Invest for total return or for income?

[nun]

Our problem (and it's a nice one to have) is we have almost as much cash (47% of NW*) as we do bond funds in tax deferred (53% of NW*). We either need to put some/all of the balanced funds in our taxable (going for something more stock heavy like Wellington), go with stock index funds in the taxable, or substitute some of the bond funds in the tax deferred with munis in the taxable. I think the latter is a better bet if you're still working and want to avoid adding more income to salary.

* - Net worth not including the equity in our house

What is your net worth and how large is your pension? What annual income do you need? Those numbers will help in deciding a sensible asset allocation. You should also seriously consider deferring SS until age 70.

 

[Bflotomny]

Statsman I understand your dilemma. It is well & good for other posters to make suggestions for your situation. You need to keep in mind some things. Ask yourself what is your comfort level with 80/20, 20/80 or 40/60 or 60/40 percentages of your portfolio. STOP the index fund vs. balance fund et.al. Your first decision point is your percentage of equity/fixed income. If you choose 20% equity or 80% you must first be confortable with it. I found out recently that a 50/50 or 60/40 was not for me now that I’m retired. I pulled back to a 40/60 level and sleep well at night.
The next issue is how involved do want to be with day to day operations. An income or total return portfolio with the amounts that you have implied will require some management on your part. Which implies some knowledge of the market as a whole. It will also require you to be hands off or a tinker. I would think that you would rather travel with the wife or play golf.
What I’m advocating is for you to stop and think about what you want, and what you do and do not want to do with your retirement before you concern yourself with what to invest.

 

[statsman]

What is your net worth and how large is your pension? What annual income do you need? Those numbers will help in deciding a sensible asset allocation. You should also seriously consider deferring SS until age 70.

Tax deferred accounts: $1.25M
Taxable (cash): $1.1M
Pension (me): $2,450/mo (non-COLA)
Social Security (wife@64): $2,050/mo

Income needed: $6,000-6,250/mo (pre-tax) - probably more than is needed, but better to overestimate the budget a little bit

 

[Animorph]

I think most of our advice applies fairly well to that income and asset base. For all we knew you were dealing with a $100 portfolio and $1/year withdrawals, though that did seem unlikely.

 

[statsman]

I think most of our advice applies fairly well to that income and asset base.

That's good to know. I debated on whether to list rough estimates for our net worth. I wasn't sure whether it was that important. For some people, the amounts listed would not be near enough for them. For others, way more than enough. It's why I initially stated the situation as a % of assets needed for income, at least at the start of retirement.

 

[nun]

Tax deferred accounts: $1.25M
Taxable (cash): $1.1M
Pension (me): $2,450/mo (non-COLA)
Social Security (wife@64): $2,050/mo

Income needed: $6,000-6,250/mo (pre-tax) - probably more than is needed, but better to overestimate the budget a little bit

You have ample money to delay SS until age 70 so I'd do that. Will you also be getting SS?

Now you need to invest $2.35M to produce $45.6k a year so that's a 2% return. This can easily be done with a 100% equites portfolio, but you might struggle to get that return over the next 10 years with 100% bond index funds.
Given your nervousness about the stock market I imagine you won't want to go with a really high equity percentage, but you should have some, so why not do 50% index equity fund and put the rest into a CD ladder and a short term investment grade bond fund and some TIPS.

 

[statsman]

Total return. Definitely, total return. Read this:
https://personal.vanguard.com/pdf/s557.pdf
and this
https://personal.vanguard.com/pdf/s352.pdf

I've had a chance to read the documents. It's a lot to absorb all at once, but I did have a question about the spending down philosophy. Vanguard suggests spending down the taxable accounts first before touching the tax deferred accounts (excluding any RMDs).

Let's assume at the start of retirement the tax deferred accounts are entirely in bonds and the taxable accounts are entirely in stocks, and this allocation meets your desired AA.

It would seem like there is the potential for such a portfolio to veer away from the desired AA. I guess much depends on how well the assets are performing at the time of spending down the taxable accounts first. If there were some really down years in the stock market at the beginning of retirement, you could really have your AA altered.

Which takes priority: maintaining AA throughout retirement, or optimizing asset placement according to their tax structure? In the above situation, it would appear either the AA would have to change or some assets would need to be moved to less ideal assets from a tax standpoint (or both).

Sorry for going off tangent. But in thinking about changing our AA to move forward into retirement next year, it was something that I started pondering today.

