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What Change Would I Make to My Portfolio?

A reader writes in, asking:

“If you were to change your portfolio, what would the change be?”

I began using the Vanguard LifeStrategy Growth fund for the entirety of our retirement savings back in 2011, and I have been super happy with the fund. I really appreciate the hands-off nature of an “all-in-one” fund.

Still, if I were to make a change, I know exactly what it would be. I would swap out my bond funds for CDs. Allan Roth has convinced me that active management is worthwhile in fixed-income — via shopping for CD rates. And because that means I would no longer be able to use an all-in-one fund, I would use Vanguard’s Total Stock Market Index Fund and Total International Stock Index Fund for my stock holdings (or possibly Vanguard Total World Stock ETF).

On the fixed-income side, there would be a significant increase in yield and a decrease in risk.

On the stock side, the risk would remain the same, but there would be a slight decrease in expense ratio.

In other words, it’s a strict improvement in terms of risk/return. Risk goes down slightly and expected return goes up slightly.

What isn’t an improvement is that the portfolio would require more ongoing work. I’d be shopping for CD rates occasionally. I’d be doing my own rebalancing. And (unless I want to stick exclusively to CDs available at Vanguard) I’d have to manage accounts across multiple providers. None of those tasks are challenging, but they do take a little time and occupy a bit of “mental space.”

So in short it’s just a question of how much I’m willing to pay (in the form of forgone earnings) for the simplicity of an all-in-one fund. As our portfolio gets bigger, the amount we’re paying for that simplicity each year grows. It’s likely — though not certain — that at some point I’ll decide that the price is sufficiently high that I no longer want to pay it.

How Much Does Simplicity Cost?

On the stock side of the portfolio, the weighted-average expense ratio would decrease by 0.094% (due to switching to Admiral shares rather than the Investor shares held by the LifeStrategy fund). So for every $100,000 that’s invested in stocks via a DIY allocation rather than a LifeStrategy fund, there would be annual savings of $94. Not a big deal, but not nothing either.

Much more significant is the improvement on the bond side of the portfolio. As of this writing, Vanguard Total Bond Market Index Fund has an SEC yield of 2.25%, with an average maturity of 8.3 years and average duration of 6.1 years. And Vanguard Total International Bond Index Fund has a yield of 0.77%, with an average maturity of 9.2 years and average duration of 7.8 years. So, given the US/international breakdown of the bond holdings in a LifeStrategy fund, the current weighted-average yield is 1.81%.

By way of comparison, via Vanguard Brokerage you can currently get a 5-year CD yielding 2.35% or a 7-year CD yielding 2.5%. If you’re willing to look elsewhere (e.g., shop around on bankrate.com or depositaccounts.com) you can often find slightly better yields. And CDs have no default risk (provided you stay under FDIC limits) and in many cases less interest rate risk (because if you buy directly from a bank you can often find some with very low penalties for early redemption).

So for every $100,000 invested in CDs rather than in bonds via a LifeStrategy fund, that’s an increase of $690 in expected interest per year (assuming a 2.5% yield on the CDs) — and a slight reduction in risk.

I don’t know exactly how high the annual cost would have to be before I make the switch. But I think it’s reasonably likely that it will happen at some point.

Stop Reading This Blog.

Admittedly I don’t mean for the headline to apply to every reader. But I don’t mean for it to be just “clickbait” either. I genuinely mean that some of you would be better off unsubscribing from this blog/newsletter.

That probably requires a bit of an explanation.

When I started writing this blog in 2008, the whole idea (i.e., “oblivious” investing) was that:

  1. Most people should stop reading/watching financial news, because such sources of information talk constantly about things that have no real significance to a long-term investor, and
  2. Most people shouldn’t check their investments very often, because doing so can cause unnecessary stress about short-term fluctuations.

What I’m coming to realize, however, is that there’s a group of people who would be well served by discontinuing their intake of even “good” sources of investing information (e.g., this blog, the Bogleheads forum, etc.).

Specifically, based on correspondence with readers, I’m coming to realize that there are some people (quite a lot, actually) who find themselves second-guessing their own investment decisions whenever they’re confronted with a conflicting suggestion from a credible source. This personal characteristic combined with frequent intake of investment information can lead to a problematic situation.

In short, if:

  1. You’re already at a point where you know enough to create and manage a low-cost, diversified portfolio that’s roughly suitable for your risk tolerance, and
  2. Reading about investing is making it harder to manage that portfolio (because it makes you constantly doubt your choices)

…then additional reading might be doing more harm than good. (Plus, reading has a cost in that it’s taking up your time.) Of course, the above two points are an evaluation that only you can make. But it’s worth thinking about at least.

One of the most important lessons in investing is that there is no “perfect” portfolio, but there are many “perfectly fine” portfolios. Once you are confident that you have a “perfectly fine” portfolio, just stick with the plan and let the portfolio do what it is meant to do.

