RobBerger.com

Digital Marketing for the Professional Blogger

Rob Berger

Fidelity ZERO Funds–Are They Worth the Cost?

by

Fidelity launched its ZERO index funds in 2018 to much fanfare. As their names suggest, these funds carry no expense ratios, a first in the industry.

As great as a “free” mutual fund may sound, however, many wonder whether there is a catch. Recently a subscribe to my YouTube channel asked the following questions:

Could you please share your thoughts on Fidelity ZERO funds vs their fee based funds?Fidelity ZERO International Index Fund (FZILX)Fidelity ZERO Total Market Index Fund (FZROX)Fidelity ZERO Large Cap Index Fund (FNILX)Fidelity ZERO Extended Market Index Fund (FZIPX)

Is FNILX + FZIPX = FZROX ?

ZERO funds have no fees, but other than cost, do you see any reason why one should invest in fee based instead of zero funds?

If you could please create video and share your thoughts, that would be very helpful.

Let’s dive into the details to get a better understanding of the Fidelity ZERO funds.

4 Fidelity Zero Funds

The ZERO funds consist of four index funds. These funds charge no fees in the form of an Expense Ratio, although they do pass on transaction costs to investors. There are also no minimum investment requirements.

The catch, if you want to call it that, is that the funds track proprietary indexes Fidelity created. That means, for example, that the Fidelity ZERO Large Cap index fund does NOT track the S&P 500, as one might expect.

Here are the details on each fund’s tracking index. (Note that Fidelity does not offer a ZERO fund for bonds.)

Fidelity ZERO Large Cap Index Fund (FNILX)

The Fidelity ZERO Large Cap Index Fund tracks the Fidelity U.S. Large Cap Index. The index is a float-adjusted market capitalization-weighted index. That simply means it tracks companies based on the number and value of shares outstanding in the market. Its focus is on the U.S. large capitalization equity market.

The index tracks the top 500 companies. It can, however, have fewer companies based on liquidity and investing screens that Fidelity uses. For example, the index (and the other two U.S. indexes discussed below) exclude companies with capitalizations under $75 million or with limited trading volume.

It can also have more than 500 stocks if some companies have multiple share classes. Fidelity rebalances the index annually on the third Friday in February (so mark your calendars!).

The index is similar to the S&P 500 index, but there are some differences, as we’ll see below.

Fidelity ZERO Extended Market Index Fund (FZIPX)

The Fidelity ZERO Extended Market Index Fund (FZIPX) tracks the Fidelity U.S. Extended Investable Market Index. Its designed to track U.S. mid- and small-cap stocks. It is a subset of the Fidelity U.S. Total Investable Market Index (see below), excluding the 500 largest companies.

Perhaps the closest comparison of this index is the the Dow Jones U.S. Completion Total Stock Market Index. The primary difference is that the Fidelity index is limited to 2,500 companies, whereas the Dow Jones index has just under 3,500 companies.

Fidelity ZERO Total Market Index Fund (FZROX)

The Fidelity ZERO Total Market Index Fund (FZROX) tracks the Fidelity U.S. Total Investable Market Index. This index is effectively a combination of the Large Cap and Extended Market indexes described above. As such, it is limited to 3,000 companies.

Its closest comparison is the Dow Jones U.S. Total Stock Market Index. It’s not an exact match, however, as the Down Jones index tracks nearly 4,000 companies.

Fidelity ZERO International Index Fund (FZILX)

Finally, the Fidelity ZERO International Index Fund (FZILX) tracks the Fidelity Global ex. U.S. Index. Fidelity designed this index to track mid- and large-cap companies headquartered outside the U.S. The index is created by selecting the top 90% of stocks as measured by market cap in each country.

This index is similar to the MSCI ACWI Ex USA Index. This index, however, holds about 4,700 companies, while the free version holds about 2,300 companies.

How Fidelity ZERO Funds Compare

While free funds offer an initial appeal, one wonders if investors are getting what they paid for. Are the Fidelity indexes used by the ZERO funds generating the same or better returns as the more widely used indexes? This is particularly important given that other Fidelity index funds, while they charge a fee, are still very close to $0 in cost (generally 6 basis points or less).

To get a better understanding, I compared each of Fidelity’s ZERO funds with a close counterpart offered by Fidelity.

FNILX vs FXAIX

Fidelity’s Large Cap ZERO fund is arguably the closest to its most comparable index, the S&P 500. A comparison of the fund to Fidelity’s S&P 500 index fund (FXAIX) in Morningstar shows very similar style boxes and the same top 10 holdings. The notable difference is in the percentage held of each of the top 10 companies (the ZERO fund is on the left in each snapshot).

Performance data on the ZERO funds is limited as the funds were launched in 2018. Nevertheless, since then the ZERO Large Cap fund has outperformed Fidelity’s S&P 500 index fund by substantially more than its 1.5 basis point fee:

Whether the ZERO fund will continue to outperform the S&P 500 index only time can tell. As you’ll see below, however, the other ZERO funds haven’t performed as well.

https://fundresearch.fidelity.com/mutual-funds/summary/315911750 (FXAIX)

FZIPX vs FSMAX

Fidelity’s Extended Market Index fund (FSMAX) tracks the Dow Jones U.S. Completion Total Stock Market index. Think of it as everything except the companies in the S&P 500. As such, it covers about 1,000 more companies than Fidelity’s proprietary completion index used for the ZERO extended fund. Its cost is just 3.5 basis points.

In the short time FZIPX has been available, it has significantly underperformed FSMAX even with the same volatility. Here are the comparisons:

FZROX vs FSKAX

Fidelity’s Total Market Index fund (FSKAX) is the closest comparable to its ZERO Total Market fund. FSKAX charges just 1.5 basis points and gives investors exposure to over 3,700 stocks. The ZERO fund, in contrast, holds about 2,600 equity holdings.

While returns thus far have been nearly identical, FSKAX has managed to edge out the ZERO fund by 2 basis points. The comparable performance is likely driven by the similar returns amongst the larges U.S. companies in these cap-weighted funds.

https://fundresearch.fidelity.com/mutual-funds/summary/315911693 (FSKAX)

FZILX vs FTIHX

Fidelity’s Total International Index (FTIHX) charges 6 basis points and tracks the MSCI ACWI ex USA Investable Market index. The style box for this and the ZERO International Index are nearly identical. The free fund, however, holds just under 2,400 stocks while FTIHX holds over 4,700 stocks. And FTIHX has edged out the ZERO fund in performance thus far.

Final Thoughts

The cost of most index funds have fallen dramatically over the last few decades. Today one can invest in an index fund for 10 basis points or less. In many cases, a fund costs less than 5 basis points. For that reason, Fidelity ZERO funds seem more like a marketing strategy than a product that meets investors’ needs.

Certainly free beats even a very small cost. The problem is that fidelity achieves a 0% Expense Ratio by tracking its own proprietary indexes. I’m not sure that’s worth saving a few basis points each year. And thus far, with perhaps the exception of the Large Cap ZERO fund, these funds have trailed their Fidelity counterparts by more that the cost savings.

That said, I would have no reservations investing in one of these funds in a 401k if it were my best option.

I use Personal Capital to track all of my investments. The free tool shows me my asset allocation, total costs, and even retirement projections. Check out my Personal Capital Review and User’s Guide to learn how it can help you, too.

Resources

The 60/40 Portfolio for Retirees–Good, Bad or Ugly?

by

The 60/40 portfolio has powered retirements for decades. With 60% stocks and 40% bonds, this balanced fund offers equity-fueled growth and fixed income stability.

