Investment Planning

Postby Laura Sat Sep 22, 2007 7:51 pm

Welcome to the Bogleheads/Diehards Forum. There are many knowledgeable and helpf
ul people who are part of this online community. Most of these posters are willi
ng to share their time and expertise with new posters who are looking for help,
but they can't or won't give advice in a vacuum. We need to know some important
things about you, including all the investments you already have. Otherwise, we
may be advising you to buy into a fund that overlaps your present holding(s), do
esn't fit your asset allocation plan, or, worse, is either too risky or too cons
ervative for your investing temperament. To make sure you get the help you need,
we would like to provide a few suggestions.
Educate Yourself
If you have never taken the time to educate yourself on investing basics, you sh
ould do that now. There are several easy-to-read books that do not require math
knowledge, finance interest, or hours to read. Several authors post on this foru
m frequently and usually answer questions related to their books. Taylor Larimor
e, Mel Lindauer, and Michael LeBeouf wrote the excellent The Bogleheads Guide to
Investing. The series continued with The Bogleheads Guide to Retirement Planning
. In addition, Financial Advisor Rick Ferri has a terrific online book available
called Serious Money and Larry Swedroe has several easy to read books available
, including The Only Guide to a Winning Investment Strategy You'll Ever Need: Th
e Way Smart Money Preserves Wealth Today. Another favorite is The Coffeehouse In
vestor. All of these books can help you build a base of knowledge in just a few
hours. A list of other books is available on the Diehards Reading List.
Investment Plan
After educating yourself, the first step on your investing journey should be to
settle on an investment plan that includes your desired asset allocation. Your i
nvestment plan should look out into the future and include things like a new car
or home purchase in a few years, education expenses for children, and retiremen
t, just to name a few. All of these goals require money in different time frames
, and the money should be invested accordingly. Studies have shown that your ass
et allocation will determine more than 90% of your portfolio return, so you shou
ld focus on your asset allocation first rather than on fund selection.
Since risk and return are directly related, your asset allocation should balance
your NEED to take risk with your ABILITY to withstand the ups and downs of the
market. NEED can be determined in many different ways. If you are young, you hav
e the benefit of many years of compounding, so in one respect your NEED to take
risk is low. On the other hand, your portfolio size is probably small, leaving y
ou with a long way to go to reach your retirement goals. As a result, you could
argue that your NEED to take risk is high.
For people closer to retirement, it may be possible to more closely determine NE
ED. First, estimate approximately how much income you will need annually after r
etirement. For this example, we ll assume you need $100,000 per year. Next, look a
t any pensions or social security benefits that will provide a source of income.
If a pension provides $30,000 per year and social security provides an addition
al $20,000 per year, then your portfolio would need to provide an extra $50,000
each year. To prevent running out of money, you should probably start by withdra
wing 4% a year or less with an annual inflation adjustment. To generate $50,000
per year at 4% requires a minimum portfolio size of $1,250,000. How close are yo
u to your goal?
Turning to ABILITY, this relates to your ability to withstand the ups and downs
of the market without getting nervous and making changes to your asset allocatio
n. Selling in the face of a decline is about the worst thing you can do. Here is
 a table offered by author Larry Swedroe, based on the 1970s bear market, showin
g the amount of decline for various stock/bond allocations:
Max Equity - Exposure Max loss
20%...............5%
30%..............10%
40%..............15%
50%..............20%
60%..............25%
70%..............30%
80%..............35%
90%..............40%
100%.............50%
There are other ways to determine an asset allocation, including several rules o
f thumb:
Your age in bonds. So, if you are 40 years old, then use a 60/40 (equity/bond) a
llocation.
110 minus your age = equities (110-40 yrs old=70/30 asset allocation)
120 minus your age = equities (120-40 yrs old = 80/20 asset allocation)
Vanguard can also help you Create an Investment Plan and canmake an investment r
ecommendation
Asset Allocation
Once you have identified the split between stocks and bonds, you need to focus o
n whether you prefer to use funds that cover large parts of the market (Total Ma
rket funds) or whether you prefer to slice and dice your portfolio into sub-asse
t classes. For many people, this choice will be determined by the funds availabl
e in their 401k-type plans. Others may prefer to have fewer funds that cover lar
ger parts of the market for simplicity of management.
One part of the market that everyone needs to consider is international investin
g. Many experts recommend investing 20-40% of your equity allocation in internat
ional holdings. Some people on the forum believe that 50% is the better number t
o reflect the position that the US represents in the world economy (approximatel
y 50%). Since none of us can predict the future, the correct number that would r
eturn the highest percentage in the next 20 to 30 years could be any of these fi
gures. Like much of investing, the ultimate choice is yours. Pick one number and
then stick with it.
