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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).

Where Can You Get Unbiased Financial Information?

A reader writes in, asking:

“I’m a bit of a late starter, financially speaking. I am in my late 30’s but only now beginning to learn in earnest about personal finance. One challenge I have run into is that I cannot tell who is giving good information and who is just selling me something. Where would you recommend looking for unbiased financial and investing information?”

The short answer is that nobody in the financial services industry (or financial publishing industry) is an unbiased source of information.

With regard to advisors, the most obvious conflicts of interest are created by a commission pay structure. Commission-paid advisors have a strong incentive to steer you toward insurance products and mutual funds that pay a commission, rather than low-cost index funds that do not pay a commission.

But other advisors have conflicts of interest too.

  • Advisors paid as a percentage of assets under management have an incentive to maximize your portfolio size, even when doing something else (e.g., spending the portfolio down to pay off your mortgage, delay Social Security, or buy a lifetime annuity) may be in your best interest;
  • Advisors who charge a fixed periodic retainer (e.g., a flat $X quarterly fee) have an incentive to gather a lot of assets while doing the least work possible on each portfolio, even when it may be beneficial to the client to pay somewhat more attention to it; and
  • Advisors who charge an hourly fee have an incentive to make things more complicated than they really need to be. (And all advisors have an incentive to make investing appear more complicated than it really is.)

Financial publications (and their writers) have conflicts of interest as well.

  • Most financial publications make the majority of their revenue from advertising. As a result, they’re often reluctant to publish articles explaining exactly how bad certain financial products are.
  • And every financial publication (including this one!) has an incentive to convince you of the importance of each topic being discussed. We need you to keep visiting our sites, buying our books, paying subscription fees, etc.

Even academic research can’t be assumed to be conflict-free. In many cases, the research is funded by a company with a product to sell. (For instance, many pieces of research regarding annuities have been funded by insurance companies.)

Of course, this doesn’t mean that none of these sources are helpful. Advisors, financial publications, and academic studies can all be very helpful. But it’s critical to be aware of the conflicts involved so that you know how the information you are encountering might be slanted.

So Where Can You Get Unbiased Information?

About the only way to get truly unbiased information is to get it from somebody who makes their living in a completely different field. For example, your neighbor who works as a software developer has little reason to convince you to make one investment decision as opposed to another. Of course, the problem is that, in most cases, such sources not only lack conflicts of interest, they also lack expertise.

As far as unbiased sources that are still knowledgable, something like the Bogleheads forum is about the closest you can get. Most people there do not work in the financial industry at all and therefore have nothing to gain from convincing you of one course of action over another. That said, even there it is important to be careful. Most people are anonymous, so it can be hard to know how much faith to put in any one person’s information or opinions. Also, some people there do actually have conflicts of interest (specifically, those of us who work in any of the types of positions mentioned above).

Should I Really Be Buying Stocks (or Bonds) Now?

A reader writes in, asking:

“Lately I’ve seen expert after expert saying that a big stock market correction is coming because of Greece and a bond correction is coming because of rising interest rates. My question is whether it still makes sense to be investing money. If stocks and bonds are going to be less expensive in the near future, shouldn’t I just wait?”

Personally, I place no value in expert opinions about where the market is going.

For example, with regard to bonds, people have been predicting the bursting of a “bond bubble” for almost five years now. In August of 2010, Jeremy Siegel and Jeremy Schwartz wrote the following in an article for The Wall Street Journal:

“Ten years ago we experienced the biggest bubble in U.S. stock market history. […] A similar bubble is expanding today that may have far more serious consequences for investors. It is in bonds, particularly U.S. Treasury bonds. Investors, disenchanted with the stock market, have been pouring money into bond funds, and Treasury bonds have been among their favorites.”

Near the end of the article they concluded that, “those who are now crowding into bonds and bond funds are courting disaster.”

And yet, over the last five years, Vanguard’s Intermediate-Term Treasury Fund has earned an annualized return of just over 3%. That’s not exactly off the charts, but it’s hardly a “disaster.” And it’s definitely not the sort of thing I think of when I imagine a financial bubble bursting. (In other words, it’s exactly the sort of ho-hum return one would typically expect from Treasury bonds.)

By keeping your money in cash in order to avoid a “bond bubble,” you miss out on interest that you could have earned in the meantime. And the longer you end up waiting for the correction, the more interest you forgo.

And with regard to stocks, high profile experts are similarly unreliable. For example, think back to December of 1996. As of that point in time, the stock market (as measured by the S&P 500) had quadrupled in value over the last 10 years. And, on December 5, 1996, Fed Chairman Alan Greenspan (i.e., the person then regarded as both knowing more about the economy and having more power over the economy than anybody else) gave a speech in which he publicly suggested that stock prices might be “unduly escalated” due to “irrational exuberance.”

That’s as clear of a get-out-of-the-market signal as anybody can hope for. And yet, if you took your money out of the market immediately after hearing that speech, you missed the 112% (!) increase in value that occurred from December 1996 to March 2000.

In short, knowing that a market decline is coming isn’t especially useful unless you know when it is coming — and even the experts get that wrong on a regular basis.

