pay $275 tax on the TIRA withdrawal, leaving you with $1,325 total, way less.

The argument is even more compelling when you consider RMDs. When you hold stocks in your Roth you have a bigger TIRA, meaning you are forced to make larger withdrawals. That’s terrible.

The reason behind this little miracle is that arcane details in the tax code require that the TIRA environment provide soothing lighting, groovy mood music, and pixie dust to help soften a stock market collapse. I know, I get a little teary about it, too, thinking about those congressional aides working late into the night to fashion laws that protect us from the evil grip of Wall Street.

Seriously: What I just wrote is baloney. If you can spot the fallacy in my little math model, you’ll know to look for the same fallacy in the stocks-in-Roth arguments.
Let me try. You only need a given net amount to cover your expenses. It's either $1325 or $1475, but not both. You would work in reverse from the dollar amount you need, and make withdrawals from either your Roth or your Traditional to net that amount.

If you have high RMDs in your traditional IRA, you would just take that and then withdraw less or nothing from the Roth IRA.

But I think in some cases, your net from RMDs might still be higher than your expenses. In that case it probably means your equities are actually doing well and you are actually selling high. Though, if the 50% crash happened on January 1, you might still be hosed and forced to sell some of your equities low due to the RMDs. However that problem should be temporary, only for one yea - the next year your RMDs should be less. Unless the market somehow consistently doubles on December 31 and halves on January 1.
It's simpler than that. $1,000 of TIRA is not the same as $1,000 of Roth. So my comparison is invalid. What I'm really doing is comparing two different AA's. There is nothing magical about focusing stocks or bonds in TIRA or Roth. Put another way, it's entirely invalid to assume in a mathematical model that your TIRA withdrawals are going to be taxed at X% but not apply that assumption consistently by discounting the TIRA by X%. Try this yourself and you'll see that the result is exactly the same no matter where you hold stocks. You don't have to do this in real life -- typically the difference in your AA is minimal, but it does account entirely for the difference in outcomes in the model.

As for RMDs, it is argued that you should hold stocks in Roth because Roths don't have RMDs. However, if you are close to retirement you don't have a long enough horizon to be sure stocks will do better than bonds, so you risk giving up the very advantage you seek. On the other hand, if you are far from retirement it is unreasonable to assume that current RMD rules will survive the boomer retirement era. Remember that boomers have mostly traditional 401k's and IRAs. The 2008 RMD holiday was a portent. Bear in mind that many of us have more years to RMD age than the Roth is old; don't make 20-year bets on something that's only 15 years old.

It is also argued that placing stocks in a Roth provides better protection against tax changes. This isn't true, either. If you grasp the first point above, then you understand that a tax rate on withdrawals must be assumed to compare different asset placements. Nobody knows that your actual tax rate will be, but you have to make a best guess to model the options (or even to choose between TIRA and Roth if you have the choice). bogleheads do this all the time, especially newcomers who say "My tax rate will be higher in retirement, so I have chosen the Roth 401k." If your tax rate turns out to be higher than your best guess, stocks in Roth wins. But if your tax rate turns out to be lower than your best guess, stocks in TIRA wins. There is an equal probability of each, because that's the definition of best guess -- that is, it's illogical to say, "My best guess is that my tax rate on withdrawals will be 20%, and I will further assume that my best guess is low," or, more succinctly, "My best guess isn't best."

There are some valid reasons for selective asset placement. As Oblivious Investor points out, it is most important to place your assets such that you take advantage of the lowest cost and best funds where they are available to you -- this typically means using the best options in your traditional 401k and completing your AA in your Roth IRA. As zephyr points out, if you are relying on your Roth as an emergency fund, it should be in short term bonds (although I don't understand his statement about health problems in retirement). Similarly, I rely on a 401k loan as a back up emergency fund; it's at an old employer, and I have just over $100,000 in it, so I keep it in bonds so as not to jeopardize the availability of the maximum $50,000 loan amount. (Yes, it's unusual to be able to take 401k loans post-employment.)

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Re: Any reason to have different allocation in ROTH?

Post by Taylor Larimore » Tue Jan 31, 2012 6:15 am

McCharley wrote:Hi, Folks,

I'm rolling over a 401(k) and part of it is ROTH. Is there any reason to make this AA different from the rest of the portfolio?

The whole portfolio is about $330k and the ROTH portion is only about $26k. I'm thinking I don't want to totally mirror the larger portion because I'd like to keep Admiral shares. But other than that I can't think why I'd put one fund type (e.g. REIT) in the ROTH account vs. another.

Thank you!
Hi McCharley:

I agree with Larry Swedroe's post.

With few exceptions, it is better to locate taxable bonds in tax-advantaged accounts and tax-efficient index funds in taxable accounts.

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

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