Vanguard as IRA Custodian for USian HBPP via ETFs

[nomamesbuey]

https://personal.vanguard.com/us/whatwe ... ommissions

I just stumbled upon Vanguard Brokerage Services (VBS) 2010-May-4 notice.  To summarize
1 All Vanguard ETFs trade for free
2 worst scenario for non-Vanguard ETF fees (if you have a "Standard" account with <50K in assets):
2a: $20 annual account fee
2b: $7/trade for non-Vanguard ETFs for initial 25 trades in calendar year (more than enough for me).

Before I was leaning towards Wells Fargo's Wellstrade for the IRA custodian, because of the 100 free trades with a 25K account.

But now, I am thinking Vanguard is superior.  I like Vanguard's status as a "customer owned company", & long track record of stable good pricing, & not screwing their customers.  I feel like WF could remove Wellstrade or change its terms randomly, & then I would be screwed & have to on short notice transfer to another custodian.  Plus, I'd rather not patronize a "Too Big Too Fail" bank like WF if there is a reasonable alternative.

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My take on USian HBPP with Vanguard as custodian (expense ratio = ER, avg bid ask ratio = BA), I'd appreciate any feedback:

stock: VTI, as well as VEA, VWO, VBR, etc if diverging from the classic Harry Browne/craigr HBPP.  I don't see needed to ever use non-VG ETFs for stock, VG is the best in both thoroughness & low cost for stock ETFs as far as I can tell.

bonds: non-VG TLT (0.15%ER, 0.01%BA).  I have seen clive & MediumTex on another thread the possibility of combining VG's EDV (0.14%ER, 0.38%BA) along with TLT.  My thought is to just exclusively use TLT.

cash: VGSH (0.15%ER, 0.08%BA) which tracks the "Barclays Capital US 1-3 Yr Gov Free Float Index", seems to track the same index as the non-VG SHY (0.15%ER, 0.01%BA).  VGSH was just started on 2009-Nov-23; I would hope the avg bid ask ratio would decline by 2011 or so.

gold: non-VG GLD (0.40%ER, 0.01%BA)
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The ability to buy VG ETFs, for the cash & stock assets, will be great for manually reinvesting dividends, & avoid getting the low sweep rate.  Per this mymoneyblog article, in the IRA account the sweep rate is the VMMXX fund, & in a taxable account the customer between VMMXX & "Tax-Exempt Money Market Fund".
http://www.mymoneyblog.com/archives/201 ... eview.html

I'd especially like feedback of anyone who has experience with both Vanguard Brokerage Services & Wellstrade.  My gut is that it would be worthwhile to pay <$50 in total annual fees ($20 account fee + $7 for each trade of TLT & GLD), then roll the dice on the indefinite continuation of the (temporary?) good deal that is Wellstrade.  Thx in advance.

[KevinW]

After Vanguard made this announcement I thought about this topic on a hypothetical basis, and came to exactly the same conclusion as you did: VTI, VGSH, TLT, and GLD/IAU.  Total expenses with this approach are reasonable under the $50k threshold and extremely competitive above it.

One caveat is that VGSH holds "government" bonds, not purely Treasury bonds.

This portfolio implementation seems solid, but I've only window shopped it and have no first-hand experience.

I am also uneasy with the brand new freebie brokers such as WellsTrade and Zecco.  Their price structure seems like a loss leader intended to lure in customers for a future bait-and-switch.  I am more comfortable doing business with organizations that, like Vanguard, have figured out a way to operate cheaply in a sustainable way. 

[nomamesbuey]

One caveat is that VGSH holds "government" bonds, not purely Treasury bonds.

Thx KevinW.

https://personal.vanguard.com/us/FundsA ... Order=desc
I looked up the holdings, most recent report is 2010-mar-31, which I dumped into a spreadsheet. 

72.99% of VGSH by market value, is "United States Treasury Note/Bond".  There is some questionable garbage in small amounts in VGSH, such as bonds from TBTF banks like Wells Fargo & JPMorgan.

[nomamesbuey]

http://www.bogleheads.org/wiki/Vanguard_Fund_Info

I made the mistake there of being a hammer manufacturer, instead of a carpenter using the right tool for the job, hammer (Vanguard ETF) or other tool (Vanguard index fund).

cash - VFISX (0.22%ER, $3K min) is a short term treasuries fund.  I checked holdings & see that as of 2010-mar-31, 98.40% in "United States Treasury Note/Bond".  2.1 yr avg mat & avg maturity.  18.7% is in the 3-5 yr maturity; most in the 1-3 yr maturity range. It looks similar to SHY 1.92 yr avg mat, 1.88 yr avg dur.

bonds - check this kka/MediumTex discussion from a bonds thread:

EDV offers 1.5 times the volatility of TLT.