What Other Financial Products Do I Use?

A reader writes in, asking:

“I would be very interested in reading about the various financial products that you use if you would be open to sharing that information.”

I’m happy to discuss it, but it’s not very exciting. As with our retirement savings — the entirety of which is invested in a single mutual fund — the goal isn’t to squeeze out every last dollar of performance. Rather, the goal is simplicity.

As regular readers surely know, we use Vanguard for our solo 401(k) plans, Roth IRAs, and traditional IRAs.

For our checking accounts (business and personal), we use Bank of America. The accounts earn no interest, but they also do not charge any fees for any of the things that we do. (Also, back when we were using S-corp taxation for our businesses, it was nice that BoA had an integrated payroll service — which was actually done by Intuit — that was easy to use and inexpensive.)

We use two credit cards:

  • The Amazon Prime Visa that gives 5% back at Amazon; 2% at restaurants, gas stations and drugstores; and 1% on everything else; and
  • The REI MasterCard that gives 5% back at REI, 2% on groceries, and 1% on everything else.

For tax preparation, I use TurboTax — not because I think it’s necessarily any better than the alternatives, but because it’s what I’m used to using at this point, and I don’t particularly want to invest the time to learn a new piece of software.

As far as other personal finance software, it’s rare for me to use anything other than Excel. Our finances are not complicated, so we don’t really need anything fancy here. (Also, given my background in accounting, I’m very comfortable using Excel — and actually enjoy using it.)

With regard to most types of insurance (life, auto, liability), my overall approach is simply to buy the cheapest policy that provides the coverage I want, as long as the company’s credit ratings are satisfactory.

As far as health insurance, we buy ours on the Affordable Care Act exchange. We’ve moved a lot (from one state to another) over the last several years, and our healthcare needs change from year to year, so our health insurance provider and plan change from one year to another as well. For instance, this year we opted for a plan with a low deductible, as it was pretty likely that I was going to need a few medical tests/procedures that I don’t need in other years.

As far as disability insurance, I have a policy through Prudential via the AICPA.

And that’s about it.

(Also, because it’s good policy for you to check regarding conflicts of interest: I am not compensated by any of the above companies in any way. I do not receive any commissions, for example, if you sign up for the credit cards mentioned above.)

Where is the “Sweet Spot” for Passive Investing?

A reader writes in, asking:

“At what level of money does passive investing make the most sense? Is there a ‘sweet spot’ so to speak in terms of portfolio size or income? How would the strategy have to be adapted to work at different levels?”

Firstly, there’s no sweet spot. Passive investing is a prudent choice across the full spectrum of asset and income levels — as soon as you reach an income/asset level where investing becomes relevant in the first place, that is.

Passive investing makes sense for the new beginner who is just getting started with small amounts, and it makes sense for huge pools of money such as university endowments.

The primary reason why passive investing is a reasonable choice at all levels is that it’s based on a mathematical truism — one that applies regardless of the amount of money in question. Specifically, as long as the average passively managed dollar incurs lower costs than the average actively managed dollar, it is mathematically certain that passively managed dollars will on average outperform actively managed dollars. (If you’re unfamiliar with that concept, I’d encourage you to read William Sharpe’s wonderfully succinct paper “The Arithmetic of Active Management.”)

What Does Change at Higher Income or Asset Levels?

Having said the above, it’s important to note that the implementation of a passive investment philosophy is somewhat different at different income/asset levels.

For example, tax-efficient investing strategies are very different for the person whose entire portfolio consists of a $5,000 Roth IRA than for the person with a seven-figure portfolio, most of which is invested in taxable brokerage accounts. And they’re different still for investors whose portfolio size is such that they have to be concerned with the estate tax (with its 2016 exclusion of $5.45 million, and twice that for married couples). But in each case, it’s perfectly prudent to use a passive portfolio of boring index funds.

In addition, the asset allocation decision is somewhat different at different levels of assets/income. Specifically, when your total assets are low relative to your living expenses, you have less flexibility with your asset allocation. That is, you cannot afford to have a risky allocation if you may need this money in the near future (i.e., if your retirement savings are currently doubling as an emergency fund). But again, a boring passive portfolio is still a good idea.

Why I (Still) Like All-in-One Mutual Funds

A reader writes in, asking:

“You haven’t written about how you feel about the LifeStrategy funds in light of current market events. Are you still using one? Are you happy with it?”

The short answer is that:

  • Yes, we’re still using the Vanguard LifeStrategy Growth Fund for all of our retirement savings,
  • Yes, we’re still super happy with it, and
  • Neither my investment strategy nor investment tactics change as a result of market conditions, so that’s not really playing a role (in either direction) regarding my level of satisfaction.

