Archive for the 'Retirement' Category
Tuesday, February 21st, 2012
I took some time this weekend to check on my investment portfolio, including employer 401(k) plans, self-employed plans, IRAs, and taxable brokerage holdings.
Asset Allocation & Holdings
You can view my target asset allocation here, along with links to other model asset allocations. Despite the headlines, I still like to buy, hold, and rebalance primary in low-cost index funds. Here is my current asset allocation:
I continue to rebalance continuously with new cashflow. Everything looks okay; stocks have been on a pretty good run recently for whatever reason and bond yields are still kept low by central bank policy. My personal outlook for the world economy is still uneasy. My current ratio is about 75% stocks and 25% bonds, but my goal is to get closer to a 60% stocks and 40% bonds setup, the classic balanced fund ratio within the next 5-7 years.
The main change since last time is that I dropped the stock funds in my 401k plan and moved them all to my taxable accounts for tax-efficiency reasons. I needed for space for bonds. I also stopped buying shares of the stable value fund in my 401k because new purchases only earn 1.25% interest. Instead, I am buying the only other bond option which is the behemoth PIMCO Total Return (PTTRX) which has a relatively low 0.46% expense ratio due to it being an institutional share class. This fund is actively managed and includes various types of bonds, but since the portion is so low, I’m still classifying it under my short-term nominal bond asset class.
Vanguard Total Stock Market ETF (VTI)
Vanguard Small-Cap Value Index Fund (VISVX)
Vanguard FTSE All-World ex-US ETF (VEU)
Vanguard MSCI Emerging Markets ETF (VWO)
Vanguard REIT Index Fund (VGSIX)
Vanguard Limited-Term Tax-Exempt Fund (VMLTX)
PIMCO Total Return Institutional* (PTTRX)
Stable Value Fund* (3% & 1.8% yield on existing balances, no longer contributing)
iShares Barclays TIPS Bond ETF (TIP)
Individual TIPS securities
* Denotes 401k holdings due to limited choice.
The overall expense ratio for this portfolio is in the neighborhood of .20% annually, or 20 basis points, which is much lower hurdle to overcome than the average mutual fund expense ratio of over 1% annually. This is all self-directed inside accounts held at Vanguard (IRAs, taxable), Fidelity (401k, Solo 401k), and a small retirement plan provider. I have some “play money” assets at other discount brokers that is invested in individual stocks, but the total is less than 2% of our net worth and not included here.
Due to our goals to achieve financial independence early, I use a 3% theoretical safe withdrawal rate on my portfolio for the purposes of my tracking. This means that I expect every $100,000 that I save will provide me an inflation-adjusted $3,000 in expenses forever. However, in reality we will probably adjust our withdrawals based on our personal inflation, continuing income, and market returns.
With portfolio increases and additional contributions, at a 3% withdrawal rate our current portfolio would now cover 50% of our expected non-mortgage expenses. If you recall, I also plan to have the house paid off, and I will be making a lump sum payment shortly to bring our home equity past 50% as well. Hopefully as we cross the 50% hump, things will accelerate as portfolio growth will benefit from compounding returns and our mortgage balance will shrink faster from the opposite effect as more of our monthly payment goes towards principal as opposed to interest!
Monday, February 20th, 2012
Congress has just passed a bill which the President has promised to sign that includes an extension of the 2% payroll tax cut for the rest of 2012. Specifically, the employee portion of the Social Security tax is reduced to 4.2% in 2012 instead of the standard 6.2%. The employer portion remains unchanged at 6.2%. The Medicare tax remains unchanged at 1.45% each for employers and employees. This tax cut has already been in effect since the beginning of 2011 and was scheduled to end at the end of February 2012 before this most recent extension.
For example, someone earning $50,000 annually will see increased take-home pay of $1,000 spread out evenly over a year of paychecks. The limits on wages subject to Social Security tax is $110,100 for 2012, so the maximum savings per person is $2,202. You can verify this tax cut for yourself by checking your most recent paycheck stub. Divide the Social Security tax line by your Gross Pay line. It should be either equal or less than 0.042, or 4.2%. (It might be less than 4.2% due to items that are exempt from SS tax like flexible spending account contributions.)
