401k & Roth confusion - Help, I'm going crazy!

[Moneyboy]

This is my first post, but I've read hundreds of posts on this forum and also read The Permanent Portfolio book.  Let me start by giving some background info:

* 46 years old
* Just starting to invest for retirement
* My applicable choices in my 401k are Vanguard 500 Index(VIFSX), Vanguard Target Date funds, Vanguard Intermediate-Term
  Treasury fund(VFIUX), and Vanguard Prime Money Market fund(VMRXX)
* I have approximately $14,500 available to contribute annually and am thinking about investing $9000 in my 401k and $5500 in my
  Roth.

I currently have a spreadsheet created to play with various scenarios, in an attempt to determine how to allocate my dollars to best utilize the PP.  Needless to say, it's been driving me crazy!

1) Should I invest $9000 annually in the 401k with all of it going into the Vanguard 2035 Target Fund and set up a pure PP in the
    Roth, using Schwab to invest the remaining $5500?

2) Should I try and combine the 401k and Roth? This will require me to use the Money Market(VMRXX), S&P500(VIFSX), and the
    Intermediate-Term(VFIUX) Bond fund as my short and long term allocation.  I would count it as a 15% cash and 35% long term
    bond allocation mix.  Is this appropriate since it has a 5.3 year duration?  This would appear to me to be a bullet approach.

3) Should I skip the Roth and use the Money Market(VMRXX), S&P500(VIFSX), and the Intermediate-Term(VFIUX) Bond fund in the
    401k, along with using some cash and also buying gold directly with after tax money?

The biggest limitation I see is the Intermediate-Term Treasury fund in my 401k.  I would like to keep things simple, but I also want it to be effective.  Any suggestions?
 

[AdamA]

I might consider something like this in your situation.  It's not the only option, but it's the simplest one.

50% VFIUX
25% VIFSX
25% Gold coins.

Using 50% intermediate treasuries is basically the same as 25% cash, 25% 30 year bonds.

It's a little bit of a modification, but would probably work fine.

[Pointedstick]

Here is what I would do, were I in your situation:

1. Contribute $5,500 to the Roth IRA, split evenly between bonds, gold, cash, and stocks. With Schwab, this can be totally commission-free!

2. Contribute the remaining $9,000 in your 401k to a 50/50 mix of VIFSX and VFIUX

401ks are rarely ideal, and IMHO if you can't make a full PP (or close to one) within each tax-shetered account, you're going to end up repeatedly banging your head against the wall regarding contributions, rebalancing, tax planning, etc. That's why I'd just give up and use the 401k for a simple Boglehead stock/bond portfolio. You could consider it your VP.

The allocation might be change depending on your income. If you're in the federal 25% bracket or above and live in a state with substantial income taxes, sheltering more of it with a 401k could pay off big, especially if you plan to retire to an income tax-free state on less than you currently make.

[KevinW]

IMO your three alternatives, and the ones that others have suggested, are all reasonable. You'll just have to pick whichever alternative minimizes hassle/regret/expenses/risk according to your personal preferences and fund options.

Personally I have come around to agree with

IMHO if you can't make a full PP (or close to one) within each tax-shetered account, you're going to end up repeatedly banging your head against the wall regarding contributions, rebalancing, tax planning, etc.

Spreading one portfolio across different accounts with different tax treatment is a slippery slope to market timing. IMO it's better to treat each account as its own isolated portfolio and build the best portfolio you can inside each account. Ideally they're all PPs. When that's not possible I'd use a conservative Boglehead-style stock/bond allocation since those are usually feasible in 401ks and have a lot in common with the PP.

[rhymenocerous]

My retirement accounts are lopsided as well, with more contributions going to the 401k each year.  This is what I do:

In your 401k, I would split it 50/50 between the Vanguard 500 Index and Vanguard Intermediate-Term Treasury.  In your Roth IRA, I would split it 50/50 between 30 year treasuries and gold.  This maintains a traditional PP with the VP being 50/50 stock/bonds in the 401k.  I don't mind using an intermediate treasury fund for the cash portion of my PP.

