Asset allocation question

[gadoc]

Question regarding asset allocation. This is my set up currently

 

His 403B max out

His 457B max out

Her 401A about 18k

His roth IRA, haven't made any contributions to this since residency 3 years ago

HSA max

529 about 2k a month

200k in student loans, pay about 5-7k a month

200k in tax deferred accounts

10k in taxable account

100K in cash ( saving for house downpayment)

Vanguard taxable account VTSMX

 

My question is regarding asset allocation. I am currently 100% equity. I'm 31 y/o.  I know bonds are supposed to go into tax deferred and stocks into taxable.  I'm not sure I completely understand this when it comes to asset allocation. For example, if i went to 80/20 I would place 20% of my total assets into bonds in the tax deferred account. The only benefit to this would be it would hurt less if the stock market were to crash. But why should this matter to me if my bonds are in a tax deferred account and i wont be touching it for 25+ years?

 

The way I look at the situation is there are 2 buckets here. One for today's money and the other for retirement.  Should I have a seperate asset allocation for my retirement accounts and my non retirement accounts? For example if the market were to crash by 50% shouldnt I have some bonds in my taxable account to help soften the blow? Or is that the purpose of the emergency fund?

I hope this makes sense.

thanks

 

[Hatton]

The reason to own bonds is to act as a shock absorber when a crash or correction occurs.  Bonds in a taxable account should be muni bonds so you are not eaten alive by taxes.  I think of my taxable and tax deferred accounts as one big portfolio as far as asset allocation is concerned. If you are new to investing then you really don't know if you would panic and start selling into a crash.  I think it might be wise to have some small percentage of bonds until you are tested.

[Miss Bonnie MD]

You don't need bonds at your age or anytime soon.

[Slav4ikMD]

I've been asking myself the same question:  do I need to have ANY bonds being in my 30's.  If the market tanks and you have say 20% bonds, well guess what you are still tanking - just because you will crash by say 40% instead of 50% down, I don't think it will make a big difference psychologically in terms of having a temptation to sell.  I might be wrong of course.  Not sure.  Debating this myself and haven't read enough on the subject.

[gadoc]

That what i've been thinking. If my bonds are all in my tax advantaged account I will not be touching them anyways until i'm close to retirement so a market crash is irrelevant. I dont plan on selling any of my stocks in a market crash. I have good cash flow per month and have a sizable emergency fund. As i get closer to retirement age I think it makes more sense to own bonds as it gives you more security when you have a decreased monthly income.

 

 

[Antares]

I don't even like having bonds at 58. But I do, 25%. Maybe I'll like them better as the market crashes. But I've been there many times, I don't sell stocks in a down market, so the only advantage I feel is the ability to sell the bonds and buy stock on sale.

[nachos31]

gadoc wrote:

But why should this matter to me if my bonds are in a tax deferred account and i wont be touching it for 25+ years?

Click to expand...

gadoc wrote:

For example if the market were to crash by 50% shouldnt I have some bonds in my taxable account to help soften the blow? Or is that the purpose of the emergency fund?

Click to expand...

Look at your asset allocation as being a single asset allocation across all of your accounts. If you choose to have 20% bonds in your asset allocation, you do not need to have 20% of each account be bonds. Instead, you can think about tax efficient asset placement/location. Most believe that you want bonds in tax-deferred space due to them being tax-inefficient. WCI has some articles showing that bonds can actually make more sense going in taxable.

Bonds are a separate asset class that act differently from stocks. Not only can they "soften the blow," of a big drop in stocks, but they also give you a pool from which you can rebalance. Conventional wisdom (maybe wishing) suggests that if stocks did drop 40% then bonds/fixed income would hopefully go up, then you could sell some bonds (at a higher price) and buy more stocks (at a lower price). Not only are you getting back to your planned asset allocation, but you are doing it by selling something doing well at a high and buying at the low (behaviorally, the best way to go about that).

This pool from which you rebalance does not need to be in the same account (eg, taxable or tax-deferred) as the account in which you have stocks. If you have the bond allocation in your tax-deferred account and the market tanks as above in the theoretical situation and your stocks in your taxable take a huge hit. You sell bonds in your tax-deferred account and buy stocks within your tax-deferred account to get to your planned asset allocation. Then as you add more to your taxable account you can switch some stocks in tax-deferred back to bonds.

Your emergency fund is to cover other unexpected expenses like if your car needs repairs or your lose your job. It's not typically used to buoy your retirement portfolio. However, if you keep a stash of cash separate from your emergency fund to do that, then that is the fixed income portion of your portfolio. This cash is serving the same function as the bonds, except you are guaranteeing it has no chance of keeping pace with inflation. You can do that, but don't deceive yourself into believing that it's not essentially the same as owning bonds in your asset allocation.