Spend it, or save it?
The idea behind this tax break is to provide a small, steady increase in income that you’ll hopefully spend quickly and thus stimulate the economy. Even though $1,000 sounds like a lot, when it comes to you as $40 every bi-weekly paycheck, you tend not to notice it. Surveys confirm that the majority of people don’t even know this tax cut exists after enjoying the benefits for a year.
However, if you’re happy with how you’ve already stimulated the economy and would like to put something away to invest and spend later, this might be a good time to increase your savings rate instead. Remember that your savings rate is the most important factor in whether you’ll be able to retire early (or perhaps ever).
Since this tax break comes automatically every paycheck, it makes sense to “pay yourself first” by putting it aside immediately via automatic savings. Instead of mindlessly spending like they want you to, mindlessly save it instead. If you have a 401(k) or similar employer-sponsored retirement plan, why not increase your contribution rate by 2%, and see if you notice it for the rest of the year? Of course, if you have high-interest debt and some extra willpower, perhaps you should put it aside each paycheck and pay that off instead. You can also use direct deposit or automatic transfers to send money over every paycheck to an online savings account.
Sources: Philadelphia Inquirer, Associated Press
Thursday, February 16th, 2012
I recently started subscribing to Consumer Reports magazine again, and the February 2012 issue included an article about the major financial brokerage companies (subscription required, press release). The first part was an investigation about the big firms (ex. Citibank, Fidelity, Schwab, T. Rowe Price) and their pre-packaged investment plan advice, and the second part was a survey on the quality of service from discount brokerage firms (ex. E-Trade, Ameritrade, Scottrade).
Consumer Reports is always unique because they don’t take any advertisement money at all, and so they sent in their own staffers anonymously (by this I mean they didn’t disclose they were writing this article) and then had the resulting advice analyzed by independent financial planners. Here were my takeaway notes:
- Many firms will offer some level of “free advice” if you have a certain level of assets with them, usually $100,000+.
- Good news: In general, the free advice is okay, but not surprisingly it tends to be boilerplate stuff.
- Bad news: Most people you talk to won’t provide you fiduciary duty. Most of them avoided disclosing how they were paid, and one researcher got pitched a complicated variable annuity after just a brief initial consultation.
I think fiduciary duty is a big deal, as I see no point in paying even a penny for financial advice if they won’t even promise it is in your best interest. Just seems like common sense to me. I don’t think I would bother to take them up on this free advice unless they were fiduciaries.
Self-Service Brokerage Firm Reviews
The Consumer Reports survey revealed that readers were “very satisfied” with 10 of 13 major brokerages, but it also left out a lot of the cheaper guys like OptionsHouse ($3.95) and TradeKing ($4.95). They seem to run this survey every few years, so here are the publicly-available May 2009 ratings:
One new change was that they separated out the “full-service” brokerage firms like Ameriprise, Edward Jones, and Morgan Stanley. In comparing the remaining “discount/online” brokerage firms, it’s noteworthy that the top 4 stayed the same for both 2009 and 2012, although the order changed slightly:
- USAA Brokerage – $8.95 trades at basic tier. Also offer banking and insurance products, although insurance is limited to the military-affiliated. Good all-in-one choice for military-affiliated.
- Scottrade – $7 trades, limited free ETF trade list. Large physical branch network. Has more active-trader tools than others on this list.
- Vanguard Brokerage – $7 trades at basic tier, all Vanguard ETFs trade free. Best known for low-cost index mutual funds.
- Schwab – $8.95 trades, limited free ETF trade list. One of the original “discount” brokers, also expanding into banking.
Tuesday, February 14th, 2012
Mrs. MMB and I both contributed $5,000 each to a non-deductible Traditional IRA again for the 2012 tax year this week, with the intention of converting it into a Roth IRA in the future. Are you eligible to do this as well? Of course, we had to wade through a ton of IRS fine print to try and achieve a bit of tax savings.
