Archives for March 2017

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Investing Blog Roundup: Keeping Your Finances Organized

One thing I’ve learned over and over through writing this blog is that I’m not alone in wanting my finances to be simple. That’s something that many people really crave.

This week, Christine Benz of Morningstar has some great tips on simplifying the administrative side of personal finance.

Investing Articles

Other Money-Related Articles

Thanks for reading!

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.)

Investing Blog Roundup: Retirement Income Planning

The goal of investing during the accumulation stage is simple: get your portfolio to grow as fast as possible, without exceeding your risk tolerance along the way. And there’s now pretty strong evidence that for most people, the best tools for that job are simple, low-cost index funds or ETFs.

Turning a portfolio into a source of income that will last throughout your retirement is a more complex task, because there are risks that aren’t relevant during your accumulation stage, and because there are additional tools that merit your consideration. This week, Andrea Coombes, Wade Pfau, and Michael Kitces each take a look at different aspects of converting a portfolio into income.

Other Money-Related Articles

Thanks for reading!

iShares Core Allocation ETFs vs. Vanguard’s LifeStrategy Funds

A reader writes in, asking:

“I noticed that iShares seems to have a platform of 4 ‘core allocation’ funds, e.g. AOM, AOK, AOR, AOA. I’m curious if you feel these are comparable to Vanguard’s LifeStrategy funds?”

For anybody who hasn’t encountered the iShares Core Allocation ETFs before, they’re funds that (like the LifeStrategy funds from Vanguard) offer a static, diversified allocation. In other words, they seek to offer a diversified portfolio in a single fund.

As far as differences, first and most obviously, they’re ETFs rather than traditional mutual funds. The differences between ETFs and traditional mutual funds are very small though for most individual investors. (Personally, I have a very slight preference for regular mutual funds, because I like to be able to place orders for round dollar amounts without having a few dollars of cash sitting around left over.)

As far as costs, the iShares Core Allocation ETFs have expense ratios of 0.25%. That’s somewhat higher than the 0.12-0.15% expense ratios for Vanguard’s LifeStrategy funds (which are themselves somewhat more expensive than what you’d pay with a DIY portfolio of individual index funds), but it’s still well below average for mutual fund expenses in general.

As far as asset allocation, the overall stocks/bond allocations are as follows:

  • iShares Core Aggressive Allocation ETF (AOA): 80% stocks, 20% bonds;
  • iShares Core Growth Allocation ETF (AOR): 60% stocks, 40% bonds;
  • iShares Core Moderate Allocation ETF (AOM): 40% stocks, 60% bonds; and
  • iShares Core Conservative Allocation ETF (AOK): 30% stocks, 70% bonds.

If you’re familiar with the LifeStrategy allocations, you’ll notice that this is very similar, with the one difference being that they only go as low as 30% stocks, whereas the LifeStrategy Income Fund has a 20% stock allocation.

Key point: As with target-date funds, it’s best to ignore the names and focus instead on the allocation. For instance, the iShares Core Growth Allocation ETF (AOR) is closer in asset allocation to Vanguard’s LifeStrategy Moderate Growth fund rather than Vanguard’s LifeStrategy Growth fund.

With regard to the actual underlying holdings, it’s pretty run-of-the-mill stuff. Nothing esoteric in any way. For instance, here’s the underlying allocation of the iShares Core Aggressive Allocation ETF (AOA), according to Morningstar as of 3/15/2017:

  • iShares Core S&P 500 39.76%
  • iShares Core S&P Mid-Cap 3.27%
  • iShares Core S&P Small-Cap 1.43%
  • iShares Core MSCI Europe 17.35%
  • iShares Core MSCI Pacific 12.23%
  • iShares Core MSCI Emerging Markets 7.64%
  • iShares Core Total USD Bond Market 9.23%
  • iShares US Treasury Bond 3.55%
  • iShares US Credit Bond 2.63%
  • iShares Core International Aggregate Bond 2.75%

You may notice from the above that the iShares funds have relatively higher international stock allocations and relatively lower international bond allocations than the LifeStrategy funds. Specifically:

  • The iShares funds have about 45% of their stock allocation in international stocks and about 15% of their bond allocation in international bonds, whereas
  • The LifeStrategy funds have about 40% of their stock allocation in international stocks and about 30% of their bond allocation in international bonds.

Frankly, I like the iShares funds ever so slightly better in that regard.

