The loss of a family member is a terrible event. How do you avoid losing your inheritance as well?
Target Retirement Funds. The good, the bad and the downright ugly.
How many assets classes do you need to be sure that your portfolio is properly diversified?
I deal with these challenging questions in this week's column.
If you want me to consider your questions, please add them as comments to this blog.
I encourage readers who know the answers to some of the questions posted to continue to reply to them. Many of your answers are excellent and this permits me to respond to even more inquiries.
Question From: Deecarda
Mr. Solin, please, I need some guidance. My mom recently passed away & left me the beneficiary of her insurance policies. I am having a hard time dealing with my sorrow, and I feel guilty for leaving this money earning approx 3% due to my inability to make any financial decisions. I just don't know what to do & am skeptical of financial counselors in the marketplace. Can you offer any advice?
Deecarda,
I am very sorry for your loss. You are wise to take your time before making important financial decisions.
Your skepticism about financial counselors is well placed. My recommendation would be to avoid them and to consider taking these steps:
1. Keep 6-12 months of expenses in a money market account or in an FDIC insured certificate of deposit;
2. Take the asset allocation questionnaire at: www.smartestinvestmentbook.com
3. Use low cost index funds for your portfolio. You can see the funds I recommend by going to my blog here.
I don't know the amount of your inheritance. However, you might want to also consider whether using (and paying for) a passive advisor who can place your funds in mutual funds managed by Dimensional Fund Advisors (DFA) might make sense for you.
A recent study by a Professor of Finance at Duke and a master's candidate in economics also at Duke, found that DFA funds, which are passively managed, significantly outperformed Vanguard funds during the period studied, and justified paying an advisory fee. You can access this study here. [PDF]
I have previously disclosed that I recommend DFA funds to my individual clients and also recommend that they be included in 401(k) plans.
Question From TheLar:
Hey Dan! It's great to see this down-to-earth advice on HuffPo. A couple questions:
1. In keeping with a broad and general view of HuffPo's values (which I share deeply) what is the best way to invest ethically? For example, there is much mention of Fidelity divesting its investments in Darfur. I also tend to avoid international funds and oil because international businesses do not always respect basic human rights and worker rights. Also, the oil industry's misdeeds are well known. Any advice on ethical investing for the common man? (i.e. Not Warren Buffet?)
2. How do you feel about retirement targeted funds? Speaking of Fidelity again, they have "Freedom Funds 2030," for example. The goal being they manage your money with the understanding you intend to retire in 2030. Thoughts?
TheLar,
Please see see my prior blog on socially responsible investing which you will find here.
Targeted Retirement Funds come in all stripes. I like the concept of a pre-allocated portfolio since asset allocation is the most critical decision that investors can make and these funds not only make that decision, but take over the burden of rebalancing to insure that the asset allocation remains in place.
However, here are some important caveats:
Not all people who are going to retire at a given date should have the same asset allocation. For example, an employee with a large trust fund could afford to take greater risks than someone without that financial cushion. Therefore, it is important to determine if the fixed asset allocation the Target Retirement Fund you are considering is appropriate for you.
I also do not recommend Target Retirement Funds unless all of the underlying funds are low cost index funds. Most of the funds in the Fidelity Freedom Funds are actively managed. The expense ratio of the Fidelity Freedom Fund 2030 is 0.80%.
In contrast, the Vanguard Target Retirement Funds consist of only index funds and their expense ratio is a rock bottom 0.21%.
This is a significant difference in fees which is meaningful to investors over the long term. I have no affiliation with either Vanguard or Fidelity.
Question From: SpyvsSpy
Love the commentary, Dan. Keep it up.
Just read something by Scott Burns on MSNMoney suggesting a non-standard allocation that cuts risk but keeps up with market returns. Would be very interested in your opinion.
Here's the quote:
"His two-asset portfolio -- 50-50 U.S. large- and small-cap stocks -- produced an annualized internal rate of return of 10.74%. But it lost a deadly 30.8% in its worst year. His seven-asset portfolio -- equal portions of U.S. large- and small-cap stocks, international stocks, U.S. intermediate fixed-income investments, cash, REITs and commodities -- provided an 11.25% return. But the worst-year loss was only 10.2%".
So whaddya think? Does an allocation like this make more sense that a conventional 70/30 stock/bond mix for a self-directed mid-fifties buy and hold investor?
Scott Burns is one of the most respected financial journalists around. He has been advocating index based investing for years. I am in agreement with his basic premise.
I agree that a two asset portfolio does not give investors adequate diversification and is too risky for most investors.
I don't know all of the details of his seven asset class portfolio, but it seems very close to the portfolios I recommend. My recommended portfolios consist of three, low cost index funds:
* The domestic stock fund has as its benchmark the Wilshire 5000 index;
* The international stock fund has as its benchmark the Total International Composite Index;
* The bond fund has as its benchmark the Lehman U.S. Aggregate Bond Index
There is a wealth of long term historical data indicating that this mix of funds, appropriately allocated, provides excellent diversification (which reduces risk) and optimal returns.
The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein.