MY PORTFOLIO HAS evolved over my 35 years as an investor, as I’ve learned more and as new funds have become available. A total stock market index fund? Sure, I’ll consolidate money in that. An emerging markets index fund? Yeah, a modest stake looks promising. How about a small-cap value index fund? The academic literature says that makes sense.
Today, I own a dozen different Vanguard Group mutual funds, each giving me exposure to a different part of the global financial markets. Some have had excellent performance. Some haven’t. The poor performers don’t much bother me. That’s the price you pay for portfolio insurance—otherwise known as diversification.
Instead, what nags at me is the complexity. As I approach age 60 and ponder working less, do I really want to keep tabs on all these funds and rebalance them periodically? Am I being overly clever? This has led me to consider five possible investment mixes, all involving Vanguard funds:
Targeting Retirement. Perhaps the simplest solution would be to opt for a single Vanguard target-date fund for my longer-term money, plus a money-market fund to hold money that I’ll spend over the next few years. This will become a more appealing option in February, when Vanguard will lower its target-date fund expenses to 0.08%, equal to 8¢ a year for every $100 invested. Vanguard Target Retirement 2030 Fund might be the right choice for me. In January 2030, I’ll turn age 67.
Almost my entire portfolio is in traditional and Roth retirement accounts, so the potential tax-inefficiency of a target fund, as it rebalances and shifts to bonds over time, isn’t an issue. Instead, my bigger concern is the relatively modest stock allocation of Vanguard’s target funds once they’ve passed their target retirement date. The stock allocation continues to fall, reaching just 30%. That’s way too low for my taste. I could compensate by buying, say, the 2040 or 2045 fund—but those, too, will eventually land at 30%.
One-Stop Shopping. Instead of one of Vanguard’s target-date funds, I’ve toyed with buying one of its LifeStrategy funds, plus—once again—a money market fund to cover upcoming spending. Vanguard’s four LifeStrategy funds don’t change their stock-bond mix over time. Instead, each of the four funds has a fixed asset allocation, ranging from 20% to 80% in stocks. For instance, Vanguard LifeStrategy Moderate Growth Fund aims to keep 60% in stocks at all times.
Like Vanguard’s target funds, the LifeStrategy funds hold a diverse collection of Vanguard index funds. One downside: Unlike the target funds, the LifeStrategy funds aren’t slated for an expense cut, which means I’d pay a tad more—0.11% to 0.14% a year, depending on which of the four I chose.
The Classic. If I bought a Vanguard Target Retirement or LifeStrategy fund, I’d be getting something akin to the classic three index-fund portfolio—a total U.S. stock market fund, a total U.S. bond market fund and a total international stock fund—with some foreign bonds and maybe some inflation-indexed bonds also thrown in.
But there’s a case to be made for buying the three funds directly, rather than as a package. The overall annual expenses would be a tad lower. I could also hold stocks and avoid bonds in my taxable account, which should be more tax-efficient. In addition, I could limit my selling to bonds if I needed to generate cash during a stock market decline. By contrast, if I owned a target or LifeStrategy fund, selling during a market decline would mean selling a little of everything, including stocks—not something I’d want to do. Still, I could probably sidestep that risk by keeping perhaps five years of spending money in a money-market fund or a short-term bond fund.
Three to Two. Instead of the classic three-fund portfolio, I could make things even simpler by going for two total market funds—Vanguard’s Total World Stock ETF and its total U.S. bond market fund—plus a cash account for upcoming spending needs.
I’d argue that Vanguard Total World represents the ultimate in stock indexing: You get every stock in the world of any significance bought according to its market value. To me, it’s the quintessential buy-hold-and-forget stock market investment.
Indeed, I’m thinking of purchasing the fund in my Roth accounts, which I hope to leave untouched and instead bequeath to my kids. Because that’s my goal, I can take plenty of risk and owning 100% stocks makes sense. I’d also consider buying Vanguard Total World Stock in my regular taxable account—if I were starting from scratch today. But instead, I already own a stock index fund in that account with hefty unrealized capital gains, and it doesn’t make sense to take that tax hit to swap over to Vanguard Total World Stock.
Going in Style. Today, I use index funds to overweight U.S. and foreign value stocks and small-company shares, as well as emerging markets. Meanwhile, I have my bond holdings split between a short-term government bond fund and a short-term inflation-indexed bond fund.