First, can we just contribute directly to a Roth IRA? Per this IRS flowchart, because we are married filing jointly and will most likely have a modified adjusted gross income (MAGI) over $183,000, we are unable to contribute to a Roth IRA. How many people know what their MAGI is? It’s not impossible to figure out, but if I was closer I’d rather wait and have TurboTax figure it out for me when I filed my 2012 taxes.
Can I contribute to a Traditional IRA, even if I have a work retirement plan? Yes, it doesn’t matter if you have a 401k or 403b or whatever. The question is whether it is tax-deductible. Remember, when money is withdrawn from a Traditional IRA, it is taxed again at ordinary income rates.
Well, is the contribution tax-deductible? From this other IRS flowchart, because we are married filing jointly, covered by a retirement plan at work, and have an MAGI of over $112,000 or more, I see out that our contribution is not tax-deductible. Finally, you should remember to note the non-deductible (post-tax) contributions on IRS Form 8606 at tax time.
Can I convert my non-deductible IRA to a Roth IRA? In 2010, the previous $100,000 income limit for Roth IRA conversions was removed. It was initially thought to be a temporary thing, but it has not been addressed since. There is some speculation that the government is quietly (and happily) collecting taxes right now on all the rollover money, as opposed to later. Thus for 2012, there is again no income limit on the conversion from a Traditional IRA to Roth IRA. Even so, there are still some catches if you have both deductible and non-deductible (pre-tax vs. post-tax) IRA balances available to be converted. We have already converted all our pre-tax IRAs a while back, so it will be a simple “same trustee transfer” at Vanguard for us.
Okay, so we successfully navigated all these IRS rules and legally minimized our tax liability. But how many people won’t? Even for tax benefits for low to moderate-income earners like the Earned Income Tax Credit, the Government Accountability Office (GAO) found that between 15% and 25% of households who are entitled to the EITC do not claim their credit, or between 3.5 million and 7 million households. I mean, just look at how long the Wiki page that supposedly summarizes the credit is. It shouldn’t be this complicated.
Thursday, January 26th, 2012
You’re probably aware of the wonders of the Roth IRA and how it allows your money to grow completely free from taxes, even upon withdrawal. An added wrinkle is the lack of age restriction, so that even kids with earned income (wages, salaries, tips) can contribute to a Roth IRA up the lesser of their taxable income or $5,000.
Along those lines, I received a PR e-mail from a site called 1417power.com. The idea is that you pay them “tuition”, and in return they pay your kids official job income that makes them eligible to contribute to a Roth IRA. They claim to follow all applicable child labor laws for those aged 14 to 17 (thus the name). Your kids do thing like fill out marketing surveys, but you’re essentially buying them a job. Digging through their fee structure, roughly 50% of what you pay them is skimmed off to go to the site owners.
Naturally, my question was – why can’t I just do this myself? The idea of paying your kids to do things like babysitting, lawn care or landscaping work, or manual labor seems simple enough. However, this Fairmark article argues that paying your own kids for chores is usually not considered taxable income, so you can’t “switch it” to taxable income for Roth IRA purposes when it benefits you. I’m not completely convinced, but for the sake of argument let’s explore other options:
- Have the teenager earn money via traditional jobs like grocery bagger, cashier, food delivery, waiting tables, etc.
- The child earns income from other neighborhood families doing things like babysitting, lawn care, or painting. The pay rate would have to be at reasonable market rates. You could even work out a “I’ll pay your kid if you pay mine” agreement, if you find a like-minded parent.
- If you run your own business, you could pay the child for more clerical or administrative-type duties such as proofreading, delivering documents, or office organization.
- If the teenager is especially industrious, they could be doing more skilled work like graphic design or making iPhone apps.