 

[nun]

Yes spending form taxable is usually done first. If your AA drifts away from your ideal many people would rebalance. So if you have equities in taxable and sell some of those for income you might then buy some more equites in the tax deferred accounts to get back to your AA. Personally I am going to let my equity percentage increase over time......this is a "reverse glide path" where the percentage of equites increases as you get older. You can do this when you have matched your liabilities with safe income sources.

 

[nun]

Sorry for going off tangent. But in thinking about changing our AA to move forward into retirement next year, it was something that I started pondering today.

Owning only bonds and cash in a low interest rate environment is very risky, IMHO, as I don't think you'll make 2% with that portfolio.

 

[statsman]

Owning only bonds and cash in a low interest rate environment is very risky, IMHO, as I don't think you'll make 2% with that portfolio.

Agreed, which is why I started this thread. We are not about to keep it at 0/100, but we won't go 100/0 even if there is the belief we have the assets to do it. Some of the cash will be slotted for stocks. How much in stocks remains to be seen.

Since we are not going to approach 50/50, we will need something other than stocks in our taxable account. That's where the tax inefficiencies can kick in. If we go with the suggestion to go all Wellington in the taxable account to get to 30/70 overall, we run into the problem I alluded to in my previous post. If the need arises to have sell in the taxable account (Wellington), a 30/70 AA starts to head towards 25/75.

Having 100% bonds in the tax deferred account, while great from a tax efficiency standpoint, makes keeping whatever AA we decide on more difficult. Odds are we probably would need separate stock and bond funds in the taxable rather than something like Wellington in order to maintain this type of conservative investing. Or maybe convert some bonds to stocks in the tax deferred accounts. Still better than 0/100, right?

 

[Meadbh]

Statsman, I think you are making this more difficult than it really is. I think we have established that you will need a WR of 2% and that relying on cash and bonds alone to sustain that over the long term is risky. We've also reached a consensus that the bonds should go in your tax sheltered account.

Step 1: Decide on your asset allocation.
Step 2: Fill up your tax sheltered account with your bond allocation. If there is space, top it up with equities. If there is overflow, put some bonds into the taxable account and top that up with equities. Choose low cost indexed funds.
Step 3: Enjoy your life.
Step 4: Look at your portfolio after a year. If your asset allocation is off target by more than 5%, adjust it.
Step 5: Repeat Steps 3 and 4.

FWIW, my portfolio is approximately the same size as yours, but I have no pension. I have equities, and I sleep at night.

 

[mathjak107]

according to michael kitces keeping bonds in a deferred account at these levels could be a waste of valuable space .

when financial planning dictated in the beginning that bonds and cash should be in the deferred accounts and equity's in the taxable account not only were rates higher but no one looked under the hood any farther .

even a 1% dividend over decades in the taxable account can eat up any tax savings . depending on tax bracket and stock turnover it gets worse .

kitces found that almost any kind of distribution over time be it dividends or capital gains in the taxable account destroyed the tax advantage of lower capital gains rates . anything above zero was a deal breaker most of the time . equity's usually did better in the deferred accounts and bonds and cash in the taxable accounts , especially at these low levels .

https://www.kitces.com/blog/are-the...ow-turnover-investment-strategies-overstated/

 

[pb4uski]

.....Having 100% bonds in the tax deferred account, while great from a tax efficiency standpoint, makes keeping whatever AA we decide on more difficult. Odds are we probably would need separate stock and bond funds in the taxable rather than something like Wellington in order to maintain this type of conservative investing. Or maybe convert some bonds to stocks in the tax deferred accounts. Still better than 0/100, right?

Think of AA and rebalancing across both taxable and tax-deferred. You want to have your tax inefficient investments (like bonds) in tax-deferred and rest in taxable. The reason for viewing it across taxable and tax-deferred is that when you redeem taxable investments and take cash to live on you can rebalance by buying or selling equities as necessary.

You are right that having equity and bond funds makes it easier to rebalance. I think you might be able to do it with Wellington being 2/3rds or so of your taxable account and then use equity and bond funds for the other 1/3 for rebalancing... or if you let your equity allocation float within a range (say 25% to 35%). But I concede that I have never done it.

Below is an example that I used for someone else last month of rebalancing. In your case, since your equity allocation is so low that your tax-deferred is all bonds your rebalancing would occur in taxable accounts for some time which may have some tax implications. A workaround might be to simply carry 10%-15% of your tax deferred account as equities to mitigate the tax implications of rebalancing in a taxable account.

