401(k) Investment Advice

In My Humble Opinion
21

I base my IRA allocations on when I’m going to need the money. I’m in retirement, so I withdraw money monthly to supplement my pensions. I keep two years worth of withdrawal money in cash equivalents. That’s eight separate two-year certificates of deposit in a ladder so that one matures every quarter.

Then I keep seven years worth of money in a bond index fund at Vanguard.

The balance is kept in equities, split up between the Vanguard Total Stock Market Index Fund, The Vanguard International Stock Index Fund, and the Vanguard REIT Index Fund. Probably 60% Total Stock Fund, 30% International Stock Fund, and 10% REIT Index Fund, although those percentages are liable to drift because I only rebalance annually.

Something you need to look at when you consider expenses is what they are in relation to the return, not the portfolio. For example, you mention the Fidelity Intermediate Bond Fund has a fee of 0.45%, which you called minimal. The ten year return on that fund is 4.0%, which means that over the last decade 11.25% of the return goes to fees. You might not call that minimal. I sure wouldn’t. My largest holding is in the Vanguard Total Stock Market Index and has a ten year return of 14.71% with an expense ratio of 0.04%, that’s about 0.3% on return.

22

The key with rebalancing is to do it on a set schedule, rather than at random times when you think the market is particularly high or low; the latter approach is basically trying to time the market, which is likely to work out poorly for most folks.

As Voyager has said, the idea is that you choose a stock/bond investment ratio for your portfolio to establish a risk profile you’re basically comfortable with. Since stocks and bonds tend to perform differently, the actual ratio in your portfolio will tend to drift over time. So once per year you review your portfolio to see what you need to buy/sell in order to get it back to your target ratio. In a typical year, the stocks will outperform bonds, so you’ll sell a few stocks and use the proceeds to buy bonds. If a recession hits, stocks perform worse than bonds - so in this case you end up selling bonds so you can buy stocks. You’re doing this on a set schedule, so there’s no wondering about whether this is a good time to buy/sell anything, you just follow the rule once per year: buy/sell whatever you need to restore your target ratio. The net result is that this strategy forces you to sell things that are priced high (locking in those gains) and buy things that are priced low, even if they are not currently at their absolute peak/trough (it’s not possible to do the latter unless you can predict the future).

Some people think that being 100% in bonds is the safest thing, but it’s not. Not only does being 100% in bonds give you the lowest return, it also doesn’t minimize your risk (defined as the uncertainty/range of possible nest egg sizes at the end of your multi-year investment period). You can minimize your risk by keeping about 20% of your assets in stocks, while increasing your average return at the same time. This is why the standard advice for retirees is to keep roughly that much in stocks, rather than moving 100% to bonds.

At the same time, as the plot I linked to shows, being 100% in stocks means taking on a lot of extra risk for only a very small increase in average return. If you’re willing to sacrifice half a percent from your annual average return (by targeting 20% bonds in your portfolio), you can greatly reduce your risk, increasing the likelihood that your nest egg will hit (or be very close to) its expected target at the end of your investment period. So even for new investors at the start of their professional career, it’s sensible to keep a significant portion of their portfolio in bonds.

There are target-date retirement mutual funds available that keep a portion of the fund in bonds. The fund manager rebalances on a regular basis, and the bond percentage increases year after year, with the intent that the investor doesn’t need to bother with rebalancing. But the performance of the specific stocks involved, along with the fund’s expense ratio, are much more important considerations. It’s probably smarter to invest in other funds that perform better and/or have a lower expense ratio, and just manage the annual rebalancing yourself (this also lets you choose whatever stock/bond ratio you’re most comfortable with).

So, my advice to the OP? 12% bonds is not a bad place to be at 50. I wouldn’t move any of that to stocks at this point. In fact, year after year from now on, I’d suggest rebalancing on an annual basis to increase your bond percentage by maybe a couple of points. So on January 1, 2020, rebalance to 14% bonds. On 1/1/2021, rebalance to 16% bonds. And so on. In 15 years, when you’re close to retirement, you’ll be at about 42% bonds, 58% stocks. The rule of thumb is that your stock percentage should be 100 minus your age, i.e. at 65 you should have 35% stocks in your portfolio. So my advice has you taking on a little more risk than is generally recommended; it’s up to you whether you want to take on that risk (in pursuit of greater gains) or be more conservative (for a lower but more predictable nest egg result), as by ramping up your bond percentage faster than I suggested.

