Re-balancing to three-fund portfolio

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XtremeSki2001
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Re-balancing to three-fund portfolio

Post by XtremeSki2001 » Sat Aug 01, 2020 6:57 am

Hi All - My details are below, but seeking input to help re-balance. I've been in VANGUARD TARGET 2055 since college and now in my mid-30's. I'd like to align with Boglehead's recommendation of a three-fund portfolio (e.g., VTSAX, VTIAX, VBTLX). Unfortunately, my Fidelity 401k doesn't offer these funds. The funds they do offer are listed below.

1) What funds below (from Fidelity) are close to the equivalent of Boglehead's recommended three-fund portfolio? Thank you in advance for your input and feedback.

2) What is a common allocation following the three-fund approach? Currently I'm in VFFVX, which is 90% stocks and 10% bonds. This breaks down to 50% VTSMX, 40% VTIAX, and 10% VBTLX). I would probably do age minus 20 for bonds so maybe somewhere between 10-20%. I'd put what remains in stocks and I'm not married to the percentages of each. I've read many posters split what's left (e.g., say 40% in VTSAX and 40% in VTIAX). Of course I don't have access to the aforementioned funds with Fidelity.

3) VFFVX is relatively close to the recommended three-fund portfolio. Is staying here better than trying to do three of the funds below?

Fidelity 401k Fund Options
ACTIVE INTL EQUITY (Gross Expense Ratio: 0.41%)
DEVELOPING MARKETS (Gross Expense Ratio: 0.78%)
INTL EQUITY INDEX (Gross Expense Ratio: 0.06%)
LARGE CAP GROWTH (Gross Expense Ratio: 0.35%)
LARGE CAP VALUE (Gross Expense Ratio: 0.32%)
MIDCAP EQUITY INDEX (Gross Expense Ratio: 0.03%)
RUSSELL 2000 INDEX (Gross Expense Ratio: 0.02%)
S&P 500 INDEX (Gross Expense Ratio: 0.01%)
SMALL CAP STOCK (Gross Expense Ratio: 0.66%)
DIVERSIFIED BOND (Gross Expense Ratio: 0.23%)
STABLE VALUE (Gross Expense Ratio: 0.25%)

Details
Goal:
Option to retire at age 55 (will need the markets help a bit!)

Monthly expenses:
~$5,600

Other spending:
~$21,000

Emergency funds:
6 months

Debt:
Mortgage ($288k @ 3.625%, 22 years to go)

Tax Filing Status:
Married

Dependents :
4 Children

Tax Rate:
Federal: 25%/15% (Marginal / Effective)
State: 3.07%
State of Residence: PA
Age: Mid-30's

Current Total Portfolio:
~$366k (I don't include taxable stocks/TSRUs as these normal cover other spending like vacations, home improvement, etc.)

Current retirement assets

Taxable
~$42k in restricted stocks and total shareholder return units on vesting schedule

Fidelity 401k
~320k in Vanguard Target Retirement 2055 Fund (VFFVX)
Company Match: 100% of the first 3% and 50% of the next 3%

His Roth IRA at Vanguard
~$16k in Vanguard Target Retirement 2055 Fund (VFFVX)

Her IRA at Vanguard 
~23k in Vanguard Target Retirement 2055 Fund (VFFVX)
Company match: No earned income / left workforce

Her Roth IRA at Vanguard 
~7k in Vanguard Target Retirement 2055 Fund (VFFVX)

Contributions

New annual Contributions 
$19k for his 401k. Add company match 100% of the first 3% and 50% of the next 3%
$6k for his Roth IRA
$6k for her Roth IRA
$0 taxable
Last edited by XtremeSki2001 on Sat Aug 01, 2020 7:28 am, edited 2 times in total.
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Re: Re-balancing to three-fund portfolio

Post by bertilak » Sat Aug 01, 2020 7:08 am

The only fund I like in that list is the S&P500.

I'd go for that and use the other accounts to get to your desired AA. (Bond funds, that is.)

You say you want to re-balance but don't say what your current AA and target AA are.

Is the "Fidelity 401(k)" the same account as "his 401(k)?"
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Re: Re-balancing to three-fund portfolio

Post by XtremeSki2001 » Sat Aug 01, 2020 7:21 am

bertilak wrote:
Sat Aug 01, 2020 7:08 am
The only fund I like in that list is the S&P500.

