Portfolio Allocation Advice

[dreamcast]

Hi, I have read several books (Malkiel, Bernstein) and have read through many posts on these boards. I still have not found any advice particular to my situation...

Common advice suggests using one asset allocation strategy that spans
both taxable and tax-advantaged accounts, with the goal of putting tax
inefficient assets (bonds, REITs, etc) in tax-advantaged accounts and
sticking with low-turnover stock funds in taxable accounts. This
strategy seems to be geared towards the individual that doesn't plan
to access either account until much later in life (20+ years).

I am in my early 30s, have been maxing my IRA and 401k, as well as
aggresively saving earnings in a taxable account. My taxable account
is about 6x my retirement account. I think I could semi-retire within
5 years, and be fully ER-capable by 40. When my non-retirement funds
double in value, I could comfortably live off a 4% SWR. I have no
debt, mortgage, or kids currently. A house purchase in the near future
is possible.

I find it difficult to plan a singular asset allocation strategy that
spans a taxable and IRA account. It seems simpler to keep the IRA
money on an aggressive long-term path as it won't be tapped until I'm
60. I hope to start living off the taxable account within the next 5-8
years. It seems that's where I should be reducing the risk with less
stock and more of the tax-ineffecient and income-producing bonds and
REITs. Therein lies my confusion.

What is a good strategy? Here's my thinking. Everything in indexes of
course.

IRA
70% stock (2/3 total US, 1/3 total int'l)
20% bond (total bond market)
10% REIT

Taxable
45% stock (2/3 total US, 1/3 total int'l)
40% bond (total bond market)
10% REIT
5% cash

thanks.

 

[bosco]

IRA
70% stock (2/3 total US, 1/3 total int'l)
20% bond (total bond market)
10% REIT

Taxable
45% stock (2/3 total US, 1/3 total int'l)
40% bond (total bond market)
10% REIT
5% cash

thanks.

Just my opinion, but if I were in my early 30s and not planning on accessing the tax-deferred portion until I was 60, I would skip the 20% in bonds in the IRA for a decade or so. Also, aren't REITs fairly tax-inefficient? I guess maybe not so much if you will be drawing on the portfolio anyway.

 

[retire@40]

Taxable
45% stock (2/3 total US, 1/3 total int'l)
40% bond (total bond market)
10% REIT
5%  cash

40% in bonds is too much, especially in this rising rate environment. I would move more into equities at age 30.

 

[unclemick]

Hmmm

While house hunting after Katrina - my low income didn't look good finance wise - so had to do a net worth thingy - which prompted - my canned lecture with the real estate lady(her hubby works with a auction company):

1. Don't read books

2. Vanguard - keep it simple - Target Retirement Series.

3. Vanguard Tax Managed funds where appropriate.

Showed her where to find Vanguard on the internet.

She turned her 30 something daughter onto Vanguard.

I held off on the Norwegian widow and dividends - since she had twenty years to retirement - on their plan.

 

[dreamcast]

I'll try to restate the root of my questions more concisely.

Does it make sense to have different allocations for retirement vs. non-retirement accounts, given that the retirement account would not be touched for 28 years, and that I wish to begin drawing on the taxable account much sooner?

Should the aggresiveness be related directly to age, or more directly to when I expect to ER? In other words, do I start transferring to a less aggressive portfolio as I reach ER, or as I reach 60?

 

[Dawg52]

I'll try to restate the root of my questions more concisely.

Does it make sense to have different allocations for retirement vs. non-retirement accounts, given that the retirement account would not be touched for 28 years, and that I wish to begin drawing on the taxable account much sooner?

Should the aggresiveness be related directly to age, or more directly to when I expect to ER? In other words, do I start transferring to a less aggressive portfolio as I reach ER, or as I reach 60?

Most would tell you to base it on your age. One rule of thumb is the 100 rule.
100 - age = stock portion of your allocation. That is considered a pretty conservative formular.

 

[JPatrick]

As others have said - -chop the bonds, like down to 15-20%.  You are to young for that sleepy time stuff, not to mention this is a poor time to be buying bonds. 
I encourage all people your age to get more than "index" involved with your money.  Do some studying and buy some ETF's or sector funds that strike you as the current or next big thing.  If you don't, for the most part you'll miss great runs like we have had in energy.  Compare XLE (energy) to the S&P 500.  How hard was it to figure out that the oil companies were in for a huge run?  I was one of the slow ones and I "got it" in January, then it really hit me in May where I dumped most of my big indexes and bought oil.  Glad I did. 
Similar could be said of the healthcare sector. Look at the record of FSHCX.
Runs do end and happily they give pretty good clues when they do.  When the tech bubble popped it was preceded by waves of smart folks screaming to get out.

