Asset Allocation Blues

[Badass by 41]

Is there a rule of thumb for distributing funds across accounts in your AA? Should you attempt to recreate the entire AA in each of your accounts, or specialize accounts to a specific portion of your AA?

I ask because of the following situation I find myself in.

I've got roughly $600k to balance/rebalance across my much simplified AA (Thanks jlcollins!)

Target AA:
VTSAX         50%
VGSLX         25%
VBTLX         20%
VMMXX        5% (Note, this is just here as a placeholder for "cash".  This could just as easily be my bank account. And probably will be unless someone wants to point out a reason not to do that. Especially given where interest rates are these days. ;-)

Funds distribution by company and account:
Fidelity 401k          45% - Current employer so no Vanguard until I leave in 5-6 years
Cash - To invest      34% - Was saving for a downpayment, now investing for FIRE!
Vanguard IRA#1     16%
Vanguard IRA#2     2%
TIAA-CREF 403b     2%
Vanguard Roth        1%

My understanding is that for my target AA I want to favor tax deferred/exempt accounts as follows.

VTSAX - Stocks       Taxable
VGSLX - REIT         Tax Deferred/Exempt
VBTLX - Bonds        Tax Deferred/Exempt
VMMXX - Cash        Taxable

Depending on the answer to my initial questions, I see two ways of distributing the funds in my accounts across this AA.

A) Replicate my AA within each account (401k, IRA, 403b, Brokerage, etc.).
B) Target accounts at specific parts of my AA (401k->VGSLX, IRA#1->VBTLX, etc.).

In the big scheme of things, either one seems reasonable to me.  The problems arise because of 2 issues.

1) "Fairness" to the owners of the accounts.
2) Funds availability in each account.

For #1 the issue is that whichever account isn't in stocks will necessarily lag in growth, which puts the "owner" of the account at a distinct disadvantage. In this case, I own the 401k, and my wife owns IRA#1.  If I put my 45% in stock and her 16% in bonds I feel like I need to explain why that's not "screwing her" since 100% of her account would be in bonds.

For #2 the issue is more acute.  My 401k has only one fund worth investing in which is FUSVX a rough analog of VTSAX.  Which means I'm now backwards on my AA tax plan with 45% of VTSAX in a Tax Deferred account leaving only taxable accounts available to pick up the majority of remaining AA in REITs  and Bonds.

I'm tempted to just adjust my AA to accommodate my situation.  My only concern is that a 100% or even 80/20 AA is too aggressive given that I want to FIRE in 5-6 years.  I'm 37 so I get that I've got time, but not sure what to do when taking FIRE into consideration.

I'm not entirely sure I did a good job of communicating my situation/questions so please let me know if I need to clarify anything.


Addendum #1: 401k Funds by Expense Ratio

0.07%   FUSVX   Spartan® 500 Index Fund - Fidelity Advantage Class
0.26%   FXIFX   Fidelity Freedom® Index 2030 Fund - Class W
0.64%   DODFX   Dodge & Cox International Stock Fund
0.67%   LCEYX   Invesco Diversified Dividend Fund Class Y
0.77%   FVIAX   Fidelity Advisor® Government Income Fund - Class A
0.82%   FDTOX   Fidelity Advisor® Diversified Stock Fund - Class A
0.85%   PTTAX   PIMCO Total Return Fund Class A
0.98%   ABYSX   AllianceBernstein Discovery Value Fund Advisor Class
1.00%   FIADX   Fidelity Advisor® International Discovery Fund - Class I
1.01%   Fidelity Advisor Stable Value Portfolio Class II
1.01%   FNIAX   Fidelity Advisor® New Insights Fund - Class A
1.11%   JSRAX   JPMorgan SmartRetirement® Income Fund Class A Shares
1.13%   JSWAX   JPMorgan SmartRetirement® 2010 Fund Class A Shares
1.15%   FIIAX      Fidelity Advisor® Mid Cap II Fund - Class A
1.16%   JSFAX   JPMorgan SmartRetirement® 2015 Fund Class A Shares
1.17%   FHEAX   Fidelity Advisor® Real Estate Fund - Class A
1.20%   JTTAX   JPMorgan SmartRetirement® 2020 Fund Class A Shares
1.22%   JSCSX   JPMorgan U.S. Small Company Fund Select Class
1.24%   JNSAX   JPMorgan SmartRetirement® 2025 Fund Class A Shares
1.28%   JSMAX   JPMorgan SmartRetirement® 2030 Fund Class A Shares
1.32%   SRJAX   JPMorgan SmartRetirement® 2035 Fund Class A Shares
1.35%   SMTAX   JPMorgan SmartRetirement® 2040 Fund Class A Shares
1.37%   JSAAX   JPMorgan SmartRetirement® 2045 Fund Class A Shares
1.41%   JTSAX   JPMorgan SmartRetirement® 2050 Fund Class A Shares
1.46%   JFFAX   JPMorgan SmartRetirement® 2055 Fund Class A Shares

