"LawsFinance" <lawsfinance[at]nospam.com> wrote
E
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The counsel, "Do not chase past returns" conventionally
refers to the misguided proposition that one can repeat high
returns demonstrated only recently and in a particular
investing category (or a few categories). A reasonably
diverse allocation strategy that effectively is rebalancing,
as yours is, includes all sizes of company, foreign and
domestic, without regard for recent returns.

I can see how the wording is confusing, without more
context, for someone new to investing.

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Yes, this is true. And that will likely entail a shift out of small caps.
So this could be another reason for having those in the Roth. I could
then switch the Roth asset class without paying all those capital gains.


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I doubt I will want to do individual stocks. But who knows, I guess...


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This is certainly possible. I do not deny it. But I don't really see how
it affects my planning. Regardless, I will still want save according to
some logical plan. This is especially true in those early years where I
actually do have a legal job (assuming there is a change later and it
entails a smaller income).


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Also a possibility, but unless I have some way to forecast those changes,
I think I just have to ignore them. One forecast is "tax rates will be
higher across the board" and that may be true, but it does not necessarily
imply changes to the tax structure of IRA's. But it could affect the
capital gains/dividend distinction.


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Seems like a very sensible plan, and one I have also been considering.


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Allocation based on asset class does focus on historical returns, so it
does actually chase past returns. This is why I have an interest in small
caps to begin with, they have higher returns. Granted, these are
historical returns, not the immediate past returns of something like, say,
gold. But small caps have done well recently, so at least some of that
"historical return" is due to the recent run-up.

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Thanks for your advice. That's the way I was leaning. Based on my
assumptions, I think you're probably right. But all this is really just
guesswork could definitely be changed by the stroke of a congressional
pen.

LawsFinance wrote:

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Whatever you expect the highest return sector to be, belongs in the
Roth. As Rich pointed out, the tax structure for div/cap gains/ord
income is not cast in stone. But it would seem to me that if you are
asking for an answer based on the assumptions above, the Roth escapes
any further taxes and, based on your assumptions, you put the small cap
ETF in the Roth.

JOE


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"LawsFinance" <lawsfinance[at]nospam.com> wrote
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Because of the inexactness of much of financial forecasting,
I think you're splitting hairs. For one thing, different
sources have different forecasted returns (typically based
on historical returns) for small cap vs. large cap, but in
any event, the two tend to be close. Let's take the 12.5%
and 11.6% returns proposed for each, respectively, at
http://www.ibbotson.com/content/kc_p...D=ARTC41620024 .
(These returns include the effect of dividends.) Twenty-five
years hence the small cap fund would presumably be worth
about 22% more. Some will insist that's a lot. I insist that
reliance on something with so much uncertainty is illogical.
ISTM the returns could easily be flip-flopped.

Plus, your allocation is likely going to change as
(1) you get closer to retirement;
(2) you change investing philosophies. For example, if you
continue your studies of financial planning, I think the
probability is fair that you'll prefer individual stocks
over ETFs and mutual funds.
(3) you experience changes in your career. For example, you
may not enjoy law, or you may find it unprofitable. The
attrition rate for new attorneys these days is not something
to ignore, IIRC. It seems to me it's a bit flooded. My
impression is that the lifting of advertising restrictions,
for one, some years ago has made the field more competitive
and less profitable. Also, perhaps in your chosen legal
field you'll see investing opportunities outside stocks.
E.g. specific real estate property.
(4) tax law changes. Capital gain and dividend tax
treatment, for example. Roth tax treatment post-retirement,
as another example.

I'd put half of each allocation (small and large cap) in the
Roth, half outside it, for now.

In contrast to Ign's suggestion, I wouldn't call your
approach "conservative." I'd call it an approach that does
not chase past returns. This is an intelligent move.

BTW, IFA's site is not the only one with a free online
allocating tool. Google, and try more. Assumptions do vary
somewhat from one to the other.

I have been thinking about this, and I haven't been able to come up with a
clear answer...

Assuming that you were going to hold equal amounts of a small cap ETF and
a large cap ETF, but only one could be in your Roth IRA, which would you
put in the Roth?

This seems to come down to tax differences. Let's assume that ETF's don't
generate any capital gains taxes until sold. The small cap fund has a
higher expected return and those extra capital gains would all be taxed
(when sold at the end). But the large cap fund pays higher dividends,
which would be taxed each year if held outside the Roth. We are also
talking about a pretty long time horizon here, say 25 years. How do you
think those differences balance out?

My guess is that the tax savings from the compounded higher return on the
small caps would outweigh the savings from having the extra tax free
dividends. But I'm really not sure.