Switching to Three Fund Portfolio

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Topic Author
blue42
Posts: 5
Joined: Wed Feb 25, 2015 3:01 pm

Switching to Three Fund Portfolio

Post by blue42 » Wed Mar 25, 2020 9:21 am

Hello Everyone,

I have just finished reading the Boglehead’s Guide to a Three Fund Portfolio, and I am inspired to switch to it.
Desired Asset Allocation: 90% Stocks / 10% Bonds
Desired Int’l Allocation of stocks: 20%
Considering these three Vanguard funds:
72% VTSAX Total US Stock Market
18% VTIAX Total Int’l Stock Admiral Shares
10% VBTLX Total US Bond Market

I am requesting the Bogelheads forum critique my plan, or change it entirely:
1) All 7 funds currently in my taxable account are as of recently worth less than the principle I’ve invested in them. I plan to “hold the course” on them, even if it is years, to avoid selling them at a loss. As the market recovers, I will sell them when they are at or just above break even on capital gains. Money would be reinvested into my new three fund portfolio.
2) Invest my lump sum cash of $50,000 into the three new funds.
3) Put my annual Roth IRA contribution and monthly taxable account contributions into the three fund portfolio.

Emergency Funds: Six Months Saved
Debt: None
Tax Filing Status: Single
Tax Rate: 24% Federal / 9.3% State
State of Residence: California
Age: 34
Total Portfolio: Mid-Six Figures

Current Retirement Assets
Taxable
0% Cash
10% VTIAX Total Int’l Stock Admiral Shares
8% VFIAX S&P 500 Admiral Shares
7% VIMAX Mid Cap Stock Admiral Shares
6% VCITX California L/T Muni Bonds Inv. Shares
5% VSGAX Small Cap Growth Admiral Shares
4% VGSLX REIT Admiral Shares
3% VEMAX Emerging Market Stock Admiral Shares

Thrift Savings Plan
42% L2050 Lifecycle 2050

Roth IRA
12% VFIAX S&P 500 Admiral Shares
3% VSGAX Small Cap Growth Admiral Shares

Contributions
$22,500 to TSP ($19,500 my contribution to Roth TSP, $3,000 employer to Traditional TSP)
$6,000 to Roth IRA
$50,000 available to invest now in taxable account + another $50,000 over the course of 2020

Thank you for your help.

Jon

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climber2020
Posts: 1347
Joined: Sun Mar 25, 2012 8:06 pm

Re: Switching to Three Fund Portfolio

Post by climber2020 » Wed Mar 25, 2020 9:26 am

blue42 wrote:
Wed Mar 25, 2020 9:21 am
1) All 7 funds currently in my taxable account are as of recently worth less than the principle I’ve invested in them. I plan to “hold the course” on them, even if it is years, to avoid selling them at a loss. As the market recovers, I will sell them when they are at or just above break even on capital gains. Money would be reinvested into my new three fund portfolio.
You may want to reconsider this.

If you do the exchange now, you can take advantage of tax loss harvesting and save some money on your taxes next year. Many of us here actually wait for a dip to have the opportunity to sell unwanted funds at a loss.

You'd probably want to exchange the old funds immediately into your 3 fund portfolio so you're not out of the market during these volatile times.

Explorer
Posts: 371
Joined: Thu Oct 13, 2016 7:54 pm

Re: Switching to Three Fund Portfolio

Post by Explorer » Wed Mar 25, 2020 11:00 am

I never understood why people hesitate to pay taxes on gains. OP's proposal makes sense to me - what doesn't make sense is to sell assets for a loss when there is actually no need to sell them at all.

To each their own..

retired@50
Posts: 1721
Joined: Tue Oct 01, 2019 2:36 pm

Re: Switching to Three Fund Portfolio

Post by retired@50 » Wed Mar 25, 2020 11:20 am

climber2020 wrote:
Wed Mar 25, 2020 9:26 am
blue42 wrote:
Wed Mar 25, 2020 9:21 am
1) All 7 funds currently in my taxable account are as of recently worth less than the principle I’ve invested in them. I plan to “hold the course” on them, even if it is years, to avoid selling them at a loss. As the market recovers, I will sell them when they are at or just above break even on capital gains. Money would be reinvested into my new three fund portfolio.
You may want to reconsider this.

