advice on shifting some funds out of stocks?

[citizen24128]

Most of my portfolio is in stock index funds and I've recently realized that I need to get serious about defining my desired asset allocation, sticking to it, and rebalancing on a defined schedule. I might retire early or at least take a sabbatical in the next couple of years. I know that I want to convert some stocks to cash or bonds soon -- after I finalize my Investment Policy Statement -- and I have a few questions.

1) To avoid taxes, it seems smart to sell stock funds in my Roth IRA and buy money market funds there. However, I have questions about basis and also about the hold-for-five-years-then-withdraw-without-penalty rule.

  a) Assume I bought $5,000 of a stock index fund in my Roth IRA in 2010. In 2021 I sell it and buy money market funds (still within my Roth IRA). Am I still free to withdraw that money without penalty? OR, by selling stock and buying money market did I "reset" the five year period and I will now need to wait until 2026 to withdraw those funds penalty-free?

  b) A similar question about basis: am I correct that in the example above I no longer care about keeping track of the basis for the original stock purchase? The basis "resets" and now I only care about the basis of the purchase transaction for the money market funds?

2) Right now I cannot convince myself to move a large (to me) amount of money into bonds. Cash and money market funds seem like a better bet. (I WILL buy as many I bonds as I'm allowed, though. And I already own some bonds and will likely keep those.)

  a) Is this sane or not sane?

  b) I realize that at some point in the future, it may again make sense to buy and hold bonds. If possible, I am interested in defining something in my IPS so that the IPS directs me to buy bonds if/when it makes sense (so that I execute a plan instead of making a willy-nilly decision). However, I'm not sure how to identify that point in time. I read a random comment that suggested that one should at least wait "until short term treasuries yield more than a high-yield savings account." Any comments on this topic?

3) Any other general advice on how to smartly adjust XX% of my portfolio out of stocks? I have already identified the following ongoing things I can do until I reach my desired asset allocation:
  * Save new money coming in from paychecks instead of investing in after tax index funds.
  * I have some less-desirable taxable mutual funds that I bought before learning about index funds. Instead of reinvesting dividends in these, I will have them pay out to cash.
  * Put 2022 Roth IRA contribution into a money market fund. (My thinking is that I wouldn't want to miss the opportunity to contribute for the year, and I could always use these funds to rebalance in the future.)
  * Buy I bonds now, asap next year, and in future years if it continues to make sense.
  * ???

Thanks in advance for any advice that you have to offer.

[ysette9]

You can switch investments around inside a Roth IRA and it doesn’t reset the 5-year clock. Ideally you will be keeping your Roth money in stocks because that is the last money you will spend and you want the max possible growth on the money that can grow and be taken out tax-free.

Do you have traditional-flavored retirement investments you can switch over to bonds? Otherwise you have to decide, as we did, whether to do bonds in Roth or a taxable account. With bond yields being so low now it doesn’t matter much either way, but a third option is a muni bond fund in your taxable account so at least the income is shielded from taxes.

Can you dig into lot history for your taxable account and see how much money you have with no appreciation or losses or only a bit of appreciation? Those would be the first to sell to rebalance if you can’t find another solution between traditional retirement accounts and rebalancing going forward with new contributions.

[Financial.Velociraptor]

Bonds pay abysmal yield right now.  But you don't hold them for return, you hold them for low correlation to market and safety.  In a 50%+ broad market correction, a diversified broad bond fund will only fall about 6%.  I understand the reticence to have a major portfolio drag (e.g. that is a steep "insurance premium".)  I'm keeping a good chunk in alternative fixed income, namely convertibles and preferred funds.  Really like JPS (preferred closed end fund, yields a little over 6%). 

[Villanelle]

The main reason to have an IPS and a set asset allocation is so you don't time the market.  But, "I think it is a bad time to own bonds but may do so later" is basically trying to time the market.

