Bond index fund in 401K or munis in taxable?

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Topic Author
calisun
Posts: 12
Joined: Tue Jul 25, 2017 7:52 am

Bond index fund in 401K or munis in taxable?

Post by calisun » Thu May 21, 2020 2:10 am

I’d appreciate it if the wise people on this forum can comment on a bond location question I’m grappling with.

My wife and I started investing in earnest in May of 2019. Since then we have done monthly DCA to invest a good chunk of cash that we had been saving until then. We aren’t fully invested yet. We plan to continue doing so at a monthly cadence. We also plan to rebalance annually. When it came time to rebalance this year, we realized that our asset allocation for bonds is significantly off from our desired number.

Desired Asset allocation: 60% stocks / 40% bonds
Desired International allocation: 15% of stocks

Current Asset allocation: 44.5% stocks / 16.4 % bonds
Current International allocation: 13.5% of stocks
Current Cash: 25.6%

I’m considering 2 possibilities:
We have maxed out both our 401K for this year. Each month, I can exchange $x of the Vanguard TR 2050 from my wife’s 401K for $x of VBTIX. We will continue buying equities in the taxable account with existing cash as well as new money. We will also continue investing the cash in both the Roth IRAs as well as the new cash that will come in her Roth IRA (via mega backdoor) into equities. The equities bought will be of the same $x as exchanged for bonds in the 401K.
I can buy munis in the taxable account. I was thinking of splitting it evenly between Limited-Term Tax-Exempt and CA Long-Term Tax-Exempt. This thought was based on David Grabiner’s recommendations that I read on one of the posts.

Is one option better than the other? Whichever option I pick, I would do so gradually over the course of many months.

Additionally, all of my 401K is invested in a bond fund. Is it common to do so? Or am I losing on years of tax-free growth by doing so?

Here’s our situation:

Debt: No debt

Tax Filing Status: Married Filing Jointly

Tax Rate: 35% Federal, 10.3% State

State of Residence: CA

Age: 44/39

Desired Asset allocation: 60% stocks / 40% bonds
Desired International allocation: 15% of stocks

Current total portfolio is about 2.4M. This includes $600K set aside for down-payment and home improvements when we will buy a house. We live in the bay area, hence the high down payment. This 600K is not included in the assets below.


Current retirement assets

Taxable at Vanguard
22.6% Vanguard Treasury VUSXX (for investing) (0.09)
12.4% Vanguard Total Stock Market Index Fund (VTSAX) (0.04)
7% Vanguard LifeStrategy growth fund (VASGX) (0.14)
3.8% Vanguard FTSE All-world Ex US Index Fund (VFWAX)
7.4% His employer vested RSU


His 401k at Fidelity
12.9% Fidelity US Bond Index Fund (FXNAX)(0.025)
No Company match

His Roth IRA at Vanguard
0.4% Vanguard 500 Index Fund Admiral shares (VFIAX) (0.04)
4% Vanguard Total Stock Market Index Fund (VTSAX) (0.04)
1.3% Cash (for investing)

Her 401k at Fidelity
21.3% Vanguard Inst Target retirement fund 2050 (VTRLX) (0.09)
Has a fairly standard employer match

Her Roth IRA at Vanguard
4.3% Vanguard Total Stock Market Index Fund (VTSAX) (0.04)
0.4% Vanguard 500 Index Fund Admiral shares (VFIAX) (0.04)
1.3% Vanguard Small Cap Value Index Fund (VSIAX) (0.07)
0.3% cash (for investing)

Contributions

New annual Contributions
$19.5K his 401k (No employer matching contributions)
$19.5K her 401K (6% for the first 50 % employer matching contributions)
$6K his Roth IRA through backdoor
$6K her Roth IRA through backdoor
~$30K her Roth IRA through mega backdoor
$70K taxable (for retirement, not short term goals)