If you do the exchange now, you can take advantage of tax loss harvesting and save some money on your taxes next year. Many of us here actually wait for a dip to have the opportunity to sell unwanted funds at a loss.

You'd probably want to exchange the old funds immediately into your 3 fund portfolio so you're not out of the market during these volatile times.
+1
OP, selling at a loss feels wrong. I get it. However, it's also an opportunity to clean up and simplify your holdings. If you truly desire the simplicity of a three fund portfolio, now could be a great time to act. Before you do anything, I'd suggest you read up on the concept of tax loss harvesting. There can be some pitfalls if you're not careful. See link.

https://www.bogleheads.org/wiki/Tax_loss_harvesting

Otherwise, if you don't want to sell at a loss, then I'd suggest you find a way to re-locate the REIT fund into your Roth IRA. This will become a tax headache if you leave it in your taxable account. Also, you've created some international overlap by holding both Total International AND Emerging Markets funds in your taxable account. I'd sell the EM fund and put the proceeds into VTIAX.

Regards,
Boggle - a game from Parker Brothers. Bogle - investor, founder of Vanguard.

Topic Author
blue42
Posts: 5
Joined: Wed Feb 25, 2015 3:01 pm

Re: Switching to Three Fund Portfolio

Post by blue42 » Wed Mar 25, 2020 1:26 pm

Thank you all for the replies. I will read about tax loss harvesting and consider that approach. I would prefer to simplify immediately, so if I can grasp the concept, then I may go that route. Thank you for the link.

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Wiggums
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Joined: Thu Jan 31, 2019 8:02 am

Re: Switching to Three Fund Portfolio

Post by Wiggums » Wed Mar 25, 2020 1:40 pm

I hold the three fund portfolio. No regrets here...

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ruralavalon
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Location: Illinois

Re: Switching to Three Fund Portfolio

Post by ruralavalon » Wed Mar 25, 2020 2:20 pm

Asset allocation.
blue42 wrote:
Wed Mar 25, 2020 9:21 am
I have just finished reading the Boglehead’s Guide to a Three Fund Portfolio, and I am inspired to switch to it.
Desired Asset Allocation: 90% Stocks / 10% Bonds
Desired Int’l Allocation of stocks: 20%
Considering these three Vanguard funds:
72% VTSAX Total US Stock Market
18% VTIAX Total Int’l Stock Admiral Shares
10% VBTLX Total US Bond Market
At age 34 I suggest about 20% in bonds or other fixed income investments (like CDs, savings accounts, money market fund). This is expected to substantially reduce portfolio volatility (risk), with only a relatively modest decrease in portfolio return. Graph, "An Efficient Frontier: the power of diversification". Please see:
1) Wiki article Bogleheads® investment philosophy, part 3 "Never bear too much or too little risk";
2) Wiki article, "Asset allocation"; and
3) Morningstar (8/20/2019), "The Best Diversifiers for Your Equity Portfolio".

I suggest around 20 - 30% of stocks in international stocks. Vanguard paper (March 2012), "Considerations for investing in non-U.S. equities". Historically, allocating 20% of an equity portfolio to non-U.S. stocks would have captured about 84% of the maximum possible diversification benefit, and allocating 30% of an equity portfolio to non-U.S. stocks would have captured about 99% of the maximum possible diversification benefit (p. 6). (You can find lots of debate here on international allocation, opinions ranging all the way from 00% to 50% of stocks in international stocks. If you want more viewpoints on international stocks please try the Google search box, upper right, this page).

Morningstar (11/14/2019), "Revisiting the Case for International". "The case for diversifying internationally isn’t as strong as it used to be, especially if you’re looking for significant risk reduction or consistently better returns. From a portfolio perspective, we typically recommend a healthy international weighting--roughly 25% of total assets--for investors with longer time horizons."