Today, however, many are calling into question the sustainability of the 60/40 portfolio. Some even argue that it’s dead and that retirees need take on more risk if they want to avoid outliving their retirement savings.

In this article we’ll take a deep dive into the 60/40 portfolio and whether it’s still a viable approach to investing for retirees.

Table of contents

A Brief History of the 60/40 Portfolio

Dating back to 1926, the 60/40 portfolio has enjoyed an annualized return of 9.1% (Source: Vanguard). Its best year, 1993, saw returns of 36.7%, while its worst year, 1931, experienced a loss of 26.6%. Over those 95 years, 22 saw the portfolio decline in value. The returns combined with relative stability have made the balanced portfolio ideal for retirees.

More recent returns show similar results. From 1972 to 2021 a 60/40 portfolio consisting of an S&P 500 index for stocks and intermediate term Treasuries for bonds has returned 9.61% with a standard deviation of 9.51% (via Portfolio Visualizer). The combination of solid returns with less volatility has been ideal for retirees.

In his 1994 paper, certified financial planner Bill Bengen gave us what is now known as the 4% Rule. In brief, the 4% Rule states the following:

  • A retiree can spend 4% of their investments in the first year of retirement;
  • In subsequent years, the retiree can adjust the prior year’s distribution by the rate of inflation; and
  • Following this approach, the retiree should not outlive their money.

Why do we care about the 4% rule? We care because the 60/40 portfolio fits in the sweet spot of the 4% Rule. Bengen found that retirees should hold somewhere between 50% and 75% in equities. In a later book, he identified 60/40 as the ideal portfolio in retirement to avoid outliving a nest egg. Other papers evaluating safe withdrawal rates have reached similar conclusions (as we’ll see in a minute). Some have even evaluated its performance back to 1871!

Notwithstanding the 60/40 portfolio’s stellar history dating back to the post-Civil War era, many are now calling into question its future.

Arguments that 60/40 Portfolio is Dead

There have been several arguments put forth that the 60/40 portfolio is no longer ideal for retirees. All of the arguments stem from the unprecedented financial times we are currently in.

Argument #1: Bond yields are at all-time lows

The yield on the 10-year Treasury sunk to its lowest in 2020 and remains at historic lows. When viewed on a yearly basis, the yield sunk below 2% back in 1941 (1.95% to be precise). Apart from that one year, it remained above 2.00% until 2012 (Source: Shiller). It’s currently at about 1.30%.

During much of the 20th century, the yield was significantly higher. It reached over 14% in 1982. At today’s low yields, many question how a 60/40 portfolio could survive a 30-year retirement.

From Money (4/21/21):

“I think the 60/40 portfolio is antiquated,” says Keith Singer of Singer Wealth Advisors in Boca Raton, Florida. “When bonds used to pay 6-8% and interest rates were falling, the 60/40 model worked great. But as they say, past performance is no guarantee of future results, and that is especially true with the 60/40 portfolio.” (Source: Money).

Argument #2: The 40-Year Bull Market in Bonds Is Over

The second argument relates to the fall of yields over the past 40 years. They hit a high in 1982, and then steadily dropped to their historic lows today. As bond yields fall, the value of existing bonds go up. As such, retirees have benefited from falling interest rates. Unless rates go negative, however, most believe the bull market in bonds is over

If the bond bull market is over, and rates begin to rise, the value of existing bonds will fall. Rising rates can also lead to lower asset values on everything from stocks to real estate, which brings us to the third argument.

Argument #3: Equity Valuations are High (and must fall significantly)

Many point to the richly valued S&P 500. The Shiller PE, which measures price-to-earnings over 10-year periods, is at one of its highest levels.

Shiller PE
Source: https://www.multpl.com/shiller-pe

The argument here is simple. Lofty valuations suggest that stock returns over the next decade will be much lower than historical averages.

At the same time, many argue that the 60/40 portfolio should shift to a greater allocation in stocks. The reason is that while stocks are expensive, the additional long-term returns are needed to offset the paltry returns expected from bonds.

A recent report from Goldman Sachs framed the issue as follows:

The beneficial role of bonds in balanced portfolios has more recently been in doubt given that bond yields close to the zero lower bound offer a diminished returns buffer during “risk-off” periods. These doubts have only increased alongside concerns that an accelerating economic recovery from the pandemic-induced recession, amplified by historically large US fiscal stimulus, could lead to a strong rise in inflation and, in turn, the start of a prolonged bond bear market. During most historical bond bear markets, equities have outperformed bonds and have delivered positive real returns. This has been especially the case over the last 20 years, during which bond bear markets tended to be short and shallow.

Source: https://www.goldmansachs.com/insights/pages/gs-research/reflation-risk/report.pdf

Argument #4: Negative Correlation May be Over

Finally, many believe the negative correlation that stocks and bonds have enjoyed over the past two decades may be over. In a report entitled The End of 60/40, Bank of America analysts warn that bonds may no longer provide the diversification investors have come to expect.

60/40 portfolio diversification

The authors explain,

The core premise of every 60/40 portfolio is that bonds can hedge against risks to growth and equities can hedge against inflation; their returns are negatively correlated,” Woodard and Harris added. “But this assumption was only true over the past two decades and was mostly false over the prior 65 years. The big risk is that the correlation could flip, and now the longest period of negative correlation in history is coming to an end as policy makers jolt markets with attempts to boost growth.

In short, there’s no place to hide.

Arguments that 60/40 Portfolio is Still Solid

All of the above arguments identify real and significant challenges to the capital markets. Interest rates are at historic yields. The 40-year bull market in bonds does appear to be over. And stock valuations are extremely high.

Nevertheless, I believe the 60/40 portfolio is still ideal for retirees. It’s not the only reasonably allocation in retirement, but it will continue to support a retiree for 30 years or more who relies on the 4% Rule. Here’s why I believe this.

Argument #1: Retirees are long-term investors

Those who retire at a traditional age are long-term investors. For a 65-year-old couple, there is a 1-in-4 chance of at least one spouse living past 97 and a 1-in-10 chance of at least one spouse living to 100 (Source: BofA). Retirees could be in the market 35 years or longer. To put that number in perspective, 35 years ago Ronald Reagan was President and Boy George and Mr. T were filing an episode of The A-Team.

The point is that while both equities and bonds may underperform over the next several years, or decade, retirees must consider a much longer time horizon.

Of course, the first ten to 15 years of retirement are critical. Due to the sequence of returns and inflation risk, a devastating market in the first decade of retirement could spell disaster. And that brings us to the second point.

Argument #2: The 60/40 Portfolio has Worked Since 1871

No, that’s not a typo. Researchers have tested the 60/40 portfolio against the 4% Rule with markets dating back to just after the Civil War. It’s never failed.

Michael Kitces, CFP, published a paper showing the maximum initial withdrawal rate one could have taken in the first year of retirement without running out of money over a 30-year retirement. His research tested retirements beginning in 1871.

Initial safe withdrawal rate by year
Source: https://www.genesiswealthmanagement.com/files/documents/SafeWithdrawalRate%20%28Kitces%29.pdf

The lowest initial withdrawal rate was 4.4% in 1966. Some years could have seen an initial withdrawal rate of over 10%. The point is that a 60/40 portfolio has sustained a 30-year retirement through the aftermath of the Civil War, the Panic of 1893, WWI, the Great Depression, WWII, the stagflation of the 1970s, the tech bubble, 9/11, the Great Recession, and the ongoing Covid pandemic.

