market timing using asset location

[karluk]

The recent market timing threads seem to have all ended, or are in the process of ending, with decidedly mixed results. I seem to remember at least one case of a market timing winner, whereas other posters have sold only to buy back in after the stock market has reached new highs.

I guess the only conclusion we can come to based on a handful of anecdotal cases is that market timing is rather difficult to pull off successfully, which is something that few of us have ever doubted. But all of these market timing experiments shared one thing in common - significant changes in asset allocation. Perhaps it's not essential to change asset allocation to make a market timing move. The Roth conversion thread that I participated in got me thinking that a relatively low risk way of making a bet on future stock market direction is to switch the location of one's stock holdings from a Roth IRA to a tax deferred account and back again. If you sell from one account and repurchase identical securities in the other, you can pull off a switch without changing a penny of your asset allocation. But you have changed your expected after tax profit. In general it's best to hold stocks in a Roth IRA and bonds in tax deferred because in the long run stocks tend to outperform bonds, so goosing the performance of the Roth while restraining the growth of tax deferred will minimize your future tax liability.

So the obvious tactic, if you expect a stock market downturn, is to temporarily switch holdings so that bonds are in the Roth and stocks are in tax deferred. If you're right, any losses in the stock market will be reflected in a lower value of your tax deferred accounts, thereby saving you some taxes down the road. The nominal value of your portfolio hasn't changed, just the adjusted after tax value. So you aren't putting any "real" money on the line. And as we saw in the Roth conversion thread, future taxes are uncertain in any case and often fall to the heirs to pay, not the retiree.

Has anyone tried this? Was it successful? I inadvertently used it in 2008-2009, when for completely unrelated reasons I had DW's Roth IRA mostly in bonds during late 2008 and mostly stocks in early 2009. It came out of the bear market with hardly any losses and exploded in value with the recovery. Most of my losses in 2008 were in my tax deferred accounts. So I guess you could call this accidental market timing. It wasn't intentional, but it worked out very well.

[Options]

"If I sell now, how will I know when it is safe to buy again? This the big problem for those who sell during crises."

"Investors following an active management strategy spend much of their precious leisure time watching the latest business news, studying the latest charts, reading financial trade publications and so on."

"Investing was never meant to be exciting."

-Warren Buffett

[karluk]

Quote:

Originally Posted by Options "If I sell now, how will I know when it is safe to buy again? This the big problem for those who sell during crises."

Thanks, Options. I am well aware of the strong arguments against market timing, and I personally tend to side with the buy and holders. But I would prefer that this thread, if it goes anywhere at all, not deteriorate into a debate about the merits, or lack thereof, of market timing. The point I was trying to make is that market timing can be done via asset location as well as asset allocation, and that using asset location removes some of the downside risk of making a wrong guess, while still retaining some benefit from making a right guess.

[REattempt]

So, I don't do this myself. Yet. Trying to figure out if I want to.

I can't speak to the asset location, and I don't think I want to.

As for the market timing, the only thing that I have found that makes sense to me is Jim Otar's hurricane warning:

http://http://retirementoptimizer.com/

11th link down the left side it says "Hurricane Warning" and "Chart."

His premise is that to PROTECT your investments means eliminating the EXTREME losses. Use his hurricane chart to "go defensive" with equitites. Not sure what EXACTLY that means, but I'm interpreting that to mean to move assets from equities to fixed.

I'm sure there are lot's of issues and pitfalls, particularly tax related, but one of the few views of how to protect a portfolio in decumulation phase that I'm contemplating.

YMMV

[Options]

Well, I'm going to pull a few words/phrases from your post: "mixed results"..."winner"..."anecdotal"..."experiments". .."goosing the performance"..."tactic"...and ask, what is your intention, investing or gambling? It comes down to more than simply a debate about market timing. Confusing what appears to be skill with luck is financial suicide while being one of the most expensive forms of entertainment one could engage in. Better to take up bowling.