I’m not quite ready to abandon these portfolio tilts. But I’m toying with housing them within my traditional IRA, while devoting my various Roth accounts entirely to Vanguard Total World Stock. Thereafter, as I ease into retirement, I may gradually abandon these tilts. Where will I move the money? I’m not 100% sure.
But I’m thinking of perhaps splitting my traditional IRA, putting longer-term money in Vanguard LifeStrategy Growth, with its 80% stock exposure, and money earmarked for spending in the years ahead in a short-term government bond fund. But whatever funds I settle on, one overriding principle will guide my thinking: As I age, I want my financial life to be simpler.
Jonathan Clements is the founder and editor of HumbleDollar. Follow him on Twitter @ClementsMoney and on Facebook, and check out his earlier articles.
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Jonathan, I know that this article is an older one but I have just re-read it. I find your recommendation for using the Vanguard Total World Stock ETF to be a good one. I know that the EFT did not exist back in the 1980s and 1990s but I cannot help but wonder that if it had, it would have been hugely invested in the Japanese stock market. How to you square your use of the ETF to what occurred back then? Do you feel that the circumstances at that time were somehow unique? Thank you for your thoughts.
Market-cap weighted index funds hold the exact same stocks in the exact same percentages as those held by active investors as a group — but do so, of course, at much lower costs. Active investors back at year-end 1989 were collectively convinced that Japanese stocks were a great investment and had bid them up to high prices, and index funds simply mimicked their holdings. Were active investors horribly wrong? In retrospect, we know they were. Active investors will continue to make bad collective misjudgments –think tech stocks in early 2000 or small-cap growth companies in late 2021 — and index funds will, by their nature, mimic those misjudgments. That’s the nature of index funds. But over the long run, we know the result of that apparent “flaw” — they end up beating 90%-plus of active investors.
There is something to be said for the enjoyment to be gained by investing successfully as a retired person. I enjoy it. If I had two or three Vanguard index funds I’d have to figure out something else to do.
That – having to figure out something else to do – made me laugh. Yes, reading all the financial blogs and managing personal finances can be fun. My guess is most of the Humble Dollar regular readers enjoy it. But, when/if you become incapable or unwilling to spend your time on managing your portfolio and finances, will your spouse/family/friends enjoy it as much as you do, and do it properly? Age 73.
All of the target date funds I have seen include very significant bond positions, even at a relatively young age. We live a lot longer now. Worse, your bonds will return the lowest projected yield in our lifetime because of the Fed, meaning if you are successful in your equity investments, you can be guaranteed your bonds will drag down your return significantly. How can you call something an investment if it’s projected return is below zero in real terms? Is the substantial price of the reduced volatility gained by buying low yielding bonds worth the price? I say no. 100% equities for me until bonds have a positive real return. Age 77.
I really enjoy reading the articles but also the comments here. It’s a good “discussion” area rather an “arguing” area, which is nice. All of the comments remind me of something my father said: “Teach it to them in black and white and they will shade it in themselves.” Ages, life experiences, etc. all seem to help form the various opinions and comments here. Maybe Dad was right?
Yes, I think your dad was right — and I think you are, too. Internet forums are often vile cesspools, which is why the level of civility here at HumbleDollar is heartening.
Great topic Jonathan. I started building a portfolio years ago and didn’t have a dozen funds but found over time it was somewhat of a pain to rebalance plus I sometimes second guessed my choices at time. I have more taxable investments than qualified money so tax consequences mattered. In my case working with a low cost advisor took away those burdens for me. I realize it’s probably not the route for you but have you given thought to the possibility of low cost advisor as you grow older? We are never certain of our future health and in a way like asset diversification it may be another form of portfolio insurance.
Hiring a low-cost advisor at some point is definitely something I’m considering.
Jonathan, why the Vanguard Total World Stock ETF rather than the Vanguard Total World Stock Mutual Fund in view of Vanguard’s patented method of not paying out capital gains on those Mutual Funds that have a “sister” EFT?
Either would be a fine choice. The mutual fund is 0.02% more expensive, but I wouldn’t fret much about that, especially as buying and selling the ETF would likely mean losing a little to the bid-ask spread.
I agree simplicity is important especially as we age.