Argument #3: The 60/40 portfolio offers growth and stability

When compared to a portfolio heavily weighted in stocks, the 60/40 portfolio stands out for its excellent growth and muted volatility. That’s not to say it’s not volatile, but its up and downs are significantly less than a 100% stock portfolio. And that’s precisely what many retirees need.

Since 1972, a 60/40 portfolio has returned an annual compound rate of 9.61%. These returns are lower than a 100% stock portfolio, which returned 10.75% over the same period. What’s notable, however, is the volatility. The standard deviation of a 60/40 portfolio was just 9.51%, while the stock portfolio came in at 15.25%.

To put these differences in perspective, the worst year for a 100% stock portfolio during this period was -37.45%, compared to just -16.88% of the 60/40 portfolio. At the same time, the worst maximum drawdown for the stock portfolio was nearly -51%, compared to -28% for the balanced portfolio.

The increased volatility that comes with 100% stocks brings us to the next argument.

Argument #4: Retirees can stick with a 60/40 portfolio

Studies have shown that investors are not adept at timing the market. Called the investor gap, studies have documented the gap between an investment’s return and an investor’s return. Because investors tend to buy high when stocks are rising and to sell low in a panic when investments fall, they consistently underperform the very investments where they place their money.

One Morningstar study found that investors lost on average 45 basis points due to market timing. There was, however, one bright spot. The study found that investors in less volatile investments performed better. From the study,

When we broke down funds within asset classes based on their standard deviation, we found that funds in the least-volatile quintiles consistently had higher investor returns than those in more-volatile quintiles. This suggests that “boring” funds work well because they aren’t as likely to inspire fear or greed.

A portfolio with more stocks may perform better over the long-term. Investors in retirement, however, need to ask whether they can handle the ride.

Argument #5: The 60/40 portfolio survived rising rates and inflation

No two time periods are identical. Today we face challenges the U.S. and world have never faced. We can, however, look back at similar times to gain an understanding of how the 60/40 portfolio might perform when interest rates and inflation rise. Here I’m thinking of the period from 1941 to 1982.

The yield on the 10-year Treasury stood at 1.95% at the start of 1941. In 1982 it began the year north of 14%. Over the decade leading up to 1982, the U.S. experienced double-digit inflation, with low growth, giving way to the term stagflation.

During this time how did the 60/40 portfolio perform for retirees? Just fine. To be sure, this period is why we have the 4% rule. It represents the low water mark on a safe initial withdrawal rate. But that rate still stands at 4 to 4.5%.

The 60/40 portfolio also performed well more recently when rates began to rise earlier this year. The first quarter of 2021 was the worst for U.S. investment-grade bonds in the last two decades. The 60/40 portfolio did just fine:

“The first quarter of 2021 showed that even the worst quarter for U.S. investment-grade bonds in the last 20 years wasn’t enough to derail the classic 60/40 portfolio”, says Jason Kephart.

So what’s the take for investors. As long as the correlation between traditional asset classes doesn’t shift dramatically and the portfolio continues to rise over time, then holding a 60/40 portfolio still makes sense.

That doesn’t mean investors shouldn’t consider some alternative mixes but perhaps hold those on the margins and keep your core in stocks and bonds. Although, instead of holding broad indexes, they might want to consider diversifying by adding buckets of individual stocks and bonds.

At the end of the day, the most important risk any investor should always think about is the permanent loss of capital and the loss of purchasing power. The 60/40 portfolio still offers the best defence. And even it if did seem to veer off course at one point, it could have been by design.

Source: https://www.morningstar.ca/ca/news/213154/does-the-60%2F40-portfolio-still-make-sense.aspx

Building a 60/40 Portfolio

So far we haven’t discussed the stock and bond investments that make up a 60/40 portfolio. Most of the studies on a balanced portfolio use an S&P 500 index for stocks and intermediate term U.S. bond fund for fixed income. Given current economic challenges faced by retirees, should we further diversify our asset classes?

Warren Buffett would likely say no. The Warren Buffett portfolio he recommends consists of just two asset classes: S&P 500 index and short term U.S. government bonds. He’s bullish on the future of the United States.

At the same time, the U.S. faces significant hurdles. Its population is aging, reducing the workforce while increasing the cost of social programs for senior citizens. The country’s debt to GDP ratio skyrocketed as a result of the pandemic and now stands at more than 125% (Source: The Fed). And our politicians in Washington seem willing to continue borrowing at unprecedented levels indefinitely. Eventually we’ll have to pay for all of this spending.

As a result, some financial advisors recommend moving beyond U.S. stocks and Treasuries. Bob Rice, the Chief Investment Strategist for Tangent Capital made such an argument when he spoke at the fifth annual Investment News conference for alternative investments.

“You cannot invest in one future anymore; you have to invest in multiple futures,” Rice said. “The things that drove 60/40 portfolios to work are broken. The old 60/40 portfolio did the things that clients wanted, but those two asset classes alone cannot provide that anymore. It was convenient, it was easy, and it’s over. We don’t trust stocks and bonds completely to do the job of providing income, growth, inflation protection, and downside protection anymore.”

Source: https://www.investopedia.com/articles/financial-advisors/011916/why-6040-portfolio-no-longer-good-enough.asp

While I don’t share his pessimistic views of the 60/40 portfolio, diversifying to international equities seems reasonable. This could include both developed countries and emerging markets. Other diversification opportunities could include real estate (REITs) and commodities. For bonds, some argue that retirees should take on more credit risk through high-yield bonds and emerging market debt.

Having said that, there’s no guarantee that diversifying the portfolio will lead to better results. A well diversified portfolio has significantly underperformed a basic 60/40 portfolio over the last 15 years (commodities data wasn’t available before 2007 in Portfolio Visualizer).

diversified 60/40 portfolio

At the same time, if we remove commodities and add the 5% allocation back into the S&P 500, we extended the data to 1999 AND see that the greater diversification paid off.

60/40 diversification

Of course, this time period saw the tech bubble burst, 9/11 and the Great Recession, all of which had significant affects on the S&P 500. And that really is the point. While diversification is generally a sound approach to investing, it’s not a guarantee of higher returns.

Final Thoughts

The 60/40 portfolio is certainly not the only reasonable approach to investing in retirement. Yet for many retirees, it has stood the test of time. It offers both growth and stability, which retirees need for their money to last 30 years or more.

Nobody knows the future. Is it possible that we could see unprecedented economic conditions that could wreck havoc on retirees? Of course we could. Although if that happens, one wonders if any asset allocation would save us.

How Much Cash Should Retirees Keep On Hand?

by

Moving from a regular paycheck to living off of your nest egg is not an easy transition. At least it hasn’t been for me. One of the many decisions retirees must make is how much cash should they have in the bank.

For some it’s a question of budgeting. They keep enough to pay the bills over the next several months, but that’s it. For others cash acts as a buffer in the event the stock market drops 10%, 20% or more. For those who see cash as a buffer, several more questions need to be considered:

  • How much cash should you keep in the bank?
  • How do you decide when to replenish your spending account?
  • Do you factor the amount of cash you have into your overall asset allocation?

In this article I’ll explore these questions. We’ll look at some research papers that address these questions. We’ll also talk about how you can get the psychological benefits of holding lots of cash without actually holding lots of cash.

The starting for all of this is the 4% Rule. First, however, we need to cover the basics.

Table of contents

What is Cash?

