Help with bond funds for 8-10 year horizon?

[BarbWire]

I need some help with AA for my taxable account. My taxable investments are held at Vanguard, and will be the primary source of living expenses for 8-10 years. (My tax advantaged and tax-deferred accounts are scattered among Vanguard, TIAA-CREF and Fidelity.)

Through a combination of ignorance ("gotta learn more about bond markets -- manana"), neglect and an infusion of uninvested cash, my current taxable holdings are:

• · 39% Money Market Prime
• · 5% Inflation Protected Securities Fund
• · 7% Balanced Index -- Admiral(40% bond, 60% equities)
• · 7% Total International Stock – Admiral
• · 27%Total Stock – Admiral
• · 15% Extended Market Index Admiral

This leads to an asset allocation of:

• · 39% cash
• · 8% bonds
• · 47% domestic stock
• · 7% international stock

A bit short on bonds and dividend generating stocks, I’d say!

I also have a tiny brokerage account – about 2% of my taxable assets – as “play money” currently all invested in MMM. I’ve started reading about ETFs.

I’m 54 (single, no kids), and had planned to FIRE in a couple of years, but now it may be in 6 months (unless I’m willing to relocate from TX to NC – nope.) My intention has been to draw down the taxable account for living expenses (modest, currently living on 25% of gross monthly income) for 8-10 years, after which I will turn to tax-deferred and tax-advantaged accounts.

Since I will only have w*rkforce income for half of 2012, I’m not gun-shy about generating income rather than capital appreciation, if that is advisable: the tax hit won’t be too bad.

The cash in this account can be used to rebalance to get to something more appropriate for my time horizon. But what should I do? The simplest would be to dump all the cash into Total Bond Market Admiral shares, but there might be a better strategy. Put half in GNMA? Or elsewhere?

Also, should I stick with mutual funds, or invest the cash in ETFs? I’ve just begun to educate myself on the merits of ETFs in taxable accounts rather than mutual funds.

Many thanks for your help.

 

[donheff]

It sounds like you are trying to have an AA in taxable and a separate AA in tax deferred. Your true AA is reflected in both. Depending on how large your tax deferred accounts are you could probably keep all of your bonds there (and a lot more MM) and increase your equities in the taxable toward 80-100%. Convert bonds to equities in the tax deferred at the same time you sell equities in the taxable to fund your annual withdrawals. That will maintain your AA as you draw down taxable and will keep income taxable interest lower in the taxable account.

 

[ronocnikral]

Just in case you haven't come across the boglehead's wiki on tax efficiency, here it is to puruse at your leisure.

Principles of Tax-Efficient Fund Placement - Bogleheads

As I am starting my "taxable" accounts, I have found being tax efficient adds a whole 'nother dimension which is a huge pain in the butt. ymmv.

 

[BarbWire]

Thanks for the replies

Yes, I do think of my AA in the taxable and non-taxable fund separately at this point; perhaps this is more of a bucket approach, with a "near term" 8-10 year bucket and a long-term bucket. I won't be able to touch my non-taxable funds for several years.

Thanks for the boglehead link. I read their WIKI far into the night last night, and learned quite a bit.

I'm still somewhat stuck on how to evaluate the performance of bond funds, and thus, for example, how to compare Total Bond Fund to GNMA.

 

[donheff]

Thanks for the replies

Yes, I do think of my AA in the taxable and non-taxable fund separately at this point; perhaps this is more of a bucket approach, with a "near term" 8-10 year bucket and a long-term bucket. I won't be able to touch my non-taxable funds for several years.

If you are viewing your taxable as your "near term" bucket because that is where you will initially be withdrawing funds you may be making the same mistake I made years back and changed based on advice I got here. I used to be very heavy on equities (around 85%) and wanted to get somewhat more conservative when I retired including having a liquid cash or cash like "bucket" to cover expenses in years when equities are down so I wouldn't sell low. I was inclined to establish that liquid cash bucket in my taxable account since that is where I will be getting my cash for annual expenses for many years. Based on advice here I realized that from an income tax perspective a better approach is to keep our taxable 100% in stocks and all of our bonds in IRAs/401ks. I converted my entire Federal TSP fund to the ultra safe G fund which, although a bond fund, is cash-like and now constitutes our "cash bucket." The rest of our bond funds and A REIT are in DW's 401ks. Distributions from taxable go into a MMF and are the first thing pulled for annual expenses. For the remainder of annual expenses I now evaluate what needs to be sold based on performance and AA. If equities are up substantially, I would simply sell them in taxable. But, if equities are down or flat (e.g. this year), I "liquidate" some of DW's bonds or my G funds. Since I don't want to actually pull the money out of those tax deferred accounts I simply exchange the amount are "pulling" for equities in the same account. I then sell a commensurate amount of equities in taxable and send the proceeds to checking. The net effect is we have "converted" IRA bonds or G Fund cash into taxable account cash without actually making a distribution from the IRA. That is what I meant be switching to a total portfolio view for asset allocation.

If such a strategy is what you are looking for others can describe it better since I learned it from them. And others can answer you bond question better than I can as well.

 

[BarbWire]

Wow, yes -- that's exactly the way I was thinking: use the taxable for the "near term" so load it with the bonds and other income generating investments, and put the equities in the tax advantaged/deferred accounts.

Your explanation of the folly of this approach is absolutely clear.

And, to add bit of sweetness to the pot, as I sell equities in the taxable account, I have considerable carry-over capital loss to write off any gains against (I did some stupid panic selling in late 2008/early 2009 .. sigh). This can help keep my tax rate low, and as long as I can stay in the 15% bracket, I'll roll some of my tIRA to Roth each year. At least, that's my plan right now (though plan might be too strong a word at this stage.)

So now I get to rethink. If I put dividend-generating stocks in the taxable fund, will the dividends be taxed at a favored rate, or at my marginal tax rate? I'm a bit confused about what I read regarding "qualified dividends."

Oh, dear -- so much to read! I take comfort in the fact that if I'm doing the bond thing in the 401(k)/IRAs, I can't go too wrong by putting all my bond eggs in Total Bond Market now, and then shifting around as I learn more about TIPS, GNMA, and so on.

Ultimately I want a strategy with just a few Vanguard funds or ETFs, and a once-a-year event at which I pay myself for the upcoming year and rebalance. And then ignore everything for another year.

Thanks again!