Target Date Fund As Part of 3-Fund Portfolio

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etfan
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Target Date Fund As Part of 3-Fund Portfolio

Post by etfan »

General question about trying to implement a 3-Fund Portfolio in a taxable account plus a 401K with limited options. The 401K plan does not include a "Total Stock Market" fund.

There seems to be 4 options that I can think of and I'm curious to know if any of them is preferred:

1- Using the S&P 500 fund in lieu of a total stock market fund in the 401K. So S&P 500/international/total bond in 401K, and VTI/VXUS (total stock + ex-US) in taxable.

2- Recreate the total stock market fund using the appropriate ratios of large, mid and small cap funds (all of which are available in the 401K), and add the needed ex-US, total bond in 401K plus VTI/VXUS in taxable.

3- Use a target date fund in 401K, and VTI/VXUS in taxable. In addition, add total bond in 401K as needed as the taxable side grows too big. In other words: TDF+Total Bond in 401K and VTI+VXUS in taxable.

4- Just hold a TDF in 401K and the same TDF in taxable and be done with it.

Leaning towards (3) as it seems like a middle ground choice that includes a "real" total stock market.

Thoughts?
wetgear
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Re: Target Date Fund As Part of 3-Fund Portfolio

Post by wetgear »

Any of the first 3 are good options depending on the fees to implement each. 4 tends not to be very tax efficient. S&P 500 funds tend to have the lowest fees in 401k plans while being great proxies for total market so number #1 shines when you have a bad 401k plan. I personally use #3 because my 401k plans have low cost TDF funds too. Note, I've never had to add a total bond fund to my 401k because I just use an earlier date for the TDF fund to get the correct amount of bonds in my 401k to support the whole portfolio. The date on the TDF is not relevant to the date you actually want to retire so pick the one with the correct AA instead if you end up using one.
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etfan
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Re: Target Date Fund As Part of 3-Fund Portfolio

Post by etfan »

wetgear wrote: Sun Sep 12, 2021 6:15 pm Any of the first 3 are good options depending on the fees to implement each. 4 tends not to be very tax efficient. S&P 500 funds tend to have the lowest fees in 401k plans while being great proxies for total market so number #1 shines when you have a bad 401k plan.
Yes, using the individual stocks seems slightly cheaper but not by a lot. I know people here always say S&P 500 is equivalent to TSM but I suppose if possible, one should try and hold TSM.
I personally use #3 because my 401k plans have low cost TDF funds too. Note, I've never had to add a total bond fund to my 401k because I just use an earlier date for the TDF fund to get the correct amount of bonds in my 401k to support the whole portfolio.
I know you should pick the TDF that has your preferred AA regardless of "target date", but switching TDF's all the time for rebalancing seems like a misuse of what TDF was intended for, doesn't it? I've read articles that go as far as to say that a TDF is designed to be your one and only fund, so any addition to it means you should not hold a TDF.

If you're just doing TDF in 401K plus TSM/ex-US in taxable, how do you control your international allocation?
Triple digit golfer
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Re: Target Date Fund As Part of 3-Fund Portfolio

Post by Triple digit golfer »

#1 and #4 are the simplest. #4 is less tax efficient and probably more expensive due to TDF in 401(k). I vote (and myself do) #1.
Mike Scott
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Re: Target Date Fund As Part of 3-Fund Portfolio

Post by Mike Scott »

It depends on what is available to you and at what cost. I do something kind of like your #3 with balanced funds in a mix of tax advantaged accounts and total stock market funds in taxable.
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etfan
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Re: Target Date Fund As Part of 3-Fund Portfolio

Post by etfan »

Triple digit golfer wrote: Sun Sep 12, 2021 7:33 pm #1 and #4 are the simplest. #4 is less tax efficient and probably more expensive due to TDF in 401(k). I vote (and myself do) #1.
#1 seems like the answer but I wish it had TSM. It's really strange that any 401K plan would choose to exclude that very obvious option.
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etfan
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Re: Target Date Fund As Part of 3-Fund Portfolio

Post by etfan »

Mike Scott wrote: Sun Sep 12, 2021 8:13 pm It depends on what is available to you and at what cost. I do something kind of like your #3 with balanced funds in a mix of tax advantaged accounts and total stock market funds in taxable.
There are no other "funds of funds" besides the TDF's.
exodusNH
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Re: Target Date Fund As Part of 3-Fund Portfolio

Post by exodusNH »

etfan wrote: Sun Sep 12, 2021 5:56 pm General question about trying to implement a 3-Fund Portfolio in a taxable account plus a 401K with limited options. The 401K plan does not include a "Total Stock Market" fund.

There seems to be 4 options that I can think of and I'm curious to know if any of them is preferred:

1- Using the S&P 500 fund in lieu of a total stock market fund in the 401K. So S&P 500/international/total bond in 401K, and VTI/VXUS (total stock + ex-US) in taxable.

2- Recreate the total stock market fund using the appropriate ratios of large, mid and small cap funds (all of which are available in the 401K), and add the needed ex-US, total bond in 401K plus VTI/VXUS in taxable.

