Three Fund Portfolio Excluding TSP?

[RamblinDoc]

First, I'd like to thank everyone - I've spent many weeks reading through these forums. I've learned a lot as I embrace the BH mindset.

Currently, we have a traditional TSP (401k) and his and hers Vanguard Roth IRA accounts. We are very early into the accumulation phase. For convenience, as I learn more, I have an L-fund in the TSP and a Vanguard Lifestrategy fund in both Roths that match our desired AA. We are in our mid 30's and think 80/20 stocks/bonds are appropriate.

At some point, I'd like to transition into a three-fund portfolio utilizing:
Vanguard Total Stock Market Index Fund (VTSMX)
Vanguard Total International Stock Index Fund (VGTSX)
Vanguard Total Bond Market Fund (VBMFX)

I know that we are supposed to look at all of the accounts together. However, what are people's thoughts about keeping an L-fund in the TSP (it has a super low ER and then I don't have to worry about allocating and reblancing the odd fund options)? Then, I could just look at the two Roths and a taxable account to balance the three fund portfolio. (I will be wise and keep bonds out of the taxable account.)

Also, if the Roths are large enough to fund Admiral shares of each of the three funds, is there any reason not to keep all three funds in both Roths? Rebalancing should still not be difficult and then one fund won't outgrow the other as much. Thoughts?

Thank you!

[nps]

I know that we are supposed to look at all of the accounts together. However, what are people's thoughts about keeping an L-fund in the TSP (it has a super low ER and then I don't have to worry about allocating and reblancing the odd fund options)? Then, I could just look at the two Roths and a taxable account to balance the three fund portfolio. (I will be wise and keep bonds out of the taxable account.)

Unless I am missing something, it sounds like you're saying you'll use an L fund then set your other accounts such that your portfolio as a whole reflects your desired AA. If so you would be following the advice to look at all accounts together. Do you think it means something else?

[rkhusky]

I know that we are supposed to look at all of the accounts together. However, what are people's thoughts about keeping an L-fund in the TSP (it has a super low ER and then I don't have to worry about allocating and reblancing the odd fund options)? Then, I could just look at the two Roths and a taxable account to balance the three fund portfolio. (I will be wise and keep bonds out of the taxable account.)

Also, if the Roths are large enough to fund Admiral shares of each of the three funds, is there any reason not to keep all three funds in both Roths? Rebalancing should still not be difficult and then one fund won't outgrow the other as much. Thoughts?

Thank you!

L Fund in TSP and 3-Fund in Roth and taxable is fine. All three funds in each Roth is fine (assume you plan to keep the same AA for both).

If you don't mind some extra complexity, it may be worthwhile to keep most of your bonds in the TSP and mostly stocks in Roth, because you will eventually have to pay taxes on the Traditional TSP, while you won't for the Roth. Therefore, having investments with the best chance for growth in Roth and slower growing investments in Traditional has some advantage.

You could also use muni bond funds in taxable, if you want to replicate the AA of the TSP and IRA's there too. Although, muni bonds only make sense at a certain tax bracket level (~24% or higher).

Will you try to match the AA of the L-fund in your other accounts?

[RamblinDoc]

I know that we are supposed to look at all of the accounts together. However, what are people's thoughts about keeping an L-fund in the TSP (it has a super low ER and then I don't have to worry about allocating and reblancing the odd fund options)? Then, I could just look at the two Roths and a taxable account to balance the three fund portfolio. (I will be wise and keep bonds out of the taxable account.)

Unless I am missing something, it sounds like you're saying you'll use an L fund then set your other accounts such that your portfolio as a whole reflects your desired AA. If so you would be following the advice to look at all accounts together. Do you think it means something else?

Yes, that is my plan. I can rebalance the three other accounts no more than annually to reflect the desired AA as the TSP changes.

[RamblinDoc]

I know that we are supposed to look at all of the accounts together. However, what are people's thoughts about keeping an L-fund in the TSP (it has a super low ER and then I don't have to worry about allocating and reblancing the odd fund options)? Then, I could just look at the two Roths and a taxable account to balance the three fund portfolio. (I will be wise and keep bonds out of the taxable account.)

Also, if the Roths are large enough to fund Admiral shares of each of the three funds, is there any reason not to keep all three funds in both Roths? Rebalancing should still not be difficult and then one fund won't outgrow the other as much. Thoughts?

Thank you!

L Fund in TSP and 3-Fund in Roth and taxable is fine. All three funds in each Roth is fine (assume you plan to keep the same AA for both).

