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Do You Invest Your Money as Prudently as You Would Invest Somebody Else’s?

The Uniform Prudent Investor Act is a model law that outlines the principles a trustee has to follow when investing the trust’s money. The Act, or something similar, has been adopted in all 50 states. So, roughly speaking, the rules set forth in the Act are the rules you have to follow if you’re managing money on somebody else’s behalf.

And as it turns out, it’s actually a great set of guidelines for managing one’s own money.

The Act begins with various wording about its applicability. And then we get into the nitty gritty with the following opening instruction: “A trustee’s investment and management decisions respecting individual assets must be evaluated not in isolation but in the context of the trust portfolio as a whole and as a part of an overall investment strategy having risk and return objectives reasonably suited to the trust.”

The key takeaways here?

  • Decisions should not be made looking at one piece of the portfolio in isolation. Instead you must take an overall portfolio approach.
  • You must consider the purpose of the money and the circumstances of the investor — and craft the portfolio to suit those.
  • The relationship between risk and return is the fundamental point of interest when making investment decisions.

And then the Act provides us with the following list of things to consider when making decisions:

“Among circumstances that a trustee shall consider in investing and managing trust assets are such of the following as are relevant to the trust or its beneficiaries:

  1. general economic conditions;
  2. the possible effect of inflation or deflation;
  3. the expected tax consequences of investment decisions or strategies;
  4. the role that each investment or course of action plays within the overall trust portfolio, which may include financial assets, interests in closely held enterprises, tangible and intangible personal property, and real property;
  5. the expected total return from income and the appreciation of capital;
  6. other resources of the beneficiaries;
  7. needs for liquidity, regularity of income, and preservation or appreciation of capital; and
  8. an asset’s special relationship or special value, if any, to the purposes of the trust or to one or more of the beneficiaries.”

Key takeaways:

  • We’re concerned with real returns (i.e., after inflation).
  • We’re concerned with after-tax returns (i.e., tax-efficiency is important).
  • We’re concerned with total return. (In other words, even if the beneficiary is spending from the portfolio, the focus must be on total return, rather than income/yield.)
  • And again, one individual asset should not be considered in isolation. It’s about the portfolio as a whole. And you have to consider the investor’s individual needs and circumstances.

The concept of diversification is sufficiently important that it gets its own (brief) section: “A trustee shall diversify the investments of the trust unless the trustee reasonably determines that, because of special circumstances, the purposes of the trust are better served without diversifying.”

Investment costs get their own section as well: “In investing and managing trust assets, a trustee may only incur costs that are appropriate and reasonable in relation to the assets, the purposes of the trust, and the skills of the trustee.” And the following comment is provided: “Wasting beneficiaries’ money is imprudent. In devising and implementing strategies for the investment and management of trust assets, trustees are obliged to minimize costs.”

Diversifying and minimizing costs are not just suggested; they’re required.

The Act then concludes by making various important points about conflicts of interest and the trustee’s duty to put the beneficiaries’ interests before the trustee’s own interests, but those are not really relevant to our purpose here.

So, if you were a trustee for somebody else, you would be legally obligated to manage their money pursuant to the above principles. Are you treating your own money as well as you would treat somebody else’s?

10 Years with a One-Fund Portfolio

Roughly 10 years ago (December 2011), we switched our retirement savings portfolio from a combination of individual index funds to a single fund: Vanguard LifeStrategy Growth.

I wrote a couple of articles about it at the time:

And I gave an update about 18 months later:

I haven’t written too much about it since then, but people still ask regularly: are we still using the LifeStrategy fund? Are we still happy with it?

Yes, we’re still using it. Yes, we’re still happy with it.

I like it because it’s easy to understand. It owns “total market” funds for both stocks and bonds, US and international. And that’s it.

I like it because it’s reasonably low-cost (expense ratio 0.14%, as of this writing). Using individual ETFs or index funds would be slightly cheaper, but I am willing to pay the extra cost for the convenience.

I like it because it’s hands-off. I never have to rebalance. It makes it easy to ignore what the market is doing from one day to the next, which is the whole idea of the Oblivious Investor blog to begin with. (That said, if you use an “all-in-one” fund, you do still have to pay some attention, at least occasionally, because the fund company can make changes to the underlying allocation. And you want to know about such in order to check whether or not the fund is still a good fit for you.)

As an all-in-one fund, it is not particularly tax-efficient. But for our household, that doesn’t matter, because basically all of our savings are in retirement accounts.

It is not, frankly, the exact asset allocation that I would select if I were creating a DIY portfolio of individual index funds/ETFs. (I would probably exclude international bonds, I might use just Treasury bonds rather than a US “total bond” fund, and I would probably use a higher international stock allocation.)

But as I’ve written before, I’m really not that optimistic about the value to be gained from various modest changes to asset allocation. For any given investor, there’s an unlimited number of asset allocations that would be “good enough.”

We treat the fund roughly like a savings account — not in the sense that it’s low risk, because with an 80%-stock allocation it most definitely is not — but in the sense that it occupies a similar level of mental space (i.e., almost none). We just dump money into it, and we’re confident that it will grow over time.

An all-in-one fund is about as boring as it gets, which is what I want. And it also checks the boxes of being diversified and reasonably low-cost. For us, that’s (still) a good fit.

Full disclosure: our portfolio is not strictly one-fund anymore, because the 401(k) at my wife’s place of employment uses non-Vanguard funds. But she uses a target-date fund in that 401(k) for all the same reasons discussed above: it’s simple, it’s diversified, it’s low-cost, and it’s low-maintenance.

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.

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