At a minimum you should at least pickup a few managed funds that have great long term records.  FCNTX is one of the largest funds on the planet,  which implies that it may be a bit slow and stoggy.  However, even this fund has pretty well whipped the 500 index.
The index funds are great for a portfolio core, in fact, they are the only way to go for something like emerging markets.  Indexes have long proven to be better bets than the average managed fund, but who wants to buy average anyway.  Also, the great showing put in  by indexes was generally in a pre ETF world.  The times may be changing.

Bottom line:  I think when you turn 60 and look back you will be glad you got a bit more racy than just bonds and indexes.
As always, just my 2 cents (inflation adjusted of course)

 

[MasterBlaster]

Another suggestion:

Allocation models aside, you should think about keeping any bonds in the tax deferred plans and use the taxable accounts to hold equities.

The reason being that bonds will generate current income that is taxable in the year it is paid. Equities in a low turnover taxable account should not generate much current taxes. Also equities are taxed at (lower) capital gains rates than bond income. Bond income is taxed at (higher) income tax rates.

 

[Brat]

DreamCast: Take a look at FinancialEngines.com I think they can do the job for you. If you are a Vanguard client it is available at a discount, as I recall.

 

[bosco]

I'll try to restate the root of my questions more concisely.

Does it make sense to have different allocations for retirement vs. non-retirement accounts, given that the retirement account would not be touched for 28 years, and that I wish to begin drawing on the taxable account much sooner?

Should the aggresiveness be related directly to age, or more directly to when I expect to ER? In other words, do I start transferring to a less aggressive portfolio as I reach ER, or as I reach 60?

I believe you don't manage you portfolio based on when you expect to ER, but on how long you need out of the portfolio. If I were to ER at 40, I'd have 50 years that I'd need withdrawals out of that portfolio, possibly. I'd keep 5 years worth in low-risk short-term bonds or money market, and have the rest invested in longer-term stuff. You need to invest the money appropriate to the time frame of when you might need the money.

I think you still want the bulk of your portfolio aggressive even at age 60. Personally, I think you have too much bond exposure in both parts. I'd cut the bonds down to 20% in the after tax, and get rid of it altogether in the tax-deferred.

That's what I would do, if I were a "buy and hold" sort of guy. In reality, I "AIM" my investments, which means buying various (but hopefully non-correlated) equities but keep around 1/3 cash. Then I buy and sell pieces based on a mechanical algorithm. Over time, it tends to keep up with or beat the market, but with less volatility.

 

[HFWR]

I'd keep the REITs in the tax-deferred accounts; they are not tax friendly...

 

[dreamcast]

If bonds and REITs are relegated to the retirement account, leaving stocks in the taxable account, does that mean ER income is generated by selling stock? What is the withdrawal strategy from a taxable account?

 

[bosco]

If bonds and REITs are relegated to the retirement account, leaving stocks in the taxable account, does that mean ER income is generated by selling stock? What is the withdrawal strategy from a taxable account?

most of my investment $ are in tax-deferred so I don't worry about this too much right now. However, I believe the theory is to put taxable money into stocks that pay dividends and have a long history of dividend increases. Then you only pay on the dividends, which have a much lower rate than capital gains. In this way, long-term income is generated without selling the underlying stock and taking the capital gains.

 

[ats5g]

If bonds and REITs are relegated to the retirement account, leaving stocks in the taxable account, does that mean ER income is generated by selling stock? What is the withdrawal strategy from a taxable account?

This paper may shed some light on the subject:

Taxable or Tax-Deferred Account? Portfolio Decision with Multiple Investment Goals

from Eric Haas' commentary

This paper's conclusions are dependent on whether a person anticipates needing access to assets before age 59.5.  If they do anticipate such a need (that is, they have a liquidity need), then it is prudent to locate taxable bonds in both taxable and tax-deferred accounts.  If they do not anticipate such a need, then investors always should prefer bonds to be in tax-deferred accounts.  The bottom line is that, in the absence of liquidity needs, you should put the investments with the highest dividend payout ratio in the tax-deferred account (an investment's dividend payout ratio is defined as its dividend yield divided by its total return).

