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Investing Blog Roundup: Rick Ferri Launches Robo-Advisory

This week, well-known author/advisor Rick Ferri announced that he will soon be launching a robo-advisory service, targeted toward younger investors. Cinthia Murphy of has the scoop:

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Moving Money from Taxable Accounts to Retirement Accounts

A reader writes in, asking:

“I recently came into some money, about $40,000 of assorted stocks. Is there a way to get this into one of my retirement accounts? I gather that I am not allowed to roll it into my 401K or IRAs, is that correct?”

It is correct that you cannot roll money from a regular taxable brokerage account into a retirement account. (If you could, there would be no point in having contribution limits, because you could save as much as you wanted in a taxable brokerage account and just roll it over.)

However, there may be a way to ultimately get the money into a retirement account. Specifically, if you are not maxing out your retirement account contributions at the moment, you could use the recently acquired assets to pay the bills while bumping up your retirement account contributions to the max.

For example, if you have a 401(k) with a contribution limit of $18,000 and a Roth IRA with a contribution limit of $5,500 (for a total of $23,500), yet you’re only making contributions of $15,500 per year, you have an additional $8,000 of contribution space that’s currently going unused. So you could bump your contributions up to the max and use the taxable investments to help pay the bills (to the tune of $8,000 per year). After 5 years, the $40,000 sum would effectively have been transferred into your retirement accounts.

This tends to work well with recently acquired sums of cash (e.g., from the sale of a business or from downsizing living quarters). It also works well for recently-inherited assets, because when you inherit something you (in most cases) get a step-up in cost basis. That is, your cost basis will usually be equal to the fair market value of the asset on the date of the original owner’s death, meaning that there would be little-to-no capital gains tax to pay if you sell the assets (which you would be doing in order to free up cash to max out your retirement account contributions).

This strategy does not work quite as well for investments that you’ve held for a long time, and which have large unrealized capital gains — because there could be a significant tax cost to selling the assets in order to free up cash to make additional retirement account contributions. In such cases, whether it makes sense to do it depends on several factors, such as:

  • How much tax you’d have to pay if you liquidated the assets now;
  • How much tax you would have to pay if you waited and did it later (For example, if you expect your income to decline in the near future, it may make sense to wait if doing so will allow you to pay a lower rate of tax on the capital gains.);
  • How long you expect to hold the assets (the longer, the greater the tax cost of keeping them in a taxable account and paying taxes on interest/dividends along the way); and
  • Whether you expect your heirs to be inheriting the assets in the not-entirely-distant future (if so, it may make sense to simply hold the assets in the taxable account and let your heirs inherit them so they get a step-up in cost basis).

Investing Blog Roundup: Finding Balance in Bonds

Update: Vanguard unpublished the article mentioned below for some reason. I’ve asked them via Twitter if they’ll be republishing it, but have not yet received an answer.

Over the last several years, with interest rates being so low, many investors have been making changes to their bond portfolios. Some are choosing longer duration bonds in the hope of getting a decent yield, while other investors are making exactly the opposite decision — using short-duration bonds in order to minimize the price decline they’ll experience when rates do eventually go up. This week, Vanguard discusses the pros and cons of each approach:

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Why Would an Experienced Investor Buy a Target-Date Fund?

A reader writes in, asking:

“I saw the recent article on Squared Away about target funds appealing to inexperienced investors. [Mike’s note: see here.] I gather that you use a target date fund yourself, despite being an experienced investor. Could you elaborate on why experienced investors might want to use a target date fund?”

Target-date funds, like anything else, are not a good fit for everybody. But personally I’m of the opinion that they’re a sophisticated tool, offering fantastic value for their cost (at low-cost fund families anyway). And I’ve heard from many experienced investors, citing a variety of reasons why they choose to use target-date funds.

I’ve heard from people who use target-date funds primarily for the time savings. They found that it took quite a while to rebalance a portfolio of several different asset classes across many different accounts, and they like not having to deal with that.

I’ve heard from people who use target-date funds because they consider themselves to be math-averse (or finance-averse) and they found the process of rebalancing to be stressful.

I’ve heard from people who use target-date funds to simplify the portfolio for the sake of their spouse (e.g., in case their spouse outlives them).

