First time investor question(s)

[ukuleledad]

Hello folks,

 

Not sure if it's good timing to post here on election night or not, but here goes.....

We're not young anymore and finally trying to save aggressively. Our goal is a 35% savings rate. With those savings 19% would be in 401k, 12% in rIRA, and 69% taxable.

I've posted here before and have been reading a bit and now my wife and I are digging into the investing game pretty much for the first time and could use some advice. We've recently opened a traditional IRA through Vanguard and are about to pull the trigger on converting those funds over to a Roth IRA. That's the easy part, from what I understand. What seems to be a matter of personal preference and to which there is no simple "follow these steps..." answer is the subject of asset allocation. I've read a number of posts on this and have gotten through most of a recommended investment book, so for anyone who has the time and inclination I'll post what we have in place and what our investment plan is and if you'd like to chime in with a thumbs up or thumbs down with a sprinkle of advice thrown in I'd sure appreciate it.

We're thinking about this for asset allocation:

35% Lg cap stocks, 20% Small Stocks, 20% International stocks, and 25% US Bonds (we have a percentage of this as Cash Equivalent in a 401k as you'll see below)

My wife started a new job a year ago and recently opened up a 401k as she became eligible to do so. She rolled her previous 401k earnings from her previous job ($183,637) into the new one. When she signed up for the 401k through The Standard we decided to choose one of their asset allocator portfolios. It breaks down like this: 30% Cash Equivalent, 30% Large Cap Stocks, 30% Small/Mid Cap Stocks, and 10% International Stocks. Not sure if we want to keep that 30% Cash Equivalent as is or put that into Bonds.

In any case, that's one piece of the puzzle. In regards to the backdoor Roth, we're thinking of doing the following:

Her rIRA: made up of 70% Vanguard total bond market index fund and the other 30% Vanguard total international stock market index fund

My rIRA: made of 50% Vanguard total bond market fund, the other 50% Vanguard small cap index fund

Lastly, the biggest piece of the puzzle will be our taxable account, broken down like this:

18% Bonds, 42% Large cap index fund, 16% Small cap index fund, and 24% International stocks

All of these percentages when looking at the big picture across all accounts comes out to our previously stated asset allocation of 35% Lg cap stocks, 20% Small Stocks, 20% International stocks, and 25% US Bonds.

How does this look to you folks? Should we change anything? Scrap the whole shebang and start from scratch? Fine tune here and there? Thanks in advance, and happy voting day.

 

[ENT Doc]

Seems heavy small, or did you lump mid and small in together?  To put things in perspective VTSAX has a 3:1 ratio of giant/large to mid/small.  While this depends on your tax rate now and in the future you may want to consider putting your bond allocation in her 401k.  I would put international in taxable so you can benefit from the tax credit.  That asset allocation analyzer looks weird - 30% in cash equivalents and no bonds?  Seems strange.

[Peds]

no bonds in rIRA.

[White.Beard.Doc]

It sounds like your investments are very heavy in bonds and cash equivalents.  How many years are you from your planned retirement?  Unless you are very close, this sounds like too much of a conservative asset allocation for good long-term growth.

I feel like I am a very conservative investor.  I am planning to retire in nine years. I have 10% of my net worth in cash equivalents, 5% in bonds, and 25% in real estate which performs similar to bonds.  You are probably younger than I am, and yet you have a much more conservative asset allocation.

With a higher cash allocation and bond allocation, you do have a lower risk portfolio in terms of avoiding losses, but you also give up a lot of potential growth if you have enough of a timeline ahead of you to weather the ups and downs of the market.

[ukuleledad]

ENT Doc wrote:

Seems heavy small, or did you lump mid and small in together?  To put things in perspective VTSAX has a 3:1 ratio of giant/large to mid/small.  While this depends on your tax rate now and in the future you may want to consider putting your bond allocation in her 401k.  I would put international in taxable so you can benefit from the tax credit.  That asset allocation analyzer looks weird – 30% in cash equivalents and no bonds?  Seems strange.

Click to expand...

Thanks for the feedback.

In the 401k portfolio we chose small and mid are lumped in together, but outside the 401k I was solely focusing on small (20%) and large (35%). I'll do more research in regards to finding a better ratio while including mid size.