[Ad Orientem]

Hi and welcome to the forum. Wow! I am absolutely green with envy. You have an awesome choice of funds for a 401k which is extremely rare. That aside here are a few quick observations and suggestions.

1. I agree with Pointedstick. 401Ks are just a pain in the butt to work into a PP. I have spent a lot of time on threads in the past trying to help people do financial contortions in an effort to come up with something PPish that in the end is very complicated and high maintenance in terms of constantly having to play with parts of your portfolio. No more. Forget about it and go with Plan B, which should be a good old fashioned Jack Bogle special. I am very conservative and love the PP, but it  just doesn't work well in or with 401Ks and I no longer think it's worth the trouble to keep trying to jam a round peg into the proverbial square hole. And while it's not a PP, a Boglehead portfolio is actually a pretty good investment vehicle. So go with 50% Intermediate Term Treasuries or even a Total US Bond Market Index Fund and then 50% in either the S&P 500 or total US Stock Market. You could even go global stock market index if you wanted to. Since you won't have any gold to hedge inflation that might actually be a good idea. Reinvest the dividends and rebalance at 60/40. You will want to adjust your asset allocation as you get closer to retirement.

2. You are starting a bit late in the retirement game but better late than never. Unfortunately this does have some implications. You are probably going to have to make some serious adjustments in your lifestyle if you want to retire by 70. By which I mean the standard rule of saving 10-15% of your income is not going to cut it unless you have some other anticipated source of revenue that I am not aware of. To which end...

3. You need to max out contributions to both your 401K and an IRA. The IRA should be a PP. And on top of that you need to sock away, even in taxable accounts, every penny you possibly can. You need to pay off and thereafter avoid all forms of debt. Debt is the mortal enemy of financial security. I don't know your specific income level but I would suggest trying to invest half of your income for retirement. That's easier said than done. But you really need to make up for lost time and compound interest. So that might require taking a hard look at your current living arrangements and making some deep cuts in the budget.

Don't get discouraged though. Living a scaled back lifestyle can have its own rewards that might prove surprising. Above all, don't give up. Again welcome to the forum.

[rocketdog]

Here is what I would do, were I in your situation:

1. Contribute $5,500 to the Roth IRA, split evenly between bonds, gold, cash, and stocks. With Schwab, this can be totally commission-free!

2. Contribute the remaining $9,000 in your 401k to a 50/50 mix of VIFSX and VFIUX

401ks are rarely ideal, and IMHO if you can't make a full PP (or close to one) within each tax-shetered account, you're going to end up repeatedly banging your head against the wall regarding contributions, rebalancing, tax planning, etc. That's why I'd just give up and use the 401k for a simple Boglehead stock/bond portfolio. You could consider it your VP.

I generally agree with this advice, although at your age I might go with a 60/40 VIFSX/VFIUX blend, or even 70/30 if you're somewhat agressive and optimistic and you don't plan on retiring early.  Don't forget that you'll be dollar cost averaging into these funds, which will lower your average per-share price over time. 

Also, you say the funds you listed are the "applicable choices in my 401K".  I'm assuming by "applicable" you mean PP-friendly?  I wouldn't get too hung up trying to create a PP inside your 401K plan.  Like PS said, 401Ks are far from ideal for a PP, unless you have a brokerage window (you don't mention if you do, but it's worth looking into).  If you have access to other passively managed low-cost funds that will give you greater diversity, I would consider throwing them into the mix. 

For instance, on the equities side I hold a foreign fund, a small-cap fund, and a mid-cap fund in my 401K in addition to an S&P 500 fund.  VIFSX doesn't give you any exposure to these areas.

[notsheigetz]

No one has yet mentioned the most important issue, IMHO. Is there a match on the 401k? If so, can you capture more of it by contributing more than $9000? If so, the first consideration should be to capture the full and maximum match prior to investing anything in the Roth.

Unless he has a more generous match than I've ever had I suspect the $9k contribution covers it.

