Three Fund Portfolio Question

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Topic Author
mtswiss
Posts: 2
Joined: Sun Apr 19, 2020 11:25 pm

Three Fund Portfolio Question

Post by mtswiss »

I am in my 40s and I just read the Three Fund Portfolio book and I had a question about the bond portion of the portfolio. In the book they said that the Vanguard Total Bond fund isn't tax efficient and unless you are using a tax advantaged retirement account that you should look at using a tax free bond. I already have a 401K which I contribute the annual maximum to. I also have a Roth IRA that I contribute the Maximum to and my I have maxed out my HSA. I am new to personal investing and based upon the Three Fund Portfolio book and based upon my age of 40 I was going to do a 70% Stocks 30% bonds allocation. My original plan was to allocate the following:

60% Vanguard Total Stock Market ETF (VTI)
10% Vanguard Total International Stock ETF (VXUS)
30% Vanguard Total Bond Market ETF (BND)

But based upon the recommendation of using a tax free bond as my account isn't tax advantaged I was thinking of changing the bond fund to the following:

30% Vanguard Intermediate-Term Tax-Exempt Fund (VWITX)

This fund however has an ER of 0.17 which is quite a bit higher than the Total Bond Market fund.
I had a friend advise using two bond that are not tax exempt but have a lower ER than the tax exempt fund. The suggested allocation was as follows:

15% Vanguard Long-Term Corporate Bond ETF (VCLT)
15% Vanguard Short-Term Corporate Bond ETF (VCSH)

At this point I think I have confused myself by reading to many things on the topic and I am looking for some perspective from the group. Specifically I would like to get input on the following questions:

Which of the options above is the most efficient for a long term investor?
What is the best way to compare ER to benefits of a Tax-Exempt fund?
Is the three fund portfolio still a good way to go for an inexperienced investor?

Federal Tax Rate is 24% and state tax rate is a flat rate of 4.95%

Any insight on these points would be greatly appreciated. Thank you in advance for your consideration.
Last edited by mtswiss on Wed Oct 13, 2021 9:51 pm, edited 1 time in total.
ivgrivchuck
Posts: 883
Joined: Sun Sep 27, 2020 6:20 pm

Re: Three Fund Portfolio Question

Post by ivgrivchuck »

mtswiss wrote: Tue Oct 12, 2021 10:11 pm I am in my 40s and I just read the Three Fund Portfolio book and I had a question about the bond portion of the portfolio. In the book they said that the Vanguard Total Bond fund isn't tax efficient and unless you are using a tax advantaged retirement account that you should look at using a tax free bond. I already have a 401K which I contribute the annual maximum to. I also have a Roth IRA that I contribute the Maximum to and my I have maxed out my HSA. I am new to personal investing and based upon the Three Fund Portfolio book and based upon my age of 40 I was going to do a 70% Stocks 30% bonds allocation. My original plan was to allocate the following:

60% Vanguard Total Stock Market ETF (VTI)
10% Vanguard Total International Stock ETF (VXUS)
30% Vanguard Total Bond Market ETF (BND)

But based upon the recommendation of using a tax free bond as my account isn't tax advantaged I was thinking of changing the bond fund to the following:

30% Vanguard Intermediate-Term Tax-Exempt Fund (VWITX)

This fund however has an ER of 0.17 which is quite a bit higher than the Total Bond Market fund.
I had a friend advise using two bond that are not tax exempt but have a lower ER than the tax exempt fund. The suggested allocation was as follows:

15% Vanguard Long-Term Corporate Bond ETF (VCLT)
15% Vanguard Short-Term Corporate Bond ETF (VCSH)

At this point I think I have confused myself by reading to many things on the topic and I am looking for some perspective from the group. Specifically I would like to get input on the following questions:

Which of the options above is the most efficient for a long term investor?
What is the best way to compare ER to benefits of a Tax-Exempt fund?
Is the three fund portfolio still a good way to go for an inexperienced investor?

