Author Topic: Roth IRA Investments  (Read 7440 times)

zurich78

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Roth IRA Investments
« on: May 10, 2014, 08:48:19 AM »
Hey Guys-

Just curious.  What do you invest in with your Roth IRA account?  What are your thoughts on the best investments for a Roth IRA?

I have a Roth IRA and then a regular taxable account.  I don't know much about investing so my taxable account just utilizes a regular 3-fund portfolio approach (Total Stock, Int'l Stock, Bonds with 80/20 stocks/bonds allocation). 

But I have my Roth IRA in the exact same investments (same 3-fund portfolio) -- is this a bad approach?  Should I be diversifying more?  How would you approach investing in your Roth IRA separately from your taxable account(s), if at all differently?

Joel

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Re: Roth IRA Investments
« Reply #1 on: May 10, 2014, 08:51:21 AM »
It's best to put international stocks in your taxable account for the foreign tax credit, and bonds in your tax deferred accounts to avoid the interest and dividends being taxed at ordinary income rates.

Is there a reason you don't have a 401k or IRA? You probably should be taking advantage of the tax deferral unless you have a really low income now and expect it to increase significantly in the near future (ie you are in college and in the marginal 15% tax bracket)

I would poke around on the bogleheads wiki about tax efficient placement of funds.

zurich78

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Re: Roth IRA Investments
« Reply #2 on: May 10, 2014, 09:01:20 AM »
Thanks Joel!

I do have a 401K.  Again, because I'm new to investing, I have it in a target date retirement fund so I can set it and forget it.

I do not have an IRA.  The reason I've chosen not to have an IRA (I had one, and I rolled it all in to my 401K) is because I exceed the income limit for Roth contribution.  So I essentially use my tIRA to complete a backdoor Roth contribution every year and avoid pro rata.

I did poke around on bogleheads but I didn't see any specific investment recommendations (other than the total stock/int'l stock/bonds 3-fund approach which I mirrored in both my Roth and taxable accounts). 

So if you guys are doing something different with your Roth vs taxable, I'd love to see specifically what some of you guys are doing differently and why.

Joel

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Re: Roth IRA Investments
« Reply #3 on: May 10, 2014, 09:05:43 AM »
I have a pretty specific investment policy in the link in my signature. You could take a look at that to see exactly how I have it setup.

What is your marginal tax rate right now? You are probably better focusing on maxing out your tax deferred accounts ( 401k and IRA ) instead of doing the back door Roth and paying taxes now. For almost all people, their marginal tax rate upon retirement will be lower than it is now. At least until you have over 1 million in tax deferred savings accounts (or 50k+ in ordinary income upon retirement)

zurich78

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Re: Roth IRA Investments
« Reply #4 on: May 10, 2014, 09:23:49 AM »
My marginal tax rate is 28%.

So, what if I plan to work until 59.5?  The reason I've been doing Roth instead of tIRA, is I had planned to work until at least 59.5, and then withdraw my Roth earnings tax-free and put it somewhere else at that time.  And if I'm working still at 59.5, I'm assuming I'll be making at least what I'm making today.

I took a look at your link.  Ok, I think what I have been misunderstanding is that I've been treating my accounts as separate accounts but what it looks like you assume everything is in one physical account and then allocate accordingly.  Do I have that right?

So if I want a 80% stock/bond allocation for instance, and let's say I have $100K combined in my Roth and taxable accounts, I would make sure I have 20K all in bonds in my Roth and then 80K in my taxable?

I'm sorry, these are probably such newb questions but I've never taken control of my finances until this year and this site is helping me learn a LOT.

Joel

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Re: Roth IRA Investments
« Reply #5 on: May 10, 2014, 09:32:05 AM »
Correct. You want to consider all of your accounts and the asset allocation as a whole. So if you want 80%/20%. You should put the 20% bond allocation into your tax deferred accounts, preferably your 401k or Traditional IRA. Then depending on how much of that 80% you want to be in international stocks, those should be in your taxable accounts. Your stocks should fill in the rest. From a tax efficiency stand point, you want to consider all accounts as one, as opposed to making this allocation in each individual account.