I make yearly contributions to Individual Roth IRA's for both me and my wife but I'm not so sure I would do it if I was in your situation. I only started doing it after we both maxed out the 401ks and still had money left over for the Roth.

[rocketdog]

No one has yet mentioned the most important issue, IMHO. Is there a match on the 401k? If so, can you capture more of it by contributing more than $9000? If so, the first consideration should be to capture the full and maximum match prior to investing anything in the Roth.

Unless he has a more generous match than I've ever had I suspect the $9k contribution covers it.

I make yearly contributions to Individual Roth IRA's for both me and my wife but I'm not so sure I would do it if I was in your situation. I only started doing it after we both maxed out the 401ks and still had money left over for the Roth.

Same here.  There's something to be said for the pre-tax advantage of a 401K, even in light of its other flaws. 

[Pointedstick]

Same here.  There's something to be said for the pre-tax advantage of a 401K, even in light of its other flaws.

Same here too... Roths are great but unless you don't pay much in taxes, tax-deferred accounts can really help you invest even more every year since you can (and should) invest the tax savings. As Ad Orientem said, getting more money socked away ASAP is important. If you save 50%, you could safely retire in 10 or 15 years (depending on how much you already have).

You can also lower your tax bracket by socking away more money into tax-deferred accouts, and if you do this enough to get your income below the magical 15% federal tax bracket, then your dividend and long-term capital gains tax rates are 0%. That means that taxable accounts become like more flexible Roth IRAs.

[whatchamacallit]

I will post my opinion since it is different. You have some free lunches you can take while accumulating:


1. Maximize your 401k match and nothing more buying the stock index fund. If you don't get a match, don't use the 401k.

Use IRA to complete your stock balance or fill your balance if there is not a 401k match.

2. Buy EE bonds instead of LTT while interest rates are below 3.5 %. If LTT goes back above 3.5% you can then sell and buy LTT.

The 20 year treasury is currently at 2.5% versus  EE bond at 3.5%. If the EE bond was marketable, it would be like buying a $1157 bond for $1000 (15.7% gain for free).

I would count these as bonds for 5 years and then count them as cash if the interest rates are still below 3.5%. Buy more EE bonds with lower paying cash after you move them to cash after 5 years.

I feel that loses very little reward potential to the amount of risk you lose.

3. Buy I bonds with deep cash that you won't need for a year. Any you buy before May, you earn 1.76 apy for 6 months and then 1.18 apy for 6 months.

4. Either buy physical gold or fill out your IRA benefit with a gold fund.

[notsheigetz]

I make yearly contributions to Individual Roth IRA's for both me and my wife but I'm not so sure I would do it if I was in your situation. I only started doing it after we both maxed out the 401ks and still had money left over for the Roth.

Forgive my narcissism for quoting myself but maybe I latched onto some kind of investing rule. Roth IRA's make good sense if you are going to find yourself in a high tax bracket when you retire, maybe not so much otherwise.  If you find yourself in a situation of maxing out your 401k and still having money left over to invest that might be good evidence that Roth would be advantageous for you.

[Moneyboy]

Thanks to everyone for your feedback...lot's of good info!  I apologize if my formatting doesn't come across very neat.  When I preview my post, it all looks good, but when it actually posts, the formatting takes on a mind of it's own.

Let me clarify or answer a couple questions that came up from the responses:

*  I'm well into the 25% Federal tax bracket, with a 4% State tax.  So, I'm leaning towards not using a Roth, but increasing the $9000
    401k amount to approximately $14,500 to take advantage of reducing my taxable income.
*  I have a pension that will pay 25% of my highest pay when I reach 65.  Also, from my understanding, Social Security should equal
    about 36% of my income.  So, I should be ok when I reach 65ish, but I have to get busy.
*  The $9000 annually I mentioned, includes company match. 

From most of the feedback, it looks like I'm leaning towards not trying to put together a PP.  Below is where I'm at now:

*  50% S&P500/50% Intermediate Term Treasury.  I might move that to a 60/40 favoring the S&P500.
*  Or using The Vanguard Target Retirement Income Fund as my foundation for about a 70% portion of my 401k, then adding 30%
    S&P500 to make it somewhat more aggressive.
 
