Allocations and 401(k)

This is a follow-up to my previous messages on setting up my accounts. For brevity I won't rehash previous information.

Anyway, I've decided to treat all accounts as one big one, and created a spreadsheet to manage all. That means that all the bond exposure will go into the 401(k), which will be about half of the that accounts funds currently. Now I have to figure out which other things should be in there. I'll list my planned allocations and the available funds in the

401(k). Any thoughts would be appreciated.

Bonds(30%) Stocks(70%): International Equity Large Cap 15.00% Large Value 20.00% Small Cap 10.00% Small Value 10.00% REIT 10.00% Commodities 5.00% Total 70.00% International Equity 30.00% Large Cap 5.00% Large Value 5.00% Small Cap 5.00% Small Value 5.00% Emerging Markets 5.00% REIT 5.00% Total 30.00%

Fund Annual Fund Management Other Per Fees Expenses Total $1,000 Lifecycle Funds: Lifecycle Retirement Fund 0.4900% 0.0671% 0.5571% $5.57 Lifecycle 2010 Fund 0.4900% 0.0543% 0.5443% $5.44 Lifecycle 2020 Fund 0.4900% 0.0489% 0.5389% $5.39 Lifecycle 2030 Fund 0.4900% 0.0602% 0.5502% $5.50 Lifecycle 2040 Fund 0.4900% 0.0646% 0.5546% $5.55

Index Funds: Bond Market Index Fund 0.0120% 0.0690% 0.0810% $0.81 Balanced Index Fund 0.0110% 0.0516% 0.0626% $0.63 (S&P 500 Index Fund [60%] Bond Market Index Fund [40%]) S&P 500 Index Fund 0.0100% 0.0402% 0.0502% $0.50 International Index Fund 0.0350% 0.0817% 0.1167% $1.17 Russell 2000 Index Fund 0.0220% 0.0378% 0.0598% $0.60

Actively Managed Funds: Stable Value Fund 0.1731% 0.0394% 0.2125% $2.12 Large Companies Value Fund 0.2400% 0.0400% 0.2800% $2.80 Large Companies Core Fund 0.3000% 0.1893% 0.4893% $4.89 Large Companies Growth Fund 0.3600% 0.0458% 0.4058% $4.06 Large Companies International Fund 0.4500% 0.1808% 0.6308% $6.31 Small/Mid Companies Value Fund 0.5800% 0.0499% 0.6299% $6.30 Small/Mid Companies Growth Fund 0.7300% 0.0454% 0.7754% $7.75 Science & Technology Fund 0.5625% 0.0395% 0.6020% $6.02

Other: Company Stock Fund 0.0112% 0.0373% 0.0485% $0.48

Brian

Reply to
Default User
Loading thread data ...

Brian- It's not clear to me what you are asking for.

jIM

Reply to
jIM

I've shown my desired overall asset allocation. A bit more than half of all investment funds are in a 401(k). All my bond allocation will go in there, which uses up about half the funds there. So what should the remaining 401(k) funds be used for within the overall allocation. Not all categories are available in the 401(k), so there's a list of what is available.

Sorry for any confusion.

Brian

Reply to
Default User

Only piece I saw missing was the REIT fund and maybe the international small cap.

In this case Ignore the REIT and add to the domestic large cap position for 401k. For international small cap and emerging markets, just add this position into a total international index position. You'll have some of the style box covered with the index, then use other accounts to diversify appropriately.

IMO, I think your allocation is very detailed. Get a more general allocation and it might be easier to apply a general allocation to the situation.

General like 70% equity-30% bond or General like 40% domestic equity, 30% international equity, 30% bond.

Then choose 40% domestic funds in 401k Then choose 30% international equity in 401k Then choose 30% bond in 401k.

If you are missing a desired piece, use the IRA to add this piece in.

My IRA is much more diversified and specific than my 401k.

For example, my 401k has only 1 international fund, where as my IRA has 5 international funds.

401k has international value Roth IRA has international value, international growth, world technology, small cap and emerging markets.
Reply to
jIM

There's no explict Emerging Market, although the Large Companies International Fund is about 25% EM (it's the Julius Baer II). Also not available in the 401(k) are the US Small Value, Commodities, International Large Value (except as may be part of the LCIF), and International Small Value

I'm sticking to index funds where possible, and the S&P Index wouldn't be a good candidate for a tax-advantaged account, I think.