Let's say at the beginning of retirement you want to have a little over a year in cash so your overall AA is 60% equities, 36% bonds and 4% cash. So your taxable account would be 1,496 of equities and 104 of cash and your tax-deferred account would be 64 of equities and 936 of bonds for a total of 2,600.

A year later, equities have increased 10%, bonds 3% and you used 78k for living expenses... so in your taxable account equities are 1,646 (110% of 1,496) and cash is 26 (104-78) and in your tax deferred account equities are 70 (110% of 64) and bonds are 964 (103% of 936) for a total of 2,706.

When you rebalance, your new targets are 60%/36%/4% of 2,706 or 1,623 equities, 974 bonds and 109 cash. In your taxable account, you sell 83 of equities and put it into cash, bringing your cash balance to 109 (and reducing the equities in your taxable account to 1,563). You then sell 10 of equities in your tax-deferred account and buy 10 of bonds in your tax deferred account.

After those two transactions you are now back to 60/36/4 with 1,623 in equities (1,563 in taxable and 60 in tax deferred), 974 in bonds (all tax-deferred) and 109 in cash (all in taxable).

Rinse and repeat each year.

Sometimes a picture is easier

	Begin	Activity	Before rebal	Rebal	Ending
Taxable
Equities	1,496	150	1,646	(83)	1,563
Cash	104	(78)	26	83	109
	1,600	72	1,672	-	1,672
Tax-deferred
Equities	64	6	70	(10)	60
Bonds	936	28	964	10	974
	1,000	34	1,034	-	1,034
Equities	1,560	156	1,716	(93)	1,623
Bonds	936	28	964	10	974
Cash	104	(78)	26	83	109
	2,600	106	2,706	-	2,706
Equities	60%		63%		60%
Bonds	36%		36%		36%
Cash	4%		1%		4%
	100%		100%		100%

 

[rayvt]

Since we are not going to approach 50/50, we will need something other than stocks in our taxable account. That's where the tax inefficiencies can kick in. ...
Having 100% bonds in the tax deferred account...

You are overthinking it, making it harder than it really is. You are agonizing over minutia.

Pick an asset allocation, say 30% stocks/70% bonds. In your taxable accounts go 30% VTI and 70% AGG. In your IRA accounts go 30% VTI and 70% AGG. Done and done.

When you make your (annual?) withdrawals, take from a combination of VTI & AGG such that they get back toward your chosen AA.

Vanguard or somebody wrote a paper on optimal withdrawal sequencing (taxable vs. IRA) methods. IIRC, overall there's not a major difference. Try googling "Optimal Withdrawal Strategies for Retirees"
But that's a minor item. Your major issue is the AA.

 

[nun]

Agreed, which is why I started this thread. We are not about to keep it at 0/100, but we won't go 100/0 even if there is the belief we have the assets to do it. Some of the cash will be slotted for stocks. How much in stocks remains to be seen.

Since we are not going to approach 50/50, we will need something other than stocks in our taxable account. That's where the tax inefficiencies can kick in. If we go with the suggestion to go all Wellington in the taxable account to get to 30/70 overall, we run into the problem I alluded to in my previous post. If the need arises to have sell in the taxable account (Wellington), a 30/70 AA starts to head towards 25/75.

Having 100% bonds in the tax deferred account, while great from a tax efficiency standpoint, makes keeping whatever AA we decide on more difficult. Odds are we probably would need separate stock and bond funds in the taxable rather than something like Wellington in order to maintain this type of conservative investing. Or maybe convert some bonds to stocks in the tax deferred accounts. Still better than 0/100, right?

You're aversion to equities is making your portfolio riskier than it needs to be. Your portfolio is large enough compared to your income needs that you have almost no chance of running out of money, but you are setting yourself up for poor returns and will probably have to spend some of your capital. I would rather see you average into some SPIAs that carry so much in bond funds. But, as I said, you have enough for that not to be an issue.....at least until your wife reaches 70 and you start taking that larger deferred SS check. If you can't bring yourself to fill the taxable up with equity index funds at least keep it tax efficient and look at municipal bonds.....although they are usually quite sensitive to interest rates. If you can buy individual bonds and hold to term that would be good.

 

[rayvt]

... Which I see is what Meadbh posted. ... Great minds think alike.

