In Part I, we explored the various types of common retirement and investment accounts, including workplace retirement plans, self-employed retirement plans, and the taxable brokerage account.

Today, in Part II, we will explore how to choose funds to occupy those accounts, touching on fees, asset allocation, and asset location (yes, those are two different things), and we’ll touch on real estate.

Entire books are written on these topics, so if you’re looking for a deeper dive into some of these topics, please see my recommended book list. This is meant to be a brief overview for the busy professional who wants to get started but doesn’t know where to start.

Let’s get to it.

 

Investing Basics for Professionals With Little Time or Experience, Part II

 

Choosing Funds

 

Hopefully, I’ve brought a little bit of clarity to the different types of accounts you might be investing in. Conversely, I may have overwhelmed you and thoroughly confused you. If that’s the case, take some time to review the accounts that you (and your spouse, if applicable) currently own or have access to, and revisit this two-part series when you’ve got all the information.

Now, I’d like to talk about how to select funds to place in these accounts. We need to consider a few factors, including the type of fund, the cost of the fund, and the location (account) in which you place the fund.

For the remainder of this article, I’ll use the term “fund” to refer to any collection of stocks and or bonds whether held in a mutual fund or it’s cousin, the ETF. If you’re into individual stocks, and you’d better have a good reason to be, the word fund will substitute for those, too.

Before we choose funds, we’ll choose an asset allocation. A simple way to do this is to choose a percentage of stocks versus bonds and a percentage of stocks that are international. I go into this in more depth in the following posts:

• 20 Steps to Effective DIY Investing
• You Need an Investor Policy Statement

 

Let’s say you choose to own 80% stocks and 20% bonds and you want to have 40% of your stocks in international funds, just like Vanguard does in its “target date funds,” a set of funds with an asset allocation that automatically adjusts with age. Your asset allocation will be 48% US Stocks, 32% International Stocks, and 20% bonds.

While you could try to make this happen in each and every account, that would be tax-inefficient and a lot of work.

Your life will be easier, as will rebalancing (maintaining the desired asset allocation when things get out of whack) if you treat your collection of accounts as one entity that matches your desired asset allocation as a whole.

How can you do this without too much trouble? I do it in two steps.

 

 

Step 1: Use Empower’s free service to log into all of your accounts at one time. They’ll calculate your current asset allocation across all accounts, the performance of your current portfolio compared to benchmarks, and you can even track your spending.

 

Step 2: Enter your funds and balances into a spreadsheet. I’ve created one for you.

This spreadsheet has two tabs. The first is a blank slate where you can enter your fund information. The second is an example — it’s my actual portfolio, but with the balances altered to add up to exactly one million dollars.

 

 

You could get by with Step 1 only but I really like the versatility of a spreadsheet, and there’s no better way to really understand what you own than going through the process of entering the data yourself.  This sheet will tell you how much you’re paying in annual fees based on the expense ratios, and it will also show the difference between the desired asset allocation you have identified and your current allocation, aiding in rebalancing efforts.

To download the spreadsheets, kindly provide your e-mail address and you’ll receive a link to download. You’ll be subscribed to my e-mails, but will be given the option for a weekly digest, and can opt out entirely with a single click.

 

 

Expense Ratios or the Cost of Owning a Fund

 

Your return from any given fund will be its performance minus its cost. Over short and long periods of time, passive index funds tend to beat more costly actively managed funds somewhere between 75% to 90% of the time. And the winning active funds tend to vary from one year to the next.

I mainly invest in passive index funds, but if I were to own an actively managed fund, I would look for low fees and an excellent track record over a very long time. Vanguard’s Wellington and Wellesley funds are reasonable choices, but I’d only own them in a tax-advantaged fund due to the tax inefficiency of owning them in a taxable account due to taxes on capital gains when holdings within the fund are bought and sold (turned over).

In my opinion, and I’m certainly not alone in this opinion, passive index funds are a great option. You get diversity, low turnover, and ultra-low fees with certain fund families. Vanguard, Fidelity, and Schwab all offer funds with expense ratios of 0.10 or less, as does the US government’s Thrift Savings Plan (TSP). A three fund portfolio with a total stock market fund, total international stock fund, and a total bond fund will get you excellent diversity and market returns.

 

 

Expense ratios are the annual percentage cost of owning a fund. It is typically subtracted from the balance over the course of the year, so you don’t actually see a “charge” on your statement, but your returns will be reduced by the expense ratio of the fund.

The expense ratios (ER) is listed as a percentage. An  ER of 0.10 is one tenth of a percent, and can also be expressed as “10 basis points.” For every $100,000 you have invested, an expense ratio of 0.10 will cost you $100 per year. An expense ratio of 1.5% (150 basis points) on that same $100,000 investment will cost you $1,500 per year.

