Allocation of Foreign stocks among brokerage/IRA/401 accounts

[bots2019]

Recently I’ve been giving some thought to how my domestic/foreign equities are allocated between my various account types. Historically I’ve tried to allocate the highest yielding assets to the retirement accounts in order to minimize taxes since I just end up reinvesting the proceeds anyway (I’m currently 10+ years from retirement). Each of these account types have roughly the same proportion of domestic and foreign assets.

I’m wondering if it isn’t wiser to move more foreign assets into my brokerage accounts since I’m not taking advantage of the foreign tax credit with them in retirement accounts. The problem with this is that the foreign assets have significantly higher yields on average than domestic, so I would end up paying more in taxes. I also don’t necessarily want to end up with retirement accounts full of domestic equities and brokerage accts full of all foreign. It seems most prudent to keep some kind of a balance among accounts (for purposes of future tax and withdrawal strategy).

Just curious how others handle this allocation decision – any thoughts on the best approach to take?

 

[LOL!]

I try to be very tax efficient. So my taxable brokerage accounts are filled with ETFs of foreign equities. Be careful about thinking that the foreign stocks pay out at a higher dividend rate. That may be true, but you don't get that whole rate because foreign taxes are removed before you see it.

I don't have any problem at all holding only foreign equities in my taxable accounts. Why do you think this is a problem? If I look, I have about 75% foreign equities (VEU, VSS, SCZ, EEM) in my taxable brokerage accounts and just 25% US equities. I also have a foreign index fund in my tax-deferred. I would go 100% foreign in taxable if my 401(k) had a low-expense ratio small cap value fund.

I also don't get why you would want to keep a balance among accounts either. I can always get the asset allocation I want with my current set of accounts in a tax-efficient way. This may be because my assets are split about 50:50 between taxable and tax-deferred.

You have to think outside the box sometimes. For example, suppose all my bonds are in tax-sheltered and I wish to sell bonds in order to buy a car. I sell bonds in tax-sheltered, buy the foreign index fund with the bond money, then I sell the foreign ETF in my taxable account. This is 3 trades to get the bond assets out of tax-sheltered without a penalty.

Also note that it doesn't matter whether I have a gain or loss in the taxable foreign ETF because I am replacing those shares with something similar in the tax-advantage account (a foreign index fund). Indeed, if I sell for loss that saves on taxes. If I sell for a gain, it will probably be a LT cap gain which is taxed favorably. It would be easy to avoid selling for a ST cap gain which is taxed at ordinary rates.

 

[FUEGO]

Be careful when looking at your foreign dividend yields. Foreign companies' attitudes toward dividend payments are a lot different, generally speaking, than US companies' attitudes. US companies generally try to keep dividends constant year to year, and increase them when they can. But US companies can be viewed as weak if they have to cut their dividends, so as a result many US companies only pay out a conservative dividend that they know they can cover in good times and bad.

In contrast, the general trend among foreign stocks is to pay out a significant portion of earnings each year. In great years (think 2007 and parts of 2008), they pay out a very large dividend. In years that they lose money, they may pay little or nothing. No stigma exists for those cutting dividends, since divs abroad are more like profit sharing that is variable.

Over time, I'm not necessarily sure that foreign stocks will yield significantly higher than US stocks (but I'm sure you could research that a little more to make sure).

 

[bots2019]

LOL - to your question on keeping the proportions similar between accounts... I've never actually targeted this, but for whatever reason they're all pretty similar (around 35-40% foreign).

I guess the reason I'd like some level of both foreign and US equities in each account type is due to the harvesting of gains/losses and withdrawl patterns. For example, if foreign equities went on extended run while the US languished, and you were withdrawing only from a taxable account (containing only foreign) it seems you'd end with a larger tax bill than if there were some US equities to offset some of the gain. That said, I'm not sure the added benefit of this is sufficient to offset the tax advantage of having the foreign stuff in a taxable account (I think I'm starting to come around on this one).

 

[bots2019]

Be careful when looking at your foreign dividend yields. Foreign companies' attitudes toward dividend payments are a lot different, generally speaking, than US companies' attitudes. US companies generally try to keep dividends constant year to year, and increase them when they can. But US companies can be viewed as weak if they have to cut their dividends, so as a result many US companies only pay out a conservative dividend that they know they can cover in good times and bad.

In contrast, the general trend among foreign stocks is to pay out a significant portion of earnings each year. In great years (think 2007 and parts of 2008), they pay out a very large dividend. In years that they lose money, they may pay little or nothing. No stigma exists for those cutting dividends, since divs abroad are more like profit sharing that is variable.

Over time, I'm not necessarily sure that foreign stocks will yield significantly higher than US stocks (but I'm sure you could research that a little more to make sure).

Good point. I looked into this issue using VFINX as a proxy for US and VEURX as a proxy for foreign. According to yahoo finance, here are the dividend yields for each fund from 1990-2008 based on the closing price when each dividend was paid (hopefully this displays well):

VEURX 1990 - 1.6% 1991 - 2.7% 1992 - 2.8% 1993 - 1.4% 1994 - 2.9% 1995 - 2.6% 1996 - 2.6% 1997 - 2.3% 1998 - 2.6% 1999 - 2.3% 2000 - 1.8% 2001 - 2.3% 2002 - 2.5% 2003 - 2.2% 2004 - 2.3% 2005 - 2.5% 2006 - 2.6% 2007 - 3.1% 2008 - 7.7%

VFINX 1990 - 4% 1991 - 3.4% 1992 - 3.1% 1993 - 2.7% 1994 - 3.2% 1995 - 2.5% 1996 - 2.3% 1997 - 2.3% 1998 - 1.7% 1999 - 1.9% 2000 - 1% 2001 - 1.2% 2002 - 1.6% 2003 - 1.6% 2004 - 1.8% 2005 - 1.8% 2006 - 1.8% 2007 - 1.8% 2008 - 2.4%

Interesting that the foreign yield has been higher for the past 12 years, but US was higher in the early 1990s. Average is 2.7% foreign and 2.2% US. As you note, the standard deviation of the foreign yields is nearly twice as high.

 

[FUEGO]

Interesting that the foreign yield has been higher for the past 12 years, but US was higher in the early 1990s. Average is 2.7% foreign and 2.2% US. As you note, the standard deviation of the foreign yields is nearly twice as high.

That is roughly what I concluded when I was studying similar data sets. I think I went back a little further and saw that US was higher than foreign a little before 1990 too. US = steady, slowly increasing; Foreign = highly variable.