Asset Allocation: Keep it Simple

This is a fancy way of saying, “where do I put my money?” You don’t know, so you look into financial advisors. Maybe Edward Jones, Northwest Mutual, or Ameriprise have someone who would work with me. They do. They will happily explain investments, answer questions, make simple things look complicated, and underperform the market -- all while charging you a fee to do so. I am not sponsored by any of the companies or stocks in this blog post, I just call it how I see it.

Disclaimer:

There are managers that outperform the market. Considering fees, they likely underperform the market. Statistically, most managers underperform. Just a fact. If you have someone who outperforms the market, can they repeat the outcome year after year? If you have a magical unicorn of an investment team, please stop reading here. If not, continue.

Back to the main event

I have hired two financial advisors in my lifetime. The first occurrence was in high school when I wanted to invest $2,000 into a mutual fund. It all went into that fund. I paid my frontloaded fee plus an annual 1.5% fee for rebalancing. Considering fees, I should have left the money in my underwear drawer.

My second attempt at hiring a financial adviser was during anesthesia school, sometime just after the start of the COVID happenings. I had $40,000 to spare and went in knowing index funds are good. Expenses are bad. I didn’t know where to start, so I searched for assistance. CS was a good guy who understood index funds and believed in conservative living. Risk and volatility were not synonymous to him, so he chose a “high risk” profile for himself, and recommended the same based on our conversation. I gave him the money and that $40,000 went every which direction. Some T Rowe Price investments. Some Hartford growth stuff. Vanguard mid-caps. Various SPDR ETFs. JP Morgan equity income pieces. Just to name a few. Sprinkle some bonds in the mix and a bit of cash on the side. These are just funds sold by companies. When combined they cover most, if not all, of the stock market. For a portfolio that was to compete with the S&P 500, it really sucked. Not only did it consistently underperform, but I actually paid a 1.26% fee to CS, plus a flat annual $400 for my IRA. Real insult to injury. I get it, he needs to make a living. This started my thinking for a better solution.

The ideal asset allocation varies based on who you are speaking with. This is my blog, so you are sort of speaking with me. Or maybe reading my internal monologue. Either way. Keep it simple. Have an emergency account, maximize tax-advantaged accounts, and invest heavily. Two phases of asset management. Are you in the growth phase or the maintenance phase of wealth accumulation?

The Growth Phase

For those in the growth phase, I recommend all of your eggs go in a 4,000 stock basket that is a US total stock market index fund. Vanguard has a total stock market index fund (VTSAX) and a total stock market index ETF (VTI). Both have really low expense ratios at 0.04% and 0.03% respectively. Other brokerages have similar funds. I use Vanguard because the platform is free and I can trade without fees. So, I go with their ETFs (exchange traded funds). ETFs trade like stocks. You can buy and sell at any point of the trading day. Index funds typically trade as the market closes. Capital gains taxes are paid slightly differently on the options, but I’ll cover this later. If your brokerage has fees for buying ETFs, just go with the cheapest option.

If you want an alternative, VOO (Vanguard S&P 500 index fund ETF) is a good one. It is actually where I started my self-management investing journey. VOO basically focuses on 500 larger companies, hence the Standard and Poor’s 500. The main difference is the total stock market funds include all publicly traded companies, not just 500 of the big boys. At the end of the day, VTSAX, VTI, and VOO all produce nearly identical returns.

So how much money to put in these index funds? Well, nearly all of it (aside from the emergency fund). If you are trying to grow your wealth, you need a vehicle that will support growth, and that is the US stock market. Using numbers from the start of the year, VTI has averaged a 9.54% return over the past 30 years. Based on the rule of 72, that doubling your money every 7 years. This past year was rough with the market being down 20%. Even with that dip, the 10-year return works out to just over 12%. We went through a strong bull market where your investment doubled every 6 years. Total stock market returns over the past 150 years average out to 9% annually making for an inflation adjusted return just under 7%. That’s through all of the highs, lows, recessions, and depressions. Not too shabby. If you are looking for growth and have the fortitude to endure another 2000 dot com bubble, 2008 financial crisis, or Coronavirus fiasco, this is the way to go. Will your portfolio lose 50% of its value at some point — probably. Could you lose everything — yes, but we have bigger problems because the entire United States stock market is crumbling and 100 million people are without work. Way bigger problems than losing your retirement account. I’m talking a combination of a world war, mass chaos, asteroid storms, and a zombie apocalypse. All unlikely, but be aware. Short of civilization as we know it coming to an end, will the most robust economy in the world rebound and make new highs — probably.

