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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.

Investing Blog Roundup: “Oblivious Investor” with Jonathan Clements

At the White Coat Investor conference earlier this month, I got to spend a fair bit of time chatting with Jonathan Clements (one of my personal-finance-writer heroes). He recently summarized a few of the things we discussed in an article for his blog:

Other Recommended Reading

Thanks for reading!

Should I Roll My 401k into My New 401k or into an IRA?

A reader writes in, asking

“If I’m leaving my employer to take a new position, how should I determine whether to roll my current 401K into the new 401K or into an IRA?”

If you have already decided that you do want to roll your 401(k) somewhere else (e.g., because the old 401(k) has very expensive investment options), there are a handful of factors to consider. Not coincidentally, those factors are very similar to the factors considered when determining whether to roll a 401(k) over to an IRA in the first place.

Where Do You Have Better Investment Options?

If your new employer-sponsored plan has investment options that are better than what you’d have access to in a regular IRA, rolling your money into the new employer plan can be advantageous. Common examples would be people starting a job with the federal government (and who would therefore have access to the super-low-cost Thrift Savings Plan) or people whose new employer plan includes something like Vanguard Institutional share classes (i.e., Vanguard funds with lower costs than Admiral shares).

When Do You Plan to Retire?

If you separate from service with a given employer in or after the year in which you reach age 55, you can take penalty-free distributions from that employer’s 401(k) plan, whereas normally you have to wait until age 59.5 (unless you meet one of a few other exceptions).

As such, if you plan to retire in or after the year you turn 55 but before you turn 59.5, having more money in your final employer’s 401(k) may make it easier to meet your living expenses without having to find another exception to the 10% penalty. If you expect to be in such a scenario (e.g., because you’re age 50 right now when you’re switching jobs and you expect to retire 5-6 years from now), rolling your current 401(k) into your new 401(k) could be advantageous.

Are You Planning Roth Conversions?

If you are planning Roth conversions in your traditional IRA (or you have already done one this year) and your traditional IRA includes amounts from nondeductible contributions (e.g., because you’re executing a “backdoor Roth” strategy), then it can be wise to avoid rolling 401(k) money into a traditional IRA, because doing so would increase the amount of tax you’d have to pay on your conversions.

This wouldn’t necessarily mean, however, that you should roll your old 401(k) into the new 401(k). It might just mean that you should temporarily leave your old 401(k) where it is, with the plan to roll it into an IRA in some future year (e.g., the year after the year in which you do your last Roth conversion).

Expecting a Lawsuit?

I don’t write about this often, as it’s distinctly outside my area of expertise, but in some cases money in a 401(k) may have better protection from creditors than money in an IRA. So if you are expecting to be sued — or you work in a field where lawsuits are common — you should speak with a local attorney to discuss whether your money would be safer in a 401(k) than in an IRA.

Investing Blog Roundup: Pros and Cons of “Bucket” Strategies

This week Dirk Cotton continues his series looking at different strategies for retirement portfolios. (Prior articles: “Floor and Upside” and “Variable Spending from a Volatile Portfolio.”) This time he takes a look at the popular “bucket” strategies.

Other Recommended Reading

Thanks for reading!

An Ideal Retirement Spending Strategy?

Late last year, Steve Vernon, Joe Tomlinson, and Wade Pfau released a new piece of research (full version here, summary version here) that evaluated many different retirement income strategies according to several different criteria:

  1. Average annual real retirement income expected during retirement,
  2. Increase or decrease in real income expected during retirement (i.e., does the income go up for down over time),
  3. Average accessible wealth expected throughout retirement (liquidity),
  4. Rate at which wealth is spent down,
  5. Average bequest expected upon death,
  6. Downside volatility,
  7. Probability of shortfall relative to a specified minimum level of income, and
  8. Magnitude of such shortfall.

The report was pretty lengthy, so I put off reading it. But I recently had a long day of traveling (to the White Coat Investor conference), with plenty of time to read.

The report is primarily focused on discussing metrics for testing retirement income strategies, rather than recommending any particular strategy. And the authors repeatedly make the point that no strategy is perfect — it’s always a tradeoff between the different goals/metrics. That said, the authors do spend quite a bit of time discussing one particular strategy, essentially saying, “given our assumptions, this strategy is a pretty good one, when measured by the metrics discussed here.”

In short, the strategy works as follows:

  • Delay Social Security until 70.
  • For the part of the portfolio that is used to fund the delay, invest in something safe, such as a money market fund or short-term bond fund. (For example, if you are forgoing $150,000 of Social Security benefits by waiting from 62 until 70, set aside $150,000 in something safe in order to fund the extra spending necessary until age 70.)
  • For the rest of the portfolio, use IRS required minimum distribution (RMD) tables to determine the amount of spending each year.

And with regard to asset allocation for the rest of the portfolio, the authors write:

“Our metrics support investing the RMD portion significantly in stocks – up to 100% if the retiree can tolerate the additional volatility (which is modest because of the dominance of Social Security benefits). However, the asset allocation to stocks for a typical target date fund for retirees (often around 50%) or balanced fund (often ranging from 40% to 60%) also produces reasonable results.”

Overall, this is basically a combination of several findings that we’ve seen repeatedly from other research over the last several years (including research by these same individuals). Specifically:

  • Delaying Social Security is usually advantageous (especially for the higher earner in married couple);*
  • It’s good to have safe money set aside in order to fund such a delay;*
  • For the rest of the portfolio, a high stock allocation is reasonable (if you can tolerate the volatility) given that you have a significant “safe floor” of income from delaying Social Security;*
  • It’s usually wise to adjust spending over time based on portfolio performance, rather than spending a fixed inflation-adjusted amount each year of retirement;
  • It’s usually wise to adjust spending based on your remaining life expectancy (i.e., you can afford to spend a larger percentage of your portfolio per year when you are age 90 than when you’re age 60); and
  • Using the RMD tables to calculate a spending amount each year does a reasonably good job of achieving the two prior points.

The authors also note that it’s wise to keep a separate emergency fund that would not be used to generate retirement income but which would be used as necessary to pay for unforeseen one-time expenses (e.g., home repairs). And they note that some people may want to make adjustments based on differing goals. For example, retirees who wish to spend at a higher rate during early retirement may wish to carve out a separate piece of the portfolio to fund such spending (and such piece of the portfolio should likely be invested conservatively given that it will be spent over a short period of time).

Again, no retirement spending strategy is perfect, because there’s always a tradeoff between competing goals (e.g., a higher level of spending now, as opposed to a higher expected bequest for your heirs). But a strategy roughly like the one discussed above does appear to be “pretty good” according to a whole list of different metrics.

In his summary write-up, Steve Vernon even concludes with the following:

“I’ve been studying retirement for my entire professional career, and at age 64, I’ve been thinking seriously about my own retirement. This actuary will be using a version of [the strategy discussed above], based on my 30+ years of study. My life-long quest may just be coming to an end!”

*With regard to these three bullet points, I find that it can be helpful to think of them in combination. That is, as you move from 62 to 70, you’re spending down your bonds to buy more Social Security. In other words, you’re shifting your portfolio from “stocks and bonds” to “stocks, a little bonds, and a lot of Social Security” — which is an improvement for most people given that delaying Social Security is, on average, a better deal than you can get from regular fixed-income investments and given that it helps reduce longevity risk.

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Investing Blog Roundup: A New Tax Scam

This week a reader informed me about a new tax-related identity theft scam that I hadn’t yet heard of. Admittedly, it strikes me as pretty clever — the sort of thing many people might fall for.

Other Recommended Reading

Thanks for reading!

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