For our purposes, I define cash as money in an FDIC-insured account (checking, savings, money market account or possibly a certificate of deposit) or a money market fund. The later is not FDIC-insured, but it’s extremely safe.

What I don’t include in cash are bonds. That’s true even for short-term U.S. government bonds. T-bills as they are called are extremely safe. But they aren’t cash. And even a short-term bond fund can lose money when interest rates rise.

What about Social Security, Pensions, Annuities, and Part-Time Work?

Retirees fund retirement from many sources. Most receive social security. Many have pensions or annuities. And some, myself included, still do part-time work to generate some income. All of these sources generate cash for us, typically on a monthly basis.

The question we are addressing is how much cash, over and above any cash these other sources generate, do we need to pull from our investments. In other words, how much do we need to pull from 401k, IRA and taxable accounts each month or year for living expenses.

These other sources will of course reduce how much we have to pull from our investments. But most of us have to pull something out, and that’s what this article addresses.

The Budget-Dividend Strategy (My Preferred Approach)

My preferred approach to cash in retirement is what I call the Budget-Dividend Strategy. The nice thing about this approach is that it addresses three liquidity concerns at the same time:

  1. It guarantees that I’ll always have cash on hand
  2. It helps with budgeting
  3. And it coincides with quarterly dividend payments, which can be used as a source of funds

Here’s how the Budget-Dividend Strategy works.

At the start of the year I pull six months worth of living expenses from our investment accounts. In our case the money gets deposited into our checking account.

When the balance declines to three months of living expenses, we add cash to bring the balance back to the six months of expenses level. If we are generally on track with our budget, this should happen after three months.

The timing is convenient because ETFs and mutual funds typically pay dividends at the end of each quarter. In our taxable account, we do not automatically reinvest dividends. So once the dividends hit our money market fund in our brokerage account, I can move some or all of them over to our bank account.

If we need more than the dividends give us, I withdrawal additional funds from investment accounts. Here I make the decision on a number of factors, such as taxes and which asset classes have performed best.

Once we start taking Required Minimum Distributions (still two decades away), we’ll use the RMD to fund living expenses as well.

Benefits of the Budget-Dividend Strategy

The are several benefits to this approach.

First, we keep the vast majority of our capital fully invested. Even assuming an initial 4% distribution per year, we never have more than 2% in cash (6 months of living expenses). And this number drops to 1% (3 months of living expenses) before we replenish the cash account.

Second, the timing of when we replenish the account coincides with distributions from ETFs and mutual funds. This isn’t necessary, and may be irrelevant for those without significant taxable investments. But it’s convenient for us.

Third, the approach also makes budgeting easier. We track our spending in Personal Capital and Tiller Money. This approach to cash, however, makes it easy to know at a glance if we are on track, over spending or under spending.

The No Cash Strategy

One approach to cash in retirement is virtually no cash at all. One could sell investments monthly to cover just one month of expenses. If most spending is put on a credit card, the no cash strategy could work.

Personally, I find the idea of tapping my investments monthly to be too much of nuisance. Still, it’s worth pointing out that one could take this approach. For those who do, finding a broker that offers check writing, online bill pay, and perhaps even a debit card would be useful. Even here, however, you’d be transferring funds from stock and bond funds to a money market fund every 30 days, which many would find tiresome.

The Buffer Strategy

Our approach to cash keeps the vast majority of our assets fully invested. Some advocate a different approach called the Buffer Strategy. The idea is to keep as much as five years worth of living expenses in cash. The strategy has some initial appeal.

Over the past 100 years, the worst stock market performance saw a decline four years in a row (from 1929 to 1932). The market has never been down five years in a row.

Here’s a chart of the S&P 500’s yearly performance dating back to 1928:

S&P 500 performance by year from 1928 to 2021

Of course the market could be down 5 years in a row sometime in the future. But the idea of a cash cushion is to avoid selling stocks when the market is down. It has some intuitive appeal.

And it’s a bad strategy.

First, if we rebalance our portfolio at least once a year, we won’t sell stocks in a bear market. When the market is down significantly, the simple act of rebalancing will cause us to sell bonds and buy stocks. This is true even if bonds decline a bit.

For example, in 1931 the 10-year Treasury Bond was down 2.56%. The S&P 500 (or equivalent) was down more than 43%! In that scenario, we still be selling bonds to buy stocks as part of rebalancing.

Just as important, holding five years worth of cash creates a serious drag on our portfolio’s performance. Let’s make sure we understand why.

Cash and the 4% Rule

The 4% Rule comes from a 1994 paper written by financial planner Bill Bengen. Using historical returns and inflation data, Bengen tried to answer how much a retiree could spend each year without going broke.

His conclusion was that a retiree could spend 4% of his or her nest egg in the first year of retirement. Thereafter, they could increase this amount by the rate of inflation (he used CPI). Following this approach, he concluded, a retiree’s nest egg would last at least 30 years, and in some cases 50 years or longer.

There were, however, some important underlying assumptions in his work. For example, he assumed retirees invested in an S&P 500 index fund for stocks and an intermediate U.S. government bond fund for bonds. He also concluded that stocks should represent 50 to 75% of a retiree’s asset allocation. Any more and a big stock market decline (e.g., 1929 to 1932) would shorten the longevity of a portfolio. Any less and a return to double-digit inflation could do irreparable harm.

So what does this have to do with how much cash we should hold?

For his analysis, Bengen assumed that retiree withdrew funds from the portfolio once a year and then rebalanced. The rebalancing did not factor in the cash that was just taken from the portfolio. His focus was not on how much cash to hold. That’s just the approach he chose for his analysis.

Nevertheless, it’s important to keep his approach in mind. For those choosing to deviate from a once-a-year distribution strategy (at most) to hold significantly more cash, keep in mind that the conclusions from his research may not hold. And indeed, subsequent research confirms this outcome.

Research on the Buffer Strategy

Arguably the most comprehensive study comes from Professor Walter Woerheide, Ph.D., ChFC, CFP®. At the time of publication, he was the Frank M. Engle Distinguished Chair in Economic Security Research, at The American College in Bryn Mawr, Pennsylvania.

In 2012 Professor Woerheide published a paper entitled, Sustainable Withdrawal rates: The Historical Evidence on Buffer Zone Strategies. He evaluated cash buffers of one to four years, using a replenishing strategy based on whether the investment portfolio was up or down the previous years.

If the investments were up, the cash buffer was replenished along with any required withdrawals. If the portfolio was down, withdrawals came from the cash buffer. The only time cash came from the investment portfolio following a down market was if the cash buffer were exhausted.

Looking at several different asset allocations, the results were clear. A cash buffer strategy underperforms a standard rebalancing approach. It reduces the likelihood that a portfolio will last 30 years. It also reduces the portfolio’s balance at death.

Here’s a summary of his findings:

Cash Buffer and Sustainable Withdrawal Rates

Several other studies have confirmed these results:

Harold Evensky

Harold Evensky is the father of the bucket strategy. He’s also a proponent of the Buffer Strategy for cash. In 2021 he co-authored a paper (The Benefits of a Cash Reserve Strategy in Retirement Distribution Planning) that concluded a cash buffer equal to one year of expenses actually improved the likelihood that a portfolio could be sustained for at least 30 years. His study is the outlier and deserves a brief comment.

He found the a 1-year buffer strategy (he called it the Cash Flow Reserve or CFR) out performed a standard rebalancing approach (RDCA–Reverse Dollar Cost Averaging), particularly with taxes and transaction costs were factored in. Here’s a summary of his findings:

Survival Rates for Cash Buffer Strategy

There are several serious flaws in the study.