I wouldn't commit the entire LT treasury piece of the PP to EDV (that might produce TOO much volatility relative to the other PP assets), but I own some and I like the protection it offers when everything else goes haywire.

So maybe half VUSTX and half EDV?

That's a very perceptive suggestion.

I think that would work fine, and it would potentially keep you from ever having to pay any commissions (if you are with Vanguard) while still more or less following the PP recipe.

(There is a little junk in the trunk of VUSTX, so do you due diligence.)

You could just rebalance VUSTX and EDV to 50/50 when you rebalance the rest of the portfolio.

I checked the 2010-mar-31 holdings: both VUSTX (0.25%ER, $3K min, 20.5y avg mat, 12.1y dur) & EDV (0.14%ER, 0.38%BA, 24.9y mat, 26.3y dur) are 100% US Treasuries.  MediumTex, I was interpreting your "VUSTX junk in the trunk" to refer to some non-US Treasury holdings, were you were referring to something else?

Honestly, if this VUSTX/EDV is a "good enough TLT approximation", in a VBS IRA account, it seems a no brainer to use VUSTX/EDV instead of TLT.  Besides avoiding the $7 TLT trading fee, it will be possible to recycle dividends into VUSTX or EDV, if bonds happens to be the "trailing asset" closest to the 15% total asset allocation.  Also it would be easier to reach the $50K in Vanguard assets "Voyager Services", with 3 of the 4 HHPP assets being represented by Vanguard funds, as opposed to 2 of 4 if TLT is used.

[nomamesbuey]

any feedback/constructive criticism?

stock: VTI (&/or other Vanguard stock ETFs if drifting from classic HBPP)

bonds: 50% VUSTX & 50% EDV.  Track the total bonds value of the combined VUSTX & EDV, & rebalance when the total bonds hits 35% or 15% of portfolio, but when rebalancing reset VUSTX & EDV to be roughly equal again.

cash: VFISX

gold: the only non-Vanguard ETF - a gold ETF such as SGOL

[KevinW]

Any thoughts on how to go forward here?  Should I just put everything in taxable?  Buy PRPFX in taxable and create a 4x25 PP in my IRA with smaller amounts for rebalancing?  Hold just stocks with Vanguard and purchase the other asset classes individually via Treasury Direct, etc.?

You can think of the tax shelters as an "umbrella" that covers some, but not all, of your assets.  You want to move things around to maximize the benefit of that coverage.  So usually the most tax-efficient solution is to think all your investments as one big portfolio, and prioritize placing the most tax-inefficient assets in tax shelters like IRAs and 401(k)s.  If some of the more tax-efficient investments peek out from under the "umbrella," that's just how it goes, but you have minimized the costs associated with that.

Between 401(k)s and IRAs most workers can shelter more money than they invest in a year.  So over time a larger and larger percentage of assets are sheltered, and this becomes less of a problem.

There is another wrinkle if you have both Roth and traditional shelters.  The traditional accounts will be taxed when you withdraw from them, but the Roths will not.  If you had the choice, you'd rather have the Roths grow faster than the traditionals.  So if you have more than one asset class sheltered, you might try to hold the ones with higher expected returns in the Roth.  This optimization helps with taxes you pay only once when you finally withdraw from the IRA, so it's less important than the taxable/tax-exempt optimization, which comes into play every tax year.

[KevinW]

1. I have 60k to invest and only 5k available sheltered space for 2010.

2. Gains from assets in my tax-sheltered space cannot be Distributed to balance assets in the taxable portion of the portfolio as an 'early withdrawal' penaly would occur. So, I could only add new fnds to balance, but again run the risk of running out of room in my IRA.

Usually this is not a problem because securities are fungible and the "seam" between one asset class and the next rarely falls exactly on the "seam" between tax-sheltered and taxable space.

If I understand your figures correctly, about 8% of your portfolio can be sheltered and 92% is taxable.  I would rank the assets, from least tax-efficient to most, as
1) bonds
2) cash
3) stocks
4) gold
(Others may disagree.)  Under that ranking your first priority is sheltering as much of the bonds as possible, then cash, etc.  So I would allocate the funds as

IRA: 8% of portfolio in bonds
taxable: 17% of portfolio in bonds, and the other three asset classes

When it comes time to rebalance you can buy and sell the bonds within the taxable account.  The interest on the bonds inside the IRA can be reinvested inside the IRA, and the interest outside the IRA can be reinvested outside the IRA.  In all likelihood the bonds in the IRA will just sit there undisturbed.

