Asset Location

[SuperNintendo Chalmers]

Hi all,

I'm new here (well, been reading the forums for almost two years but new to posting) and have a question I'd really appreciate some input on.  As the title says, asset location.

I understand the basics (I think):  put high income-generating investments (like corporate bond funds, dividend stock funds, REITs, etc.) in a tax deferred account, and put less income-producing investments (like stock funds, municipal bond funds, etc.) in a taxable account. 

What I'm stuck on is the following:

1.  If your tax-deferred account isn't liquid (putting aside a Roth conversion over 5 years, etc.), isn't it a bad idea to keep all equity in your taxable account?  Wouldn't you want to have access to bond funds or other more stable investments if you needed to tap the $ in your taxable account (or at least have options in terms of what asset class to sell if you need the $, depending on what's up or down)? 

2.  Let's say you want to invest more in taxable bond funds for whatever reason.  If you've already contributed the max to your tax-deferred account or otherwise are not eligible to deduct contributions to your tax-deferred account, wouldn't any further money invested to buy those bond funds be not deductible (and therefore defeating one of the main benefits of contributing to a tax-deferred account)? 

My situation is I've got a decent amount of VBTLX (Vanguard Total Bond Fund) and VGSLX (REIT Fund) in my taxable account.  Now I've learned that's a no-no for asset location.  But I like being able to buy those when I feel it's appropriate, but am not eligible to deduct contributions to my IRA (which is with Fidelity in any event).  I suppose I could transfer my Fidelity IRA to Vanguard and buy large amounts of VBTLX and VGSLX there, and sell them in my taxable account to recreate my overall asset allocation, but that seems like a big hassle.  Plus I like having both Vanguard and Fidelity, and it wouldn't solve the problem of having flexibility in buying those funds in the future.

OK, TL/DR:  Do people here use asset location strategies?  How do you do so if you may need to tap your taxable account funds in the short term, and can't make deductible contributions to your tax-deferred account?

Thanks so much for any replies!!

[Indexer]

I think putting asset location in it's place within the investment decision process will help.

1. What is your goal? When will you need the money, and how much will you need? Included within this would be, which accounts are liquid?

2. What is your tolerance for risk?

3. Based on 1&2 decide your asset allocation.

4. Pick investments, which includes tax implications, so asset location goes here.


Now to your questions.

"1.  If your tax-deferred account isn't liquid (putting aside a Roth conversion over 5 years, etc.), isn't it a bad idea to keep all equity in your taxable account?"

Yes, it would be a bad idea to keep the money you will need soon all in stocks. Within the decision tree, process #1 outranks process #4. The money you will need within 5 years(some would say 10 years) should probably be in bonds or cash. If you can't access your other accounts this means your taxable needs to be more conservative. When this isn't the case then you would put your most tax efficient investments, stock index ETFs, in the taxable account. So if you are still far from FIRE or you have access to other money, then you would use ETFs in the taxable, but if you need the money soon it makes sense to use bonds. If you need to use bonds in the taxable I would look into 'tax equivalent yields' to determine if you need taxable or muni bonds.

"2.  Let's say you want to invest more in taxable bond funds for whatever reason.  If you've already contributed the max to your tax-deferred account or otherwise are not eligible to deduct contributions to your tax-deferred account, wouldn't any further money invested to buy those bond funds be not deductible (and therefore defeating one of the main benefits of contributing to a tax-deferred account)?  "

In case this part wasn't known, you can always exchange investments within an IRA or 401k with no tax implications*. So if you have stocks in the 401k you can switch them to bonds. If your pre-tax accounts are already 100% bonds and you need to add more bonds then you should add bonds to the taxable account. In this case, process #3 is overriding process #4.

Example: 700k in taxable, all stock ETFs. 300k in 401k, all bonds. You are currently 70% stocks and 30% bonds. What if you want to get to 60/40. Well you would need to hold 100k worth of bonds in the taxable account. Your goals, tolerance for risk, and AA are more important that tax efficiency.



*Exception being if you are adding an investment that can't go into an IRA, like your own home. This is very rare.

[ILikeDividends]

Does your asset allocation include a cash component; i.e., a separate bucket from Fixed Income?

I keep my cash allocation*, 5%, in my taxable account, and I keep my fixed income allocation in my tIRA.

* Even though MM funds could be technically considered fixed income, I categorize it as a cash asset.  Sold MM shares settle in one day, so it's as close to actual cash as you can get and still get at least some just-ok interest on it, apart from a savings account; which would be another option.

I also keep a months worth of expenses in my checking account, which is outside of my AA.

[MustacheAndaHalf]

Besides your investment account, you should also have a savings account and an emergency fund.  The emergency fund should prevent you from selling taxable investments - you spend from savings and the emergency fund first.

You might look at tax-exempt bond funds.  Depending on your income tax level, you can get a higher after-tax return with these funds than with the total bond market.

A total stock market fund is much more tax-efficient than a REIT.  I don't follow why you want the REIT in taxable.  If your REIT doesn't have too much in gains since you bought it, I might sell the REIT and buy a total stock market index fund with that money.  And then in the IRA, if you want a specific allocation to REIT, you could buy it within the IRA.

For example, VNQ (Vanguard Real Estate ETF) had $3.53 in distributions per share in 2018.  If you ignore it's -6% return in the past year, and just divide by the current stock price, you get 4.4% distributions.  So I think you'd be paying ordinary income tax on 4.4% distributions.  Compare that with VTI issuing 2.1% dividends, almost all of which are qualified and have a lower tax rate.

[SuperNintendo Chalmers]

Thanks for the replies all.  Yeah, I think I need to go back to square one and realistically evaluate my overall allocations.  It's a bit hard to predict because my income could keep going for 20 more years or could stop in a couple months.  I do have a six-month or so EF in an online savings account, so that should provide some cushion for transitioning my taxable account to more stock funds.  Another problem I have is I never like to sell anything for some reason--I still have a couple small funds I bought over 15 years ago, lol.  I think I need to clean house, and as part of that, slowly convert stuff in my IRA to more bond funds and a REIT fund to the extent possible, and stop buying (and maybe even selling) those in my taxable. 

Thanks again.