Stocks — Part V: Keeping it simple, considerations and tools

Posted: May 9, 2012 in Stock Investing Series
Tags: , , ,

Simple is good.  Simple is easier. Simple is more profitable.

What I’m going to share with you in these next couple of articles is the soul of simplicity.  With it you’ll learn all you need to know to produce better investment results than 80% of the professionals and active amateurs out there.  It will take almost none of your time and you can focus on all the other things that make your life rich and beautiful.

How can this be?  Isn’t investing complicated?  Don’t I need professionals to guide me?

No and no.

Since the days of Babylon people have been coming up with investments, mostly to sell to other people.  There is a strong financial incentive to make these investments complex and mysterious.

Babylon

But the simple truth is the more complex an investment the less likely it is to be profitable.  Index Funds out perform Actively Managed Funds in large part simply because Actively Managed Funds require expense active managers.  Not only are they prone to making investing mistakes, their fees are a continual performance drag on the portfolio.

But they are very profitable for the companies that run them and as such are heavily promoted.  Of course, those profits come from your pocket.  So do the  promotion costs.

Not only do you not need complex investments for success, they actually work against you.  At best they are costly.  At worst, they are a cesspool of swindlers.  Not worth your time.  We can do better.

Here’s all we are going to need:  Three considerations and four tools.

The Three Considerations.

You’ll want to consider:

  1. In what stage of your investing life are you:   The Wealth Building Stage or the Wealth Preservation Stage?  Or, mostly likely, a blend of the two.
  2. What level of risk do you find acceptable?
  3. Is your investment horizon long-term or short-term?

As you’ve surely noticed, these three are closely linked.  Your level of risk will vary with your investment horizon.  Both will tilt the direction of your investing stage.  All three will be linked to your current employment and future plans.  Only you can make these decisions, but let me offer a couple of guiding thoughts.

Safety is a bit of an illusion. 

There is no risk free investment.  Don’t let anyone tell you differently.  If you bury your cash in the back yard and dig it up 20 years from now, you’ll still have the same amount of money.  But even modest inflation levels will have drastically reduced its spending power.

If you invest to protect yourself from inflation, deflation might rob you.  Or the other way around.

Your stage is not necessarily linked to your age.

You might be planning to retire early.  You might be worried about your job.  You might be taking a sabbatical.  You might be returning to the workforce after several years of retirement.  Your life stages may well shift several times over the course of your life.  Your investments can easily shift with them.

F-you money is critical.

If you don’t yet have yours, start building it now.  Be relentless.  Life is uncertain.  The job you have and love today can disappear tomorrow.  Nothing money can buy is more important than your fiscal freedom.  In this modern world of ours no tool is more important.

Don’t be too quick to think short-term.

Most of us are, or should be, long-term investors.  The typical investment advisor’s rule of thumb is:  subtract your age from 100 (or 120).  The result is the percent of your portfolio that should be in bonds.  A 60-year-old should, by this calculation, have 40% in conservative, wealth preserving bonds.  Nonsense.

Here’s the problem.  Even modest inflation destroys the value of bonds over time and bonds can’t offer the compensating growth potential of stocks.

If you are just starting out at age 20 you are looking at perhaps 80 years of investing.  Maybe even a century if life expectancies continue to expand.  Even at 60 and in good health you could easily be looking at another 30 years.  That’s long-term in my book.

Or maybe you have a younger spouse.  Or maybe you want to leave some money to your kids, grand kids or even to a charity.  All will have their own long-term horizons.

The Four Tools.

Once you’ve sorted thru your three considerations you are ready to build your portfolio and you’ll need only these four tools to do it.  See, I promised this would be simple.

1. Stocks.  VTSAX (Vanguard Total Stock Market Index Fund)  You’ve already met this fund in earlier posts of this series.  It is an index fund that invests in stocks.  Stocks, over time, provide the best returns and with VTSAX, the lowest effort and cost.  This is our core wealth building tool.  But, as we’ve discussed, stocks are a wild ride along the way and you gotta be tough.

