Planning for Retirement? Simplify, Simplify … to Just 3 Funds

This is a useful exercise in finding an easier way to invest

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There’s no single bulletproof plan in constructing a retirement portfolio. You have to consider things like time horizons and asset allocations among risk-on and risk-off markets — to say nothing of choosing investments from an endless selection of stocks and funds.

retirementinsights Planning for Retirement? Simplify, Simplify ... to Just 3 FundsWell, The Wall Street Journal’s Anna Prior refreshingly suggests that “less is actually more,” highlighting a trend that’s getting some traction — a simplified look at investing that involves very few mutual funds or ETFs.

Like, three.

Of course, while that might simplify your brokerage account, it doesn’t simplify the decision as to which funds to buy. Because it depends.

Before you attempt to narrow down your portfolio to just three investments, at least ask and answer these two questions: 1) What is your time horizon, and 2) What is your risk tolerance?

While yours might be different than mine, I’d like to use my own personal situation to show you an example of how you can find a comfortable investment trio:

Time Horizon: 10 to 15 years
Risk Tolerance: Moderate to high

Just for benchmark’s sake, Prior turns to a textbook trio consisting of

  1. a U.S. stock market proxy, Vanguard Total Stock Market Index (VTSMX), at 40% of the portfolio;
  2. a bond market proxy, Vanguard Total Bond Market Index (VBMFX), at another 40%; and
  3. an international market proxy, Vanguard Total International Stock Index (VGTSX) at 20%.

There’s plenty to like — geographical diversification and a bond fund to help reduce a little risk. But it’s not how I would roll on this one.

I like the notion of a U.S. stock market proxy, and VTSMX isn’t bad by any measure. It has a five-year annualized return of 8.8% and costs just 0.17% in expenses, or $17 of every $10,000 invested.

However, my choice for this category is the SPDR S&P 500 ETF (SPY). The SPY holds many similar names — like Apple (AAPL), Exxon Mobil (XOM) and Johnson & Johnson (JNJ) — but without going overboard on the broad exposure (500 stocks vs. VTSMX’s 3,000). It also yields a bit more in dividends currently, at 1.98% vs. 1.8% for VTSMX, and it charges less in expenses at 0.09%. The only downside is its annualized return is roughly 50 basis points worse over the past five years, but “past performance is not an indicator…” and all that.

As for allocation percentage, it again depends on time horizon. You’re fine with 40%, though if you’re as bullish on U.S. stocks in general as I am, even up to 60% would be appropriate.

As for bonds …. well, in the past, I’ve expressed an aversion to bond funds, so you know where I stand. Nonetheless, with the right amount of exposure, bonds can work for you. Before you dive in, though, check out the effective duration in the portfolio; shorter is better for risk purposes, though you might be trading away a bit more in return.

With duration in mind, Prior’s Vanguard Total Bond pick is a nice one. VBMFX has an effective duration of just more than five years, and a cheap 0.2% expense ratio. The fund’s 5.1% annual return for the past half-decade isn’t buying you any yachts, but you won’t lose sleep on the downside, either.

An alternative that gets you just a little bit further out on the duration but with little excess risk: iShares 7-10 Year Treasury Bond ETF (IEF). IEF is invested almost entirely (99%) in U.S.-backed bonds, with an effective duration of just more than seven years. It has returned 5.85% in the past five years, and charges just 0.15% in expenses, plus its 30-day SEC yield sits around 30 basis points higher, at 2.16%.

Regardless of time horizon, I’d allocate 30% here. This is classic protection, nothing more.


Article printed from InvestorPlace Media, http://investorplace.com/2013/08/planning-for-retirement-simplify-simplify-to-just-3-funds/.

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