First, it used a 1-year cash buffer that was allowed to fall to just two months. As a practical matter, that’s no cash buffer at all.

Second, he used a Monte Carlo simulations instead of historical data. In and of itself this isn’t a problem, but the inputs he used heavily favored cash. He assumed an average stock return of 8.75%, well below the historical average. He also assumed a 3.5% return on cash with a 3.0% rate of inflation. This gave cash a 0.50% real return.

In other words, the study was designed to reach a certain conclusion, in my opinion. The fact is that a significant cash cushion represents a significant drag on performance that hurts retirees in the long run.

How to Sleep at Night with Little Cash in the Bank

While it’s clear that the Buffer Strategy underperforms, we need to address the psychology factors. As someone who is semi-retired, I understand firsthand the fear of spending investments. That fear grows when the stock market drops as it did at the start of the Covid pandemic.

To address this real concern, here are a few approaches retirees can take that won’t do as much harm as holding too much cash.

First, calculate how long you can live on just your bonds. If you have a 60/40 stock/bonds allocation, for example, you can live on just the bonds for about 10 years, assuming an initial 4% withdrawal.

This approach assumes your bonds are primarily U.S. government short and intermediate-term bonds. Riskier bonds, such as high-yield or emerging market debt might not provide as much comfort. The point is that recolonizing just how long your bond portfolio can get you may help you weather a stock market decline.

Second, and related to the first, is to allocate some of your bonds to cash. For most this would mean a money market fund. For example, a 60/40 portfolio would become a 60/30/10 portfolio (stocks/bonds/cash). Studies have found that converting some of the bonds to cash doesn’t have a major effect on the longevity of the portfolio.

Bill Bengen actually reached this conclusion in a 1997 paper. He found that a 10% allocation to short-term U.S. Treasury Bills did not significantly reduce the starting safe withdrawal rate of about 4%. Others have reached similar conclusions (see here and here).

Final Thoughts

Investing during retirement can be stressful. Still, we need to resist the urge to play it “safe” by holding too much cash. What may feel safe could over time do far more harm than good. A simple approach of three to six months in cash keeps are capital invested while still giving us ample room to do with unexpected expenses.

How Investment Fees Affect Wealth

by

It costs money to invest. We pay all types of fees, some obvious, some not so obvious. In this article I’m going to walk through the most common investing fees you are likely to encounter. Then we’ll examine just how destructive a seemingly small amount of fees can be to your wealth and retirement.

Table of contents

Do Fees Really Matter?

Before looking at specific types of investment fees, let’s first ask whether fees really matter. To answer that question, the first thing we must recognize is that seemingly small fees, over time, can seriously reduce the value of an investment portfolio.

The Securities and Exchange Commission (SEC) published a paper on this very topic in 2014. It noted that “fees may seem small, but over time they can have a major impact on your investment portfolio.”

Invest fees affect on a portfolio over 20 years

Some have argued that fees don’t matter. Instead, what matters are returns after factoring in the fees. In other words, paying high fees is not only fine, but ideal, if the investment returns enough to justify the fees. Conceptually this makes sense. In practice, however, it falls apart.

Study after study after study shows that expensive investments underperform inexpensive investments. For example, Vanguard looked at the annualized returns for a 10 year period ending December 31, 2014 for two groups of mutual funds: 25% of the funds with the lowest expense ratio and 25% with the highest. The low-cost funds won.

Funds with lower costs outperform more expense ones

The primary way we keep fees down, as we’ll discuss more below, is to use low-cost index ETFs and mutual funds. It’s an approach Warren Buffett, the CEO of Berkshire Hathaway and arguable the best investor alive today, supports:

Nevertheless, both individuals and institutions will constantly be urged to be active by those who profit from giving advice or effecting transactions. The resulting frictional costs can be huge and, for investors in aggregate, devoid of benefit. So ignore the chatter, keep your costs minimal, and invest in stocks as you would in a farm.

My money, I should add, is where my mouth is: What I advise here is essentially identical to certain instructions I’ve laid out in my will. One bequest provides that cash will be delivered to a trustee for my wife’s benefit. . . . My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals – who employ high-fee managers.

Types of Investment Fees

There are countless fees investors may encounter. I’m going to list them in the order you are more likely to encounter them. Some fees are virtually unavoidable, but can be kept to a minimum. Other fees should be avoided at virtually all costs. Frankly, the only fee that is truly unavoidable is the first one on our list–expense ratio.

Expense Ratio

Mutual funds and ETFs charge investors a fee. The fee covers the cost of the fund, including payroll, as well as profit for the fund company. Expense ratios are expressed as a percentage. For example, a fund that charges a one percent (1%) expense ratio would cost an investor 1% of the amount invested in the fund (e.g., $100,000 investment would cost $1,000 per year with a 1% expense ratio).

The expense ratio is practically unavoidable. Fidelity does offer a few funds with no expense ratio, but that’s the exception. Even low-cost fund provider Vanguard charges expense ratios on its ETFs and mutual funds.

Transaction Costs

There can be costs to buy and sell stocks, mutual funds and ETFs. By and large these costs are easy to avoid. Most mutual fund companies and brokers have gone to $0 trades if made online. There is, however, one important exception.

Many brokers charge a commission when you purchase a mutual fund (not an ETF). For example, I have an account at Merrill Edge, and the broker charges $19.95 when I purchase certain mutual funds. They do have a list of fee-free funds, but many of the funds I use from Vanguard would require payment of the commission.

For this reason, it’s important to understand the types of investments you want to make before choosing a broker. If you know, for example, that you’ll invest entirely in Vanguard funds, it makes sense to open an account at Vanguard or a broker that offers at a minimum free Vanguard ETFs. M1 Finance is a good example and a broker I also use.

Investment Advisor Fees

Advisor fees come in two forms: (1) a percentage of assets under management (AUM), or (2) a fixed or hourly fee. The vast majority of advisors charge a percentage of AUM, with 1% the industry standard (although fees do vary based on account size and services provided).

Some lower cost AUM advisors have entered the market over the past 10 years or so. Vanguard offers advisory services for just 30 basis points. A number of so called robo-advisors offer their services for about 25 basis points (e.g., Betterment and Wealthfront).

A growing list of advisors have turned to hourly or fixed fees. These arrangements almost always favor the client, as the total cost is generally far less than the AUM model. One such advisor is Mark Zoril of PlanVision.

As you’ll see in a minute, Advisor fees based on a percentage of AUM destroy more wealth than any other fee (although high expense ratios are a close second).

Load Fees

Some mutual funds charge what are called load fees. Front-end load fees are paid when you invest in a mutual fund with this type of fee; Back-end load fees when you sell.

Front-end load fees typically cost 5.75%. For every $100 invested, fees take $5.75, leaving $94.25 in your account. There’s absolutely no reason to invest in mutual funds that charge load fees. Ever!

Where to Find the Expense Ratio of a Mutual Fund

There are several easy ways to find the expense ratio of any mutual fund or ETF. For starts, you can Google the ticker symbol of the fund. VSTAX, for example, is Vanguards total stock market fund. Searching “VSTAX” returns the following result, including the fund’s expense ratio:

How to find expense ratio using Google
(The Expense Ratio of 0.04% is in the bottom right of the image)

You can also see if a fund charges a load fee AGTHX, an American Funds growth fund:

how to find load fees
Note the “Front load” of 5.75%

Another free tool that tracks both the expense ratio as well as any load fees is Morningstar. You can also check the prospectus of the funed.

