Eliminated Advisor - AA review please

[Travelwanted]

As noted in another post, I finally terminated my FA. So I am constructing my AA and breakdown. I'm 43, less than 2 years to ER. Likely have hit FI already. (Yes, that means I am in OMY syndrome.) I'm in 39.6% fed, 6% state tax brackets. And yes, this account is my taxable account. I have only a small IRA and Roth - not enough room to put in the REIT or energy and another IRA through w*rk.

Please give feedback on the following allocation. I'm using Vanguard but am posting only broad sectors. I know in advance this is more than most Bogleheads divide it but after reading Bogleheads Guide it is my conclusion.

60% equities:
60% US large cap
20% International, emerging markets
10-15% small cap
5% REITs
5% Sector funds (i like healthcare and energy)

40% bonds:
40% short-term tax exempt
40% intermediate tax-exempt
5% long-term tax-exempt
15% high-yield tax-exempt (not junk bonds - 90% are rated AAA-BBB)

Not yet retired, I plan to reinvest my bond income. My research says if you re-invest dividends in rising rates environment you come out ahead even in long term bonds.

Thanks.

 

[nash031]

I will only comment on the equity portion as I'm not a huge bond guy and most of my bonds are in the form of TSP's G fund.

You are aware that Total Stock Market already includes small cap I assume. TSM is roughly 80/20 Large/(Mid/Small), thus your actual US equity allocation is significantly tilted towards small cap relative to overall market cap.

I don't see the need for specific sector allocation, again because you're tilting significantly towards two already heavily weighted sectors represented in your TSM funds. Energy and health care are third and fourth in terms of sector weighting, representing right around 12% of overall US market cap each.

The sum of those is that I think you've increased your market risk inside your equity allocation unnecessarily by tilting towards small cap, energy, and health care. You may have very valid reasons for doing so, so I can't judge that, but I'd rather achieve higher expected returns by increasing my overall equity allocation rather than by tilting as you are inside of it. The risk there being that by tracking specific sectors and small caps more, you're open to more volatility IMO and you stated you're two years from ER. That's not what I would personally do, but... YMMV!

I agree with your allocation otherwise.

 

[pb4uski]

It seems sensible to me, but like nash, I would probably just go 70/30 TSM/TISM within equities and keep it simple rather than try to tilt it but that is me. I assume that the bond side is tilted short because of interest rate risk concerns and munis because of your high tax rate.

 

[Travelwanted]

Excellent points, Nash, thank you.

To clarify, I should have put US large cap stock market instead of TSM. I agree that would heavily tilt to small cap. Some tilt is ok to me, but not this much as indicated by what I expressed above. I will edit the post to show that now.

The issue is I have large unrealized gains in several ETFs such as IWD, IWF (US large cap) from my prior account. I cannot simply move into TSM. Thus I did not put the exact fund but meant to give an overall allocation. Does it make more sense now? Also, my total position for sectors is 5%. Not a major overweight I don't think.

 

[Travelwanted]

It seems sensible to me, but like nash, I would probably just go 70/30 TSM/TISM within equities and keep it simple rather than try to tilt it but that is me. I assume that the bond side is tilted short because of interest rate risk concerns and munis because of your high tax rate.

Thanks, pb4uski. As mentioned I cannot simply move entirely into the desired funds (TSM, TISM) without realizing very large gains and taxes.

I am tilted short and to munis on bonds because of my income and relative interest rate risk. Would you suggest increasing LT bonds? Thanks.

 

[bad_LNIP]

So, what are you going to do if/when interest rates rise and 40% of your portfolio starts taking a hit?

 

[Travelwanted]

So, what are you going to do if/when interest rates rise and 40% of your portfolio starts taking a hit?

I am tilted to short-term as to minimize the "hit". However, I have read that reinvesting dividends in the bond funds overcomes the "hit" over time.

Beyond the comment, do you have a suggestion? Thanks.

 

[bad_LNIP]

I wouldn't be in bonds at all, outside of maybe 5-10% in short term, only. Not sure what they are paying now, but it doesn't seem worth the risk of buying in at all time highs. AAA ratings don't mean much when you get a 20% haircut on price. Long term is going to get it the worst when rates rise.

I would need to see the numbers on reinvesting dividends, but I think you might be referring to holding the bonds to maturity, which would overcome the price, but you are going to lose out a lot on the super low interest rates. You are reinvesting the bond dividends back into the bond fund as rates are rising? Do I have that right?

I would look at something like preferreds, closed end funds, covered call closed end funds that are less rate sensitive but still give some decent income.

 

[Texas Proud]

As mentioned.... bond funds have a problem coming up... but nobody knows exactly when and how fast it will present itself... heck, some people have predicted the rise for the last 5 years....