[karluk]

Quote:

Originally Posted by Options Well, I'm going to pull a few words/phrases from your post...and ask, what is your intention

My intention is to pick your brains as to what type of assets you think belong in a Roth IRA compared to what belongs in a tax deferred 401k. Do you have both a Roth and a 401k? If so, do they have the same asset mix or different? Can you think of any reasons why you might change the assets held in your Roth IRA while still keeping the same overall asset allocation? Any thoughts on these issues?

[clifp]

I tried a similar thing several year ago. As part of a Roth conversion I created 3 separate Roths accounts, one had a Asia market index fund, an other a couple of domestic stocks, and a 3rd was regular US market fund. At the end of the year I kept the winner in Roth (Asia fund) and rolled back (recharacterized) the two worst performers back in my conventional IRA. I read somewhere where guy did like 10 separate different IRAs.
In hindsight, I should have picked bonds as one of the asset classes.

As often happens, things that in theory in paper have gotcha in practice. Somewhere between me, Schwab,and the IRS there was confusion on the process of recharacterization. So I got letter from the IRS want me to pay tax on all three conversions,I filled out their paper work and the problem went away. Still when reading the rules more closely my interpretation was that I made to much money to do the conversion. I decided to stop being that tricky in the future for Roth stuff.

My fairly small Roth now consists of international stocks funds, on the theory that they should outperform my roughly 75/25 AA in my conventional IRA. My bonds in my taxable account now consist almost entirely of PenFed CDs. In fact international stock have underperformed the last decade or so so my Roth is up less than my regular IRAs.

I'm not sure if this is what you were asking for Karluk, but the subject seems interesting.

[Options]

Yes, I have both a Roth and a 401K (even a small Roth 401K but that was an accident). My AA is as follows: 40/60, with 20% of equity devoted to international and 20% of bonds devoted to TIPS. Without looking at the PF, IIIRC, 2 of every 3 dollars is after-tax, all of which is in a VG tax-managed fund. Not sure I would do that again today, but am pleased with it and could have done much worse. Everything else is in IRA, Roth, and 401k (which will be converted to an IRA in 3/15 when I leave my employer to take advantage of lower VG Admiral fund fees).

I'm satisfied with my PF as it, and can find no compelling reason to change it. Current set up makes tax-efficient rebalancing easy, which is main reason I'm pleased with it. Things will get a bit more complicated when I begin Roth conversions. Beyond playing with IORP and tax software, I've not read anywhere any easier/better method to accomplish this.

Generally, if your goal is to maximize after-tax return, then equity or tax-managed funds belong in taxable accounts with taxable bond funds reserved for tax-deferred accounts.

Everything I've read without exception points to the benefits of simplicity as protection against behavioral errors when it comes to financial management. It also makes managing your PF so much easier. The more I practice this and experience its benefits the more I believe in it.

Hope this helps.

[karluk]

Since I have asked others to share their thoughts on asset location, I should provide mine as well. Here are the current allocations of my Roth IRA and my 457 tax deferred account.

Roth:
43% International stocks
22% REITs
16% US large cap
11% US small cap
8% bonds

457:
61% fixed income (in the form of a stable value fund)
17% bonds
11% US large cap
6% International stocks
5% US mid cap

If one looks only at the Roth allocations, I come across as a hyper aggressive investor. Looking only at the 457 allocations, I am conservative to the point of being frightened of my own shadow. Neither view is correct. Some of the allocations are accidental, being caused by the trades I've had to make in order to get money to where I need it without changing my overall allocations. The large percentage of international in my IRA is an example of that. Last year it was much lower.

But the overall tilt of the Roth IRA towards equities and the 457 towards fixed income and bonds is quite intentional. I set this strategy up hoping for stocks to outperform bonds, as they often tend to do, so that most of my profits would be tax free rather than tax deferred.

So far this strategy has worked like a charm. My average annual return in my Roth is roughly triple the average in my 457. The benefit to me is a reduction in my future tax liability that I believe will be well over six figures when I finally start taking RMDs from the 457.

What could go wrong? Well, the main risk, as I see it, is that the stock market doesn't go up forever. If I keep on tilting the Roth towards equities, sooner or later I will run into a bear market that will reduce, and perhaps eliminate altogether, the outperformance of the Roth compared with the 457. My hoped for reduction in future taxes may fail to materialize.

