balancing portfolio (for the first time)

[steady saver]

DH plans to retire after the first of the year.
We are attempting to balance our portfolio for the first time. We've gotten into the weeds with this in the past and also with numerous trips to our Fidelity advisors.
We really want to keep things simple.
We are in a high tax bracket so I've tried exploring how best to minimize our tax burden but there doesn't seem to be a whole lot of wiggle room. Honestly at this point, I still don't quite see how best to do that. Fidelity was suggesting a Separately Managed Account but I couldn't see a big savings for the hassle.

So here I am, looking at picking 3-4 index funds and calling it good for now.

Like many people, we have money parked here and there. I want the cash we have for cash flow for when DH retires. He will be 56 at the time.

That leaves our Fidelity individual account and our 401K. The Individual account consists of roughly 1/3 VTI, 1/3 company stock, 12% cash and the rest scattered among a dozen stocks, all of which have done very well over the years except one that I need to sell (Viacom). I'm stumped on rebalancing this account at the moment because I don't need the money and I don't want to pay a tax on stock sales. I can't tax loss harvest because I don't have any losses except for Viacom. I'd appreciate your thoughts on this.

So that leaves our 401K in which to apply our 60/40 allocation. Right now that is in mostly aggressive growth stock index funds that I picked years ago based on company provided information that I didn't really understand. It has done well enough. I thought I would start in this 401K account and take my first stab at getting rid of what I have and introducing 3-4 Vanguard index funds (Total stock market, total international and total bond?).

I've let fear of making a wrong move lead to inaction and we'd really like to move forward in having a more balanced portfolio. Does what I'm proposing even make sense? I'm aware that it's not perfect but I need to make a step in the right direction.

Thank you for your thoughts.

 

[gcgang]

Use the 401k to "balance" - no taxes.
Hold the taxable Equities at a gain (unless you have inside info to sell-lol).

 

[steady saver]

Thank you, gcgang.

 

[RunningBum]

Yes, rebalance in the 401K. Nothing wrong with going heavy into bonds there. Bogleheads recommend it. https://www.bogleheads.org/wiki/Tax-efficient_fund_placement

International funds are not as good in a 401K, because you can't take advantage of the foreign tax credit. You'll pay the foreign taxes, but won't get the credit as you would if you held them in taxable. So if you can find a way to put international in taxable, that's better.

As long as you've got LTCGs, that's usually just a 15% tax + state, unless you are high wager earners. Unless you're going to be in the 12% bracket in retirement when you sell, it's not terrible to sell some now, especially if you can specify some low gainers that will generate smaller taxes.

 

[pb4uski]

What tax bracket will you be in when your DH retires?

If you will be living off of savings/taxable accounts you may be in the 12% tax bracket ($101k of income or less) in which case, qualified dividends and LTCG are tax-free.... so you may be able to do a lot of restructuring and pay nothing in taxes.

In fact, it may be better to defer pensions and SS to allow you headroom to work with the magic of 0% LTCG.

 

[DrRoy]

Use the 401k to "balance" - no taxes.
Hold the taxable Equities at a gain (unless you have inside info to sell-lol).

This is largely what I do, except I use the IRA's instead of the 401K.

 

[LOL!]

1. Where are the accounts held? Fidelity? Vanguard? I would not pay commissions to buy Vanguard products at Fidelity. I would not pay commissions at Fidelity anyways and certainly not a separately managed account. I would use Fidelity index funds and iShares index ETFs at Fidelity. I would use Vanguard products at Vanguard.

2. Sell all the losing Viacom. That is a no brainer.

3. You didn't' state what was your desired asset allocation. You know: Percent in US equities, percent in foreign equities, percent in fixed income. What is it? Just 60/40? If you don't have a plan, then you cannot move towards fulfilling the plan.

4. In the 401(k), there is no tax when making sales of investments, so that is where all your "rebalancing" is going to happen. But you are not really rebalancing, you are changing your asset allocation according to a plan that you are going to tell us about. You can get back to the taxable account later.

5. And speaking of the taxable account, you didn't say if it was 5% of your total portfolio or 96% or something else. Because 1/3 company stock of 5% of total portfolio is a lot different than 1/3 company stock of 96% of total portfolio.

6. If you want 3-4 index funds, then you know them already. They are listed in this link for both Vanguard and Fidelity: https://www.bogleheads.org/wiki/Fidelity

It is not clear whether you need to keep the 401(k) or will roll it over. Maybe you all are using the age-55 thing with the 401(k). If you keep the 401(k), then it is not clear what kinds of funds are available in the 401(k). Are the index funds you want available in the 401(k)?

