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Using these three tools and your own experience, you should be able to decide what a suitable stock/bond/cash allocation for your personal long-term asset allocation plan is. This is the most important portfolio decision you will make.
make money, bears make money, but hogs get slaughtered.” If you decide to add one or more sector funds, we suggest that your total allocation to sector funds not exceed 10 percent of the equity portion of your portfolio. Jack Bogle had this to say: “You could go your entire life without ever owning a sector fund and probably never miss it.”
Real Estate Investment Trusts (REITs) are a special type of stock. REIT funds often behave differently than other stock funds. This characteristic of noncorrelation can make them a worthwhile addition to larger portfolios. We suggest that REIT funds not exceed 10 percent of your equity allocation.
We believe that investors will benefit from an international stock allocation of 20 percent to 40 percent of their equity allocation.
We also suggest a broad-based, diversified bond fund such as Vanguard’s Total Bond Market Index Fund.
The shortest route to top quartile performance is to be in the bottom quartile of expenses. —Jack Bogle
The expense ratio is the only reliable predictor of future mutual fund performance.
In eight out of nine categories, lower-cost funds beat higher-cost funds during 1-year, 3-year, 5-year, and 10-year periods. They also found a similar pattern with bond funds.
Accordingly, we will avoid all load funds and we will favor low-cost index funds. We will always read the prospectus to determine the published costs of any fund we are considering. We will always know a fund’s turnover so that we have an idea of the fund’s hidden transaction costs—the higher the turnover, the higher the cost is likely to be. We will not use wrap accounts. We will remember that low cost is the best predictor for selecting funds with above-average performance. Above all, we will remember—cost matters.
“For all long-term investors, there is only one objective—maximum total return after taxes.”
The lower rates on qualified dividends increase the tax-efficiency of stocks relative to bonds whose yield is taxed at ordinary income tax rates. For this reason, and the fact that stocks benefit from the lower capital gains tax rates, we generally recommend placing stocks in taxable accounts and bonds in tax-advantaged accounts.
One of the easiest and most effective ways to cut mutual fund taxes significantly is to hold mutual funds for more than 12 months. Buy-and-hold is a very effective strategy in taxable accounts.
For maximum tax efficiency in taxable accounts, you should do the following: Favor funds with low dividends. Favor funds with “qualified” dividends. Favor funds with low turnover. Favor tax-efficient index funds and tax-managed funds.
We suggest that the best solution to this problem in taxable accounts is to use low-cost, low-turnover, tax-efficient index funds that do not depend on the skill (or luck) of stock-picking managers. They are tax efficient and low cost, reflect their benchmark index, and can be held indefinitely.
Keep turnover low. We know that buying and selling funds in a taxable account generates capital gains taxes. Therefore, we will try to buy funds that can be held “forever.” Use only tax-efficient funds in taxable accounts. We will try to use only tax-efficient funds in our taxable account(s). This usually means low-turnover index and/or tax-managed funds. Avoid short-term gains. We know that short-term gains are taxed at about twice the rate of long-term gains. Therefore, we will try to hold profitable shares for more than 12 months before selling. Buy fund shares after the distribution date.
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Of all the expenses investors pay, taxes have the potential for taking the biggest bite out of total returns. —The Vanguard Group
The rule is simple: Place your most tax-inefficient funds into your tax-deferred accounts, then put what’s left into your taxable account.
Diversification is a protection against ignorance. —Warren Buffett
In order to diversify your portfolio, you want to try to find investments that don’t always move in the same direction at the same time. When some of your investments zig, you want other parts of your portfolio to zag.
Don’t gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don’t go up, don’t buy it. —Will Rogers
The Motley Fools define market timing as “A strategy based on predicting short-term price changes in securities, which is virtually impossible to do.”
Economists report that a college education adds many thousands of dollars to a man’s lifetime income—which he then spends sending his son to college. —Bill Vaughan
It’s a simple fact of life: More education usually means higher earnings over a lifetime.
Remember, you can always borrow for college, but you can’t borrow for your retirement.
If only God would give me some sign ... a clear sign! Like making a large deposit in my name at a Swiss bank. —Woody Allen
Of all the expenses investors pay, taxes have the potential for taking the biggest bite out of total returns. —Michael LeBoeuf
“Asset allocation is critically important; but cost is critically important, too. All other factors pale in significance.”
Foolproof systems don’t take into account the ingenuity of fools. —Gene Brown
We want to make sure that whichever method we choose, it will be one that we’ll stick with through thick and thin during all market conditions.
Rebalancing is simply the act of bringing our portfolio back to our target asset allocation after market forces or life events have changed the percentages of our various asset classes and segments of those classes.
