Asset location question

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
Topic Author
Tom_T
Posts: 4837
Joined: Wed Aug 29, 2007 2:33 pm

Asset location question

Post by Tom_T »

I've often read that it's preferable to have bonds in an IRA and equities in taxable. I've also read that it's preferable to have equities in a Roth IRA because of tax-free growth. What would be an approach to allocating a portfolio across taxable, regular IRA, and Roth IRA? I am 62, so there are no age restrictions on withdrawals. I am in the 22 percent bracket. Total portfolio is less than a million.

My overall allocation is 60/40. Could I just simplify matters by keeping that allocation in each of the three accounts? Or, fill up Roth with equities, then regular IRA to fill out 60/40 allocation, and treat taxable as a separate beast?
livesoft
Posts: 86079
Joined: Thu Mar 01, 2007 7:00 pm

Re: Asset location question

Post by livesoft »

We are 60/40. Our 40% in fixed income can easily fit in our tax-deferred accounts since we have more than 40% of our portfolio in tax-deferred. That also means that we have equities in tax-deferred, Roth, and taxable. Is this clear?

BTW, rebalancing is totally simplified because we only need make exchanges in our largest tax-deferred account from equities to bonds or from bonds to equities in order to keep our entire portfolio at 60/40. The Roth IRAs and the taxable account need no transactions at all.*

*Except for tax-loss harvesting in the taxable account and having the dividends go to our checking account for expenses.
Last edited by livesoft on Fri Sep 24, 2021 7:29 am, edited 1 time in total.
Wiki This signature message sponsored by sscritic: Learn to fish.
User avatar
ruralavalon
Posts: 26353
Joined: Sat Feb 02, 2008 9:29 am
Location: Illinois

Re: Asset location question

Post by ruralavalon »

Our asset allocation is 50/50. My rollover IRA contains both bond and stock index funds, and our bond allocation is entirely in my rollover IRA. Our joint taxable account and two Roth IRAs are entirely in stock index funds.
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link: Bogleheads® investment philosophy
Nowizard
Posts: 4842
Joined: Tue Oct 23, 2007 5:33 pm

Re: Asset location question

Post by Nowizard »

Others will provide details and may ask for additional information. Ideally, you would make changes in asset location within either your Traditional or Roth-IRA since it would not incur taxation consequences. It does not matter other than for taxation where the stocks and bonds are located so long as the totals equal your chosen stock/bond ratio. One issue is the percentages of totals located in IRA's versus taxable accounts since that determines the degree of flexibility existing to make changes. You are correct that you want to minimize in most cases bonds in taxable accounts, though many have at least some bonds there for various reasons, attempting to avoid annual taxation as much as possible and escalation to a higher tax bracket based on interest and dividends from taxable assets. Some find that they have income that exceeds expenses after fully funding IRA's and have considerations of how to invest the remainder. One, common decision is to place those assets in their emergency fund or in stocks that do not pay dividends, knowing there is no taxation until the assets are sold. These are only a few considerations and individual circumstances are primary in decision making based on factors such as risk tolerance, tax bracket, need to take risk, etc.

Tim
Topic Author
Tom_T
Posts: 4837
Joined: Wed Aug 29, 2007 2:33 pm

Re: Asset location question

Post by Tom_T »

Taxable is 25% of the total in my situation. More accurately, it will be, as I have some windfall money coming. So, there's no consequence to making changes -- I'm determining how to allocate this new money in conjunction with my existing TD & Roth accounts. A few months' expenses will only be around two percent of the total, so the concept of an emergency fund isn't a factor.

The Roth account is relatively small right now. Maybe I should concentrate on all equities there, and then figure out how to allocate the rest to taxable and deferred? I've also thought about simply using Vanguard Balanced Fund everywhere and be done with it.
terran
Posts: 3049
Joined: Sat Jan 10, 2015 9:50 pm

Re: Asset location question

Post by terran »

You may already have gathered this, but just in case you don't already know, I'll try to explain the reason for the typical advice as that might help you make this decision. Most of the increase in value from bonds comes from the interest they pay, which is taxed at ordinary income tax rates. Some of the increase in value from stocks comes from dividends, most of which are qualified (taxed at lower capital gains rates) and some of which may be unqualified (taxed at ordinary income tax rates). Most of the increase in value of stocks comes from capital gains, which, as long as you hold them at least 1 year, are taxed at lower capital gains rates. Further, on average the total increase in value of stocks should be larger than bonds.