Portfolio Construction
After settling on your primary asset allocation you can turn to selecting funds
that flesh out your desired asset allocation and placing them in the most tax ef
ficient manner. If you do not have taxable accounts, then tax efficiency isn t a h
uge concern but it is still a factor that should be considered. It is usually be
st to consider all of your investments together. If you are married you should u
sually blend accounts held by both spouses into one unified portfolio.
The best place to start building a portfolio is by making a list of all your cur
rent investment accounts and the investments in each account.
Next, start with the account types that offer the most limited investment choice
s, which are usually 401k and 403b type plans. These plans normally offer limite
d fund choices, so starting here and building around the best fund choices is of
ten the best idea. Look at all the funds available in your 401k and list the one
s with the lowest expense ratio from each category (US equity, international equ
ity, bonds, etc).
Finally, you must consider the tax consequences of investing, especially in taxa
ble accounts. Generally, the most tax efficient way to use your different accoun
ts is (our thanks to Taylor Larimore and David Grabiner for this list):
1. Invest as much as possible in your tax-deferred and tax-free accounts.
2. Put the most tax-inefficient funds in your tax-deferred and tax-free accounts
.
3. Use only tax-efficient funds in taxable accounts.
4. If all else is equal, put funds with higher expected returns in tax-free (Rot
h) accounts in preference to tax-deferred (traditional 401(k), 403(b), tradition
al IRA) accounts.
Here is a list of securities in approximate order of their tax-efficiency. (Leas
t tax efficient at the top.):
Hi-Yield Bonds
Taxable Bonds
TIPS
REIT Stocks
Stock trading accounts
Balanced Funds
Small-Value stocks
Small-Cap stocks
Large Value stocks
International stocks
Large Growth Stocks
Most stock index funds
Tax-Managed Funds
EE and I-Bonds
Tax-Exempt Bonds
Investing Priority
The general rule of thumb for investing priority is:
1. 401k/403b up to the company match
2. Max out Roth
3. Max out 401k/403b
4. Taxable Investing
Now that you have established your investment plan you can follow the Asking Por
tfolio Questions link to learn how to post your portfolio and receive many helpf
ul suggestions.
Laura
The Three-Fund Portfolio
Postby Taylor Larimore Sun Jan 01, 2012 6:02 pm
After a lifetime of investing since 1950 trying to "beat the market," I am convi
nced that a simple 3-fund (or ETF) portfolio of Total Stock Market, Total Intern
ational, and Total Bond Market, properly allocated, is an ideal portfolio for mo
st investors. The advantages are many (use blue links):
* Avoids wasted time, confusion and the possibility of mistakes trying to pick t
he best of thousands of mutual funds and ETFs.
* Very diversified with over 18,000 worldwide securities (lower risk).
* Very low expense ratios.
* Very low (hidden) turnover costs.
* Very tax-efficient.
* The many Advantages of Simplicity.
* Fewer but larger funds results in earlier eligibility for low-cost Admiral sha
res.
* No adviser risk.
* No fund manager risk.
* No style drift.
* No asset bloat.
* No tracking error to cause abandonment of the strategy.
* No fund overlap.
* No front-running that reduces sub-index returns.
* Efficient (highest return per unit of risk).
* Automatic rebalancing within each fund.
* Less worry. Never under-performs the market.
* Easy to maintain for the owner, spouse, caregivers and heirs.
* More free time.
* Mathematically certain to out-perform most investors. This was Morningstar's 1
5-Year Category performance for each stock fund (return) and bond fund (risk) up
dated on January 01, 2017[/color]:
TOP 21% = Vanguard Total Stock Market (VTSMX)
TOP 13% = After tax.
TOP 32% = Vanguard Total International (VGTSX)
TOP 30% = After tax.
TOP 9% = Vanguard Total Bond Market (VBTLX) in 2008 bear market.`
GOLD Analyst Rating: Total Stock Market and Total International
SILVER Analyst Rating: Total Bond Market
Asset Allocation: Use this Investor Questionnaire to help you decide your very i
mportant stock/bond allocation. I suggest International stocks = 20% of equity.
Fund Placement For Maximum Tax-Efficiency: Place Total Bond Market in tax-advant
aged account(s). If full, use a tax-exempt bond fund in a taxable account. Place
Total Stock Market and Total International Stock Market in either a tax-advanta
ged account (best) or a taxable account.
