Author Topic: Help talk me into/out of Target Date vs Indivdual Funds (esp for taxable acct)  (Read 1338 times)

PNW_FIRE

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Hi, I'm new to investing (started late in the game last year in my late 30s). I am hoping to retire in around 18 years and I am planning on maxing out my IRA and 457B for the next 18 years.

I currently have all my investments in Vanguard Target Retirement 2050. I love the ease and simplicity of this (especially considering I'm new and inexperienced with investing and really like the hands-off approach), however I'm beginning to question if this fund is the best decision for the long run.

Question: I currently have about $40K that I would like to put into a taxable account. Considering my current retirement investments (listed below), should I just put this $40K into Vanguard TR 2050 (to continue to keep things simple, which I like)? OR, should I take this opportunity to put the money in the taxable account into individual funds (according to the asset allocation I'm comfortable with) and also switch my IRA and 457B to individual funds?

I understand this would allow me to have slightly lower expense ratios in all my accounts and would allow me to maximize tax efficiency in the taxable account (by putting equities in the taxable account and bonds in the tax-advantaged accounts). It seems clear in theory that switching to individual funds would be the "optimal" decision, but can someone help put an actual estimated dollar amount on what switching would save me over an 18 year period? I'm willing to trade some optimization for the benefit of continuing to be hands-off with my investments, but only to a certain point.

Basically, can someone help me understand if I should continue with all Vanguard TR 2050 investments (in taxable and tax-advantaged accounts) since I love the simplicity, or can you help spell out what this approach will cost me over the long run and make the case why I should switch to individual funds in all my accounts?

Current retirement accounts:

Pension:
10% of salary goes into this/year (currently have about $30K in to date).

Roth IRA:
Have $12,452 all in Vanguard Target Retirement 2050. ER: 0.15%

457B
Have $8,500 all in Vanguard Target Retirement 2050 (currently this is all in Roth but I've switched all future contributions to Traditional).
ER: .09% for the fund. and The Plan charges an annual asset fee of 0.14%.

Buffaloski Boris

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There is a lot to be said about keeping it super simple.  Unless getting into the nuts and bolts of investing really gets you excited, and for the OP that doesnít seem to be the case, I donít see much point in changing a well diversified portfolio that has very minimal fees. What are you going to save by trying to slightly improve a good strategy?

IsThisAGoodUsername

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Bonds are not tax efficient. See https://www.bogleheads.org/wiki/Tax-efficient_fund_placement. Generally, one should have all stocks in taxable brokerage accounts and Roth IRA accounts. Generally, bonds should be in tax-deferred accounts (like 401k and traditional IRA).

I suggest investing the full $40,000 in VTSAX in a taxable account. In your Roth IRA, exchange enough of your Target Retirement 2050 for VBTLX in order to maintain your overall desired asset allocation.

EDIT: Math:
I'm presuming your pension is 50/50 equities to bonds.  That means your overall AA is 66/34 stocks to bonds and your total portfolio is $50,952.  If you were to add $40,000, your total portfolio would be $90,952. To keep the same approximate AA, you would need to exchange the entire $12,452 in the Roth IRA Target 2050 Fund to VBTLX. Doing so would put your AA at 69/31 stocks to bonds.  You could further improve your tax efficiency by adjusting the rIRA to be more pure stocks as you add funds (and buy bonds with them) in the traditional IRA.

« Last Edit: January 09, 2020, 03:53:08 PM by IsThisAGoodUsername »

BECABECA

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Bonds are not tax efficient. See https://www.bogleheads.org/wiki/Tax-efficient_fund_placement.

I suggest investing the full $40,000 in VTSAX in a taxable account. In your Roth IRA, exchange enough of your Target Retirement 2050 for VBTLX in order to maintain your overall desired asset allocation.

^this

Your target date fund has ~10% in bonds, so thatís approximately what youíll want in VBTLX held in your retirement accounts to offset the VTSAX youíll buy in your new after tax account. So in your retirement account convert $4444 of your target date fund to VBTLX.

EliteZags

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I think a lot of people (like me previously) that defaulted into that Target fund might not have realized it was ~35% in international, whereas if allocating to funds on my own I'd imagine being in more domestic, thus I've been gradually transitioning portions of my Target fund accts towards more VTSAX/VIGAX

PNW_FIRE

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What are you going to save by trying to slightly improve a good strategy?

Thanks for your response! This is exactly what I'm trying to figure out.