A couple of questions I have:

1)  Is gold necessary to add to the above options since I'm not following the PP?  I would buy it with taxable dollars, most likely coins.
2)  If it's necessary, how would I determine when is a good time to buy and how much would be appropriate?
3)  Since I can't use the PP balancing band 15/35 formula, what approach should I use to capture returns?
4)  Are the above portfolio choices too conservative at my age starting from scratch?  I can't imagine either of these options producing
    more that about 8% average over 15-20 years, but the only other choice I have is to go heavier into the S&P500.

Thanks for everyone's help!

 

[Ad Orientem]

I will post my opinion since it is different. You have some free lunches you can take while accumulating:


1. Maximize your 401k match and nothing more buying the stock index fund. If you don't get a match, don't use the 401k.

Use IRA to complete your stock balance or fill your balance if there is not a 401k match.

2. Buy EE bonds instead of LTT while interest rates are below 3.5 %. If LTT goes back above 3.5% you can then sell and buy LTT.

The 20 year treasury is currently at 2.5% versus  EE bond at 3.5%. If the EE bond was marketable, it would be like buying a $1157 bond for $1000 (15.7% gain for free).

I would count these as bonds for 5 years and then count them as cash if the interest rates are still below 3.5%. Buy more EE bonds with lower paying cash after you move them to cash after 5 years.

I feel that loses very little reward potential to the amount of risk you lose.

3. Buy I bonds with deep cash that you won't need for a year. Any you buy before May, you earn 1.76 apy for 6 months and then 1.18 apy for 6 months.

4. Either buy physical gold or fill out your IRA benefit with a gold fund.

Great observation on the EE Bonds... That is a very interesting topic that I believe merits some thought. Not so sure about using them as a substitute for LTTs though. Remember we don't hold the LTTs for their yield but rather for their volatility. EE's are basically non-tradable.

A better argument might be made for using them as part of your cash, as long as you have enough in liquid assets to ride out any rough spots.

[Ad Orientem]

Thanks to everyone for your feedback...lot's of good info!  I apologize if my formatting doesn't come across very neat.  When I preview my post, it all looks good, but when it actually posts, the formatting takes on a mind of it's own.

Let me clarify or answer a couple questions that came up from the responses:

*  I'm well into the 25% Federal tax bracket, with a 4% State tax.  So, I'm leaning towards not using a Roth, but increasing the $9000
    401k amount to approximately $14,500 to take advantage of reducing my taxable income.
*  I have a pension that will pay 25% of my highest pay when I reach 65.  Also, from my understanding, Social Security should equal
    about 36% of my income.  So, I should be ok when I reach 65ish, but I have to get busy.
*  The $9000 annually I mentioned, includes company match. 

From most of the feedback, it looks like I'm leaning towards not trying to put together a PP.  Below is where I'm at now:

*  50% S&P500/50% Intermediate Term Treasury.  I might move that to a 60/40 favoring the S&P500.
*  Or using The Vanguard Target Retirement Income Fund as my foundation for about a 70% portion of my 401k, then adding 30%
    S&P500 to make it somewhat more aggressive.
 
A couple of questions I have:

1)  Is gold necessary to add to the above options since I'm not following the PP?  I would buy it with taxable dollars, most likely coins.
2)  If it's necessary, how would I determine when is a good time to buy and how much would be appropriate?
3)  Since I can't use the PP balancing band 15/35 formula, what approach should I use to capture returns?
4)  Are the above portfolio choices too conservative at my age starting from scratch?  I can't imagine either of these options producing
    more that about 8% average over 15-20 years, but the only other choice I have is to go heavier into the S&P500.

Thanks for everyone's help!

1. Yes. If you are going to go with a Boglehead portfolio you will still want to have some gold.

2. 25% is probably a bit high for a Bogle portfolio. I would suggest at least 10% though. Buy 5% right away if you can and the rest you can scale in. You might also want to add some international stock exposure if that is an available option as part of your stock holdings. Index as always.