One interesting point – you are not selling stocks when they are down when you sell a Life Strategy fund in a bear market. As explained to me by Ben Felix of Rational Reminder podcast (which I highly recommend), these asset allocation funds rebalance daily (largely with cash flows), so when you sell in a bear market, the stocks you sell have been bought that same day with the proceeds of bonds that have been sold as part of the rebalancing process. So you are really just selling bonds, not stocks. So there is no problem with keeping everything in a Life Strategy fund and selling off slivers as needed regardless of market conditions.
I also wouldn’t move away from small cap and value tilts in retirement. In fact, according to Larry Swedroe, that diversification across risk factors is particularly important in retirement as it’s not predictable when factors, including market beta (total market) will do best. Eg retirees in 2000 only in total market funds go hammered, whereas those diversified into small cap value had a better experience.
Thank you for this and all the great articles you have written. Would Vanguard Wellington meet the needs you describe? Diversified, low cost, 65% stock allocation and simple with no need to rebalance.
Wellington is a fine fund — but it is actively managed and the stock portfolio is largely (and perhaps entirely) U.S.
Jonathan, if you have a long-term horizon (except for cash), why do you hold only short-term bonds? Expected increases in inflation are presumably already baked into bond prices, and don’t drops in bond prices due to *unexpected* increases in inflation break even at the 5-6 year duration of an intermediate-term bond fund (from re-investing dividends at the lower prices / higher rates)?
Intermediate bonds are riskier than short-term bonds and, as a result, should indeed deliver higher returns over time. But I don’t buy bonds to make money, but rather to have a pool of readily available cash to cover upcoming spending.
Fantastic article, I tend to lean to the three to two fund strategy. I once met a man in grad school who was 90 years old and had 90% allocated in stocks. I assume he had low living costs and a high risk tolerance that allowed him to weather the ups and downs of the market. His lifetime strategy was to essentially as he put it to, “Let er rip”. I lean towards his principles. In my taxable account, my long term approach is to hold etf’s (tracking the Dividend 100, such as $SCHD) which generate 99.9%+ of dividend payouts in qualified dividends. In my pre-tax (Traditional) and post-tax (Roth), I intend to migrate to either a three fund strategy ($VXUS, $VTI, $BNDW) or two fund strategy ($BNDW, $VT) probably with a 90% stock allocation, and 10% bond allocation).
A few Roth conversions during the bear market years and mini-retirements over the 20-30 year period, and hopefully I can be super close to the 0% tax bracket in retirement. Live off a combination of Qualified Dividends, Roth Distributions, and social security payable (fingers crossed) 😊.
A younger person reading Jonathan Clements with a long-term approach to investing is quite likely one day gonna have income well above the 0 % tax bracket. And, that will be a good problem to have. 🙂
Tax planning is a large part of the picture. Everyone needs a tax avoidance strategy. If the vast majority of your income comes from Qualified dividends, and Roth Distributions you’re in the 0% tax bracket as Qualified Roth distributions are not taxed, and Qualified dividends are taxed at the Long Term Capital Gains Rate as long as you stay within the 12% bracket threshold, your LTCG rate is 0%.
Now the 0% is a misnomer as taxes were paid, just on the planting of the seed and not the full harvest. Planning out your conversion of traditional (pre-tax) amounts over periods when your income is low allows you to convert in lower marginal tax brackets, and ultimately avoid costly RMDs when approaching your 70’s in retirement especially if your estimated compound growth could push you over the 8mm mark.
The Roth Conversion ladder is a good way to make your way to the 0% bracket and is definitely apart of the approach for us humble dollar readers with a long term approach.
I agree that tax planning/tax avoidance is important. The problem is that no one knows what future tax rates, types of taxes, definitions of income, tax implications of various investments, or even “investment types” will be. IRAs, index funds, Roths, ETFs, RMDs, all were first developed during my investing career. A young person deciding whether to invest in taxable, traditional IRA, or Roth today has no idea what those decisions will look like 20 to 30 years from now. And the terms “qualified dividends, Roth, capital gains rate, tax bracket threshold, LTCG, RMD, and Roth Conversion ladder” can be intimidating to someone who is just starting to invest, and can scare people not to save and invest.
