Investing with Moving Targets: Complicated Case Study

Now what if things are more complicated and I don’t know exactly how much money I’m going to invest at the beginning of the year? I can instead set an algorithm and then follow that throughout the year.

Let’s say that my investments look like this and it is early May:

Roth IRA

  • $3,000 Vanguard Extended Stock Market Index Fund
  • $6,400 Vanguard Total International Stock Market Index Fund
  • $7,700 five-year CDs that I opened while in college

401(k)

  • $14,400 Vanguard 500 Index Fund
  • $5,600 Vanguard Retirement Savings Trust
  • $10,200 Vanguard Total International Stock Market Index Fund
Total investments: $47,400

Then my asset allocation looks like this:

  • 28% Cash
  • 30% US Large-cap stocks
  • 6% US Small/mid-cap stocks
  • 35% International stocks

Target is 23% Cash / 39% US stocks / 38% International stocks, so that isn’t too far off base.

I plan on maxing out my 401(k) and obtaining the full match from my employer, which would put an additional $12,600 into my 401(k) in 2012. My goal though is to invest 20% of my gross income, which isn’t covered by maxing out my 401(k) and receiving the employer match, so I will invest further in a taxable account. With the stock price that I’m using in my income forecasting, I should put $7,300 into my taxable account in addition to investing the $5,500 which is currently sitting in a money market fund at Vanguard.

Let’s plan this out like we did with the simpler case above.

First of all, with the amount that I plan on investing in taxable this year, I want to simplify my portfolio a bit so that it looks like this:

Roth IRA

  • $9,400 Vanguard Total Stock Market Index Fund
  • $7,700 five-year CDs that I opened while in college – these are staying

401(k)

  • $9,100 Vanguard 500 Index Fund
  • $3,000 Vanguard Retirement Savings Trust
  • $18,100 Vanguard Total International Stock Market Index Fund

I’m going to pretend that Vanguard 500 Index Fund = Vanguard Total Stock Market Index Fund since it makes rebalancing easier, the return graphs are similar, and I only have the former available in my 401(k).

The general advice is to put international stocks in taxable, but I would prefer to put the total US fund in taxable since I don’t have access to it in my 401(k), whereas I do have access to my the total international one in my 401(k). I’ll use the S&P 500 index fund to fill in the remaining US stock room in my portfolio.

  • Months 5 & 6 401(k) contribution allocation: 31% Vanguard 500 Index Fund / 26% Vanguard Retirement Savings Trust / 43% Vanguard Total International Stock Market Index Fund
  • Late in Month 7 taxable investment: $11,200 to Vanguard Total Stock Market Index Fund. In 401(k), move $6,800 from Vanguard 500 Index Fund split to: $2,600 to Vanguard Retirement Savings Trust / $4,200 Vanguard Total International Stock Market Index Fund.
  • Months 7-12 (regular) taxable investment: 100% to Vanguard Total Stock Market Index Fund
  • Month 7 401(k) contribution allocation: 23% Vanguard 500 Index Fund / 29% Vanguard Retirement Savings Trust / 48% Vanguard Total International Stock Market Index Fund
  • Month 8 401(k) contribution allocation: 24% Vanguard 500 Index Fund / 29% Vanguard Retirement Savings Trust / 47% Vanguard Total International Stock Market Index Fund
  • Month 9 401(k) contribution allocation: 24% Vanguard 500 Index Fund / 28% Vanguard Retirement Savings Trust / 48% Vanguard Total International Stock Market Index Fund
  • Month 10 401(k) contribution allocation: 24% Vanguard 500 Index Fund / 29% Vanguard Retirement Savings Trust / 47% Vanguard Total International Stock Market Index Fund
  • Late in Month 11 taxable investment: $400 to Vanguard Total Stock Market Index Fund
  • Month 11 401(k) contribution allocation: 9% Vanguard 500 Index Fund / 34% Vanguard Retirement Savings Trust / 57% Vanguard Total International Stock Market Index Fund
  • Month 12 401(k) contribution allocation: 8% Vanguard 500 Index Fund / 35% Vanguard Retirement Savings Trust / 57% Vanguard Total International Stock Market Index Fund

With all of that, at the end of 2012, my accounts would look like this:

Taxable

  • $12,800 Vanguard Total Stock Market Index Fund

Roth IRA

  • $9,400 Vanguard Total Stock Market Index Fund
  • $7,700 five-year CDs that I opened while in college – these are staying

401(k)

  • $1,400 Company stock
  • $4,800 Vanguard 500 Index Fund
  • $8,800 Vanguard Retirement Savings Trust
  • $27,700 Vanguard Total International Stock Market Index Fund

Based on the above data, I only need to adjust the allocations to my 401(k) in the months where I make a larger than regular taxable investment. In months 8-10 and 11-12 of what I’ve shown above, the suggested percentages are so close to the same, that it’s not worth fidgeting over. So that does prove my hypothesis that I should adjust my 401(k) future allocations after I make a larger-than-regular taxable investment in the month since that throws the asset allocation off a bit. This will be even more true next year (2013), when there will be several months where I invest $2,200 or so in my taxable account (or more, depending on what 20% of my gross turns out to be).

Algorithm

  • Buy only shares of Vanguard Total Stock Market Index Fund in my taxable account.
  • If a large contribution offsets the balance in my portfolio, then make adjustments as necessary to the existing shares I hold in tax-deferred accounts only if it represents a significant shift. Otherwise, just re-balance with new contributions.
  • Only adjust the contribution allocations to my 401(k) in the months where I make a larger than regular taxable investment, e.g. in the RSU vest months of January, May, July, and November.
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10 thoughts on “Investing with Moving Targets: Complicated Case Study

  1. PUT IT ALL ON RED

    lol but srsly good work analyzing your portfolio. I think my entire financial plan would fit on one embarrasingly sparse page.

  2. Leigh, honestly, the return between S&P 500 and TSM are so similar that I’d just use S&P 500 and keep the international in taxable.

    In your tax bracket, I think you would be leaving a decent chunk of $$ on the table by not taking advantages of the foreign tax credit that you would be entitled to if holding TISM in a taxable account.

    • Where can I find out more about how much the foreign tax credit would save me?

      I’m really not happy with the added complexity of using the Extended Market fund to complete the S&P 500 one – that’s way too complicated. So I’d rather say that S&P 500 = US stock if the return is similar enough.

      • Personal decision. The companies in the S&P 500 represents something like 80% of the Total US Stock Market ( I am sure that % varies based on how well the various companies in and out of the 500 do…) but, when you consider that roughly 40% of your target allocation is U.S. stocks, you’re talking about whether you want 32% exposure to the S&P 500 and 8% to the Extended Market, or 40% to the S&P 500. The rates may be different, but is it going to make that much of a difference? (I dont have the answer.

        Is 8% of a portfolio is going to make a sufficient difference in your long term return? Beats me,

        I’m using the extended market just because that’s how I started (in taxable account) and I don’t think it really adds much complexity, but in the long term, I don’t think it’s going to make a sufficient difference just because it is such a small portion of my portfolio, and always will be as long as i target market cap. its obviously simpler to use a total market fund and I wouldn’t choose S&P 500 over the Total Market if both were available, but I also don’t think it’s absolutely necessary to complete the S&P 500 with extended market…

        I’m not sure if that answers your question. :)

        • No, it didn’t, but it provided more food for thought :)

          I would really like to make my Roth IRA one fund, so I’m honestly debating making it all Extended Market and then when re-balancing, just counting that as “US Stocks” and never re-balancing it. (That would mean exchanging International in my Roth IRA for Extended Market.) I’m most likely not going to put much into my Roth IRA this year and I could very likely put nothing into it next year, so I want to basically just leave it alone.

          Another option is to make it Total US Stock Market since when I leave my employer and move my 401(k) into a Rollover IRA, I would have access to TSM in addition to S&P500. That seems silly to plan for in case I end up staying with my employer for another 5 years though I don’t think it’s a bad option here.

          My 401(k) is already 3x my Roth IRA investment balance and my taxable account will very likely be worth more than my Roth IRA by the end of this year, so no matter what is in my Roth IRA, it is going to be a small portion of my overall portfolio.

          In case you can’t tell, I’m really bad at making decisions when there is no clear “right” or “wrong” answer.

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