A couple of months ago I was alerted by Nickel to a great tool for Vanguard customers called Portfolio Watch. This tool allows you to look comprehensively at one’s investment portfolios, even if they are scattered across a number of different management companies.
If you are a Vanguard customer (and I strongly urge you to become one for the low overhead costs), you can use Portfolio Watch by logging into your account and clicking the link in the menu bar at the top of the page. When I first tried this, I only got an option for something called Portfolio Analysis. Vanguard has this to say:
Portfolio Watch is a tool that is almost identical to Portfolio Analysis except Portfolio Watch is only available to clients enrolled in Vanguard’s Enhanced Services (with Vanguard assets greater than and equal to $100,000).
The Portfolio Analysis tool allows you to manually enter your non-Vanguard portfolio data, but Portfolio Watch is more of an active service that actually connects to your other accounts and continually updates the analysis. Having only the former option, I entered my portfolio, totaling over $100,000, manually. Wouldn’t you know, that within a few days of doing this, Portfolio Analysis turned into Portfolio Watch. Apparently you do have to have greater than $100,000 — just not solely with Vanguard. I suspect that if this is the case it will be very easy to scam the system.
As a bit of background, I currently have 3 investment accounts at two brokerages: A Traditional and Roth IRA at Vanguard and a 401(k) from a previous employer at T. Rowe Price. Since stocks represent about 90% of the value of my portfolio, this article will concern itself with only that portion.
So, on to the analysis:
This first graph shows the relative amounts of domestic and international stock in my portfolio. Most of the money in my portfolio is allocated to the respective Target Retirement Funds at the two brokerages. At some point in the past I also purchased some shares in my 401(k) in a stand alone international fund. Because the Target Retirement Funds already invest some of their assets in international funds, the amount of money I put into the stand alone international fund has made my exposure a bit higher than in really should be in this category, as can be seen from the cautionary note that goes along with the analysis.
As a general rule of thumb, one’s international mix should be approximately 20% to 40% or so of total stock allocations. From Vanguard:
A stock portfolio can gain important diversification by investing up to 20% in international stocks. Moving beyond 20% improves a portfolio’s diversification but at a significantly lower rate. Because of the risks inherent in international investing, an upper limit of 40% is prudent.
This next table compares my portfolio to the overall market with respect to the mix of large, medium, and small companies. As you can see, my portfolio is a bit heavy on large capitalization stocks. This came as a bit of a surprise to me. This skewing largely has the T. Rowe Price Target Retirement Fund (TRF) to blame. Unlike the Vanguard TRF, which counts the Total Stock Market Index Fund as its largest asset, the T. Rowe Price fund has very few investments in medium and small cap stocks. While the vast bulk of the value of the US Stock Market is in large cap companies, much of the growth that occurs in the market is in the small and mid cap companies. Therefore, it is important to have a good amount of exposure to this class of businesses.
This deviation actually closely matches the difference between an index fund that seeks to match the Standard and Poor’s 500 Index and one that seeks to match the total market. The S&P 500 index tracks, as its name would suggest, the stocks of 500 mostly American companies, all of which are large cap. This represents about 75% of the total market capitalization. A Total Stock Market Index Fund, on the other hand, seeks to match the entire market as an index. The Vanguard version of this fund invests in approximately 1300 stocks which together represent about 95% of the total value of the stock market.
This final chart illustrates the deviation of the international portion of my portfolio from the market. Despite the fact that my portfolio is heavy on international stock, the stock itself is not well balanced with respect to the various world markets. As with the difference between large and small cap investments, Emerging Markets are (by definition) not as mature as other markets. These provide great growth opportunities that other markets do not. It is again important not to over-, or in my case under-, invest in this category.
Specific Conclusions:
- I have a number of deficiencies in my portfolio that need to be addressed.
- Most of these deficiencies seem to stem from the investment selections that I have made in my 401(k) at T. Rowe Price. Because my money is still in a 401(k) the overall number of options available to me is relatively low.
Plan:
- In the short term, I will sell some my T. Rowe Price International Fund shares and purchase some additional fund shares in the TRF as well as some in a small cap fund. This will reduce my international exposure and increase my small cap exposure. I will use the Portfolio Tester tool in the Vanguard Portfolio Watch analysis to figure out what the dollar amounts to move should be.
- In the long term, I will begin the process of finally rolling this account into my Vanguard IRA account. This will have the additional benefit of giving me enough money so that I can balance my portfolio the way that I suggested in this post. Vanguard has a $3000 minimum investment in most of its funds. To implement the strategy that I laid out before, I will need to have at least $18,000 in my account.
