It is easy to accumulate multiple investment accounts. While it may not always be practical to consolidate them, there are effective strategies to simplify their management and track your asset allocation. It is not dangerous to use just one firm for all accounts, as long as it is reputable mutual fund firm using a third party custodian.
Here is a pretty realistic breakdown of investment account types for an average working couple:
- His IRA
- Her IRA
- His 401(k)
- Her 401(k)
- His Roth
- Her Roth
- Joint aftertax investment account
Managing an asset allocation requires looking at all accounts together as one portfolio, but having your allocation spread out over a lot of different accounts can complicate things when setting up the asset allocation or when rebalancing. There is no easy fix because tax laws force you to keep different accounts types, well, separate. But there are a few ways you can make it a bit easier.
While you can’t do anything about the number of account types, you can consolidate where those accounts are held. IRAs and after-tax investment accounts can be moved to just one firm. There are some worried folks over at the Bogleheads forum who fear that, if only one firm holds all of an investor’s assets, and they go belly up, they would lose most if not all their life savings, a la Bernie Madoff. This outcome is not a realistic scenario for anyone who is a passive index investor.
The Securities Investor Protection Corporation (SIPC) “protects the securities and cash in your brokerage account up to $500,000. The $500,000 protection includes up to $250,000 protection for cash in your account to buy securities.”
But, what if your account value is greater than $500K?
The SIPC protects investors by guaranteeing the securities held on your behalf by your broker. When Lehman and MF Global went belly up, it was not necessary for the SIPC to issue any actual payments because no investor securities or cash were actually missing. This is because both firms properly separated investor accounts from the firm’s finances. The SIPC limits of $500K and $250K apply to what may be missing after the distribution of securities and cash held in the investors’ accounts. So, if you have a $5M account and the bankrupt firm “somehow lost” 10% of all investor account assets, that investor would receive $4.5M before the SIPC insurance limit of $500K would apply. In other words, this investor would get back all of her $5M account. Futures accounts are not covered, but all other publicly traded securities are.
Vanguard took an added step. It “secured additional coverage from certain insurers at Lloyd’s of London and London Company Insurers for eligible customers with an aggregate limit of $250 million, incorporating a customer limit of $49.5 million for securities and $1.75 million for cash.”
The point is when a financial collapse happens to a broker, it is highly unlikely to have a serious impact on the individual investment accounts managed by the firm. The firm has no legal title to them as corporate property. The Madoff case was a bit of a different matter. He used fraud, which was executed using the cover of managed account services, and for which there was not an adequate separation of duties. Retail brokerage firms (like Schwab, Fidelity, or Vanguard) have adequate protections for investors holding securities, and if you follow the principles of this site and of Bogleheads, you will not need managed services.
If your investments are only in mutual funds, not individual stocks and ETFs, that is better. The custodian is a third party, one who is highly regulated and not a broker. They keep track of the assets in the mutual fund, and the transactions made in the fund. They also keep track of all the transactions of the investors. The mutual fund manager does not see investor purchases and redemptions of the fund. This separation of duties prevents mismanagement or fraud by the fund manager. Banking laws prevent creditors from claims or liens against mutual fund assets held by a bank custodian. In the case of Vanguard, they use several different independent custodian banks. As I have said before, there are good reasons to own mutual funds rather than ETFs. Here is another good reason.
Consolidating accounts to a single mutual fund firm who uses a third party custodian is a very good idea. The point of all this is, when most of your holdings are held by one firm, it is much simpler for you to track your overall asset allocation. Even so, it will still take some effort to allocate the allocation between the accounts themselves. If you use just one firm, they can normally provide consolidated reports for combined amounts by asset class. You may have fill out some paperwork if you want to also include holdings from any spousal-owned accounts. Some firms also let you track holdings from external accounts, but you may have to enter those holdings manually. I avoid tracking services like Mint, but then I am more paranoid than most about sharing my accounts information.
Now, let’s discuss what to put where. If you are beginning to set up your allocation, or just need to restructure account locations, first identify which accounts are tax-deferred versus taxable. Place the more inefficient asset classes into those accounts first, such as REITs and taxable bonds. I hope you are an indexer, but if you have active stock funds with a lot of turnover, then they should also be considered tax inefficient. If practical, match your stock/bond ratio in each account, but it is not critical. All that really matters is the ratio for the portfolio as a whole. Think of all the accounts together as just one big portfolio. If you have multiple tax-deferred accounts, does it really matter if all REITs go in one account and all bonds go in another? It might make rebalancing a bit trickier if you have large taxable balances, but I have not had any issues with it. If you are still working and saving, it may be more convenient to duplicate asset types across accounts so you have more tax flexibility. After all, the reason for considering asset location is to improve tax efficiency.
Build a spreadsheet with your asset allocation, calculate what percentage each account represents of the whole portfolio. Then, starting with tax deferred accounts, fill in which assets go where:[table id=5 /]
In the above example, account 1 used only 15% of the 40% available for bonds, so tax deferred account 2 gets the remaining 25% of the 40% bond total. When rebalancing, it is basically the same process. Calculate the percentage of the whole portfolio each account comprises, then adjust the balances to restore the allocation:[table id=6 /]
Note in the above example, now it is time to rebalance, since total bonds fell from 40% to 30% we need to buy bonds and sell stocks. Notice the percentage total contribution of each account has changed. For example, Account 1 was 25% of the total, and now it is 27%. Of course, we are not going to change the 27% part, but we do need to change how that 27% is allocated.
Here is what it should look like after rebalancing:[table id=7 /]
The portfolio level allocation percentages have been restored, even when the individual account percentages have changed.
A final word. Note that account 1 consists of 10% for REITs and 17% Total Bond Market, for a total of 27% of the portfolio total. But, when we rebalance, we have to do transactions at the account level. In this example, REITs are (10%/27%=37%) 37% of the account total while TBM is the difference of 63%.