Simplicity can become too simple. A 2- or 3- fund approach does give peace of mind, and it can keep you invested. However, there is also something to be said for adding small-cap stocks as they are not well-represented in the normal 2- ir 3- fund portfolios. Even if only adding 10% small-cap…..
One, it is good that you know what you are investing in–you’ve mentioned the portfolio composition and the management fees. Any investor should know what they are investing in, right? But, if you know all this, why don’t you just buy what you need? Three or four funds for a person like you is not that complicated. But like you say, why not start with the broadest and cheapest funds possible and only supplement with more expensive, selective products as little as possible?
Two, you realize that taxes matter. Therefore, you don’t need an advisor (or a robot) telling you how to be tax efficient. Of course you should take taxes into account while treating your investing as one whole, not just separate accounts. This might be a great topic for another post.
Three, you realize that previous decisions you have made have an effect on what you do today. That’s true for all of us, and to some extent, unique, reminding us that no product can quite anticipate everything we’ve done before. To tell the truth, this has been one of the biggest mistakes I’ve seen advisers make as well–they don’t quite get the whole story before they give the advice. (Well, let’s be honest, sometimes we clients don’t quite tell the whole story….)
Great article. I would argue that if you have to keep some of your retirement savings in a taxable account, it would be more tax efficient to invest your bond allocation in your taxable account (via munis), and invest in stocks using your IRA (whether traditional or Roth).
On a risk adjusted, after-tax return basis, municipal bonds compare favorably to both treasuries and other taxable bonds. Vanguard has many low-cost muni bond funds tailored to different investors’ objectives (e.g. duration, credit quality, state specific).
The reason to have stocks in IRAs is that the expected long-term return of equities is so much higher than bonds. Having stocks in your IRA allows you to take greater advantage of the tax benefits of an IRA. The tax advantages are greater in a Roth, but would still be true in a traditional IRA.
Please consider this a question rather than a statement of opinion. Wouldn’t it be more efficacious to have a “lifecycle” type fund approach the investment balance issue from the perspective of when the investor might need access to the asset, versus the investor’s age? I’m of a age where generational planning takes a bigger and bigger role in my decisions, and frankly there are some asset pools that I’ll very likely not tap in my lifetime. In those cases it would seem I have an almost unlimited (some would even say “eternal”) time horizon, so why not be as aggressive as possible? I can’t think of any investment vehicle that works that way, but am open to ideas.
That’s my thinking behind holding the World Stock Index fund in my Roth accounts, which I plan to bequeath.
I’ve spent a lot of time in my life trying to find the best investment portfolio. My learnings:
1. Read Scott Burns annual articles about the results of his Couch Potato Portfolio.
2. Read White Coat Investor’s “Best Investment Portfolio – 150 Portfolios That Are Better Than Yours”.
3. Read William Bengen’s 2006 book, Conserving Client Portfolios During Retirement. Bengen brought attention to the 4% rule. He calls it SafeMax. It is a very good book, which is good because I paid $57 for it years ago. He looked at actual market returns for 30 year periods starting in 1926 through 1975. (Means the last year of his market data was 2005.) In his analysis of SafeMax, he says:
–T bills/money market funds can replace completely all other types of fixed income investments, including intermediate term govt bonds, without any adverse effects on withdrawal rates
–unless client’s life expectancy is shortened by disease, etc., it is not beneficial to reduce equity allocation during retirement
–increasing rebalancing interval from 12 months to 75 months improves safe portfolio withdrawal rates
–SafeMax withdrawal rates are virtually unaffected by large company stock allocations anywhere between 32% and 67%
4. Read Jonathan Clement’s WSJ article: “How to Make Your Daughter a Millionaire”.
Invest regularly in a portfolio with stock allocation between 32 to 67%.
Relax.
On point #4, do you have a link to the article in the WSJ “How to make your daughter a millionaire”?
Check out Michael Kitces’ article on the 4% rule. It is a well written evaluation of the implications of the rule. In essence, the 4% doesn’t account for making adjustments (lowering your withdrawal rates during down markets). Accounting for making adjustments during down years can make the 4% lean towards being a conservative approach.