1.5% doesn’t sound like much, but if the stock market returns 6%, a 1.5% fee is 25% of your return lost to the fee. If a bond fund returns 3%, you’ve lost half of your return to the 1.5% fee.

What is a typical expense ratio? Here’s a sampling as of July 2018:

• Schwab Total Stock Market Fund (SWSTX) 0.03 or $30 per $100,000 per year
• Vanguard Total Stock Market Fund (VTSAX) 0.04 or $40 per $100,000 per year
• T. Rowe Price Total Stock Market Fund (POMIX) 0.30 or $300 per $100,000 per year
• American Funds Fundamental Investors (ANCFX) 0.60 or $600 per $100,000 per year (plus a front-end load as high as 5.75% of your investment)
• Rydex S&P 500 (RYSOX) 1.57 or $1,570 per 100,000 per year (plus a front-end load of up to 4.75% of your investment)

 

Those front-end loads are particularly costly, and you should really question an advisor who suggests you purchase a fund with an upfront fee. In the example of a 5.75% fee, a $100,000 investment would be worth $94,250 the next day. Fees matter and if you’re not careful, Investment Fees Will Cost You Millions.

 

 

Asset Location

 

This is different than asset allocation. Asset location refers to where you hold your assets. As I stated above, it’s counterproductive to own everything everywhere. International stock funds are good in a taxable account since you only benefit from the foreign tax credit when you hold it there.

If you own bonds in taxable, they should be municipal bonds, as you won’t owe tax at the federal level on bond income, a benefit wasted by owning them in a tax-advantaged account. Other bond funds, like a corporate or total bond fund, are tax-inefficient in a taxable account and belong in a tax-deferred account.

The same is true of REIT funds which generate significant dividends. These are best located in a tax-advantaged account like a Roth IRA or 401(k).

There’s really no particularly good or bad place to own US stocks, and since they will be a significant chunk of the portfolio for many of us, you may own them in most or all of your accounts. I have US Stocks in all of my accounts, but I avoid holding the same mutual funds that I have in the taxable account in any other account. This helps me avoid inadvertent wash sales when tax loss harvesting.

 

 

A Few Words on Real Estate

 

Last, but not least, I’ll touch on real estate. Your primary home should be considered a consumption item rather than an investment due to the often underestimated costs of owning and maintaining a home, but it’s not uncommon for investors to own additional real estate and there are many ways in which to do so.

Real Estate can be owned inside a retirement account — typically in a self-directed IRA — and is more commonly owned outside of an investment account. There are dozens of websites and podcasts devoted entirely to the subject of real estate investing, and I won’t attempt to give anything but a broad overview here, but it would be wrong for me to ignore it completely, since it is a large part of some investor’s portfolios.

Real estate investments can include:

• Single-family rental homes
• Multi-family rental homes (duplex, triplex, quadplex, etc…)
• Larger apartment buildings
• Commercial Real Estate
• Farmland
• Mobile home parks
• Property to be developed (like our lakefront property)

 

Investments can be made directly in individual properties, which will require knowledge of the local market and a significant up-front and perhaps ongoing effort in terms of time and due diligence. Another option for the investor with limited time and lesser knowledge of real estate markets are syndicated deals, which include crowdfunded real estate in which numerous investors pool their money to either purchase real estate or lend money to allow others to do so.

In these syndicated investments, due diligence has been done by a third party platform, and that information is made available to you. I’ve invested in a handful of these crowdfunded real estate opportunities thus far across different platforms thus far, but those investments only represent about 2% to 3% of our invested assets. You can learn more on my crowdfunded real estate resource page which includes bonus offers for new investors on several platforms that I’ve used.

Real Estate Investment Trusts or REITs, are another hands-off way of investing in numerous real estate deals at once. I own Vanguard’s REIT mutual fund in my Roth IRA, and about 3% of Vanguard’s total stock market fund (which I own plenty of) is invested in REITs, as well.

 

Wrapping Things Up

 

In summary, busy professionals (and everyone, really) should know what investment accounts are available to them, and what assets they are holding in them. I believe efforts should be made to treat the entire bunch of accounts as one collective portfolio, and an asset allocation should be applied broadly across the portfolio rather than individually within each account.

Attention should be paid to tax-efficient fund placement. An emphasis should be placed on low fees.

Despite what the National Association of Realtors would like you to believe, your primary home is not your best investment, even if it may be your most valuable. Fortunes can be made and lost in real estate, and it’s usually not the passive income panacea most busy professionals are looking for. REITs, REIT funds, and syndicated deals including crowdfunded investments are more truly passive.

If you happened to discover this post first, I encourage you to continue your learning with Part I of this two-part series.

 

 

I wish you success when you invest. Please leave your comments and questions below. And don’t forget to grab your portfolio tracking spreadsheet!