There would still be some loss, as their gross income would be subject to payroll taxes like Social Security and Medicare, as well as a small amount of federal income taxes (less than 10%). But if your child has the discipline to not touch the money for decades, the tax-free growth could be enormous. You’d have to be comfortable with the fact that they could do whatever they wanted with the money at age 18 as they can withdraw the money after taxes and penalties.
The Parental IRA Match
Another move taken from this Forbes article for those that are already parents of teenagers with part-time jobs is to match their earned income. If little Jane earns $3,000 being a lifeguard, then let her spend her all or part of her take-home pay, but help her fund a Roth IRA to the full $3,000.
Effect on College Financial Aid
From my quick research, it appears that retirement accounts like Roth IRA are not considered an asset by the generic FAFSA form, but individual universities may deem them as a student asset. This could make for example 25% of the IRA to counts toward the student’s expected contribution, which doesn’t seem too bad.
Here’s a question for the parents out there – have you done anything along these lines? What did you do and why (or why not)?
Thursday, January 19th, 2012
After my post counting down my years until early retirement earlier this week, I received a very thoughtful e-mail from reader Tim:
I’ve been reading and enjoying your blog for a long time, and think it’s one of the best out there for your mix of personality, short-term and long-term financial tips and advice. But one thing bothers me: the ongoing, almost central theme (obsession?) with early retirement. It seems to be the goal around which everything else in the blog revolves and leads toward.
Why is that? Do you hate your job so much, and can’t even imagine a job you would enjoy enough that you would want to do it whether you were paid or not? It doesn’t strike me that someone as industrious, curious and intellectually active as yourself would really ever retire. I understand there may be other activities you’d like to pursue, but my guess is that most of them would be potentially income-generating. So you’d still have a “job.” And if that’s the case, then why not pursue one or more of those things now, rather than delaying them until “retirement?”
It seems to me that “MyMoneyBlog” is likely one of those things, and I’m very glad you’re doing it. And if one reason is the hope to fully monetize the blog to the point of retirement from your nine-to-five job, then I hope you do that too.
But still, something about that recurrent theme of retiring just leaves me with a hollow, dead feeling in the pit of my stomach, as if we’re all inmates marking time on the wall of a dreary prison cell until our release. Maybe it’s the implied resignation to the assumption that joyless jobs are unavoidable – a bitter fact of life – that I reject. I just don’t like to think that as a society we accept a lifetime of delayed gratification as a given, and don’t rouse ourselves to do anything more about it than make sound financial plans to enjoy ourselves when the pain finally stops.
There are some great questions in there, and really it also showed me that I can improve on explaining my philosophies. I have all these ideas rattling around in my head, and not all of them reach the keyboard. My reply became rather long…
Definition of early retirement. I know that retirement is a very tricky word to use. For too many people, it conjures up images of playing golf and sitting around all day. Financial independence or financial freedom are better terms, and they all mean the same thing to me – I get to do whatever I want. Cook a new dish every day, rebuild a Land Rover Defender or Willys Jeep, volunteer, spend a year abroad, anything. F— You money.
Delayed gratification. Going back to the early retirement curve, a major assumption is that your current expenses are the same as your future expenses. Let’s say your household earns $80k and lives on $40k. Well, that curve assumes you’ll be living on $40k in “retirement” as well. Using a food analogy, getting there is not a crash diet, but requires a permanent change to healthier eating habits. I don’t feel deprived with my current lifestyle as it pertains to spending, otherwise it wouldn’t be sustainable.
A job that I would do forever? I’ve thought about this. Let’s try to design the best job possible. To start, it should satisfy this Career Venn diagram which reminds us to seek the intersection of things that we do well, things that pay well, and things we like to do. In addition, it should provide all the factors that make a job satisfying beyond money: autonomy, complexity, and a connection between effort and reward.
Does my current job cause me pain? Does my wife’s job? Not really, we are white-collar professionals so we have a certain degree of autonomy and challenge to our work. But we also have managers, meetings, clients, and politics.
