Asset Allocation Advice

[Done by Forty]

Hi there, Mustachians. I'm hoping you can help me with my asset allocation question:

-We currently use Bernstein's Simpleton's Portfolio: http://ed-chang.com/review/
     25% Large US Stocks (VFIAX)
     25% Small US Stocks (VSMAX)
     25% International Stocks (VTIAX)
     25% Short Term US Bonds (VBIRX)

-But with this AA, we are missing out on midcap, a large variety of bonds, and are simply not tracking the true market cap for Large & Small US companies (i.e. - we're overweighted for small, underweight for large)

-I know there are as many recommendations for asset allocation as there are investors. But I'm torn between simply sticking with our AA as we initially thought it was a sound plan (trust our former selves) and between going with a more traditional AA (X% Total Stock, Y%Total Bond, Z% Total International, and, um, A% Total International Bond).

-The latter plan will have tax consequences: most of our holdings for US Stocks are in taxable accounts, due to us hitting the limits on 401k and IRA pretty early. In fact, the amount we have in taxable accounts is about equal to what we have in tax-advantaged accounts.  If we were to completely sell out of our taxable positions today to get into some new AA, we'd have about $1,400 in short term gains and about $6,200 in long term gains.

-Anyway, I thought the Mustachian investor community might be able to help us out with a plan. Thanks in advance.

[Aphalite]

Just shift new contributions to the right buckets until you ahve the asset allocation you are looking for. There's no rule that says you HAVE to follow total market cap allocation. In fact, right now, short term bond funds are much safer than long term bond funds (if you believe the interest rates will go up eventually)

I wouldn't take a tax hit just to shift some indexes around unless if I somehow realized I possessed some high expense funds, but you're with Vanguard, so don't worry about it

[Done by Forty]

Thanks, apahlite. I suppose that's my question behind the question: is my current AA fine as is, or is there a need to change? If so, is there a generally accepted AA by the mustachian community (or is that just wishful thinking)?

[Aphalite]

It's fine - you have good exposure to international and domestic (mid cap and small cap are honestly interchangeable - both have the capacity for a lot of growth and that's why people buy them)

Generally accepted AA by the mustachian community seems to be either
1) 100% total market (VTSMX/VTSAX/VTI)
2) A 80/20 or 70/30 equity/bond mix
or 3) Vanguard suggested mix where your equity allocation has some international exposure, so something like 56 Domestic Total Market/24 International Total Market/20 Bond

But no one can tell you which asset class will do best in the future (which really is the heart of your question), if they say they can, they're lying

[StockBeard]

Just shift new contributions to the right buckets until you ahve the asset allocation you are looking for.

This.
You don't have to take any tax hit if you are still contributing, you can progressively realign to your new goals by sending your contributions to the right bucket.

[Done by Forty]

I can appreciate that approach (though I like Aphalite's approach of leaving well enough alone, too).

In the case of my AA, would you recommend buying a midcap US index from Vanguard (say, starting with VIMSX then moving to investor class), to approximate the Total Stock Market fund with three different index funds (Large US, Mid US, Small US)?

Bonds are easier to change, as they're all in IRAs.

[Aphalite]

I can appreciate that approach (though I like Aphalite's approach of leaving well enough alone, too).

In the case of my AA, would you recommend buying a midcap US index from Vanguard (say, starting with VIMSX then moving to investor class), to approximate the Total Stock Market fund with three different index funds (Large US, Mid US, Small US)?

Bonds are easier to change, as they're all in IRAs.

If you want to do that, then why not just leave what you have alone for now and buy the total market for your domestic exposure from this point on? Easier to track and that way you won't have to calculate what % to allocate (so going forward, your contributions would be 50% VTSAX, 25% international, 25% you-pick-it bond fund)

The nice thing about index funds is its simplicity, no need to overcomplicate things if you want to approximate the Total Stock Market fund, just buy the Total Stock Market fund. A little over exposure to small caps and under exposure to midcap with your starting capital is a rounding error in the long term

[Done by Forty]

I could do that, but I feel like what we've got in play is large enough that it'll take me a long while for the current S&P500 and Small Cap Index to become immaterial. We have about $300k invested now, so roughly $75k in each bucket. We're investing about $85k to $90k a year, and I suppose half of that would go to the total stock market fund in this plan annually.

We have about 6 years left in the accumulation phase, so I suppose that means putting in $264k into the total stock market over that time.

[a1smith]

AA seems reasonable.  I also have international bonds.  Right now, Vanguard recommends 60/40 US/Intl for stocks and 70/30 US/Intl for bonds.  But it is up to you.

Another way to get midcap coverage is to stop contributing to the stock funds you have and switch to Vanguard Total Stock Market Index Fund Investor Shares (VTSMX), switching to Admiral class as soon as you go over $10,000.  Vanguard switches it for you, it is a non-taxable transaction (just share class change).

But, don't sell VFIAX and VSMAX so you won't have a taxable transaction.

I use Vanguard Total Bond and Total Bond Intl for bonds.

Edit - just noticed Aphalite had the same idea for midcap a few posts above . . .

[a1smith]

If you switch to VTSMX in six years you will have this AA:

7/1/2021, small 23.69%, mid   12.18%, large   64.13%

using this makeup of VTSMX from Morningstar:

Size   % of Portfolio   
Giant   42.08
Large   29.9   
Medium   18.94
Small   6.45   
Micro   2.62

I lumped Giant and Large together to get 71.98% Large, 18.94% Mid, and lumped Small and Micro to get 9.07% Small.

You would still be off the market allocation in six years.  See attached plot for exponential growth/decay of categories over time.

If you are super concerned about matching large, mid, small allocation of market it would be faster to buy VIMSX and contribute only to large and mid until proportions are as desired.  I'll leave the best split for Large/Mid as homework assignment, I don't have time right now.  ;-)

Edit - of course, this calculation doesn't include any effects of AA changing due to future market changes

[Done by Forty]

a1smith: that's a fantastic graph...thanks so much for putting it together, along with the numbers in the post above.

I suppose the big call I have to make is whether to leave well enough alone and keep on the path we're on, or to try to 'buy' into a different AA over time that has more diversification and at least gets closer (maybe close enough) to the actual market cap over time.

I'm leaning towards the latter, especially when we can remove any tax consequences.

[johnny847]

Another way to get midcap coverage is to stop contributing to the stock funds you have and switch to Vanguard Total Stock Market Index Fund Investor Shares (VTSMX), switching to Admiral class as soon as you go over $10,000.  Vanguard switches it for you, it is a non-taxable transaction (just share class change).

But, don't sell VFIAX and VSMAX so you won't have a taxable transaction.

Also, stop reinvesting dividends and redirect them to mid/small caps.