So, strictly as a defensive measure, it might make sense to shift the Roth and 457 allocations closer together, so that they both share equally any gains or losses in the stock market. I can go even farther, if I have an extremely negative opinion of future stock market performance. I could reverse the asset allocations, so that the Roth is tilted towards bonds, and the 457 is tilted towards stocks. If I do this and happen to be right about a fall in stocks, I might see my IRA gain value during a bear market, while my 457 declines, thereby decreasing my future tax liability even more, without any effect whatsoever on the total value of my portfolio - the gains and losses are the same, just transferred to an account that will benefit from a lower future tax liability.

The downside? If I make this change in asset location and stocks continue to rise, I will have increased the value of my 457 at the expense of my Roth. That would lead to higher RMDs from the 457 in about a decade, with a corresponding increase in my tax bill. Not too onerous a price, in my view.

[Gearhead Jim]

Quote:

Originally Posted by Options Well, I'm going to pull a few words/phrases from your post: "mixed results"..."winner"..."anecdotal"..."experiments". .."goosing the performance"..."tactic"...and ask, what is your intention, investing or gambling? It comes down to more than simply a debate about market timing. Confusing what appears to be skill with luck is financial suicide while being one of the most expensive forms of entertainment one could engage in. Better to take up bowling.

Unfortunately, investing is inevitably also a form of gambling.
Whether we use long term "truisms", like "in the long term, stocks outperform bonds but with greater volatility", or short term predictions from "experts", we don't really know what will happen.

I do understand that at the extremes of the spectrum, it's easier to define whether a person is investing or gambling. Closer to the middle, not so easy.

For a 75 year old retired person, 10% stocks/90% bonds would be considered a form of investment by most of us. Reverse the AA to 90/10 because he/she is convinced a boom is coming, most of us would consider that gambling. But 50/50? 60/40? 70/30?

[target2019]

Quote:

Originally Posted by karluk Thanks, Options. I am well aware of the strong arguments against market timing, and I personally tend to side with the buy and holders. But I would prefer that this thread, if it goes anywhere at all, not deteriorate into a debate about the merits, or lack thereof, of market timing. The point I was trying to make is that market timing can be done via asset location as well as asset allocation, and that using asset location removes some of the downside risk of making a wrong guess, while still retaining some benefit from making a right guess.

I think you're heading in the right direction. I read most of the timing and allocation threads here and elsewhere. My take on this subject is that there is a lot of labeling, but little experimentation. The subject is valid, and since there are so many different types of investors, I find it hard to say don't do that. I learn from every conversation about this. I'm very cautious, and not a daily trader or anything like that. But I've heard persuasive arguments about the use of timing signals for mitigation. I think you're headed in that direction. You have to filter out the noise, and develop your own approach.

It is difficult to design and follow through, but you'll learn quite a bit. Off the top of my head, a few items:
- the timing signal (I monitor the 200dMA).
- use a channel around the signal so you don't go crazy
- decide on buy/sell rules
- pick a bond fund that gives you some income while you're out of your sector (or whatever)
- set aside a limited time to do this
- set up and measure alternative strategies
- divide each investment into 4 or 5 equal buckets

[target2019]

Quote:

Originally Posted by karluk My intention is to pick your brains as to what type of assets you think belong in a Roth IRA compared to what belongs in a tax deferred 401k. Do you have both a Roth and a 401k? If so, do they have the same asset mix or different? Can you think of any reasons why you might change the assets held in your Roth IRA while still keeping the same overall asset allocation? Any thoughts on these issues?

I suggest a new thread if you want to see my pretty picture of allocation.


Seriously, where you might place assets (and why) is very interesting, but your question might not fit in with market timing. Maybe I'm wrong. Very ambivalent today.

[LOL!]

Yes, I do this occasionally and it has been successful.

Not only can one do Roth to tax-deferred, but one can sell in tax-deferred to taxable if one expects (but is not certain) that the investment in question is going to drop in price. That captures the gain in the tax-deferred and then in taxable one gets a deductible loss. Of course, the loss in tax-deferred would have reduced future taxes, too.

Does it lead to meaningful better performance? Probably not, but it is psychologically satisfying to a make a few extra bucks.