Is there any such ideal job that exists? Honestly, if it had to pay $50k a year and 40 hours a week, probably not for me. I am the type of person that likes to do something for a while, and then move on to something else. Even self-employment has it’s own set of restrictions. Even though blogging is a sweet gig , having income that depends on advertising is very volatile.
This is where financial freedom comes in, because it means more flexibility. I have realized over time that I will probably need to do something, and that is a big reason why I am happy with a 4% safe withdrawal rate. All the academic studies that calculate this withdrawal rate stuff assume that a theoretical person blindly takes out 4% inflation-adjusted to the CPI every single year. From reading experiences of real early retirees, they adjust and adapt.
Let’s say we want that 4% withdrawal rate to create $40,000 of income from investments, but it ends up that 3% is a more reasonable number. Now, I need to find a job that pays $10,000 a year. I could do all kinds of things that would be kind of cool for $10,000 a year, and I wouldn’t have to work 40 hours a week either. I could do just about anything – web design, tutor high school or college students, teach English in a foreign country, apprentice with a skilled craftsman, or work as a travel guide.
Indeed, the possibilities are endless. One day, if the stars align, we will have children. At that point, we plan on downshifting to working part-time so that we can both enjoy raising kids without all the financial stress that our parents had. Our portfolio can already cover half of our expenses. Once the kids go to school, there will be more time for work, if needed. In the end, I would say that I am obsessed with freedom and autonomy.
Tuesday, January 17th, 2012
One of the recurring themes of personal finance is that while the concepts are often simple, execution can be quite difficult. A couple of excellent posts from Mr. Money Mustache and The Military Guide (both also mention the Early Retirement Extreme book) provide another example when answering the question “How many years until I can retire?”
Let me summarize. A simple definition of financial independence is creating enough income from your investments to pay for your expenses. Assuming a “safe” withdrawal rate of 4%, this means your portfolio must be 25 times your expenses. So if you spend $30,000 a year, you’ll need $750,000. (If you want “safer” withdrawal rate of 3%, that increases it 33 times expenses.)
Given the rough assumptions of starting with nothing and earning a 5% inflation-adjusted (real) return on investments every year, you can simplify things even further. (5% real return looks plausible based on the past, but I know it’s harder to see it now.) It works out that the only thing that matters is your personal savings rate:
After-tax numbers work better since expenses are usually after-tax. MMM provides a table, which I in turn converted into a single curve:
- The harsh truth is that if you want to retire before Social Security steps in, you’re going to have to save a lot more than 10%.
- The curve is steepest at lower savings rates. That means increasing your savings rate from 10% to 20% shaves off more time working (14 years!!!) than increasing from 20% to 30% (still 8 years!), and so on.
- Retiring in 20 years requires roughly a 40% saving rate. Retiring in 10 years requires a 65% savings rate.
If you’re new to the financial independence community, the idea of saving 40% or more of your income may be incomprehensible. Hopefully you will realize that it is possible, if you wish to pursue it. I have come to the conclusion that some people will happily work for 30 years in exchange for the ability to drive a new BMW every 3 years. Others (gasp!) just like their jobs that much. All that’s fine as long as that’s a conscious decision.
To increase your saving rate, you must either increase income or decrease expenses. While decreasing expenses is actually the more accessible option for most families, it will likely remain unpopular forever. That doesn’t mean you can’t do it, because many people are quietly doing exactly that. Try – you may surprise yourself.
I am also a strong proponent of increasing income. In the end, in our household we did a combination. Both of us earn an solid income after a combination of tuition-based postgraduate education and “DIY education”, but we only live on the lower income. Armed with a 60%+ saving rate, we are on track to achieve financial freedom according to this definition within another 5 years, although we may take a different path by working part-time for a longer period.
I must admit, even though I have known this “truth” for many years, I don’t actively talk about it because we do earn much higher incomes than average. However, that doesn’t change how the numbers work. I applaud all those bloggers and journalists that don’t patronize you and push the idea of higher savings rates, like this article in The Atlantic by Megan McArdle:
If you’re like, well, almost everybody, you’re not saving enough. 15% of each paycheck into the 401(k) is the bare minimum you can get away with, not some aspirational level you can maybe hope to hit someday when you don’t have all these problems.