If you don't mind some extra complexity, it may be worthwhile to keep most of your bonds in the TSP and mostly stocks in Roth, because you will eventually have to pay taxes on the Traditional TSP, while you won't for the Roth. Therefore, having investments with the best chance for growth in Roth and slower growing investments in Traditional has some advantage.

You could also use muni bond funds in taxable, if you want to replicate the AA of the TSP and IRA's there too. Although, muni bonds only make sense at a certain tax bracket level (~24% or higher).

Will you try to match the AA of the L-fund in your other accounts?

That’s a great idea. Perhaps I’ll put most of the bonds into TSP then the rest into a desired L-fund. Then domestic and international stock in the other three accounts.

I have a spreadsheet and use Personal Capital to help keep my AA straight.

[RamblinDoc]

If most or all of bonds are in the TSP, would you suggest a 50:50 of F:G? I’ve seen that in other threads.

[TSR]

I have 100% of my TSP in L2040. I maintain a separate three-fund portfolio in my Fidelity Roth that roughly matches that allocation. It's super easy. I think that's the best course of action for you.

One reason I think this that is not directly responsive to your question, is that I think it's good to have some "strategy buy-in" from your spouse. If your spouse's Roth is a three-fund portfolio, he or she will have some experience looking at how the different asset classes interact and will have to take more ownership over rebalancing. That is important long-term when people start dying or divorcing or whatever (not to be morbid!). Anyway, lots of good options here, and best of luck!

[RamblinDoc]

I have 100% of my TSP in L2040. I maintain a separate three-fund portfolio in my Fidelity Roth that roughly matches that allocation. It's super easy. I think that's the best course of action for you.

One reason I think this that is not directly responsive to your question, is that I think it's good to have some "strategy buy-in" from your spouse. If your spouse's Roth is a three-fund portfolio, he or she will have some experience looking at how the different asset classes interact and will have to take more ownership over rebalancing. That is important long-term when people start dying or divorcing or whatever (not to be morbid!). Anyway, lots of good options here, and best of luck!

Great insight. Thank you!

[rkhusky]

That’s a great idea. Perhaps I’ll put most of the bonds into TSP then the rest into a desired L-fund. Then domestic and international stock in the other three accounts.

I have a spreadsheet and use Personal Capital to help keep my AA straight.

That should work if you plan to do most of your rebalancing within the TSP. Note that you are allowed two rebalancing moves per month in the TSP, which should be plenty. Plus the G Fund is a very good deal for those that have access to it.

[RamblinDoc]

That’s a great idea. Perhaps I’ll put most of the bonds into TSP then the rest into a desired L-fund. Then domestic and international stock in the other three accounts.

I have a spreadsheet and use Personal Capital to help keep my AA straight.

That should work if you plan to do most of your rebalancing within the TSP. Note that you are allowed two rebalancing moves per month in the TSP, which should be plenty. Plus the G Fund is a very good deal for those that have access to it.

Thanks!

[grabiner]

If most or all of bonds are in the TSP, would you suggest a 50:50 of F:G? I’ve seen that in other threads.

I prefer 100% G. For most investments, there is a trade-off between risk and return; higher-yielding bonds lose more money if interest rates rise or if bonds default. The G fund is an exception, as it has zero risk, but has the return of an intermediate-term bond fund.

[RamblinDoc]

If most or all of bonds are in the TSP, would you suggest a 50:50 of F:G? I’ve seen that in other threads.

I prefer 100% G. For most investments, there is a trade-off between risk and return; higher-yielding bonds lose more money if interest rates rise or if bonds default. The G fund is an exception, as it has zero risk, but has the return of an intermediate-term bond fund.

Thanks!

[blaugranamd]

FWIW, rebalancing in the TSP is about as easy as it gets. Takes about 2 minutes to do the math on your own once a year then you literally pull up the page, type in your desired allocation and it's done automatically.

[RamblinDoc]

I have 100% of my TSP in L2040. I maintain a separate three-fund portfolio in my Fidelity Roth that roughly matches that allocation. It's super easy. I think that's the best course of action for you.

One reason I think this that is not directly responsive to your question, is that I think it's good to have some "strategy buy-in" from your spouse. If your spouse's Roth is a three-fund portfolio, he or she will have some experience looking at how the different asset classes interact and will have to take more ownership over rebalancing. That is important long-term when people start dying or divorcing or whatever (not to be morbid!). Anyway, lots of good options here, and best of luck!