[aj_yooper]

Rank order your funds according to tax efficiency, then start placing the least tax efficient funds first, then the second order...  So, the REITs are the least efficient, then bonds, money market and total market.  It looks like you have lots of space in tax advantaged (66%).  It is usually not possible to replicate your AA in each account and some accounts offer more or more efficient choices.  If you can, I would do it.  Since you are still contributing to the tax advantaged accounts, you can keep to your AA levels by your contributions too, somewhat.  The fairness issue can be partly solved by communicating the portfolio strategy and by using what is available per investment vehicle. 

One rule that people often use in re-balancing is to do it when the stocks/bond AA is 'off' by 5% (then you re-balance).  And, when the allocations within the  stocks or bonds category is off by 10%, re-balance.  So, if REITs were >+ 10%, you would re-balance. 

With the total market having about 3% REITs (http://www.forbes.com/sites/rickferri/2014/01/07/reits-and-your-portfolio/) and your current allocation to them at 25%, you are way tilted there. 

[MustachianAccountant]

Could I complicate this for you?
Don't forget about fees. If your allocation to the Fidelity funds happens to be their most expensive offerings (e.g., REIT), and you could allocate to a cheaper Fidelity fund (e.g. Stocks), you should take that into account.
But take it into account with the tax piece of the puzzle too.

(I have no idea what Fidelity fees are like, so I only used REIT and Stocks as an example, for clarification)

[Badass by 41]

I'm no expert and can't address your specific situation but I have a link that might interest you:
http://www.bogleheads.org/wiki/Principles_of_tax-efficient_fund_placement
I hope that's at least somewhat useful.

Thanks cjottawa, that's exactly how I arrived at my initial tax plan for my AA.  8)

[Badass by 41]

Rank order your funds according to tax efficiency, then start placing the least tax efficient funds first, then the second order...  So, the REITs are the least efficient, then bonds, money market and total market.  It looks like you have lots of space in tax advantaged (66%).  It is usually not possible to replicate your AA in each account and some accounts offer more or more efficient choices.  If you can, I would do it.  Since you are still contributing to the tax advantaged accounts, you can keep to your AA levels by your contributions too, somewhat.

I get what you're saying here for sure.  The unique issue I have is for the 45% of my AA that's in my 401k, I really only have one reasonable fund option which is a Total Market Index.  I can do that, but then what am I supposed to invest the 34% Cash in?  The other options in my AA (REIT, Bonds) aren't ideal for taxable accounts.  8(

For more context, I've updated the OP with my 401k available funds and expense ratios.

With the total market having about 3% REITs (http://www.forbes.com/sites/rickferri/2014/01/07/reits-and-your-portfolio/) and your current allocation to them at 25%, you are way tilted there.

Great catch! And thanks for the pointer.

[beltim]

Despite the nifty graphic on the Bogleheads site, the better advice is in the text, in particular the "tax efficiency of bonds" section.  Besides that, here's why I think bonds should not go in your tax advantaged accounts: the bond fund you're looking at, VBTLX, is nearly two thirds government (read: tax-free) bonds.  Why would you put tax-free bonds in a tax-deferred account?  Plus, consider the total amount of tax.  VBTLX is yielding ~2.2%.  Let's say half of that is tax free (tax free bonds generally yield less than taxable bonds).  So only 1.1% is taxable, so the maximum tax per year is about 0.4%.