Available funds

Funds available in his 401(k)
Fund name (ticker symbol) (expense ratio)
Fidelity 500 Index (FXAIX) (0.015)
Fidelity Total Market Index (FSKAX) (0.015)
Fidelity Mid Cap Index (FSMDX) (0.025)
DFA US Targeted Value INST (DFFVX) (0.36)
Fidelity Small Cap Index (FSSNX) (0.025)
Fidelity Emerging Market Index (FPADX) (0.076)
Fidelity International Index (FSPSX) (0.035)
Fidelity Real Estate Index (FSRNX) (0.07)
Vanguard INST Target retirement 2015 - 2065 (in 5 year increments) (all with ER of 0.09)
Vanguard INST TR INCOME (VITRX) (0.09)
Fidelity US Bond Index (FXNAX) (0.025)
Vanguard Short term bond Index (VBIRX) (0.07)
Fidelity Govt Money Market Fund (FZCXX) (0.36)

Funds available in her 401(k)
Vanguard INST Index PLUS (VIIX) (0.02)
Vanguard MIDCAP IDX INST (VMCIX) (0.04)
DFA US Target Value (DFFVX) (0.36)
Vanguard SM Cap IDX INST (VSCIX) (0.04)
Vanguard Total INTL STK IS (VTSNX) (0.08)
Vanguard INST Target retirement 2015 - 2065 (in 5 year increments) (all with ER of 0.09)
Vanguard INST TR INCOME (VITRX) (0.09)
Vanguard Total Bond Market Index (VBTIX) (0.035)
Vanguard Treasury MM (VUSXX) (0.09)

Thanks!

gjlynch17
Posts: 148
Joined: Wed Apr 15, 2015 12:32 pm

Re: Bond index fund in 401K or munis in taxable?

Post by gjlynch17 » Thu May 21, 2020 6:55 am

calisun wrote:
Thu May 21, 2020 2:10 am

I’m considering 2 possibilities:
We have maxed out both our 401K for this year. Each month, I can exchange $x of the Vanguard TR 2050 from my wife’s 401K for $x of VBTIX. We will continue buying equities in the taxable account with existing cash as well as new money. We will also continue investing the cash in both the Roth IRAs as well as the new cash that will come in her Roth IRA (via mega backdoor) into equities. The equities bought will be of the same $x as exchanged for bonds in the 401K.
I can buy munis in the taxable account. I was thinking of splitting it evenly between Limited-Term Tax-Exempt and CA Long-Term Tax-Exempt. This thought was based on David Grabiner’s recommendations that I read on one of the posts.

Is one option better than the other? Whichever option I pick, I would do so gradually over the course of many months.
You can compare the potential alternatives with some spreadsheet work. I would recommend that you check out the discussions below (the first one has a spreadsheet available) and do a search. However, based on your tax rates and current yields you would likely be better off investing in munis in taxable and equities in tax deferred.

viewtopic.php?t=286785
viewtopic.php?t=301087

Using a split between CA Long-Term and Limited Term-Tax Exempt is reasonable. Muni yields are historically high compared to Treasuries and Corporates as some investors are concerned about the long-term financial health of state and local governments. I believe those concerns are valid but overblown. On a personal level, I am more than comfortable with the risk-reward tradeoff of muni bond funds and have the vast majority of my bond investments in muni funds.

tashnewbie
Posts: 179
Joined: Thu Apr 23, 2020 12:44 pm

Re: Bond index fund in 401K or munis in taxable?

Post by tashnewbie » Thu May 21, 2020 8:35 am

I'm sure you're aware but the Vanguard Life Strategy Growth has 20% bond allocation, so you already have some bonds in your taxable account.

I'll leave the details to more experienced users.

Topic Author
calisun
Posts: 12
Joined: Tue Jul 25, 2017 7:52 am

Re: Bond index fund in 401K or munis in taxable?

Post by calisun » Thu May 21, 2020 2:15 pm

gjlynch17 wrote:
Thu May 21, 2020 6:55 am
calisun wrote:
Thu May 21, 2020 2:10 am

I’m considering 2 possibilities:
We have maxed out both our 401K for this year. Each month, I can exchange $x of the Vanguard TR 2050 from my wife’s 401K for $x of VBTIX. We will continue buying equities in the taxable account with existing cash as well as new money. We will also continue investing the cash in both the Roth IRAs as well as the new cash that will come in her Roth IRA (via mega backdoor) into equities. The equities bought will be of the same $x as exchanged for bonds in the 401K.
I can buy munis in the taxable account. I was thinking of splitting it evenly between Limited-Term Tax-Exempt and CA Long-Term Tax-Exempt. This thought was based on David Grabiner’s recommendations that I read on one of the posts.