2.  Bonds.  VBTLX (Vanguard Total Bond Market Index Fund) Bonds provide income, tend to smooth out the rough ride of stocks and are a deflation hedge.  Deflation is what the Fed is currently fighting so hard and it is what pulled the US into the Great Depression.  Very scary.   The downside for bonds is that during times of inflation and/or rising interest rates they get hammered.

3.  Real Estate.  VGSLX  (Vanguard REIT Index Fund)  REITs (Real Estate Investment Trusts) invest in real estate.  They provide an inflation hedge and, typically, dividend income.  REITs allow us the benefits of ownership without the headaches of actively buying and managing properties.  But during periods of deflation real estate prices plummet.  That’s exactly what’s been happening to home prices these past few years.

REITS are in a sense the Ying to our Bonds’ Yang.

4.  Cash.   Cash is always good to have in hand.  You never want to have to sell your investments to meet emergencies.  Cash is also king during times of deflation.  The more prices drop, the more your cash can buy.  But idle cash doesn’t have much earning potential and when prices rise (inflation) its value steadily erodes.

We tend to keep ours here:  VMMXX   This is a Money Market Fund and time was they offered higher yields than banks.  These days, with interest rates near zero, not so much.  Now we also keep some in our local bank.  If you prefer, an on-line bank like ING works fine too.

So that’s it.  Four simple tools.  Three Index Mutual Funds and a money market and/or bank account.  A wealth builder, an inflation hedge, a deflation hedge and cash for daily needs and emergencies.  Low cost, effective, diversified and simple.

You can fine tune the investments in each to meet the needs of your own personal considerations.  Want a smoother ride?  Willing to accept a lower long term return and slower wealth accumulation?  Just increase the percent in VBTLX.

Next time we’ll talk about a couple of specific strategies and portfolios to get you started.

Meanwhile, a brief note on….

You will have noticed Vanguard is the company that operates all of these funds.  It is the only investment company I recommend, and the only one you need (or should) deal with.  Vanguard’s unique structure means that its interests and yours are the same.  Vanguard the company is owned by the Vanguard funds.  In other words, by us, the fund shareholders. This is unique among investment companies.

Awhile back a commentator on Reddit, referring to one of my posts, said:  “This really just looks like a commercial for Vanguard.”  I can see his point, although I wish he’d made it directly on here.

I am a huge Vanguard fan, but I am not on their payroll and I have no financial interest in the company other than owning the funds I describe.

You might find an index fund in another investment company that is a bit cheaper.  They create some as “loss leaders.” But you can’t trust these other companies long-term.  Their interests are not your interests.  Their interests lie in making money for their owners.

If you play with snakes, to quote Dave Ramsey, you’ll eventually get bitten.

Don’t bother.  Stick with Vanguard.

Disclaimer:  Like everything on this blog, this is only sharing ideas.  You are solely responsible for your own choices.

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Comments
  1. […] Stocks — Part V: Keeping it simple, considerations and tools […]

  2. Albert Choy says:

    JH,

    I think you have this flipped:

    ” The typical investment advisor’s rule of thumb is: subtract your age from 100 (or 120). The result is the percent of your portfolio that should be in bonds. “

  3. […] Me: I do think about my future, so I buy term insurance and invest the difference in an Index fund. […]

  4. […] Stocks — Part V: Keeping it simple, considerations and tools […]

  5. ChetBodet says:

    Great blog! I have really enjoyed going back through all the posts.

    I was wondering if you had some advice for my current situation. I am 24 and I have about $20K in my Roth IRA all in the Vanguard STAR fund. I am looking to invest in the VTSAX going forward, but with the $10K initial requirement I am not sure how exactly. Can I take $10K of the STAR fund and basically just switch it to the VTSAX Fund? If so do you know what if any tax implications or Vanguard fees I would incurr? Also, would I then be able to buy more VTSAX funds, but in a seperate account from my Roth?

    • jlcollinsnh says:

      Thanks Chet!