I'm not trying to get that allocation scheme just for the 401(k), but spread the scheme over all accounts. I want to cover things as specifically as possible, so if something is unavailable in the 401(k) it will be taken care of in the external account.

That information is in the list I provided, if you knock out the subcategories (and I realize I made a mistake, listing International Equity twice), so:

Bonds(30%) Stocks(70%) Domestic 70.00% International 30.00%

However, the specifics are what I'm after. That is, which of my available funds in the 401(k) are best to use achieve some aspect of the overall allocation, either due its tax-deferred status or the lower expenses. For instance, all the bond exposure for the entire portfolio will be in the 401(k), accounting for about half its money. So the other half needs to cover some allocations from the list.

I fear I'm not explaining things well.

Brian

Reply to
Default User

I've caught what you are trying to do, I think you are trying to put a round peg into a square hole.

With a heavy enough hammer, anything is possible.

Index funds inside 401ks are OK. I think you are letting the account type tail waive the selection dog.

You need to have an allocation. From what I've read you know what this is.

Having two distinct large cap indexes (one value, one growth) seems overkill to me... why not just get one extended market index fund and be done with choices? If you are trying to stick with index funds, then keep it simple, choose a broad index fund, and let that fill 2 or

4 of the style boxes (extended/total market would fill 4, S&P 500 index would fill only two).

With International, use the broad international fund in the 401k, then be done with selections.

If you want a REIT fund in 401k, but 401k does not have one, then I think you need to re-evaluate what you are doing.

I think the IRA should be the core allocation you are after. The 401k compliments this- even if the 401k has more money.

Here's my logic:

The IRA will last your whole life if you do things right. You may have 4-5 401ks in your life, and you'll roll these into the IRA when you switch jobs. The IRA is the true core, even if the amount in it now is smaller.

So the allocation for the IRA can be quite specific.

10% large value 10% small value 10% large growth 10% small growth 5% REIT 20% bond 10% international value 10% international growth 5% emerging market 10% cash

or whatever it is you've already figured out.

The 401k compliments this closely, but based on selections might not be exact. make 401k 20% large cap- S&P 500 index would be good enough, for example (most 401ks have this), then 20% small cap (choose best small cap fund in 401k, or extended market index), 20% broad international fund. If no Emerging markets fund, or REIT fund or cash choice was available, make a guess (like move cash into a bond index fund, move REIT into an equity income fund...).

IMO you have paralysis from analysis. You have gone so deep in the forest you only see the trees, but cannot see the forest.

I hope my comments help, I am not trying to confuse you.

Reply to
jIM

Well, I probably won't. I've been with this company 26 years.

I have little in the way of IRA capacity, only about 10% of the funds outside of the 401(k). That's why I've decided not to just try to apply the asset allocation scheme separately to the 401(k) and the other accounts. So, for instance, all the bonds go into the 401(k). I'll put what REITs I can into the available Roth space.

:)

I hope not. I'm finishing up the overall strategy.

Brian

Reply to
Default User

  • 55% 401K
  • 5% Roth IRA
  • 40% Taxable

Let's tackle the easy part first:

  • 5% Roth IRA
- REITs
  • 30% 401K - Total Bond Market

Leaving you with available space:

  • 25% 401K
  • 40% Taxable

Value fund are less tax efficient than Growth or Blend so now let's fill in your 401K with LCV and SCV with taxable holding the remainder.

  • 14% 401K - Large Value
  • 7% 401K - Small Value
  • 10.5% Taxable - Large Blend
  • 7% Taxable - Small Blend
  • 3.5% Taxable - Intl Large Blend
  • 3.5% Taxable - Intl Large Value
  • 3.5% Taxable - Intl Small Blend
  • 3.5% Taxable - Intl Small Value
  • 3.5% Taxable - Intl RE
  • 3.5% Taxable - Emerging Markets
  • 3.5% Taxable - Commodities

To be honest, that taxable portion now looks a bit ugly and rebalancing would be tax inefficient. We can approximate it by collapsing a few classes together and then offset with the available

401K 4%:
  • 12% Taxable - Total Stock Market
  • 12% Taxable - EAFE
  • 4% Taxable - Emerging Markets
  • 4% Taxable - Intl Small Value
  • 4% Taxable - Intl RE
  • 4% Taxable - Commodities

Putting it all together, we end up with the following percentages that will be close enough to your original plan:

  • 5% Roth IRA
- REITs
  • 30% 401K - Bonds (Bond Market Index)
  • 14% 401K - Large Value
  • 7% 401K - Small Value
  • 4% 401K - Small Blend (Russell 2000)
  • 24% Taxable - Global Market
  • 4% Taxable - Emerging Markets
  • 4% Taxable - Intl Small Value
  • 4% Taxable - Intl RE
  • 4% Taxable - Commodities
Reply to
wyu

Is this true? I would have thought that growth funds would be less tax efficient than value funds due to higher turnover. ?