The Problem With FIREing At 4% And The Need For Flexible Spending Rules
https://www.kitces.com/blog/the-problem-with-fireing-at-4-and-the-need-for-flexible-spending-rules/
Thanks for the link to Kitces article. Bengen’s book looked at 30 year retirements, or shorter. Not a prescription for retire early people. Bengen’s analysis showed that over 30 year retirement, a wide range of asset allocations worked ok. During retirement there are things to worry about. Finely adjusting an investment portfolio’s asset allocation is not one of them. Scott Burns points out that early death affects portfolio “success” a lot more than asset allocation.
😊 I agree. Bengen’s study was absolutely groundbreaking, at the time advisors were recommending 7% withdrawal rates. Bengen’s study demonstrates a withdrawal rate number and portfolio allocation that would survive even a Great Depression and a world war in succession and a roughly 10 year bear which is amazing when you think about it, and the stock allocations used were not nearly as diversified as the indexing tools we have today.
When you crunch compounding (@1mm or 500k) numbers over 40-50 year compounding periods you can end up with huge amounts if early retirees are willing to adjust the withdrawal rate to 2% in down markets, and potentially work part-time (25K in income is worth 500k in investments when accounting for the 4% rule).
I have a “Drop Dead” portfolio. It’s constructed so if I drop dead someday my wife doesn’t have to change anything. She can just continue distributions. I have friends with really fancy portfolios but their wives have no interest in investing so I guess they’ll be at the mercy of some stockbroker who will “help” them. Our money is at Vanguard where she might actually get more real help than commission-enhancing investment shuffling.
I like the drop dead portfolio simplification idea. It will make it easier for your wife. She will still be at the mercy of whoever she trusts to advise her. My wife and I have worked with an advice-only advisor who shares our principles of passive, low-fee, long-term investing. She has someone to turn to for advice if she needs it. I have used Vanguard advisors, but these days, they, too, want you to turn over your portfolio to them to manage for a fee, rather than provide advice only for a DIY portfolio.
I really like the World Stock idea. Last couple of years I’ve been simplifying the portfolio and have pretty much reached the 3 fund portfolio. I considered the world stock but the consensus opinion seemed to be that it’s better to reduce the international exposure during retirement when it’s being drawn down for spending. Having a total world stock obviously doesn’t provide that flexibility. I think I saw even Bill Bernstein say that and may be some others. Based on that, I stuck to total US and International fund. But the simplicity of the world stock is really appealing. Just not able to make up my mind.
I know folks shy away from the World Stock Index fund because of its currency exposure. But think on this: As we age, we tend to hold more bonds — typically U.S. bonds — and thus the foreign-exchange exposure in the overall portfolio will tend to trend lower over time.
Another minor concern is the expense ratio. May be I’m worried about pennies, but something like VTI is 0.03% while VT is 0.08%. It seems a bit cheaper to buy them separately, though we now have to manage the overhead of rebalancing them.
When I actually look at the companies, I would argue that large US companies are quite the “world stocks” without the currency exposure. This might be a reason for leaning toward larger companies as it is less true of smaller companies.
I have followed Mr. Bogle’s advice over the years to stay in the US. At age 73 I am at 50% Total Stock Market Index, and 50% Total Bond Market Index. He knew more about investing than I will ever know, and his reasoning has been supported nicely by returns over the past decades. None of us know whether going forward international stocks will outperform US, but we do know that in general they have not in the past. And psychologically, I like simplicity for both my own sake, and for the sake of my heirs.
Good article with plenty to digest. One thing I don’t understand is why one would keep cash in a money market fund that pays .01% but which costs between .09-.16% (essentially costing one money to keep cash) when one can earn 1% in an online savings account.
My Wells Fargo checking account pays more interest than the savings account – hahaha.
Here in Switzerland due to negative interest rates, I pay my bank to hold my deposits in amounts over 100K.
I agree with you on the too low stock allocation in Vanguard’s target funds.
In my traditional IRA I have only total world stock and total U.S. bond.
My taxable account has too many funds, but they’re all good, so rather than sell them and pay the capital gains, I have the dividends sent to my settlement fund.
In a bull run, it’s always too low of a stock allocation… in a recession, people wonder why they had so much equity exposure.
Fitting name, Scrooge. 😛
Lots of interesting ideas that I had considered myself at some point. Here are a few thoughts on some of them:
1) Money-market cash is often better held at a credit union. NASA Federal Credit Union for example offers 0.25%, vs 0.01% from Vanguard, and offers membership in many ways ranging from free to just under $50/year. Shopping around to see which credit unions you qualify to join, and keep all cash equivalents there, can also save the limited room we are given in tax advantaged accounts for much higher yielding assets.