Advice to OP’s son? Unless he’s willing to do research on forecasts for various market segments, I’d recommend 80% of his investment be in index stock funds, and the other 20% in a bond fund, along with annual rebalancing to maintain that ratio until he’s in his mid-50s, at which point he would be wise to start shifting the balance toward bonds.

For a good book on investing, including some very basic explanations of why stocks are better than bonds for long-haul investors and why rebalancing works, I recommend The Intelligent Asset Allocator. In the early parts of the book, he communicates the fundamentals of investment with easy to understand examples involving a benevolent uncle and some coin tosses, and goes on to show how actual investment strategies would have performed during any given period of actual stock market performance. It’s pretty illuminating.

23

I snipped a lot of stuff I agree with to get to some that I don’t. Any allocation should take into account both how much you have and how much you need and not be fixed by your age. A 65 year old who needs X dollars per year and has only 5X dollars shouldn’t have 35% in stocks, the risk is too high. If the same person has 25X dollars they can have more than 35% in stocks as they can outlast a ten year drop in value.

24

Sensible. Rules of thumb apply to typical cases, not to outliers.

25

The OP is not talking about Treasury Bonds, these are corporate bonds. Very different risk/reward.

26

Actually, they’re both corporate and treasury bonds. The OP said the fund was the Fidelity Intermediate Bond Fund, which according to the website is a mixture.

27

While I’m going to answer the OP’s question, this is rather general investing advice and represents my philosophy.

In general, you want to be invested in things with the highest average returns and lowest correlations. Bonds are not particularly correlated with stocks, but they aren’t 100% uncorrelated. In order to get as many different things as possible uncorrelated with each other, you want to spread out into as many different fields as you can find reasonable investments in and can stomach the time the manage them. For me, this is a lot of different things, but it sounds like for OP, not so much. The easiest way to get this kind of diversity is a retirement target date fund, but these are funds of funds and thus have two levels of fees. If you can do the same balancing yourself, you can save one layer of fees. But if you don’t want to bother and like the idea of division of labor, just throw it all into a retirement target date fund offered by Fidelity. Which target date to use if you’re smack in the middle of two, or are just unsure, depends on your tolerance for risk.

Going beyond that, if you can handle rebalancing 2 things, they should be a total stock market fund and a total bond market fund. I use Schwab, so I’ll just tell you that with them there are SWTSX and SWAGX. Develop a plan, either using internet resources or paying an advisor an hourly rate to come up with one, in which your allocation between the two slowly trends more towards bonds as you age. At least once a year buy and sell to get to the allocation desired for the current year.

If you feel like you can juggle more things, you can add a small-cap fund like SWSSX and change your main large-cap fund to an S&P 500 fund like SWPPX. Stocks of smaller companies tend to not be as correlated as the stocks of large companies, so your rebalancing is more likely to catch each of them when they’re out of equilibrium and thus get yourself a small bump in return by buying low and selling high. Again, develop a plan where you slowly move out of both equity funds and into bonds, and rebalance at least once per year.

If you want to juggle even more, you can look at a mid-cap fund like SWMCX, large-cap growth like SWLGX, and large-cap value like SWLVX. The more slices that you cut your portfolio into that are likely to be uncorrelated, the more you can gain from rebalancing by selling each segment at higher than average prices. If you have a taxable account in addition to your retirement accounts, I would recommend holding some international index funds, perhaps even branching out into international small and emerging markets equity funds. You could diversify into these in a retirement account, but you’ll pay foreign taxes on dividends and can’t claim the foreign tax credit. I wish I could find, but have yet to see, an international equity fund specifically designed to be held in retirement accounts by only investing in companies that either don’t pay dividends or are domiciled in countries that respect IRAs’ tax-free status, such as Canada, or countries that don’t tax dividends, like Singapore. (See here, down at the bottom - search for Singapore). You can instead invest in individual stocks in those places, but that entails more risk and more need to watch the market and pay attention.

So I’ve mentioned the various types of equities there are out there you could consider diversifying into, but there are also various types of bond investments to consider. When you’re young, you probably don’t want anything in ultra-safe investments besides an allocation to cash that you still put into the riskiest cash money market there is available, but there are bond investments that entail more risk and thus have higher return associate with them. There are three main categories here: Floating rate loans, Sub-investment grade Corporate bonds, and Emerging Market or even Frontier Debt. You can find funds paying around 6% for each of these, which is less than the average yield on stocks, but is comparatively safer while not resorting to the more anemic 3% on high quality corporate bonds or 2% on Treasuries or CDs. These are particularly suited to retirement accounts if you have a taxable account as well, since they produce ordinary income (not capital gain or qualified dividends), which you want to keep out of your taxable accounts as much as possible.