That works out to about 20% bonds, 20% international stocks, and 60% domestic stocks. Asset allocation is a very personal decision. You must decide on an allocation that is comfortable for you based on your own ability, willingness and need to take risk.




Timing, tax consequences.
blue42 wrote:
Wed Mar 25, 2020 9:21 am
I am requesting the Bogelheads forum critique my plan, or change it entirely:
1) All 7 funds currently in my taxable account are as of recently worth less than the principle I’ve invested in them. I plan to “hold the course” on them, even if it is years, to avoid selling them at a loss. As the market recovers, I will sell them when they are at or just above break even on capital gains. Money would be reinvested into my new three fund portfolio.
If you sell at a loss that means no income tax liability for capital gains.

The tax losses can be rolled over into subsequent years, so each year until your losses are used up you can apply up to $3,000 of the losses against your income on your federal tax returns.

If you sell low, you are also buying low. If you wait to switch to your desired very diversified low expense index funds, then you are betting that your current funds will outperform the very diversified index funds you would use instead. That is probably not a good bet.

In my opinion now is probably a good time to switch the taxable account to your desired very diversified low expense index funds.



Fund selection and placement.
blue42 wrote:
Wed Mar 25, 2020 9:21 am
2) Invest my lump sum cash of $50,000 into the three new funds.
3) Put my annual Roth IRA contribution and monthly taxable account contributions into the three fund portfolio.
It is often better to coordinate investments among all accounts, in other words treat all accounts together as a single unified portfolio, rather than view each account separately.

Select just one or two of the better funds (most diversified + lower expense ratio) in the work-based account (401k, 403b, 457, SIMPLE IRA, TSP etc.), where the choices offered are limited. Then complete the rest of the asset allocation using the nearly unlimited choices available in a taxable account or any IRAs. It is not necessary to put all elements of the desired asset allocation in each account.

This approach allows for better tax-efficiency when you also use a taxable account. Wiki article, "Tax-efficient Fund Placement".


Domestic stocks.
For domestic stocks I suggest using a total stock market index fund where available. "In a 401(k) plan with limited choices one might very well opt for an S&P 500 index fund to serve as the domestic stock component of a three-fund portfolio." Wiki article, Three-fund portfolio, "Other considerations".

In my opinion in a plan that lacks a total stock market index fund, a S&P 500 index fund is good enough by itself for a domestic stock allocation. A S&P 500 index fund (like the C Fund in the TSP) covers more than 80% of the U.S. stock market, investing in stocks of selected large-cap and mid-cap U.S. companies. In the 28 years since the creation of the first total stock market index fund the performance (total return with dividends reinvested) of the two types of funds has been almost identical. Morningstar, "growth of $10k" graph (1992 – 2020), VTSAX vs VFIAX. So it seems that adding a little in mid/small cap stocks trying to mimic the holdings of a total stock market fund has historically made little difference in performance.

See also:
1) Allan Roth, CBS Moneywatch (02/03/2010), "John C. Bogle on the S&P 500 vs. the Total Stock Market"; and
2) Wall Street Physician (01/17/2019), "Should You Invest in the S&P 500 or the Total Stock Market?".

If you want to add the S Fund, then an 84/16 mix of the C Fund and the S Fund will mimic the content of a total stock market index fund. Wiki article, "Approximating total stock market". In my opinion this is not necessary, it is optional if you prefer to do this.


Bond Funds.
The F Fund in the TSP tracks the Bloomberg Barclays U.S. Aggregate Bond Index. Wiki article "Thrift Savings Plan". So the F Fund is almost identical to Vanguard Total Bond Market Index Fund Admiral Shares (VBTLX) which tracks the Bloomberg Barclays U.S. Aggregate Float Adjusted Bond Index.

The G Fund in the TSP is "a uniquely attractive bond fund that provides yields similar to an intermediate-term Treasury bond fund, but with the stability of principal of a money market fund, and no default risk." Wiki article "Thrift Savings Plan".


Tax efficiency
In a taxable account use very tax-efficient stock index funds. Wiki article "Tax-efficient fund placement". At Vanguard I suggest using Vanguard Total Stock Market Index Fund Admiral Shares (VTSAX) ER 0.04% and Vanguard Total International Stock Index Fund Admiral Shares (VTIAX) ER 0.11%. Stock index funds are also well suited to any type of account.