3. No hard and fast rule here. But try not to deviate too far from your assigned asset allocations. One simple approach would be to just hit the reset button annually.

4. You don't want to get too aggressive in your investments. The best way to improve your retirement position is to sock away a larger percentage of your income. I would be really uncomfortable with more than 50% in equities even if I was Bill Gates. And even that is risky. You need to have a strong stomach and be ready to ride out volatility. A lot of people freak out during market dives and sell at or near the bottom, locking in their losses. Definitely adjust your asset allocation in favor of bonds as you get closer to retirement.

[notsheigetz]

*  I have a pension that will pay 25% of my highest pay when I reach 65.  Also, from my understanding, Social Security should equal
    about 36% of my income.  So, I should be ok when I reach 65ish, but I have to get busy.

Social security is slated to pay only 70% of current benefits when the trust fund runs dry in year 2031 (or whatever year, take your pick). Are you taking that into consideration?

Good luck with the pension. 19 years is a long time. If you work in private industry your company could be bought out tomorrow and they might decide to discontinue the pension plan and give you a cash payout instead. I speak from experience.

From most of the feedback, it looks like I'm leaning towards not trying to put together a PP. 

I think the PP will work a lot better for you when you have more control over the investments. Most of mine was in a self-directed SEP-IRA account when I started out. Probably a good idea to make the most of what you have available right now and not get too hung up on a perfect implementation of the PP strategy.


Below is where I'm at now:

*  Or using The Vanguard Target Retirement Income Fund as my foundation for about a 70% portion of my 401k, then adding 30%
    S&P500 to make it somewhat more aggressive.

See above about the discontinuation of my company pension plan. I rolled the proceeds over into T. Rowe targeted Retirement funds and it was a disaster (2008 stock meltdown). I have read that Vanguard has some much better targeted funds. Based on my experience I wouldn't add 30% S&P 500 to make it "more aggressive".
 
A couple of questions I have:

1)  Is gold necessary to add to the above options since I'm not following the PP?  I would buy it with taxable dollars, most likely coins.

I think gold is absolutely necessary. I would come up with some strategy with what you have to make sure I had some

2)  If it's necessary, how would I determine when is a good time to buy and how much would be appropriate?

You consult whoever currently has the crystal ball in their possession and pay them a fee.

3)  Since I can't use the PP balancing band 15/35 formula, what approach should I use to capture returns?

No clue whatsoever how to answer that

4)  Are the above portfolio choices too conservative at my age starting from scratch?  I can't imagine either of these options producing
    more that about 8% average over 15-20 years, but the only other choice I have is to go heavier into the S&P500.

I don't know that much about the Vanguard targeted funds but I think you will be plenty stock heavy and I wouldn't worry about it.

Thanks for everyone's help!

You get what you pay for.

[Pointedstick]

I'm not a fan of most target retirement funds for a few reasons:

1. High expenses
2. Opaqueness; difficult to know how much risk you're actually taking on
3. Loss of control; no way to adjust things to your liking unless you ditch the whole thing
4. Many lack ticker symbols you can use to monitor them

Some may be better than others, but all will suffer from most of these problems.

Just hold some gold outside your 401k that's full of bonds and stocks and you'll probably be fine; I would say don't get caught too much on the percentages. Melveyr has in the past described the PP as "a conservative Boglehead portfolio with a slug of gold thrown in" (or something to that effect) and I absolutely agree with him. You're probably looking at something like a 50/30/20 mix, or 60/25/15 or something.

And I too wouldn't own much more than 30% stocks, especially given how close you are to your desired retirement date. Stocks have had 30-year losing periods in the past; you want to be sure that you have the 1) time and 2) counterbalancing assets to ride out any such periods that may come to pass.

Know your psychology, too. If a falling stock market triggers your panic reflex rather than your inner bargain hunter, you will want to underweight them even more.

[MachineGhost]

A better argument might be made for using them as part of your cash, as long as you have enough in liquid assets to ride out any rough spots.

I haven't look at this situation in a while, but are EE bonds a better deal right now than I-Bonds which pay 0% real?

