Man, figuring out a good set of funds to work into your asset allocation plan is hard! There are so many different funds to choose from. So I’ve decided to break it down into three possible scenarios that I can then choose from, varying from complex to super-simple. The first scenario is to pick a variety of funds that each focus on a specific asset category. This will result in more complexity and possibly higher fees, but in theory may result in better long-term returns.
First, I’ll list the funds that I would use in theory, and then I’ll list how they would actually fit in reality into our two Roth IRAs, one Traditional IRA, and taxable accounts. The goal is to put the most tax-inefficient funds into the most tax-deferred accounts.
Theoretical Allocation
20% S&P 500 Index (VFINX/VTGIX)
20% Large Cap Value Index (VIVAX)
10% Small Cap Index (NAESX)
10% Small Cap Value Index (VISVX)
10% REIT (VGSIX)
10% International Value (VTRIX)
10% Emerging Markets (VEIEX)
5% Short-Term Bond Index (VBISX)
5% TIPS Fund (VIPSX)
This allocation was based on information in The Intelligent Asset Allocator, The Four Pillars of Investing, and other sources. Of course, now I must try to shoehorn the chosen allocation into the available funds in my separate accounts:
Wife Roth IRA – $11,000
Roth IRA – $14,000
Trad IRA – $24,000
Joint Taxable Account – $12,000
Real-Life Allocation ($60,000 Portfolio)
Wife Roth IRA
Large Cap Value – $11,000 (18%)
Roth IRA
International Value – $7,000 (12%)
Emerging Markets – $7,000 (12%)
Traditional IRA
Short Term Bonds – $3,000 (5%)
TIPS – $3,000 (5%)
REIT – $6,000 (10%)
Small Cap – $6,000 (10%)
Small Cap Value – $6,000 (10%)
Joint Taxable Account
S&P 500 Tax-Managed (VGTIX) – $12,000 (20%)
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Expenses
Vanguard has a lot of little fees for funds with low balances. To avoid the $10/fund low-balance fees for my IRAs, I am putting $12,000 into a taxable joint account. This will be funded partially by me selling off my individual stock holdings, as well as some from our cash stash. I feel it’s time to put a bit more of our cash into stocks.
In addition, Vanguard charges a $10 fee annually for any Index mutual fund account of less than $10,000. Of the above funds, my low balances in the Small Cap, Small Cap Value, Emerging Markets, and Short-Term Bond funds will result in an extra $40 a year in fees at least for now. Taking it all into account, the overall annual expense ratio for this portfolio is currently $31 per $10,000, or 0.31%.
Next, I’ll try to put together a simpler but similar asset allocation with fewer funds.
Edited: I screwed up last night. One should put the most tax-inefficent assets into a Traditional IRA/401k first, then Roth IRA, then taxable account. I had switched the IRAs around, so my Real-Life portfolio is changed up from what I first posted.
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What are the other options?
Portfolio Option #2: Keep It Simple
Portfolio Option #3: Just One Fund
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It’s not a large amount, but don’t forget about the purchase fee on the Emerging Markets index fund.
I messed up my Real Life allocation, and have made some changes. The reason is noted at the bottom of the post.
Tim – Thanks, I forgot to address that. There is a 0.5% purchase and redemption fee on the Emerging Markets fund (VEIEX), but everyone has to pay that, not just those with low balances. Since the fee goes back into the fund and not the company’s profit, you’re basically getting that back through the funds earnings. The only reason it is there is to discourage active trading and therefore keep expenses down, so as an inactive trader I’m fine with paying it.
Figuring out this mix is a nightmare, between 401k offering, IRAs, and the split between spouses. I’ve just accepted that my allocation is going to be a mess for the next few years. My main tactic now is to just make sure I’m putting most of my contributions into higher-risk (intl value, US value, EM), regardless of what the short-term allocation is.
One thing Paul Merriman recommends is to invest in the order of highest-risk/return to lowest-risk/return if you don’t have enough to properly diversify and meet fund minimums. My plan is to be properly diversified with account minimums in 5 years by putting into each asset class the amount, in order of risk, that both meets the minimum and is the correct proportion to the 5 year projected holdings.