If you do need to change the asset mix inside the shelter, you can accomplish that by simultaneously buying and selling in both accounts.  Hypothetically let's say somehow you end up at
IRA: 30% of portfolio in bonds
taxable: 10% bonds, 10% cash, 25% stock, 25% gold

To get back to 4x25, you can do the following transactions:
IRA: sell 5% bonds, buy 5% cash
taxable: sell 10% bonds, buy 10% cash

leaving you with
IRA: 25% bonds, 5% cash
taxable: 20% cash, 25% stock, 25% gold

Note that you didn't withdraw or deposit anything to the IRA, so there is no penalty.  This way you can migrate more assets into the IRA over time.

[SmallPotatoes]

Thanks for the advice.  I think this will probably be the route I take until I have more sheltered space.  In essence it will be akin to having 2 PP in my portfolio.

[6 Iron]

The recent changes in the Vanguard fee structure for trading make holding ETF's more attractive. At present, my Vanguard holdings are in funds (except for TLT and a little SGOL). But this brings to mind a question regarding maximizing returns on volatility. With ETF's it would be possible to place standing limit purchase orders for the components of the permanent portfolio, based on a significant drop in prices, with a portion of the cash component of the PP held in the sweep account of that particular brokerage account.

Enough cash would have to be in the sweep account to cover a deflationary drop in all assets that could trigger all limit orders. This money would not be in a treasury money market or T bills, deviating from HB's instructions.

I would love to hear from others that are critical of this idea, and why. Thanks.

[foglifter]

Here's my real issue though:  I want to use my Roth IRA to shelter the more tax inefficient assets, e.g. VUSTX+EDV, but that precludes any rebalancing since I cannot move money from my IRA without a penalty or until my 59 1/2 Birthday.

AFAIK you can't withdraw earnings from Roth IRA, but you can withdraw your contributions anytime for any reason without penalty. On the other hand, you can't deposit them back once you withdrew them.

[SmallPotatoes]

Here's my real issue though:  I want to use my Roth IRA to shelter the more tax inefficient assets, e.g. VUSTX+EDV, but that precludes any rebalancing since I cannot move money from my IRA without a penalty or until my 59 1/2 Birthday.

AFAIK you can't withdraw earnings from Roth IRA, but you can withdraw your contributions anytime for any reason without penalty. On the other hand, you can't deposit them back once you withdrew them.

Bingo. I'll just shelter what I can for now and transition over the years. Better to start investing early I feel. Even if I'm not getting every advantage I have the irreplacable advantage of time.

[SmallPotatoes]

Just curious if anyone out there has analyzed comparable Vanguard ETFs and Index Funds, and if so, which would be the best representation to the HBPP 4x25?  I'm aware that better options (VTI, SHY, GLD, TLT) have been proposed, but at present I'm looking at Vanguard-only options to reduce costs, and those that truly reflect what Harry had in mind.

I'm currently running the PRPFX in my taxable and EDV in my Roth IRA (90/10% respectively) until I have enough tax-sheltered space to house most/all of my investments.  At that time I'll move to using Vanguard ETF's or Index Funds (I like these better for buying, investing, and rebalancing) and gold bullion to do a true 4x25 HBPP.

Fire away. 

[KevinW]

Thanks for the advice.  I think this will probably be the route I take until I have more sheltered space.  In essence it will be akin to having 2 PP in my portfolio.

Sort of, I suppose I'd say that you have one big permanent portfolio that's split in two.  The split happens at the boundary between taxable and tax-deferred space.  One asset class straddles the boundary and has to be divvied among two accounts, but the other three asset classes can exist as a single chunk in one of the accounts.  Maybe I'm splitting hairs...

Just curious if anyone out there has analyzed comparable Vanguard ETFs and Index Funds, and if so, which would be the best representation to the HBPP 4x25?  I'm aware that better options (VTI, SHY, GLD, TLT) have been proposed, but at present I'm looking at Vanguard-only options to reduce costs, and those that truly reflect what Harry had in mind.

For the stocks Browne suggested a S&P 500 index fund.  I think it's clear from context that he was trying to get the lowest-cost fund that replicated the market as a whole, which at the time was a S&P 500 fund, but now would be a total market fund.  So I think Total Stock Market Index is the purist's choice.

Browne said to use a treasury money market for the cash.  Vanguard has a Treasury Money Market fund.  It is closed to new investors at the moment but I expect that to change once interest rates pull away from 0.  You could look at the other money market and short term bond funds if you are comfortable with the (modest) risks involved.

