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The Higher Your Income, The More Obliviously You Should Invest

Mike’s note: While I do not ordinarily publish guest articles, I recently invited Jim Dahle to write something for Oblivious Investor readers, and he was kind enough to oblige, with the following article.

A recent article by Tadas Viskanta, discussing a book entitled Scarcity: Why Having Too Little Means So Muchpromotes the idea that we all have limited psychological “bandwidth.” Much like your computer runs slower when you’re running a dozen programs in the background, so does your mind and life run more poorly when your bandwidth is heavily taxed.

One method of “freeing up bandwidth” is to put your investing plan on autopilot — to invest “obliviously,” as Mike frequently discusses on this blog. Doing so frees you from having to worry about picking stocks, watching active mutual fund managers for the inevitable downturn, evaluating “alternative” investments, and timing the market. As Michael LeBoeuf famously said, “Invest your time actively and your money passively.”

Aside from freeing up bandwidth, a simple investing plan also frees up a great deal of time. My life, for example, became abnormally busy recently. I normally work as an emergency physician full-time and also run an increasingly busy website/blog called The White Coat Investor, where I help doctors and other high income professionals get a “fair shake” on Wall Street. However, in addition to these two jobs, I recently wrote and self-published my first book, The White Coat Investor: A Doctor’s Guide to Personal Finance and Investing.

Becoming busier was a very gradual process, but I finally realized I had simply run out of bandwidth. The final straw was when I took my laptop to work one night in the hopes that if the Emergency Room got really slow, perhaps I could deal with some of the 50 or 100 emails I had received that day. As those of you who have had the misfortune to visit an ER are probably well aware, it isn’t exactly a slow-paced job. When your life gets so busy that a job in an ER is the only place left from which you can steal some time in order to balance everything else out, you know you’re in trouble.

When you run out of bandwidth, something has got to give. You don’t want it to be your family or your career. Putting your investment portfolio on autopilot is not only likely to lead to higher long-term returns, but also frees up valuable bandwidth for you to use in the rest of your life, on things that really matter.

High-income professionals like doctors, lawyers, and business owners are even more likely to benefit from an oblivious investing plan than someone in a more typical career field, because their time can be used to generate money at a very high rate. It makes little sense to spend hours trying to eke out a little extra return on the portfolio when those hours could be better spent simply earning more money and increasing the amount contributed to the investment account — especially early in the career when the portfolio is small and the business is growing.

Some choose to hire an investment manager in order to free up this time and bandwidth. That is certainly a reasonable option, if you use a low-cost adviser who uses a smart investing strategy. But choosing a simple, low-cost investing strategy and putting it on autopilot will not only cost you less time and money, but counterintuitively, may also lead to better after-expense portfolio returns in the long run. The higher your income, the more obliviously you should invest. You can spend that time and bandwidth better elsewhere.

Safeguarding Your Asset Allocation

“I think sticking with an allocation is more important than getting the allocation exactly right in the first place.” — financial advisor/writer Allan Roth, at the 2013 Bogleheads reunion/conference.

The average investor underperforms his/her own funds due to jumping back and forth between them at exactly the wrong times. In other words, most people would have better investment performance if they simply crafted an asset allocation, chose some funds to implement that allocation, then stayed put.

Staying put, however, can be difficult. That’s why it’s often worthwhile to take concrete action steps to safeguard your allocation — that is, to improve the likelihood that you will stick with your portfolio as planned.

Making It Easier to Stick With Your Plan

For some people — those with the most fortitude — simply creating a written Investment Policy Statement is sufficient. Once they have an explicit plan in writing, they’re able to stay put.

Some investors (me, for instance) find that using a balanced fund or other all-in-one fund makes it easier to stick with the plan. According to Morningstar research, investors in balanced funds tend to trail the performance of their funds by less than the amount by which investors in other funds tend to trail the performance of their funds. Based on correspondence from readers, I think there are two primary reasons why all-in-one funds make it easier to stick with a given allocation:

  1. Because the portfolio doesn’t require any ongoing maintenance, there are fewer opportunities/temptations to tinker, and
  2. There’s no longer the stress (and temptation to make a change) that comes from seeing one or more funds in the portfolio perform very poorly over an extended period.

For other people, avoiding news about the market is the key to staying the course. This is another strategy that I personally use. I don’t check my portfolio balance more than once a month, and I never check the market’s daily performance. I find that it’s much easier to avoid worrying about a bad day in the market when you don’t even know that it happened.

For some people, the only way to stick with an investment plan is to hire an advisor to manage the portfolio. If you know that you’re somebody who, left to your own devices, would likely mess up the implementation of your investment strategy, hiring a low-fee advisor can make a whole lot of sense.