I mean, obviously if one out of two workers in your household just lost their job, or has been stricken with some horrid cancer requiring all sorts of ancillary expenses, then it’s okay to cut back on the retirement savings for a bit. But let’s be honest: that doesn’t describe most of us in those years when we don’t save enough.
Wednesday, November 9th, 2011
Time for another update of my investment portfolio, including employer 401(k) plans, self-employed plans, IRAs, and taxable brokerage holdings.
Asset Allocation & Holdings
You can view my target asset allocation here, along with link to other model portfolios. Despite the headlines, I still like to buy, hold, and rebalance. Here is my current actual asset allocation:
Everything is within acceptable ranges, other than I need to buy more TIPS. This is just an overshoot since I have my 401k buying shares in a stable value fund automatically, and my TIPS are mostly stuck in IRAs. Actually, my TIPS holdings have been doing great, due to how low real yields are right now. Last I checked, even 10-year TIPS had negative real yields.
My current ratio is about 75% stocks and 25% bonds. I’ve been thinking about this balance. On one hand, I’m contributing a lot of money into the portfolio, and I hope that I can get my “early” retirement on within the next 10 years. At that point, I’m going to want something closer to a 60% stocks and 40% bonds setup, the classic balanced fund ratio. So I want to shift towards bonds, but bond yields don’t look very appetizing right now. For now, I’m just going to keep up the gradual shift.
Vanguard Total Stock Market ETF (VTI)
Diversified S&P 500 Index Fund (DISFX)*
Fidelity Extended Market Index Fund (FSEMX)*
Vanguard Small-Cap Value Index Fund (VISVX)
Vanguard FTSE All-World ex-US ETF (VEU)
Vanguard MSCI Emerging Markets ETF (VWO)
Vanguard REIT Index Fund (VGSIX)
Vanguard Limited-Term Tax-Exempt Fund (VMLTX)
Stable Value Fund* (3% yield on past purchases, 1.8% on new)
iShares Barclays TIPS Bond ETF (TIP)
Individual TIPS securities
The overall expense ratio for this portfolio is in the neighborhood of .20% annually, or 20 basis points, which is much lower hurdle to overcome than the average mutual fund expense ratio of over 1% annually. This is all DIY, so I don’t pay portfolio management or financial advisor fees.
3% Safe Withdrawal Rate
I’ve also decided to use a 3% theoretical safe withdrawal rate instead of a 4% withdrawal rate. So instead of reaching 25 times our annual expected expenses, we will need to save 33 times. This is due to the fact that we will probably reach early retirement with 10 years, and thus our portfolio will have to last a lot longer than a conventional age 65 retirement. 3% is a more conservative number, and in reality I doubt that we will even go by the 3% number in strict terms. From reading other early retiree stories, we’ll stay flexible and adjust our withdrawals somewhat with market returns.
With portfolio increases and additional contributions, at a 3% withdrawal rate our current portfolio would now cover 43% of our expected expenses. If you recall, I plan to have the house paid off at retirement as well. It might be nice to have a portfolio that yields 3% where we could spend the dividends and interest payments, and I have been tossing around ideas for that as well. I still like the idea of 50% Target Retirement Income (or similar) and 50% Wellesley Income.
Monday, November 7th, 2011
We closed on our mortgage refinance about a month ago, the old loan has been paid off, and we are just about to make our first payment on the new loan. Still, I always seem to go back and forth between different possible scenarios of paying down the house quickly or according the “minimum payment” as I call it. Technically, I could just about pay off the house now, if I chose to liquidate my taxable investments and empty out my emergency fund reserve.
I decided to go back and reconstruct a chart of our home equity over time, and compare it to a couple of alternate scenarios.
