August 6, 2015
I recently shared a TED Talk on “The Future of Lying“. I’d like to continue by suggesting this one by behavioral economist Dan Ariely. He studies the hidden reasons we think it’s OK to cheat or steal (sometimes). Clever studies help make his point that we’re predictably irrational – and can be influenced in surprising ways.
A Recommendation: Cuba is in the news almost daily. I’m sure one day there will be a new Cuba ETF… and I am not recommending it. But I am recommending Aysha Griffin’s “Writers’ and Book Lovers’ Journey To Cuba.” Communications Director for my Foundationsince 2012, Aysha has been dedicated to helping Cuban writers for a couple of years and has created a first-of-it’s-kind tour where you’ll get an insider experience of Cuba. I know that my newsletter subscribers are a diverse group, and among you are some writers and book lovers who’d enjoy and gain a lot from it. Check it out at:http://www.CubaForWriters.com
Upcoming Podcasts: In recent podcasts andMarketWatch articles, I’ve addressed Performance, which I consider the most important aspect for investors to understand. In the next few months my podcasts will focus on questions received firstname.lastname@example.org.
Your “Ask Paul” Questions: I appreciate your questions and comments, but sometimes I struggle when I read an email full of detailed personal situations because I cannot give specific advice. So I try my best to find something that’s helpful to the questioner and of possible interest to other readers. You may also find some topics I’ve addressed before; they are the common ones that keep coming up, like: “How do I get started with $1,000?” I believe they are worth explaining again. You can expect at least five Q&A’s on each podcast and 10 in each newsletter until I get caught up with your important questions.
Thank you for reading, listening and sharing “sound investing” with your loved ones, friends and associates. More peace of mind means more peace in the world, and that’s a good thing.
To your success,
Here are 10 Q&A’s (all Questions and Answers arearchived on my website)
Q: How do your market-timing strategies compare with your Ultimate Buy and Hold Strategy?
I enjoyed the market timing podcast. It sounds like you do market timing for defensive reasons, not to make more money. What have the historic returns been for your strategy and how do they compare to the Ultimate Buy and Hold Strategy?
A: I compared some real time (after all fees) market-timing and buy-and-hold returns in a recent MarketWatch.com article. As you will see, the unit of return per unit of risk is very similar.
It’s important to note that the buy-and-hold results were easy to produce but the timing results came with many challenges I suspect few investors can replicate. But there’s another reality of timing that must be taken into consideration: there are hundreds, if not thousands, of timing approaches you might use. While I disagree with most of them, it doesn’t mean the advisor using them isn’t confident they will work. Most market-timing systems are based on data mining that most amateur investors would not understand or know how to evaluate. If you don’t know how to test a market-timing system for over optimization, you should stick with a simple buy-and-hold approach.
I could give you a list of 1,000 experts who’d provide you with high-quality help with buy-and-hold. The problem with timing is that almost every timer has a black-box approach that can’t be analyzed. I have someone I trust with my timing money, but it’s hard for me to recommend others.
How should I best handle my 401(k) situation?
Q: I am changing jobs and have a couple of questions about rolling over my 403b. I understand I will be taxed if I rollover into my Roth IRA. I am considering opening a traditional IRA instead and rolling the funds into it. If I do this, can I still contribute to my Roth IRA for this year or does the rollover count as my contribution?
A: You can roll over both traditional 401(k)s and 403(b)s into a traditional IRA, tax-free. You can roll over a Roth 401(k)/403(b) into a Roth IRA, tax-free. You can also roll over a traditional 401(k)/403(b) into a Roth IRA. That conversion is considered a Roth conversion so there will be taxes to be paid. Neither rollovers or conversions are considered a contribution. Be aware that if you do the traditional 401(k)/403(b) to Roth IRA conversion, it may increase your AGI enough that you exceed the income thresholds to be able to contribute to a Roth. So while the conversion itself doesn’t count as a contribution, the impact of the conversion may disqualify you due to income limitations. I strongly suggest you ask the new custodian for help. If you are going to use Vanguard, call 800-523-9442 for personal help. They will help you every step of the way.
Should I take a lump-sum distribution or convert to an annuity?
Q: When I retire I have to make the decision to take a lump sum distribution or convert my company retirement investments into an annuity. What guidance can you give?