Also, the easiest way to rebalance, without any tax consequences or anything else tricky, is to use future investments.  If you want money market funds, why not just put 100% of any new investment dollars into them until you are at your set AA?  If that timeline is too long, at least consider doing that for part of that MM allocation.  Then, when you get to where you want to be, all future buys should match your overall AA. 

Lastly, if you have money in places other than just a Roth, consider where you want to put your lower yield holdings as far as tax implications.  For example, you are better off with high yield bonds in a trad IRA (if you have it) because there is more expected growth and it will be tax-free, and muni bonds in your taxable account (as examples, and obviously REITs, small value stocks, or large growth stocks, or whatever else you hold would fall at various places in the middle of that continuum).

[erutio]

100% stock index funds is a perfectly reasonable
AA.

[ysette9]

100% stock index funds is a perfectly reasonable
AA.

It is a perfectly fine AA for someone in the accumulation stage and a strong stomach. But it is very risky for someone right before and right after retirement due to sequence of returns risk. You can do more reading by googling Bond Tent/reverse equity glide path. Kitces and Big ERN have both written extensively about it.

[MustacheAndaHalf]

The government only views the overall Roth IRA account, not it's contents, for tax purposes (*).  You can buy and sell within the Roth IRA, and not worry about paying taxes.  ​I think the 5 year rule might be for a Roth Conversion.

In the March 2020 crash, the only thing moving upwards was short-term treasury bonds.  In the past, when I've been afraid of rates moving upwards sharply, I've been wrong.  I suspect most people are wrong to avoid all bonds now, although I'm not a great example.  I put some money in an ultra short bond ETF, but have more in cash.  So I both fear the Fed's moves on interest rates, and suspect that I'm overreacting.

The traditional retirement portfolio is 60% stocks, 40% bonds.  The higher your stock allocation, the greater the loss during a market crash.  The greatest risk to your retirement is a crash right after you retire, so that's when you need the highest percentage in safe assets like bonds.

(*) No tax impact except for wash sales: if you sell something at a loss in taxable, and buy it in your Roth IRA, the wash sale rule can make you lose the taxable loss forever

[Wintergreen78]

The main reason to have an IPS and a set asset allocation is so you don't time the market.  But, "I think it is a bad time to own bonds but may do so later" is basically trying to time the market.

Also, the easiest way to rebalance, without any tax consequences or anything else tricky, is to use future investments.  If you want money market funds, why not just put 100% of any new investment dollars into them until you are at your set AA?  If that timeline is too long, at least consider doing that for part of that MM allocation.  Then, when you get to where you want to be, all future buys should match your overall AA. 

Lastly, if you have money in places other than just a Roth, consider where you want to put your lower yield holdings as far as tax implications.  For example, you are better off with high yield bonds in a trad IRA (if you have it) because there is more expected growth and it will be tax-free, and muni bonds in your taxable account (as examples, and obviously REITs, small value stocks, or large growth stocks, or whatever else you hold would fall at various places in the middle of that continuum).

This is good advice. If you want to adjust your allocations, just put 100% of your contributions into bonds until you hit your target. Then you don’t have to worry about selling or tax implications.

[Radagast]

1a no reset
1b cost basis does not matter
2a not sane
2b Timing the bond market is stupid. At best, you have a 50% chance of being right. If you are right, you get what, like a 1% annual rate of return if you get it perfect? Spend that time and investment money somewhere where it matters.

3 Do NOT use Roth for money market. You want that in stocks as much as you can, because you pay no taxes on money coming out, so put it in something with the most growth potential so you pay no taxes on the most money. Traditional is best for traditional bonds.

Just put new money in, no selling especially in taxable.

Don't reinvest dividends in crappy funds. Try to sell out if they crash.