Also SHELTER YOUR BONDS? THINK AGAIN

With the advent of tax efficient equity vehicles and lower capital gains tax rates, I think it makes sense to put equities in the taxable account, if you have a taxable account. That is unless you've got liquidity needs, some early retirement spending, then probably bonds and equities in both is fine.

- Alec

 

[JohnnieRed]

I'll try to restate the root of my questions more concisely.

Does it make sense to have different allocations for retirement vs. non-retirement accounts, given that the retirement account would not be touched for 28 years, and that I wish to begin drawing on the taxable account much sooner?

Should the aggresiveness be related directly to age, or more directly to when I expect to ER? In other words, do I start transferring to a less aggressive portfolio as I reach ER, or as I reach 60?

My thought is the answer depends on whether you view the investment time frame between "taxable" investments and "tax deferred" investments as "real". If you view them as "real" then your investments should be different because you are saying that your comfort with the "risk" level (standard deviation of returns) is different between the two investment pools of assets.

My personal opinion is the difference in time frames is whatever you perceive to be true. However, to me it is imaginary.

There are ways to access "tax deferred" investments if you want to even before 55 without penalty....one way is "substantially equal payments" over your life expectancy....having said that, accessing your "tax deferred accounts" early is something that you don't want to do without having given it a lot of thought... IN ANY EVENT, having the bulk of your assets in "taxable" accounts gives you the greatest flexibility but definitely brings the taxman into the equation for rebalancing, dividends and interest...

If it was me, I would be setting my overall risk and return objectives for the total pool of your assets.

 

[wstu32]

One thing that i also recommend is how much do you have...
if you need $60k per year for retirement and are 40 yrs old, for example, and you have a million bucks, you do not need to put it to that much risk!
this will help you sleep good at night...

so, my advice is to reshuffle your allocation according to this factor also!>..

 

[Alex]

My advice is to follow the strategy outlined by the Diehards. Place tax inefficient holding in tax deferred accounts. Here is the post from Taylor Larimore:

Here is a 4-step rule for fund placement:

1. Put your most tax-Inefficient funds in 401Ks, 403Bs, Traditional IRAs and similar retirement accounts. When full..

2. Put your next most tax-Inefficient funds in your Roth(s). When your Roth(s) are full--

3. Put what's left into your taxable account.

4. Try to use only tax-Efficient funds in taxable accounts.
-------------------------------------------------------------------
Here is a list of securities in approximate order of their tax-efficiency. (Least tax-efficient at the top.):

Hi-Yield bonds
TIPS
Taxable bonds
REIT stocks
Stock trading accounts
Small-Value stocks
Small-Cap stocks
Large Value stocks
International stocks
Large Growth stocks
Most stock index funds
Tax-Managed funds
EE and I-Bonds
Tax-Exempt bonds

I hope that helps!

 

[LOL!]

Does it make sense to have different allocations for retirement vs. non-retirement accounts, given that the retirement account would not be touched for 28 years, and that I wish to begin drawing on the taxable account much sooner?

Definitely not. To do so would fall into a behavioral finance trap. Money is money. It does not matter if it is in your retirement account or non-retirement account. You want to put the tax-inefficient assets into your tax-deferred and tax-free accounts: TIPs and bonds in IRAs and 401(k)s, REITs the same. You want to put tax-efficient assets into your taxable accounts. You want to put large cap index funds in your taxable accounts. You want to do tax loss harvesting in those taxable accounts. Etc.

When you get to the withdrawal stage, you can always change the asset allocation you want and then follow the same tax-efficient principles just mentioned.

 

[LOL!]

Here's something else to consider: You will probably want to convert some of your tax-deferred IRA to a Roth IRA each year while you are retired, in a low tax bracket, under age 59.5, and before you draw social security. Such "conversions" give you a chance to withdraw fixed income from your tax-deferred account, use it if needed and replace in a Roth IRA with equities that you have sold for long term capital gain (and low tax hit).

I know I don't think I explained this well, but think it through. When I retire in my 50's, I don't see any problems with which account my assets are in and which I withdraw first. Because I can always move money around without bad tax consequences.