I also learned:
- It is important to write down your investment strategy so you remember why you made specific investment decisions.
- Not all Target Retirement Funds are created equally. Taking this for granted can find your portfolio skewed from the composition of the rest of the market and what your goals are.
- The Portfolio Watch tool (as well as the Morningstar X-Ray tool) provide much needed cross-sectional views of mutual funds, brokerage accounts, and even whole portfolios spread across multiple custodians. I strongly encourage you to give one of these tools a try as soon as possible. While my portfolio was not horrible, every fraction of a percentage in total return is important over a 30 year investment horizon.
Have you looked at your portfolio lately? What did you find out?
- Yesterday I was chatting with one of my company’s summer interns about his plans for the weekend. He told me that he was going skydiving. Wow! I thought, that’s awesome. I’ve always wanted to go skydiving, but never got around to it before I got married and became a parent. I explained to the intern that the second thought that went through my head after “Wow” was “life insurance policy.” I have a sizable life insurance policy in place already, but I’ve been meaning to read up on the fine points of it to figure out exactly what coverage I have. I find that I have many insurance policies, but don’t know what insurance I actually have. You always hear horror stories about people having insurance, but not being covered for some bizarre sequence of events. So back to the top of my to do list goes: Read and understand current insurance policies.
- A short phone call this week earned me about $150. I have been engaged in a kind of progressive credit card arbitrage. We got a cash back rewards credit card last summer that came with a high limit and a 0% APR on purchases for a year. We’ve been making minimum payments to the card while stashing the rest of the full payment in a high interest savings account. I had written in my credit card notes that the 0% offer expires in July. I called the credit card issuer to ask specifically when the offer expires. The answer is that the offer is good until the END of my August billing cycle, which means that I don’t have to settle up until the middle of September. I estimate that I should be able to earn about $150 dollars in extra interest on the money that is sitting in my Vanguard Money Market fund.
- We finally received our tax refund this week, which isn’t bad considering that we didn’t file until about 3 weeks ago. It took longer than expected to file this year due to some Traditional to Roth IRA conversions that we ended up being ineligible to make. So it took a while to figure out how to undo the conversion and then how to record that on the tax return.
- In case you’re wondering: this tax refund will be used to bolster our emergency funds which currently total $10,233. This is far short of 6 months worth of expenses, but we’re getting there.
Some articles that I enjoyed over the last two weeks:
- Gather Little By Little investigates the fine art of hypermiling — eking every possible mile out of a gallon of fuel for your car. We have been de facto hypermilers since 2001 when we purchased a diesel car that easily gets 45 miles per gallon. However, I have been independently implementing some of the suggestions that also appear in GLBL’s article and anecdotally seem to have improved city mileage to previously unheard of heights. I won’t know for sure until the next fillup, which may still be weeks away.
- The Boston Globe reports that People in Debt Feel Literal Pain. Wow! Debt troubles are pervasive! The lesson here: If you want to improve your health, get out of debt.
- Gametheorist writes about his children’s entrepreneurial teamwork in selling candy bars for their sports club fundraiser. What fascinated me about this was the posturing of the pricing in order to induce people to buy more. What further fascinated me is that it worked so well!
- Lastly, PaidTwice had another rough week in homeownership. Her week went from dreams about a more luxurious bath experience to a shorted circuit breaker to a major, necessary home repair. Isn’t it nearly always the case that just when we start to feel secure, comfortable, and in control of our lives Mr. Murphy comes knocking? This happens to me at work, with our finances, around the neighborhood, on the highway, etc. The best guard against Mr. Murphy is a healthy emergency fund, both in literal and figurative senses. Always try to foresee alternative outcomes and plan around them or hedge against them. We can’t foresee or prepare for everything, but a little planning can go a long way — see Point 1 at the top of this entry.
Next month ScrapperMom and I will have both maxed out our Roth IRAs for the year. Since this is currently the only tax advantaged vehicle available to us, for us to continue to save will require a new strategy of some kind. Our prior experience with saving in taxable accounts has been in high interest savings accounts. We have never purchased stocks or mutual funds outside of a retirement account.
We have a number of medium term plans, including purchasing a new home, paying cash for a new (to us) car, buying more investment properties, etc. Some of these, like the new home and car, are expected to take place in approximately five years. This leads me to start wondering again what kinds of investments make sense for parking the money which we will begin to save in 2 months.