 

[racy]

The folks at Bogleheads.org will give you detailed help IF you post your situation and questions in this format: https://www.bogleheads.org/forum/viewtopic.php?f=1&t=6212

 

[SumDay]

Steady, I too am struggling with this whole rebalancing thing as we being the withdrawal phase of our retirement walk.

I'm trying to make life as simple as possible, and have been digging around to see what others are doing.

I found a couple of articles that might interest you. I'm in the process of moving to this:

https://www.bogleheads.org/wiki/Three-fund_portfolio

and this is also something that has piqued my interest:

How to Build A Retirement Paycheck From Your Investments - The Retirement Manifesto


You didn't ask, but I thought I'd share anyway. Seems like we may be in somewhat the same boat. Good luck!

 

[pb4uski]

Steady, I too am struggling with this whole rebalancing thing as we being the withdrawal phase of our retirement walk....

I guess I floundered around for a year or so. I ultimately settled on 60/35/5 AA. The 5 of cash is in taxable accounts... the remainder of taxable accounts is equities. Our HSA's and Roth are all equities. IRAs are a mix of bonds and equities and is where I rebalance.

During the year, I have an automated monthly withdrawal of 0.2 from cash to our local bank account that we use to pay bills... my monthly paycheck. Taxable account dividends replenish cash.

At the end of the year, I sell taxable account equities as needed to bring my cash back to 5%, then I sell bonds and buy equities as needed to rebalance back to 60/35/5.

Then I Roth convert to the top of the 12% tax bracket... but the Roth conversion is the equivalent of sell equities in tax-deferred and buy equities in Roth... so it doesn't impact my AA.

Easy peasy.

The taxable accounts will be gone about the time we reach FRA and start SS so we will then draw from tax-deferred, leaving tax-free Roths to grow.

 

[steady saver]

What tax bracket will you be in when your DH retires?

If you will be living off of savings/taxable accounts you may be in the 12% tax bracket ($101k of income or less) in which case, qualified dividends and LTCG are tax-free.... so you may be able to do a lot of restructuring and pay nothing in taxes.

In fact, it may be better to defer pensions and SS to allow you headroom to work with the magic of 0% LTCG.

I'm really not sure what tax bracket we'll be in because I'm confused about marginal tax rates vs. effective tax rates.

 

[steady saver]

The folks at Bogleheads.org will give you detailed help IF you post your situation and questions in this format: https://www.bogleheads.org/forum/viewtopic.php?f=1&t=6212

Thank you racy. I will check that out.

 

[steady saver]

1. Where are the accounts held? Fidelity? Vanguard? I would not pay commissions to buy Vanguard products at Fidelity. I would not pay commissions at Fidelity anyways and certainly not a separately managed account. I would use Fidelity index funds and iShares index ETFs at Fidelity. I would use Vanguard products at Vanguard.

2. Sell all the losing Viacom. That is a no brainer.

3. You didn't' state what was your desired asset allocation. You know: Percent in US equities, percent in foreign equities, percent in fixed income. What is it? Just 60/40? If you don't have a plan, then you cannot move towards fulfilling the plan.

4. In the 401(k), there is no tax when making sales of investments, so that is where all your "rebalancing" is going to happen. But you are not really rebalancing, you are changing your asset allocation according to a plan that you are going to tell us about. You can get back to the taxable account later.

5. And speaking of the taxable account, you didn't say if it was 5% of your total portfolio or 96% or something else. Because 1/3 company stock of 5% of total portfolio is a lot different than 1/3 company stock of 96% of total portfolio.

6. If you want 3-4 index funds, then you know them already. They are listed in this link for both Vanguard and Fidelity: https://www.bogleheads.org/wiki/Fidelity

It is not clear whether you need to keep the 401(k) or will roll it over. Maybe you all are using the age-55 thing with the 401(k). If you keep the 401(k), then it is not clear what kinds of funds are available in the 401(k). Are the index funds you want available in the 401(k)?

1. Accounts are held in Fidelity - both individual and company sponsored 401K. I don't pay commissions on either Fidelity or Vanguard funds in either account.

2. Yep. I just need to do that. Today.

3. Yes, I said 60/40 (equities to bonds). I am not counting the cash I have that we will use for the first couple of years. I know that is not exacting but oh well.

4. 60/40 in the 401K is the plan

5. Good point. Taxable account is 42.5%. A company lump sum that we have to cash out at retirement is another 9%. 401K is 49.5%.

6. We will keep the 401K as is. Doesn't seem to make sense to roll it over b/c we don't have fees and we are not penalized if we withdrawal prior to 59 1/2.

Thank you for your thoughtful questions. With the new info. I gave, what thoughts to you have?

 

[steady saver]

Sum Day - thanks so much for the article links! I am about to check them out. It does, indeed, sound like we are in similar situations. Your "sum day" is here!