For years now I have been suggesting a mix of I-bonds, VWALX (High yield tax exempt) for credit risk exposure as desired and if I-bonds are maxed out, and long term bonds such as VGLT/EDZ/ZROZ in a trad IRA/401k if longer duration or greater rebalancing potential is desired. That way you waste as little tax sheltered space as possible on bonds. I-bonds have always had the highest return per unit of risk of any bond type (except usually G-fund), so there has never been a time to exclude them. Just use VWALX and ZROZ on top of them to boost your risks to your taste, if their yields drop below.

[citizen24128]

Thanks all for taking the time to respond. I appreciate it.

My situation: I think I have "enough" already, but am working a bit longer for a few personal reasons. I would really be sad to find that a year from now, I no longer have "enough." I think I'm fine with holding more cash if that gives me peace of mind for the next few years.

If you want money market funds, why not just put 100% of any new investment dollars into them until you are at your set AA?

I will do that, but I want the option to quit in a year or so. I won't have enough new income between now and then to save as much bonds/cash/money market funds as I think I need.

The main reason to have an IPS and a set asset allocation is so you don't time the market.  But, "I think it is a bad time to own bonds but may do so later" is basically trying to time the market.

I know. And I don't want to do that. As I talk it through, I think that maybe I am conflating two different things. I want to have an asset allocation that I feel comfortable sticking to for the long term. I also want to have a couple (?) years of RE expenses in a place that is "safe." Maybe I want an asset allocation that includes bonds but is also more cash heavy, just for my own peace of mind, and until some years pass and sequence of returns risk is less of a fear.

Can you dig into lot history for your taxable account and see how much money you have with no appreciation or losses or only a bit of appreciation?

Thank you for explaining this in a way that makes sense to me. I've (almost) never sold any investments, so this is helpful.

Do NOT use Roth for money market. ... Just put new money in, no selling especially in taxable.

I need to sell stocks and buy bonds/money markets somewhere in order to achieve a reasonable asset allocation before I retire. As I mentioned above, I think I want more "safe" funds in my allocation, and I want to be able to access them. I don't want to sell anything taxable. I was tempted to rebalance in Roth so that I could access some of those bonds and/or money market funds without penalty if I choose (via withdrawing contributions and also via future conversions to tranfer 401(k)/traditional IRA funds to Roth)? But are you suggesting that despite all this it would be still preferrable to rebalance in 401(k)/traditional IRA?

Ideally you will be keeping your Roth money in stocks because that is the last money you will spend

I understand the desire to hold stocks long-term in Roth for the tax benefit. But the ability to withdraw my Roth contributions and set up Roth conversion ladders will allow me access to a portion of my Roth funds before I reach full retirement age. So, it probably won't be "the last money" I spend.

[Holocene]

I need to sell stocks and buy bonds/money markets somewhere in order to achieve a reasonable asset allocation before I retire. As I mentioned above, I think I want more "safe" funds in my allocation, and I want to be able to access them. I don't want to sell anything taxable. I was tempted to rebalance in Roth so that I could access some of those bonds and/or money market funds without penalty if I choose (via withdrawing contributions and also via future conversions to tranfer 401(k)/traditional IRA funds to Roth)? But are you suggesting that despite all this it would be still preferrable to rebalance in 401(k)/traditional IRA?

You should look at your asset allocation across all of your accounts.  Put bonds in the traditional accounts and stocks in the Roth.  If you're planning to withdraw from Roth only and want to withdraw bonds rather than stocks, you can sell stocks in Roth when you're ready for the money, and then convert the same dollar amount from bonds to stock in your traditional account at the same time.  So you're essential withdrawing bonds since your total stock allocation is the same.  But this way you're still keeping your highest growth assets in Roth.

Example: You want to withdraw $10k.  You currently have $100k of stocks in your Roth account and $100k of bonds in your traditional account.  You'd withdraw $10k of stocks in the Roth and convert $10k from bonds to stock in the traditional.  So you'd end up with your $10k withdrawal, $90k of stocks in Roth, $90k of bonds in traditional, $10k of stocks in traditional.  You still have $100k of stock, so you've essentially withdrawn $10k of bonds despite withdrawing from your Roth and your bonds being in your traditional account.

