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Rebalancing Question
Old 07-09-2011, 12:10 PM   #1
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Rebalancing Question

I currently have all of my bonds in my tax-advantaged accounts (Vanguard Total Bond Index, and Vanguard Inflation Protected Treasuries). I have all of my equities (Vanguard Total Stock Market Index and Vanguard Total International Stock Index) in my taxable accounts. This is to make everything as tax-efficient as possible). I also have some cash in a Vanguard Money Market. It so happens that the current break down is the way I wish my asset allocation to be (approximately 35/55/10 in equity/bonds/cash).

My question is this: I am no longer contributing to my tax-advantaged accounts. What is the best way to perform re-balancing in these circumstances when I determine it is time to do so? If I need more bonds should I just go ahead and purchase them in my taxable accounts? If I need more equities should I purchase them in my tax-advantaged accounts? Should I always keep some of each in my tax-advantaged account so that I can exchange between bonds and equities without causing a taxable event?

Thanks for your help.
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Old 07-09-2011, 12:15 PM   #2
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If you have to buy bonds in taxable, then so be it. Which bonds you will buy will depend on your tax bracket.

1. Always buy I-bonds first. They are tax-advantaged. Unfortunately, the limit is $10,000 per year.

2. If you are taxed by your State on bond income and are in a low tax bracket, then consider buying Treasury bonds.

3. If you are in a low tax bracket and not taxed by your State, just buy Total Bond Index.

4. If you are in a high tax bracket, buy a tax-exempt bond fund.

If you need more equities, then exchanging in tax-advantaged to an equity fund has no tax consequences.

In taxable, you may wish to take all distributions from those equity funds in cash and use them for rebalancing as needed.

If you need to withdraw money, then withdraw from taxable by selling shares held long-term with highest cost basis. This will generally give the lowest tax. If selling equities puts your asset allocation out of whack, then exchange bonds for equities in tax-advantaged. Also do not forget about Roth conversions. Also do not forget about tax-loss harvesting in your taxable account.
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Old 07-09-2011, 12:32 PM   #3
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Quote:
Originally Posted by potto0213 View Post
I currently have all of my bonds in my tax-advantaged accounts (Vanguard Total Bond Index, and Vanguard Inflation Protected Treasuries). I have all of my equities (Vanguard Total Stock Market Index and Vanguard Total International Stock Index) in my taxable accounts. This is to make everything as tax-efficient as possible). I also have some cash in a Vanguard Money Market. It so happens that the current break down is the way I wish my asset allocation to be (approximately 35/55/10 in equity/bonds/cash).

My question is this: I am no longer contributing to my tax-advantaged accounts. What is the best way to perform re-balancing in these circumstances when I determine it is time to do so? If I need more bonds should I just go ahead and purchase them in my taxable accounts? If I need more equities should I purchase them in my tax-advantaged accounts? Should I always keep some of each in my tax-advantaged account so that I can exchange between bonds and equities without causing a taxable event?

Thanks for your help.
I would continue to keep all of your bonds in tax advantaged (to the extend that they fit in your tax advantaged accounts).

1) If your bond allocation does not all fit in your tax advantaged accounts, then these accounts will be 100% bonds. You also will probably have some bonds or bond funds left over which go in taxable since they don't fit in your tax advantaged accounts. You can use these when rebalancing. In this situation, rebalancing occurs in your taxable accounts and can be a taxable event. As "LOL!" suggests, you should take your dividends in cash and use that cash for rebalancing.

2) If your bond allocation does all fit in your tax advantaged accounts with more room to spare, then you probably have some equities or equity funds there too and no bonds or bond funds in taxable. You cannot buy new funds, but you can exchange between funds. In this situation, rebalancing occurs in your tax advantaged accounts.

3) If your bond allocation exactly fits in your tax advantaged accounts, then rebalancing occurs in your tax advantaged accounts when you need more equities or equity funds, and you would be trading some bonds or funds for these equities, as in #2 above. Rebalancing occurs in taxable when you need more bonds or bond funds, trading some equities or equity funds for these in taxable.

Remember that when you are rebalancing, the usual goal is to establish an asset allocation over ALL your accounts, whether taxable or tax advantaged.
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