I only know the bare minimum at this point about investing and yet I also thought it a bit strange that the 401k asset allocator portfolio has 30% in cash equivalents (still trying to figure out exactly what that is) and no bonds. We were presented with six asset allocator portfolios and, not knowing anything at the time, we took their quick, little assessment to determine which portfolio to choose. The only two portfolios that contain any percentage of bonds also contain a much higher percentage of cash equivalent. For example; Portfolio 1 has 50% cash equivalent, 20% Bonds, 10% lg, 5% small, 5% international and 10% other. In any case, I do think the more confident and educated I become the more I will take this portfolio under my control and adjust the bonds vs cash equivalent ratio.

I have a good chunk of international already assigned to the taxable account but some in the rIRA as well. You're saying put all international into taxable?

Looking back on my original post I think I laid it out in a much more confusing way than it needed to be. So again, thanks for taking the time to provide feedback.

[ukuleledad]

Peds wrote:

no bonds in rIRA.

Click to expand...

Thanks for the advice!

I was reading a Bogleheads post about investment planning in which it was recommended to "put the most tax-inefficient funds in your tax-deferred and tax-free accounts." The post then goes on to list securities in order of their tax-efficiency. Hi-Yield Bonds and Taxable Bonds were listed as the least tax efficient and EE and I-Bonds and Tax-Exempt Bonds were listed as the most tax efficient. I clearly need to educate myself more about bonds.

ENT doc recommended that I think about putting the bonds into my wife's 401k.

 

[ukuleledad]

White.Beard.Doc wrote:

It sounds like your investments are very heavy in bonds and cash equivalents.  How many years are you from your planned retirement?  Unless you are very close, this sounds like too much of a conservative asset allocation for good long-term growth.

I feel like I am a very conservative investor.  I am planning to retire in nine years. I have 10% of my net worth in cash equivalents, 5% in bonds, and 25% in real estate which performs similar to bonds.  You are probably younger than I am, and yet you have a much more conservative asset allocation.

With a higher cash allocation and bond allocation, you do have a lower risk portfolio in terms of avoiding losses, but you also give up a lot of potential growth if you have enough of a timeline ahead of you to weather the ups and downs of the market.

Click to expand...

Thanks very much for the feedback.

As it stands at the moment, we have a total of 6% cash equivalents (and I'm still not sure what exactly that means) and 19% bonds.

I am 48 and my wife, who brings home the bacon, is 49. The plan is for her to retire in 18 years. In the meantime I just started working as an independent contractor so that might open things up a little for us financially but we're not counting on it just yet.

I've always taken the "put my money under my mattress" approach to finance, and getting involved in investing has always scared me. I've finally decided to put on my big boy pants and wade in the water. But yeah, at this point I'd consider myself a very conservative investor. That might change as I become more confident and educated.

[ENT Doc]

ukuleledad wrote:

ENT Doc wrote:

Seems heavy small, or did you lump mid and small in together?  To put things in perspective VTSAX has a 3:1 ratio of giant/large to mid/small.  While this depends on your tax rate now and in the future you may want to consider putting your bond allocation in her 401k.  I would put international in taxable so you can benefit from the tax credit.  That asset allocation analyzer looks weird – 30% in cash equivalents and no bonds?  Seems strange.

Click to expand…

Thanks for the feedback.

In the 401k portfolio we chose small and mid are lumped in together, but outside the 401k I was solely focusing on small (20%) and large (35%). I’ll do more research in regards to finding a better ratio while including mid size.

I only know the bare minimum at this point about investing and yet I also thought it a bit strange that the 401k asset allocator portfolio has 30% in cash equivalents (still trying to figure out exactly what that is) and no bonds. We were presented with six asset allocator portfolios and, not knowing anything at the time, we took their quick, little assessment to determine which portfolio to choose. The only two portfolios that contain any percentage of bonds also contain a much higher percentage of cash equivalent. For example; Portfolio 1 has 50% cash equivalent, 20% Bonds, 10% lg, 5% small, 5% international and 10% other. In any case, I do think the more confident and educated I become the more I will take this portfolio under my control and adjust the bonds vs cash equivalent ratio.

