Bad portfolios are messy. Good ones, even very big good ones, are simple.
This essay is the first in a series of seven aimed at distilling the essence of retirement finance into short lessons. Future installments will deal with such matters as seeking yield and paying for a nursing home.
You don’t need complicated or expensive advice to get on a good path. You don’t need to devote a lot of time to finances, either. My seven-step plan asks for a very small investment in that scarce resource.
The biggest mistake people make with their money is in how they invest it. They have complicated, expensive portfolios.
I see a lot of this mistake. A dentist came to me at a social event and asked for advice on accessing his retirement assets. I had no clever escape from his dilemma. Seems he had followed the recommendation of some experts and set up a defined-benefit Keogh to maximize the tax savings. Now, well ahead of retirement, he needed cash.
The dentist had paid a ton to lawyers and actuaries to set the thing up and now he was going to pay ordinary income tax, plus a bunch of professional fees, to get the money out. He would have been better off without the fancy footwork. If he had just put his earnings into a brokerage account he could have gotten at the money whenever he wanted. The tax would have been at the low capital gain rate.
My second case study is a $550,000 retirement account whose details were shared with me. It was a clutter pile, with 20 different fund positions in amounts as small as $5,000. Some of the funds were quite expensive.
Who picked this hodgepodge? A professional. This planner was collecting a 1% annual fee to run the money. It’s hard to justify pocketing $5,500 a year for providing the correct advice, which is to buy a few cheap index funds and not touch them. So the planner didn’t provide the correct advice. Instead, he provided complicated advice.
Example three involves a lawyer who did work for investment partnerships and wound up with stakes in a lot of them. There was some method to this madness—tax minimization—when he was around to monitor all the pieces. But then he fell mortally ill. In his final weeks he scrambled to simplify and liquidate, but there wasn’t time.
On the day he died, he had two dozen accounts at a dozen custodians. His accounts were titled seven different ways (joint, individual, different trusts with different beneficiaries, IRA and so on). To untangle the mess his family spent a small fortune on estate professionals.
If investing is your passion, if you love spreadsheets, if you do your own taxes, then maybe having a lot of positions or financial accounts makes sense. But do think about your heirs. They might have different hobbies.
And if you hate managing money? You don’t have to spend $5,500 a year to get the work done. I have two portfolio recipes. Both recipes are free, and both use as ingredients only cheap index funds.
The first recipe takes five minutes. It consists of a single investment in what I’ll call the Zen fund.
Put all your retirement savings in the Vanguard Balanced Index Fund. Your portfolio will be a collection of 11,400 stocks and bonds, professionally managed for a microscopic fee. How often should you check on how it’s doing? Once every 40 years is often enough.
The second solution takes 20 minutes. It’s my 4-3-2-1 portfolio. You put 40% in U.S. stocks, 30% in high-quality bonds, 20% in foreign stocks and 10% in slightly risky bonds. Use cheap index funds from the Forbes Best ETFs for Investors list.
Unlike the 5-minute portfolio, the 20-minute portfolio needs occasional refreshing. Do some selling and buying to get your percentages more or less back to where they were at the start. This is called “rebalancing.”
Financial planners recommend rebalancing every three months, but I think that’s a needless complication in your life. Bear in mind that rebalancing doesn’t increase your expected return one bit; it only keeps your risk level in place. Why do the pros make a fuss over doing it frequently? In order to justify their fees. If you’re on your own, and if you don’t relish massaging your assets, rebalance every 5 years.
Tomorrow’s installment will tackle the eternal quest for yield. To find it, bookmark this page.
Originally published at Forbes