As for investment advisor fees, you should ask. It’s as simple as that. It should also be reflected on your statements. You can also find fee disclosures in the advisor’s Form ADV. But asking is much easier.

How to Determine the Expense Ratio of Your Investment Portfolio

While it’s important to know the expense ratio of each investment, what really matters is the overall expense ratio of your portfolio. You could calculate this by hand. Just take the weighted average of your expense ratios across all of your investments. If that sounds as inviting as a root canal, there is an easier way. Use Personal Capital.

Personal Capital is a free financial dashboard. Link all your financial accounts (checking, savings, credit cards, retirement accounts, HSAs, loans, taxable investments) and Personal Capital provides a wealth of tools. You can do everything from budgeting to loan payoff to retirement planning. And for our purposes, it will automatically calculate the expense ratio of your investment portfolio.

Here’s the results from a demo portfolio I entered into Personal Capital:

Note the 0.10% annual fee to the right. That’s the expense ratio of a portfolio that included dozens of investments. You can read my review of Personal Capital or go directly to its free signup page (truly free-no credit card needed–ever).

How Fees Affect Your Wealth

Let’s imagine that we make the maximum contribution to an IRA ($6,000) during our working years from age 20 to 65. If we earn an average of a 9% return on our investments, we’ll retire with about $3.1 million (gotta love compounding).

Now let’s assume we pay an investment advisor a “small” 1% fee. Our retirement fund drops to $2.3 million. Add in a 1% expense ratio on the mutual funds, and our nest egg falls further to $1.7 million. Yeah, fees matter.

How to Avoid Most Investment Fees

There are several important steps to take to keep you fees low.

Low cost index funds: First, stick to low cost index funds (ETFs or mutual funds). They outperform the vast majority of actively managed funds over time. There are plenty of sound “lazy portfolios” that make for great long-term investment strategies. Here are a few of them:

Avoid Expensive Advisors: There’s simply no good reason to pay more than about 0.30% of AUM, at the most. Vanguard offers its services at this price. Why pay more? And there are plenty of advisors who charged by the hour, which is even better.

Consider Automated Investment Services: For those that want a little help, you can consider a robo advisor. They come in all shapes and sizes. I like Betterment and Wealthfront for those who want a set-it-and-forget-it arrangement. Cost is about 25 basis points. For those who want more control, M1 Finance is the way to go. It lets you create your own mutual fund (they call them Pies). It’s easy to use, easy to rebalance, and free.

Personal Capital Review and User’s Guide (Update for 2022)

by

Personal Capital is a financial tool that enables you to manage 100% of your finances from a single dashboard. I’ve used the app for years. In this Personal Capital review and user’s guide, I’ll walk through all of its features and how to leverage them to help you make the most of your money.

Table Of Contents
  1. Getting Started with Personal Capital
  2. Personal Capital Banking
  3. Personal Capital Investing
  4. Personal Capital Planning
  5. Personal Capital FAQs

This article contains references to products from one or more of our advertisers. We may receive compensation when you click on links to those products. The opinions and views expressed, however, are our own.

Getting Started with Personal Capital

The first step is to sign up for a free account. Then you want to connect all of your financial accounts. While Personal Capital is perhaps best known for analyzing and tracking investments, I also connect all of my bank accounts, credit cards, loans, mortgage, and even my home. You can add your home and Personal Capital will pull in the value from Zillow.

Get Personal Capital for Free

Linking Your Accounts

Over the years I’ve linked may of the following types of accounts to Personal Capital:

  • Bank Accounts (checking, savings, CDs, money market accounts)
  • Retirement Accounts (401k, 403b, TSP, IRA, among others)
  • Non-Retirement Investment Accounts
  • HSA
  • Credit Cards
  • Mortgage
  • Student Loans
  • Personal Loans

You can link just about any financial account for which you have online access. You’ll need your username and password for each account. To link an account, you’ll search for the name of your financial institution in the “Link Your Account” dialog box on Personal Capital (you get to it by clicking the “+” icon near the top left of the Dashboard):

Link Your Account to Personal Capital

Tip: You can search by the name of your financial institution or by its website address (url). In the unlikely event you have a financial account that can’t be linked to Personal Capital, you can enter it manually.

So why bother to connect all of your accounts? As you’ll see below, Personal Capital does a lot more than keep an eye on your investments. By connecting all of your financial accounts, you can track your net worth, budget, cash flow and even your bills. And all of this information is pulled together in a Dashboard.

Settings & Profile

Once you’ve linked your accounts, it’s critical that you complete your Settings and Profile. Both can be found by clicking on your name in the top right corner of the screen.

With Settings, you have control over email subscriptions (you can get daily or weekly updates of all your income, spending and investments), whether to include investment income and dividends in cash flow (I do), and any accounts to exclude from the advice Personal Capital offers (I don’t exclude any).

Settings also include important security features. It’s here that you can configure multi-factor authentication (highly recommended) and an alert anytime a login is attempted from a foreign country (also highly recommended).

Personal Capital also shows you a list of the devices you’ve authorized to access your account and when the last sign-on from that device occurred. I’ll often delete old devices I no longer use from this list.

The Profile is where you can set information about you and your spouse, your savings, income sources, and investment objectives. These are important settings that Personal Capital uses in its planning tools, such as its free Retirement Planner.

Dashboard

Once you’ve linked all of your accounts, Personal Capital aggregates it in the Dashboard. The Dashboard gives you a snapshot of your entire financial picture. Here’s what the dashboard looks like:

Personal Capital Dashboard
Personal Capital Dashboard

As you can see, it gives you a snapshot of your net worth, your monthly budget, your cash flow, your investments, and even where you are on your retirement and emergency savings goals.

Net Worth

There’s nothing more important to your financial freedom than racking your net worth. While I’m a big believer in keeping tabs on it in a spreadsheet (which I’ve done for years), I also track it in Personal Capital. If you connect all of your financial accounts, it’s tracked automatically.

Here’s what the Net Worth screen looks like in Personal Capital:

Personal Capital Net Worth
Try Personal Capital

Personal Capital Banking

I’m surprised at how much I use the banking features of Personal Capital. The primary features that I rely on are the Cash Flow and Budgeting functions. Specifically, the tool shows me how much investment income we generate each month (interest and dividends). The budget tool shows me how much we spent and on what by category.

Cash Flow

Cash flow shows both your income and expenses at a transaction level. Expenses are automatically categorized. You can easily drill down into income or expenses to look at the details.

You can also select which accounts to include in the report. I use this account selection feature to look at just my business expenses (I’ve connected by business checking and credit card accounts). I also use it to look at income just from my investment accounts. This allows me to quickly see all dividends and interest earned in my portfolio.

Personal Capital Cash Flow Calculator

Budgeting

The budgeting feature is not a traditional budgeting app. You can set an overall monthly spending goal, but you can’t set goals by category. If that’s what you need, I highly recommend YNAB (You Need a Budget).

What Personal Capital does well is give you visibility into how you’ve spent your money by category. It automatically imports all spending from each linked account and categorizes the spending. You can customize the categories. I’ve found Personal Capital to do a reasonably good job of getting the categories right, although I do spend about 5 minutes a month correcting some transactions.

Tip: In addition to categories, you can tag transactions, too. I use a limited number of categories, and than tag transactions as needed. For example, we have a home maintenance category. For work on our pool, I tag those transactions as “pool” so I can see how much we spend on the pool without need to create a separate categori.