All income in a traditional IRA is taxed at ordinary income tax rates, which is why it can make sense to hold bonds there since most of that income will be taxed at ordinary income tax rates regardless of source. No income in a Roth IRA will ever be taxed, which is why it can make sense to hold stocks there since they have the highest expected income. Income in a taxable account is taxed based on the income source, which is why it can make sense to hold stocks there since most of that income is taxed at lower capital gains rates.

Especially in the current low interest rate environment, which means low bond interest, there are those that argue that it's better use your taxable account for investments that are expected to have low income even if that income is taxed at higher rates (bonds). You can invest in bonds that aren't taxed, such as municipal bonds, but that really only makes sense for people in a high tax bracket since they tend to have lower interest, so you need larger tax savings to overcome that fact. Maybe there's a counter argument, but I still think it makes sense to fill the traditional IRA with bonds since stocks will make the account larger and convert income otherwise taxed at lower capital gains rates to income taxed at ordinary rates.

Another wrinkle is international stocks which tend to both higher dividends and more unqualified dividends than US stocks (so more income taxed at higher ordinary income tax rates), but have a foreign tax credit that reduces tax, but only if held in a taxable account. You'll need to do the math for yourself, but this tends to favor holding international in taxable if you're in a low tax bracket since everyone gets the same foreign tax credit, so the question is whether the higher income and higher ordinary income overcomes the credit. I've found that in the 12% ordinary income, 0% long term capital gains bracket it makes sense to hold international in taxable, but I'm not sure how it would shake out in higher brackets, except to say that I know the highest brackets have the opposite result.

On balance, I think I would fill traditional with bonds (edit thanks to livesoft: If the amount in my traditional accounts exceeds the total amount of bonds I want to hold I would add stocks), fill Roth with US stocks, and then put whatever I needed to in taxable to balance out my asset allocation. I expect to easily stay within the 12% (or 15% once the old tax brackets come back in 2025) ordinary income tax bracket and 0% long term capital gains bracket in retirement.
Last edited by terran on Fri Sep 24, 2021 8:10 am, edited 1 time in total.
livesoft
Posts: 86079
Joined: Thu Mar 01, 2007 7:00 pm

Re: Asset location question

Post by livesoft »

terran wrote: Fri Sep 24, 2021 7:52 amOn balance, I think I would fill traditional with bonds, fill Roth with US stocks, and then put whatever I needed to in taxable to balance out my asset allocation. I expect to easily stay within the 12% (or 15% once the old tax brackets come back in 2025) ordinary income tax bracket and 0% long term capital gains bracket in retirement.
If one reads your words literally, then if one had 90% of their assets in a traditional IRA, they would have at least 90% of their portfolio allocated to bonds. Is that really what you wanted to say?
Wiki This signature message sponsored by sscritic: Learn to fish.
pkcrafter
Posts: 15461
Joined: Sun Mar 04, 2007 11:19 am
Location: CA
Contact:

Re: Asset location question

Post by pkcrafter »

Well, you could use VG tax-managed balanced in taxable.

https://investor.vanguard.com/mutual-fu ... file/VTMFX


Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.
terran
Posts: 3049
Joined: Sat Jan 10, 2015 9:50 pm

Re: Asset location question

Post by terran »

livesoft wrote: Fri Sep 24, 2021 7:56 am
terran wrote: Fri Sep 24, 2021 7:52 amOn balance, I think I would fill traditional with bonds, fill Roth with US stocks, and then put whatever I needed to in taxable to balance out my asset allocation. I expect to easily stay within the 12% (or 15% once the old tax brackets come back in 2025) ordinary income tax bracket and 0% long term capital gains bracket in retirement.
If one reads your words literally, then if one had 90% of their assets in a traditional IRA, they would have at least 90% of their portfolio allocated to bonds. Is that really what you wanted to say?
Good point. No, that's not what I mean. If the amount in my traditional accounts exceeds the total amount of bonds I want to hold I would add stocks.
User avatar
ruralavalon
Posts: 26353
Joined: Sat Feb 02, 2008 9:29 am
Location: Illinois