-Will

Reply to
Will Trice

Value funds probably have consistent dividends, where as a growth index probably would not have much turnover.

Reply to
jIM

Default User prefers index funds so there is no turnover. Hence it is only the dividend yield that counts. Value funds are 1.5%-2.5% compared to 0.5% for growth funds.

For actively-managed funds, you could find *some* value funds that keep their turnover down but it's hit and miss. I was in Mutual Qualified (LCV) for a decade and it had not only a decent dividend rate but plenty cap gain distributions.

Reply to
wyu

Don't index funds still have the turnover from the companies being added/deleted to/from the index? Small %, I agree, for some indexes, but wouldn't even an SPY have a cap gain distribution based on that turnover? JOE

Reply to
joetaxpayer

I wonder how you came to put all your bonds in the 401k. As you roll forward 5, 10+ years, will that still make sense? Keep in mind the "tax events" aren't just fund distributions, there's also the inevitable sales for rebalancing & changes in asset-class mix as you enter retirement and draw from the accounts.

Example for one asset class (Lipper data reported in WSJ.com) - for the period ending 9/30/07, Intermediate-term bond funds returned 3.88%, annualized, over the past 5 years (21% total return, before tax). Emerging Markets returned 36.79%, annualized, over the same period (379% total return, before tax).

So just look at those two pieces of your allocation, imagining you'd done this 5 years ago and gone with bonds in 401k, EM in taxable accounts. You'd be 5 years closer to retirement and might want to pare back your EM fund, because it's well over your 5% target allocation, or because you want to shift to a lower-risk asset allocation, or both. But that would trigger substantial, taxable gains...perhaps more "tax drag" than all those years of bond interest combined? Plus, all that growth happened outside the tax-advantaged accounts so less of your net worth, as a percentage, is in a 401k/Roth.

That's the basic idea and you'd need to look at each asset class and make similar comparisons. Point being, in today's low-yield world...is avoiding tax on ~4-5% interest the best use of a 401k's tax deferral? Not just this year, but over the looooong life of these investments?

Also...part of the decision relies on the low rate on long-term capital gains. It's worth considering the possibility that capital gains rates will be higher in the future - they're historically low now.

-Tad

Reply to
Tad Borek

Two things. The EE is still only 5% of the overall, versus 30% for the bonds.

Also, there isn't an EE fund available in the 401(k). The closest I can get is with the actively managed Large International, which shows about

25% in EE.

If I try to use that fund, then I have to change my allocations somewhat. I'd planned International Large, Int Large Value, and EE all at 5% of the equity portion. I'm not even sure how the rest of the fund breaks down as far as growth/value. The info sheet shows regional information. I assume that it's essentially JETIX which is listed as "Foreign Large Blend".

Brian

Reply to
Default User

On this first point - EM was just an example, it applies to others too. The problem is that the bonds just aren't going to grow much, barring substantial changes in interest rates. It's just not possible. You listed many other asset classes with higher expected returns. If they grow as expected over the long term, your mix is going to get out of whack because of that "dead money" (relatively speaking) in the 401k. And selling is going to trigger taxes that may be much larger in magnitude than the taxes you're avoiding on the bonds.

Take the five-years-ago example and start with $100k...$5k in EM, 30k Intermediate bonds, 25k International, 40k S&P 500 and use the lipper data I mentioned before for these categories. Ignoring taxes, the returns in each (5-yr annualized) were 36.79%, 3.88%, 22.62%, and

14.84%. This is an example of a strong period for stocks and a weak one for bonds so it skews the example, of course, but it makes the point.

Still ignoring taxes I think (check my math) you'd have ended up with $23,950, $36,300, $69,300, and $79,900 for those four asset classes, respectively - total of $209,450. But now you have 11% EM, 17% bonds,

33% Intl, 38% S&P which is way off the original target. And it's 5 years closer to retirement so maybe you're shooting for more like 60/40 now? If so you'd need to do a lot of selling. 60/40 would require about 48k shifted from stocks to bonds, with perhaps 10k of realized/taxable gains just from EM? But at least your 3.88% on bonds ($6300 over five years) wasn't taxed. Hmmm.