Look, I think most people are being silly about tax efficiency in retirement. Our thinking is colored by having to pay income taxes on our W-2 paychecks for the last 30+ years. Retirement is not like that.

When I retired I was amazed to see that most of our income was in the 10% bracket and unless we did hefty IRA->Roth conversions we were way below the top of the 15% bracket.

So no LTCG tax or tax on dividends in the taxable accounts. But IRA withdrawals are ordinary income, so those get hit by 10% and 15% tax.

 

[kaudrey]

Statsman, I think you are making this more difficult than it really is. I think we have established that you will need a WR of 2% and that relying on cash and bonds alone to sustain that over the long term is risky. We've also reached a consensus that the bonds should go in your tax sheltered account.

Step 1: Decide on your asset allocation.
Step 2: Fill up your tax sheltered account with your bond allocation. If there is space, top it up with equities. If there is overflow, put some bonds into the taxable account and top that up with equities. Choose low cost indexed funds.
Step 3: Enjoy your life.
Step 4: Look at your portfolio after a year. If your asset allocation is off target by more than 5%, adjust it.
Step 5: Repeat Steps 3 and 4.

FWIW, my portfolio is approximately the same size as yours, but I have no pension. I have equities, and I sleep at night.

This. Although it is good to think about taxes, and be as tax-efficient as possible, don't let the tax-tail wag the investment/AA dog.

 

[Danmar]

As for me, even if I have won the war (and I have not), I would still want to go on to become the Emperor of the World.

My feeling as well. I like the game. Gives me a little something to do, not that I need such. Really I do this for my heirs (daughter).

 

[nun]

If we can get you up to something like 40/60 overall what about this allocation

Tax deferred: Wellesley
Taxable: 40% US stock index, 60% tax free municipals

Psst........or even just put everything in Wellesley and don't worry about paying a bit of tax in the taxable account. That gives you a very simple 40/60 split that will rebalance itself. A pension, SS and $2.3M in Wellesley to produce $45k/year looks like a pretty enviable setup and maybe the Wellesley managers will do something to head off the bond headwinds (sorry for the profanity). But the obvious thing for you to do is defer SS, no one has mentioned that or commented on it.

 

[Chuckanut]

Yes spending form taxable is usually done first.

I've been wondering it that rule always makes sense given the RMD rules many of us will face. It might be wiser to balance spending between taxable money, Reg IRA, and Roth IRA in some situations. Or maybe not?

The idea of being able to use money I have already paid taxes on to help keep me out of a higher tax bracket seems appealing.

 

[daylatedollarshort]

Statsman, have you tried running your plan through a retirement planner like the Fidelity Retirement Planner (FRP)? You can model different portfolios there and see the results. You can also put in your non-COLA pension and see what that does to your retirement income over time. (We have our non-COLA pensions matched with a low interest, fixed rate mortgage.) You can also play around with taking SS at different ages (that one's for you, nun).

If you are risk adverse and can max out your retirement readiness score with a 10/90 type portfolio in an underperforming market, then maybe you don't need anything riskier. It doesn't seem like significantly more stocks would suit your personality type.

There are many discussions here on mortgage or not, when to take SS, needing stocks for the long run, etc. but really the final answer is in the planners and your own spreadsheets, if you know how to do that. We kept a mortgage, plan on SS at 62, have a low AA for stocks, don't have a bazillion dollar portfolio and yet we can max out the FRP score with an estate leftover because our retirement expenses are low in relation to our retirement income.

 

[LOL!]

according to michael kitces keeping bonds in a deferred account at these levels could be a waste of valuable space .
[…]

Thanks for the Kitces link. I had seen it before and figured out it did not apply to me mostly because of the tax-loss harvesting I have done. Essentially, I have no taxable turnover in my taxable account. Also, I have equities and bonds in my tax-advantaged accounts, so all rebalancing can be done in those accounts leaving the taxable account to grow virtually untaxed.

I really like the articles of Kitces, but one has to really study them in order to decide for themselves what he leaves out and whether they really apply to one's personal situation. They make you think and I really like that.

 

[hnzw_rui]

I've been wondering it that rule always makes sense given the RMD rules many of us will face. It might be wiser to balance spending between taxable money, Reg IRA, and Roth IRA in some situations. Or maybe not?

The idea of being able to use money I have already paid taxes on to help keep me out of a higher tax bracket seems appealing.