Any insight on these points would be greatly appreciated. Thank you in advance for your consideration.
1) Forget corporate bond funds

2) If you are in a high tax bracket (>30% federal marginal tax rate) tax-exempt bonds make sense

3) Otherwise stick with BND

And lastly if your portfolio is not huge, consider i-bonds.
40% VTI | 40% VXUS | 13% I-bonds | 7% EE-bonds
carminered2019
Posts: 968
Joined: Fri Jun 21, 2019 7:06 pm

Re: Three Fund Portfolio Question

Post by carminered2019 »

1. put All Total US market in Roth
2. Put all Total Bond in 401k then put leftover Total US and Total International in 401K.
3. Rebalance once per year.


The taxes on dividends in Roth or 401k will not affect your yearly tax filing.
Last edited by carminered2019 on Wed Oct 13, 2021 9:20 am, edited 1 time in total.
UpperNwGuy
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Joined: Sun Oct 08, 2017 7:16 pm

Re: Three Fund Portfolio Question

Post by UpperNwGuy »

mtswiss wrote: Tue Oct 12, 2021 10:11 pm But based upon the recommendation of using a tax free bond as my account isn't tax advantaged I was thinking of changing the bond fund to the following:

30% Vanguard Intermediate-Term Tax-Exempt Fund (VWITX)
The book doesn't say that. It says to use a tax-exempt bond fund if you are in the higher tax brackets. If you're in the 24% tax bracket or below, use the Total Bond Market ETF (BND).
billfromct
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Joined: Tue Dec 03, 2013 9:05 am

Re: Three Fund Portfolio Question

Post by billfromct »

ivgrivchuck said: “Forgot corporate bonds”

It would be helpful if you could explain why you make this recommendation.

The average 10 year average return of the Total Bond Market Index (VBTLX) was 2.96% while the 10 year average return for the Intermediate Term Corporate Bond Index (VICSX) was 5.00%. Both have similar average duration of about 6.6 years.

The Intermediate Term Corporate Bond Index does have a “.25% purchase fee”.

Of course past performance is no guarantee of future results.

Full disclosure, my fixed income asset allocation in my retirement accounts are in corporate bond funds.

bill
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oldcomputerguy
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Location: Tennessee

Re: Three Fund Portfolio Question

Post by oldcomputerguy »

To expand a bit on what UpperNwGuy said:

Taxable bonds do cause some tax issues in a taxable account. That is because when bond income is taxed, it is always at your marginal tax rates, unlike with stocks where you get preferential tax rates for long-term capital gains and qualified dividends. What you want to do is minimize the tax consequences.

One might assume that tax-free municipal bonds are always preferred in a taxable account, but that's missing one piece of the picture; namely, that taxable bonds generally have a bit higher return than municipal bonds. So if you were to replace your taxable bonds with municipal bonds, it's quite possible (depending on your marginal tax bracket) that you would end up with less after-tax return. What you have to decide is whether it makes sense financially to give up the somewhat higher return of taxable bonds in exchange for decreasing your tax hit.

There is a decent discussion of doing this calculation here: Calculating Tax Equivalent Yield: Are Municipal Bonds Right for You?
whereskyle
Posts: 1876
Joined: Wed Jan 29, 2020 10:29 am

Re: Three Fund Portfolio Question

Post by whereskyle »

mtswiss wrote: Tue Oct 12, 2021 10:11 pm I am in my 40s and I just read the Three Fund Portfolio book and I had a question about the bond portion of the portfolio. In the book they said that the Vanguard Total Bond fund isn't tax efficient and unless you are using a tax advantaged retirement account that you should look at using a tax free bond. I already have a 401K which I contribute the annual maximum to. I also have a Roth IRA that I contribute the Maximum to and my I have maxed out my HSA. I am new to personal investing and based upon the Three Fund Portfolio book and based upon my age of 40 I was going to do a 70% Stocks 30% bonds allocation. My original plan was to allocate the following:

60% Vanguard Total Stock Market ETF (VTI)
10% Vanguard Total International Stock ETF (VXUS)
30% Vanguard Total Bond Market ETF (BND)

But based upon the recommendation of using a tax free bond as my account isn't tax advantaged I was thinking of changing the bond fund to the following:

30% Vanguard Intermediate-Term Tax-Exempt Fund (VWITX)

This fund however has an ER of 0.17 which is quite a bit higher than the Total Bond Market fund.
I had a friend advise using two bond that are not tax exempt but have a lower ER than the tax exempt fund. The suggested allocation was as follows:

15% Vanguard Long-Term Corporate Bond ETF (VCLT)
15% Vanguard Short-Term Corporate Bond ETF (VCSH)

At this point I think I have confused myself by reading to many things on the topic and I am looking for some perspective from the group. Specifically I would like to get input on the following questions:

Which of the options above is the most efficient for a long term investor?
What is the best way to compare ER to benefits of a Tax-Exempt fund?
Is the three fund portfolio still a good way to go for an inexperienced investor?

