Author Topic: My Taxable Asset Allocation: 100% Equities to...  (Read 7338 times)

Lifestyle Deflation

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My Taxable Asset Allocation: 100% Equities to...
« on: April 22, 2016, 10:23:22 AM »
Hi all, quick question about my asset allocation in my taxable accounts.

Right now, I have:
Vanguard Total Index VTSAX: $21,000 (65%)
Vanguard Int'l Index VTIAX: $11,200 (35%)

My question is around tax treatment and whether it makes sense to add bonds to a taxable account. I have bonds and tax-inefficient funds in my 401k and Roth IRA, so there's some degree of balance there (though it is weighted more towards equities to the tune of about 80% in my retirement accounts).

Should I keep with my 80%/20% asset allocation in taxable funds (and start buying bonds) or does it make sense to continue doing equities-only in my taxable accounts?

ColaMan

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Re: My Taxable Asset Allocation: 100% Equities to...
« Reply #1 on: April 22, 2016, 10:54:24 AM »
I see nothing wrong with equities only in the taxable accounts.  Evaluate your total asset allocation across all accounts to make sure that you are achieving your target (don't know if you're going for 80/20 overall, or some other weighting). 

MustacheAndaHalf

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Re: My Taxable Asset Allocation: 100% Equities to...
« Reply #2 on: April 22, 2016, 10:55:12 AM »
Depends on your tax bracket if tax-exempt bonds make sense.

I'd suggest bonds in the pre-tax 401k.  In a 401k (except for Roth 401k) you eventually pay ordinary income tax - just like you do on bond income.  So it defers that tax payment, without changing it.  Putting stocks in pre-tax raises your tax rate from long-term capital gains (and qualified dividends) to your ordinary tax rate in retirement.

Also bonds are expected to grow slower than stocks.  Growing your pre-tax 401k at an expected slower rate (not guaranteed) will tend to be less tax later.  Still, it helps to be able to rebalance so you might opt for some stocks mixed in with bonds.

As to tax rates, the median tax rate is 25%.  These two choices look rather close:
Total bond market has an SEC yield of 2.09% pre-tax, so taxed at 25% yields 1.57%.
Tax-exempt bond index shows an SEC yield of 1.56% without tax.

forummm

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Re: My Taxable Asset Allocation: 100% Equities to...
« Reply #3 on: April 22, 2016, 11:10:04 AM »
People generally advise keeping your bonds in a tax advantaged account because of the taxation of interest. If you need to sell something in your taxable you can always shift allocations in your tax advantaged to keep balanced.

Indexer

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Re: My Taxable Asset Allocation: 100% Equities to...
« Reply #4 on: April 23, 2016, 04:34:26 PM »
Keep your bonds in tax deferred accounts. I would say just keep doing what you are doing.

Those two funds are what I keep in my taxable.

ecomic

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Re: My Taxable Asset Allocation: 100% Equities to...
« Reply #5 on: April 24, 2016, 02:30:24 AM »
Careful with the bonds. As interst rates come from a very low rate and are progressively being rised by the fed, all these US bonds are going to lose some value. I would stick to equity for at least a couple of years.

NWOutlier

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Re: My Taxable Asset Allocation: 100% Equities to...
« Reply #6 on: April 24, 2016, 09:27:05 AM »
I'm 100% VTSAX in my taxable account while building wealth.

I'm spread over Fidelity Nasdaq type funds in my 401k and HSA, but items outside my work related accounts are Vanguard 94% VTSAX and 6% VGSLX (REIT) in my ROTH.

I'm pretty happy with heavy equities, not really interested in bonds yet.


humblefi

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Re: My Taxable Asset Allocation: 100% Equities to...
« Reply #7 on: April 24, 2016, 09:48:00 AM »
Should I keep with my 80%/20% asset allocation in taxable funds (and start buying bonds) or does it make sense to continue doing equities-only in my taxable accounts?

The most important question in my mind is: what is your asset allocation plan? If your plan is to be 100% equities and deal with the risk that comes with it, then what you have is one very good implementation of the plan. If you want to add a safety margin to  your asset allocation, then one way to do it is to add a percentage of bonds and cash. Stocks can take a 50% drop in value as we saw in 2008, bonds perhaps not that much, cash even less so.

That said, the main question backing many asset allocation plans (imo) is: when do you need the money back? If you do not need to use the money in your taxable account for the next 10 years, I would say 100% equities is good enough...10 years is reasonable for a bear+bull market cycle. If you need your money back in 5 years, then 100% equities is not a safe option...I would think of adding some safety to it.

Once you decide your asset allocation, as others have hinted at, you may want to look at tax efficient bonds (MUNI bonds if you are in the higher tax bracket). Refer to Tax Equivalent Yield Calculator for MUNIs.

Hope that helps.

Indexer

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Re: My Taxable Asset Allocation: 100% Equities to...
« Reply #8 on: April 24, 2016, 01:16:58 PM »
Careful with the bonds. As interst rates come from a very low rate and are progressively being rised by the fed, all these US bonds are going to lose some value. I would stick to equity for at least a couple of years.