[WildAboutHarry]

I haven't look at this situation in a while, but are EE bonds a better deal right now than I-Bonds which pay 0% real?

Only if you intend to hold the EE bonds for the 20-year bump.

[rocketdog]

I'm not a fan of most target retirement funds for a few reasons:

1. High expenses
2. Opaqueness; difficult to know how much risk you're actually taking on
3. Loss of control; no way to adjust things to your liking unless you ditch the whole thing
4. Many lack ticker symbols you can use to monitor them

Some may be better than others, but all will suffer from most of these problems.

Agree here.  Check the expense ratio and if it's below 50 basis points (highly doubtful) then go ahead and put maybe 50% into it.  You might even put 25% into 2 of them in order to "straddle" your planned retirement date.  But methinks you'll still be better off with the low-cost index funds. 

And I too wouldn't own much more than 30% stocks, especially given how close you are to your desired retirement date. Stocks have had 30-year losing periods in the past; you want to be sure that you have the 1) time and 2) counterbalancing assets to ride out any such periods that may come to pass.

Disagree here.  I thought he said he was 46 with a targeted retirement at 65?  If so, he's got lots of time and needs sufficient stocks to generate those long-term gains.  I try to keep 100 minus my age in stocks, so for him that's 54%.  I should add that this is my overall equity percentage, where my PP is still 25% equities but my VP is much higher, which raises my overall equity exposure. 

There has never been a 30-year losing period in stocks for investors who dollar cost average.  Maybe if you invested everything you had at the very peak right before the crash of 1929 and then just held on for dear life waiting for it to recover, but that's an edge case.  Plus things are different today: there is a global economy, people have better & faster access to the markets, the government has more tools at its disposal to prevent such events, and so on.  Outside of a SHTF scenario, we will never see another 30-year period where the stock market trades below its previous highs (oh wait, did I just jinx us??)

[Pointedstick]

Dollar-cost averaging isn't a free lunch. DCA-investing will help you avoid bear markets as much as it will hurt you in bull markets, where you're consistently buying on the way up, only to have a high basis for more of your stocks when the inevitable crash happens. That'll take you longer to recover from.

[rocketdog]

Dollar-cost averaging isn't a free lunch. DCA-investing will help you avoid bear markets as much as it will hurt you in bull markets, where you're consistently buying on the way up, only to have a high basis for more of your stocks when the inevitable crash happens. That'll take you longer to recover from.

But you're buying more stocks on the way down and fewer stocks on the way up, which brings your basis down below the market's average.  So although it's not a free lunch, DCA pays off in the long term since we can never predict which way the market is heading on any given day. 

That said, I'm aware of at least one study that compared an "all-in" approach vs. using DCA over the course of a year.  They found it was slightly better to go "all-in", but you don't get that option in a 401K (unless you put 100% into a cash-equivalent fund and then shift it all into equity and bond funds once a year, but who would do that?)

[MachineGhost]

Only if you intend to hold the EE bonds for the 20-year bump.

I certainly intend to hold the PP longer than 20-years.  So what's the catch?  No early redemption?

[rickb]

Only if you intend to hold the EE bonds for the 20-year bump.

I certainly intend to hold the PP longer than 20-years.  So what's the catch?  No early redemption?

You can redeem with a 3-month interest penalty after 1 year (same as I-bonds) and penalty free after 5-years (also same as I-bonds).  However, they're guaranteed to double after 20 years regardless of the stated coupon rate.  This bump you get only if you hold them for 20 years.  So if inflation really takes off, I-bonds will (presumably) keep pace but your EE bonds won't.  And if you cash them in before 20 years to chase current cash yields (of greater than 3.5%) you get the lousy, measly 0.2% (or whatever they're actually paying).

They keep changing the rules on EE bonds as well.  I have some (you can't get these) that are past their 20-year doubling and now pay 4%/year (tax deferred).  It's pretty much like getting 4% (tax deferred!) on a T-bill since I can cash these at any time.  They will ultimately reach their "final maturity" - at which time they stop paying interest - but until then they're absolutely awesome.