7

This question is in the context of securities held within a 401k.

As I understand it, one of the advantages of a retirement target date fund (like Fidelity's FFFHX, which I am in 100%) is that the fund automatically adjusts its holdings to become more conservative as the target date approaches. This fund has an expense ratio of 0.77%.

For comparison, I looked at two other funds available in a Fidelity 401(k) - the Spartan 500 Index Fund (FUSVX - expense ratio of 0.03%) and the Spartan U.S. Bond Index Fund - Fidelity Advantage Class (FSITX - expense ratio of 0.17%).

Assuming I were to be comfortable regularly (yearly-ish?) rebalancing my portfolio both by changing the percentage of my 401(k) contributions in each fund as well as rebalancing principal as I grow closer to retirement, there seems to be an advantage in this "do it yourself" approach with regards to fees.

However, what about taxes? This is something I can't quite wrap my head around. If I rebalance regularly I would expect to incur some sort of tax liability. On the other hand, if I invest in a fund which rebalances itself automatically, would there be any tax implications for me when the fund rebalances? As a result, are such funds a better bet when it comes to taxes?

Ultimately, is there a way to calculate whether a self-reblancing fund with a higher expense ratio that (may) shield me from taxable events (in rebalancing) is worth the premium?

7

A 401(k) is tax-deferred. Rebalancing assets in a 401(k) is not a taxable event.

In a taxable non-retirement account, you would figure out what investments have the best return after taxes. In a tax-advantaged account (like a 401(k), Roth 401(k), IRA, or Roth IRA) you simply figure out what investments have the best return. This is why some people advise putting tax-inefficient assets (like bonds) into tax-advantaged accounts and tax-efficient assets (like stocks) into your regular non-retirement accounts.

  • 5
    Can you explain (or provide a link) about what "tax-inefficient" means and why bonds are tax-inefficient? – Jer Feb 4 '14 at 18:03
3

As Greg points out, rebalancing assets within a 401(k) (similarly, an IRA or a 403(b)) account is not a taxable event. If you are continuing to contribute to a tax-deferred account, one way of achieving re-balancing (or changing from a 70%-30% split to a 65%-35% split between stocks and bonds, say) is to change where your new contributions are going, putting more new money in one fund than the other, until the desired split is achieved.

  • 1
    But this will be the slow way to rebalance it. If you want to rebalance, just rebalance. If there were tax implications then the adjustment of the contributions would make sense. – mhoran_psprep Aug 6 '12 at 0:08
  • 1
    @mhoran_psprep While investments in no-load mutual funds with no withdrawal restrictions can be re-balanced in one swell foop, there can be monetary losses if the funds have sales charges (yes, load funds are offered in some 401ks) or withdrawal restrictions (e.g. can't sell within a year of purchase). Some 401ks have brokerage accounts so that investments in stocks (or ETFs) are possible. So there are commissions for buying and selling, and perhaps it is better to rebalance by directing new contributions. But for FUSVX and FSITX, I agree that a simple re-balance as needed works fine. – Dilip Sarwate Aug 6 '12 at 2:18

You must log in to answer this question.

Not the answer you're looking for? Browse other questions tagged .