To follow-up:
Do you worry about minimizing tax free growth by having bonds in your Roth?

[Dogsbestfriend]

RamblinDoc,

I think your proposed approach is fine, but if you're up to it, you can probably optimize it a bit with fairly minimal effort, as others have suggested. We are in a similar situation regarding age and AA, so I'll share how I do it:

- All bond allocation (20%) is in TSP (G fund). Any remaining TSP money is in C:S at 4:1 to approximate the total stock market.
- All international allocation (30% of stocks; 24% of total portfolio) is in taxable (Vanguard total intl).
- Everything else (Roth IRAs, any remaining taxable space) is in Vanguard total stock market.

This has worked very well for me. Rebalancing is very easy, and everything is simple. Your approach may be even easier/simpler, and my guess is that it would probably perform very similarly. I've recently been re-thinking this a little bit, in that some of my TSP is Roth TSP, and unfortunately, you can't specify how your Roth vs. Traditional TSP is invested. I would like my G fund to be in the Traditional and my C/S funds to be in the Roth portion, but TSP just spreads your allocation evenly, so that's something to consider if you have any Roth TSP. Not sure what, if anything, I can do about that though.

Best,
Dogsbestfriend

[RamblinDoc]

RamblinDoc,

I think your proposed approach is fine, but if you're up to it, you can probably optimize it a bit with fairly minimal effort, as others have suggested. We are in a similar situation regarding age and AA, so I'll share how I do it:

- All bond allocation (20%) is in TSP (G fund). Any remaining TSP money is in C:S at 4:1 to approximate the total stock market.
- All international allocation (30% of stocks; 24% of total portfolio) is in taxable (Vanguard total intl).
- Everything else (Roth IRAs, any remaining taxable space) is in Vanguard total stock market.

This has worked very well for me. Rebalancing is very easy, and everything is simple. Your approach may be even easier/simpler, and my guess is that it would probably perform very similarly. I've recently been re-thinking this a little bit, in that some of my TSP is Roth TSP, and unfortunately, you can't specify how your Roth vs. Traditional TSP is invested. I would like my G fund to be in the Traditional and my C/S funds to be in the Roth portion, but TSP just spreads your allocation evenly, so that's something to consider if you have any Roth TSP. Not sure what, if anything, I can do about that though.

Best,
Dogsbestfriend

That’s a great strategy - Thanks!

[TSR]

I have 100% of my TSP in L2040. I maintain a separate three-fund portfolio in my Fidelity Roth that roughly matches that allocation. It's super easy. I think that's the best course of action for you.

One reason I think this that is not directly responsive to your question, is that I think it's good to have some "strategy buy-in" from your spouse. If your spouse's Roth is a three-fund portfolio, he or she will have some experience looking at how the different asset classes interact and will have to take more ownership over rebalancing. That is important long-term when people start dying or divorcing or whatever (not to be morbid!). Anyway, lots of good options here, and best of luck!

To follow-up:
Do you worry about minimizing tax free growth by having bonds in your Roth?

Sorry for the delay on this. No, I don't worry too much about that. I think it's a perfectly reasonable approach, but I value simplicity above most other things, and for me this is the simplest approach. That's not just due to laziness, but because complexity can lead to tinkering for me. Overloading bonds in your TSP will also force you to confront the seemingly existential question for some TSP participants of whether the G fund is somehow fundamentally better than the F fund, thus justifying overweighting G while lacking any real evidence supporting that. Truth is, I think that the tax effects of having some 25-35% of your Roth holdings (which are themselves only going to be, say, 20% of your total holdings in the long run) in bonds will be somewhat muted, so you should probably just do what makes the most overall sense to you. Again, what the other folks are suggesting here is WELL within the bounds of what is mathematically reasonable and what is relatively easy to pull off. I'm just describing what I do and why. Both good options.

[tadamsmar]

If most or all of bonds are in the TSP, would you suggest a 50:50 of F:G? I’ve seen that in other threads.

I use a higher percentage of G for my bond allocation (my overall bond allocation for my overall AA). I use something similar to the F:G allocations in the L funds. Those L fund allocations are designed to optimize risk-adjusted return.

I notice that Gabiner is recommending 100% G for your bond allocation. That's another common recommendation here.

I have seen other approaches where people pair G with more of a non-government bond allocation instead of F or a total bond fund. This is on the theory that G kind of covers the federal government bond allocation.

There are only 2 AA models that I know of that include the G fund: (1) The L funds and (2) financialengines.com. I think that government employees and Vanguard users can use a free version of financialengines.com.

