Category Archives: Diversification

How Much Do You Need to Save for Retirement?

In the financial advisory business, one of the most pressing and controversial topics is how much money people need to save during their working years in order to provide for long-term retirement income.  The research on this topic has evolved quite a lot in recent years, and a recent issue of Money magazine features a series of articles representing the current view on this critical topic.  These articles, based around interviews with a number of the current thought leaders on this topic, deserve to be widely read and discussed.

The series of articles in Money kicks off with perspectives by Wade Pfau.  Pfau’s introductory piece suggests a difficult future for American workers.  A traditional rule-of-thumb in retirement planning is called the 4% rule.  This rule states that a retiree can plan to draw annual income equal to 4% of the value of her portfolio in the first year of retirement and increase this amount each year to keep up with inflation.  Someone who retires with a $1 Million portfolio could draw $40,000 in income in the first year of retirement and then increase that by 2.5%-3% per year, and have a high level of confidence that the portfolio will last thirty years.  It is assumed that the portfolio is invested in 60%-70% stocks and 30%-40% bonds.  The 4% rule was originally derived based on the long-term historical returns and risks for stocks and bonds.  The problem that Pfau has noted, however, is that both stocks and bonds are fairly expensive today relative to their values over the period of time used to calculate the 4% rule.  For bonds, this means that yields are well below their historical averages and historical yields are a good predictor of the future return from bonds.  The expected return from stocks is partly determined by the average price-to-earnings (P/E) ratio, and the P/E for stocks is currently well-above the long-term historical average.  High P/E tends to predict lower future returns for stocks, and vice versa.  For a detailed discussion of these relationships, see this paper.  In light of current prices of stocks and bonds, Pfau concludes that the 4% rule is far too optimistic and proposes that investors plan for something closer to a 3% draw rate from their portfolios in retirement.  I also explored this topic in an article last year.

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Financial Literacy: State of the Union in 2013

April is financial literacy month.  I believe that lack of financial knowledge is one of the most critical problems that our country faces. Continue reading

Target Date Strategies Over The Last Five Years

The intent of target date strategies is to provide investors with fully-diversified portfolios that evolve appropriately as investors age.  Target date funds have enjoyed enormous growth over recent years, not least because the Pension Protection Act of 2006 allows employers to direct retirement plan participants into these funds as the default investment option.  Consultancy Casey Quirk projects that target date funds will hold almost half of all assets in 401(k) plans by 2020.

Target Date Folios are an alternative to traditional target date funds, launched on the Folio Investing platform in December of 2007.  These portfolios now have more than five years of performance history.  Prior to the design of the Folios, a detailed analysis of target date funds suggested that they could be considerably improved.  The Folios were designed to provide investors with an enhanced target date solution.  In this article, I will discuss the design and performance of the Folios and target date mutual funds over this tumultuous period.  The risk and return characteristics of these funds and Folios provides insight into the effectiveness of different approaches to portfolio design and diversification.  Continue reading

Folio Investing Celebrates Its Target Date Folios’ Five-Year Record of Outperformance

Folio Investing’s Successful ETF-Based Alternative to Legacy Target-Date Funds Offers Superior Diversification, Risk Targeting and Flexibility; Firm Seeks Distribution Partner to Broaden Availability

Folio Investing announced today that, over the five years since they were brought to market in December 2007, its Target Date Folios have significantly outperformed traditional target-date funds. The Folios have provided both higher returns and lower volatility than the competing funds during this tumultuous period. Continue reading

Falling ETF Fees and What They Mean

Vanguard has just reduced the expense ratios of 24 of its ETFs.  The reductions are fairly substantial.  What I noticed, in particular, is that the reductions include sector-specific ETFs.

The Vanguard Energy ETF (VDE), the Vanguard Information Technology ETF (VGT), the Vanguard Telecom ETF (VOX), and the Vanguard Utility ETF (VPU) each now have 0.14% expense ratios vs. 0.19% previously.  While the expense ratios of these funds were already low, the new expenses are 26% lower than before. Continue reading

Getting Help in Choosing and Managing a Portfolio

There is currently $5 Trillion invested in Individual Retirement Accounts (IRAs), $4.7 Trillion invested in self-directed retirement plans provided by employers (401(k), 457, and 403(b) plans), and $2.3 Trillion invested in traditional pension plans offered by private companies.  These numbers are stunning for a number of reasons.  First, self-directed retirement plans (IRAs, 401(k)’s, etc.) dramatically dwarf the amounts invested in traditional pensions.  This is part of a long-term trend, as employers move away from traditional pensions, but the magnitude of the shift is striking.  With the assets in IRA’s surpassing the $5 Trillion mark earlier this year, the amount of money in individual accounts is moving ahead of employer-sponsored plans.  What’s more, it is anticipated that IRA’s will continue to grow relative to employer-sponsored plans as people retire and roll their savings from their ex-employer’s plan into an IRA.  This matters because investors in IRA’s have even less help in creating and maintaining their portfolios than investors in employer-sponsored plans.  Continue reading

What Are the Core Asset Classes for Income Portfolios?

In a recent post, I presented a list of the ‘core asset classes’ that investors need in order to build portfolios that fully exploit available diversification opportunities.  That article focused on portfolios designed for total return potential, the combined return from price appreciation and income generated by the assets in the portfolio.  For investors focusing on building income-generating portfolios, the core asset classes are somewhat different.  In this article, I present a proposed set of core asset classes for income-focused investors, along with examples of representative funds.  Continue reading

What Are the Core Asset Classes for Total Return Portfolios?

One of the most important questions for investors and advisors is identifying a set of asset classes that will be considered for inclusion in a portfolio.  Some people will decide that all they need or want is one broad stock market index fund and one bond fund.  Others will choose to include Real Estate Investment Trusts (REITs) and commodities.  There are well-thought-out arguments that inflation-protected government bonds (TIPS) are a major core asset class.  It is also quite common for investors or advisors to break stocks out into value vs. growth and small cap vs. large cap.  Continue reading

An Alternative Approach for Drawing Income from Your Portfolio

The question of how to safely generate income from a retirement portfolio is one of the most challenging in financial planning.  In the days when people had traditional pensions, their employers simply promised them a constant inflation-adjusted income for the duration of their retirements.  As we have moved away from traditional pensions and into self-directed savings plans such as 401(k)’s and IRA’s, investors and advisors must create their own customized income plans.  New research from Morningstar highlights what appears to be a better approach to creating a stable income stream from an investment portfolio. Continue reading

Do We Live in the Golden Age of Investing?

Guest post by Contributing Editor, Matthew Amster-Burton, Mint.com.

Do we live in the golden age of investing?

Moronic question, right? Of course we don’t. The S&P 500 sits at about the same level it did five years ago. Bond interest rates have never been lower, and the Fed says it’s planning to keep them that way through mid-2015.

Turn on any financial channel and you’ll find as many gloomy predictions as you care to sit through: debt-fueled implosion in Europe, the next flash crash, the shrinking dollar, a stagnant labor market, Great Depression 2.0 (or is it 3.0 by now?). Continue reading