I was in the same boat as you last year, being pretty stock heavy.  I'm planning to FIRE next spring, so I've been converting stocks to bonds in my traditional accounts.  I just did it in chunks at a time.  $10k every couple weeks, new 401k contributions going to bonds, etc.  Eventually I got to where I felt comfortable.  I have enough cash/bonds to last me probably 6-7 years.  Now I'm not worried about stock market crashes, but still have a lot of equity to keep my money growing.  If you do it all in traditional accounts, you don't have to worry about capital gains or anything like that so it's not complicated.  You just have to do it.  While bonds kind of suck right now, it's the price you pay for a bit of safety.  If you're planning to retire in the next year or so, keeping some just in savings/CD/MM over bonds probably makes sense.  Ibonds are good right now.  But for anything 2+ years out, I'd just pick a bond fund and put the money in now rather than trying to time the bond market.

[citizen24128]

Thanks for the thoughts, @Holocene. That does make sense. And thanks again to everyone else for their comments.

[FLBiker]

I'm in a similar boat (basically have enough, still working for another year or two).  I've got ~10% in bonds (including I-bonds) and ~10% in cash.  I'd be comfortable with a 10% combo of cash and bonds (rather than 20%) if I wasn't also concerned about currency fluctuations -- I earned in the US and am retiring in Canada, so I want a bigger cash cushion to avoid having to convert at inopportune times.  I'm planning to leave the rest in stocks.  And I'm planning to account for the SORR by working part-time, rather than by using a bond tent, but that's more of a mental health decision than a financial one.

And, like other folks have said, I'm keeping my Roth fully stocks (because I'd like my higher gains to be tax-free) and I keep my bonds in things that will get taxed like income, where possible -- so a traditional IRA, a 401k, a 403b or a 457b.  I also have some (like I-bonds) just in taxable.

Finally, I've become somewhat convinced that it doesn't really make sense to have both bonds and a mortgage, so I'm (currently) leaning towards paying my mortgage off when it matures in ~4 years (mortgages in Canada are typically "closed" so you can't pay them off early without a penalty -- I'm currently on a 5 year mortgage [meaning the rate is locked for 5 years] but it's amortized over 25 years).  This is another reason I'm pro-cash right now.

[ysette9]

Bonds are dead IMO.  I was a bond etf holder for years.  But now with interest rates starting to climb, bonds will lose money.  100% stock as long as you can handle the wild swings.  Also diversify across the globe.  You could go 90% stock, 10% cash.  However any cash and bond holding will create a drag on your account. Remember, your time horizon is 30-50 years, stocks win in every case in that time range.

I think this illustrates recency bias (https://www.bogleheads.org/wiki/Behavioral_pitfalls). Just because bonds haven’t given good returns now and in the memorable past doesn’t mean they haven’t done well or done a good job of being steadying ballast in the past. And I fully expect they will do that job in the future when the situation changes. I can’t predict the future of the market but I would be pleasantly surprised if the next ten years have spectacular stock market returns like the previous ten years have had.

[ysette9]

Bonds are dead IMO.  I was a bond etf holder for years.  But now with interest rates starting to climb, bonds will lose money.  100% stock as long as you can handle the wild swings.  Also diversify across the globe.  You could go 90% stock, 10% cash.  However any cash and bond holding will create a drag on your account. Remember, your time horizon is 30-50 years, stocks win in every case in that time range.

I think this illustrates recency bias (https://www.bogleheads.org/wiki/Behavioral_pitfalls). Just because bonds haven’t given good returns now and in the memorable past doesn’t mean they haven’t done well or done a good job of being steadying ballast in the past. And I fully expect they will do that job in the future when the situation changes. I can’t predict the future of the market but I would be pleasantly surprised if the next ten years have spectacular stock market returns like the previous ten years have had.

in the short term bonds smooth things out, yes. But are we looking at the short term or the long term?  Long term stocks win in every 25 year period with average returns of 5 - 15% per year depending on which snapshot we look at.  Interest rates are almost nothing and below inflation.  The last time interest rates were this low was about 1950, bonds lost 50% over the next 30 years after inflation!