Bonds, James Bonds

I couldn’t help myself and it is a better header than “The Maintenance Phase.” If you have read this far, but choose to leave because of a cheesy pun, I don’t blame you. Asset allocation is often viewed as the balance of stocks and bonds. Well, it is for our intents and purposes. A bond is an agreement where you loan money and receive a predetermined interest rate. An easy way to buy bonds is through a total bond market fun from, you guessed it, Vanguard. BND is their ETF and VBTLX is their total bond market index fund with an expense ratio of 0.03% and 0.05% respectively. Returns are just under 3% over the past 10 years. Basically, keeps pace with inflation and decreases portfolio volatility.

Lately, I bonds have been the talk of the town. They are a variable interest rate loan to the United States government. The rates are based on inflation and change each May and November. Recently, I bonds were paying 9.62% and are currently paying 6.89%. Yes, I bit and purchased $10,000 (the maximum per SSN) in I bonds. EE series bonds are the fixed rate version of I bonds. The rate is lower but guaranteed for 20 years. The rate may change from years 21 to 30. There are other many types of bonds, but they all represent fixed income. You are guaranteed to make some money, but that value is typically less than what the market returns. So, as you surpass your financial independence marker, growth becomes less important. As you retire and look to live off your investments, growth becomes less important. A rule of thumb is as follows:

% in Stocks = 120 – age

The remainder goes into bonds. At age 65, a broad recommendation would be approximately 55% stocks and 45% bonds. I think Bogle recommends a minimum of 65% in stocks unless the economy says otherwise, then go 50/50 for a short time. As for those in their 20s, 30s, and 40s looking to build wealth, keep it in stocks. Data supports similar net outcomes with a 90/10 or 85/15 split as it buffers the highs and lows of the market just a bit. My bonds are all located in my target date funds, not my self-managed accounts.

Target Date Funds

I have answered a couple questions about these. They are an investment option that automatically transitions a portfolio from heavy stocks to that 50/50 split we talked about above. They have a date such as “Target Date Fund 2050.” As the retirement date nears, the transition happens. If you want more stocks, pick a later date. More bonds, then 2030 is the choice for you. These funds have much higher fees than the aforementioned options, but they are easy, and I used them in my past 2 401(k)s. I moved one 401(k) to…drum roll…VANGUARD to self-manage. This way I can sell the bonds, buy VTI and lower my expenses. Both companies that have managed employer retirement accounts used target date funds. Brokerages also carry target date funds, but why pay the fees when you can just go buy a bit of BND once per decade to balance out your broad index funds as you age?

About me again

So, what am I doing? I am in the growth phase with a six-figure net worth. I have a way to go before financial independence, but the trajectory looks good. I plan to max my 401(k) which is tied to a 2060 Target Date fund. Fine. My personal brokerage contains a variety of broad market index funds. Some S&P 500, some small caps, etc... I was buying various ETFs that made up the total stock market. Now I know there is an easier way to have a piece of everything. The plan going forward is to ride the VTI train until I see a reason to stop. Simple. Easy. Paid on Friday, transfer on Monday. Buy VTI later that week. For folks below a 7-figure net worth, the majority of progress comes through diligent savings and consistent investing. I recommend doing just that to see that money tree flourish.

Can it really be this simple?

Yeah. Your financial guy has a colorful pie chart with 85 small wedges. It makes for a professional looking graphic and clean presentation, but upon closer examination, the contents are the same as VTI, but in slightly different proportions. And those slightly different proportions aren’t worth the 0.5% or whatever you are paying for the service (the more money you have, the lower percentage they charge). It’s kind of a sales pitch. Show you some good data. Reassure your goals and aspirations. These financial types spend a career studying finance and still fail to consistently outperform the market. Dave Ramsey makes it sound so easy to find one of these wild mutual fund managing unicorns retuning double digit percentages annually, but after fees, they don’t exist. I’m a Dave fan, but facts and statistical significance don’t lie.

There are more asset classes than stocks and bonds. Real estate, cryptocurrency, hedge funds, and venture capitalism are investment routes commonly talked about. I would enjoy speaking to each of these. I have done the research and have the capital to start in real estate, but the margins for my area do not support the financial return over locum work. Crypto is a conversation all on its own. Most do not have the net worth to consider hedge funds as they typically have terrible returns (hence, “hedging the market” which returns 9% annually), but will save some serious bacon for guys like Zuckerburg if the market goes South. And venture capitalism depends on how business savvy you are. Again, consider the time commitment when you make really good money giving anesthesia. Sometimes it’s worth starting a little side hobby in something like VC or angel investing. I would recommend financial stability before straying too far from the paved path, but life is short and its only money. Carry on if this is important to you.