Congrats!

 

[Jerry1]

I'm really not sure what tax bracket we'll be in because I'm confused about marginal tax rates vs. effective tax rates.

Effective tax rate is your average tax rate. If you’re in a higher tax bracket, it’s the weighted average of the dollars earned in each tax bracket (very over simplified definition). Typically the one that matters most is the marginal tax rate.

Let’s assume you’re earning around $101,000. If married filing jointly, after deductions, you will be right at the top of the 12% tax bracket. Then, the next dollar you earn, and all dollars thereafter until the top of that (22%) bracket, will be taxed at 22%. So if your planning is to withdraw up to a certain tax bracket, the next dollar will be taxed at the next bracket. So if you draw up to the top of the 12% tax bracket, the marginal tax rate on the next dollar will be 22%. Your effective tax rate will hardly change by adding a few dollars at the next bracket because it is an average of all dollars at each bracket. And, since some of those dollars are at a zero bracket, a 10% bracket and a 12% bracket, your effective rate at the top of the 12% tax bracket will be less than 12% while your marginal rate for the next dollar(s) will be 22%.

 

[steady saver]

pb4uski - You have quite a plan there. I've read it twice and I need to reread it a few more times. I love that you have a clean, clear sequence. I just need to more fully grasp it.

We've been given different advise about holding off on taking our pension but the consensus seems to always be to go ahead and start it now. And because we are wanting to use some of our cash for larger home remodeling expenditures, I don't know that we would be able to delay taking the pension, but it is certainly something we will give more consideration to. Our pension is generous but is a roughly 2/3 of what we calculate we need each year.

This tax bracket thing really stumps me.

I noticed you are in Sarasota part of the year. That is an area we've considered for further down the road. Right now we have a weekend farm that we want to fully commit to for the next 5 years, while we still have it in us and the sweet old dog is still with us. After that, we think we'll want to downsize and travel more.

Thanks for your input. I always welcome your ideas.

 

[steady saver]

Effective tax rate is your average tax rate. If you’re in a higher tax bracket, it’s the weighted average of the dollars earned in each tax bracket (very over simplified definition). Typically the one that matters most is the marginal tax rate.

Let’s assume you’re earning around $101,000. If married filing jointly, after deductions, you will be right at the top of the 12% tax bracket. Then, the next dollar you earn, and all dollars thereafter until the top of that (22%) bracket, will be taxed at 22%. So if your planning is to withdraw up to a certain tax bracket, the next dollar will be taxed at the next bracket. So if you draw up to the top of the 12% tax bracket, the marginal tax rate on the next dollar will be 22%. Your effective tax rate will hardly change by adding a few dollars at the next bracket because it is an average of all dollars at each bracket. And, since some of those dollars are at a zero bracket, a 10% bracket and a 12% bracket, your effective rate at the top of the 12% tax bracket will be less than 12% while your marginal rate for the next dollar(s) will be 22%.

That is the cleanest explanation I've read so far; thank you Jerry!

I looked up a tax calculator.So if our pension is 81K and our needs at the moment are 150K, then up to 77,400 will be taxed at 12%, then the remaining (up to 165K) is taxed at 22%. So the $68,640 difference will be taxed at 22%. Which comes to a tax bill of $24,249 but that is NOT taking into consideration any deductions, etc. so it is the worst case scenario? Our taxes this last year doubled and our 150K needs take into account the 33K we paid in taxes. So I really do think we are being overly cautious here, but it's just a little unnerving to actually pull the plug. I know people do it all the time, but for us it's a whole new ball game and it's scary and exciting all at the same time. We just want to get it as right as possible in the beginning, and allow room for mistakes and surprises.

Thank you for your insights Jerry.

 

[OldShooter]

... So here I am, looking at picking 3-4 index funds and calling it good for now. ...

For equities, how about one? VTWSX or VT. Vanguard total world funds, which will split you roughly 50/50 between US and non-US equities, which is what the relative market caps are.

Want to manage your US/non-US allocation? How about two funds? VTSMX and VGTSX or two equivalent ETFs. Total US and total non-US, respectively. The academic research would point you to just the one fund, but if you don't want quite so much non-US exposure, there is Vanguard research that points to about 30% non-US as the point of minimum volatility. Personally, I don't subscribe to the popular notion that risk = volatility, but YMMV.

Re fixed income, most here seem to point people to bond funds. I hate 'em, primarily for the fees. The FIDO bond guys can help you build a ladder of bonds at whatever risk level you're comfortable with. I have read that they have one option where they charge an ongoing fee to manage this, but I'd avoid that one. Just buy the bonds and be happy.