What experts say:

American Association of Individual Investors: "It should come as no surprise tha

t behavioral finance research makes a strong case for buying and holding low-cos
t, broadly diversified index funds."
Mark Balasa, CPA, CFP: "That three-pronged approach is going to beat the vast ma
jority of the individual stock and bond portfolio that most people have at broke
rage firms. There is a certain elegance in the simplicity of it."
Christine Benz, Morningstar Director of Personal Finance: "By buying total-marke
t index funds--one for U.S. stocks, one for foreign stocks, and one for bonds--i
nvestors can gain exposure to a huge swath of securities in three highly economi
cal packages."
Bill Bernstein, author of The Four Pillars of Investing: "Does this (three fund)
portfolio seem overly simplistic, even amateurish? Get over it. Over the next f
ew decades, the overwhelming majority of all professional investors will not be
able to beat it."
Jack Bogle, Vanguard founder: "The beauty of owning the market is that you elimi
nate individual stock risk, you eliminate market sector risk, and you eliminate
manager risk. -- There may be better investment strategies than owning just thre
e broad-based index funds but the number of strategies that are worse is infinit
e."
Warren Buffett, famed investor: I d rather be certain of a good return than hopeful
of a great one. -- Most investors are better off putting their money in low-cos
t index funds."
Scott Burns, financial columnist: "The odd are really, really poor than any of u
s will do better than a low-cost broad index fund."
Jonathan Burton, MarketWatch: "There are plenty of ways to complicate investing,
and plenty of people who stand to make money from you as a result. So just thin
k of a three-fund strategy as something you won't have to think about too much."
Andrew Clarke, co-author of Wealth of Experience: "If your stock portfolio looks
very different from the broad stock market, you're assuming additional risk tha
t may, or may not, pay off."
Jonathan Clements, author and Wall Street Journal columnist: "Using broad-based
index funds to match the market is, I believe, brilliant in its simplicity.
John Cochrane, President American Finance Association: "The market in aggregate
always gets the allocation of capital right."
Consumer Reports Money Book: "Simply buy the market as a whole."
Laura Dugu, Ambassador and co-author of The Bogleheads' Guide to Retirement Plan
ning: "With only these three funds in your investment portfolio you can benefit
from low costs and broad diversification and still have a portfolio that is easy
to manage."
Charles Ellis, author of Winning the Loser's Game: "The stock market is clearly
too efficient for most of us to do better."
Eugene Fama, Nobel Laureate: "Whether you decide to tilt toward value depends on
whether you are willing to bear the associated risk...The market portfolio is a
lways efficient...For most people, the market portfolio is the most sensible dec
ision."
Paul Farrell, author of The Lazy Person's Guide to Investing: "Where does Fama i
nvest his retirement money? 'In index funds. Mostly the Wilshire 5000.' "
Rick Ferri, Forbes columnist and author of six investment books: "The older I ge
t, the more I believe the 3-fund portfolio is an excellent choice for most peopl
e. It's simple, cheap, easy to maintain, and has no tracking error that would ca
use emotional abandonment to the strategy."
Graham/Zweig, authors of The Intelligent Investor: "The single best choice for a
lifelong holding is a total stock-market index fund."
Alan Greenspan, former Chairman of the Federal Reserve: "Prices in the marketpla
ce are by definition the right price."
Mark Hebner, author of Index Funds: A diversified portfolio which captures the ri
ght blend of market indexes reaps the benefit of carrying the systematic risk of
the entire market while minimizing exposure to the unsystematic and concentrate
d risk associated with individual stocks and bonds, countries, industries, or se
ctors.
Hulbert Financial Digest: "Buying and holding a broad-market index fund remains
the best course of action for most investors."
Sheldon Jacobs, author of No-Load Fund Investing: "The best index fund for almos
t everyone is the Total Stock Market Index Fund.--The fund can only go wrong if
the market goes down and never comes back again, which is not going to happen."
Kiplinger's Retirement Report: "You'll beat most investors with just three funds
that cover the vast majority of global stock and bond markets: Vanguard Total S
tock Market; Vanguard Total International Stock Index and Vanguard Total Bond Ma
rket Index."
Lawrence Kudlow, CNBC: "I like the concept of the Wilshire 5000, which essential
ly gives you a piece of the rock of all actively traded companies."
Prof. Burton Malkiel, author of Random Walk Down Wall Street: "I recommend a tot
al-maket index fund--one that follows the entire U.S. stock market. And I recomm
end the same approach for the U.S. bond market and international stocks."