A: There are many serious considerations in making the choice between taking a lump sum or converting your retirement savings into an annuity. I think it is one of the most important decisions a retiree will make so I can’t give specific advice, but here are several considerations.
1. Are you a seasoned investor who will be able to manage your portfolio in all market conditions? Many well intended investors find out the process is more difficult than it looks and they get into trouble before they realize their lack of experience. Many retired investors panicked and moved to cash in March of 2009. I’ve talked to many of those folks who are still sitting in cash. The panic may have been due to too much equity in the portfolio or simply a matter of having unrealistic expectations for the risks or investing. I find most amateurs don’t know enough about investing, or themselves, to maintain the objectivity to be a successful investor and are better served converting their money to an annutiy.
2. If you are going to hire someone to do it for you, are you qualified to hire the right professional to do it for you? I suggest you read my free e-book, “Get Smart or Get Screwed: How to select the best and get the most out of your financial advisor.”
3. Some retirees have retired with “enough to live on,” but not enough for a major financial mistake. For those retirees, an annuity produces a good payout without the fear created in the day-to-day movements of the stock market. I have given workshops for over 30 years and there is no question that a pension (annuity) creates a level of peace of mind that investing on your own will rarely accomplish.
4. If the needs from the portfolio are in the range of 3 to 5 percent, then it is likely possible to have a balanced portfolio support a long-term retirement. Please see my updated 2015 distribution tables to get an idea of what is possible with a balanced portfolio. See my recent podcasts on distributions.
5. The obvious challenge in converting your retirement savings to an annuity is the loss of liquidity. For this reason most people who do annuitize their investments only do it with a portion of the proceeds. If you decide on an annuity for part or all of your retirement investments, be sure and check out USAA and Vanguard for best rates. If you have an advisor who doesn’t take any commissions, they will likely work with Low load insurance Services where rates are lower than Vanguard and USAA. You might want to check out LLIS, which only works with clients of advisors.
How often do you update your mutual fund and ETF portfolios?
A: I review the portfolio recommendations annually. It is not unusual for the recommendations to stay unchanged, as there is no attempt to market time these portfolios. The main reason to make a change would be the addition of an asset class that has not previously been available within a fund family.
What might I do to earn some interest in the short-term?
Q: If you had $100K in cash savings beyond your emergency funds, would you recommend putting it into your monthly income portfolio? I may end up using this money to help purchase a new home in the next 1-3 years. I don’t want to let the money stagnate and make zero returns in the meantime.
A: The Monthly Income Portfolio at Vanguard is focused on producing interest, with some risk of principal. If you really need the entire portfolio to be available and are willing to take a little risk, I suggest sticking with the Vanguard Short Term Investment Grade Bond Fund (VFSTX), with a current SEC yield of 1.7%.
How much more can I make if I convert my Vanguard funds to Admiral Shares?
Q: I was wondering if you might consider doing a Vanguard Admiral™ Shares podcast? Once investors at Vanguard get approximately $10,000 in each of your recommended funds they can convert to the Admiral Shares, which have much lower expenses. For instance, I only pay .05% for Vanguard 500 Index, and .09% for Vanguard Developed Markets (essentially nothing), because I have more than $10.000 in each fund. It would be interesting to see how much the returns would grow with the additional savings with the Admiral Shares. That’s probably a lot of work, but it would still be interesting! Keep up the good work! I’ve been with you since 2007!
A: Great topic! To see what the reduced expense might mean over the long term, I will focus on one of the funds mentioned in your email. The Vanguard Developed Markets Investor Shares (VDMIX), which has a $3,000 minimum, has a .20 expense ratio, or $2 for every $1,000 under management. As you noted, the Admiral Share Class (VTMGX) only costs .09% or $.90 per $1,000. So the question is what difference this will make over the long term? The answer depends on the base return. For example, over the last 15 years the funds compounded at 2.87% (VDMIX) and 2.99% (VTMGX). Assuming a $10,000 investment, the values today would be $15,287 and $15,557, or a $270 difference. If we assumed the same difference in return but the returns were 10% and 10.11% the difference would be $631.