Now compare that to stocks.  Profits from stocks held in a taxable account can be taxed from 0% (qualified dividends at certain tax brackets) to about 43.4% (short term capital gains in the highest tax brackets).  If you estimate 8% annual returns (including inflation, since cost basis is not indexed for inflation), and assume that most people will realize long term capital gains at the 15% rate, then the annual tax cost is .15*.08 = 1.2%.

Since 1.2% is larger than 0.4%, the average tax bill for stocks is much higher than the maximum tax bill for bonds.  To minimize taxes, then, stocks belong in tax-advantaged accounts.

[Badass by 41]

Since 1.2% is larger than 0.4%, the average tax bill for stocks is much higher than the maximum tax bill for bonds.  To minimize taxes, then, stocks belong in tax-advantaged accounts.

Wow, awesome analysis.  Thanks!

Given the AA presented in my OP, this is exactly why I feel stuck.  I've got 34% of my investable assets sitting outside of tax-advantaged accounts, and 45% of my investable assets in a tax-advantaged account only reasonably investable in a Total Stock Market Index. REITs definitely don't belong in my taxable accounts, so even if I put the full 20% Bond allocation in a taxable account, I would still have 14% of my cash assets unallocated.

All signs point to an 80/20 AA for me util I can get more funds into my Vanguard tax-advantaged accounts.

[beltim]

Since 1.2% is larger than 0.4%, the average tax bill for stocks is much higher than the maximum tax bill for bonds.  To minimize taxes, then, stocks belong in tax-advantaged accounts.

Wow, awesome analysis.  Thanks!

Given the AA presented in my OP, this is exactly why I feel stuck.  I've got 34% of my investable assets sitting outside of tax-advantaged accounts, and 45% of my investable assets in a tax-advantaged account only reasonably investable in a Total Stock Market Index. REITs definitely don't belong in my taxable accounts, so even if I put the full 20% Bond allocation in a taxable account, I would still have 14% of my cash assets unallocated.

All signs point to an 80/20 AA for me util I can get more funds into my Vanguard tax-advantaged accounts.

No problem!  I'm happy to run these sorts of analyses if you're interested.

25% REITs is high, but if that's what you want, you can get to 20% by filling your IRAs and 403b with REITs.  It may be suboptimal to put 5% REITs in taxable accounts, but in general, tax optimization isn't a great reason to avoid sticking to your asset allocation.  And as others mentioned, there's no problem with filling your various accounts each with different things.

[Badass by 41]

25% REITs is high, but if that's what you want, you can get to 20% by filling your IRAs and 403b with REITs.  It may be suboptimal to put 5% REITs in taxable accounts, but in general, tax optimization isn't a great reason to avoid sticking to your asset allocation.  And as others mentioned, there's no problem with filling your various accounts each with different things.

Ok, that makes sense.  Out of curiosity, do you have a particular take on this question from my OP?

I'm tempted to just adjust my AA to accommodate my situation.  My only concern is that a 100% or even 80/20 AA is too aggressive given that I want to FIRE in 5-6 years.  I'm 37 so I get that I've got time, but not sure what to do when taking FIRE into consideration.

Thanks!

[beltim]

I'm tempted to just adjust my AA to accommodate my situation.  My only concern is that a 100% or even 80/20 AA is too aggressive given that I want to FIRE in 5-6 years.  I'm 37 so I get that I've got time, but not sure what to do when taking FIRE into consideration.

So there's two ways to think about this:
1) You want to retire in 5-6 years
2) Your asset allocation should be such that it lasts the rest of your life

While I think there are times that a 100% stock allocation is fine, if you're at all hesitant about it I would say that 100% stocks is not right for you.  I'm not sure what the relative volatilities of an 80/20 vs 50/25/20/5 (stock/reit/bond/cash) portfolio is – I'd guess that the low correlation between reits and stocks over the long term makes your suggested portfolio less volatile, but maybe not by very much.

