IS IT TIME TO STOP messing around with our portfolios—and go for radical simplicity? I’ve been asking myself that question in recent months, as I eye the growing list of funds that offer broadly diversified “one-stop shopping” portfolios built solely with low-cost index funds.
Take Vanguard Target Retirement 2050 Fund, which invests its assets in four Vanguard index funds and is geared toward those retiring in 2050 or thereabouts. The 2050 fund has a $1,000 investment minimum and charges just 0.15% a year, equal to 15 cents for every $100 invested. What does that get you? Pretty much the entire world: 55% U.S. stocks, 35% foreign stocks, 7% U.S. bonds and 3% foreign bonds.
On my recommendation, my daughter owns that fund in her Roth IRA. I’ve also bought Vanguard target-date funds for my son and two stepdaughters. But I don’t own target-date funds myself, except in two small accounts, where I’m trying to keep things simple.
Still, I’m tempted. Which funds are tempting me? One-stop shopping index funds fall into two camps. First, there are target-date retirement funds, which become more conservative as they approach the year specified in their fund name. Here are three of the lowest-cost providers, with their funds’ annual expenses shown in parentheses:
Keep in mind that both Fidelity and Schwab also have target-date funds built around actively managed funds. I would avoid those. Also note that there are other fund companies with target-date index funds, but often the truly low-cost versions of these funds are only available in larger 401(k) plans.
Prefer something that offers a static mix of stocks and more conservative investments? Check out these choices:
Vanguard’s LifeStrategy series consists of four funds, with stock allocations of 20%, 40%, 60% and 80%. BlackRock’s iShares unit also offers four asset allocation funds that take varying levels of risk, such as the iShares Core Growth Allocation ETF, which has 60% in stocks. But at 0.25% a year, the iShares funds are a tad expensive. And because they are exchange-traded funds, not mutual funds, you’ll also incur trading costs, which could prove significant if you’re regularly adding fresh savings or making frequent sales.
What’s the appeal of these one-stop shopping index funds? You get simplicity and a mix of assets chosen by investment experts. You’re also relieved of the need to rebalance, because you have everything in a single fund that’s continuously rebalancing its investment mix. On top of that, there’s a large emotional benefit: While you can always sell your one-stop shopping fund, you can’t meddle with the underlying portfolio. In fact, you may be blissfully unaware of the market turmoil affecting the fund’s investments, because all you see is a single share price that moves relatively sedately.
Set against those advantages are four drawbacks. First, you may be able to purchase the fund’s component parts for less than the fund itself is charging. For instance, those with relatively modest sums to invest will find Vanguard’s target-date and LifeStrategy funds are as cheap as anything they could put together on their own using the underlying Vanguard funds.
But those with larger portfolios can save money by buying what Vanguard calls Admiral shares, which have lower expenses but typically require a $10,000 minimum investment. Still, the savings aren’t huge, unless you have a huge portfolio. My daughter’s 2050 fund charges 0.15% a year. Using Admiral shares, she could replicate the fund’s mix for 0.07% a year—an $800 annual savings on a $1 million portfolio.
Second, if you buy one of these funds in a regular taxable account, rather than a retirement account, there’s the potential for larger tax bills. One-stop shopping funds invest in taxable bond funds, which kick off taxable income distributions each year. Investors could avoid those tax bills if they own the component parts, and either hold the taxable bonds in their retirement account or—if their tax bracket justifies it—purchase tax-free municipal bonds in their taxable account.
On top of that, one-stop shopping funds may make capital gain distributions each year, as they realize taxable gains when rebalancing their investment mix. I eyeballed the various funds and this seems to be at least a modest issue: Many of the funds have made capital gains distributions, something that’s rare among broad market index funds.
Third, when you sell a one-stop shopping fund, you sell out of every market segment owned by the fund. But suppose stocks are in the midst of a brutal bear market and you’d rather leave them to recover, while selling only from the bond side of your portfolio. With a one-stop shopping fund, that isn’t a choice. True, you could aways repair the damage by immediately reinvesting part of the sale proceeds in a pure stock fund. But that, of course, means introducing complexity into a portfolio whose goal was simplicity.
Finally, the virtue of a one-stop shopping fund is also its vice: You get a preset investment mix—and maybe it isn’t quite what you wanted. As I look at the investment mixes on offer, I’d want more of the stock market money invested abroad, especially in emerging markets, and I’d like a tilt toward smaller-company stocks and value stocks. I could, of course, pursue a core-and-explore strategy, dumping maybe 80% of my money in a target-date fund and then adding smaller stakes in funds that provide the investment weightings I want. But again, that seems to defeat the object of the exercise, which is simplicity.
Which way am I leaning? For now, I plan to stick wth my current portfolio. But if Vanguard ever introduced target-date funds with Admiral pricing, I might make the switch. And even if the firm doesn’t, I could see dumping everything in a one-stop shopping fund as I grow older and decide I want a less complicated financial life.
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