Regarding traditional vs. roth, if you are in the 28% marginal tax rate now, you should be maximizing your 401k and IRA contributions before contributing anything to the Roth. The 28% marginal tax rate means your taxable income exceeds $90k if you are single. that means it's more like $100k once you include your standard deduction and exemption. This number is higher if you are married, but let's run the numbers as single to prove my point. You will need $2.5 million in order to have a 28% marginal tax rate upon retirement. ($100k / 4% = $2.5 million) So in theory, you would want to have $2.5 million in tax deferred accounts before you need to worry about putting money into roth accounts. My point is that you should absolutely be taking advantage of the tax-deferred accounts at your marginal tax rate. Save the taxes now, they will be practically guaranteed lower upon retirement. Regardless of when you plan to retire.

aj_yooper

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Re: Roth IRA Investments
« Reply #6 on: May 10, 2014, 09:36:41 AM »
zurich78, you got it.  First, establish your asset allocation policy (AA).  Then, place your least tax efficient assets in the tax advantaged accounts, 401K, tIRA, HSA (location).  In our Roths, we have REITs and small cap value.

Why would you cash out Roths when your retire?  Take the money out only if you need to spend it.  If you take it out of the Roth, you then lose the tax free benefit of the account, e.g., if you decide to put it into a taxable account or use it to buy real estate.

zurich78

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Re: Roth IRA Investments
« Reply #7 on: May 10, 2014, 09:44:44 AM »
Awesome feedback guys.  Thanks!  Ok, so how would I handle a situation like this?

I have $125K in my 401K (only thing other than an Emergency Fund and some random savings and checking accounts I had this time last year).

I have $15K in my Roth.

I have $10K in my taxable account (I just started it).

If this were you, and you wanted 80/20 allocation, you would...

- Put 100% of the taxable account in stocks.
- Put 100% of the Roth in bonds
- Put 88% of the 401K ($110K) in to stocks and the remaining 12% of the 401K ($15K) in bonds.

That would give me...

- $120K in stocks, and $30K in bonds (80/20)

zurich78

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Re: Roth IRA Investments
« Reply #8 on: May 10, 2014, 09:49:07 AM »
zurich78, you got it.  First, establish your asset allocation policy (AA).  Then, place your least tax efficient assets in the tax advantaged accounts, 401K, tIRA, HSA (location).  In our Roths, we have REITs and small cap value.

Why would you cash out Roths when your retire?  Take the money out only if you need to spend it.  If you take it out of the Roth, you then lose the tax free benefit of the account, e.g., if you decide to put it into a taxable account or use it to buy real estate.

Ok, this is starting to make sense.

And the reason bonds are not as tax efficient as stocks, is because they typically pay dividends or interest which, in a taxable account you'd have to pay taxes on?  So if you keep them in a tax deferred account you can just re-invest them.

And for things like Total Int'l Stock Market index funds, they pay a foreign tax credit which is deductible and so you want that in your taxable accounts so you can claim the credit?  (Because if that was in your Roth, you couldn't as everything in there is non-deductible).

Phew.

Joel

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Re: Roth IRA Investments
« Reply #9 on: May 10, 2014, 10:16:01 AM »
First, do you want international stocks in your asset allocation?

Personally, I keep international stocks at 30% of my overall stock allocation. If you do want international stocks, they belong in your taxable account.

As far as where to put your bonds, personally, I would put them in my 401k or IRA, as they are likely going to get less of a return than stocks, and I like to put the funds that are going to grow the most in my roth accounts, which have already had the taxes paid on them. That is all tax-free growth, so why not have the funds you expect to grow the most in that account? I do not expect bonds to grow more than stocks in the future, and that's why my bonds are in my 401k or IRA.

Undecided

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Re: Roth IRA Investments
« Reply #10 on: May 11, 2014, 10:39:11 PM »
It's best to put international stocks in your taxable account for the foreign tax credit ...

I see that repeated here, but it seems to me that it depends on the qualified/non-qualified dividends coming out of a particular international investment, and the investor's marginal tax rate.

MooseOutFront

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Re: Roth IRA Investments
« Reply #11 on: May 12, 2014, 01:45:03 PM »
I have REITs, Emerging Markets, and Small Cap Value in our roths.  A combo of the least tax efficient asset class and the highest expected growth asset classes.  My taxable investments aren't near big enough to hold all my international so that's not a consideration for me yet.

Davids

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Re: Roth IRA Investments
« Reply #12 on: May 12, 2014, 04:47:16 PM »
For my Roth I am pretty lazy and just do the Vanguard Target 2045 fund. Nothing wrong with it but I like the fund.

zurich78

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Re: Roth IRA Investments
« Reply #13 on: May 14, 2014, 10:55:59 AM »
First, do you want international stocks in your asset allocation?

Personally, I keep international stocks at 30% of my overall stock allocation. If you do want international stocks, they belong in your taxable account.