I'd go for that and use the other accounts to get to your desired AA. (Bond funds, that is.)

You say you want to re-balance but don't say what your current AA and target AA are.

Is the "Fidelity 401(k)" the same account as "his 401(k)?"
Oops. I would probably do age minus 20 for bonds so maybe somewhere between 10-20%. I'd put the rest in stocks and not married to what percentage of each. I've heard many split what's left (e.g., say 40% in VTSAX and 40% in VTIAX).

His 401k = Fidelity

Note: Updated original post to reflect this information.
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Re: Re-balancing to three-fund portfolio

Post by oldcomputerguy » Sat Aug 01, 2020 7:44 am

If it were me, I would build a three-fund portfolio using these three:

S&P 500 INDEX (Gross Expense Ratio: 0.01%)
INTL EQUITY INDEX (Gross Expense Ratio: 0.06%)
DIVERSIFIED BOND (Gross Expense Ratio: 0.23%)

The bond ER is not that great, but it's not hugely expensive either, and at this point in your career, with a relatively lower allocation to bonds, that ER won't hurt you all that badly.
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Re: Re-balancing to three-fund portfolio

Post by bertilak » Sat Aug 01, 2020 9:15 am

oldcomputerguy wrote:
Sat Aug 01, 2020 7:44 am
If it were me, I would build a three-fund portfolio using these three:

S&P 500 INDEX (Gross Expense Ratio: 0.01%)
INTL EQUITY INDEX (Gross Expense Ratio: 0.06%)
DIVERSIFIED BOND (Gross Expense Ratio: 0.23%)

The bond ER is not that great, but it's not hugely expensive either, and at this point in your career, with a relatively lower allocation to bonds, that ER won't hurt you all that badly.
I would agree with that, assuming there isn't a better bond fund available. I didn't notice the Intl at .06% -- that's not bad at all.
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Re: Re-balancing to three-fund portfolio

Post by Outer Marker » Sat Aug 01, 2020 9:40 am

XtremeSki2001 wrote:
Sat Aug 01, 2020 6:57 am

VFFVX is relatively close to the recommended three-fund portfolio. Is staying here better than trying to do three of the funds below?

Debt:
Mortgage ($288k @ 3.625%, 22 years to go)

Age: Mid-30's

Fidelity 401k
~320k in Vanguard Target Retirement 2055 Fund (VFFVX)
Company Match: 100% of the first 3% and 50% of the next 3%

His Roth IRA at Vanguard
~$16k in Vanguard Target Retirement 2055 Fund (VFFVX)

Her IRA at Vanguard 
~23k in Vanguard Target Retirement 2055 Fund (VFFVX)
Company match: No earned income / left workforce

Her Roth IRA at Vanguard 
~7k in Vanguard Target Retirement 2055 Fund (VFFVX)

Contributions

New annual Contributions 
$19k for his 401k. Add company match 100% of the first 3% and 50% of the next 3%
$6k for his Roth IRA
$6k for her Roth IRA
$0 taxable
Why are you desiring to switch from Vanguard 2055 to a 3-fund portfolio? As you note, the two approaches are very similar. With all retirement assets in tax advantaged accounts, you don't have to worry about tax effecient placement of bonds. Expenses in the TR fund are a low 0.15% and doesn't seem worth the extra complexity for the very small potential savings. If you'd like a little more in bonds, just pick a fund with an earlier date to get you to age-20. The only reason I might consider switching is if you think TR has too much in foreign and/or you don't like foreign bonds.

The low hanging fruit in your situation is: Mortgage ($288k @ 3.625%, 22 years to go). I'd refi that puppy down to today's much lower rates and take out a 15 year at 2.5%. That retires the mortgage before you plan to and will save you tens of thousands in interest.

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Re: Re-balancing to three-fund portfolio

Post by retiredjg » Sat Aug 01, 2020 9:53 am

S&P 500 INDEX (Gross Expense Ratio: 0.01%) and RUSSELL 2000 INDEX (Gross Expense Ratio: 0.02%) at 83%/17% equals total stock market (80/20 would be close enough)

DIVERSIFIED BOND (Gross Expense Ratio: 0.23%) is reasonable good

You can hold your international in the IRAs.