I think bonds are important in the mid term. Initially you need the minimum to keep you sleeping well at night and not bail from sticks in a downturn.

Close to retirement and for a few years after you need bonds to hedge against sequence of returns risk as your portfolio is its largest and bad returns would have an outsized effect as compared to contributions before or withdrawals after retirement. After the danger zone, go wild with stocks if you like.

[MustacheAndaHalf]

Bonds are dead IMO.  I was a bond etf holder for years.  But now with interest rates starting to climb, bonds will lose money.

Generally "bonds are dead" means forever, which is the kind of statement that ages badly.  What I've read is an expectation of one rate hike of 0.25% in 2022.

[ysette9]

Bonds are dead IMO.  I was a bond etf holder for years.  But now with interest rates starting to climb, bonds will lose money.  100% stock as long as you can handle the wild swings.  Also diversify across the globe.  You could go 90% stock, 10% cash.  However any cash and bond holding will create a drag on your account. Remember, your time horizon is 30-50 years, stocks win in every case in that time range.

I think this illustrates recency bias (https://www.bogleheads.org/wiki/Behavioral_pitfalls). Just because bonds haven’t given good returns now and in the memorable past doesn’t mean they haven’t done well or done a good job of being steadying ballast in the past. And I fully expect they will do that job in the future when the situation changes. I can’t predict the future of the market but I would be pleasantly surprised if the next ten years have spectacular stock market returns like the previous ten years have had.

in the short term bonds smooth things out, yes. But are we looking at the short term or the long term?  Long term stocks win in every 25 year period with average returns of 5 - 15% per year depending on which snapshot we look at.  Interest rates are almost nothing and below inflation.  The last time interest rates were this low was about 1950, bonds lost 50% over the next 30 years after inflation!

I think bonds are important in the mid term. Initially you need the minimum to keep you sleeping well at night and not bail from sticks in a downturn.

Close to retirement and for a few years after you need bonds to hedge against sequence of returns risk as your portfolio is its largest and bad returns would have an outsized effect as compared to contributions before or withdrawals after retirement. After the danger zone, go wild with stocks if you like.

Bonds protecting you from sequence of returns risk is a myth. Instead you are better off working a tad longer instead if that is a concern. In fact, you are more likely to run out of money during a long retirement at a 4% swr, with a portfolio with a bond allocation vs an all equity portfolio.  That is a fact, and more likely now than ever.

Both Michael Kitces and Big ERN write extensively about bond tents/reverse equity glide paths for managing sequence of returns risk. Both are names I trust in the FIRE analysis space, so I’ve chosen this method for managing our risk in early retirement. Personal finance is personal, so you are obviously welcome to choose another path.

[goodmoneygoodlife]

WOW! Margin loan rate at 1.25%?

That's ridiculous. Seems like a huge spread you'd be able to make if you were to YOLO it into $QYLD or something like that.

At a mill, that's a good ~70-80k spread (pre-tax).

--

https://goodmoneygoodlife.com

[MustacheAndaHalf]

Conventional wisdom is that bonds do protect against sequence of return risk.  If you disagree with that, the onus is on you to prove it.  Not everyone else.

Similarly, claiming bonds are dead for the next 20 years needs more than a quote.  Warren Buffet decided to leave his inheritance with a 10% short-term treasury bond allocation.  So his actions speak louder than the words you quoted.  And for him, that 10% is millions of dollars - others might need more bonds than that.

"Legendary investor Warren Buffett invented the “90/10" investing strategy for the investment of retirement savings. The method involves deploying 90% of one's investment capital into stock-based index funds while allocating the remaining 10% of money toward lower-risk investments."
https://www.investopedia.com/terms/1/90-10-strategy.asp