3- Use a target date fund in 401K, and VTI/VXUS in taxable. In addition, add total bond in 401K as needed as the taxable side grows too big. In other words: TDF+Total Bond in 401K and VTI+VXUS in taxable.

4- Just hold a TDF in 401K and the same TDF in taxable and be done with it.

Leaning towards (3) as it seems like a middle ground choice that includes a "real" total stock market.

Thoughts?
1-3 are reasonable. It depends on how much work you want to do. Behavioral mistakes are likely the biggest risk to keeping everything in balance manually.

#4 has a tax inefficiency due to the rebalancing and bond payments. In addition, holding a separate ex-US fund allows you to claim the foreign tax credit.
chem6022
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Re: Target Date Fund As Part of 3-Fund Portfolio

Post by chem6022 »

I value simplicity more and more, so I would likely do #3 if you can pick your likely retirement date within 10 years. If you are likely to have behavioral issues like not contributing during down markets or not rebalancing then #4 could make you more money despite some minor tax ineffeciencies.
TJat
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Re: Target Date Fund As Part of 3-Fund Portfolio

Post by TJat »

I use option 2. Use Morningstar to set the weights and auto rebalance quarterly
tashnewbie
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Re: Target Date Fund As Part of 3-Fund Portfolio

Post by tashnewbie »

etfan wrote: Sun Sep 12, 2021 8:53 pm
Triple digit golfer wrote: Sun Sep 12, 2021 7:33 pm #1 and #4 are the simplest. #4 is less tax efficient and probably more expensive due to TDF in 401(k). I vote (and myself do) #1.
#1 seems like the answer but I wish it had TSM. It's really strange that any 401K plan would choose to exclude that very obvious option.
TSM funds didn't become available until the 1990s, so I think it's a relic of the past that more and more 401ks haven't added them as an option. I think it's more common to see S&P 500 funds (and sometimes also the Extended Market fund) in a 401k than a TSM fund. I think using the S&P 500 is sufficient for US stock, although personally I use S&P 500 and extended market in my 401k to approximate TSM. If I only had access to the separate mid and/or small cap funds instead of extended market, I would just use S&P 500, and one day I may decide to drop the extended market and just use S&P 500.

I vote for #1 (or a modified #2 if you have access to an extended market fund and want to do a little more work to approximate TSM).
wetgear
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Re: Target Date Fund As Part of 3-Fund Portfolio

Post by wetgear »

etfan wrote: Sun Sep 12, 2021 7:30 pm Yes, using the individual stocks seems slightly cheaper but not by a lot. I know people here always say S&P 500 is equivalent to TSM but I suppose if possible, one should try and hold TSM.
I personally use #3 because my 401k plans have low cost TDF funds too. Note, I've never had to add a total bond fund to my 401k because I just use an earlier date for the TDF fund to get the correct amount of bonds in my 401k to support the whole portfolio.
I know you should pick the TDF that has your preferred AA regardless of "target date", but switching TDF's all the time for rebalancing seems like a misuse of what TDF was intended for, doesn't it? I've read articles that go as far as to say that a TDF is designed to be your one and only fund, so any addition to it means you should not hold a TDF.

If you're just doing TDF in 401K plus TSM/ex-US in taxable, how do you control your international allocation?
I think if you are holding TSM elsewhere in your portfolio and using S&P 500 in your 401k, the difference between that and only using TSM is even smaller.

I hear what you are saying regarding rebalancing with TDFs and switching between them to frequently. That being said I've only ever made one adjustment as part of a rebalance switching from a 2035 to a 2030 as the equities in my other accounts grew so large I needed to increase my bond holdings by making this switch. I've found that because your TDFs are rebalancing themselves daily the need to rebalance elsewhere in my portfolio isn't common because my 401k is the largest account in my portfolio and it's always where it's supposed to be.

Regarding international % my IPS states I should hold international at ~ market weight which is roughly 45%. My TDF fund holds international at 40% and all my other accounts I hold at 50/50 TSM/TISM. This averages out to approximately market weight per my IPS. I'm not really concerned about keeping that to an exact percentage and my IPS reflects that as it also states a more hands off approach that rebalances TSM/TISM by new purchases only unless very far off from market weight. Being as though my largest account (401k) is always locked in at 40%, it's unlikely I'll drift too far from market weight anyway.

Hope this helps.
Last edited by wetgear on Mon Sep 13, 2021 10:39 am, edited 1 time in total.
sycamore
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Re: Target Date Fund As Part of 3-Fund Portfolio

Post by sycamore »

etfan wrote: Sun Sep 12, 2021 5:56 pm Leaning towards (3) as it seems like a middle ground choice that includes a "real" total stock market.

Thoughts?
That's a good one. Rather than adding some Total Bond as needed, I like wetgear's suggestion to use a different TDF fund with more bond in its allocation.