Is one option better than the other? Whichever option I pick, I would do so gradually over the course of many months.
You can compare the potential alternatives with some spreadsheet work. I would recommend that you check out the discussions below (the first one has a spreadsheet available) and do a search. However, based on your tax rates and current yields you would likely be better off investing in munis in taxable and equities in tax deferred.

viewtopic.php?t=286785
viewtopic.php?t=301087

Using a split between CA Long-Term and Limited Term-Tax Exempt is reasonable. Muni yields are historically high compared to Treasuries and Corporates as some investors are concerned about the long-term financial health of state and local governments. I believe those concerns are valid but overblown. On a personal level, I am more than comfortable with the risk-reward tradeoff of muni bond funds and have the vast majority of my bond investments in muni funds.
Thanks for pointing out the spreadsheet, gjlynch17. Very helpful!

Topic Author
calisun
Posts: 12
Joined: Tue Jul 25, 2017 7:52 am

Re: Bond index fund in 401K or munis in taxable?

Post by calisun » Thu May 21, 2020 2:18 pm

tashnewbie wrote:
Thu May 21, 2020 8:35 am
I'm sure you're aware but the Vanguard Life Strategy Growth has 20% bond allocation, so you already have some bonds in your taxable account.

I'll leave the details to more experienced users.
Yes, those were bought a few of years ago before we had an investing strategy and didn't know that we shouldn't be putting bonds in taxable. I'll have to revisit it and see if we can TLH some of it. Thanks for pointing it out.

User avatar
Duckie
Posts: 7303
Joined: Thu Mar 08, 2007 2:55 pm

Re: Bond index fund in 401K or munis in taxable?

Post by Duckie » Thu May 21, 2020 6:00 pm

calisun wrote:Additionally, all of my 401K is invested in a bond fund. Is it common to do so? Or am I losing on years of tax-free growth by doing so?
A pre-tax employer plan is the perfect place for bonds.
Age: 44/39

Desired Asset allocation: 60% stocks / 40% bonds
Desired International allocation: 15% of stocks
This is reasonable for your ages.
Taxable at Vanguard
22.6% Vanguard Treasury VUSXX (for investing) (0.09)
12.4% Vanguard Total Stock Market Index Fund (VTSAX) (0.04)
7% Vanguard LifeStrategy growth fund (VASGX) (0.14)
3.8% Vanguard FTSE All-world Ex US Index Fund (VFWAX)
7.4% His employer vested RSU
When fiscally prudent sell VASGX and his RSUs.
His 401k at Fidelity
12.9% Fidelity US Bond Index Fund (FXNAX)(0.025)
Good choice.
His Roth IRA at Vanguard
0.4% Vanguard 500 Index Fund Admiral shares (VFIAX) (0.04)
4% Vanguard Total Stock Market Index Fund (VTSAX) (0.04)
1.3% Cash (for investing)
Don't leave cash in a Roth IRA, invest it. You don't need both 500 Index and Total Stock. Because of the wash sale rule, it's better to NOT hold the same assets in taxable as in tax-sheltered so either hold Total Stock in taxable and 500 Index and maybe Extended Market in tax-sheltered or the reverse. Or, since you have VFWAX in taxable you could put the rest of your international allocation in the Roth IRAs using Total International VTIAX.
Her 401k at Fidelity
21.3% Vanguard Inst Target retirement fund 2050 (VTRLX) (0.09)
If you really want a 40% bond allocation this should be all bonds now. Don't shift piecemeal, just sell all VTRLX and buy VBTIX.
Her Roth IRA at Vanguard
4.3% Vanguard Total Stock Market Index Fund (VTSAX) (0.04)
0.4% Vanguard 500 Index Fund Admiral shares (VFIAX) (0.04)
1.3% Vanguard Small Cap Value Index Fund (VSIAX) (0.07)
0.3% cash (for investing)
Again, don't hold the same funds in the Roth IRAs as in taxable.
_____________________

The following example has an AA of 60% stocks, 40% bonds, with 15% of stocks in international. That breaks down to 51% US stocks, 9% international stocks, and 40% bonds. Ignoring taxes you could have something like:

