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Why I Don’t Pay Much Attention to Net Worth

A reader writes in, asking:

“What metric(s) do you track with respect to your portfolio? Net worth I assume? Anything else?”

Yes, my personal finance tracking spreadsheet does calculate our net worth. It also calculates another asset-related number that I find more useful: our funded ratio.

But the number I pay most attention to is not a measure of our assets. The number I pay most attention to is our annual retirement account contributions.

To explain, allow me to share a brief bit of personal history. From age 17-21, I worked in a sales position in which the compensation was purely commission. In that position, some days were good, and others were not so good — and it often had nothing to do with how hard I worked or how smartly I worked. It was just luck.

The first year or two in the job felt like a rollercoaster. Some days were crushingly bad. Other days I was riding high. Eventually, I learned that it all averaged out over time, as long as I did the necessary amount of work. And so I shouldn’t be too sad or worried about a particularly bad day.

Because the short-term results were significantly out of my control, it was helpful to judge my performance based on effort rather than the results. Doing so allowed me to stay sane. In addition, focusing on the effort (i.e., making sure I worked enough) was in fact the best way to improve results.

With regard to investing, the stock market has been shooting upward over the last several years. So of course our stock-heavy, index fund portfolio has been growing rapidly. But that’s not because of anything brilliant we did. Similarly, our portfolio fell by nearly half from late 2008 to early 2009. But that wasn’t because of any mistake we made.

We have no control over how the market performs over any particular period. But we do have control over how much we save each year (for the most part, anyway).

Sometimes the trajectory of your net worth will be good. Sometimes it will be bad. But focusing on such results a) makes you crazy and b) sometimes leads to faulty conclusions. By focusing on what you have control over, it’s easier to stay level-headed and stay motivated.

To be clear, my point here isn’t that the results don’t matter. Results do matter, of course. But improving the inputs that you control is the best way to improve results. And you’ll be mentally healthier along the way.

Are Most Investors Better Off with All-In-One Funds?

A reader writes in, asking:

“Investing includes an emotional and psychological component for many individuals. One can suggest a portfolio with proper allocation, but to maintain it, especially with major changes in the stock or bond market may be a difficult matter to actually implement. Would some or most investors be better off with a fund such as a Vanguard Life Strategy Fund with an appropriate allocation rather than the individual components, given that those all in one funds appear to avoid both the euphoric highs, as well as the depressing lows of individual funds?”

If we’re assuming there’s no difference in original allocation (i.e., the person would start off holding either the LifeStrategy fund or an identical allocation via individual index funds), then the upside of an all-in-one fund is that it’s easier to stick with the allocation plan. That has certainly been my personal experience since switching to a LifeStrategy fund 6 years ago, and I have heard from many people over the last several years who have had similar experiences. Conversely, to date I have never heard from anybody who switched to an all-in-one fund and found it harder to stay the course afterward.

Part of this is due to what the reader above mentioned — the fact that an all-in-one fund somewhat camouflages the volatility of the higher-risk holdings by combining them with lower-risk holdings.

Part of it is also due to the simple fact that, with an all-in-one fund, you know everything is taken care of, so you don’t sign in to your account as often. And if you aren’t signed in to your account, you’re obviously not making any changes.

I have also heard a few people say that they found it easier to stick with an all-in-one fund because they knew that the allocation had been designed by a professional. (Though presumably such a benefit would also accrue to people using live advisors or robo-advisors.)

In other words, I’m very confident that many people have an easier time sticking with their portfolio when it consists of an all-in-one fund rather than a DIY selection of funds. And Morningstar’s data on “investor returns” seems to indicate that such ease of implementation does in fact lead to better results, on average. (See this recent study or this article from 2015, for example.)

Of course, all-in-one funds do have some downsides relative to an identical allocation via individual funds. Specifically:

  1. They have slightly higher expense ratios than individual index funds, and
  2. They can cause inefficiencies to arise when other accounts are involved.

For example, all-in-one funds are tax-inefficient if the portfolio includes a taxable brokerage account. Or, if one of the accounts involved is a 401(k) in which there’s only one asset class with a low-cost fund, it may be possible to significantly reduce overall costs by picking that one fund and filling in the rest of the desired allocation elsewhere. Such a plan would be disrupted by the use of an all-in-one fund.

But if we change the original question slightly and we remove the assumption that the DIY investor uses the same underlying initial asset allocation, then I think it’s very clear that most people are better served by an all-in-one fund than by a self-created, self-managed portfolio. Many people who build their own portfolios end up with a mess — overlapping funds, dangerously high allocations to a single stock, funds selected purely on 5-year performance figures, etc.

Most all-in-one funds are going to be quite a bit better than that.

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.

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