All-in-One Funds Are Low-Stress, Low-Maintenance

One of the primary reasons I’ve enjoyed using the LifeStrategy fund is that it is a very low-hassle way to invest. When I sign into the Vanguard site to make a contribution, I don’t have to spend any time figuring out how much to buy (or sell) of each fund in order to maintain our desired overall allocation across accounts. Nor am I spending any time or energy considering adjustments to our asset allocation. All I’m doing is entering the amount of the contribution I want to make, confirming the transaction, and signing out.

If you use an all-in-one fund, you will want to make a point of staying informed about changes made to the fund (for example, Vanguard recently increased the international allocations in their all-in-one funds), because it’s possible that the fund company could change the underlying allocation in such a way that it’s no longer appropriate for your needs. But, at least with Vanguard, such changes don’t happen especially often, so the amount of work (and thought) involved is minimal.

All-in-One Funds Help Reduce the Likelihood of Mistakes

A second reason I like using an all-in-one fund is that it reduces the likelihood that I’ll tinker with our portfolio in a way that will ultimately be detrimental to performance.

Morningstar research has consistently shown that investors tend to underperform the funds that they use, because they switch between funds at the wrong times. (This is generally the result of buying immediately after a period of good performance and selling after a period of poor performance.) Interestingly, in research from earlier this year*, Morningstar found that investors in target-date funds have actually had better performance than the funds themselves over the 10-year period ending 12/31/2014.

But They’re Not for Everyone

Despite the benefits mentioned above, all-in-one funds have their limitations. Last time I gave an update on using the LifeStrategy fund, I wrote the following, which I still think is true.

All-in-one funds are not a perfect fit for everybody. There are plenty of reasons why any given investor might be better off taking the DIY-allocation approach. For example:

  • The fund-of-funds structure is tax-inefficient, which is relevant if you have assets in a taxable brokerage account.
  • Some people will not be able to find an all-in-one fund with an asset allocation that suits their needs (e.g., because they need to underweight U.S. stocks in their IRA in order to make up for the fact that they’re overweighting U.S. stocks in their 401(k) because their retirement plan’s only decent choice is a U.S. stock fund).
  • Some people will prefer to implement a strategy that “tilts” the portfolio in some way (most commonly toward small-cap value stocks or REITs).
  • Some people don’t mind the modest work involved in managing a portfolio, are completely confident they will not do any detrimental tinkering, and want to take advantage of the slightly lower costs of individual index funds or ETFs.

*A free Morningstar account is required to view the article.

What to Do about a Bad Day (or Week) in the Stock Market

On Thursday the U.S. stock market (as measured by Vanguard’s Total Stock Market ETF) went down by 2.17%. And on Friday it went down by 2.88%. The week’s market performance (down approximately 5.5% in total) has received quite a bit of news coverage, and if my email inbox and Facebook feed are any indication, many people are nervous — or even downright scared.

This Could Be No Big Deal

According to Yahoo Finance, in the last 5 years (i.e., during a roaring bull market) there have been 8 other days worse than Friday and 28 days worse than Thursday.

You might say, but this was two bad days in a row, surely this is a problem! Well, those 8 days worse than Friday? Two of them were in a row as well (9/21/11 and 9/22/11). In fact, all 8 of the days that were worse than Friday occurred within the August-November window of 2011. Perhaps, like me, you have already forgotten about that brief little period of not-so-great returns. Until looking at the data just now, I had forgotten about that period because it turned out to be no big deal. The market continued to climb for another (so far) nearly 4 years after that.

In other words, this sort of thing is normal, and it can even happen right in the middle of a period of great market returns. It doesn’t necessarily mean the bull market is over.

But Maybe We Are in for a Crash

On the other hand, maybe this is the beginning of the next bear market. We could be in for a much greater decline. In the 2007-2009 decline, for instance, the market fell by more than 50%.

If last week’s not-that-big-of-a-deal performance has you in near panic mode already, you have learned an important lesson. Specifically, you have learned that you overestimated your risk tolerance and chose a portfolio that is probably too risky for you. If a decline of less than 10% has you scared, imagine how you’d feel if the market fell another 40%.

The point of strategic asset allocation is to give up on guessing where the market is going next and instead craft a portfolio that will allow you to sleep well at night, regardless of whether we’re in for another 4 years of great returns (as we were after that little blip in late 2011) or a further decline of 40% or more.

What to Do Now?

Evaluate. How are you feeling about your portfolio and its risk level right now?

If you’re feeling perfectly comfortable, this week could be a great time to rebalance your portfolio back to its target allocation, which likely means buying more stocks. (It may also be an opportunity to tax-loss harvest.)

On the other hand, if you’ve been stressing about this modest decline, you may want to scale back your stock allocation somewhat. Yes, that means selling immediately after a decline, which isn’t ideal. But chalk it up as a lesson — one that could have been much more expensive.

And take note of the stress you’ve been feeling. Literally. Make a note of it. Record how you are feeling right now. Then sign and date that document. You want something that you can refer back to the next time things are looking rosy and you are tempted to bump up the risk level of your portfolio (to a level that you have already proven is too risky for you).

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