Investments to do this with: Tax efficient, but volatile ETFs such as VWO (emerging markets large-cap) or maybe VEA (large-cap developed). My records show a sale of VWO in an IRA for a profit on 7/22/2014 and a buy on 7/23/2014 in taxable with a sale on 08/07/2014 for a loss.

For the Roth vs traditional IRA, one might use VNQ (REIT index) as well.

[Gotadimple]

Quote:

Originally Posted by karluk My intention is to pick your brains as to what type of assets you think belong in a Roth IRA compared to what belongs in a tax deferred 401k. Do you have both a Roth and a 401k? If so, do they have the same asset mix or different? Can you think of any reasons why you might change the assets held in your Roth IRA while still keeping the same overall asset allocation? Any thoughts on these issues?

This thread started out as a question about the advisability of timing the market by switching assets between investment accounts (i.e., taxable vs. tax-free) and then morphed into a discussion about asset location.

As to being able to physically move assets between sheltered and brokerage, you need to have a sufficient reserve of cash or the willingness to sell in one and buy in the other. That also assumes you have a good choice of good performing mutual funds in a 401(K).

Asset location, however, is best used to create a beneficial tax result. So equities and tax-advantaged bonds in a brokerage account. More specifically, index ETFs which do not produce a lot of dividends, and international equity funds/ETF's which also provide a foreign tax credit on your 1040. You have the advantage in this type of account in taking a capital loss or gain on your 1040 as well.

You asked: "Do you have both a Roth and a 401k? If so, do they have the same asset mix or different?" When I was working, I had both. That said, the asset mix was not identical because of the choices available in the 401(K). I found those choices to be more expensive and not as good in performance as funds I could choose to use in a Roth. So, I looked at all accounts and put the more conservative choices in the 401(K) and concentrated the better performing equities in the Roth.

Your asset allocation may change as you get closer to retirement. In practice, I moved from 70-30 allocation to 55-45. I left equities in the Roth and also converted equities to the Roth. To maintain an asset allocation, I used cash to add a small amount of short-term and medium-term bond etf's in this account, to smooth volatility.

The 401(k) was converted to a Traditional IRA (Roth 401(K) are relatively recent). This account is mostly bonds funds/etfs with various equities such as US Small Cap, and Large Cap etf/funds to boost the overall growth of the account.

Why?
Because I intended to draw down the Traditional IRA/convert to Roth early in my retirement and needed to have an account that was relatively stable. The Roth is long-term growth and will be used, along with the Brokerage account, to supplement the T-IRA draws to control the T-IRA tax impacts.

So overall, the approach needs to consider growth, mechanics of harvesting cash, and asset allocation and location. Cash is higher this time of year as dividends and capital gains are allowed to accumulate during the year. I re-allocate and drawdown after the first of the year.
Brokerage 90-10 90% International Funds with 10% cash (used to rebalance, drawdown as needed)
T-IRA 30-70 30% Equities - 70% Bonds (cash will rise at year-end)
Roth 70-30 70% Equities - 15% Bonds 15% Cash (cash again used to rebalance to draw with the T-IRA)

-- Rita

[LOL!]

Quote:

Originally Posted by Gotadimple As to being able to physically move assets between sheltered and brokerage, you need to have a sufficient reserve of cash or the willingness to sell in one and buy in the other. That also assumes you have a good choice of good performing mutual funds in a 401(K).

In general I have good funds in all my accounts, namely low-expense-ratio passively-managed index funds. I can exchange from an equity ETF to a bond ETF trivially in my Roth, traditional IRA, or taxable account. My 401(k) has index funds in all major asset classes.

For tax efficiency in a taxable account, the bond funds don't matter much nowadays since the yields are so incredibly low, but one could use cash, too. Indeed, some folks are now saying that muni bond funds are better in taxable than regular bond funds in tax-advantaged. The reason stated is that when interest rates rise, those muni bond funds will lose money and one can tax-loss harvest them.

Folks also say glibly that one's Roth should have the riskiest equities since they tend to go up the most and those big gains will not be taxed. These folks conveniently ignore that the riskiest equities are the one's that drop the most and those big losses can really be a heartbreaker in a Roth.

