Don’t Mess Around

Jonathan Clements

THERE ARE CERTAIN things I did right during my financial journey, notably saving like crazy, tilting heavily toward stocks and favoring index funds. But if only all my doing had stopped there.

Looking back over almost four decades of investing, what I see is far too much tinkering. At various times, I’ve owned funds devoted to precious metals, global real estate, commodities, emerging market bonds and more. I know this tinkering devoured precious time—and I strongly suspect it hurt my investment results. To be sure, there was pleasure in the tinkering or, at least, I used to think so. I enjoyed pondering my portfolio and I liked the “fresh start” that came with buying new investments.

Some of the tinkering was also necessary because the universe of investment options has changed so much over the past four decades. When I moved to the New York area from London in 1986, Vanguard Group’s S&P 500-index fund was its only index offering. Today, my largest fund holding is Vanguard Total World Stock Index Fund, which wasn’t even launched until 2008.

How can we avoid tinkering too much? A few years ago, I would have suggested purchasing a target-date retirement index fund, which means buying one of those offered by Charles Schwab, Fidelity Investments or Vanguard Group. And I still like these funds for younger investors looking for a sensible one-fund investment for their retirement account.

But my enthusiasm for target-date funds has waned. Even if we ignore the 2021 tax debacle triggered by Vanguard’s move to allow investors to shift into a lower-cost share class of its target funds, these funds can generate significant tax bills each year. The reason: Target-date funds own bonds, and they may need to do some selling to rebalance or cash out departing shareholders. That means the funds can make large income and capital gains distributions, and hence they aren’t suitable for a taxable account.

But forget the question of tax efficiency. Of greater concern to me is how conservative these funds become as they approach and pass their target retirement date. Check out the so-called glide paths for the target funds offered by Fidelity, Schwab and Vanguard. In all three cases, the funds are at roughly 50% stocks as of their target retirement date—Schwab is notably conservative at just 44%—and retirees eventually end up with some 20% to 30% in stocks.

I get it. Many investors are much more jittery than me, and fund companies have an incentive to err on the side of caution, so investors are less likely to complain during down markets. Still, with the threat from inflation and the prospect of living 30 years or more in retirement, such a conservative portfolio strikes me as far from prudent.

So, how can you minimize the sort of dangerous tinkering that can harm your portfolio’s performance? If you’re looking for a one-fund solution for your retirement account, I’d consider one of Vanguard’s four LifeStrategy funds, each of which holds a static mix of stocks and bonds. I’d lean toward either the growth fund with its fixed 80% stock allocation or the moderate growth fund with its fixed 60% stock weighting. Alternatively, you might buy Fidelity Multi-Asset Index Fund (symbol: FFNOX), which has some 85% in stocks. Sound too aggressive? You could twin the Fidelity fund with a bond fund if you favor a more conservative asset allocation.

But my favored strategy for retirement account investors is to buy Vanguard Total World Stock Index Fund, which is available as both a mutual fund (VTWAX) and an exchange-traded fund (VT), and then combine it with short-term government bonds to get the risk profile you want. Vanguard Total World offers the broadest possible stock market diversification. Whatever part of the global stock market is shining, the fund’s shareholders will get a piece of the action.

What if you’re investing through a regular taxable account? Vanguard Total World Stock Index Fund, like target-date and other multi-asset funds, wouldn’t be quite as good a choice—again for tax reasons. If a fund has less than half its portfolio in foreign securities, which is currently the case with Vanguard Total World Stock, shareholders can’t claim the foreign tax credit.

What to do? When investing through a taxable account, it’s important to pick wisely from the get-go—because you’ll soon be locked in by capital gains and, if you sell, you’ll lose the impressive tax benefits that come with buying and holding stock index funds in a taxable account over a decade and preferably far longer. With that in mind, I’d favor purchasing two total market index funds, one focused on U.S. stocks and the other on international shares.

Other than the need to raise cash, there shouldn’t ever be a reason to sell these funds, though that may reflect a failure of imagination on my part. Will Wall Street come up with an even better way to index, similar to the way exchange-traded index funds have edged out index-mutual funds? It could happen. Still, even if today’s total market index funds turn out to be a less-than-ideal choice down the road, I suspect you could do a whole lot worse—and the benefits of switching funds wouldn’t be justified by the tax bill involved.

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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