Bills

The bills feature is another reason to link your credit cards, mortgage, and other loans. Personal Capital keeps track of when bills are due with your linked accounts. This helps you avoid missed or late payments, and it helps with planning throughout the month.

Try Personal Capital

Personal Capital Investing

Here’s where Personal Capital really shines. Once you’ve connected your retirement and non-retirement accounts, it tracks your investments automatically. It updates prices throughout the trading day and keeps tabs on mutual fund expenses. It also shows you your asset allocation and offers a number of tools to help you evaluate your portfolio

Holdings

You get an overview of each of your holdings. The tool shows the following for each investment you own:

  • The name of each investment
  • Its ticker
  • How many shares you own
  • The current price
  • The days change (in both dollars and as a percentage)
  • The total value

It also gives you an overview of your performance. Here’s mine in the middle of the 2020 bear market (Yikes!):

Personal Capital Portfolio performance Graph

Allocation

Personal Capital also shows you your asset allocation. It automatically evaluates your investments and reports on your stock/bond allocation. For each it breaks down asset classes further, showing U.S. and International stocks and bonds, as well as alternatives.

The tool also provides a useful interactive graphic representation of your portfolio allocation. With the click of a mouse, you can explore what investments make up each of these asset classes. One interesting item is cash. The asset allocation tool not only shows you the cash in say money market accounts, but it also sees the cash held by stock mutual funds.

Tracking Bitcoin & Crypto

In big news for those who invest in Bitcoin, Ethereum, Litecoin and other cryptocurrencies, Personal Capital can now track these investments. Best of all, investors do not need to grant access to their crypto wallets or turn over passwords.

Instead, investors can add a manual account in Personal Capital. For each token owned, you simply indicate the symbol, exchange and amount. Personal Capital is now able to track thousands of tokens across hundreds of exchanges.

Personal Capital Planning

So far the dashboard has simply shown you your accounts and investments from various perspectives. It’s the planning tools that really take the tool to the next level.

Retirement Planner

Personal Capital’s retirement planner is both robust and easy to use. Because you’ve connected all of your investment accounts, Personal Capital can use this data to determine your retirement readiness. The screenshot below shows you want the calculator looks like once you’ve linked your accounts.

Personal Capital Retirement Planner

There’s a lot going on here, so let’s break it down:

  • Profile: In the bottom right of the above screenshot is the “Edit Profile” button. It’s here that you can set your marital status, tax filing status, you and your spouse’s name and dates of birth, how much you each earn per year, and any children you have.
  • Assumptions: The “Edit Assumptions” button enables you to set an estimate of your effective tax rate, inflation rate, and your life expectancy.
  • Income Events: You can add ongoing or one-time income events. These may include your yearly savings, a planned sale of a business or other asset, pension income you’ll receive in retirement, and even an estimate of your social security.
  • Spending Goals: Spending goals can include an estimate of your yearly spending in retirement as well as one-time expenses. For example, you could include the cost of a planned vacation in retirement or the cost of a future wedding for your children.
  • Retirement Score: Your retirement score shows a percentage representing the likelihood that your money will last through retirement. According to Personal Capital, a score of 50% to 80% “suggests you are on track, but it is important to understand and acknowledge that the portfolio does deplete in a meaningful amount of the projected scenarios.” A score above 90% means “there is relatively little to worry about and, most likely, you could afford greater spending now or it will be possible to increase spending over time.”
  • Graph Views: The graph above shows the portfolio based on an analysis of thousands of potential market returns. You can also view your accounts by asset location (i.e., Taxable, Tax Deferred and Tax Free.

The Retirement Planner also enables you to create multiple scenarios and then compare them. For example, one scenario may have you retiring at a traditional age, while another one has you retiring early. In one, you may include an estimate of social security, while in another one you exclude it. You could also change the assumptions on one scenario related to your effective tax rate, future inflation, or your life expectancy.

Once you’ve created a new scenario, you can then compare them side-by-side.

Savings Planner

The Savings Planner is three tools in one: Retirement Savings, Emergency Fund Savings, and Debt Paydown. Each enables you to set and track goals.

Personal Capital Savings Planner

Retirement Savings Planner

Here you can set an annual retirement savings goal. The planner tracks your actual savings throughout the year, including your contributions to retirement accounts like 401k and IRAs. It will also track any savings you have in taxable accounts.

Keep in mind that this planner and your Retirement Planner are connected. If you change your savings goal in one, it automatically updates the other.

Emergency Fund Savings Planner

For the Emergency Fund, Personal Capital totals the value of all of your linked bank accounts. It then recommends an Emergency Fund of 3 to 6 months worth of expenses based on the budget amount that you set. As with the retirement planner, any changes in your monthly budgeted amount here automatically updates your Budget in the Banking section of Personal Capital.

Debt Paydown Planner

Any debts, including car loans, mortgages and personal loans, will show up in the Debt Paydown planner. Note that credit card debt will also show up in the planner if there have been at least two interest transactions within the last 90 days. In other words, your credit cards will not show up here if you pay them off in full each month, thereby avoiding interest charges.

The planner will show each debt, along with its interest rate (APR), change in balance year to date, and current balance. It also displays a graph of the changing in debt balances in the current year.

Retirement Fee Analyzer

The retirement fee analyzer is, I must confess, my favorite part of Personal Capital. It’s easy to dismiss relatively “small” investment fees as unimportant. The problem, of course, is the effect fees have on your wealth over decades of time. A 1% advisor or mutual fund fee may seem small, but over time it can literally cost you hundreds of thousands of dollars.

Retirement Fee Analyzer

Personal Capital calculates a weighted average expense ratio for all of your linked accounts. Mine comes in at just 6 basis points–0.06%. That’s well below the average, and yet it will still cost me $17,865 over the next seven years according to the Fee Analyzer!

Fees matter–a lot. This tool by itself makes Personal Capital a must.

Investment Fee Checkup

The investment checkup evaluates your asset allocation and compares it to what Personal Capital recommends. Based on your investment profile, Personal Capital recommends an asset allocation. Here’s what it recommends for me, given my age, years to retirement and risk tolerance:

Personal Capital target asset allocation
Recommended Asset Allocation

My actual allocation has about 5% more bonds than what the above graphic shows. What’s interesting about this tool is that Personal Capital also shows you the historical performance of its recommended portfolio, future projections, risk & return and a comparison with your actual allocation.

If you want to follow the recommendation, Personal Capital provides a listing of those asset classes that need to increased, decreased and by how much.

Personal Capital FAQs

Is Personal Capital safe?

Yes. Personal Capital encrypts data with AES-256 with multi-layer key management, including rotating user-specific keys and salts. Further, no individual at Personal Capital has access to your credentials.
In addition, you must authenticate each device that accesses your account. You’ll receive an automated phone call, email or text message to confirm your identity. You can learn more about Personal Capital’s security here.

Is Personal Capital really free?

Yep. Its investment services are not, but its financial tools are completely free.

Will Personal Capital call me?

Yes. They use the financial dashboard as a marketing tool. I’ve spoken with their advisors in the past, although I’ve never used the investment services. If you don’t want them to call you, just tell them. They honored my request.

Do I have to invest with Personal Capital to use the dashboard?

No.

How much does Personal Capital cost?

The financial dashboard is free. If you do want to use their investment advisory services, the fees start at 0.89% for the first $1 million and go down to 0.49% for amounts over $10 million.

