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Asset Allocation Advantages in Taxable vs. 401k
Old 05-28-2011, 01:07 AM   #1
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Asset Allocation Advantages in Taxable vs. 401k

When it comes to my whole portfolio, I'm combining my 401k/Roth and taxable investments into 1 big pool. However, I'm curious, for the stuff I do put in my tax-advantaged 401k/Roth, would there be a reason or advantage to keeping more bonds in there or more stocks in there vs. taxable?

As in, if all my stocks were in taxable and all my bonds were in 401k, would it really be any different than if my bonds were in taxable and stocks were in 401k?

To me, it seems better to put assets that get a higher ROI in the 401k, but I wanted to see if there was something that I'm missing.

I feel like I poorly explained this, and if you need additional details, let me know.
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Old 05-28-2011, 05:12 AM   #2
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Here are a couple of things to read carefully that will explain all this:

Principles of Tax-Efficient Fund Placement - Bogleheads

http://www.vanguard.com/pdf/s556.pdf
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Old 05-28-2011, 05:33 AM   #3
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Yes, it makes a substantial difference what's where...you can check the tax efficiency of your specific holdings on Morningstar among other sources.
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Old 05-28-2011, 11:39 AM   #4
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Thanks! That's just the kind of stuff I was looking for.
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Old 05-28-2011, 03:39 PM   #5
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While immediate tax impacts are a big consideration, also consider total returns and how soon you plan to use the investments.

I think something extreme like all bonds in a 401k might result in slow growth of your 401k, which may hurt your lifetime taxation when you pay more capital gains taxes from your taxable account. I'm 100% equities, so I haven't run the numbers on that. I place some of the big dividend funds mostly in the 401k/Roth, but mostly I keep the AA the same for taxable and tax advantaged.

Also, if you want to significantly alter your AA (spend only bonds during a severe market drop or spend all the bonds first in retirement), or simply spend down all your taxable accounts first, you'll have to work a bit harder to sell bonds in the 401k, sell equities in the taxable account, and replace some or all of those stocks in the 401k in order to maintain the AA while withdrawing only from the taxable account. That was my main reason for keeping the AA pretty much the same for both types of accounts and just hedging them a little bit to reduce taxable income.
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Old 06-04-2011, 10:38 AM   #6
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Thanks for the links and responses, they were very enlightening. However, this new knowledge now has me somewhat confused as to what to do next.

In a few months, we'll have all of our non-mortgage debt paid off and we're going all-in on saving and investing. About $900/month (~25%) will go into our 401k (including match) and we should have about $2500/month outside of that which will (presumably) go into taxable accounts. However, this leads to the problem Animorph mentioned because if I want a 25/75 equity/bond ratio, then my 401k is all bonds and may grow quite slowly.

Given this information, what would you do? Would you recommend any of the following?
  • Invest more in my 401k even though I don't get the employer match. Maybe try to hit the 401k Roth yearly limit.
  • For my 75% outside of the 401k, set up an IRA and invest some of the $2500 in there and spread my bonds across the 401k and the IRA.
  • Put some bonds in my taxable and some equities in my 401k
  • Go 100% equities for now, and then switch all equities in the 401k to bonds at a later date.
  • Stay with the Fido "Lifepath 20XX" funds in 401k Roth, and just focus on my 75% and how I'll allocate that.
Thanks!
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Old 06-04-2011, 11:58 AM   #7
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What I would do is go over to Bogleheads Investing Advice and Info and click on the "Getting Started" link and follow the advice there.

I see no problem with 401(k) being 100% bond fund and contributing $22K a year to it. That's what my spouse does. I would not use a Roth 401(k) at all because it would cause me to pay more taxes in both the short and long term.

I would have a Roth IRA. I might have a 529 plan.

I would put all my equities in taxable. If I still needed more bonds, then I would not mind having bonds in taxable. I would choose either tax-exempt muni bonds or taxable bonds depending on my marginal income tax bracket.

I would engineer my holdings so that my effective income tax rate on $200K+ income was less than 10% like always.
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Old 06-04-2011, 06:40 PM   #8
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Yep, max you're comfortable tying up in the traditional 401k, any left over fills up a Roth IRA (you can always withdraw contributions without penalty), then taxable for any left over.

You'll convert TIRA funds to a Roth IRA when you RE and your income drops you into lower tax brackets. That is "almost always" a better deal than using the Roth 401k now because your average tax rate then will be lower than your marginal tax rate now. The Roth IRA however is "almost always" better than a taxable account, since both start with already taxed money but the Roth IRA avoids future taxes on gains. The reason the Roth 401k and Roth IRA are very different is that an investment in the Roth 401k means that much less invested in the TIRA. The Roth IRA can be used in addition to the normal 401k.
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Old 06-04-2011, 09:54 PM   #9
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It's amazing how every time I ask a question here I learn something that completely causes me to change what I'm doing/planning on doing because I didn't really know what I was doing.

Just 2-3 months ago I switched all my automatic investments from T401(k) to Roth 401(k), thinking it was totally the right thing. Now it turns out I should switch back, lol!

Thanks guys, and your recommendations make a lot of sense.
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Old 06-04-2011, 11:18 PM   #10
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I have a T401K because I expect my tax rate in retirement will be lower than my tax rate currently. I also have my T401K all bond funds to minimze my current taxes. Taxable accounts are a mix of bond and equity funds.
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