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My Future Investing Strategy

Last week I met with a Certified Financial Planner for the first time. This was a free service provided by Vanguard, so it was a good opportunity to speak to a professional about my specific situation. For many years, I’ve been relying on mostly generalized advice, whether from books, large communities like the Motley Fool discussion forums (particularly the Living Below Your Means section), financial columnists, or a community of bloggers that has grown from fewer than a dozen to more than a thousand.

My financial planner and I started by discussing my goals. This was tough for me, as I’ve changed my long-term goals several times in the last decade. I’m trying to find the right mission for my life. I’ve made personal finance my passion since the creation of shizennougyou in 2003, but long before that date I was passionate about other aspects of my life. I need to look at how I want to spend the next twenty, thirty, or forty years of my life and some of the more important developments along the way, like having a family.

From a financial standpoint, my next major expenditure will most likely be a house, though that purchase relies on making other choices in my life first.

With my current level of investable net worth — my assets outside of an emergency fund and money put aside for shorter-term goals like a house — I’m willing to give up potential returns in the stock market for less risk. We decided on a mix between 60% stocks and 40% bonds. Complicating the issue is the fact that almost all of my non-cash investments are in stocks. It will be important to look at my portfolio as a whole rather than analyzing my 401(k) separately from my IRA and separately from my taxable account. This is where tools like Quicken, offering charting and reporting across a variety of accounts regardless of where they are held, come in handy.

The 60%/40% split between stock funds and bond funds is more conservative than I would generally recommend for someone my age (thirty-five), but that might be appropriate based on my lower needs for long-term returns and need for maintaining value in the intermediate term as I determine the next steps for my life.

Before discussing specific investments, I made sure the planner was aware that I prefer index mutual funds rather than ETFs, managed mutual funds, or individual investments. The planner suggested that 70% of the stock portion of my portfolio be invested in the Total Stock Market Index with the remaining 30% in the International Stock Market Index. Half of the bond portion of the portfolio should be invested in the Intermediate Tax-Exempt Bond Fund with the other half in the New Jersey Tax-Exempt Municipal Bond Fund. I’m not sure how excited I am about the prospect of investing in New Jersey, but the tax advantage could be helpful.

I brought up the issue of tax efficiency. It was my understanding that tax-efficient investments, such as the bond funds recommended, should be invested in taxable accounts, while investments that did not offer any tax advantages should be invested in retirement plans like 401(k)s and traditional IRAs, where the tax is deferred until retirement. After analyzing my tax situation, the planner concluded the opposite would be true, admitting the idea seemed counter-intuitive. In today’s environment, the tax rate for qualified dividends, the result of stock-based mutual funds, is 15%, while income from bond-based mutual funds is taxed at ordinary income rates.

However, the bond funds he suggested to are federally tax-exempt, and one is also state tax-exempt as long as I continue living in New Jersey. The adviser’s suggestion to invest in bonds in my tax-deferred retirement accounts might make more sense if those investments were not tax-exempt. I think there’s a piece of discussion missing from my notes that might have explained this situation with a more satisfying rationale. I’ll seek a second opinion about this particular aspect of my planning.

With most of my portfolio in cash, the planner suggested moving these funds to stocks and bonds slowly, over the course of eight quarters. Leaving behind any amount I’d like to have let in cash at the end of two years, I would divide the remainder by eight to determine my quarterly investment amount. This method of dollar-cost averaging could ease the pricing risk inherent in investing a lump sum.

If my goal is only to have money for retirement, my time horizon would be long. Again, I’ll need to define some of my life goals to determine time horizons for specific pools of assets. That would be a topic for a later discussion.

In summary, these are the main points of our discussion:

  • Six months to one year of living needs in cash, including an emergency fund and any other spending needs.
  • With the rest, a 60%/40% split between stock funds and bond funds.
  • Using a dollar-cost averaging investing strategy over the next eight quarters for current funds.
  • Add the bond fund portion to 401(k) investments and stock fund portion to taxable investments.

What do you think of this strategy?

Published or updated December 22, 2011.

About the author

Luke Landes is the founder of shizennougyou. He has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about Luke Landes and follow him on Twitter. View all articles by .

{ 28 comments… read them below or add one }

avatar 1 Anonymous

Honestly, I think that it’s a sound investment strategy that you’re pondering. Personally, I figure that you’re going to knock it out of the park. :)

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avatar 2 Anonymous

Interesting to hear that you looked at portfolio as a whole rather than separate (retirement vs non-retirement) I have always kept each items separately and have thought about possibility of treating it as a whole to see if it would be better. Something to think about on my side for new year.