I have a good chunk of international already assigned to the taxable account but some in the rIRA as well. You’re saying put all international into taxable?

Looking back on my original post I think I laid it out in a much more confusing way than it needed to be. So again, thanks for taking the time to provide feedback.

Click to expand...

Try this one instead:

 

https://personal.vanguard.com/us/FundsInvQuestionnaire

[Peds]

ukuleledad wrote:

But yeah, at this point I’d consider myself a very conservative investor.

Click to expand...

75:25 is not a conservative AA for a 50yo. just fyi.

[DMFA]

Your bonds should not be in Roth; they should be in tax-deferred.  Don't let the tax tail wag the total return dog.

You want your highest-earning funds, like stocks, in Roth so you pay zero tax on them.  If your stocks earn 8% but your bonds earn 4%, and are taxed at 25% effective rate from a tax-deferred account like a 401(k), then stocks in Roth gets you 11% (8 + [.75 * 4]) and bonds in Roth gets you 10% (4 + [.75 * 8]).

On the other hand, bonds (other than munis) do poorly in taxable because they earn interest, which is taxed as income, so a bond with a 3% yield quickly becomes 2% or less at a higher bracket, never mind any capital appreciation which is taxed as capital gains rates.

75/25 is *not* conservative, by the way...but it's OK not to be conservative.  Keep in mind that over 19 years, however market cycles may work in the future, you might be better served to have a higher fixed-income portion since a major market loss near to retirement can significantly reduce your retirement income (or shorten the number of years you can use it) unless you have a longer time horizon in order to "ride it out."

See: https://www.bogleheads.org/wiki/Tax-efficient_fund_placement and an interesting perspective, "bonds go in taxable:" https://www.whitecoatinvestor.com/asset-location-bonds-go-in-taxable/

 

[Tim]

With being relatively new to allocations and opting toward lesser volatility using allocations, I would be concerned about the behavioral finance reactions with significant favorable and unfavorable periods.

Large, medium, small
US, Foreign developed, emerging markets
That’s 9 buckets to split just stocks.
Then the debt portion Corp, US gov & muni’s.

The stock/bond ratio is number 1, period.
https://personal.vanguard.com/us/insights/saving-investing/model-portfolio-allocations?lang=en
Bonds are the ballast. Lower gains or losses.
I have never heard a criticism of a 60/40 split.
If you can handle it, 70/30 works well too for a long term investor (which I suggest is not retirement but date of death).

The trade-off of concentrating stocks or bonds involves more than dividends. Capital gains , tax deferred growth, tax impacts of rebalancing and volatility of each account are difficult to digest when one account performs significantly different than the other. I would suggest the tax on the dividends is minor compared to the stability of each account.

Strongly suggest staying with 3 or 4 broad indexes.
These contain, large, mid cap and small. One what basis do you think separate will perform better? You have Total World or weighting by region if you wish US concentration like S&P 500. Once you have your bond allocation, choose the most beneficial for the bucket.

[ukuleledad]

Still trying to wrap my head around all the info.

So, I think at this point we're leaning towards 70% stocks and 30% bonds, which might look like this: 30% bonds, 34% large US stocks, 18% international, 18% small/mid.

19% of our total investments will be in 401k, 12% will be in Roth IRA, and 69% will be in taxable.

From what I gather so far, bonds should not go into the Roth IRA, they should go into the 401k (unless they are muni bonds), yes? Ok, so the 401k is 19% of our total investments. If we want to have 30% bonds overall do we just have the 401k consist of nothing but bonds and then have the remaining percentage of bonds (11%) be muni bonds and put those in taxable? Or is it better to have a more balanced 401k and mix in some stocks and increase the percentage of muni bonds in taxable?

It also seems that I should put international in taxable.

Thanks again for your help folks

[JBME]

yes, instead of thinking that your AA should be the same in 401k/Roth IRA/taxable, instead look at the big picture (the total amount in all 3 accounts) and then efficiently allocate. Bonds out of Roth IRA. Roth IRA should be tilted towards more risky investments (small/mid/emerging markets) since that money should, in the end, be used last, and therefore have the longest investment period. Bonds in tax-deferred space except muni bonds, which should be in taxable, yes. Yes, put some international in taxable b/c you're likely to pay some taxes on that money (taxes on any dividends from it) and it may qualify you for a $300 foreign tax credit at tax time.