Finally, the selection of the allocation itself does of course play a big role in your ability to stick with it. Most investors will find that it is better to err on the side of being too conservative rather than too aggressive, given that, for most investors, it is more difficult to stick with the plan in bad markets than in good markets.

Are We Still Using the LifeStrategy Growth Fund?

A reader writes in, asking:

“I’m curious if you are still using the LifeStrategy fund? Are you satisfied or do you have second thoughts?”

Yes, we’re still using Vanguard’s LifeStrategy Growth fund for our retirement savings. And yes I am still quite happy with it — precisely because I don’t have second thoughts. I think about it roughly the same way that I think about a savings account — not in the sense that it has the same risk/reward profile, because it most certainly does not, but in the sense that it takes a similar amount of maintenance and mental energy (i.e., none).

I no longer spend any time or mental energy thinking about:

  • Whether or not now is a good time to rebalance,
  • Which fund(s) my monthly contributions should go into, or
  • Whether my asset allocation is precisely right.

I know my allocation is not perfect. But by using an all-in-one fund, I forced myself to accept that ahead of time. And because it requires no maintenance, there is no longer the monthly temptation (which used to occur when making new contributions) to change something here or there in an attempt to make the portfolio slightly better in some way.

Not One-Size-Fits-All

Of course, 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 using an all-in-one fund would still worry about whether the allocation is good enough.
  • And some people with DIY allocations don’t worry about whether their allocation is good enough.

But, yes, our all-in-one fund is continuing to work quite well for us.

8 Simple Portfolios

I recently came across an interesting question on the Boglehead forum:

If you could only own one fund, what would you own?

That question got me thinking about one aspect of investing that doesn’t often get discussed: desire for simplicity. While some investors don’t mind managing a portfolio of ten different funds, other investors would never consider anything so complex.

Generally speaking, the more asset classes you include in your portfolio, the better diversification you’ll achieve, but it begins to require more work to manage the portfolio. Also, the additional diversification derived from adding each asset class is less than the diversification gained by adding the prior asset class.

I thought it would be fun (and perhaps helpful to investors reworking their portfolios) to put together a list of portfolios sorted by complexity. The following are my recommended one-fund portfolio, two-fund portfolio, and so on (followed by some additional thoughts). Please feel free to share your own suggestions. 🙂

For each fund, the first ticker is the open-end version of the fund, and the second ticker is the ETF version of the fund.

[Update: Some readers requested that I put together a similar list of portfolios using Fidelity funds rather than Vanguard. You can find that list here.]

One-Fund Portfolio

Two-Fund Portfolio

  • 70% Vanguard Total World Stock Index (VTWSX, VT)
  • 30% Vanguard Total Bond Market Index (VBMFX, BND)

Three-Fund Portfolio

  • 35% Vanguard Total Stock Market Index (VTSMX, VTI)
  • 35% Vanguard Total International Stock Index (VGTSX, VXUS)
  • 30% Vanguard Total Bond Market Index (VBMFX, BND)

Four-Fund Portfolio

  • 30% Vanguard Total Stock Market Index (VTSMX, VTI)
  • 10% Vanguard REIT Index Fund (VGSIX, VNQ)
  • 30% Vanguard Total International Stock Index (VGTSX, VXUS)
  • 30% Vanguard Total Bond Market Index (VBMFX, BND)

Five-Fund Portfolio

  • 30% Vanguard Total Stock Market Index (VTSMX, VTI)
  • 10% Vanguard REIT Index Fund (VGSIX, VNQ)
  • 30% Vanguard Total International Stock Index (VGTSX, VXUS)
  • 15% Vanguard Total Bond Market Index (VBMFX, BND)
  • 15% Vanguard Inflation-Protected Securities Fund (VIPSX, TIP*)

Six-Fund Portfolio

  • 20% Vanguard 500 Index (VFINX, VOO)
  • 10% Vanguard Small-Cap Value Index (VISVX, VBR)
  • 10% Vanguard REIT Index (VGSIX, VNQ)
  • 30% Vanguard Total International Stock Index (VGTSX, VXUS)
  • 15% Vanguard Total Bond Market Index (VBMFX, BND)
  • 15% Vanguard Inflation-Protected Securities Fund (VIPSX, TIP*)

Seven-Fund Portfolio

  • 20% Vanguard 500 Index (VFINX, VOO)
  • 10% Vanguard Small-Cap Value Index (VISVX, VBR)
  • 10% Vanguard REIT Index (VGSIX, VNQ)
  • 20% Vanguard Total International Stock Index (VGTSX, VXUS)
  • 10% Vanguard FTSE All-World Ex-US Small-Cap Index (VFSVX, VSS)
  • 15% Vanguard Total Bond Market Index (VBMFX, BND)
  • 15% Vanguard Inflation-Protected Securities Fund (VIPSX, TIP*)