 

[LOL!]

Thank you for your thoughtful questions. With the new info. I gave, what thoughts to you have?

Since bogleheads.org was mentioned, I would say head over there and get help and don't be intimidated. They're the best.

 

[pb4uski]

....We've been given different advise about holding off on taking our pension but the consensus seems to always be to go ahead and start it now. And because we are wanting to use some of our cash for larger home remodeling expenditures, I don't know that we would be able to delay taking the pension, but it is certainly something we will give more consideration to. Our pension is generous but is a roughly 2/3 of what we calculate we need each year.

This tax bracket thing really stumps me.

I noticed you are in Sarasota part of the year. That is an area we've considered for further down the road. Right now we have a weekend farm that we want to fully commit to for the next 5 years, while we still have it in us and the sweet old dog is still with us. After that, we think we'll want to downsize and travel more.

Thanks for your input. I always welcome your ideas.

If you delay taking your pension, does it grow... IOW, will you get more per month if you defer? Depending on the increase, it may be worthwhile to defer. My plan had good annual percentage increases from age 55 to 60 and then lower annual increases from 60 to 65... I ended up taking at 61 to get the benefit of the higher annual percentage increases from 55 to 60.

The benefit of deferring the pension was that I was able to do larger Roth conversions from age 56 when I retired to 61 when I started taking my pension. We lived off of taxable account funds so our income was low and we could do good Roth conversions... I converted about $260k and paid ~7.5% in tax vs 28%+ when I deferred that income or 22% once we start SS.

When we talk about tax brackets, we are typically referring to the marginal tax rate... the tax rate on your last $1 of income. For a couple, 12% is $19k to $77k and 22% is $77k to $165k... but those are after deductions... before deductions 12% is $43k to $101k of income and 22% is $101k to $189k of income.

 

[steady saver]

For equities, how about one? VTWSX or VT. Vanguard total world funds, which will split you roughly 50/50 between US and non-US equities, which is what the relative market caps are.

Want to manage your US/non-US allocation? How about two funds? VTSMX and VGTSX or two equivalent ETFs. Total US and total non-US, respectively. The academic research would point you to just the one fund, but if you don't want quite so much non-US exposure, there is Vanguard research that points to about 30% non-US as the point of minimum volatility. Personally, I don't subscribe to the popular notion that risk = volatility, but YMMV.

Re fixed income, most here seem to point people to bond funds. I hate 'em, primarily for the fees. The FIDO bond guys can help you build a ladder of bonds at whatever risk level you're comfortable with. I have read that they have one option where they charge an ongoing fee to manage this, but I'd avoid that one. Just buy the bonds and be happy.

Thanks. I'll look into those funds. I tend to want a lower international exposure so I will consider those. I really considered going the ladder route too, but lately it just seems that I want to buy index funds, hold them and be done. But I will revisit the ladder before I do anything, for sure. Thank you.

 

[steady saver]

Since bogleheads.org was mentioned, I would say head over there and get help and don't be intimidated. They're the best.

will do, thanks!

 

[steady saver]

If you delay taking your pension, does it grow... IOW, will you get more per month if you defer? Depending on the increase, it may be worthwhile to defer. My plan had good annual percentage increases from age 55 to 60 and then lower annual increases from 60 to 65... I ended up taking at 61 to get the benefit of the higher annual percentage increases from 55 to 60.

The benefit of deferring the pension was that I was able to do larger Roth conversions from age 56 when I retired to 61 when I started taking my pension. We lived off of taxable account funds so our income was low and we could do good Roth conversions... I converted about $260k and paid ~7.5% in tax vs 28%+ when I deferred that income or 22% once we start SS.

When we talk about tax brackets, we are typically referring to the marginal tax rate... the tax rate on your last $1 of income. For a couple, 12% is $19k to $77k and 22% is $77k to $165k... but those are after deductions... before deductions 12% is $43k to $101k of income and 22% is $101k to $189k of income.

I did some checking last night and there wasn't a big difference when I put in for just a year delay as my example. It came up to a little over 3K a year plus an increase in 7K of a lump sum. And that lump sum will obviously stop once we take our pension so it's not like it would be recurring. I liked the idea of delaying it and living off taxable funds for a while, especially since we will have to take some lump sum money (apart from pension) anyway, but it doesn't seem like that would make sense to delay pension for such a small increase. I will play with it some more tonight though.

Your clarification of the tax rates helped explain where deductions fit in. Thank you!

 

[OldShooter]

... I tend to want a lower international exposure ...

Here's a Vanguard analysis of international equities: https://www.vanguard.com/pdf/ISGGEB.pdf

and guru Ken French: https://famafrench.dimensional.com/videos/home-bias.aspx