Asset Allocation and Tax Efficiency for Young Investor
by vanguardian » Sun Mar 16, 2014 11:16 am
Hello,
I have been a long-term reader of the boards and finally feel like I have done enough research to ask intelligent questions. I would like your help in evaluating my portfolio below. Particularly, I am fairly young and would like to start with a good strategy for the long-term investing. Any advice you can offer would be very helpful.
Emergency funds: six months
Debt: 30-year mortgage of $105,000 at 4.75% (currently receive tax deductions for real estate taxes and mortgage interest)
Tax Filing Status: single
Tax Rate: 28% Federal, 6.4% State
State of Residence: NJ
Age: 26 (~39 yrs to retirement)
Desired Asset allocation: 90% stocks / 10% bonds
Desired International allocation: 20% of stocks
Goal: I work hard and live a frugal life so that I can invest a substantive amount with a good long-term strategy. Ideally, I would like to set aside money/time for travel and possibly early retirement.
History
I maxed out my Roth IRA and Roth 401k contributions last year. I started with a very simple plan in 2012, where I had target retirement funds in a Roth IRA. Since then, I have begun getting more involved with ETFs that have a low expense ratio and good growth. As I have some money saved for investing, new tax-deferred accounts opened, and will not be eligible to contribute to a Roth IRA in 2-3 years, I could use your help in becoming more strategic.
Taxable Accounts (~10k)
domestic small cap (VB) - 4k
international large cap (VEA) - 6k
Roth IRA (~15k)
domestic small cap (VB) - 3k
domestic large cap (VOO) - 5.5k
Europe large cap (VGK) - 3k
target retirement (VTTSX) - 3k
Roth 401k through employer (~55k)
domestic small cap - 25k
large cap - 25k
(there are bond and international options also)
savings: ~45k
new Utah ESP 529: none (I do not have any kids, but am currently going to school)
new HSA w/ investment account: none
I would appreciate any general advice, but also am looking for specific answers:
1. Asset Allocation: Through a M* X-ray analysis, I am close to my targets of ~35% domestic large cap, ~35% domestic small cap, and ~20% international. Is my current mix a good portfolio to move forward with?
2. Tax Efficiency: I started filling my tax-deferred accounts first, which is why I have VB in both taxable and non-taxable accounts. Moving forward, I would like to streamline my accounts for maximum efficiency. The Bogleheads wikis on tax-efficient placement and asset allocation among multiple accounts have been very helpful in formulating a general strategy. For my particular ETFs, where is the optimal placement for the tax-deferred and taxable accounts? Between the tax-deferred accounts (Roth IRA, 401k, 529, and HSA), are there placements that work better than others?
3. I recently enrolled in a HDHP which has an HSA investment option. Following the advice on this forum, I have set up a new ELFCU account. What are some good TD AmeriTrade options? As you can tell, I have thus far only focused on Vanguard ETFs.
4. I also have a new Utah 529 account. I am currently doing school part-time and plan to save money in this account for tuition and books. Are there good short-term strategies since I will be using this account for the next 3-4 years? The account offers Vanguard funds across most categories. I am also open to long-term advice for my future kids, though it would be at least 20 years from now 
5. Are there other strategies I should consider for my particular situation?
Thanks for all your advice!
Posts: 2
Joined: 16 Mar 2014
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Re: Asset Allocation and Tax Efficiency for Young Investor
by Laura » Sun Mar 16, 2014 1:45 pm
Hi and welcome,
Just a few comments. At your high tax rate I am not sure the roth 401k is the right option. It seems likely that you would be in a lower tax bracket in retirement so why pay taxes today at the higher rate? Also, if you use a traditional 401k that will lower your taxable income and keep you roth eligible for more years. You may want to switch to the traditional 401k contributions for several years to stay under the income limits but if you go through even that figure you can reconsider.
In your taxable account you mention holding
domestic small cap (VB) - 4k
international large cap (VEA) - 6k
While not a huge problem I think you are putting yourself on a path forward you won't want to manage for the long term. Small companies either grow up and out of the index causing a forced sale or they fail and fall out completely. Slicing and dicing into small cap is fine but probably best done in your roth. The same happens with your large cap international. Personally I think using broad market indexes in taxable works better over the long term then you can overweight and slice and dice in your tax advantaged accounts.
In your IRA you have a target retirement fund and individual funds. You don't need that. Pick one or the other. Given the fact that you have multiple different types of accounts I think you are better off with individual funds so I would eliminate the target retirement fund.
How much money are you contributing to each account each year, including matching funds? Taxable figures are very important to help plan how to do this. Also what are the funds available in your 401k with expense ratios?
Laura
Posts: 6931
Joined: 19 Feb 2007
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Re: Asset Allocation and Tax Efficiency for Young Investor
by vanguardian » Sun Mar 16, 2014 6:23 pm
Thanks for your advice, Laura. There is a chance that my tax bracket may be higher in retirement. My logic for the Roth 401k was two-fold:
1.) Based on several assumptions including my continued contributions to my retirement account, my projected retirement savings will be high. This is by design so that I can live comfortably and pay off healthcare expenses.
2.) Additionally, with tax trends on the rise, I assume there will be several tax increases in the next 37 years.
That being said, I like your idea of switching to a traditional 401k as I approach the maximum MAGI to qualify for the Roth IRA. I will likely switch over to a traditional 401k middle of this year and continue.
According to M*, VGK, VEA, and VB have the highest 5 Year Tax Cost Ratios (0.82, 0.61, and 0.4, respectively). Do the foreign tax credits for the international accounts offset this tax drastically? I thought it was better to have the international ETFs in the taxable account, but upon your suggestion and further research, I am questioning whether it still makes sense to have international in taxable accounts for the foreign tax credit. If I move VB and VEA into my Roth IRA, I plan to trade VOO and VTTSX in its place and move the VOO into my taxable account.
What would you suggest for my new 529 and HSA accounts? Is there a certain type (small, large, domestic, international) that I have omitted here? M* seems to think I have an international tilt, but I bought because the European market presented opportunities.
Posts: 2
Joined: 16 Mar 2014
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Re: Asset Allocation and Tax Efficiency for Young Investor
by Duckie » Sun Mar 16, 2014 6:29 pm
vanguardian, when your income gets above the contribution limit you can still add to a Roth IRA using the
Backdoor Roth IRA
method. Since you currently have no non-Roth IRAs you will not be subject to the pro-rata rule.
For another tax-sheltered option you could buy
I savings bonds through Treasury Direct. The interest can be tax-deferred for up to 30 years.
Posts: 2046
Joined: 8 Mar 2007
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Re: Asset Allocation and Tax Efficiency for Young Investor
by Laura » Sun Mar 16, 2014 6:29 pm
Are you planning to withdraw the money from the 529 in the next few years? If yes, then keep it conservative in fixed income. If you are planning for the long term then I would select one of the age based aggressive options inside the plan you select.
For the HSA, it depends on what the company holding the funds offers but equity probably if you are going to pay your medical bills out of pocket and keep this for the long term.
Can you clarify how much money is going into the different accounts?
$xx taxable
$xx 401k
$xx roth
$xx HSA
$xx 529 is separate unless you are planning for the long term.
Laura
Posts: 6931
Joined: 19 Feb 2007
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