One idea that has crossed my mind a number of times is that of using Target Retirement Funds. Target Retirement Funds are a relatively new concept that has gained ground quickly in recent years. Generally TRFs are funds of stocks, bonds, and/or other funds that are balanced by the fund manager to be appropriate for someone who plans to retire close to the year in the name of the fund. For example, the Vanguard Target Retirement Fund 2010 has an appropriate mix of stocks and bonds for someone who is just about to retire and needs to shift from growth to a more steady income with preservation of capital. The nice thing about these funds is that they automatically adjust over time so that someone who owns shares of one of these funds does not have to rebalance her portfolio periodically. The funds also continue to adjust as the date of retirement passes by, so they continually become more and more conservative.
The Vanguard 2010 Target Retirement Fund (VTENX) is currently composed as follows:
Top 10 Holdings
Typical TRFs have some interesting characteristics. They are passively managed, meaning that the funds or the contents seek to match some index, and are only adjusted periodically by a manager to track the index. The balance in the fund is only adjusted periodically to be appropriate for the date of retirement. Because of this, the management fees or expense ratios tend to be low. They also tend to be tax efficient since there isn’t a lot of trading so the realized gains are low. They are now available at most major brokerages. As Kevin at No Debt Plan shows, one huge advantage of a TRF is that the barrier to entry into the fund is substantially lower than inventing in each of the funds in the fund individually.
Why am I considering a “retirement” fund for medium term savings? Well, that’s what I’m trying to figure out also. If a 2010 TRF is a smart move for someone at or near retirement who needs to try to continue to earn enough to keep pace with inflation but can’t afford to lose any money, then why wouldn’t this also be ideal as a medium term savings vehicle?
Let’s look at the pros and cons:
Pros:
- Low cost barrier to entry; if I wanted to create a well rounded portfolio for this savings goal it would take nearly over $15,000 just to get started.
- More upside potential than a cash account like a CD or Money Market account
- Easy to manage
- Tax efficient
Cons:
- No guarantee on return
- No guarantee on capital; more downside potential than a cash account
- Periodic fees in the form of expense ratios
- Lack of “peer review” in concept
I’m the type of person who is generally willing to take on a bit more risk than many. While this investment is not without risk, the risks are generally low, as the fund is well diversified across several different investment classes, many different investments within those classes, and through global investment exposure. I’d like to see some real estate investment trusts in the mix, but I think this is probably as good as it’s going to get for now.
So what do you think? Am I crazy or brilliant? Is this a good strategy for a medium term (5-10 year) savings plan, or is it too risky for such a short term? Should I go for the 2010 or 2015 plan? What do you think about using the 2020 or 2025 TRF for longer term goals?
In Part I of this series, I explained a way of creating a spending plan. Now we should look at how to put it and keep it in action, as well as how to fine tune the plan. Now that the plan is in place, I would like to make a very important point about spending plans:
Spending plans are not static.
Many people set up a spending plan and then begin to hate it, eventually giving up on it altogether, as they feel boxed into having to spend a certain way every month. This is simply not the case.
At the end of every month, I review my spending plan for the previous month and determine how closely my plan met reality. Since many of my plan entries are averages, I usually compare with my plan from one or two months earlier to determine whether the number in the plan is correct or whether it should be adjusted up or down. As long as I’m hitting the average over a number of months, I don’t worry too much: underages simply get swept into my money market account, and overages are absorbed by that same account. If, however, the number in the plan is no longer average, I have to adjust the entry for the next month’s spending plan. Of late, I have adjusted Fuel and Food up, and Electricity, DirecTV, and Auto Insurance down.
Since I’m using a simple spreadsheet for my spending plan, it’s easy to create a plan for the coming month. To do so, I simply copy the current sheet in the spreadsheet to a new sheet, and then rename the sheet for the upcoming month. In addition to the changes that may be necessary to some of the average categories, any special spending categories or extra expected income should be entered. If there is special spending (upcoming car maintenance, wedding present, etc.), it should be accounted for such that spending in another category is reduced to compensate. Ideally, debt and savings should be tapped only AFTER discretionary spending is reduced. In the same way, if you’ve got extra income this month, consider applying some or all of it to your debt snowball (sometimes referred to as “snowflaking”…) or to additional savings before applying it to discretionary spending.
We looked at the concept of “snowballing” debt reduction in my post Getting Out of Debt. My sample budget includes a number of items that should fit into a debt snowball plan. As time goes by and the first debt disappears, you need to update your spending plan to reflect this, as well as to apply the snowball payment plus the minimum payment from the paid off debt to the next debt on the list.
If you get paid irregularly, on a term greater than 1 month, or get paid irregular amounts, entering the income section of your plan can be tricky. Chances are that if you’re in this camp, you’ve already learned how to budget pretty effectively. But if you haven’t, there are a few ways to handle this. These solutions all make some assumptions that you have an idea what your average income will be.