As far as where to put your bonds, personally, I would put them in my 401k or IRA, as they are likely going to get less of a return than stocks, and I like to put the funds that are going to grow the most in my roth accounts, which have already had the taxes paid on them. That is all tax-free growth, so why not have the funds you expect to grow the most in that account? I do not expect bonds to grow more than stocks in the future, and that's why my bonds are in my 401k or IRA.

Just curious -- some are recommending to consider my investment portfolio as a whole.  But, how do you factor in the advantages or disadvantages of each account type.  For instance, makes sense you want to put stocks in your Roth because it has the best chance to grow the most, but doesn't it also have the best chance to decline the most?  So now, you're not taking advantage of the tax free growth.  If you're going to lose money, wouldn't you want to lose money in a taxable investment account?

Or is this "playing to lose"?

aj_yooper

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Re: Roth IRA Investments
« Reply #14 on: May 14, 2014, 11:03:25 AM »
Yes, you could do that,e.g. tax loss harvesting.  Develop your own style.

zurich78

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Re: Roth IRA Investments
« Reply #15 on: May 14, 2014, 12:45:40 PM »
Yes, you could do that,e.g. tax loss harvesting.  Develop your own style.

Thanks.  I've been reading that a lot of people view their entire portfolio as one, but, I don't know, it doesn't seem like that makes a lot of sense UNLESS, the money in the entire portfolio is intended for one single purpose (i.e. FIRE or regular retirement).

When I think about my taxable investment account, I think of it as a backup to my savings or emergency fund.  In a way, more of a higher interest savings account I hope I never have to touch, but, if I do, I can.  So maybe I'll pull money out of there if I total my car and need to buy a new one.  Or, if I have a major home repair that I can't cover out of my regular savings which covers smaller unexpected costs (sub $2K costs).  I also want to have a little "play" money where I can invest in individual stocks that I like, and am willing to bear the risk of losing the money.

So maybe what I need to do, and please tell me if you guys think it's weird or a bad move ....

I need to either set up 2 taxable investment accounts as follows:

Taxable Investment Account 1 - Retirement
(Long-Term, Re-balance only; Do Not Sell; Consider part of retirement portfolio)
100% - Tax efficient fund placements such as int'l stocks

Taxable Investment Account 2 - Mid Term
(Backup to Emergency Fund; Touch only in case of emergencies or significantly large expenses)
100% - 3-fund portfolio (Total Stock/Int'l Stock/Bonds)

Taxable Investment Account 3 - Play Money
(For individual stocks that I'm personally interested in, in the long haul, but willing to incur greater risk here)
100% individual stocks

So I would group "Taxable Investment Account 1" in with my "retirement" portfolio, and consider Account 2 and 3 separately as part of my "investments" portfolio. 

Joel

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Re: Roth IRA Investments
« Reply #16 on: May 16, 2014, 12:44:19 PM »
Ultimately it's all your money. Think of it as one big pot, with each account having specific benefits and requirements. You have to work around the requirements, but if you need money you pull it from the account that allows it and then reallocate the rest of your investments again. If I needed to withdraw from my taxable account, I would then reaves listed my overall allocation. And yes, in the long term I am betting that stocks will have the most growth. It's very unlikely that over a long term period they would have the largest drop of the 3. Keep in mind we are talking a diversified total stock market index fund, that's about as safe as you can get when investing in stocks.

zurich78

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Re: Roth IRA Investments
« Reply #17 on: May 16, 2014, 04:15:06 PM »
Ultimately it's all your money. Think of it as one big pot, with each account having specific benefits and requirements. You have to work around the requirements, but if you need money you pull it from the account that allows it and then reallocate the rest of your investments again. If I needed to withdraw from my taxable account, I would then reaves listed my overall allocation. And yes, in the long term I am betting that stocks will have the most growth. It's very unlikely that over a long term period they would have the largest drop of the 3. Keep in mind we are talking a diversified total stock market index fund, that's about as safe as you can get when investing in stocks.

Ok, really appreciate the feedback.  Just curious .... with index funds, how is it possible that they always go up?  So, right now, I have some investments in Fidelity Spartan Total Stock Market fund and it's trading at around $55/share.  I mean, do index funds "split" like stocks?  How can they always go up?  That would mean at some point they'd cost hundreds if not thousands of dollars per share, right?

Joel

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Re: Roth IRA Investments
« Reply #18 on: May 16, 2014, 09:48:12 PM »
It's not that they always go up, especially if you are looking short term, but in the long term they generally do. And yes one method of lowering the share price is to do a stock split, but many shares you can buy partial shares.