I have a confession. So far on this site I’ve been sitting here, tooting my own horn telling how disciplined and smart we’ve been with our money and I even had the nerve to make the following rule within my Wealth Manifesto:
9. Do not invest in individual stocks – invest in low-expense mutual funds that support your targeted asset allocation mix.
The truth is I really haven’t paid much attention to the costs of the funds that we’ve been investing in for the past 15 years. Sure, if I was comparing two funds that looked similar, I’d usually pick the one with the lower cost. But beyond that, my thinking was always that as long as the expense ratio was under 1.0 that it wasn’t really that big of a deal.
Well Dr. Heinz Doofenshmirtz! How could I have understood the exponential power of compound interest for this long but not recognized that mutual fund costs have the same effect, but in a negative way that can take a serious chunk out of my accumulated nest egg? And it only gets exaggerated over time!
My Money Makeover
I’ve finally come around and have some big changes afoot. In an attempt to turn my eye toward the “low-expense” part of the equation, I met with Vanguard and together we came up with a plan.
Up to this point, all of my retirement savings have been at USAA and all of my wife’s have been at Fidelity. I reached out to Vanguard and gave them some background information. Because of the dollars we potentially would be bringing over, they offered to perform a free detailed financial plan with one of their Certified Financial Planners (CFP). Apparently if you invest a minimum of $500,000 in Vanguard assets, you can qualify for their Voyager Select Services which offer these types of benefits. Great.
Prior to our session, I completed an online questionnaire that evaluated our tolerance for risk (high), outlined our existing holdings, and our plans for the future including desired retirement date, expected social security, and college savings expectations for our kids. Also, I made it clear that I had two main goals: 1) simplify our portfolio and 2) only invest in Vanguard’s ultra-low cost index funds that can be purchased as Admiral shares.
The ‘Before’ Picture
Now, financially we didn’t look all that frumpy and unkempt. Maybe just a little outdated – kind of like someone straight out of the 1990’s with feathered hair and an untucked plaid flannel shirt.
Number of Unique Holdings: 34 (31 mutual funds, 3 ETFs)
Weighted Effective Expense Ratio: 0.63 (highest: 1.27, lowest: 0.05)
Yearly Expense Fee: $4,000
Target Asset Allocation: 87% Stocks, 13% Bonds
The ‘After’ Picture
As soon as all of our funds are successfully ported over to Vanguard, it’ll be the equivalent of getting a new, stylish outfit and a fresh haircut.
Number of Unique Holdings: Six (6) – four are Vanguard, two are elections within my 401k
Weighted Effective Expense Ratio: 0.17 (highest: 0.55, lowest: 0.05)
Yearly Expense Fee: $1,300 (a savings of $2,700)
Target Asset Allocation: 80% Stocks, 20% Bonds
Asset Allocation & Fund Specifics
You may be wondering…how did you come up with your desired asset allocation? Good question.
The first step in getting there is understanding how aggressive we wanted to be with respect to our stock/bond split. An 80/20 split here is still considered aggressive.
Within the Stock category, that leaves options for U.S. Large Cap, U.S. Mid/Small Cap, and International.
Within the Bond category, we have basically a distinction between U.S. and International bond options.
In order to accommodate the target percentages, we will be investing in the following 4 core funds:
- VTSAX – Vanguard Total Stock Market Index Fund (Admiral Shares – 0.05 expense ratio)
At last glance, this fund invests in over 3,400 stocks across all sectors and across all sizes of companies within the U.S. market. It is comprised of approximately 72% Large Cap and 28% Mid/Small Cap companies.
- VTIAX – Vanguard Total International Stock Index Fund (Admiral Shares – 0.16 expense ratio)
This fund invests in over 6,500 stocks across all sectors and across all sizes of companies around the world (top three locations being 45% Europe, 28% Pacific, 19% “emerging markets”). I like the idea of owning a portion of large, successful non-U.S. companies like Samsung and Toyota Motor Corp. Many of which also do business in the U.S.
- VBTLX – Vanguard Total Bond Market Index Fund (Admiral Shares – 0.10 expense ratio)
This fund invests in almost 6,000 U.S bonds of all maturities (short, intermediate, and long term) with about 70% invested in government bonds and 30% in corporate bonds.
- VTABX – Vanguard Total International Bond Index Fund (Admiral Shares – 0.20 expense ratio)
Prior to my meeting with Vanguard, I didn’t even realize International Bond funds were necessarily an option and not something I’ve owned in the past. It seems this is a relatively new offering and invests in over 1,350 non-U.S. bonds primarily in developed countries.
I still have about $170,000 wrapped up in my employer’s 401k. Unfortunately it does not offer these funds so I’m stuck choosing from only those options available to me. I need a larger representation of International Stocks and U.S. Bonds so I will have that allocated as such:
- International Stock Fund (0.55 expense ratio)
- U.S. Bond Fund (0.46 expense ratio)
While I’ve spared you several details and ‘percent-of-a-percent’ level of mathematics, this takes a bit of spreadsheet gymnastics to figure out the right dollar amounts that should be in each fund given the target asset allocation.
As you can see, I’m a big fan of diversification. With apologies to President Obama and the name of his policy on energy, I like to refer to this latest approach as my “All of the Above” Investment Policy. I guess the only things missing may be precious metals and P2P investing, but I’ll save that for another day.
Takeaways & Learnings
- By going to an 80/20 stock/bond split, I will actually be slightly more conservative than I am now (currently around an 87/13 split).
- You’ll notice I no longer have any specific sector represented in my target allocation (I used to target and own REIT funds). This is because VTSAX (total stock market fund) already has every industry represented in it. To prove this, you can look at Vanguard’s REIT Index Fund (VGSLX) and see that all 126 holdings in this fund are also found in VTSAX.
- Cash reserve (money market) funds at brokerages like those at Fidelity, USAA, and Vanguard all have expense ratios associated with them (0.38, 0.65, and 0.16 respectively). This was news to me.
- My effective expense ratio is still a little high (at 0.17) and should go down once I stop working and roll my 401k into existing Vanguard accounts and feather that money into the 4 core funds at the appropriate percentages. This should bring our effective expense ratio of the entire portfolio down to 0.09 nearly cutting our expenses further in half.
- While I won’t be incurring such large expense fees going forward, I will be incurring a one-time account “closing” fee for each retirement account that is ported over to Vanguard as well as some fees associated with liquidating our positions. The closing fees range from $20 to $50 per account and we have five (5) total to move. I also found out that liquidating any non-USAA funds in my USAA brokerage account will incur $45 each. Just today I sold six of these for a total of $270 in transaction fees. Ouch.
Darn fees. I look forward to not needing to deal with this in the future. The good news is that I should be able to make up the cost of them well within the first year of operation at Vanguard.
- This is the first time I’ve sat down and calculated my weighted effective expense ratio across our entire portfolio. I wish I had done this exercise earlier – it truly is enlightening.
- While I haven’t been able to figure out a way to accurately estimate the cost of not moving to these low-cost funds sooner, my off-the-cuff guess is that this has cost us at least $10,000 over the last 15 years. I guess the good news is that now we know and can be sensitive to it so we can enjoy the next several decades of growth with limited erosion due to expense fees.
Please feel free to put any comments, questions, or recommendations you may have for us in the Reply area. Thanks for reading.