Whichever option you choose, make sure it leaves you satisfied you made a "good enough" decision, and won't worry about it later or go trying to tweak it.
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Horton
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Re: Target Date Fund As Part of 3-Fund Portfolio

Post by Horton »

Any of these options are fine. Just keep it simple. The nice thing about the TDFs is that you can put it on autopilot and focus on other things.
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steve r
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Re: Target Date Fund As Part of 3-Fund Portfolio

Post by steve r »

I am a big believer in the simplicity of TDF if they are Target Date INDEX Funds.
The problem with self rebalance is some either forget. Others second guess their asset allocation strategy, often with less than ideal outcomes. (This includes me).

To partially overcome the tax issue, I might pick a slightly more aggressive (more stock) portfolio in taxable say three to five years further out than target and a slightly less aggressive mix in 401k. Set it, forget it. I particularly like the Schwab TDF Index version.
"It's much easier than most investors expect to get satisfactory investment returns and it is much more difficult than they expect to get better results than that." Benjamin Graham
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Re: Target Date Fund As Part of 3-Fund Portfolio

Post by Lazareth »

It's been suggested here that TDF's offer a relatively straightforward way to achieve a target asset allocation (AA) for all or a portion of the portfolio.

Isn't the distinct feature of a TDF that it changes AA with time? Wouldn't that require regularly switching fund's to maintain a target AA?

TDA's seems great for a dynamic AA strategy that shifts to favor fixed-income assets over time, but that didn't appear to be the objective here.
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steve r
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Re: Target Date Fund As Part of 3-Fund Portfolio

Post by steve r »

Lazareth wrote: Tue Sep 14, 2021 10:22 am It's been suggested here that TDF's offer a relatively straightforward way to achieve a target asset allocation (AA) for all or a portion of the portfolio.

Isn't the distinct feature of a TDF that it changes AA with time? Wouldn't that require regularly switching fund's to maintain a target AA?

TDA's seems great for a dynamic AA strategy that shifts to favor fixed-income assets over time, but that didn't appear to be the objective here.
Yes, TDF do shift towards bonds over time. This is what I personally wanted. I picked my target date based on what I want my bond holdings to be 10 years out. There are alternative with a more static asset allocation. Vanguard's Balanced Index and Life Cycle Funds and Fidelity Four in One Index fund comes to mind.
"It's much easier than most investors expect to get satisfactory investment returns and it is much more difficult than they expect to get better results than that." Benjamin Graham
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etfan
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Re: Target Date Fund As Part of 3-Fund Portfolio

Post by etfan »

Horton wrote: Mon Sep 13, 2021 3:42 pm Any of these options are fine. Just keep it simple. The nice thing about the TDFs is that you can put it on autopilot and focus on other things.
Well, I wish there was a TDF that spreads its assets across accounts to automatically achieve a tax efficient distribution.
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etfan
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Re: Target Date Fund As Part of 3-Fund Portfolio

Post by etfan »

steve r wrote: Mon Sep 13, 2021 7:16 pm I am a big believer in the simplicity of TDF if they are Target Date INDEX Funds.
You mean a passive index? I think the Vanguard TDFs are actively managed.
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etfan
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Re: Target Date Fund As Part of 3-Fund Portfolio

Post by etfan »

Lazareth wrote: Tue Sep 14, 2021 10:22 am It's been suggested here that TDF's offer a relatively straightforward way to achieve a target asset allocation (AA) for all or a portion of the portfolio.

Isn't the distinct feature of a TDF that it changes AA with time? Wouldn't that require regularly switching fund's to maintain a target AA?

TDA's seems great for a dynamic AA strategy that shifts to favor fixed-income assets over time, but that didn't appear to be the objective here.
That's why I'm reluctant to mix multiple TDF's. The math seems simpler to just have a TDF in tax-deferred accounts, and then have another "portfolio" of stocks/bonds spread across taxable/non-taxable accounts with an AA that match's the TDF.

I spent some time considering the single TDF across all accounts idea but from all the discussions I've read here, it just seems like the tax efficiency is worth the extra work.
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etfan
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Re: Target Date Fund As Part of 3-Fund Portfolio

Post by etfan »

steve r wrote: Tue Sep 14, 2021 10:42 am Yes, TDF do shift towards bonds over time. This is what I personally wanted. I picked my target date based on what I want my bond holdings to be 10 years out. There are alternative with a more static asset allocation. Vanguard's Balanced Index and Life Cycle Funds and Fidelity Four in One Index fund comes to mind.
At this point, I'm just using the TDF for their convenient diversification benefit, including a Total Stock Market fund, which isn't individually available and would be a lot of work to replicate manually. I also use them for information: For example, I use the TDF to inform my decision on what my AA should be based on my age, etc.
Blue456
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Re: Target Date Fund As Part of 3-Fund Portfolio

Post by Blue456 »

etfan wrote: Sun Sep 12, 2021 5:56 pm
3- Use a target date fund in 401K, and VTI/VXUS in taxable. In addition, add total bond in 401K as needed as the taxable side grows too big. In other words: TDF+Total Bond in 401K and VTI+VXUS in taxable.
This is what I do. I chose a target date found in my TSP (a form of 401k) and go 100% equities in taxable. If you do the same, as you age your 401k will become more and more conservative. At the end of my working career I plan to have two buckets. TSP for immediate income and taxable to income 10+ years later. No rebalancing required makes this set up very easy.
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