- If you have enough experience with your income to be able to create an average, then you can enter this and work off of it as if it were one of the expenses discussed above. You will have to review this monthly to be sure that you’re not spending more than you’re earning.
- You can enter the full amount that you expect to make in the coming month. If this expected income is greater than average, allocate the difference to savings. If the expected income is less than the average, draw the difference from savings as if it were another source of income.
If you don’t know what your average expected income will be, then you’d better eliminate most of your discretionary spending until you get a better handle on your income.
In conclusion, it takes some time to set up a spending plan. Once set up, it becomes a living document that is pretty easy to maintain from month to month. A spending plan has proven essential to meeting my savings and debt reduction plans.
Click
here for actual spreadsheet.
“Budget” is a dirty word in many households, and it’s no surprise why. Budgets are hard to create, hard to keep, and nearly always imply sacrifice. So for the sake of being pleasant, I will refer to budgets in this post as Spending Plans. A budget is, after all, simply a way to spend and earn money on paper before you actually spend and earn it, and therefore the term spending plan makes more intuitive sense to me. Answers.com defines budget:
budg·et (bŭj’ĭt)
- An itemized summary of estimated or intended expenditures for a given period along with proposals for financing them: submitted the annual budget to Congress.
- A systematic plan for the expenditure of a usually fixed resource, such as money or time, during a given period: A new car will not be part of our budget this year.
The creation of a working spending plan frustrated me for many years, primarily because I was trying to create one using Quicken’s Auto Budget creation feature. The problem I had with it was similar to the problem I had with tracking spending in the past: Too many categories. I was being asked to figure out how much money I would spend on small things like a pair of sneakers simply because I had a Clothing:Men’s:Footware category in Quicken. So if I buy (1) $75 pair of sneakers per year, Quicken would fill in $6.25 per month for sneakers. Multiply this by dozens or a hundred other detailed categories and very quickly the whole thing become unruly.
As discussed in one of my first posts on Getting Out of Debt, one must first understand where his* money goes every month. Some things are easy to figure out: gather up your mortgage (or rent), auto loan, student loan, credit card, insurance, cell phone, and any other bills that are fixed monthly expenses. My list also includes things like Netflix, water, and internet access. List each of these items with the associated monthly payment. I use a Google Spreadsheet for this. You will notice that there are some discretionary expenses in here, and that’s okay for now.
Next, I went through the last few months of expenses in Quicken, and pulled out other essentials that aren’t necessarily the same cost from month to month or even year to year: food, fuel, pet care, utilities, etc. I put 4-6 months worth of each of these items on separate lines, and then averaged the each line to get a monthly expense. Utility bills usually have a 1 year rolling history of usage, so this can also be used to predict upcoming usage. Entering all these average or estimated expense creates a starting point.
The next thing I did was to look at expenses that occur on an annual basis: excise taxes on my vehicles, life insurance premiums, disability insurance premiums, Christmas presents, etc. I took each of these annual amounts and divided by 12 to figure out how much I need to allocate to each of these each month. I listed these next.
Last, but certainly not least, I have included my savings contributions. The last place inclusion should certainly not indicate the relative importance of these entries. Indeed, these may be the most important entries in the list under the “pay yourself first” mantra. If you already contribute to a 401(k) plan through payroll deductions, you may not need to even bother making an entry here.
Having entered most of your expenses (most discretionary expenses are still absent), it is now time to enter your income. For most of us, this will be rather easy since we get paid a fixed amount on a set period from few sources. Others with irregular and/or multiple source incomes will have to figure out a way to average this income to create a starting point for now.
Now add up all of the incomes and subtract all of the expenses. What’s left is what you can afford to spend on discretionary items. Is this number negative? If so, you had better go back through your expenses and start trimming until you get to at least zero. If you have an option to earn more income, that can help too. If the number is positive, then you’re already doing better than many people today. Now you need to decide if it’s positive enough to satisfy your wants during the month. The only way to change this number is to decrease other expenses or increase income. You have to weigh priorities against each other, and I strongly suggest that you contribute as much as possible towards consumer debt and savings. My sample budget spreadsheet includes a post-tax savings percentage calculator.
Congratulations! You have now created a budget! Next time we’ll look at how to tweak the budget to be closer to reality, as well as how to manage your budget going forward.
Please see Part II here.
*Too many Web 2.0 contributors would have written “their” (or worse “there”) here because of a political correctness fear of being labeled sexist. Personally, I prefer to use proper English, and “his” won the coin flip. In all likelihood I have made a grammatical or spelling mistake in this aside simply because it would be ironic.