Bond funds are not very tax-efficient. Ordinarily a bond fund should be placed in a tax-advantaged account, preferably a tax-deferred account like a traditional Thrift Savings Plan account. Wiki article "Tax-efficient fund placement".

To make portfolio management and rebalancing easy it is often better to have at least one large tax-advantaged account which contains all three basic asset types (bonds, international stocks, and domestic stocks). Don’t try to put all components of the asset allocation in every account.





Example portfolio.
Here is an example portfolio that you could consider. This is a three-fund type portfolio, modified as necessary to accommodate the fund offerings in the Thrift Savings Plan. Current portfolio size = "Mid-Six Figures". New annual contributions = about $78.5k??? The asset allocation is: 20% bonds; 20% international stocks; and 60% domestic stocks.

The percentages given are percentages of the total portfolio, not of a given account. The suggestion is to switch both the existing balances and the new contributions to the funds indicated. Sometimes I state 00% to indicate funds you might want to add in the future.

Taxable account @ Vanguard (43% of total, adds $50k annually??? = 64% of new annual contributions)
23%, Vanguard Total Stock Market Index Fund (VTSAX)
20%, Vanguard Total International Stock Index Fund (VTIAX)

TSP account (42% of total; adds $19.5k + $3k employer match = $22.5k annually = 29% of new annual contributions)
22%, C Fund (S&P 500 index fund, >80% of U.S. stock market)
00%, I Fund
20%, F Fund, or G Fund, or a combination of both

Roth IRA @ Vanguard (15% of total; adds $6k annually = 8% of new annual contributions)
15%, Vanguard Total Stock Market Index Fund (VTSAX)


Rebalancing.
Because the funds will grow at different and unpredictable rates, it may be necessary every few years to rebalance in order to maintain the desired asset allocation. Wiki article, "Rebalancing". You can easily adjust the asset allocation by exchanging between funds inside the TSP account.

Avoid exchanging between funds in the taxable account, which can create income tax liability.



Education.
I suggest that you read one or two books on investing. Wiki article, "Books: recommendations and reviews". When I first stated managing my own investments, I found this tutorial very helpful in learning investing terminology/jargon and some of the investing basics. Morningstar, "Investing Classroom". Also take a look at the Boglehead’s wiki, the "getting started" link I give below. A quick education for a beginning investor is Dr. Bernstein's free short on-line book, "If You Can".

If you have any questions just ask.

I hope that this helps.
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link:Getting Started

User avatar
1789
Posts: 1078
Joined: Fri Aug 16, 2019 3:31 pm

Re: Switching to Three Fund Portfolio

Post by 1789 » Wed Mar 25, 2020 7:00 pm

Your allocation to 3 fund portfolio with 72/18/10 looks perfect to me. Congrats!
"My conscience wants vegetarianism to win over the world. And my subconscious is yearning for a piece of juicy meat. But what do i want?" (Andrei Tarkovsky)

Topic Author
blue42
Posts: 5
Joined: Wed Feb 25, 2015 3:01 pm

Re: Switching to Three Fund Portfolio

Post by blue42 » Thu Mar 26, 2020 4:33 am

Thank you again to all who replied.
Thank you very much to ruralavalon. The amount of time you must have spent organizing such a response is very much appreciated, and it really helped tie up a lot of fleeting ideas I've been mulling over to simplify my portfolio. Now it's all neatly packaged in your reply. I will be reading all of the links you included. I just started reading Boglehead's Guide to Investing and will continue to read more of the books on the list. Thank you for the sample portfolio as well. It really gives me a clear picture of what I can do to rebalance all of the funds in the different accounts, and a way to maintain into the future. I will be paying close attention to the parts on tax loss harvesting, as it's not an idea I understand fully yet. But it if it will help me simplify things now and make life much easier in the future, it sounds like a win win.
Thank you all again. Maybe in the future, I can help pay it forward.

Jon

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