I’ve heard from people who use target-date funds to simplify their portfolio to protect (to some extent) against cognitive decline.

I’ve heard from people who use target-date funds to make it easier to “stay the course” in market downturns. That is, with a target-date fund, they only see the overall portfolio decline, which is always less than the decline in the worst asset class. So there’s no longer the temptation to bail out of the worst-performing fund(s).

As for me personally, I use a LifeStrategy fund (which is very similar to a target-date fund) in order to avoid a common behavioral finance error: tinkering.

You see, even in the “passive/index investing” camp, there are many differences of opinion about how to build a portfolio. For example, there is no consensus regarding how much of your bond allocation should be invested in corporate bonds. Ditto for high-yield bonds, international bonds, mortgage-backed bonds, TIPS, and so on. And there are similar differences of opinion regarding the stock portion of the portfolio as well.

So what’s an investor to do?

Really, the only thing to be done is simply pick one option and stick with it, even if you’re not 100% sure that it’s the correct option (and, to be clear, you won’t be sure). For some people, “sticking with it” is easy to do. For other people, it’s not so easy.

For me, what I found was that, when I went to rebalance our portfolio (which was approximately every month when I made new retirement account contributions), I would often be tempted to make one small change or another based on whatever I had read recently. Now, with an all-in-one fund, that temptation is gone. I simply log in, contribute as much money as I want to contribute, and that’s all there is to it.

Investing Blog Roundup: Financial Cognitive Decline

This week, Tara Siegel Bernard reports on recent research showing that even people who are deemed by experts to be “cognitively normal” can already be experiencing a decline in financial skills. This is yet another reminder of why it’s critical to take steps to protect yourself in case of cognitive decline in your later years.

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Can I Do a Partial Roth Conversion?

Quick housekeeping note: My wife and I are on vacation for the next couple of weeks, so there will be a gap in the publishing schedule. The next article will be published on Friday 5/8.

A reader writes in, asking:

“On several occasions, you’ve explained Roth conversions with language that indicates you can convert parts of your traditional IRAs to a Roth over time, for a variety of reasons.

When I looked into doing this several years ago, I encountered the rule that required you to value ALL your traditional IRAs and pay the tax on the full value of all of them converted.  I decided against it because that didn’t make sense to me (why would I convert only part when I have to pay tax as if I converted all of them).

Did I misunderstand the rules?  Is there something else I am missing?  I see so little reference to this anywhere.”

Yes, you can do a partial conversion. And in no case will you have to pay tax on more than the amount converted. To be more specific:

  • If your traditional IRA(s) do not contain any amounts from nondeductible contributions, the amount of the conversion will be included in your taxable income for the year, and
  • If you do have amounts from nondeductible contributions in your traditional IRA(s), a portion of the conversion will be included in your taxable income.

Most likely, the misunderstanding arose from the fact that the IRS aggregates all of your traditional IRAs when calculating the taxable percentage of a conversion. That is, if you have multiple traditional IRAs, they’re all considered to be one big traditional IRA for the purpose of this calculation.*

The percentage of the conversion that is not taxable is calculated as:

  • The sum of all non-deductible contributions in all of your traditional IRA, divided by
  • The sum of: all of your traditional IRA balances on 12/31 of the year of the conversion, plus any distributions you made during the year, plus any conversions made during the year.

The idea behind this calculation is to make it so that you won’t have to pay tax twice on a given amount of money. That is, if you didn’t get a deduction when you put money into the traditional IRA (i.e., you paid tax on the money before it went into the account), then you should not have to pay tax again when you move the money to a Roth IRA.

For example, if you have one traditional IRA, and it has a value of $10,000, of which $3,000 came from non-deductible contributions, and you convert the entire traditional IRA, only $7,000 of the conversion would be taxable. The $3,000 nondeductible contribution gets to be converted tax-free.

But in the event of a partial conversion, you don’t get to choose which dollars get converted. Instead, your conversion is considered to come from non-deductible contributions and from pre-tax money on a pro-rata basis — hence the need for the math above.

*This is not true for all IRA-related applications. In some cases, the IRS does consider separate accounts to be separate accounts.

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