Why Would an Experienced Investor Buy a Target-Date Fund?

A reader writes in, asking:

“I saw the recent article on Squared Away about target funds appealing to inexperienced investors. [Mike’s note: see here.] I gather that you use a target date fund yourself, despite being an experienced investor. Could you elaborate on why experienced investors might want to use a target date fund?”

Target-date funds, like anything else, are not a good fit for everybody. But personally I’m of the opinion that they’re a sophisticated tool, offering fantastic value for their cost (at low-cost fund families anyway). And I’ve heard from many experienced investors, citing a variety of reasons why they choose to use target-date funds.

I’ve heard from people who use target-date funds primarily for the time savings. They found that it took quite a while to rebalance a portfolio of several different asset classes across many different accounts, and they like not having to deal with that.

I’ve heard from people who use target-date funds because they consider themselves to be math-averse (or finance-averse) and they found the process of rebalancing to be stressful.

I’ve heard from people who use target-date funds to simplify the portfolio for the sake of their spouse (e.g., in case their spouse outlives them).

I’ve heard from people who use target-date funds to simplify their portfolio to protect (to some extent) against cognitive decline.

I’ve heard from people who use target-date funds to make it easier to “stay the course” in market downturns. That is, with a target-date fund, they only see the overall portfolio decline, which is always less than the decline in the worst asset class. So there’s no longer the temptation to bail out of the worst-performing fund(s).

As for me personally, I use a LifeStrategy fund (which is very similar to a target-date fund) in order to avoid a common behavioral finance error: tinkering.

You see, even in the “passive/index investing” camp, there are many differences of opinion about how to build a portfolio. For example, there is no consensus regarding how much of your bond allocation should be invested in corporate bonds. Ditto for high-yield bonds, international bonds, mortgage-backed bonds, TIPS, and so on. And there are similar differences of opinion regarding the stock portion of the portfolio as well.

So what’s an investor to do?

Really, the only thing to be done is simply pick one option and stick with it, even if you’re not 100% sure that it’s the correct option (and, to be clear, you won’t be sure). For some people, “sticking with it” is easy to do. For other people, it’s not so easy.

For me, what I found was that, when I went to rebalance our portfolio (which was approximately every month when I made new retirement account contributions), I would often be tempted to make one small change or another based on whatever I had read recently. Now, with an all-in-one fund, that temptation is gone. I simply log in, contribute as much money as I want to contribute, and that’s all there is to it.

Why I Prefer Vanguard LifeStrategy Funds to Target Retirement Funds

A reader writes in, asking:

“I enjoyed the Bogleheads piece. [Editor’s note: He’s referring to this recent Money article by Penelope Wang.] I noticed that there was a recommendation for the Target Retirement Funds. I wonder if you’d run your preference for the LifeStrategies Growth Fund by me one more time?”

As a tool for investors in general, I prefer the LifeStrategy funds primarily due to their naming convention (i.e, the use of the names Growth, Moderate Growth, Conservative Growth, and Income rather than date-based names). When presented with a menu of LifeStrategy funds, an investor is forced to actually think about his/her risk tolerance in order to decide which fund is the best fit. In contrast, with the Target Retirement funds, there’s an easy alternative: just pick based on the date.

The problem here is that, while time to retirement is a factor that affects your risk tolerance, it is just one of several factors. And, in many cases, it isn’t even the most important factor.

For example, I know many Gen-Y investors who are chronically underemployed, yet who have nonetheless managed to scrape together some money to invest in a Roth IRA. Despite the fact that they’re a long way from retirement, they need to use conservative allocations in their IRAs, because there’s a significant chance that they’ll have to tap into the money in the not-so-distant future, due to income instability and small emergency funds.

On the other end of the spectrum, there are retirees whose day-to-day needs are completely satisfied via pensions and/or Social Security. Despite the fact that they’re already retired (i.e., time to retirement = zero), an aggressive allocation could be quite reasonable, should they desire to use one.

And even if investors are told to pick a target date fund based on the fund’s underlying allocation rather than the date in the fund’s name, there’s still going to be an anchoring effect involved. In other words, investors will probably not adjust as much as they should in order to account for their personal risk tolerance. For example, a conservative investor planning to retire in 2040 might be best served by the allocation of the 2015 fund. Yet because he’s been told that the 2040 fund is typical for somebody his age, he only adjusts slightly — by using the 2035 fund for instance, despite the fact that it’s still much too risky for his needs.

With regard to why I personally am using the LifeStrategy Growth Fund rather than a Target Retirement fund, the answer is that my wife and I don’t, as of right now, plan to shift our allocation toward bonds over time. Rather, as we near (and enter) retirement, we expect to simply put money into inflation-adjusted lifetime annuities (including Social Security) until we’ve reached the point where our basic needs are satisfied via very safe sources of lifetime income. With money that’s left over, the plan is to continue using a stock-oriented allocation.

All of that said, I’m still a big fan of Vanguard’s Target Retirement funds. I don’t like them quite as much as the LifeStrategy funds, but I still think they’re fantastic in that they can provide a diversified, hands-off portfolio at a very modest price.

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