I don't think any single Vanguard fund is suitable for the bonds.  Browne said to hold 25-30 year bonds, but Long Term Bond Index holds 10-30 year bonds.  As I write this the fund's average duration is listed as 12.5 years.  So that fund may not be volatile enough to carry the portfolio through deflation.  The Extended Duration Treasury ETF holds zero-coupon treasuries, and as discussed in the thread over in the bond section, zeroes are probably too volatile and Browne did not condone them.  MediumTex has suggested that a 50/50 split between those two funds could work.

Vanguard has no fund for physical gold.  The closest they have is Precious Metals and Mining, which is predominantly stocks of mining ccompanies.  craigr's FAQ explains why mining stocks are not a replacement for physical gold.

[SmallPotatoes]

Thanks again, KevinW. I appreciate the response. For such a simple concept as the PP we (humans) sure make it seem complicated.

My greatest present challenge is keeping costs & tax down, as well as just keeping things simple. It seems Vanguard is great for that though it's a shame they don't offer funds with the volitity needed to fairly represent the HBPP. Even so, VTSMX seems like a solid choice and I hope their Treasury MM will open again soon to new investors.

I would like to have all my investments at one broker and I think VG is a smart choice. Again, why is something like the PP seemingly so tricky to construct? 

[GrowingInIowa]

What do you think about taking advantage of a one time conversion from traditional IRA to Roth IRA this year to get more of your accounts under the same umbrella?

Would you pay less taxes overall by keeping GLD in a Roth?  I was thinking that the "collectibles" tax would be reduced since you didn't pay taxes on earnings when you withdraw from a Roth.

[KevinW]

I would like to have all my investments at one broker and I think VG is a smart choice.

I am also a Vanguard fan.  I think their mutual structure keeps their interests aligned with investors' interests, which is valuable in the long run.

Another alternative is to buy individual Treasury bills and bonds directly in a Vanguard brokerage account.  You can do that, but AFAIK those bonds won't count toward your "Voyager" status.

Again, why is something like the PP seemingly so tricky to construct? 

IMO the mainstream US investment world has so much pride in their own abilities, the American economy, and the Federal Reserve system that they are blinded to the need for assets that do well when one of those things fails, such as long term bonds and hard assets.  There is a pervasive and unstated assumption that prosperity will predominate, and that inflation, deflation and recessions will either never happen or will be brief and manageable.  Under those assumptions it makes sense to hold mostly US stocks, with a small allocation to short, intermediate, and TIPS bonds.  That kind of portfolio is suggested by many authorities and is convenient to implement in 401(k)s and IRAs.

Browne does not make those assumptions, and so considered the possibility of a hyperinflation that the Fed cannot reign in.  To deal with that you need something entirely outside the realm of dollar-denominated securities (e.g. gold).  Likewise, maybe the Fed hasn't permanently cured us of deflation after all, and we need some kind of deflation protection (e.g. long term bonds).

I can understand why an investment advisor or fund manager who has dedicated their life to investing inside the system wouldn't tend to plan for the possibility that the system breaks.  That would be saying "yeah, I earned a degree in this and work on it for 40+ hours a week, but there's a chance it's all BS and won't work so you should safeguard against that."  And to be fair, in practical terms it may turn out to be OK to ignore these problems, because IMO a ruinous deflation/hyperinflation/depression will probably not happen in our lifetimes.  However there is a big difference between probably and definitely that investors should consider.  In my formative years I was a sci-fi fan and had friends from former communist countries, and I suppose that made hesitant to put too much stock in the economic status quo lasting forever.

What do you think about taking advantage of a one time conversion from traditional IRA to Roth IRA this year to get more of your accounts under the same umbrella?

Would you pay less taxes overall by keeping GLD in a Roth?  I was thinking that the "collectibles" tax would be reduced since you didn't pay taxes on earnings when you withdraw from a Roth.

As I'm sure you know, with Roth contributions you pay income tax in the year you earn the income and no tax when you pull money out of the Roth later.  With IRAs you pay no taxes now but distributions are taxable income.  We have progressive income taxes so typically you pay less total tax by paying the income tax on the way in (Roth) than on the way out (traditional) since the investment grows and becomes a larger sum of money.

So, in the typical case of someone investing for retirement many years away, with a similar income to what they have now, and a similar tax structure to what we have now, Roths are better, and you should take opportunities to convert traditional IRAs to Roths. If you have a large traditional IRA, it may make sense to spread the conversion over several years to avoid the highest tax bracket.

However there are factors that could make traditional IRAs better than Roths: if you retire in a much lower tax bracket, if you retire in a state with a much lower income tax, if income tax rates are lower across the board when you retire ( ), if you plan on leaving most of the IRA to your heirs, if Congress or the IRS changes the rules out from under us, etc.