Given that you're 5-6 years from retirement, I'd say invest your portfolio with the same allocation that you'll want in retirement.  The average difference in return between 100% stocks and your asset allocation over 5 years is probably quite small, so for you it's probably not worth the extra risk.

This is, of course, just one guy's opinion on the internet, but hopefully I've provided enough explanation for you to see why that's my opinion. 

[Badass by 41]

While I think there are times that a 100% stock allocation is fine, if you're at all hesitant about it I would say that 100% stocks is not right for you.  I'm not sure what the relative volatilities of an 80/20 vs 50/25/20/5 (stock/reit/bond/cash) portfolio is – I'd guess that the low correlation between reits and stocks over the long term makes your suggested portfolio less volatile, but maybe not by very much.

Everything I've read says that 80/20 (stock/bond) has slightly out performed a 100% stock AA over time, and has the added benefit of smoothing things out just a hair.

I appreciate your thoughts on structuring my AA as we'll want it when we're FIRE.  That kind of confirms my suspicion that I might be being too aggressive.

[Badass by 41]

UPDATE: I learned something new today!

One of the major problems I have been having with my AA is that I have a large percentage in my 401k which has only one low cost fund (At least it's an S&P total index).  What occurred to me today was where those funds actually originated in my 401k.  80% of my 401k is a rollover from a previous employer.  What I learned today is that since that amount is tracked as a separate source in the 401k plan, I can do a direct-rollover of those funds into an IRA.

This is awesome!

Once I move those funds into my tIRA, I can allocate against my Vanguard funds instead of bring trapped at Fidelity.

[Badass by 41]

Since 1.2% is larger than 0.4%, the average tax bill for stocks is much higher than the maximum tax bill for bonds.  To minimize taxes, then, stocks belong in tax-advantaged accounts.

Wow, awesome analysis.  Thanks!

Given the AA presented in my OP, this is exactly why I feel stuck.  I've got 34% of my investable assets sitting outside of tax-advantaged accounts, and 45% of my investable assets in a tax-advantaged account only reasonably investable in a Total Stock Market Index. REITs definitely don't belong in my taxable accounts, so even if I put the full 20% Bond allocation in a taxable account, I would still have 14% of my cash assets unallocated.

All signs point to an 80/20 AA for me util I can get more funds into my Vanguard tax-advantaged accounts.

No problem!  I'm happy to run these sorts of analyses if you're interested.

25% REITs is high, but if that's what you want, you can get to 20% by filling your IRAs and 403b with REITs.  It may be suboptimal to put 5% REITs in taxable accounts, but in general, tax optimization isn't a great reason to avoid sticking to your asset allocation.  And as others mentioned, there's no problem with filling your various accounts each with different things.

beltim I've finished moving my principle around and would love your opinion on the following plan.  I'd love feedback from anyone else as well.

We're in our mid-30's now and plan to FIRE in 5-6yrs, then we'll have ~18yrs of pRetirement until 60, then (hopefully) 20-30yrs of tRetirement.

This is an aggressive AA which makes sense given our relatively young age, but I wonder what folks recommend in terms of AA modification between accumulation, pRetirement, and tRetirement?

Asset Allocation - Target
Stock - VTSAX 80% (For Growth)
REIT  - VGSLX 7%   (For Exposure w/o Homeownership)
Bond - VBTLX  10% (For Balance)
Cash - VMMXX 3%   (For buy opportunities)

Here's how my investable assets are distributed across the different tax treatments.

34% - Taxable
66% - Tax Deferred
1%  - Tax Exempt

My plan is to distribute my investable assets across these tax treatments in the following way

Taxable
Stock - VTSAX 22%
Bond - VBTLX 10%
Cash - VMMXX 1.5%

Tax Deferred
Stock - VTSAX 58%
REIT - VGSLX 6%
Cash - VMMXX 1.5%

Tax Exempt
REIT - VGSLX 1%

Some questions:
1) Am I right to keep bonds in my taxable accounts? (Given the state of bonds, should I be in something other than VBTLX?)
2) Am I right that I should reallocate my position in REITs if/when we purchase a house. 