I myself subscribe to the practice of equities and fixed income in a Roth, but weighted towards what I think the market my do over the next 6 months. I then counter-weight my traditional IRA and 401(k) to keep my overall asset allocation in the range I want. I am probably just fooling myself, but I want my Roth accounts to have the best performance of all my accounts annually and so far that is working out for me.

[nash031]

Roth IRAs: 100% stock funds
403(b): roughly 50/50 stocks to bonds, accounting for my entire bond allocation.

That may not be the best way, but my bond allocation is mostly TSP G fund, so take that into account.

FWIW, I wouldn't screw with the asset location as a means of market timing to try to win relatively minor tax benefits. Too complicated, too much room for error not even accounting for trade costs, etc.

[Lsbcal]

Quote:

Originally Posted by karluk My intention is to pick your brains as to what type of assets you think belong in a Roth IRA compared to what belongs in a tax deferred 401k. Do you have both a Roth and a 401k? If so, do they have the same asset mix or different? Can you think of any reasons why you might change the assets held in your Roth IRA while still keeping the same overall asset allocation? Any thoughts on these issues?

I have no problem with good market timing. I would think that only in market extremes is the situation to make IRA's equity rich and Roth's bond rich a good idea. I'm thinking about market extremes as those that existed in 2000 to 2001 when bonds paid good real rates and stocks were at extreme valuations (based only on past history). Then the risks were only that you would miss some stock gains in the Roth's but capture them in the IRA's instead. Of course, we could have been in a new era but that alternate universe didn't materialize.

I do not think we are currently anywhere near a clear extreme. Sure stocks could sell off but bonds aren't paying good real rates, so it's not as clear as previous market decline periods. Also the yield curve is not flat, rather it is very steep. The yield curve has been flat entering most of the previous recessions.

So for me, the Roth's and IRA's get the exact same allocations and the exact same asset classes. For now anyway.

[karluk]

Quote:

Originally Posted by Lsbcal So for me, the Roth's and IRA's get the exact same allocations and the exact same asset classes. For now anyway.

That's a very interesting conclusion, Lsbcal. Reading your post, I was coming to the conclusion that you expected stocks to continue to outperform bonds for the time being, which in my view would mandate a stock heavy Roth. But you are saying equal allocations, which would mean that half of the hoped for outperformance would be subject to future taxes. However, I like your suggestion and may implement it. Equal allocations doesn't smack of market timing, but rather an unwillingness to forecast what will be the best performing asset classes. You're guaranteed that your asset location will never be best, but it will also never be terrible either.

[karluk]

Quote:

Originally Posted by LOL! I myself subscribe to the practice of equities and fixed income in a Roth, but weighted towards what I think the market my do over the next 6 months. I then counter-weight my traditional IRA and 401(k) to keep my overall asset allocation in the range I want. I am probably just fooling myself, but I want my Roth accounts to have the best performance of all my accounts annually and so far that is working out for me.

This is also a very reasonable strategy. You give yourself a chance to make a good asset location decision but you are hedging your bets enough to not risk getting caught with almost all of your Roth exposed to a major market decline.

[Lsbcal]

Quote:

Originally Posted by karluk That's a very interesting conclusion, Lsbcal. Reading your post, I was coming to the conclusion that you expected stocks to continue to outperform bonds for the time being, which in my view would mandate a stock heavy Roth. But you are saying equal allocations, which would mean that half of the hoped for outperformance would be subject to future taxes. However, I like your suggestion and may implement it. Equal allocations doesn't smack of market timing, but rather an unwillingness to forecast what will be the best performing asset classes. You're guaranteed that your asset location will never be best, but it will also never be terrible either.

I think that is about what I'm thinking. In extremes as I mentioned, I would be willing to to some modest reallocating but have yet to implement such a maneuver.

For example, I might go from a 65/35 in both account types to a 70/30 in the IRA and a 50/50 in the Roth assuming the IRA is larger and the Roth is the smaller account balance. The net in that example would still be 65/35. I actually have an allocation spreadsheet set up to make this sort of adjustment easy.