      First, the STAR fund is a fine choice. Basically it is a “fund of funds” comprised of eleven different Vanguard funds and it has a mix of 60/40 stocks/bonds. The idea is a full and diversified portfolio in one fund, and you never have to worry about rebalancing it. That happens automatically.

      It’s expense ratio, at .34%, is higher than VTSAX at .06%, but that’s still low in comparison with most other funds out there.

      I would have no problem with you just keeping your STAR fund and adding to it over the next few decades. It should serve you well and with a smoother ride.

      VTSAX (100% stocks) will likely give you a greater final return when the dust settles 30-40 years from now, but it will be a bumpier ride.

      a mix of 60/40 stocks/bonds, as in STAR, is very conservative for a guy your age.

      If you do decide to switch, the process could hardly be easier. You just log on to vanguard.com, go to your account, find the section on exchanging funds and follow the prompts. If you haven’t established your online account, you’ll need to do that first, of course.

      If you like you can even call Vanguard and they’ll walk you thru the process.

      There are no fees to buy and sell Vanguard funds.

      If you are opening your new VTSAX as a Roth account and transferring money from your current STAR Roth, there is no tax conscience.

      If, however, you are taking money from the Roth to open a VTSAX (or any other) investment outside the Roth there will likely be tax consequences. Not a good idea.

      Of course, you can always open a new VTSAX account with money NOT in your Roth. No problem.

      Hope this makes sense!

      • ChetBodet says:

        Thanks so much for the quick response! I think I will start putting more of my contributions in the VTSAX fund, mainly because as you mentioned the STAR fund seems a little to conservative for me right now, although the last time I checked their returns the STAR fund had actually slightly outperformed the VTSAX over the last decade.

        Thanks again for the help and the great blog!

        • jlcollinsnh says:

          No worries Chet….

          ..glad to help.

          Looking over the last decade, it makes perfect sense that STAR (60%stocks/40%bonds) would outperform VTSAX (100% stocks). The last decade has been tough for stocks and great for bonds.

  6. Dorothy says:

    What do you suggest if the majority of my nest egg is in my 401k at work, and I don’t have the choice of the Vanguard funds you mentioned? Should I be investing outside the 401k as much as possible?

    • jlcollinsnh says:

      Hi Dorothy…..

      most 401k plans don’t have access to Vanguard. Mine didn’t when I was working. But they are wonderful tools.

      Most will have on offer at least one Index Fund tracking the total stock market and/or the S&P 500. That’s what you want.

      If you company has a match contribution you’ll want to put at least as much as it takes to get the full match. That’s free money.

      If you have more to invest it becomes a question of tax bracket (do you need the deduction) and when you plan to retire. If you’ll be retiring before 59.5 years old you’ll want some investments outside 401Ks and IRAs.

      I always maxed mine out and, because of my high saving rate, invested outside of it as well.

  7. Djoly says:

    I’m one of the rabble who landed here via MMM’s blog. Great work! Now I’ve got another place to hang out and feed my dreams. FWIW, I’m 52, so a bit beyond the MMM demographic but find the discussion and attitudes there great.

    I’m curious if you’ve ever taken a look at which Fidelity funds might best mimic those you recommend from Vanguard. I’ve been using fidelity a long while now and very much like using their FullView (account aggregator) and planning tools, but would like to understand better how much I might be paying for those in fees vs. moving over to Vanguard, assuming I’m comparing similar types of index funds.

    Any input or opinions you have are greatly appreciated, and I’ll be tuning in here from now on! Always enjoy your posts over on MMM, too. :-)

    • jlcollinsnh says:

      Hey Djoly…

      Welcome over here. Any friend of Mr. MM….

      It has been a long time since I’ve bothered to look at Fidelity so there’s not much I can offer in the way of fund suggestions there.

      I do know they have, over the past few years, introduced a line of Index Funds in response to the challenge they faced from Vanguard. Last I looked they had kept their fees on these competitive as well.