[beltim]

I hadn't thought about a REIT fund before, so I did a little research on VGSLX.  Trading at ~100 right now, it's distributed $1.18 in return of capital and $2.63 in dividends over the last year.  The return of capital is treated as a reduction in costs basis, and the dividends are unqualified, meaning that they're taxed just like ordinary income.  Assuming the last 12 months are representative, that's less tax-efficient than either bonds or stocks.  So I think putting VGSLX in a tax advantaged account is right.  If it were me, I'd put all the REITs together, and leave the tax exempt to the asset that I expected to appreciate the most – for me, I'd say stocks, but if you think REITS than your allocation is fine.

Are you contributing more funds currently, and if so, into which accounts?

[Badass by 41]

I hadn't thought about a REIT fund before, so I did a little research on VGSLX.  Trading at ~100 right now, it's distributed $1.18 in return of capital and $2.63 in dividends over the last year.  The return of capital is treated as a reduction in costs basis, and the dividends are unqualified, meaning that they're taxed just like ordinary income.  Assuming the last 12 months are representative, that's less tax-efficient than either bonds or stocks.  So I think putting VGSLX in a tax advantaged account is right.  If it were me, I'd put all the REITs together, and leave the tax exempt to the asset that I expected to appreciate the most – for me, I'd say stocks, but if you think REITS than your allocation is fine.

Are you contributing more funds currently, and if so, into which accounts?

Here's what we've been contributing from dual salary and bonuses.

Taxable - ~$110k/yr (~$5k/mo + ~$50 bonus)
Tax Deferred - $46k/yr ($35k 401k/403b + $11k tIRAs)
Tax Exempt - $0 (we don't qualify anymore )-:

Since the Tax exempt amount is so small (<$10k single account) it seems reasonable to focus that into one fund.  I could definitely move that into stocks and move the REIT allocation entirely into Tax Deferred accounts.

A wild-card in the Taxable bucket is my employer equity.  Starting this year, I have RSUs vesting sell-to-cover so I'll see an additional ~$25k and $75k (after taxes) depending on the strike price.  That will also go directly toward FIRE in our Taxable accounts.

Once we FIRE we're thinking we'll do some combination of backdoor and direct ROTH conversion to fill out the headroom in our AGI.  Thoughts?

[beltim]

Since the Tax exempt amount is so small (<$10k single account) it seems reasonable to focus that into one fund.  I could definitely move that into stocks and move the REIT allocation entirely into Tax Deferred accounts.

Agreed.  And the fact that it's only 1% means it probably doesn't matter either way.

Here's what we've been contributing from dual salary and bonuses.
Taxable - ~$110k/yr (~$5k/mo + ~$50 bonus)
Tax Deferred - $46k/yr ($35k 401k/403b + $11k tIRAs)
Tax Exempt - $0 (we don't qualify anymore )-:

Since you're contributing so much to your taxable accounts every year, the only adjustment I'd make to your plan is that I wouldn't keep any cash in your tax-deferred account.  The purpose of cash in your account is to be able to rebalance, which can be done by either:
1) buying more stocks or bonds in your taxable account
2) putting more new contributions in your tax-deferred account.

I say this because I don't see any circumstances where you'd have to sell assets in your taxable account, because of your large current contributions.  Make sense?

[Badass by 41]

Since you're contributing so much to your taxable accounts every year, the only adjustment I'd make to your plan is that I wouldn't keep any cash in your tax-deferred account.  The purpose of cash in your account is to be able to rebalance, which can be done by either:
1) buying more stocks or bonds in your taxable account
2) putting more new contributions in your tax-deferred account.

Since I'm already maxing out my Tax Deferred contributions (and next year I'm planning on maxing contributions in January/February), my thinking about keeping cash on hand is that it would allow me to take advantage of buy opportunities when the market dips.  That will naturally happen in my Taxable accounts.  Am I not thinking about that right?

I say this because I don't see any circumstances where you'd have to sell assets in your taxable account, because of your large current contributions.  Make sense?

That makes sense.

What are you're thoughts on AA modifications once we FIRE and are in pRetirement?