Bottom line, if you want 30% in bonds and your total portfolio today across the three accounts is $300k, then you have $57,000 in your 401k but want $90,000 in bonds. So in this simplistic scenario, make 100% of the 401k in bonds, and then another $33k in muni bonds in your taxable account. Your taxable account is $207k, so after $33k is in muni bonds, you have $174k left in there to put some international and large stocks (I assume you mean something like the Vanguard Total Stock Market fund). Seems like if your Roth is 12% of your total and you want 18% in mid/small, your Roth IRA should only contain mid/small and then the rest in taxable.

[ukuleledad]

JBME wrote:

yes, instead of thinking that your AA should be the same in 401k/Roth IRA/taxable, instead look at the big picture (the total amount in all 3 accounts) and then efficiently allocate. Bonds out of Roth IRA. Roth IRA should be tilted towards more risky investments (small/mid/emerging markets) since that money should, in the end, be used last, and therefore have the longest investment period. Bonds in tax-deferred space except muni bonds, which should be in taxable, yes. Yes, put some international in taxable b/c you’re likely to pay some taxes on that money (taxes on any dividends from it) and it may qualify you for a $300 foreign tax credit at tax time.

Bottom line, if you want 30% in bonds and your total portfolio today across the three accounts is $300k, then you have $57,000 in your 401k but want $90,000 in bonds. So in this simplistic scenario, make 100% of the 401k in bonds, and then another $33k in muni bonds in your taxable account. Your taxable account is $207k, so after $33k is in muni bonds, you have $174k left in there to put some international and large stocks (I assume you mean something like the Vanguard Total Stock Market fund). Seems like if your Roth is 12% of your total and you want 18% in mid/small, your Roth IRA should only contain mid/small and then the rest in taxable.

Click to expand...

Thanks very much. That helps a lot!

Seems odd to me to have nothing but bonds in a 401k, but that's coming from someone who knows next to nothing about investing and up until this point just went with whatever was recommended by the company. Looking at spreading the assets out within three buckets (401k, Roth IRA & taxable) it makes more sense. I really appreciate your time.

[ukuleledad]

If anyone is still out there, my wife just got an email from her job about an additional  retirement option, a 457(b) plan. I'll include the email below, and we're meeting with a financial consultant tomorrow about this because they need our decision by end of day tomorrow, but I'd love to know what some of you think about this. The 457(b) seems to be an option in addition to my wife's existing 401k. If this is the case I would think that the best move would be to take some of the assets we plan to invest in a taxable account and allocate them to this 457(b)? Thoughts?

In any case, here is the email we received from my wife's job:

I’m excited to announce a new retirement benefit that we are offering only to the top income earners of the company.  This additional retirement option is a 457(b) plan.  The 457(b) plan is a type of non-qualified, tax advantaged deferred-compensation retirement plan that is available for non-governmental employers in the United States. You may defer compensation into it on a pre-tax or after-tax (Roth) basis. For the most part the plan operates similarly to a 401(k) plan. The key difference is that unlike a 401(k) plan, there is no 10% penalty for withdrawal before the age of 55 (59½ for IRA accounts) although the withdrawal is subject to ordinary income taxation.  Another key advantage of offering a 457(b) plan along with a 401(k) plan is that you may defer the legal maximum of $18,500 into both plans for 2018, or $19,000 for 2019.

 

We are eager to offer more benefits to our key employees, and just found out that we have a tiny window to get this retirement benefit in this calendar year.  If you want to contribute in 2018, we need your completed savings form (attached) by the end of the day on Friday, November 30.  If you are interested in learning more or participating in the 457(b) plan, Tom Fink, Financial Consultant, will be on our campus Friday afternoon to answer questions and give more information about your retirement options.  If tomorrow afternoon doesn’t work with your schedule, he will be happy to speak with you by phone.  You may also reach out to me with any questions.