Tag Archives: Target Date Folios

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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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

Sector Watch: Municipal Bonds

Municipal bonds are issued by states and municipalities and typically have tax advantages relative to other fixed income assets.  In general, income from muni bonds is tax exempt at the federal level and at the state level for investors living in the issuing state.  Municipal bonds have historically been favored by investors in high tax brackets who, of course, derive more benefit from the tax exemptions by virtue of being in the highest tax brackets. Continue reading

Saving and Investing for Retirement: Part Three

Realities of Investing: Part Three of Our Special Five Part Series

In the various calculations that project retirement portfolio accumulations through time (such as the two discussed in the previous article), there are assumptions about how investors will allocate their savings and how those investments will perform.  In the case of the Fidelity study, no specific asset allocation is provided that would achieve the assumed risk-free 5.5% annual return.  In the Ibbotson study, the authors assume that investors hold a combination of a stock index fund and a bond index fund that progressively allocates less to stocks and more to bonds as investors get older.  The Ibbotson study also assumes that the stock index (the S&P 500) will have an average annual return of 10.96% per year and that the bond index will have an average return of 4.6% per year.  The Ibbotson study ignores expenses associated with investing. Continue reading

The End of ‘The Cult of Equity’?

One of the defining features of the last twenty years has been a persistent and fairly continuous belief that investing in the stock market was something of a sure road to wealth.  The downturns in the stock market in the aftermath of the Tech bubble and, more recently, in the financial crisis, have shaken investors’ faith in the maxim that stocks are inevitably a good bet.  The tendency of people to take it as an article of faith that equities will, ultimately, deliver high returns has been referred to as ‘the cult of equity.’  Two recent articles by experts that I respect propose that this phenomenon is dead or dying. Continue reading

The Power of Effective Diversification: Part II

Last week, I posted an article discussing how diversification is one of the most misunderstood concepts in investing. In today’s post I continue with the second half of this two-part series titled, “The Power of Effective Diversification.”

In Part I of this article, I discussed the difference between naive diversification (holding lots of stuff in a portfolio) and real diversification (combining assets in a portfolio to create risk offsets).  I also showed how a well-diversified portfolio can maintain the ability to participate in market rallies while still mitigating risk.  In Part II, we will explore what an effectively diversified portfolio looks like today. Continue reading

The Power of Effective Diversification

Diversification is one of the most misunderstood concepts in investing.

If you read a good explanation of the strategy, you’ll learn that the goal of diversification is to combine different investments that tend not to be driven by the same factors in the economy. So when one investment lags, the others in the portfolio gain ground (or at least will be unaffected)

For example: Combining gasoline stocks with bicycle manufacturers in your portfolio. When gasoline is cheap, people drive more and bike less. When gasoline prices start to rise, people usually cut back on their driving and start biking to work. Either way, your portfolio is now less exposed to the risk of a downturn in demand for either bicycles or gasoline. Continue reading

Proving the Value of Risk Management in Retirement Planning

The Wall Street Journal’s recent article, “Same Returns, Less Risk” discusses different approaches to managing portfolio risk while maintaining exposure to potential returns available from stocks and other riskier asset classes.  

 If you are a Portfolioist reader, you know that we’ve written about the importance of risk budgeting in the past (see, “Risk Budgeting: A Critical Tool for Portfolio Management”). You also know that we believe that risk budgeting is an important part of successful long-term investing. That’s why we constructed our line-up of Target Date Folios using a risk budgeting approach—and this stands in stark contrast to the strategy used in more traditional Target Date Mutual Funds that generally use static asset allocations that don’t adjust their risk allocations in volatile market conditions. Continue reading