The red line represents our actual home equity, as a percentage of our purchase price. We use the purchase price because our home is currently worth about the same as when the bought it. An appraisal done for our refinance last month came in at 6% above our initial purchase price. Before the big refinance, we did a haphazard combination up of throwing in a few hundred extra bucks each month and one big lump sum prepayment. Currently, we’re right at 35% home equity.
Just for fun, the dotted red line is an exponential trendline of the red line. It has the loan being paid off somewhere around 2020.
The blue line represents our theoretical home equity if paid according to the normal 30-year payment schedule of our initial 6% fixed mortgage, starting from when we bought the house in the start of 2008. This would have had the loan paid off in 2038.
The green line represents our theoretical home equity if paid according to the normal 15-year schedule of our new sub-4% fixed mortgage, starting from this month. This would have the loan paid off in 2026.
I definitely still want to pay it off in under the current 15-year term, but as usual I like the flexibility. If children come into the picture, we’ll probably cut back on work and slow things down. But for now, I’m still hacking away. We hit the 401k cap already for 2011, so we have some extra cashflow.
By the way, I am only a proponent of paying extra towards your mortgage if you are maximizing your available tax-advantaged accounts like 401ks and IRAs as well as have a nice cash cushion. Although now I do think everyone should consider 15-year mortgages. Who wants to take 30 years to own a home? Most other countries don’t even offer 30-year mortgages, and the government support of 30-year mortgages here simply inflates property prices.
Monday, October 3rd, 2011
Last week, Vanguard officially announced the addition of the Admiral share class to six of their existing index funds. Admiral shares have a higher minimum investment amount ($10,000 for those listed below) than the usual Investor shares ($3,000 for those listed below), but with lower annual expenses. Every time my costs and fees go down, my future performance goes up! Below is a list of the newly-available funds, along with an expense ratio comparison.
The only one I am converting over this time is the Small Value fund. However, I did notice that this now means that for every single Vanguard stock index fund I choose to own, I can choose between both Admiral shares and ETF versions. I like mutual funds because they always trade at NAV and don’t have bid/ask spreads, as well as the ability to schedule automatic monthly investments. ETFs have the advantage of not having any purchase or redemption fees and the ability to be trade in any brokerage account. I went into more detail on the Vanguard mutual fund vs. ETF decision process here.
Vanguard even has a cost comparison tool for mutual funds vs. ETFs. But long-term expenses for me are no longer a concern because they are almost identical with all these Admiral shares. (I suspect the Small Cap Value differential is only temporary.) Here’s the list:
I wrote previously about why I invest in the Vanguard Total US and Total International market funds. Want to convert your Investor shares to Admiral shares before they are automatically converted eventually? It just takes a clicks online – here’s a quick guide [pdf]. Want to convert your mutual funds to ETFs? Check out this post on Vanguard mutual fund to ETF share conversions. It turns out you can also do so easily with minimal tax implications.
Tuesday, September 27th, 2011
If you are constructing your own portfolio and like the idea of low-cost, passively-managed index funds, you should definitely be aware that just two ETFs that can provide you diversified exposure to stocks worldwide and all at rock-bottom fees. Given how many choices there are out there today, I can’t assume that everyone knows about these already.
