Author Topic: Case Study: optimal asset allocation for tax efficiency  (Read 1702 times)


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Case Study: optimal asset allocation for tax efficiency
« on: February 03, 2015, 08:48:26 AM »
I'm looking for an optimal asset allocation of my portfolio given a few conditions, and was wondering if anyone would be willing to help. I will most certainly take out a chunk for a down payment on a house in the next 5-10 years. My FI target is 12-15 years, depending on market growth/ job timing/ significant other's prospects. I am very risk-tolerant due to my area of employment and skill set.

Assume none of the funds are placed yet, and I am targeting 54 domestic stock / 24 intl. stock / 20 domestic bonds (for an 80/20 balance).

~14k 401k
~35k rIRA
~5k taxable

Every year I will contribute these amounts.

~18k 401k (max)
~5500 rIRA (max)
~16k taxable (scaling up with raises)

I wonder what the value of the "tax-exempt bonds in taxable accounts" strategy is for the long haul? It seems fairly advantageous for 5-10 year windows where you know you will withdraw a large chunk for the down payment on your house (unless I'm missing something)... but at what point do the lower-return bonds start to impede growth? Perhaps after that 5-10 year milestone withdrawal, you stop buying tax-exempt and switch over to higher return bonds?

My 401k offers small/mid/large cap S&P 400/500/600 each at an ER of 0.72 (yuck), as well as a bond market index with 0.82 ER.

The tax-exempt bonds strategy is appealing to me for two reasons. 1) It effectively is a 'safety net' fund that is highly liquid 2) It can be used as a 5-10 year store for a down payment on the house which, when withdrawn, doesn't hit you with a whopper in taxes. That strategy is also not appealing to me for one reason, though... it seems silly to 'waste' rIRA tax-free growth on such low returns.

Another strategy is to minimize the crappy ER forced on me by the 401k. This also appeals to me due to the distribution of the rIRA. It's easy to move funds around, and I don't get 'stuck' with funds in taxable. 100% of the taxable funds are placed into tax-exempt bonds, which will eventually grow into a 6 month safety net (is this also a place where I should shove that down-payment fund?). It also places the highest-growth stock into the rIRA better than the above distributions. The remaining rIRA funds go into higher-yield bonds.

Code: [Select]
Taxable 401k rIRA Total %
Stock 0 14000 16128 30128 0.56
Intl. 0 0 12912 12912 0.24
Bonds 4800 0 5960 10760 0.2

The only downside I see to this placement is that my intl. funds, which are usually good for selling off in time of need (taking the foreign tax credit, and rebalancing), aren't readily available inside of a rIRA. Does this matter, though, if I have my 'sell if needed' inside tax-exempt bonds?

Thoughts? Am I overthinking it?
« Last Edit: February 04, 2015, 01:17:07 PM by lwhorton »

Cheddar Stacker

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Re: Case Study: optimal asset allocation for tax efficiency
« Reply #1 on: February 03, 2015, 03:36:24 PM »
That's a lot to chew on.

I don't like the first strategy at all, particularly if these are all tax exempt bonds. Are these all tax exempt bonds?

I like the last strategy the best, for the reasons you state. Specifically, it places the highest-growth stock into the rIRA.

I would use this as a simplistic model:

High growth stocks = Roth IRA
Taxable Bond/conservative stocks = Traditional (401k)
Tax Exempt Bond = Taxable

Expense ratios, specific goals (buying a house), and tax brackets will make a difference, but your last strategy seems to fit the mold the best IMO.


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Re: Case Study: optimal asset allocation for tax efficiency
« Reply #2 on: February 03, 2015, 03:56:42 PM »
Heh... I agree, I may have just barfed on my keyboard with this question and hit 'post'.

All the bonds listed would be tax-exempt if placed into taxable accounts, and a higher-yield bond if otherwise placed into tax-efficient accounts.