On this board, quite likely yeah. Most people here plan for worst case so 1-4% portfolio real returns, conservative withdrawals to protect against sequence of return risks, no or greatly diminished social security benefits, sky-high health and LTC costs, etc. During accumulation, you try to save as much as possible because while you can't control returns, inflation and entitlements, you do have a lot of control on your savings and spending. Alas, I reckon more often than not, this scenario probably leads to RMDs + SS being far greater than one's pre-retirement salary. Imho, it's a good problem to have. Certainly far better than scraping by on just SS.

Mind, there are plenty of folks here who retired before 55/59.5 so spending from taxable is often the best option. Well, there's Roth IRA contributions and 72t, too, but using taxable first is just easier.

@statsman
As nun has suggested, consider putting both IRAs and taxable accounts in the same fund and just take the tax hit. That way, you don't have to worry about rebalancing. Some good options are:

• Wellesley VWIAX 35/65
• Target Retirement Income VTINX 30/70
• LifeStrategy Conservative Growth VSCGX 40/60
• LifeStrategy Income VASIX 20/80

I'm not familiar with non-Vanguard fund families so can't make recommendations on those. Using a single fund is not going to be tax efficient but I think in your case, the peace of mind of not seeing the volatility of a total stock index fund will more than make up for the tax inefficiency and should help you stay the course.

And yes, going bond-heavy means lower returns compared to equities long term but why take the risk if you don't need to?

Here's some interesting reading:

How Do You Know When You Have Enough? - CBS News
Are You Taking Too Much Risk? - CBS News
Are the Rewards Worth the Risks? - CBS News

And some backtesting:
https://www.portfoliovisualizer.com...&reinvestDividends=true&initialAmount=1000000

 

[Whisper66]

...I think most people are being silly about tax efficiency in retirement. Our thinking is colored by having to pay income taxes on our W-2 paychecks for the last 30+ years. Retirement is not like that.When I retired I was amazed to see that most of our income was in the 10% bracket and unless we did hefty IRA->Roth conversions we were way below the top of the 15% bracket......

Tax efficiency considerations appear to be mainly important for those with high IRA asset levels since they may end up in higher tax brackets when RMD's kick in. If one is worried about future escalation of tax rates (due to the country's debt situation), then making Roth conversions and considering which accounts hold what type of funds becomes a bit more important if one wishes to optimize tax payments to Uncle Sam.

 

[statsman]

@statsman
As nun has suggested, consider putting both IRAs and taxable accounts in the same fund and just take the tax hit. That way, you don't have to worry about rebalancing.
.
.
.
Using a single fund is not going to be tax efficient but I think in your case, the peace of mind of not seeing the volatility of a total stock index fund will more than make up for the tax inefficiency and should help you stay the course.

And yes, going bond-heavy means lower returns compared to equities long term but why take the risk if you don't need to?

I appreciate everyone's responses the past day. I have been taking the time to think over what advice has been offered along with the articles being linked to.

I will respond to the part I quoted above. The idea of having balanced funds as the basis of both taxable and tax deferred accounts may be a good plan for us. As was commented on, if it helps us get into sufficient equities in our portfolio and stay there, that may more than offset any tax inefficiencies.

Is there a risk in using the same fund for all investments? I don't want to get into the situation of having a half dozen balanced funds across all accounts, but how risky is using just one?

And some backtesting:
https://www.portfoliovisualizer.com/backtest-portfolio?s=y&allocation2_2=100&lastMonth=12&symbol1=VASIX&endYear=2009&symbol3=VWINX&frequency=4&symbol2=VSCGX&inflationAdjusted=false&annualAdjustment=10000&showYield=false&startYear=2000&benchmark=%5ESPXTR&rebalanceType=1&timePeriod=4&annualPercentage=0.0&allocation1_1=100&allocation3_3=100&annualOperation=2&firstMonth=1&reinvestDividends=true&initialAmount=1000000

Wellesley does well in this backtesting. I subbed in Wellington for one of the two Lifestyle funds, and it does quite well for 2000-2009 despite being 64/36. More volatile than the other funds, but better returns than the Lifestyle funds. A bit less than the Wellesley fund.

Seriously, I generated several portfolios with separate bond, income (ie. DODIX), and stock funds at 36/64, and they all lack the overall performance of Wellesley for this 10 year period. I see why Wellesley is often recommended (realizing past performance is not an indication of future results).