And of course, this is after only 5 years - you can imagine how it could look after 10, 15 year periods.

You mentioned fund availability as a limiting factor in the 401k - it usually is...but consider whether this same issue applies in other asset classes. Also...if the whole point is tax deferral with bonds, what about savings bonds or Munis rather than the 401k?

-Tad

Reply to
Tad Borek

Ok, there's a tiny bit of turnover but for most broad-based indexes, it's neglible. Often it is zero with offsets from losses in previous years. I'm in 8 different Vanguard stock index funds and not a single one of them had capital gain distributions last year. Index ETFs would be even more efficient that index funds since other shareholders selling would not cause turnover.

Reply to
wyu

Or IMO, today's "low tax rates on stock dividends and capital gains world." :-)

I have not checked all your math, but the general result is consistent with the point Joetaxpayer and others make here often lately: Taxing withdrawals from one's 401(k) at ordinary income tax rates combined with the current low tax rates on dividends and capital gains frequently argues for using taxable accounts instead of 401(k)s. (Of course, the matching of 401(k)'s still means one should contribute up to the match of 401(k)'s. But after the match? This is definitely something each individual should consider carefully.)

Reply to
Elle

Since I love to run numbers, let's do a 20 year project based on increasing tax rates. In the first case run, both income and cap gain taxes increase at 0.5% a year.

Option 1:

401K: 50K Bonds 5% return 5% yield tax: year 1 = 30% increasing to year 20 = 39.5% after tax balance: 80K

Taxable: 50K Stocks 10% return 2% yield tax: year 1 = 22.5% increasing to year 20 = 32% after tax balance: 235K

Combined Total: 315K

Option 2:

401K: 50K Stocks 10% return tax: year 1 = 30% increasing to year 20 = 39.5% after tax balance: 203K

Taxable: 50K Bonds 5% return 5% yield tax: year 1 = 30% increasing to year 20 = 39.5% after tax balance: 95K

Combined Total: 298K

Bonds in 401K/stocks in taxable continue to do better than the inverse. Now let's see what happens if capital gain taxes increase faster than income taxes until they both hit the same 39.5% in year

  1. Taxable: 50K Stocks 10% return 2% yield tax: year 1 = 22.5% increasing to year 20 = 39.5% after tax balance: 216K

Combined Total: 296K

296K just about matches the 298K number from holding stocks in 401K and bonds in taxable. So if the yield remains the same, it would take elimination of the LTCG/QDIV rate at the end of the 20 year period. Now let's see what happens if the yield also increases to 5% by the 20 year period.

Taxable: 50K Stocks 10% return yield: year 1 = 2% increasing to year 20 = 5% tax: year 1 = 22.5% increasing to year 20 = 39.5% after tax balance: 212K

Combined Total: 292K

2% downside if both yields & tax rates turn against you. 6% upside if today's favorable conditions for stocks in taxable accounts remain in place.
Reply to
wyu

wrote

I think I understand why you are putting some emphasis on stock yields (= dividend rate). It's because the tax rate is often different on dividends than it is on capital gains. But the notion that yields rise over the 20 years seems a bit off. Also, I am not sure whether you are combining principal returns and dividend yields to get total return; if you are, that also seems off.

First, it's true that historically, the S&P 500's dividend yield has averaged about 4-5%. But the dividend yield has been below 3% for about the last twenty years.Second, the much quoted historical return on stocks of about 10% already takes into account the dividend yield. Lastly, in general when dividend yield rises, the stock market has declined, lowering cap gain returns. Thus any scenario you list where stock return and yield exceed about 10% seems unrealistic.

So many unknowns exist that I might not lose too much sleep over any of the options you listed. Perhaps one should go with the one that seems best and be prepared to adjust.

First and foremost, always live within one's means, and always plan for disaster, be it retirement needs or unexpected illness.

Reply to
Elle

You are reading way too much into my simple announcement of the parameters of each scenario. I did not combine both return and yield together. The yield number was simply to describe how much of the return was taxable each year versus how much was deferred until time of sale. I absolutely did not combine return + yield together. Look at the bond parameters where I state 5% return + 5% yield. If it was combined together, the bond numbers would be way higher.

Reply to
wyu

BeanSmart website is not affiliated with any of the manufacturers or service providers discussed here. All logos and trade names are the property of their respective owners.