Eight-Fund Portfolio

  • 20% Vanguard 500 Index (VFINX, VOO)
  • 10% Vanguard Small-Cap Value Index (VISVX, VBR)
  • 10% Vanguard REIT Index (VGSIX, VNQ)
  • 10% Vanguard Total International Stock Index (VGTSX, VXUS)
  • 10% Vanguard FTSE All-World Ex-US Small-Cap Index (VFSVX, VSS)
  • 10% Vanguard International Value (VTRIX, n/a)
  • 15% Vanguard Total Bond Market Index (VBMFX, BND)
  • 15% Vanguard Inflation-Protected Securities Fund (VIPSX, TIP*)

*Vanguard’s TIPS fund does not have an ETF version. As such, I’ve included iShares Barclays TIPS Bond Fund (TIP) as the comparable ETF.

Regarding Stock/Bond Allocations

In order to make comparisons easy, each of the above portfolios is built using a 70/30 stock/bond allocation. There’s no particular reason that a 70/30 split was chosen over any other stock/bond split.

Any of the above portfolios can be adjusted to fit your ideal stock/bond allocation. Simply increase (or decrease) the allocation to the bond fund(s) and decrease (or increase) the allocation to each stock fund in proportion to its original allocation.

Regarding U.S. vs. International Allocations

Each of the above portfolios is built using roughly a 50/50 split between U.S. and international stocks. Many investors and investment professionals would view this as too heavy an international allocation. You can see my reasoning here and decide for yourself whether to adjust the international allocations downward.

ETFs or Index Funds?

These portfolios could be implemented at Vanguard via traditional open-end index funds or at an online brokerage of your choice using ETFs. If you do opt to use ETFs, you have an additional motivation to keep things simple: Fewer funds means less commissions paid. (Unless you’re using a brokerage firm that offers commission-free trades, that is.)

Which One Fund Would You Recommend to Anyone?

A reader writes in, asking:

“There are many types of investors, from those who like to micromanage, to those who don’t know and don’t care about investments. Most are in the middle: they know they have to save, have some vague notion of how stocks and bonds work, but have more important things to do, such as living their lives.

What would you recommend for investors who want to buy one fund, hold it and forget it for years, and why?”

The two primary criteria I’d use for trying to pick such a fund would be:

  1. Low costs, and
  2. A middle-of-the-road sort of asset allocation that could be at least reasonably suitable for anybody.

Unfortunately, the low-cost criteria rules out most all-in-one funds available to retail investors. Aside from a selection of funds from Vanguard, the pickings are quite slim.

Vanguard Target Retirement Funds

While I do like Vanguard’s Target Retirement Funds, there isn’t one that I’d be comfortable recommending to investors of every age and risk tolerance. Most are too aggressive for many investors, and the target date funds that currently hold moderate allocations will soon be shifting to very conservative allocations that wouldn’t make sense for many young investors.

Nor would I feel comfortable recommending that investors pick a Vanguard target fund based solely on their age. If investors did that, many would end up with a 90% stock allocation (which Vanguard’s target funds hold until 25 years from retirement). In my opinion, there are plenty of investors for whom a 90% stock allocation would not be appropriate, even if they are young.

Vanguard Balanced Index Fund

While Vanguard’s Balanced Index Fund has low costs and a reasonable 60% stock, 40% bond allocation, it’s not a fund I find myself suggesting very often, because it has no allocation to international stocks. Given how inexpensive it is to get international diversification, I don’t see a lot of reason for choosing not to do so.

Low-Cost Actively Managed Funds

While I prefer index funds to actively managed funds, the primary reason for my preference is costs. Two of Vanguard’s actively managed balanced funds (Wellington and Wellesley Income) are approximately as inexpensive as Vanguard’s Target Retirement funds and LifeStrategy funds, so they at least merit consideration.

Still, like Vanguard Balanced Index Fund, they would not be my first choice due to the fact that they both have very low international allocations — approximately 88% of their respective stock allocations are allocated to U.S. stocks.

Vanguard LifeStrategy Funds

Most likely, the one fund I’d feel most comfortable recommending to anyone would be Vanguard’s LifeStrategy Moderate Growth Fund. It has an allocation of 42% U.S. stocks, 17.5% international stocks, and 40.5% bonds.

A 60% stock, 40% bond allocation is something that I think most people have the risk tolerance to handle, and it should still provide for a decent degree of growth for young investors. In addition, studies have showed that, historically, a 60/40 allocation has done approximately as well as more conservative allocations (e.g., 40% stock, 60% bond) at supporting low withdrawal rates (i.e., 4% or less) in retirement.