Only question was why the preference of index funds over the ETF version?

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avatar 3 Anonymous

Treating the portfolio as a whole sometimes allows for either or both of two types of cost savings:

1) Tax savings, as Flexo discussed above, by making a point of tax-sheltering your less tax-efficient asset classes (e.g. REITs, taxable bonds) before tax-sheltering your more tax-efficient asset classes (e.g., stocks).

2) Cost savings by being able to utilize the lowest-cost choice(s) in a retirement plan at work (when, for instance, the only low-cost choice is a US stock index fund), then fill out the rest of the portfolio as necessary using low-cost funds in an IRA and in taxable accounts, where low-cost choices would be available in all asset classes.

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avatar 4 Anonymous

The investments should be goal/timeline based (ie retirement, college, new house, etc.)

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avatar 5 Anonymous

Hmmm…he suggested holding the tax-exempt bonds in your retirement accounts? It seems like there must be a miscommunication here (and perhaps it’s on my part — just misunderstanding what you wrote).

My suggestion for tax-efficient fund placement would have been something like this (operating on the assumption that your desired bond allocation is greater than the space you have in retirement accounts):
1) Fill up your retirement accounts with the Intermediate-Term Bond Fund,
2) Satisfy the rest of your bond allocation in your taxable account using the tax-exempt fund,
3) Own all your stocks in your taxable account.

If your total desired bond allocation is less than the total amount of space you have in tax-advantaged accounts, I don’t see the need for a tax-exempt bond fund at all.

As to the overall allocation, it sounds reasonable to me. And I sure like low-cost index funds. :)

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avatar 6 Anonymous

Taxable bonds are best in a tax-advantaged account, but it’s inherent that tax-advantaged bonds such as the munis are just wasted in a tax-advantaged account. Either there was a misunderstanding, or the planner is following a script that s/he doesn’t actually understand.

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avatar 7 Luke Landes

This is what I’m thinking — use the Intermediate-Term Bond Fund in the 401(k) accounts. (I was originally going with the tax-exempt intermediate fund, but since this is in a tax advantaged account, the regular non-exempt fund would be a better choice). Assuming filling my retirement accounts doesn’t reach the 20% of my total portfolio, complete that 20% with the Intermediate-Term Tax Exempt Bond Fund in taxable accounts. Another 20% of my portfolio would be in the New Jersey Tax-Exempt Bond Fund, held in taxable accounts. The remaining 60% should be split 70%/30% between Total Stock Market Index and International Stock Market Index in taxable accounts.

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avatar 8 Anonymous

Sounds reasonable to me.

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avatar 9 Anonymous

Mike: I think he was suggesting *not* putting the bonds in retirement accounts since they’re already tax exempt — but maybe I mis-read.

Flexo: This is very similar to our approach, including the 60/40 mix. We do, however, have our retirement accounts filled with bonds (Total Bond Market and TIPS, so there are tax considerations). We also have some tax exempt bonds in our taxable account b/c we need more bonds than our retirement accounts will hold to get up to 40%.

The idea of deploying the money over time is debatable. Lots of discussion of this, for example, on the Bogleheads forum. In the end, you have to do what you’re most comfortable with, and what will allow you to stick to the plan. But many people will argue that you should choose an allocation and dump the money in. If you’re not comfortable doing so, then perhaps your allocation is too aggressive (or so the argument goes).

That being said, I would personally deploy the money over time, if for no other reason than the fact that I would be filled with regret if I dumped the money in the market right before a big crash. Apparently I’m more sensitive to incurring losses than I am to missing out on gains. Whatever. I never said I’m rational. ;-)

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avatar 10 Luke Landes

Thanks, Nickel. Yeah, I think being irrational is just something we have to live with. Making these changes in one fell swoop could be more advantageous in the long run, but if it’s not, it could be pretty harmful, particularly if I later decide I’d rather do something else with the money rather than save it all for a few decades down the road.

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avatar 11 Anonymous

2 Thoughts came to mind:

1) I think you need to step back from this whole project. You state a few times in the post that you aren’t sure what you are doing with your life just yet. Maybe this isn’t the time to decide an investment strategy that is very long term in nature. Why not just keep everything in a short term bond fund or just pure cash for a couple months while things become clearer.

2) With the whole change in your life going on right now has income planning been a thought? Is that the purpose of the high allocation of bonds (which would make sense if they are outside your retirement b/c you can access the income).