There’s good news for investors who don’t have $10,000. The same fund as an ETF (VEA) has a .09% expense ratio. Of course ETFs have slightly higher fees as there is a very small difference between the bid and ask when buying or selling. Thanks for sticking around for so long. I hope it’s made a difference.
What are the differences in return between these various Vanguard funds?
Q: I read with interest your December 2014 article “Why Vanguard Total Stock Market isn’t the best fund in the fleet. I decided to compare Vanguard Small Cap value (VISVX) to Vanguard Total Stock Market Index (VTSMX) to Vanguard S&P 500 Index (VFINX) over the last 10-year period. Now I recognize that any one ten-year period does not a long-term investment decision make. However, it is interesting to see that all three seem to move in lock-step with each other, for the last ten years. Any comments about how close their returns have been?
A: You are right in mentioning the possibility that 10 years of performance can be much different than expected. For the 10 and 15 years ending 7/8/15 VISVX (Vanguard Small Cap Value) compounded at 7.9% and 10.0%. For the same periods VTSMX (Vanguard Total Market Index) compounded at 7.9% and 4.7% and VFINX ( Vanguard S&P 500) 7.5% and 4.1%. Check out the longer term returns in, “This 4-fund combo wallops the S&P 500 index,”
The average 40-year return (without fees), from 1928 to 2014, was 16.2% for small-cap value compared to 10.9% for the S&P 500. Normally the longer the return data, the more meaningful the differences.
Will these Vanguard changes alter your recommendations?
Q: As a do-it-yourself investor following your Vanguard portfolios, what do you think about Vanguard’s announcement of adding small-cap to Vanguard Emerging Markets Index, Vanguard Developed Markets Index; and adding Canada to Developed Markets Index.
Will Vanguard’s actions of adding about 10% small cap to Vanguard Emerging Markets Index and Vanguard Developed Markets Index funds dilute these large-blend funds with too much small cap? If so, should we consider eliminating small-cap funds, such as your recommendations of Vanguard FTSE All-World ex-US Small-Cap Index Fund, Wisdom Tree International Small Cap Dividend Fund, and an emerging markets small cap?
A: I don’t think the changes warrant making any changes to my recommendations. The new additions of small cap are not very meaningful given that the percentages are so small. Plus, the Vanguard FTSE All-World Ex-US Small-Cap Index Fund is 57% in mid-cap stocks, so it’s still not enough small cap.
Is the 2015 Fine Tuning Table correct?
Q: I see you updated the Fine Tuning Table. It doesn’t look correct for 2015. Are those numbers really right? Seems low on the higher equity end of the spectrum.
A: I know I have answered this before but it’s important enough to address again. If you are going to judge your investment returns on the S&P 500, you will find a worldwide, broadly diversified asset-class approach, hard to stomach. For the 45 years ending 2014, the average annual difference in return between the S&P 500 and my worldwide equity portfolio was 9.9%. As you can see on the Fine Tuning Table, the period from 1995 to 1999 was very favorable for the S&P 500, only to be followed by a much more favorable period for the more broadly diversified portfolio. For many investors earning a return that’s similar to the S&P 500 is emotionally much easier to accept. When I was an advisor there were two conversations I commonly faced. In years the market lost money investors would ask, “Wouldn’t I have done better in a CD?” And after years like 2014, “How come your equity portfolio didn’t make more money?” I still get the questions but I no longer get paid to answer them. It’s much easier to answer when you’re not being paid.
If you really want to establish reasonable expectations, I hope you will review all three of these links:
What should I do with dividend funds in a bear market?
Q: My wife and I are recently retired. We have several good dividend funds that provide some income for us. Would you advise us to hold on to these funds during a big bear market and just ignore the loss in value? What are the issues involved in this decision?
A: I never look at holdings in isolation. If I were your advisor I would be asking lots of questions about your distribution needs, risk tolerance, and experience in dealing with bear markets in the past. Funds holding stocks that pay dividends can lose as much as stocks that don’t pay dividends. You have to decide how big a loss you can accept. I find new retirees often have a different risk tolerance than when they were working. You are facing the decision of whether to be a market timer or buy-and-holder. If you are a buy-and-holder, I suggest putting enough in bonds funds in the portfolio to be within your willingness to accept loss. The Fine Tuning Table is my attempt to help investors with that decision.