Matt also writes:
“Since you brought up long-term investments and real rates of return, an interesting and relevant topic for a future entry might be how to structure one’s investments in today’s challenging times of a depreciating dollar, rising inflation, falling real estate and seemingly low expected future real rates of return. How do we all invest for the short-term, medium-term and long-term?”
The short answer to this question is that one should not change his or her strategy based on the current market, no matter what the market is doing. To do anything else would constitute market timing, and I firmly believe that attempting to time markets is ultimately detrimental to achieving the highest returns.
My specific strategies for different terms are below:
Long Term (essentially retirement savings):
I recommend buying and holding index funds or funds of index funds. The bulk of my retirement holdings are currently in the Vanguard Target Retirement 2040 (VFORX) fund. This fund is composed as follows:
|Vanguard Total Stock Market Index Fund||71.6%|
|Vanguard Total Bond Market Index Fund||10.4%|
|Vanguard European Stock Index Fund||10.0%|
|Vanguard Pacific Stock Index Fund||4.3%|
|Vanguard Emerging Markets Stock Index Fund||3.7%|
I am generally happy with this allocation, although I do see some ways to improve it. I will probably be changing my allocations shortly by making a few small modifications to the 2040 fund model:
- First, I think it is a little heavy on bonds for my age and risk tolerance. I will probably change this to about 7.5%
- Next, I think that one thing missing from this portfolio is some real estate. I will add the Vanguard REIT* Index Fund (Investor Shares), and adjust things so that it constitutes about 7% of the portfolio.
- Lastly, I think the foreign stock exposure is a little light. Foreign markets constitute 2/3 of the world economy, after all. I will bump up the Pacific Index Fund to 6% and the Emerging Markets Index Fund to 4.5%. This will require, with all of the other changes, that the Stock Index Fund will end up at 65%. Here’s what the final allocation will look like:
|Vanguard Total Stock Market Index Fund||65.0%|
|Vanguard Total Bond Market Index Fund||7.5%|
|Vanguard European Stock Index Fund||10.0%|
|Vanguard Pacific Stock Index Fund||6.0%|
|Vanguard Emerging Markets Stock Index Fund||4.5%|
|Vanguard REIT Index Fund||7.0%|
This allocation will be adjusted approximately yearly to become more conservative and still be based closely on the VFORX fund.
Short Term (money that may be need in less than 5 years):
The primary concern of short term funds (cash) has to be preservation of equity. A secondary concern is that inflation can reduce the real value of the cash. The best thing that most people can do is to park their money in a high interest savings or Money Market account. I have been keeping most of my cash reserves in a Money Market account. My emergency fund is in CDs, and I have some money with ING Direct. Many people have been disappointed with falling interest rates in cash accounts lately.
I have always been wary of Money Market Funds (as apposed to Deposit Accounts) since they are not FDIC insured. But after doing some recent reading on the subject, my fears have evaporated, and they generally offer a slightly higher return. So in the short term I will be shifting much of my cash to the Vanguard Prime Money Market Fund or possibly the Vanguard Tax-Exempt Money Market Fund (I have yet to do the math on this…). I may also put some minor portion of my cash into the Vanguard Short Term Investment Grade Fund or the Vanguard Limited-Term Tax-Exempt Fund in order to try for a bit higher return.
Medium Term (somewhere between 5 years and retirement):
I have saved the medium term until last, because I’m not really sure myself what the best way to invest for the medium term is. There are a number of things that I am saving for that are medium term: my child(ren)’s college education(s), a new house, a new car, etc. I can think of a few different strategies, but haven’t decided on the best one yet:
- Buy Target Retirement funds for the year in which the funds will be needed. For example, with any luck my daughter will be a college freshman in 2025, so I could put money into the Target Retirement 2025 funds.
- Put together my own mix of stocks and bonds that get more conservative over time. Currently this is the way my daughter’s 529 plan is set up. The real question here is: Do you start aggressive and quickly scale to conservative, or start somewhat conservative and then slowly get even more conservative?
- Use the same strategy as for Short Term. This would make sure that the money is always available, but may reduce its real value.
What do you think of these strategies for short, medium, and long term savings?
Editor’s note: A few words about Vanguard: I choose to keep my money in accounts with Vanguard for the simple fact that they have the lowest expenses for the products I want. I am not interested in any kind of managed mutual funds, so I don’t see any point in spending three or more times the expenses to buy index funds as would be the case at some other popular brokerage firms.
Vanguard does have high initial minimums, and if you don’t have $1000-$3000 to invest up front, then I recommend T. Rowe Price where you can open an account for as little as $50 as long as you can swing adding $50 a month to your account.
* A REIT is a Real Estate Investment Trust