Mutual Fund Recommendations

Now that you have started your automatic savings plan, you need a place to put the money. Each of the options below get progressively more complicated and take more effort to setup and manage. They also require more and more personal decisions such as your preferred ratio of Stocks to Bonds, and US to International holdings. Please note, that just because they are more complicated, it does not mean that they are "better". They do give you more options in case certain things are important to you.

Options

  1. Automate Everything
  2. Choose My Ratio of Stocks to Bonds
  3. Control My International Exposure
  4. Diversification by Capitalization
  5. Weight Stocks by Value


Option 1: Automate Everything

What do I want?

  • I want the simplest portfolio possible.

Specifics

  • I want my fund to automatically rebalance my ratio of Stocks to Bonds as I age.
  • I am comfortable with 35% of my Portfolio in International Stocks.
  • I do not care about Market Capitalization.

Thoughts

Enter the "Retirement Date" fund. Pick your retirement date and put 100% of your money into this fund. You are done.

This is a very common option in company 401k plans and suitable for anyone. This should be your baseline of comparison to any other investment. For a mutual fund to be "better" it has to be better than this. Not only in total returns, but in returns vs stability and complexity.

Example

VTHRX Stock/Bond 100% Vanguard Target Retirement 2030 Fund


Option 2: Choose My Ratio of Stocks to Bonds

What do I want?

  • I like the Retirement Date Fund idea, but I want more control over my ratio of Stocks to Bonds.

Specifics

  • I want to choose my ratio of Stocks to Bonds.
  • I am comfortable with 35% of my Portfolio in International Stocks.
  • I do not care about Market Capitalization.

Thoughts

If you are receive all of your income from mutual funds, and you have no buffer (I.E. you spend everything you make every year), then this plan is not for you.

The reason to increase the percentage of Bonds you hold over time is to have a cushion for the bad times in your portfolio. When the stock market has a "correction" you live off of the bonds until stocks have recovered.

Some people may have another source of retirement income that could replace part of this. For example if you have a government or state retirement plan that may be your "base" income and you may not be looking for your mutual funds to provide absolute critical and consistent returns.

Example

VASGX Stock/Bond 100% Vanguard LifeStrategy Growth Fund 80/20


Option 3: Control My International Exposure

What do I want?

  • I want to invest in the entire world but I want control over my International exposure.

Specifics

  • I want to choose my ratio of Stocks to Bonds.
  • I want to choose my exposure to International Stocks.
  • I do not care about Market Capitalization.

Thoughts

For many people, the ideal of holding international stocks is uncomfortable, or they may wish to have control over the amount they own.

Example

Assuming you want the following
   80/20 (Stocks/Bonds)
   80/20 (US / International)

VTHRX Stock (US) 60% Vanguard Total Stock Market Index Fund Admiral Shares (US)
VTIAX Stock (INT) 20% Vanguard Total International Stock Index Fund Admiral Shares
VBTLX Bond (US) 20% Vanguard Total Bond Market Index Fund Admiral Shares (US)


Option 4: Diversification by Capitalization

What do I want?

  • I want to do everything myself. I think that while index funds are good, unless they are broken out by capitalization you will lose the gains available from smaller or value companies. I have also probably read about Efficient Market Theory, Modern Portfolio Theory, and Famma and Frech.

Specifics

  • I want to choose my ratio of Stocks to Bonds.
  • I want to choose my exposure to International Stocks.
  • I want to choose my ratios of Market Capitalization.

Thoughts

How much Market Capitalization effects returns and should I design a portfolio around it, is a grey area. If you asked me 20 years ago I would have say "of course" dismissively along with everyone else. And then the next 20 years came along with Large Cap Growth stocks being the market lead by a mile and skewing all the pretty curves. We also have some new Mutual Fund options like the Vanguard Total Stock Market Index Fund which unlike the S&P 500 actually will give you exposure to everything. The again, it's a weighted average fund, so it will not give you equal exposure to small cap funds. So is this important? Will Growth dominate the next 20 years? Will Small Cap soar? Nobody knows.

Example

Assuming you want the following
   80/20 (Stocks/Bonds)
   65/35 (US / International)

VFIAX Large Blend 15% Vanguard 500 Index Fund Admiral Shares
VIMAX Mid Blend 15% Vanguard Mid-Cap Index Fund Admiral Shares
VSMAX Small Blend 15% Vanguard Small-Cap Index Fund Admiral Shares
VTIAX International 35% Vanguard Total International Stock Index Fund Admiral Shares
VBTLX Bond (US) 20% Vanguard Total Bond Market Index Fund Admiral Shares


Option 5: Weight Stocks by Value

What do I want?

  • I want to do everything myself. I think that while index funds are good, unless they are broken out by capitalization you will lose the gains available from smaller or value companies. I have also probably read about Efficient Market Theory, Modern Portfolio Theory, and Famma and Frech.

Specifics

  • I want to choose my ratio of Stocks to Bonds.
  • I want to choose my exposure to International Stocks.
  • I want to choose my ratios of Market Capitalization.
  • I want to overweight my ratio of Value Stocks to Growth Stocks.

Thoughts

This is the portfolio composition that I am most familiar with and have a version myself. Similar to the portfolio above, it was created at a time when there was a good 40 year history showing that over time Small Cap and Value stocks out preformed Large Cap and Growth Stocks. The idea was to make sure you had an equal weighting of Small Cap stock and to "overweight" the Value side.

I can't really complain about the return's because the numbers below don't show the entire story. It's crazy but for an industry that promotes holding stocks for the long term, they don't give 20 and 25 year returns. In those years Small Cap and Bond Funds were doing very well and you could pretty much swap these returns. Where it will go in the next 20 years, is anyone's guess.

Example

Assuming you want the following
   80/20 (Stocks/Bonds)
   65/35 (US / International)

VVIAX Large Value 11% Vanguard Value Index Fund Admiral Shares
VFIAX Large Blend 11% Vanguard 500 Index Fund Admiral Shares
VSIAX Small Value 11% Vanguard Small Cap Value Index Fund Admiral Shares
VSMAX Small Blend 11% Vanguard Small-Cap Index Fund Admiral Shares
VTIAX International 35% Vanguard Total International Stock Index Fund Admiral Shares
VBTLX Bond (US) 20% Vanguard Total Bond Market Index Fund Admiral Shares