Rebalancing controls risk. It brings our portfolio back to the level of risk that we determined was appropriate for us and that we were comfortable with when we first established our asset allocation plan. As we learned earlier in Chapter 12, one of the primary reasons we hold a diversified portfolio is that asset classes don’t always move in sync, and even when they do, they don’t all have the same expected rate of return or risk level. And, at times, one asset class, or segment of an asset class, might greatly outperform the others, resulting in the outperforming asset class or segment
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Rebalancing forces us to sell high and buy low. We’re selling the outperforming asset class or segment and buying the underperforming asset class or segment. That’s exactly what smart investors want to do. Although it might be hard for some investors to understand why they shouldn’t simply let their winners run, by doing so, they’d be letting the market dictate the makeup of their portfolio, and thus their risk level.
Rebalancing may also improve your returns, since asset classes have had a tendency to revert to the mean (RTM) over time. By rebalancing, you’re selling a portion of your winning asset classes before they revert to the mean (drop in price) and you’re buying more of your underperforming asset classes when their prices are lower, before they revert to the mean (increase in value). So, you’re selling high and buying low. If you believe in RTM, rebalancing could increase your returns. Jack Bogle believes in RTM, and we do, too.
A fake fortuneteller can be tolerated. But an authentic soothsayer should be shot on sight. —Lazarus Long
Create a simple, diversified asset allocation plan. Invest a part of each paycheck in low-cost, no-load index funds according to your plan. Check your investments periodically, rebalance when necessary, then stay the course.
You aim for the palace and get drowned in the sewer. —Mark Twain
Loss aversion is the flip side of overconfidence. Although overconfidence tends to make us overly bold, loss aversion makes us overly timid about investing.
Begin by writing down your major financial goals on one sheet of paper with dates when you will need the money. Need money for college? How much and when? Need money for a new home? How much and when? Need money for retirement? How much and when? Good planning begins by setting financial goals and target dates.
Pay off your credit card and high-interest debts and stay out of debt. Formulate a simple, sound, asset allocation plan and stick to it. Systematically save and invest a part of each paycheck in accordance with the asset allocation plan. The earlier you start, the richer you become. Invest most or all of your money in index funds. Keep your costs of investing and taxes low. Don’t try to time the market. Tune out the noise, rebalance your portfolio when necessary, and stick with your plan. By doing those things, you will intelligently manage risk.
“Everyone is a fool for at least five minutes a day. Wisdom consists of not exceeding the limit.”
Recency bias. Never assume today’s results predict tomorrow’s. It’s a changing world. Overconfidence. No one can consistently predict short-term movements in the market. This means you and/or the person investing your money. Loss aversion. Be a risk manager instead of a risk avoider. Believing you are avoiding risk can be a costly illusion. Paralysis by analysis. Every day you don’t invest is a day less you’ll have the power of compounding working for you. Put together an intelligent investment plan and get started. If you need help, seek out a good financial planner to assist you. The
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I’ve got all the money I’ll ever need, if I die by four o’clock. —Henny Youngman
Current value of your portfolio Your date of death Your portfolio returns every year leading up to your demise Your federal, state, and local tax rates each year until your demise Inflation rates Health care costs Amounts of your pension and any other income Future value of any real estate you may own All unanticipated changes in your pension and health care coverage
As British clergyman and essayist John W. Foster remarked, “The pride of dying rich raises the loudest laugh in hell.” The last suit we wear doesn’t need any pockets.
Insurance is the business of protecting you against everything, except the insurance agent. —Evan Esar
Specifically, you need to consider the following types of insurance: Life insurance for anyone in your family on whom others depend for financial support Health care coverage for everyone in your family Disability insurance on any breadwinner whose future income is vital Property insurance in case of fire, theft, or other disasters Auto insurance Liability protection against expensive lawsuits Long-term care for older family members to prevent nest-egg erosion
Basically, people tend to make three types of insurance mistakes: Insuring the unimportant while ignoring the critical Insuring based on the odds of misfortune Insuring against specific, narrow circumstances
Never fail to buy insurance because the odds of something happening are small.
Only insure against the big catastrophes and disasters that you can’t afford to pay for out of pocket. The cheapest insurance is self-insurance. Carry the largest possible deductibles you can afford. The larger the deductible, the more you are self-insuring and the cheaper the premium will be. Only buy coverage from the best-rated insurance companies. You need insurance companies you can depend on when you need to file a claim.
Most people’s greatest financial asset is their future earning power. Think about this: When you die, your living expenses are over. But let disability strike, and you can face real financial hardships. You still have to eat and pay for living expenses, but can’t work to bring in income. And if that isn’t bad enough, you’re likely to be hit with enormous health care costs too.