Try Personal Capital

Related: Best Financial Tools & Resources, Best Stock Tracking Apps, Best Quicken Alternatives, Best Mint Alternatives

The Paul Merriman Ultimate Buy and Hold Portfolio

by

I first met Paul Merriman back in 2017. He was kind enough to come on my podcast to talk about what he calls the Ultimate Buy and Hold Portfolio. We’ve kept in touch over the years, and in fact we were just talking about a month ago. In this article we’ll dig into the details of his investing strategy.

Table of contents

Who is Paul Merriman?

Paul Merriman

Paul founded an investment advisory firm back in 1983. He retired in 2012, and in 2013 he started the Merriman Financial Education Foundation where he helps educate investors. He’s also published several books, including his most recent one, We’re Talking Millions!: 12 Simple Ways To Supercharge Your Retirement.

Over the years he’s developed what he calls the Ultimate Buy and Hold Portfolio. As you’ll see, it consists of 10 stock asset classes, each implemented with a low cost index mutual fund or ETF.

The Ultimate Buy and Hold Portfolio

Stocks

There are several versions of Paul’s Ultimate Buy and Hold Portfolio. We’ll spend most of our time looking at the version that has become famous over the years. It consists of the following 10 stock asset classes:

  • S&P 500
  • U.S. Large Cap Value (LCV)
  • U.S. Small Cap Blend (SCB)
  • U.S. Small Cap Value (SCV)
  • Real Estate Investment Trust (REIT)
  • International Large Cap Blend (LCB)
  • International LCV
  • International SCB
  • International SCV
  • Emerging Markets

Paul allocates the equity portion of a portfolio equally across these asset classes. For example, a portfolio of 100% stocks would see 10% allocated to each asset class. An 80/20 portfolio would have 8% allocated to each class, with 20% going to one or more bond funds (we’ll look at examples in a moment, but you can check out Paul’s portfolio implemented as a 80/20 portfolio on M1 Finance.)

Bonds

Merriman recommends three types of bonds for the fixed income portion of his strategy:

  • Intermediate term Treasury bonds (50% of total bonds)
  • Short term Treasury bonds and bills (30%)
  • Short term TIPS (20%)

I agree with much of what he suggests. He’s avoided high-risk bonds such as those issued from emerging market governments or troubled corporations. He’s also kept to a shorter yield curve and added some exposure to inflation protected securities.

If there’s any aspect I might adjust it’s to add more TIPS. If you believe inflation will be higher in the future than the market is predicting, TIPS are a way to place that bet. In contrast, if you think inflation will be lower than expected, Treasury bonds are the answer.

For those like me who have absolutely no idea, you split your bond portfolio equally between the two. That’s exactly what the David Swensen Portfolio does. The only caveat today is that TIPS start with a negative yield, and if you’re like me, that’s a hard pill to swallow. Nevertheless, that’s how I’ve implemented the Ultimate Buy and Hold strategy in M1 Finance.

How the Ultimate Buy and Hold Portfolio is Different

There are several aspects to note about Merriman’s investing strategy:

International Exposure: The portfolio allocates a full 50% of equities to international funds. This is unique among the portfolio’s I’ve evaluated. Most are less than 50%. The Warren Buffett Portfolio doesn’t allocate anything directly to international stocks. And Vanguard’s founder, Jack Bogle, saw no need to own international stocks.

I personally think international exposure is important. My portfolio allocates about 30% to global funds.

Small Cap Exposure: The Ultimate Buy & Hold portfolio allocates 20% to small cap stocks. It does so because history tells us that small cap companies out perform large cap companies over the long term. Over the past 50 years, small cap has outperformed large cap by more than 1%. A $10,000 investment beginning in 1972 would grow to more than $2.7 million if invested in small companies, compared to $1.5 million in large companies.

Source: Portfolio Visualizer

Value Exposure: Finally, Merriman’s strategy favors value investments over growth. Again, history tells the story. Although growth stocks have outperformed value recently, over the last 100 years, value has performed better in both large and small companies.

Historical Performance of the Ultimate Buy and Hold Strategy

The big question is how Merriman’s Ultimate Buy and Hold portfolio has performed. As you can see in the chart below (click the image to enlarge it), the portfolio has trounced the S&P 500 over the last 50 years.

The portfolio has returned 12.4% annually compared to 10.7% for the S&P 500. Note, however, that it comes with more risk. The standard deviation of Merriman’s portfolio, when rebalanced annually, weighs in at 18.5%, compared to 16.9% for the S&P 500. In other words, if you can handle the volatility, Merriman’s portfolio may be a sound option. Note too that by rebalancing monthly, you decrease both the returns and volatility.

Before we leave the performance of this investing strategy, it’s worth looking at how well it’s done over the last decade. As you can see, the portfolio has lagged the S&P 500 since 2010:

Source: Portfolio Visualizer

Why? Over the last decade large companies have outperformed small companies, growth companies have outperformed value companies, and U.S. companies have outperformed international companies. In other words, in just about every way that the Buy and Hold portfolio overweights has seen underperformance.

Much of this is the result of a low inflation, and easy money policy of the Fed and federal government. Massive borrowing and spending has sent asset prices soaring, which favors larger growth companies.

I don’t believe this undermines Merriman’s portfolio. The U.S. can’t borrow to infinity. But it does underscore that any investment strategy can lag the market for extended periods of time.

Building the UB&H Strategy

There are a number of ways to construct the Ultimate Buy & Hold Strategy. I’ve built one approach in M1 Finance using low cost index ETFs:

Keep a few things in mind. First, the above portfolio is 80% stocks and 20% bonds. One can easily change this to whatever stock/bond allocation is best to meet their investment goals.

Second, some of the chosen ETFs cover more than one asset class. For example, Vanguard’s small-cap ETF (ticker: VB) includes mid-cap companies. I think this is a perfectly reasonable approach to the UB&H strategy, but one could easily substitute a micro-cap ETF (e.g, iShares Micro-Cap ETF IWC).

Here’s what the asset allocation looks like in Personal Capital:

Finally, M1 Finance is ideal for this portfolio as it makes rebalancing easy. With M1, you can rebalance a portfolio with the click of a button.

The Simplified Ultimate Buy and Hold Portfolio Alternative

Paul Merriman and his team have released simplified versions of the UB&H portfolio. These are ideal for those who don’t want to juggle 10 stock asset classes! He has both a 4-fund and a 2-fund solution.

Source: https://paulmerriman.com/4-fund-combo-latest-recommendations/

4-Fund Ultimate Buy and Hold Portfolio

The Merriman 4-Fund Portfolio (see it here at M1 Finance) consists of the following four asset classes:

  • LCB (S&P 500)
  • LCV
  • SCB
  • SCV

This portfolio’s performance is similar to the 10-fund portfolio. It has averaged 13.8% over rolling 15-year periods since 1928. The S&P 500 has averaged just 11.0%.

2-Fund Ultimate Buy and Hold Portfolio

The 2-fund solution has performed even better. Its average performance over rolling 15-year periods is an amazing 14.5%. Here, however, some cautionary words.

The 2-fund portfolio bets everything on value investing. The two asset classes are SCV and LCV. In the short to medium term, this portfolio could significantly underperform the market, such as what the 3-fund portfolio seeks to replicate.

Final Thoughts

The 10-fund Ultimate Buy & Hold portfolio is an excellent way to potentially outperform the market without sacrificing diversification. It does, however, represent a more volatile approach to investing. Therefore, it’s not for everyone. At the same time, one can modify the portfolio to better suit individual approaches to investing.

My Research for this Article

© 2021 RobBerger.com. All Rights Reserved. Contact | Privacy Policy | Terms of Use