What's an actual ballpark amount I would save by switching my current strategy over the long haul? Would it be $10K, $20K...$80K? I get that technically I could optimize returns by switching to individual funds (esp. in the taxable account)...but I'm having a hard time figuring out how to put a dollar amount on that optimization. I'd like to evaluate if the more hands-on approach would actually be worth it to me or not. If I'm only gaining say $5K or $10K, it wouldn't--I'd rather just keep everything in Target Date Funds. If we're talking $50K on the other hand, that would be a different story.

Can someone help guide me in making that actual calculation? I'm not clear how to do it.

EliteZags

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it would only make sense to put a direct value on the difference if you were to invest in the exact same funds and ratios as the Target fund then rebalance each year the way does, then calculating the impact of the ER difference accounting for the growing principle over time, not a simple calc

if you were to put the money in any different mix of funds then it would all depend on the differences in performance of them vs the Target which obviously there's no way to know
my estimation/guess is that long term US market will yield higher return than international, thus my shifting some out of Target at the cost of reduced diversification
« Last Edit: January 09, 2020, 05:16:35 PM by EliteZags »

PNW_FIRE

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EDIT: Math:
I'm presuming your pension is 50/50 equities to bonds.  That means your overall AA is 66/34 stocks to bonds and your total portfolio is $50,952.  If you were to add $40,000, your total portfolio would be $90,952. To keep the same approximate AA, you would need to exchange the entire $12,452 in the Roth IRA Target 2050 Fund to VBTLX. Doing so would put your AA at 69/31 stocks to bonds.  You could further improve your tax efficiency by adjusting the rIRA to be more pure stocks as you add funds (and buy bonds with them) in the traditional IRA.

I've never thought of factoring my pension into my asset allocation because I don't manage those investments or have any control over them. The pension pays a guaranteed set amount based on salary and years of service (regardless of investment performance--if low performance occurs, the guaranteed amount is still paid with the rest being picked up by local taxpayers and the local government). Since the pension doesn't really have any "risk" for me, why factor it in to my asset allocation?

erutio

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Will your pension be cost of living adjusted (COLA)?

Either way, some people count a pension as the cash portion of their AA.

IsThisAGoodUsername

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I've never thought of factoring my pension into my asset allocation because I don't manage those investments or have any control over them. The pension pays a guaranteed set amount based on salary and years of service (regardless of investment performance--if low performance occurs, the guaranteed amount is still paid with the rest being picked up by local taxpayers and the local government). Since the pension doesn't really have any "risk" for me, why factor it in to my asset allocation?

I wasn't sure what to do with the pension, so I put it in as 50/50.  Regardless, if you're comfortable working with formulas in Excel, you can whip up a spreadsheet like this https://imgur.com/a/PvzkkRn.  This is what I have so I can keep track of how much my total portfolio is drifting from my desired AA. I've populated some sample values for account balances. The Asset Mix section shows the relative holding %s of each fund. (You can get the %s for the Vanguard 2050 fund on https://investor.vanguard.com/mutual-funds/profile/VFIFX.)The Value of this Holding multiplies the total account balance by the relative holding. These are summed up so I can gather the total amount of domestic/international holdings of stocks/bonds. I can see from these sample values that my current AA is 75.8% stock to 24.2% bonds. If I play around with the total account values (adding/subtracting amounts to simulate an exchange), I can see what I should do to rebalance to get to my desired AA. And you can do the same thing to simulate how you could handle the $40,000 influx.
« Last Edit: January 09, 2020, 05:37:49 PM by IsThisAGoodUsername »

PNW_FIRE

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it would only make sense to put a direct value on the difference if you were to invest in the exact same funds and ratios as the Target fund then rebalance each year

I'm happy with the asset allocation and glide path of the target date fund I'm in (Vanguard TR 2050). So if comparing apples to apples (Target Date asset allocation to individual funds with the same asset allocation)---what do I gain by switching to individual funds? I would gain:

#1.  some benefit from the slightly lower expense ratios, and
#2. some benefit to having better control over where I keep equities vs. bonds (in taxable or tax-advantaged accounts)

BUT...what does this "some benefit" actually represent?

I like target date funds because they're simple. Do most people support switching to individual funds (just because of point #1 and #2 above) without knowing even a ballpark of what #1 and #2 actually represent in terms of potential dollar amount savings?

PNW_FIRE

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Will your pension be cost of living adjusted (COLA)?

Yes, the pension includes COLA.

talltexan

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The target date fund is a nice start. If you're willing to take a little more risk that--over 18 years--should give you a slightly higher return, consider this strategy:

https://paulmerriman.com/2-funds-for-life/

I personally use a brokerage link to do 10% of new money buying $SLYV and $DLS


Buffaloski Boris

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What are you going to save by trying to slightly improve a good strategy?