As I’ve written several times in the past, while I don’t think performance charts are especially useful for deciding which of two funds is better than the other, I do think such charts are helpful for showing how similar (or dissimilar) two funds are. The chart below shows the Vanguard LifeStrategy Moderate Growth Fund (in blue) as compared to the iShares Core Growth Allocation ETF (in orange) since December 2011 (i.e., the point at which Vanguard switched the LifeStrategy funds so that they no longer include actively managed mutual funds).

iShares Vanguard

As you can see, they’re very similar — almost indistinguishable.

In short, the iShares Core Allocation ETFs are perfectly fine, boring funds. They’re slightly more expensive than the LifeStrategy funds, with slightly different allocations. And they’re ETFs rather than traditional mutual funds (which probably doesn’t matter to most people). So if you’re looking for a one-fund solution that provides a static allocation (as opposed to target-date funds which shift toward bonds over time), they’re a perfectly reasonable choice.

Investing Blog Roundup: Individual Investors — Not So Dumb After All?

For many years, people in the financial industry have referred to DALBAR’s “Quantitative Analysis of Investor Behavior” studies to show that investors dramatically underperform their own investments due to poor decisions about when they buy and sell mutual funds. (You can read the 2016 edition of the report here, for instance.) The DALBAR reports consistently show large underperformance figures — often in the range of several percentage points per year.

This week, Wade Pfau published an article asserting that DALBAR is simply making a math error in their calculations — an error that makes the average investor’s performance look much worse than it actually is.

Pfau’s article is rather technical, because it’s dealing with a math dispute. But it’s interesting reading. In brief, his argument is that DALBAR doesn’t account for the fact that investors invest over time. For example, for an investor who invests a total of $10,000 over the 20-year period ending 12/31/2016 (i.e., $41.67 per month for 240 months), Pfau writes that, “the DALBAR methodology ignores the dollar-cost averaging component of these systematic investments and instead assumes that the entire $10,000 was invested at the beginning of 1997.”

John Rekenthaler of Morningstar also wrote on the topic this week, sharing Morningstar’s methodology for how they calculate investor returns (and how those differ from investment returns).

Investing Articles

Thanks for reading!

What Types of Pensions Trigger Social Security’s Windfall Elimination Provision (WEP)?

A reader writes in, asking:

“I work in a job where I do not pay social security taxes. I heard second hand through a coworker that our HR department says we’ll be affected by social security’s “windfall elimination provision.” I thought that only applied when you get an actual pension. My employer provides a 401-K plan but not a traditional pension. Is this something I need to be thinking about?”

As a bit of background for those unfamiliar with the topic: the Windfall Elimination Provision (WEP) applies when you receive a pension from employment that was not covered by Social Security (i.e., work for which you didn’t have to pay Social Security tax). The effect of the WEP is to reduce the size of your primary insurance amount, thereby reducing your retirement benefit, as well as the your spouse’s or children’s benefit on your work record.*

So for example if you work 20 years in one profession (in which you do pay Social Security taxes) and 20 years in another profession in which you don’t pay Social Security taxes (and from which you receive a pension), the WEP will reduce the Social Security benefit you’ll ultimately receive from the work you did that was covered by Social Security.

You can find the general rules regarding the Windfall Elimination Provsion here and exceptions to those rules here. But what we’re concerned with at the moment is what is considered to be a pension for WEP purposes.

What Counts as a Pension?

With regard to what, exactly, counts as a pension for WEP purposes, the rules and exceptions can be found here.

The general rule is that:

  • If the amount you ultimately receive from the plan is based only on employee payments (plus interest/dividends) then the plan only counts as a pension subject to WEP if it is the employer’s primary retirement plan.
  • If the amount you ultimately receive from the plan is based on employer payments (or a combination of employee and employer payments), then it will generally be considered a pension subject to WEP.

There are special rules for one-time payments from the plan:

  • Withdrawals of the employee’s own contributions and interest made before the employee is eligible to receive a pension are not pensions for WEP purposes if the employee forfeits all rights to the pension.
  • Withdrawals of the employee’s own contributions and interest made after the employee is eligible to receive a pension are considered a lump-sum pension for WEP purposes.
  • Any separation payment or withdrawal consisting of both employer and employee contributions is a pension for WEP purposes, whether made before or after the employee is eligible to receive a pension.

But again, all of the above is only relevant if the possibly-a-pension-retirement-plan is from employment you did for which you did not pay Social Security tax. If you paid Social Security tax for the work in question, the WEP does not apply.

*The WEP only applies while you’re still alive. When you die, your primary insurance amount is recalculated without the effect of the WEP, so if anybody else is receiving benefits on your work record at that time (e.g., your widow/widower and/or children), their benefit will increase.

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