The Vanguard Total US Stock index fund invests in over 3,000 stocks that represent the entire U.S. stock market, from small-cap to large-cap companies. The smallest company on their holding list is 100 shares of Qualstar Corp, worth a mere $200. The entire company is worth about $20 million. Compare that to the largest holding of Apple, worth $380 billion (that’s 19,000 times larger). The ETF and Admiral shares have a mere 0.07% expense ratio ($7 annually per $10,000 invested), which is taken out in tiny amounts daily out of the fund’s net asset value. That’s just 6% of what the average mutual fund charges. There are three versions:
- Vanguard Total Stock Market ETF (VTI)
- Vanguard Total Stock Market Index Fund Investor Shares (VTSMX)
- Vanguard Total Stock Market Index Fund Admiral Shares (VTSAX)
The Vanguard Total International Stock index fund invests in over 6,000 stocks that covers 98% of the world’s investable markets excluding the US (“ex-US”). This includes 44 countries from the “European, Pacific, and emerging market regions, as well as Canada.” The fund also includes both small-cap and large-cap companies from these countries. The ETF and Admiral shares charge a 0.20% expense ratio. Three versions as well:
- Vanguard Total International Stock ETF (VXUS)
- Vanguard Total International Stock Index Fund Investor Shares (VGTSX)
- Vanguard Total International Stock Index Fund Admiral Shares (VTIAX)
This graphic shows you how these two funds relate to other Vanguard ETFs you may already be aware of:
, brighter red text is added by me)
(I should also mention that there is the Vanguard Total World Stock ETF (VT), which covers the entire world in one tidy fund. However, it only holds 2,904 stocks total, which is nearly 2/3rds less than a VTI/VXUS combo. On top of that, it charges a 0.25% expense ratio, which is nearly double how much a VTI/VXUS combo would cost when weighted appropriately. I personally think the added diversification and lower cost is worth the hassle of owning two separate funds.)
As of August 31, 2011, the world market value breaks down to about 42% US and 58% Ex-US. For simplicity, I chose to own VTI and VXUS in a simple 50/50 ratio as part of my target asset allocation. I rebalance back to 50/50 regularly using new cashflows, and also at least once annually. Bonds are a separate discussion.
Side note: The reason I thought of writing this is that I previously held Vanguard FTSE All-World ex-US ETF (VEU) as my primary international holding, which as you can see above is a subset of VXUS, but realize that VXUS only arrived earlier this year. I’ve shifted most things over already, but I have been hesitant to sell some of my taxable holdings because I’d owe capital gains taxes. I noticed yesterday that I am actually at slight loss now (yay?), so I am able to do some tax-loss harvesting by selling my VEU and swapping it for VXUS. Since they are not “substantially identical” funds, I am not subject to wash sale rules.
Friday, September 16th, 2011
Recent political debates have brought up comparisons between Social Security and Ponzi schemes. (Have you read the book about the real Ponzi?) Even though seemingly every single economist on Earth has weighed in, this discussion has been around for so long that the Social Security website already has an entire page dedicated to addressing it. To summarize, yes Social Security shares some traits with Ponzi schemes in that money from new participants goes to earlier participants. However, it relies on a rather straightforward transfer and does not depend on an exponential growth of new participants to be sustainable. It is, however, sensitive to demographics.
Social Security is a pay-as-you-go system. What I pay into Social Security today goes straight to a current retiree’s Social Security check. When I retire, my paycheck will be supported by a younger worker’s taxes. It is not an investment. It is not a savings account. The problem is, that the ratio of workers to retirees is getting rather low. In 1950, there were 7.3 working-age people for each person over 65; now, the ratio is 4.7 to 1, and it is scheduled to drop to 2.7 to 1 by 2035. [Source]
Since people are living longer as well, the reality is that for a 30-something like me, the math works out that there is little chance that we will get the same level of relative benefits that current retirees get. However, there will be no sudden Ponzi-like implosion. Now, the government could smooth this transition out even more if they do the hard thing and do some combination of higher taxes, extending retirement ages with higher life expectancy, or lowering benefits. But politicians are usually reactive as opposed to proactive, so don’t count on it. That’s too bad, because people are more dependent on Social Security than ever. 70% of all eligible folks can’t even wait until 65 to start taking benefits, many as early as 62, even though that means lower payments and likely a lower total benefit. This is why in general financial experts say you should wait as late as possible to get a higher payment for the rest of your life.
Of course, Medicare is even worse. Take this analysis via this WaPo article:
Consider an average-wage two-earner couple together earning $89,000 a year. Upon retiring in 2011, they would have paid $114,000 in Medicare payroll taxes during their careers. But they can expect to receive medical services – including prescriptions and hospital care – worth $355,000, or about three times what they put in. [...] The same hypothetical couple retiring in 2011 will have paid $614,000 in Social Security taxes, and can expect to collect $555,000 in benefits.