One Size Doesn’t Fit All

Of course, anything that tries to be a one-size-fits-all solution is bound to have shortcomings. And this is no different.

As we’ve discussed before, in many cases, using all-in-one funds means passing up on cost-saving opportunities.

For example, if you have investments in a retirement plan at work, rather than using all-in-one funds to implement the same asset allocation in each of your accounts (e.g., 401(k), Roth IRA, traditional IRA), you can often reduce costs by choosing the lowest-cost one or two funds in your work retirement plan, then picking up low-cost funds in your other accounts in order to fill in the gaps in your desired overall asset allocation.

In addition, with something as straightforward as Vanguard’s LifeStrategy funds, there’s no reason to recommend the same fund to everybody. It doesn’t take much work (and it isn’t very confusing, even to rookie investors) to explain that the LifeStrategy lineup includes four different options — Growth, Moderate Growth, Conservative Growth, and Income — each with its own level of risk and hoped-for return.

What’s In My Portfolio? (Updated)

Last week, my wife and I made a big change to our retirement portfolio — one that we’ve been discussing for a little over two months now.

Background: In September, Vanguard announced significant changes to their LifeStrategy funds (specifically, lower expense ratios and a change to fixed, all-indexed allocations). Those changes have now gone into effect.

The change my wife and I made was to move every dollar of our retirement savings over to Vanguard’s LifeStrategy Growth Fund. It’s now the only fund in our individual 401(k) and our IRAs — with the exception of a portion of my Roth, which, as mentioned before, is in Vanguard’s Short-Term Treasury fund because we use it as part of our emergency fund rather than as retirement savings.

For reference, the underlying allocation for Vanguard’s LifeStrategy Growth fund is as follows:

  • 56% Vanguard Total Stock Market Index Fund,
  • 24% Vanguard Total International Stock Index Fund, and
  • 20% Vanguard Total Bond Market II Index Fund.

Why We Made the Change

The primary reason we made the change was to defend against what I’ve come to see as the biggest threat to our investment success: me.

To be more specific, it’s my temptation to tinker that scares me.

Because of my work, I’m constantly reading about different investing strategies. Most, of course, are nonsense — nothing more than methods of using the stock and bond markets as a lottery. But there are still countless ways to invest that are reasonable.

And when I go to rebalance our portfolio, I’m often tempted to make little changes. Most such changes would probably be fairly benign, like the one we discussed here. But my fears are that:

  1. One day I’ll do something truly stupid, or
  2. I’ll bounce back and forth between reasonable allocations, but do so at exactly the wrong times (for instance, choosing to overweight small-cap and value stocks, then bailing out after a period of relative underperformance).

My hope is that this automatically-rebalanced, everything-in-one-fund sort of portfolio will keep me from such temptations — both because I won’t have to execute any transactions other than buying more of the same fund and because that fund is an explicit reminder to myself that I’m not supposed to mess with anything.

I see two other benefits as well:

  1. It’s less work, and
  2. It puts my money where my mouth is, given that the whole point of this blog is to show that investing in a simple, hands-off way really can be quite prudent.

A Slightly Different Allocation

Obviously this change adjusts our asset allocation somewhat. Relative to our old allocation:

  • We now have 10% less in REITs and approximately 10% more in non-Treasury bonds (mostly government mortgage-backed bonds and investment-grade corporate bonds), and
  • We now have 16% less in Total International Stock Market and 16% more in Total (U.S.) Stock Market.

Overall, I think the effect of these changes will be rather minimal. As I’ve said before, asset allocation is a sloppy science. Small shifts one way or the other between asset classes don’t usually make much difference in an investor’s long-term success.

Still, the decrease in international allocation did give me some pause. (In fact, it was really the only thing that made me hesitant about the switch at all.) In general, I’m somewhat more comfortable with a higher international allocation rather than significantly overweighting U.S. stocks relative to their market weight.

In the end, I decided that I’m more worried about a Mike-messing-something-up scenario than I am about a scenario in which the U.S. stock market significantly underperforms the total world market for an extended period.

One potential drawback is that Vanguard could change the allocation of the fund at some point in the future in a way that I don’t like. Because I follow Vanguard-related news fairly closely though, I’m confident I’d hear about any upcoming changes in plenty of time to move out of the fund if we decide the changes don’t make sense for our needs.

Overall Conclusion

As with any change, it has its pros and cons. It’s not perfect. But I like it. I like that it’s simple. I like that it’s easy. And I like that it will (hopefully) keep my meddling hands off our portfolio.

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