I don't think doing all this improves your portfolio much if at all. If you prefer to hold the individual funds, that's fine. Just don't do it because you think it is somehow better. It might be a few bonus points cheaper, but not enough to switch if you like the target fund approach.

If you decide to stay with a target fund but want a little more in bonds, just find the target fund date that corresponds with that desired stock to bond ratio.

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Re: Re-balancing to three-fund portfolio

Post by LeeMKE » Sat Aug 01, 2020 3:54 pm

One reason to do what OP is asking to do is to make rebalancing across all accounts easier.

Having a target date fund complicates rebalancing because you must rebalance among all other holdings since you can't change the contents of the target date fund. Target Date funds are ideal for young investors starting out, but this is exactly the time to switch to individual funds.

+1 everyone else. No need to repeat good advice.
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Re: Re-balancing to three-fund portfolio

Post by Outer Marker » Sat Aug 01, 2020 7:09 pm

LeeMKE wrote:
Sat Aug 01, 2020 3:54 pm
One reason to do what OP is asking to do is to make rebalancing across all accounts easier.

Having a target date fund complicates rebalancing because you must rebalance among all other holdings since you can't change the contents of the target date fund. Target Date funds are ideal for young investors starting out, but this is exactly the time to switch to individual funds.

+1 everyone else. No need to repeat good advice.
But in this case, OP holds TR funds across all retirement accounts with no intention of starting a separate taxable account. If you hold TR funds across all accounts, there is no need to rebalance, ever. I'd stick with that.

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Re: Re-balancing to three-fund portfolio

Post by XtremeSki2001 » Sat Aug 01, 2020 7:50 pm

Thanks for all the input. Happy I’m not that far off from where I want to be. Pretty sure I picked the TR 2055 fund in 2006 or so right out of college on the advice of this forum.
Outer Marker wrote:
Sat Aug 01, 2020 9:40 am
The low hanging fruit in your situation is: Mortgage ($288k @ 3.625%, 22 years to go). I'd refi that puppy down to today's much lower rates and take out a 15 year at 2.5%. That retires the mortgage before you plan to and will save you tens of thousands in interest.
We’re waffling on this due to the cash flow impact. Would cost us ~$5k more a year to accomplish this. Maybe we’re not thinking of it the right way ...
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Re: Re-balancing to three-fund portfolio

Post by lakpr » Sat Aug 01, 2020 8:09 pm

XtremeSki2001 wrote:
Sat Aug 01, 2020 7:50 pm
Thanks for all the input. Happy I’m not that far off from where I want to be. Pretty sure I picked the TR 2055 fund in 2006 or so right out of college on the advice of this forum.
Outer Marker wrote:
Sat Aug 01, 2020 9:40 am
The low hanging fruit in your situation is: Mortgage ($288k @ 3.625%, 22 years to go). I'd refi that puppy down to today's much lower rates and take out a 15 year at 2.5%. That retires the mortgage before you plan to and will save you tens of thousands in interest.
We’re waffling on this due to the cash flow impact. Would cost us ~$5k more a year to accomplish this. Maybe we’re not thinking of it the right way ...
May be I will give you an extra push. 3.625% * $288k = $10,440. Assume the maximum property taxes, $10k. Your total itemized deductions = $20,440, less than the standard deduction of $24,800 for a married couple filing jointly.

Stated in other words, you are paying an AFTER-TAX interest rate of 3.625% on your mortgage. With an effective marginal tax rate of 25% (22% Fed + 3% state), just to break even, you need to earn 3.625/0.75 = 4.83%.

So, if someone comes to you and says: hey, i got a sweet deal for you, I will pay you 4.83% per year, but the deal is principal-limited to only $288k, and term-limited to 22 years ... will you buy the CD or no?

Remember that you are earning only 1.4% taxable on Vanguard Total Bond Market fund, for comparison. This is approximately 4 times as much.

If you say you will buy the CD -- pay down your mortgage.
If you say you will pass -- continue investing as you do.