      If you invest in Index Funds and you are already comfortable with Fidelity, I don’t think you need to move.

      My concern would be that Fidelity uses their Index Funds as “loss leaders” and my guess is that once you’re on board they’ll try to entice you into their more expensive and (for them) more profitable offerings.

      Index Funds at Vanguard, on the other hand, are the soul of what they do.

      hope this helps!

      • Djoly says:

        Thanks for your reply. Took a look and you’re right – Fidelity offers a line of Spartan index funds that are pretty reasonable. There was a good discussion at the Bogleheads site comparing Fidelitiy’s index offerings vs. Vanguard. The main negative re: Fidelity was the possibility they would raise index fees after luring investors in, and if you then sell to move to Vanguard you’re hit with capital gains. I’m of a similar mind as you; these are loss leaders for Fidelity and directly in competition with Vanguard for investors. I’d be surprised if they decided to give up on the competition and raise fees appreciably, losing a potentially large captive audience for their more expensive funds.

        • jlcollinsnh says:

          This is an important difference between Vanguard and the other investment companies like Fidelity.

          Low cost is a core principle of the Vanguard approach and it’s hard-wired into their DNA. They are always looking for ways to lower costs and fees.

          Low cost for companies like Fidelity is something they do grudgingly and only as required to meet the competition. They are always looking for opportunities to raise fees.

          That said, the competition should kept their fees in check for the foreseeable future.

  8. Um…you’re amazing. I think this is the first time I feel like I actually completely understand a post about investing. THANK YOU!

    • jlcollinsnh says:

      No, thank you FF….

      …you done made my day!

      That is exactly what I was aiming to do: demystify this whole investing thing for those who have other interests.

      very glad to hear it’s made a difference for you.

  9. MooSe says:

    Is the only way to get funds like VTSAX commission free to open a direct account with vanguard?

    Thanks.

  10. Shilpan says:

    Vanguard is my favorite too. I can’t imagine handing my money over to so-called experts on the Wall Street. Most can never even match s & P for the 10 year period. That’s why they only advertise few years of performance. Trust no one. You can’r even trust those old ladies from Beardstown. They were miss calculating their return, and in fact losing money compare to S & P.

    • jlcollinsnh says:

      Hi Shilpan….

      ….glad but not surprised to hear you’re a Vanguard guy.

      those other fund companies also fold their losers into their winners. who can’t put together what looks like a successful fund family like that. more reason for my playing with snakes comment.

      Ha! the Beardstown Ladies. haven’t thought of them for awhile.

      For those of you who may not have heard of them, a few years back they had a brief moment of fame. They were a group of classic “little old ladies” who had formed an investment club. In short order they were posting gains that put all Wall Street to shame. Media commentators hung of their every sweetly uttered word. Until it came to light that the numbers were fake.

      I think it was never clear whether they were cheats or just confused. anyone know?

  11. Michael says:

    Hey JL,
    What about Vanguard Admiral vs Investor funds, VTSAX vs VTSMX? With only $20k to start investing with, the $10k opening for the Admiral fund means I only have $10k to put in bonds, REIT, or somewhere else, which is why I’m thinking to start with $5k in VTSMX, and as I save more, eventually putting it over into VTSAX. (Same thinking applies to the other fund types.)

    Also, what about international funds? With the current European situation, the int’l funds don’t seem to be doing so well, but what over 5, 10, 15-year periods? And Asia (well, China), is on the rise, too, no?

    • jlcollinsnh says:

      Welcome Michael….

      ..and thanks for two great questions.

      You are right. Each of the funds I’ve mentioned are part of Vanguard’s Admiral Shares series. Basically they have rock bottom costs but it requires 10k to buy in. Not to worry.

      Each of these funds also has what they call Investor’s Shares. The fund holdings are exactly the same as in Admiral, but the expenses are a bit higher. But the buy in is only 3k. Once you go over the 10k threshold you can convert and the conversion is NOT a taxable event. So the Investor Share versions work just fine.