Thanks for your response! This is exactly what I'm trying to figure out.

What's an actual ballpark amount I would save by switching my current strategy over the long haul? Would it be $10K, $20K...$80K? I get that technically I could optimize returns by switching to individual funds (esp. in the taxable account)...but I'm having a hard time figuring out how to put a dollar amount on that optimization. I'd like to evaluate if the more hands-on approach would actually be worth it to me or not. If I'm only gaining say $5K or $10K, it wouldn't--I'd rather just keep everything in Target Date Funds. If we're talking $50K on the other hand, that would be a different story.

Can someone help guide me in making that actual calculation? I'm not clear how to do it.

Well, letís do the math. The expense ratio for target 2050 is .15% of what youíre investing. Thatís 40k times .15% which is $60 a year.  Letís compare that to what youíd pay for say VTSAX, which is Vanguardís total stock market fund. Expense ratio on that is .04%. Total bond fund is .05%. Letís say a 50/50 split. So.045% times 40k is $18. So you can save a a whole $42 a year to put it in different funds which are not an exact match and which have no international exposure and you would have to periodically rebalance.

Might be worth it? Personally I put a higher value on my time.

RWD

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What are you going to save by trying to slightly improve a good strategy?

Thanks for your response! This is exactly what I'm trying to figure out.

What's an actual ballpark amount I would save by switching my current strategy over the long haul? Would it be $10K, $20K...$80K? I get that technically I could optimize returns by switching to individual funds (esp. in the taxable account)...but I'm having a hard time figuring out how to put a dollar amount on that optimization. I'd like to evaluate if the more hands-on approach would actually be worth it to me or not. If I'm only gaining say $5K or $10K, it wouldn't--I'd rather just keep everything in Target Date Funds. If we're talking $50K on the other hand, that would be a different story.

Can someone help guide me in making that actual calculation? I'm not clear how to do it.

Well, letís do the math. The expense ratio for target 2050 is .15% of what youíre investing. Thatís 40k times .15% which is $60 a year.  Letís compare that to what youíd pay for say VTSAX, which is Vanguardís total stock market fund. Expense ratio on that is .04%. Total bond fund is .05%. Letís say a 50/50 split. So.045% times 40k is $18. So you can save a a whole $42 a year to put it in different funds which are not an exact match and which have no international exposure and you would have to periodically rebalance.

Might be worth it? Personally I put a higher value on my time.

You need to factor in compounding and growing balances over time as well. If he has $40k now and is planning on maxing out a 457 every year ($19.5k) over 18 years the difference between 0.15% and 0.05% is $7.5k (give or take depending on return assumptions). At that point the target date fund will be costing ~$700 per year more than the straight index funds. If you don't make any more contributions for the next 12 years expect another $16k deficit. So rough ballpark it's $20-25k you'd be missing out on in 30 years. Calculator link:
https://www.begintoinvest.com/expense-ratio-calculator/

PNW_FIRE

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If he
*she :)

Thanks for the calculator! Yes, it looks like if I'm maxing out my contributions for the next 18 years, even the "low" expense ratio of 0.09% vs the "ultra low" ~0.05% for the 457, and "low" 0.15% vs. "ultra low" ~0.05% for the IRA would add up to some $20K+ over a lifetime. That is a quantifiable amount that does seem like an actual compelling reason to switch to individual funds.

Another advantage of switching to individual funds is that I could better control where I put bonds vs equities (in taxable or tax-advantaged accounts). Again, is there a calculator or way to figure out what that strategy could actually save me over a lifetime? I understand there's a benefit to it in theory, but again I am hoping to put an actual estimated amount on it.

RWD

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If he
*she :)
Apologies. I had it in the back of my head that I wasn't sure on gender but didn't bother switching to something neutral.

Thanks for the calculator! Yes, it looks like if I'm maxing out my contributions for the next 18 years, even the "low" expense ratio of 0.09% vs the "ultra low" ~0.05% for the 457, and "low" 0.15% vs. "ultra low" ~0.05% for the IRA would add up to some $20K+ over a lifetime. That is a quantifiable amount that does seem like an actual compelling reason to switch to individual funds.

Another advantage of switching to individual funds is that I could better control where I put bonds vs equities (in taxable or tax-advantaged accounts). Again, is there a calculator or way to figure out what that strategy could actually save me over a lifetime? I understand there's a benefit to it in theory, but again I am hoping to put an actual estimated amount on it.
You're welcome! I agree that it is very helpful to see actual numbers instead of a vague "some benefit". I am not aware of a calculator for tax efficiency of fund placement but maybe one exists. I've always just whipped up some calculations in a spreadsheet to model that.