You can also do a hybrid approach. If your bond allocation is "Age-20" = 25% to bonds, going forward invest the bond portion to paying down the mortgage, and the rest completely to equities. Risk wise you are exactly the same position as before.

Since you are aiming to max out the 401k + Roth IRA, that's $19,500 + $6000 = $25,500 per person, may be $31.5k for the couple to include her Roth IRA --- 25% of it is $8,000 approximately. Resolve to pay down $8k for mortgage prepayment, and everything else to 100% equities.

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Re: Re-balancing to three-fund portfolio

Post by Minty » Sat Aug 01, 2020 8:28 pm

Yes, refi the house, to a 15 year mortgage or to a 30 if you are concerned about cash flow. If you don't want to extend the term to 30 years, get a 30 anyway and pay extra so you are finished in 22 years. Look at the Refinance Mega Thread. The deals are unbelievable on no-cost refis. It is a no-brainer to pay, say, 3% rather than 3.625%

On your main question, I would go three-fund so you could make your Roths all equities.
Core Four with nominal bonds and TIPS.

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Re: Re-balancing to three-fund portfolio

Post by XtremeSki2001 » Sun Aug 02, 2020 6:47 am

Thanks minty/lakpr.

Am I correct in saying the savings resulting from a refi down to 15yr are realized in years 15-22 where I would otherwise be paying a mortgage payment if I kept things as-is?

The savings is immediate but realization, extra cash in hand, isn’t for 15 years so I think that’s where I’m struggling. Maybe the solution is a 30yr that we pay down aggressively when we can and then back off when we can’t? If COVID wasn’t wreaking havoc I’d gladly shell out the extra $400 for the 15yr.

Lakpr is your one suggestion that we, for example, stop putting money in one rIRA and move remaining investments to 100% stocks for the 15yr refi period? If we did this, how do we get that money back for retirement? Would be commit the savings from years 15-22 to a rIRA when the savings is realized?
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Re: Re-balancing to three-fund portfolio

Post by lakpr » Sun Aug 02, 2020 9:18 am

XtremeSki2001 wrote:
Sun Aug 02, 2020 6:47 am
Lakpr is your one suggestion that we, for example, stop putting money in one rIRA and move remaining investments to 100% stocks for the 15yr refi period? If we did this, how do we get that money back for retirement? Would be commit the savings from years 15-22 to a rIRA when the savings is realized?
1. No, I would absolutely not suggest that you forego a Roth IRA contribution. Paying down the mortgage is so far down on my list of investment priorities ... I would never suggest you give up the chance to shelter $6k per person per year. That space, once given up, can never be reclaimed.

2. Roth IRA funds should ideally be invested in 100% stocks anyway. The basic premise of a Roth account is, in exchange for paying taxes here and now, you will enjoy tax free growth for your lifetime. It is in your interest to maximize that growth as much as possible. Restating that in different words, you should pack Roth IRA accounts with only those asset classes that you reasonably believe will provide you highest growth.

Which asset classes make that cut? Stocks. To a lesser extent, perhaps REITs.

Not bonds, not target-date funds, not blended-funds, not TIPS, not iBonds, not EE bonds .... all those funds instead belong in tax-deferred accounts (Trad. IRA / Trad. 401k,403b,457 etc.)

3. Yes, paying down the mortgage is basically realizing your gains 15 years later. Its equivalent is buying the EE Bonds, for you. You are sacrificing liquidity now, in order to have a secure retirement later. To mitigate the liquidity risk, you must first be comfortable with the size of your emergency fund. I suggest at least 1-year worth of expenses, before you start paying down your mortgage.

Yes it would suck to be earning 1% taxable on your emergency fund while you are paying 4.8% taxable-equivalent on your mortgage, that's why I would stop at 1-year worth, and then start paying down the mortgage.

4. I suggest you first increase your EF to 1-year expenses, then take a HELOC on your home. The higher interest rate on the HELOC will mentally give you the motivation to NOT tap it for trivial purposes, while retaining liquidity as you pay down your mortgage. Then go 100% in your investments in both Roth IRA and tax-deferred accounts.

5. If you are able to refinance down to 3% nominal, then I think it's a 4% taxable equivalent -- I would personally not pay down the mortgage either in that case. Yes, mathematically still paying the mortgage down is better, but the liquidity risk premium disappears, almost.