Taxable at Vanguard -- 53%
43% (VTSAX) Vanguard Total Stock Market Index Fund Admiral Shares (0.04%)
4% (VFWAX) Vanguard FTSE All-World ex-US Index Fund Admiral Shares (0.11%)
6% (VWIUX) Vanguard Intermediate-Term Tax-Exempt Fund Admiral Shares (0.09%)

His 401k at Fidelity -- 13%
13% (FXNAX) Fidelity U.S. Bond Index Fund (0.025%)

Her 401k at Fidelity -- 21%
21% (VBTIX) Vanguard Total Bond Market Index Fund Institutional Shares (0.035%)

His Roth IRA at Vanguard -- 6%
6% (VTIAX) Vanguard Total International Stock Index Fund Admiral Shares (0.11%)

Her Roth IRA at Vanguard -- 7%
7% (VFIAX) Vanguard 500 Index Fund Admiral Shares (0.04%)

Something to think about.

Topic Author
calisun
Posts: 12
Joined: Tue Jul 25, 2017 7:52 am

Re: Bond index fund in 401K or munis in taxable?

Post by calisun » Thu May 21, 2020 8:06 pm

Duckie wrote:
Thu May 21, 2020 6:00 pm

The following example has an AA of 60% stocks, 40% bonds, with 15% of stocks in international. That breaks down to 51% US stocks, 9% international stocks, and 40% bonds. Ignoring taxes you could have something like:

Taxable at Vanguard -- 53%
43% (VTSAX) Vanguard Total Stock Market Index Fund Admiral Shares (0.04%)
4% (VFWAX) Vanguard FTSE All-World ex-US Index Fund Admiral Shares (0.11%)
6% (VWIUX) Vanguard Intermediate-Term Tax-Exempt Fund Admiral Shares (0.09%)

His 401k at Fidelity -- 13%
13% (FXNAX) Fidelity U.S. Bond Index Fund (0.025%)

Her 401k at Fidelity -- 21%
21% (VBTIX) Vanguard Total Bond Market Index Fund Institutional Shares (0.035%)

His Roth IRA at Vanguard -- 6%
6% (VTIAX) Vanguard Total International Stock Index Fund Admiral Shares (0.11%)

Her Roth IRA at Vanguard -- 7%
7% (VFIAX) Vanguard 500 Index Fund Admiral Shares (0.04%)

Something to think about.
Thanks for taking the time to put this distribution together, Duckie!
What are your thoughts on splitting the muni in taxable between National and CA Long term Tax exempt?

User avatar
Duckie
Posts: 7303
Joined: Thu Mar 08, 2007 2:55 pm

Re: Bond index fund in 401K or munis in taxable?

Post by Duckie » Thu May 21, 2020 8:31 pm

calisun wrote:What are your thoughts on splitting the muni in taxable between National and CA Long term Tax exempt?
I'm more of an intermediate-term fan myself. But either way, no more than half of the munis should be state-specific. Because of COVID-19 California's cities are being hit hard and I expect defaults in the next few years. I live in the Bay Area and I know my state and property taxes will be going up to help cover the shortfall, but I don't think it will be enough.

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grabiner
Advisory Board
Posts: 26828
Joined: Tue Feb 20, 2007 11:58 pm
Location: Columbia, MD

Re: Bond index fund in 401K or munis in taxable?

Post by grabiner » Thu May 21, 2020 8:38 pm

Given your high CA tax, you should probably prefer CA munis in taxable and stocks in your IRA and 401(k). The reason is that you pay the same tax on CA munis as everyone else, but 15% + 3.8% NIIT + 10.3% CA = 29.1% tax rather than the usual 15% on qualified dividends and long-term gains from your stocks.

If you don't want to have all your bonds in CA munis, you could put half in Vanguard CA Long-Term Tax-Exempt, and the rest of your taxable bond holding in Vanguard Limited-Term Tax-Exempt, so that half your bonds are in CA but more than half your bond interest is exempt from CA tax.

I would get rid of the LifeStrategy Growth in taxable if the capital gain isn't too large, as it holds taxable bonds which are subject to 49.1% tax. (And in CA, you don't even get the benefit from the CA tax exemption on the Treasuries; CA only gives a partial tax exemption if a fund is at least 50% Treasuries.)
Wiki David Grabiner

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