Over at Bogleheads we read: Tax efficiency vs. fees - A 401k vs. taxable account question
Tax efficiency vs. fees - A 401k vs. taxable account questio
by murphyslaw86 » Fri Jan 03, 2014 8:00 pm
Background: The only bond fund in my 401k is the PIMCO Total Return fund (PTTRX - ER: 0.46%). The only index fund option, stock or bond, is the Spartan S&P 500 fund (ER: 0.05%). I'm a strong believer in the Bogleheads / index investing philosophy, but I also can see the value of tax efficient asset allocation.
Currently, my full 401k is in the Spartan S&P 500 fund. My bond allocation is currently split between the Vanguard Total Bond Mkt fund in my Roth IRA and the Vanguard Intermediate-Tax Exempt Bond fund in my taxable account (can't fit my full 20% bond allocation in my Roth at the moment). I also have an S&P 500 fund, extended market fund and total international stock fund in my taxable account to cover all my bases. Here's a snapshot of my current portfolio - http://imgur.com/tXQq60E
I know stock index funds are very tax efficient, so it would make more sense to have all my equity holdings in my taxable account and have my 401k be all bonds, but are the tax advantages enough to justify me switching to a slightly higher cost (0.41% diff in ER) non-index fund like PTTRX? It's one of the biggest and best performing bond funds in the world, so I figure if there's any time it makes sense to go away from index funds, this would be it.
What do you guys think?
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Re: Tax efficiency vs. fees - A 401k vs. taxable account que
by Laura » Fri Jan 03, 2014 10:14 pm
Hi murphy,
I think your portfolio choices are just fine. The only thing I would actually suggest doing in the taxable account is switching the S&P 500 and extended market funds for a Total Stock Market fund. I know why you made this choice but trying to keep those two in balance in a taxable account can be a challenge and you are locked in for a long time in a way that will only become increasingly more expensive to switch in the future.
For the bonds, I think your current choices are fine but switching would be okay as well. I like to go with the sure thing, low costs. so I would probably stick with what you have.
Laura
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Re: Tax efficiency vs. fees - A 401k vs. taxable account que
by grabiner » Fri Jan 03, 2014 10:18 pm
The 0.36% expense difference is probably more than the tax savings by holding bonds in the 401(k). Therefore, I would prefer holding the S&P index in the 401(k), bonds in your IRA if possible, and any additional bonds as I-bonds and munis in taxable, which is what you are doing.
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Re: Tax efficiency vs. fees - A 401k vs. taxable account que
by murphyslaw86 » Sat Jan 04, 2014 3:32 pm
Laura wrote:The only thing I would actually suggest doing in the taxable account is switching the S&P 500 and extended market funds for a Total Stock Market fund. I know why you made this choice but trying to keep those two in balance in a taxable account can be a challenge and you are locked in for a long time in a way that will only become increasingly more expensive to switch in the future.
Thanks for your response. So, if I switch my S&P and Extended Market funds for a TSM fund, won't I be significantly tilting towards large cap? I've received this recommendation before, but I'm not sure I understand it. Don't I want to own as close to the true market weights as possible if I'm adhering to the Bogleheads philosophy. If I just rebalance as necessary every year or so, can't I keep my ratio somewhere around 20-25% small cap pretty easily? Why will it become more expensive in the future? I'm probably not going to be adding any new money to my taxable account for many years (all contributions will be Roth IRA & 401k), if that makes any kind of a difference.
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Re: Tax efficiency vs. fees - A 401k vs. taxable account que
by Laura » Sat Jan 04, 2014 3:40 pm
The total stock market fund is the true market weight. By splitting the market into large and mid/small you are overweighting one or the other unless you rebalance to maintain the true market weight. It is easier to maintain market weighting in a total market fund. And, as companies grow or shrink resulting in a move from one category to the other you are not hit with a taxable event as the fund adjusts by selling the company out of one and then buying it into the other.
Laura
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Re: Tax efficiency vs. fees - A 401k vs. taxable account que
by murphyslaw86 » Sat Jan 04, 2014 5:24 pm
Laura wrote:The total stock market fund is the true market weight. By splitting the market into large and mid/small you are overweighting one or the other unless you rebalance to maintain the true market weight. It is easier to maintain market weighting in a total market fund. And, as companies grow or shrink resulting in a move from one category to the other you are not hit with a taxable event as the fund adjusts by selling the company out of one and then buying it into the other.
I understand that, but as I mentioned in my original post, the only index fund in my 401k is a S&P 500 fund. There's no TSM available there. So, if I have my whole 401k in that fund and have only a TSM fund in my taxable account, then I'll have a really heavy tilt towards large cap (S&P 500 + majority of TSM) overall. The only reason I have the S&P 500 fund and the extended market fund in my taxable account is to essentially recreate a a TSM fund between my 401k and taxable accounts.
Does that make more sense?
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