Paying It Forward

Jonathan Clements

ROUGHLY A QUARTER of my investment portfolio sits in three Roth retirement accounts. Ever since I first funded a Roth a dozen years ago, I’ve thought of this as money I’d avoid spending for as long as possible, so I milk maximum gain from the tax-free growth. But lately, it’s dawned on me that it’s highly unlikely I’ll ever dip into these accounts—and that realization has triggered a slew of investment decisions.

My three Roth accounts are all at Vanguard Group. They consist of a solo 401(k) that I continue to fund each year, a nondeductible IRA I converted to a Roth in 2010, and a rollover Roth 401(k) from my time at Citigroup. Because a Roth’s growth is tax-free, that’s the place where you want to earn your portfolio’s highest returns—and that’s why I have my Roth accounts invested 100% in stocks.

But until December, I managed my Roth accounts as part of my overall investment portfolio. That meant I used my Roth to own part of my portfolio’s allocation to, say, small-cap value stocks, small-cap international stocks, emerging markets and so on.

Now that I realize I’ll almost certainly never spend my Roth accounts, and instead they’ll go to my two children, I’ve changed my approach. In essence, I’m now managing two portfolios—the Roth accounts that my kids will inherit and the rest of my portfolio, almost all in a traditional IRA, which will fund my own retirement.

To be sure, a Roth isn’t quite as good an inheritance as it once was, now that Congress has nixed the ability for many beneficiaries to draw down inherited IRAs over their lifetime. Still, for my kids, my Roth accounts will come free of income taxes, plus they could get 10 more years of tax-free growth from the accounts after my death.

Meanwhile, as I’ve written about before, I’m aiming to simplify my investment portfolio—and, indeed, my overall financial life—as I look ahead to retirement. In my recent portfolio revamping, I didn’t change my asset allocation. I still have the same percentage in U.S. stocks, foreign shares and bonds, and I kept my various portfolio tilts, such as overweighting smaller companies, value stocks and emerging markets.

But I moved all of these portfolio tilts to my traditional IRA—and invested each of my three Roth accounts entirely in one fund. It’s a fund I believe I’ll be happy to hold for the rest of my life, and this part of my portfolio shouldn’t require any maintenance whatsoever. The fund: Vanguard Total World Stock Index Fund, which is available both as a mutual fund that charges 0.1% in annual expenses and as an exchange-traded fund that costs 0.08%.

The fund represents, I believe, the ultimate in stock market diversification. With it, you get exposure to every stock around the world of any significance. Right now, the fund has roughly 60% in U.S. stocks, 30% in developed foreign markets and 10% in emerging markets. It represents the global market portfolio for stock investors—a single fund that holds what all other stock investors hold and in the percentages that they collectively hold them.

Does my strategy have drawbacks? I can think of five:

  • I may be wrong and end up needing the money. This doesn’t strike me as a huge issue. Until I shuffle off my mortal coil, the money remains mine and, if it looks like I’ll need to tap my Roth, I should have plenty of warning, so I can dial down the risk level.
  • In terms of fund expenses, it would be slightly cheaper to own a separate total U.S. stock market index fund and a total international stock index fund. But I’m happy to pay a few more pennies each year per $100 for simplicity.
  • I’ll miss out on the potential performance bonus that could come from earmarking, say, 60% for U.S. stocks and 40% for foreign stocks, and thereafter regularly rebalancing back to those target percentages, thus selling high and buying low. But again, for this money, my goal is simplicity, plus zero ongoing maintenance.
  • My less rational side—the part that thinks it has some sense for where markets are headed—feels Vanguard Total World is too exposed to the U.S. market and to the biggest U.S. stocks, especially tech companies. But the fact is, Vanguard Total World reflects the collective judgment of all stock investors around the world. They’ve voted with their buys and sells, and this is what they’ve chosen to own. Who am I to question their judgment?
  • Congress could institute required minimum distributions for Roth IRAs, which means I’d be forced to draw down the account. I hope that doesn’t happen, but there isn’t a whole lot I can do about it.

Many—and perhaps most—parents strive to leave behind something of value for their kids. Still, I consider myself to be in a privileged position. I can’t give my kids full financial security and, in any case, I’m not sure that’s desirable, because we all need something to strive for. But I can give them the sense that, down the road, a financial safety net awaits them. It’s my gift to my kids. My hope: They’ll pay it forward to their children.

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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