[RamblinDoc]

I have 100% of my TSP in L2040. I maintain a separate three-fund portfolio in my Fidelity Roth that roughly matches that allocation. It's super easy. I think that's the best course of action for you.

One reason I think this that is not directly responsive to your question, is that I think it's good to have some "strategy buy-in" from your spouse. If your spouse's Roth is a three-fund portfolio, he or she will have some experience looking at how the different asset classes interact and will have to take more ownership over rebalancing. That is important long-term when people start dying or divorcing or whatever (not to be morbid!). Anyway, lots of good options here, and best of luck!

To follow-up:
Do you worry about minimizing tax free growth by having bonds in your Roth?

Sorry for the delay on this. No, I don't worry too much about that. I think it's a perfectly reasonable approach, but I value simplicity above most other things, and for me this is the simplest approach. That's not just due to laziness, but because complexity can lead to tinkering for me. Overloading bonds in your TSP will also force you to confront the seemingly existential question for some TSP participants of whether the G fund is somehow fundamentally better than the F fund, thus justifying overweighting G while lacking any real evidence supporting that. Truth is, I think that the tax effects of having some 25-35% of your Roth holdings (which are themselves only going to be, say, 20% of your total holdings in the long run) in bonds will be somewhat muted, so you should probably just do what makes the most overall sense to you. Again, what the other folks are suggesting here is WELL within the bounds of what is mathematically reasonable and what is relatively easy to pull off. I'm just describing what I do and why. Both good options.

Good points - thanks!

[RamblinDoc]

If most or all of bonds are in the TSP, would you suggest a 50:50 of F:G? I’ve seen that in other threads.

I use a higher percentage of G for my bond allocation (my overall bond allocation for my overall AA). I use something similar to the F:G allocations in the L funds. Those L fund allocations are designed to optimize risk-adjusted return.

I notice that Gabiner is recommending 100% G for your bond allocation. That's another common recommendation here.

I have seen other approaches where people pair G with more of a non-government bond allocation instead of F or a total bond fund. This is on the theory that G kind of covers the federal government bond allocation.

Thanks!

[tadamsmar]

If you don't mind some extra complexity, it may be worthwhile to keep most of your bonds in the TSP and mostly stocks in Roth, because you will eventually have to pay taxes on the Traditional TSP, while you won't for the Roth. Therefore, having investments with the best chance for growth in Roth and slower growing investments in Traditional has some advantage.

Not sure if that makes sense.

Lets say you have $75 in a Roth and $100 in the TSP and a 25% tax bracket.

If one doubles while the other stays the same, you will have $225 in after-tax money to spend.

It does not matter whether the Roth or the TSP grows faster, you still end up with $225.

In a seeming paradox, Uncle Sam gets more money if the TSP grows faster, but you don't get less money!

It is slightly better to remove the estimated taxes from the calculation for the purpose calculating your AA. Base your AA on an estimate of after tax dollars.

[rkhusky]

Lets say you have $75 in a Roth and $100 in the TSP and a 25% tax bracket.

Suppose you had $100 in Roth and $100 in the TSP?

[grabiner]

Lets say you have $75 in a Roth and $100 in the TSP and a 25% tax bracket.

Suppose you had $100 in Roth and $100 in the TSP?

In that case, 57% of the after-tax value of your portfolio is in the Roth, so if you put the Roth in stock, and the TSP in bonds, you have both higher expected return and higher risk. If you want a 50/50 allocation, the after-tax value of your portfolio is $175, so you can put $87.50 in the Roth in stock and the rest plus the whole TSP in bonds, or vice versa; these are again equivalent.

[junior]

If you don't mind some extra complexity, it may be worthwhile to keep most of your bonds in the TSP and mostly stocks in Roth, because you will eventually have to pay taxes on the Traditional TSP, while you won't for the Roth. Therefore, having investments with the best chance for growth in Roth and slower growing investments in Traditional has some advantage.

Not sure if that makes sense.

Lets say you have $75 in a Roth and $100 in the TSP and a 25% tax bracket.

If one doubles while the other stays the same, you will have $225 in after-tax money to spend.

It does not matter whether the Roth or the TSP grows faster, you still end up with $225.

In a seeming paradox, Uncle Sam gets more money if the TSP grows faster, but you don't get less money!

It is slightly better to remove the estimated taxes from the calculation for the purpose calculating your AA. Base your AA on an estimate of after tax dollars.