2) Vanguard now has an option called Target Retirement Income and Growth Trust. The glide path is identical until age 65, but will then stay locked at 50% stock forever.
3) Selling from an all-in-one fund like LifeStrategy during a decline doesn’t mean selling the proportion of stocks in a way meaningfully different than with separately rebalanced funds, since an all-in-one is being continuously rebalanced from its own internal bonds. If for example a 60% stock all-in-one fund experiences a big market decline, it will keep shifting its bonds into stocks, such that the 60% of stocks being sold for income is increasingly coming from what was bonds up until a few weeks or months prior. The process may not be as clean, going through the process of shifting bonds to stocks just to sell those stock for income shortly after, but it does guarantee people rebalance during the more opportune times.
4) While keeping bonds out of taxable is common advice, it’s not actually a big problem for tax efficient high-quality bonds. The White Coat Investor has several posts about this, but basically, leaving room for high returning stocks in tax advantaged accounts has its own offsetting benefits. There is also a YouTube video on Asset Location by Ben Felix that shows how holding separate asset allocations in accounts with different tax treatment doesn’t meaningfully improve returns. It also hides the true after-tax asset allocation, making it appear to be a free lunch when it isn’t.
5) Holding a Total World fund in a taxable account means not receiving the credit for foreign withholding tax. If an individual fund has less than 50% of its holdings in international, that tax information isn’t required to be provided for investors. LifeStrategy and Target Retirement funds get around this by being a “fund of funds”, so the international component funds are still considered individual funds themselves and do provide foreign withholding tax credit information.
6) While people like Christine Benz of Morningstar have spoken against holding “tilts” in a retirement portfolio, think twice before reducing exposure to academically sound concentrations in broadly diversified value funds. Modern portfolio theory shows that low-cost value funds can add diversification when balanced against total market exposure. As long as you plan to hold the funds for the long term, and can weather the occasional decade of underperformance relative to the market, they should provide diversification benefits when the total market goes through its own periods of underperformance.
My own stock holdings are split between Total US Market, Total International market, and US Small Cap Value. For bonds I use only the Vanguard Intermediate Term Treasuries index of 3-10 year bonds. I expect intermediate term bonds will continue to underperform short term bonds in the very near term, but since only unexpected inflation causes negative bond returns, the eventual pricing in of expected inflation should offset that through higher yields, since I plan to hold the fund far longer than the stated fund duration.
Good points, Nick. Thanks for sharing.
Target Retirement Income and Growth Trust may be an institutional product only and not available to individual investors. Which is a shame.
Great article and at 68 would really like to simplify my portfolio as well. What do you see as the advantage of the LifeStrategy Growth fund over a two-fund (Total World plus total bond fund) approach? It just seems one would be paying a higher expense for essentially the same portfolio.
Yes, it’s essentially the same portfolio, but with less maintenance. That doesn’t seem like a big deal now. But I suspect it will to my 80-year-old self.
What about the Vanguard Balanced Index Fund?
It’s a good fund — but all the stock exposure is U.S.
Interesting topic, and it is fortunate that you have sufficient funds to dabble here and there. I understand the desire for some safety, but the choices you have mentioned seems more like 6 of one or half a dozen of the other. And with inflation spreading widely of late, it may outrun many of the choices you mentioned so that you are not even keeping up.
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In my situation I am a dozen years older and have a smaller nest egg to work with. So that it seems best for me to stay actively involved in where the funds are and to maximized returns using higher dividends stocks (6 to 11%) and some conservative (low delta) option positions that have been generating in the range of 20-24% per year.
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With this mixture I can pay all my bills and sock some money away each year to grow the funds. Yes, I must work a few hours a day most of the time, but that is not a bad thing either. We do what we must to meet our needs and the answer to retirement is different for every person.
I respect your choices. I know little about options, but “low delta option positions that generate in the range of 20-24% per year” does not sound conservative or safe to me. The old rule: higher return, higher risk.
I started the simplification process a while ago. VSMBX is a terrific option, I’d argue – the forced reallocation is discipline the individual rarely has.