Re: Asset location question

Post by ruralavalon »

Tom_T wrote: Fri Sep 24, 2021 7:49 am Taxable is 25% of the total in my situation. More accurately, it will be, as I have some windfall money coming. So, there's no consequence to making changes -- I'm determining how to allocate this new money in conjunction with my existing TD & Roth accounts. A few months' expenses will only be around two percent of the total, so the concept of an emergency fund isn't a factor.

The Roth account is relatively small right now. Maybe I should concentrate on all equities there, and then figure out how to allocate the rest to taxable and deferred? I've also thought about simply using Vanguard Balanced Fund everywhere and be done with it.
Vanguard Balanced Index Fund (VBIAX) in all accounts is plausible if the taxable account is relatively small, or you are in a low tax bracket, or both, so that tax-efficiency is not an issue.

A balanced fund is generally not very tax-efficient. Wiki article Tax-efficient fund placement.

. . . . . .

Otherwise, here is an example portfolio for a 60/40 asset allocation, using tax-efficient fund placement --

Taxable account (25% of total)
25%, Vanguard Total Stock Market Index Fund (VTSAX)

Roth IRA (10% of total)
10%, Vanguard Total Stock Market Index Fund (VTSAX)

traditional account, IRA or 401k (65% of total)
25%, Vanguard Total Stock Market Index Fund (VTSAX)
40% Vanguard Total Bond Market Index Fund (VBTLX).

This is not hard or time consuming to do. This is basically what we do and have done for many years.
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link: Bogleheads® investment philosophy
User avatar
retiredjg
Posts: 54082
Joined: Thu Jan 10, 2008 11:56 am

Re: Asset location question

Post by retiredjg »

Tom_T wrote: Fri Sep 24, 2021 7:19 am I've often read that it's preferable to have bonds in an IRA and equities in taxable. I've also read that it's preferable to have equities in a Roth IRA because of tax-free growth. What would be an approach to allocating a portfolio across taxable, regular IRA, and Roth IRA? I am 62, so there are no age restrictions on withdrawals. I am in the 22 percent bracket. Total portfolio is less than a million.

My overall allocation is 60/40. Could I just simplify matters by keeping that allocation in each of the three accounts? Or, fill up Roth with equities, then regular IRA to fill out 60/40 allocation, and treat taxable as a separate beast?
It depends on your account sizes and whether you are still accumulating or if you have started withdrawal. Without that information, I would put both stocks and bonds in the IRA and stocks in Roth IRA and taxable.

However, in practice - especially in withdrawal - it can be helpful to have a little dab of each thing in each account.
JayDee37
Posts: 263
Joined: Sun Jan 17, 2021 1:08 pm
Location: California

Re: Asset location question

Post by JayDee37 »

Another reason to keep your bonds in traditional 401K/IRA (in addition to the tax treatment of their regular interest payments) is to tamp down the growth of any accounts that will eventually be subject to RMDs. This helps alleviate "tax bomb" issues and the complicated Roth conversion calculations that result.

I have the bulk of my bond allocation in my 457 account. But there is no international bond option in that account, so I have my international bonds in an old rollover IRA. And I have some Munis in my taxable account leftover from when I had just started my 457 and couldn't accommodate all the bonds I wanted in that space. Roth is all stocks, including my REIT ETF.
Tell me, what is it you plan to do with your one wild and precious life? | ~Mary Oliver
User avatar
Eagle33
Posts: 2392
Joined: Wed Aug 30, 2017 3:20 pm

Re: Asset location question

Post by Eagle33 »

Read wiki topic Asset allocation in multiple accounts. It a great starting point to understand asset allocation of your portfolio, including tax-efficient fund placement.
Post Reply