Stocks can take a 50% drop in value as we saw in 2008, bonds perhaps not that much, cash even less so.

I just want to clarify something for both of you. You have bonds because they are a hedge. That is it. They aren't expected to grow as fast as stocks so you wouldn't have bonds for the returns. You also wouldn't forgo bonds as a way to lower risk. You want bonds because when stocks crash bonds typically rise. Cash doesn't even do that. A 75% stock/25% bond portfolio has higher expected returns and less volatility than a 75% stock/25% cash portfolio. This is true because the bonds normally grow faster than cash and they act as a better hedge against stocks than cash. In 2008 VBTLX was up about 5%. When stocks crash that is what you want to help smooth out your portfolio. Then when you rebalance you can plow that much more back into stocks.

Also look at historical returns. 100% stock portfolio averages 10%, but can drop 40-50% in 1 year. 60/40 averages about 9%, and can drop around 25% in a crash. You give up around 1% in annual returns to cut your worst year performance almost in half. That is why you have bonds.

If your AA should be 100% stocks stick with it, but if it should be 80/20 as already noted then stick with that.

As for where to put the bonds, try to keep them in tax deferred accounts.

Ursus Major

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Re: My Taxable Asset Allocation: 100% Equities to...
« Reply #9 on: April 24, 2016, 03:27:15 PM »
A 75% stock/25% bond portfolio has higher expected returns and less volatility than a 75% stock/25% cash portfolio. This is true because the bonds normally grow faster than cash and they act as a better hedge against stocks than cash.
I'm not sure that bonds will grow faster than cash in a rising rate environment. The past decades bonds have extraordinarily profited from declining interest rates, so I'm not sure how much we can extrapolate their behavior into the future.

Indexer

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Re: My Taxable Asset Allocation: 100% Equities to...
« Reply #10 on: April 24, 2016, 07:30:28 PM »
A 75% stock/25% bond portfolio has higher expected returns and less volatility than a 75% stock/25% cash portfolio. This is true because the bonds normally grow faster than cash and they act as a better hedge against stocks than cash.
I'm not sure that bonds will grow faster than cash in a rising rate environment. The past decades bonds have extraordinarily profited from declining interest rates, so I'm not sure how much we can extrapolate their behavior into the future.

I think you are overestimating the impact rising rates have on bond returns.

When interest rates go up the rates on newly issued bonds go up, and those tend to be higher than cash. I can't really imagine a scenario where banks would pay higher interest on deposit accounts than the rate on prevailing bonds.* Existing bonds take a hit in the short term as they are repriced with the new rates, but you still keep getting your income payments and as those bonds mature you get to replace them with new bonds with higher rates. Rising interest rates are normally a good thing for bonds long term.

A fund like VBTLX has a duration of 5.7 years. One way to look at that is that if rates rose 1% that fund might see roughly a 5.7% drop in principle, but you keep getting income. Now as the short term bonds in VBTLX mature(at PAR by the way) it goes and buys those newer bonds at higher rates. Over the long term those higher rates more than make up for the short term drop in market value. Studies have shown that if you plan on owning a bond fund longer than its duration, in this case 5.7 years, you actually benefit from rising rates. So if you own something like VBTLX and you plan to keep owning it you should welcome interest rates rising. If you do plan on owning bonds for a shorter period of time... switch to shorter term bonds. VBIRX has a duration of 2.7 years.

*The one scenario I can see cash earning more than bonds is in a negative interest rate environment. Bonds as we have seen can go negative. Banks are hesitant to charge depositors interest for their money because the customers can just take the cash out. Banks are more likely to keep deposit interest rates at 0%, and then charge other fees like overdraft fees, ATM fees, teller fees, etc. to cover the difference.

MustacheAndaHalf

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Re: My Taxable Asset Allocation: 100% Equities to...
« Reply #11 on: April 24, 2016, 11:15:13 PM »
If you want to think of bonds as reacting to interest ways in the same way, then you run into problems when you treat 2 yr bonds and 20 yr bonds the same.  For example, according to treasury.gov:
https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield
From April 1 - April 24, you see rates change, but not by the same amount:
2 yr rates rose from 0.76% to 0.84% (0.08%)
20 yr rates rose from 2.20% to 2.30% (0.10%)
Look for it in other time periods, and you'll see it again: short-term bonds and long-term bonds may or may not rise/fall by the same amount.  So if you say rates will rise, you have to say which rates for which bonds - sometimes the impact is even more varied than this recent example.

What you expect from the above is a duration multiplied by rate increase... 2 yr impacted 0.08% against you means you lose 0.08% / year, or 0.16%.  And for 20 year rates, 0.10% rise while your bonds went nowhere good means you lose 0.10% / year, or 2.00%.  The rate and the impact is very different for long-term and short-term bonds (in this example, treasuries).