      Regarding international funds you can certainly add them if you’d like. Vanguard offers International Index Funds. I don’t bother for these reasons:

      1. The US is still the dominate world economy and, in my view, will remain so for the next 100 years and counting. That dominance will shrink over time, as it has been doing since the end of WWII, but it is not ending anytime soon.

      2. VTSAX is loaded with US companies that are fully international in their operations. Indeed many generate well over half their revenue and profits overseas. So it provides exposure to expanding world markets.

      3. This trend will continue to expand as the international economies around the world continue to grow and prosper.

      4. Accounting standards and transparencies in the US remain the envy of the world. Less funny business to worry about.

      5. Direct international investing introduces currency valuations into the mix and that is a whole other level of risk that needs to be considered.

      Hope this helps!

      • Michael says:

        Hi JL,
        That helps a lot.

        It’s pretty nice that the conversion from the Investor to Admiral series sounds so easy and, best of all, not taxable. That’s a great draw for me to just get started.

        I didn’t really think about the int’l aspect to U.S.-based companies and how that affects a fund like VTSAX. I think you’ve made some really good points there.

        Thanks for your reply!

  12. Jan says:

    Looking online and doing a comparison between Vanguard and American Funds, American Funds outperformed the top Vanguard Index Funds, even after the loads. I will concede that I did this comparison when I shifted from Vanguard to American Funds some time ago, but what say you?

    • jlcollinsnh says:

      unfortunately, Jan….

      I’d say you got swindled.

      Funds that charge a “load” (sales commission) are aggressively sold by investment advisors. That money, about 5%, goes right out of your pocket and into theirs. Not surprisingly they’ll have nifty charts, brochures and sales pitches to show why this is a good idea. It’s not. Recovering from a upfront load hit is a tough road.

      Never buy a load fund.

      But this is now water under the bridge and the question is what to do with them now that you own them.

      Since load funds are such a horrible idea, I’ve not bothered to look at them much of late. That said, I seem to recall that American Funds are actually not too bad once you get past that hideous load deal.

      What you might do is to look at their current expense ratios and performance.

      For instance, popping over to their website, I see the Growth Fund of America. Its expense ratio, at .68% is one of the lowest in the family and not bad for an actively managed fund. But it is ginormous compared to the .06% of VTSAX. That’s a huge drag over time.

      American Funds are a classic example of a fund company run for the benefit of its owners, rather than its investors. They pay, with your money, sales people to push their funds. That gives them more money under management and that generate more fee income for them. All at your expense.

      sorry to be the bearer of bad news….

      • jlcollinsnh says:

        by the way, this is nothing of which to be ashamed. Indeed if this is your biggest misstep you’ve done far better than most, including me.

        Why I remember Myraih International, as does an irked pal who I had lunch with let week and who followed me into to it.

        50K up in smoke. for me. Lord knows what he lost. too much to forgive me but not enough not to speak to me….

  13. jlcollinsnh says:

    Welcome Chris….

    …and thanks for your kind words. Glad you are finding some value here.

    My only quibbles with ETFs (exchange traded funds) are minor:

    There can be a fee to buy and sell them.
    They are designed for and encourage frequent trading.
    They are unnecessary other than for lining the pockets of investment houses.

    That said, if you understand them and prefer to execute your strategy with them Ok by me. As with all investment vehicles I would look to Vanguard for them, as you have with VNQ (REITs), VTI (stocks) & BND (Bonds)

    Just curious, what are your allocations in them?

    • Chris says:

      I am 30 years old but somewhat conservative when it comes to investing. I am currently 60% VTI, 25% BND, and 15% VNQ. I have recently increased my allocation of VNQ and backed off a bit with VTI given the run up. By the way, I completely agree with your call on Vanguard. Nothing else compares.

      Chris

  14. Chris says:

    Hey great blog! I have been following the investing series and you offer some great advice. Quick question, I usually use ETFs instead. In this case I use VTI, BND, and VNQ which appear to be the ETF equivalents of the mutual funds above. What are you thoughts on this? Thanks.

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