I'm trying to understand the best approach to determining my asset allocations for my (and my spouse's) separate tax deferred accounts. In setting up taxable and roth accounts at 100% equities for tax efficiency purposes, this leaves the remaining tax deferred accounts where I would include international equities, bonds, and money market funds (or a three fund portfolio with some added short term money market).
For the start of my plan in 2025, I am able to determine the amount of funds in taxable and roth accounts and then calculate what remaining allocations are needed across the two tax deferred accounts based on their specific starting year dollar levels. This is what I normally do when rebalancing each year. However, I am currently a little more conservative than usual (starting retirement) and am about 50/50, equities to fixed-income. I plan on slowing raising the asset allocation back up to about 65/35 over the next three years and will most likely leave it in place for the remainder of the plan. Essentially I will be slowly liquidating the money market funds over the next three years.
As I mentioned I can determine my required asset allocation for 2025 within the tax deferred accounts by using my existing end of year holdings balances. However for the Portfolio Time Periods, once 2026 and beyond rolls around, how do I determine (today) what the tax deferred accounts asset allocations should be in 2026, 2027, and 2028 given that the size of the 100% equity taxable and roth accounts will increase or decrease throughout each year through normal growth and spending?
I initially thought that just matching each new portfolio time period year's specific overall allocation to the tax deferred accounts would work. However, I'm now thinking that it won't work because the growth and spending changes happening in the taxable and roth accounts (and remaining balances at the end of each year) will impact the tax deferred equity asset allocations.
I've attached a pdf of the Mode 2 - Portfolio Allocation page to hopefully clarify my dilemma. Thank you for any tips or thoughts on how to input the tax deferred entries accurately for future changing portfolio time periods (influenced by year over year changing taxable and roth equity values).
Screenshot of example I described. Total Stock Market Index funds make up 100% of the Taxable and Roth accounts. For the tax deferred accounts I would include any remaining total stock market index (when added that matches the "overall" domestic equity allocation), total international index, total US bonds index, and money market funds (or a three fund portfolio with some added short term money market).
Mode 2 is designed to dynamically allocate stocks vs. bonds to meet your target portfolio asset allocation, it's not built to dynamically hold the allocation of more than two asset types constant. Note that competitor products don't have this at all, which really makes a mess out of Roth Conversion calculations in those tools.
I avoid complications like trying to tell Pralana about international stocks, they have the same risk profile as domestic stocks and historically have had time periods of outperformance vs. domestic, just no one knows when that may be. Just like you don't know when consumer staples might outperform tech or value might again outperform growth. So I just enter the overall desired stock/bond split each year and tell it the order of accounts that should hold stocks first. Then I tell the program that the account types I prefer to have stocks are 100% stocks and the places that have some bonds are 100% bonds. Pralana figures it all out from there.
The on-line tool can have Asset Allocation for more than 2 assets. I entered yesterday 12 assets to the on-line tool. I have now 2 scenarios with the same Asset Allocation and different Asset Location, one with my actual Location and another with a more optimal Locations (I have 50/50 US/International stocks, and they have different return/dividends characteristics. Currently I am ignoring the foreign tax paid.) Surprisingly the Location has a substantial impact on the overall saving. I need to work on this more to verify the input numbers and understand the output.
I am not sure what RacingFan is doing. I think that he is determining Location first (he calls it account allocation) before deciding on the overall Allocation. Also, his overall Allocation does not match the Locations.
I worked a little more on my 12 Assets and I am not sure how the Location algorithm works with many assets. It maintained the overall Allocation for all 12 assets as requested. However, it moved a lot of REITS to my taxable account, and I don’t know why. It will be nice to have the algorithm using tax efficiency. Now it seems that the better Location has only minor effect on the total saving.
I see how this can neatly model exUS stocks vs US stocks vs bonds, but I'm stumped on how to get municipal bonds in the mix. I want to use munibonds when my allocation calls for "bonds" in my taxable account but use taxable bonds elsewhere. I'm 100% stocks in taxable now, but as RMD's chip away at my tax deferred account, I'll need more and more bonds in my taxable account. Any ideas on how to do this?
Apologies if this is an obvious thing. I'm still new to Pralana and working my way through my first scenario.
One of our long-tenured and respected subscribers asked me about Mode 2 today via email. He was asking why the Roth account (4th in priority order), wasn't allocated any stocks. I replied:
When using Mode 2, accounts are not guaranteed to get their target asset allocation and often do not. Consider Mode 2 like a school cafeteria lunch:
- Say there are two menu selections (aka asset classes): Hot Dogs and Hamburgers and each of the 100 kids (accounts) gets one.
- Suppose the ‘overall allocation’ is 50% hot dogs 50% hamburgers, so the staff prepares 50 hot dogs and 50 hamburgers.
- But, suppose 60% of the kids want hot dogs (their target allocation is 100% hot dogs).
- Well, the first 50 kids in line (by ‘Kid prioritization’) will get what they want…either a hot dog or hamburger.
- At some point the remaining 10 kids that want hot dogs get served and find there are no hot dogs left. They get a hamburger.
- All the kids that want hamburgers are happy since there are enough to go around.
Note: the HSA and 529 plans are exempt from the Mode 2 allocation and always get their target allocation. This will in some cases cause the actual overall portfolio allocation to vary a little from the overall targets.
In his case, the overall stock allocation was consumed by higher priority accounts, leaving no stocks left for the Roth account.
I need to add this or a similar explanation to the User Manual and FAQ page. Edits/suggestions welcome.
I suggest defining Muni-bonds and regular-bonds as separate assets; slowly increase the Muni Asset Allocation/Location in taxable and decrease the regular bonds in IRA. Check if Muni is for you (recommended for higher tax brackets). Play with the assets’ order on the asset table to optimize Assets Locations.