It is not as 'safe', but you can buy a dividend fund that would give off about the same amount of income... I have not done this myself, but have thought about it off and on....

Your biggest problem will be you unrealized cap gain... you might not want to do anything right now unless you are so far out of your range that you need too.... for now you can put your new money in the funds that need to be bigger.... when it comes time to live off your assets... then sell the ones that are over their percent for your living expenses...

 

[gerntz]

If I offered a suggestion, wouldn't I'd be advising?

 

[Travelwanted]

I wouldn't be in bonds at all, outside of maybe 5-10% in short term, only. Not sure what they are paying now, but it doesn't seem worth the risk of buying in at all time highs. AAA ratings don't mean much when you get a 20% haircut on price. Long term is going to get it the worst when rates rise.

I would need to see the numbers on reinvesting dividends, but I think you might be referring to holding the bonds to maturity, which would overcome the price, but you are going to lose out a lot on the super low interest rates. You are reinvesting the bond dividends back into the bond fund as rates are rising? Do I have that right?

I would look at something like preferreds, closed end funds, covered call closed end funds that are less rate sensitive but still give some decent income.

https://personal.vanguard.com/pdf/s807.pdf

Vanguard addresses this issue.

 

[Travelwanted]

As mentioned.... bond funds have a problem coming up... but nobody knows exactly when and how fast it will present itself... heck, some people have predicted the rise for the last 5 years....

It is not as 'safe', but you can buy a dividend fund that would give off about the same amount of income... I have not done this myself, but have thought about it off and on....

Your biggest problem will be you unrealized cap gain... you might not want to do anything right now unless you are so far out of your range that you need too.... for now you can put your new money in the funds that need to be bigger.... when it comes time to live off your assets... then sell the ones that are over their percent for your living expenses...

1- one could have made a lot of money in that 5 years if they stayed the course. there has been much opportunity loss in shortening duration over the past few years.

2-do you know a tax-exempt dividend fund?

3-unrealized cap gains are a relative problem. i'd rather have gains than losses! but I do agree it complicates the structuring of the portfolio. that is why I am seeking overall advice before I implement the plan.

 

[Texas Proud]

1- one could have made a lot of money in that 5 years if they stayed the course. there has been much opportunity loss in shortening duration over the past few years.

2-do you know a tax-exempt dividend fund?

3-unrealized cap gains are a relative problem. i'd rather have gains than losses! but I do agree it complicates the structuring of the portfolio. that is why I am seeking overall advice before I implement the plan.

1 Yes...

2 No, I do not think there is such a fund.... dividends at taxable... you have to go to a muni bond fund to be tax exempt

3 Of course... it is funny, but sometime in Nov or Dec I was looking to see about selling something that I was holding at a loss... and I did not have a thing... zip, nada, nothing... I was kinda surprised that there was NO losses.... now, I have them

 

[LOL!]

The asset allocation looks fine and well within what I would call "typical". While I would not bother with the sector funds, I do like a heavily small-cap tilted portfolio. It didn't do the best in 2014 when large-caps were the best, but I cannot complain.

 

[Shawn]

Your equity allocation is similar to mine, so my completely unbiased and objective opinion is that it's fine. I consider myself to be a "total market with tilt" or "core and explore" boglehead investor, with small-to-modest tilts toward small-value, REIT's, and emerging markets. I also have a very small but growing allocation to mining stocks.

I understand the difficulty of dealing with unrealized capital gains. Sometimes you just have to work with what you have. I was fortunate to be able to clean up and simplify much of my taxable allocation in 2008/2009, and also harvest considerable capital losses (I'll have a $3K/yr income deduction for some time). I was able to harvest some losses with international this year.

I don't have too much of an opinion on your bond allocation, although it also appears somewhat similar to mine. About half of my portfolio is in 401k's and the equivalent, and I have non-trivial amounts in stable value (sort of like your short-term bonds). In taxable, I also have about 5% of my total portfolio (about 15% of bonds) in high-yield tax-exempt (CA).

 

[pb4uski]

Thanks, pb4uski. As mentioned I cannot simply move entirely into the desired funds (TSM, TISM) without realizing very large gains and taxes.

I am tilted short and to munis on bonds because of my income and relative interest rate risk. Would you suggest increasing LT bonds? Thanks.

If after you ER in a couple years you are down in the 15% tax bracket you can utilize the 0% LTCG rate in that bracket to reform your portfolio without any tax implications.

I would not go long at this point, tho I have thought that for years and it cost me about 2 percentage points in overall portfolio return in 2014. One thing you might look at as an alternative to muni bond funds are the iBond Muni ETFs, which are portfolios of munis maturing in 2014 to 2019 so they are similar to owning individual munis but provide diversification.