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avatar 12 Anonymous

The 60/40 split seems a too conservative for someone your age. Is it because you are not sure of your future? Is buying a house or marriage affecting your decision?

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avatar 13 Anonymous

ETFs have lower expense ratio than mutual funds. Why wouldn’t you want to have ETFs instead over mutual funds?

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avatar 14 Anonymous

At Vanguard, the “Admiral” share class of each fund (usually available once you hit $10,000 in the fund) typically has the same expense ratio as the ETF version of the fund.

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avatar 15 eric

So are ETFs better then if you don’t qualify for admiral shares yet? I’m a bit confused between ETFs and mutual funds. I like to keep it simple if possible.

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avatar 16 Anonymous

If you don’t qualify for Admiral shares, ETFs would be slightly lower cost. But the actual dollars saved (usually somewhere in the range of 0.1% per year of an amount less than $10,000) is typically not enough to worry about it.

For most investors, I think it makes sense to use whichever fund structure fits his/her preferences, rather than worrying about a tenth of a percent one way or the other for the handful of years prior to reaching Admiral shares.

ETFs allow you to trade during the day. They also allow for things like limit orders.

Mutual funds allow for automatic purchases and purchases of fractions of a share (so you can buy/sell round dollar amounts). Many people also find that they make rebalancing easier.

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avatar 17 eric

Thank you!

avatar 18 Anonymous

Pretty much my strategy as well, but my stocks/bond split is 70/30. However, as someone who is also self-employed I would say at LEAST a year e-fund. I had a year and a half and I burned through it in 2009-2010. Six months? I couldn’t sleep at night with that.

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avatar 19 Cejay

I would have thought that you would be riskier than the 60/40 split. I am 49 and looking to retire in the next ten years so I am very conservative. This is very similar to what we have. I find it interesting that you are.

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avatar 20 Luke Landes

Age is only one factor in determining the level of risk. Take Suze Orman for example. She encourages people she advises to take on risk due to the long-term benefits of investing in the stock market, but if you look at her massive portfolio, only some of it is in the risky category. She can afford to take on less risk because even a return of 4% on millions of dollars produces quite a good level of income. My portfolio isn’t anywhere near Suze’s level in terms of size, obviously, but I’m a in a position where I can back off some risk in favor of steadier returns.

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avatar 21 Anonymous

At the Bogleheads reunion earlier this year, William Bernstein said something about asset allocation that I enjoyed: “When you’ve won the game, you can stop playing.”

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avatar 22 Anonymous

Flexo, You’re smart to double check that advice. It seems unusual to recommend tax free NJ muni fund in a tax deferred account. You would not be benefitting from the tax advantage of owning the NJ fund. Good luck, looking forward to future updates.

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avatar 23 Luke Landes

Thanks, Barb. That was my understanding, as well, but it helps to have confirmation.

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avatar 24 Anonymous

The plan looks solid for someone looking to passively invest. If you decide to take a more active role in investing, I’d recommend the following changes:

1) Including additional asset classes, such as REITS, emerging markets and small cap stocks. Re-balancing them at intervals should help improve the returns.
2) ETFs over mutual funds. You can better control the buy/sell prices through limit orders.
3) Value averaging over DCA. This method will enhance your purchases when there’s movement in the price.

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avatar 25 eric

Love the post! I’m mucking through my own investment strategy plan so it really helps to read others’ opinions and experiences. Let us know of any updates. Thanks!

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avatar 26 Anonymous

Was any consideration given to holding tips or reits? Both have unique diversification benefits that I believe become increasingly important as asset levels increase.

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avatar 27 Luke Landes

Hi Kyle,

No, we didn’t discuss REITs or TIPS… nothing beyond stock funds and bond funds.

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avatar 28 Anonymous

Just a few observations:

1st – it’s probably not a good idea to invest in local (municipal bonds), especially if you’re planning to buy a house. You don’t want to have a large percentage of your portfolio dependent upon the same local economy that your house (and for many of us) and job are dependent upon.

2nd – there is a reasonable amount of diversification benefit to including REITs in your portfolio. VNQ is a great REIT ETF.

3rd – you should consider taking advantage of the fama/french 3 factor model by tilting your portfolio toward value and small-cap stocks (especially given how young you are). You will likely see a significant improvement in long-term returns.

4th – there’s no need for TIPS in your portfolio yet. Consider TIPS when you get closer to retirement (however you define it).

Just my 2 cents. YMMV!

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