Harry Markowitz, Nobel Laureate: "A foolish attempt to beat the market and get r
ich quickly will make one's broker rich and oneself much less so."
Bill Miller, famed fund manager: "With the market beating 91% of surviving manag
ers since the beginning of 1982, it looks pretty efficient to me."
E.F.Moody, author of No Nonsense Finance: "I am increasingly convinced that the
best investment advice for both individual and institutional equity investors is
to buy a low-cost broad-based index fund that holds all the stocks comprising t
he market portfolio."
Motley Fools: "Invest your long-term moolah in index mutual funds that are desig
ned to track the performance of a broad market index."
John Norstad, academic: "For total-market investors, the three disciplines of hi
story, arithmetic, and reason all say that they will succeed in the end."
Suzy Orman: "One of my favorite index funds, Vanguard Total Stock Market (VTSAX)
, has a total expense ratio of 0.06%"
Anna Pryor Wall Street Journal writer: "A simple portfolio of 3 funds. It may so
und counter-intuitive, but for the average individual investor, less is actually
more."
Jane Bryant Quinn, syndicated columnist and author of Making the Most of Your Mo
ney: "The dependable great investment returns come from index funds which invest
in the stock market as a whole."
Pat Regnier, former Morningstar analyst: "We should just forget about choosing f
und managers and settle for index funds to mimic the market."
Ron Ross, author of The Unbeatable Market: "Giving up the futile pursuit of beat
ing the market is the surest way to increase your investment efficiency and enha
nce your financial peace of mind."
Paul Samuelson, Nobel Laureate: "The most efficient way to diversify a stock por
tfolio is with a low-fee index fund. Statistically, a broadly based stock index
fund will outperform most actively managed equity portfolios."
Gus Sauter, former Vanguard chief investment officer: "I think a very good way t
o gain exposure to the stock market is through the Total Stock Market Portfolio
on the domestic side."
Bill Schultheis, author of The Coffee House Investor: The simplest approach to d
iversifying your stock market investments is to invest in one index fund that re
presents the entire stock market."
Charles Schwab: "Only about one out of every four equity funds outperforms the s
tock market. That's why I'm a firm believer in the power of indexing."
Chandan Sengupta, author of The Only Proven Road to Investment Success: "Use a l
ow-cost, broad-based index fund to passively invest in a little bit of a large n
umber of stocks."
William Sharpe, Nobel Laureate: "You may think your opinion is superior, but it
pays to be humble, investing in the market rather than trying to beat it."
Robert Shiller, Nobel Laureate: "A portfolio approximating the market may be the
most important portfolio."
Prof. Jeremy Siegel, author of Stocks For The Long Run: "For most of us, trying
to beat the market leads to disastrous results."
Dan Solin, author of The Smartest Portfolio You'll Ever Own: "You can get as sim
ple or as complicated as you'd like. You can keep it very simple by owning just
three mutual funds that invests in domestic stocks, foreign stocks, and bonds. T
hat's precisely what I recommend in my model portfolios."
William Spitz, author of Get Rich Slowly: "Few are able to beat a simple strateg
y of buying and holding the securities that comprise the market."
Prof. Meir Statman, author of What Investors Really Want: "It makes sense to hav
e those three funds. What makes it hard is that it seems too simple to actually
be a winner."
Stein & DeMuth, authors of The Affluent Investor: "Buying and holding a few broa
d market index funds is perhaps the most important move ordinary investors can m
ake to supercharge their portfolios."
"Robert Stovall, investment manager: It's just not true that you can't beat the
market. Every year about one-third do it. Of course, each year it is a different
group."
Larry Swedroe, author of 17 financial books: "Over the last 75-years, investors
who simply invested passively in the total U.S. stock Market would have doubled
their investment approximately every seven years."
Peter D. Teresa, Morningstar Sr. Analyst: My recommendation: "A fund that indexe
s the entire market, such as Vanguard Total Stock Market Index."
Wilshire Research: "The market portfolio offers the best ratio of return to risk
."
John Woerth, Vanguard director of public relations: "We would agree that this th
ree-fund approach offers most investors a prudent, well-balanced, diversified po
rtfolio at a low cost."
Jason Zweig, Wall Street Journal columnist and author of Your Money and Your Bra
in: "I think a total stock market index fund is not only the simplest, but the v
ery best core investment for most people."
Warren Buffett, famed investor: "There seems to be some perverse human character
istic that likes to make easy things difficult."