In my 401k, I have a small “base” of equal parts Vanguard 500 and Vanguard Ext Market. I currently have all of my 401k contributions going into Spartan Intl Index, Delaware EM (non-index, but it’s the only one in the plan), and Dodge & Cox Intl Stock (non-index value, but a solid fund with low turnover). I’d rather have these in Vanguard, but it’s what’s offered by my plan and there are no minimums. Next, I’m going to build up (in a Roth) Vanguard SmCap Value to $10K, then V. Large Cap Value to $10K.
Wouldn’t you want to put the most tax inefficient funds into your roth? I thought Roths grew and could eventually be withdrawn tax free. Traditional IRAs are tax deferred, but you still pay taxes when you have to make the mandatory withdrawals?
ALso I thought (again here I go thinking, possibly incorrectly), that Vanguard had a $10 fee for mutual funds when your balance is less than 5k in that fund.
Great blog!
Well, both grow tax-deferred, but Traditional IRA withdrawals are taxed as your usual income tax rate no matter what (as opposed to any lower capital gains rate), so it doesn’t matter if it’s stock or bonds inside in that regard. So I believe in theory you’d want the things that are expected to grow the most (not bonds) to come out tax-free and put those in the Roth.
Yes, that’s the “$10/fund low-balance fees for my IRAs” I mentioned in the post. It is waived for people with combined balances of $50,000 at Vanguard, which I can meet if I put that $12,000 into a taxable account. As for my wife I just have to keep her balances above $5k each, which I have here.
Thanks!
Your asset allocation plan looks quite well balanced and particularly considering your current age and time horizon ( you mentioned somewhere that you are close to 30 years old). There were couple of things I was wondering:
1) Are there any tools what provide what would have been the return for such portfolio over a period of say last 3 years, 5 years and 10 years?
2) Second to reduce the costs further ( for a 60k portfolio) what would be the affect on return iff you combine S&P 500 Index and S&P 500 Index, similarly Small Cap Index and Small Cap Value Index ? Also since your bond funds are in tax differed account why not go with Vanguard Total Bond Index.
BTW thanks for sharing all this valuable info with rest of us.
Thanks for your comment, that’s why I share this stuff, so people can discuss and debate it.
1) Well, there is 1,3, and 5 year historical performances for each fund on at Morningstar.com and other sites. Not sure about 10-year, I’d check the fund prospectuses.
As for long-term history of asset classes, this is some useful info taken from Taylor Larimore of the Diehards forum:
2) Yes, I’m working on a combo now that will have less funds and no $10 low-balance fees at all.
Phil – Yeah, if my wife or I get some random 401k program later on down the road, this could get really hairy… Kinda fun though! =)
One fee-only advisor with an investing style similar to yours posts his current favorites for various asset classes at http://www.altruistfa.com/dfavanguard.htm
I’m intrigued by his small-cap value option of RZV – a new Rydex ETF.
He also likes some DFA index funds – well-respected but only available thru select (fee-only) advisors. His altruistfa.com site also links to some apparently classic investing research.
Hi Jonathan:
Great blog. Look at the correlation between VTRIX and EFV. EFV is better with lesser expense ratio.
Yeah, even Vanguard itself has VWO (Emerging Markets ETF) and VNQ (REIT ETF) with significantly lower expense ratios that their fund counterparts. It’s a tough call these days between funds or ETFs.
Wow…this has been very helpful. I’m in the process of thinking through my own investment allocations.
I have a real mess on my hands from far too many accounts.
Jonathan, have you thought about life cycle funds? I think Vanguard offers them and so does schwab. I personally have put most of my retirement investments into SWERX – schwabs 2040 target date maturity. It’s performed quite well since it opened 7/1/2005.
It provides a few advantages:
1. it automatically diversifies you
2. it automatically rebalances you (I’ve failed the rebalancing test)
I suppose the disadavantages are that you’re stuck with their allocation model if you don’t agree with it.
I’d prefer more foreign investment, so I’m going to overweight my non-retirement investments in foreign ETFs. I might also add some additional ETFs such as commodities or REITs – thought I feel they’re a bit overpriced right now – need to research to confirm.
I guess the biggest disadvantages are that they may not be available in some people’s 401k plans.
I guess it may not be as sexy or exciting to actively manage investments (actively managing my non-retirement index investments is a temptation I keep pushing away), but it should take alot of work off your shoulders.
Good luck.
I have the Schwab 2040 retirement fund as well (SWERX). What do you know about the expenses/fees charged to us for using SWERX compared to other retirement funds that might provide comparable pre-expense/fee returns?