Time To Tune Up & Simplify?


First up a quick read with some thoughts from Vanguard Founder Jack Bogle. If you don't know Bogle he is considered to be the founding father of index funds, he is a big believer that most people cannot pick stocks well, that guessing what the markets will do is just about impossible and the best choice for most people is to use index funds. Despite how difficult he would say it is to have a sense of what markets will do, his track record for being right is very strong and right now he is urging caution. In the article he talks about ratcheting down equity exposure to 60% if you're normally at 70%.

The reality is the most investors, including advisors cannot see trouble when it is coming. I always frame this along the lines of looking for indicators that have warned of elevated risks in past cycles and heeding those indicators, I have been blogging about this incessantly for months but somehow people don't believe it. I am not sure if there is a this time is different mentality or something else but it seems like not a lot of folks are interested in portfolio defense until after the market drops.

Of course one way to address this is to rebalance your portfolio based on some sort of percentage shift or based on the calendar. Both have their pluses and minuses but are valid. I have another idea that could help avoid the sense of regret that goes with learning you have too much in equities after a large drop. It is human nature that sometimes when you look at your 401k balance (or whatever vehicle you're using) you think to yourself "whoa, that's pretty good." Those times when you have that sense of pride or accomplishment is actually a pretty good time to lighten up a little. Not sell out completely but along the lines of what Bogle says, reducing from 70% to 60% or something like that. This idea is purely behavioral. To the extent investing frequently is emotionally difficult, selling at times when it is not difficult likely means we're a lot closer to a top than a bottom. As far as how to buy back in, here is a post from the other day that addresses my thoughts.

Next up is an article about some insane expense ratios for index funds in 401k plans and annuities. As I have said before, my experience with people who have annuities is that the love them but as Ken Fisher might say, it is very unlikely they truly understand all the nuances of what they own. Most annuities are a glorious payday for the salesman and then are expensive on an ongoing basis.

If you are contributing to a 401k then you might be at the mercy of someone else's decision but saving into an expensive index fund is better than not saving at all. Depending on your particulars, if there is a brokerage option in your 401k that makes sense (warning, a broker option may not make sense) then go that route otherwise put in to your 401k such that you max out the employer match as well as your maximum contributions across all vehicles. What I mean is, if you're 50 or older then you can put up to $24,500 into your 401k. If the only other vehicle available to you is a Roth IRA then put the full $7000 into your Roth and then put the rest into the 401k (assumes you can afford to save exactly $24,500). If you can afford more than $24,500 then max out both.

There is only one reason I know of to keep your money in the company 401k after you've left. Money that is in a 401k is exempt from required minimum distributions if you're still working. Otherwise they are more expensive and have fewer options. One of my older brothers recently retired and I can't figure out how to make him understand this. Amusingly, he never listens to me but that's a different story. To the extent I am not your little brother and couldn't possibly be correct about anything, fewer choices and more expensive is obviously against your best interests....unless you're going to work to try to avoid the RMD (check with a CPA for all the moving parts on that one).

Finally, Meb Faber has a post about wiping your portfolio slate clean by selling everything and starting over. The potential impracticality of this could be capital gains tax for taxable accounts but Meb addresses that thoroughly. Getting past the taxes, the post then becomes about simplicity (good) and anchoring (bad). Anchoring in this case involves holding onto a stock or a fund for some sort of emotional reason (you may not realize emotion is involved). Using a simplistic example, if you own General Electric (GE) and are hanging on out of hope or desperation that it will come back, that would be an example of anchoring. As Meb says, if you wouldn't buy it all over again today then you're probably anchoring.

The idea of simplicity is more interesting to me. Provided you have an adequate savings rate, a portfolio consisting of one broad-based equity fund will very likely get the job done. Periods like the last couple of weeks are why people usually don't do that but subject to adverse sequence of returns close to retirement age, one fund can get it done. So anything else you do beyond that should arguably be considered against a one fund portfolio; is what you're doing making it better?

Meb talks about owning a mish mash of funds that don't actually function as a properly diversified portfolio. That chart has four ETFs in it that all track different indexes. No one needs more than one of those in one account. Although the indexes are different the most heavily weighted holdings are all the same. There's no diversification benefit to owning more than one of these but there are plenty of portfolios out there that own funds that overlap in the manner that these four do. If you already own ITOT, how is buying SPY going to make it better versus just buying more ITOT? It isn't going to make it better, that's how.

Now, adding a foreign equity fund might make it better (for long term investors I believe it will), that's a different story. That doesn't mean owning just a domestic fund won't get the job, it probably will, but adding a foreign fund could make it better (there is plenty of research out there about why including foreign is better).

I am all for simple but I believe simple is at least in part a function of how much time you're inclined to spend on the task. On the assumption that not too many people actually have a one fund portfolio, if you showed your portfolio to 100 people some would think it is simple and some would think it not. Do what is best for you, seeking simplicity when you can.