I'm not a math wiz but I tested this in an investment return calculator, assuming you are taxed at 25% either way.

Roth I invest $75 at 4% rate of return for 10 years. I get 111 after tax.

TSP I invest $100 at 1% rate of return for 10 years. I get 110. After tax I get 82.5.

Total after tax return, 193.5.

Now let's flip it. Roth I invest $75 at 1% rate of return for 10 years. I get 83 after tax.

TSP I invest $100 at 4% rate of return for 10 years. I get $148. After tax I get 111. Total after tax returns 194.

Unless I screwed up it appears that there is virtually no difference, but the higher return was in the TSP not the roth.

That said the Roth is Better because is doesn't have minimum distributions.

[grabiner]

I'm not a math wiz but I tested this in an investment return calculator, assuming you are taxed at 25% either way.

Roth I invest $75 at 4% rate of return for 10 years. I get 111 after tax.

TSP I invest $100 at 1% rate of return for 10 years. I get 110. After tax I get 82.5.

Total after tax return, 193.5.

Now let's flip it. Roth I invest $75 at 1% rate of return for 10 years. I get 83 after tax.

TSP I invest $100 at 4% rate of return for 10 years. I get $148. After tax I get 111. Total after tax returns 194.

Unless I screwed up it appears that there is virtually no difference, but the higher return was in the TSP not the roth.

The difference is from rounding; if you do the computation to more decimal places, the numbers will be exactly equal.

To see why this has to be equal, note that the IRS owns 25% of your TSP. Thus, if you have $100 in the TSP, you invest $75 of your tax-free money and $25 of the IRS's money. You don't care what happens to the IRS's money, but your own money will give the same returns as $75 invested tax-free.

Equality is broken if the investment options are not comparable. If you have a Roth IRA and traditional TSP, you should hold the bonds in the TSP, but not for tax reasons; the G fund in the TSP has no risk, while a bond fund in the Roth IRA with the same expected return would have some risk.

[Savio]

If most or all of bonds are in the TSP, would you suggest a 50:50 of F:G? I’ve seen that in other threads.

I am doing almost exactly what you are doing as described the OP.

I don't have anything in F because we are almost surely going to be in a rising interest rate environment for the next few years. After they have risen for a while, I will probably go 50:50.

So for now, I have only G fund.

I have bond funds in the my other accounts so I figure that I might as well take advantage of the free lunch of the G fund in the TSP. You can't get that anywhere else.

[rkhusky]

Lets say you have $75 in a Roth and $100 in the TSP and a 25% tax bracket.

Suppose you had $100 in Roth and $100 in the TSP?

In that case, 57% of the after-tax value of your portfolio is in the Roth, so if you put the Roth in stock, and the TSP in bonds, you have both higher expected return and higher risk. If you want a 50/50 allocation, the after-tax value of your portfolio is $175, so you can put $87.50 in the Roth in stock and the rest plus the whole TSP in bonds, or vice versa; these are again equivalent.

That assumes you tax-adjust your asset allocation. Many people don't.

[RamblinDoc]

If most or all of bonds are in the TSP, would you suggest a 50:50 of F:G? I’ve seen that in other threads.

I am doing almost exactly what you are doing as described the OP.

I don't have anything in F because we are almost surely going to be in a rising interest rate environment for the next few years. After they have risen for a while, I will probably go 50:50.

So for now, I have only G fund.

I have bond funds in the my other accounts so I figure that I might as well take advantage of the free lunch of the G fund in the TSP. You can't get that anywhere else.

Excellent - thanks!

[grabiner]

Lets say you have $75 in a Roth and $100 in the TSP and a 25% tax bracket.

Suppose you had $100 in Roth and $100 in the TSP?

In that case, 57% of the after-tax value of your portfolio is in the Roth, so if you put the Roth in stock, and the TSP in bonds, you have both higher expected return and higher risk. If you want a 50/50 allocation, the after-tax value of your portfolio is $175, so you can put $87.50 in the Roth in stock and the rest plus the whole TSP in bonds, or vice versa; these are again equivalent.

That assumes you tax-adjust your asset allocation. Many people don't.

If you don't tax-adjust, you still don't gain an advantage by putting stocks in the Roth. You get higher expected return, but also higher risk, which is a fair trade-off, not a net gain. If you have $100 in each account, this is $175 after tax. If you put the Roth in stock and the stock market loses half its value, you have $125 after tax. If you lose half your traditional account, you have $137.50 after tax. In return for this, you gain more with stocks in the Roth if the market rises.