My IRA Asset Allocation Is Settled
How’s that for a thrilling title? Anyway, that’s what I’m going to write about.
I quit a job recently and rolled over my 401(k) into an IRA. I’d been hesitating on how to invest the money, so for the past couple of weeks, it was in a money market. I wanted to do a reallocation of everything related to retirement savings but I wasn’t sure if different types of accounts (Roth and Traditional IRAs) should have different asset allocations. Just a couple of days ago, I finally decided and invested the money.
Asset allocation - different accounts get different treatment?
So on the question of whether a Roth IRA gets a different asset allocation than a Traditional IRA, I came to conclusion that for my time horizon and risk tolerance (medium-long and high, respectively), they can be the same. As I get closer to retirement, I imagine they’ll diverge, since you’re supposed to tap Roth funds last.
Here’s the allocation I settled on:
50% US stock index
40% Internation stock index
10% Bond index
Specifics of my investment
I had planned on using USAA mutual funds as my investment vehicle, but I ran into a couple of reasons not to. First, they don’t offer a true bond index fund or an international index fund. Second, I have a lump sum to invest, so ETFs really make more sense. I won’t be trading, so commission fees aren’t an issue for me, nor will I be adding additional money. With an ETF, I take a one-time commission hit, then it’s done. More importantly for me, though, is that ETFs deliver what I’m looking for (boring, vanilla index funds) with super low expenses - even lower than an index mutual fund charges.
Specifically, I chose the following ETFs for my mix (numbers in parentheses are expenses):
50% Vanguard total market (0.07%)
40% Vanguard FTSE index (0.25%)
10% Vanguard bond index (0.11%)
So now Vanguard has a very substantial portion of my retirement money. It’s still held through a brokerage account at USAA, incidentally.
Anybody out there have any thoughts/opinions about my allocation or use of ETFs?
March 31st, 2008 at 5:20 pm
Looks good to me. I would cut out bonds myself, but that is a bit unconventional. I wrote about retirement account allocations last month. I include a few extra categories. I would include a real estate portion myself (say 10%) but right now many people are wary of that area. Vanguard is a great option.
April 1st, 2008 at 2:14 am
April 1st, 2008 at 4:28 am
April 1st, 2008 at 7:43 pm
A couple of observations about traditional tax-advantaged assets versus Roth tax-advantaged assets. First, the “asset location” literature puts equities into taxable accounts and bonds into tax-advantaged accounts. Your total asset allocation and the size of your taxable versus tax-advantage account assets projected across your life would determine whether equities end up in tax-advantaged accounts OR bonds in taxable accounts.
For estate planning purposes, it is often assumed that traditional tax-deferred assets are withdrawn first versus withdraws of Roth assets. Traditional tax-advantaged accounts require minimum withdrawals anyway, and for many people these minimums would be sufficient to cover their expense gaps in retirement.
For estate planning purposes, Roth accounts have some very significant advantages over traditional tax-advantaged accounts. If a family’s financial model indicates that there is a possibility that they will still have some tax-advantaged account assets at death, then those should be Roth tax-advantaged account assets.
Roth assets can be inherited by children, and these inherited Roth assets can also grow tax free over the expected life of the child with certain mandatory withdrawal requirements. This means, for example, that a child inheriting a Roth account at age 40 could perhaps enjoy another 50 years of tax-free investment growth with an income stream along the way from mandatory withdrawals, which are taxed upon withdrawal. Traditional tax-advantaged retirement accounts do not provide these very significant estate planning benefits.
What follows from this is that whatever equity allocation you have in tax-advantaged accounts should go into Roth accounts. Higher long-term historical growth rates for equities indicate that equities go into Roth accounts and bonds into traditional tax-advantaged accounts, when there is a choice. The objective is to have Roth equity assets grow faster and ultimately not be taxable because they are in a Roth account. Conversely, bonds in traditional tax-advantaged accounts would tend to grow less and thus incur less ordinary income tax, that could not be avoided anyway.
Gosh, planning around our tax laws is simple, huh?