Not to mention, you can buy EE bonds and hold them for 20 years realizing 3.5% nominal per year (same duration 22 yrs vs. 20 years, or slightly longer, 15 yrs vs. 20 yrs), and Uncle Sam is the best borrower in the world guaranteed to repay your principal and interest.

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Re: Re-balancing to three-fund portfolio

Post by LeeMKE » Sun Aug 02, 2020 9:37 am

You have the discipline to do this, most people don't, so yes, refi with a 30 year fixed (or ask about the rates on an adjustable too) and then prepay it monthly. But think about this long term and check the quotes first.

1) The savings is NOT just the years after your mortgage is paid off, but also the MUCH larger portion of your monthly payment that goes to principal instead of interest. The early years of a 30 year mortgage are highway robbery. Historically, 30 year mortgages were illegal because they are so usurious. Finally Congress relented and allowed banks to offer them, and it was off to the races, for banks that is.

After all the payments you have made, your monthly payment isn't even half principal. The early years paid for bankers yachts.

2) Shorter terms have lower interest rates. On just one website I checked, 30 year refi is 3.375%, 15 year refi is 2.750%, 20 year is in the middle of these. Ask about a refi in your area. You may be able to get a 15 year term for the same monthly payment you already have. If so, do that.

3) Tax free investment. Debt repayment is tax free. Income on taxable investments is not. Your additional principal payments earn a handsome return that is tax free. After filling the tax deferred retirement accounts, this is the next best return most of us can get, paying down our mortgage.

4) At retirement, if you want to get your money out, you'll either sell the house and downsize or borrow the equity out in a new mortgage for college costs or other things. My first father in law lent us money for our first house because he could borrow at lower cost than we. The revolving line of credit did the same for several children. He made a profit and we saved money. I think this loan was funded by a loan on his home.

Good luck!
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Re: Re-balancing to three-fund portfolio

Post by Outer Marker » Sun Aug 02, 2020 10:44 am

XtremeSki2001 wrote:
Sun Aug 02, 2020 6:47 am
The savings is immediate but realization, extra cash in hand, isn’t for 15 years so I think that’s where I’m struggling. Maybe the solution is a 30yr that we pay down aggressively when we can and then back off when we can’t? If COVID wasn’t wreaking havoc I’d gladly shell out the extra $400 for the 15yr.

Lakpr is your one suggestion that we, for example, stop putting money in one rIRA and move remaining investments to 100% stocks for the 15yr refi period? If we did this, how do we get that money back for retirement? Would be commit the savings from years 15-22 to a rIRA when the savings is realized?
As you correctly state, the savings are immediate. The extra "cash-in-hand" is not realized in the form of zero mortgage payments until 15 years down the line. But, the savings can be "realized" at any time in the form of (1) a HELOC, (2), sale of house (if you decide to move,or otherwise), (3) refinancing a few years from now and spreading smaller payments out again over a longer period (which I don't recommend). If you buy a stock, you can watch the value go up on paper in your brokerage, but you don't "realize" the benefit until you sell it.

Are you sure the 15 year would cost $400 more? Plugging some rough estimates into an amortization table, taking into account your reduced principle balance for 8 years of payments, going from a 30 year at 3.625% to a 15 year at 2.5% looks like a difference closer to $300 than $400. ($330). If this is going to crimp your ability to max out your tax-advantaged savings, or strain your monthly budget, go with the 30 year refi. Compare the amortization tables on what your balance would be if you'd started on a 15 year 8 years ago. Sobering!

I think people overly value the "flexibility" of a 30 year schedule. If the budget is that tight that the difference between a 15 year or 30 year is going to kill you, then you bought too much house. In the event of a catestrophic emergeny, the $300 in monthly payments is only going to make a difference of a month or two in how long you can hold out. But, you've got plenty of other assets you would tap in the event of a true emergency before selling the house. In reality, the extra interest on a 30 year term costs you additional money every year, and enables extra spending you probably don't need.

I do not count my home as part of my asset allocation, so it has zero effect on how my IRAs or anything else is invested. Your TR fund is 90% stocks, so there is little to be gained by tinkering to try to make it 100% in your roths.

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