Any insight on these points would be greatly appreciated. Thank you in advance for your consideration.
I might just stick with total bond. Tax-exempt bonds have had higher volatility, higher expenses, and lower returns. You might want to consider them if you're in a very high tax bracket, but you might do better with total bond just the same. See the link in oldcomputerguy's post if you want to dig deeper into whether they might be suitable for you.
"I am better off than he is – for he knows nothing and thinks that he knows. I neither know nor think that I know." - Socrates. "Nobody knows nothing." - Jack Bogle
tashnewbie
Posts: 2050
Joined: Thu Apr 23, 2020 12:44 pm

Re: Three Fund Portfolio Question

Post by tashnewbie »

Welcome to the forum!

What are your marginal federal and state tax brackets? Add that information to your original post by using the pencil edit button in the top right corner of the post.

Are you using a bond fund in your 401k?

FYI, you don't have to put each and every component of the 3-fund portfolio in every account you have. It's better to place the individual asset classes with tax-efficiency in mind and view your portfolio as one big portfolio across all your accounts and manage your desired asset allocation (percentage of stocks and bonds) across those. In general, it's better to put taxable bond funds in tax-deferred accounts (Traditional 401k/IRA). See this wiki link for more about tax-efficient fund placement: Tax-efficient Fund Placement.
Topic Author
mtswiss
Posts: 2
Joined: Sun Apr 19, 2020 11:25 pm

Re: Three Fund Portfolio Question

Post by mtswiss »

I hadn't thought of looking at all my accounts and balancing at the macro level. Right now in my 401K and Roth I am using just retirement date accounts as I am not really an experienced investor. I updated the information on the original post to include the federal and state tax rates. Thanks for the link to the Tax-efficient fund placement. I will spend some time going over that.
tashnewbie
Posts: 2050
Joined: Thu Apr 23, 2020 12:44 pm

Re: Three Fund Portfolio Question

Post by tashnewbie »

mtswiss wrote: Wed Oct 13, 2021 9:57 pm I hadn't thought of looking at all my accounts and balancing at the macro level. Right now in my 401K and Roth I am using just retirement date accounts as I am not really an experienced investor. I updated the information on the original post to include the federal and state tax rates. Thanks for the link to the Tax-efficient fund placement. I will spend some time going over that.
No problem. Take your time and get comfortable and familiar with these topics.

I recommend posting a full portfolio review in this suggested format: Asking Portfolio Questions. The forum members are knowledgeable and can give you more thorough and informed advice if they have a fuller picture of your portfolio.
dbr
Posts: 37299
Joined: Sun Mar 04, 2007 9:50 am

Re: Three Fund Portfolio Question

Post by dbr »

billfromct wrote: Wed Oct 13, 2021 5:28 am ivgrivchuck said: “Forgot corporate bonds”

It would be helpful if you could explain why you make this recommendation.

The average 10 year average return of the Total Bond Market Index (VBTLX) was 2.96% while the 10 year average return for the Intermediate Term Corporate Bond Index (VICSX) was 5.00%. Both have similar average duration of about 6.6 years.

The Intermediate Term Corporate Bond Index does have a “.25% purchase fee”.

Of course past performance is no guarantee of future results.

Full disclosure, my fixed income asset allocation in my retirement accounts are in corporate bond funds.

bill
Choices like that just aren't very important. The return and risk of the one is less than risk and return for the other. The Sharpe ratios are the same.

If a person wants a little more return one can allocate a little more to stocks. At that point the whole discussion is pretty much down in the weeds and either choice is going to be fine for most people. If you really want to get into the weeds you can start looking at the correlations to stocks, which are the best diversifiers and which produces the optimum portfolio. I don't think there is much of a play to be had there.
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