The story doesn’t stop with stocks and bonds though. And I’m not talking about options, futures, commodities, and such, as those are more gambling unless you’re in the business and want to hedge your holdings. I stay way away from those, since I like being a passive investor and staying with index funds. I have time to commit to rebalance frequently, but not to do research. Anyway, there’s other investments that are available to retail investors that are relatively new that I’ve gotten involved with and have a small portion of my portfolio devoted to.

One is peer-to-peer lending. I’m not going to mention any specific sites, you can use google to find some. Each loan is extremely risky, but with $25 minimum investments, you can diversify quite a bit. You can automate your investing and get a reasonable return, or you can take the time to look at each borrower’s credit profile and not invest in the ones you think are less likely to pay them back and hopefully enhance your reward. I’m somewhat concerned about what returns are going to be like once the next recession hits, but these sites offer access to an asset class that’s not available elsewhere, and as I said up front, diversity is my number one goal.

And then there’s real estate. If you’re really rich, you can invest directly in real estate, but most of us don’t have the kinds of funds to do so with commercial buildings and don’t either want to put a large percentage of our assets into a rental home or just plain don’t want to be land lords. There are mutual funds that invest in publicly traded REITs, and you can stick with them if you’re really risk averse and want to stay on your broker’s website, but there are a number of crowdfunding real estate websites set up that you can again use google to find that offer higher rates.

Both of these last two are long-term investments. Don’t put very much money into them, and don’t expect to be able to access it easily. Despite those cautions, I feel they are very good ways to diversify your portfolio beyond what’s offered at your broker. Both offer the ability to set up an IRA which you can roll over funds from a retirement account into, which is almost definitely what you want to do for them because they’re taxed as ordinary income (although with real estate, you might get the 20% pass-through deduction on REIT dividends - still not as good as qualified dividends though). Put less than 5% of your portfolio into each, and you’ll hopefully smooth things out a bit, having investments that are less correlated than if you stick to stocks and bonds.

28

Not to pick on you, but this is a basic misunderstanding that the investment industry pushes on us. They say that in retirement you need “income” and in order to get “income” you need to invest in dividend paying stocks. This is a fundamental mis-characterization of the situation. In retirement, you don’t need “income”, you need cash flow. And how is it better to get this cash flow? By investing in dividend paying stocks, on which you will be paying full tax rates on the entire amount you use? Or by selling small amounts of stock on which

  1. You will only have to pay the much lower capital gains tax rate, and
  2. You only have to pay that lower tax rate on the PROFIT you’ve made on the stock, not the cost basis?
29

I was trying to keep it simple. Yes, cash flow is what is important, and it includes reduced expenses and money from social security,
One of the things about being retired is that you can control your taxable income pretty well. Thus, dividends do not have to be taxed at a high incremental rate. And while post-tax investments can be sold with little tax liability, pre-tax investments can have significant tax liability. I’m moving some into Roth IRAs for the long term, but the amount depends on where I stand in relation to income. My accountant figures that out.
Finally, this kind of investment is a good balance between bonds and aggressive equities. I don’t know about you, but winter - I mean a crash - is coming. A good cash flow means I don’t have to sell during a crash. I’ve done profit taking on some of my more aggressive funds to move them to these safer funds. I fully realize that I’ve given up gains by doing so - I’m not attempting to time the market - but I still think it is a good thing to do.
So far so good, and it will get even better when I hit 70 and take my maxed out Social Security.

30

I won’t disagree with the facts here but if you invest in dividend-paying stocks, even if you pay taxes on the dividends you are preserving capital, and risk is relatively low. If you sell stocks and pay tax on the gains, you are liquidating your capital; also there is some risk in holding stocks that are acquired with the expectation of growth. Neither one is right or wrong but the total picture has to be taken into account, including your total portfolio, tolerance for risk, and how long you need it to last.

31

It’s already been pointed out that we should be talking about both government and corporate bonds, but I’d like to mention that bonds can easily go down in value. If you buy a bond from the issuer and hold it until maturity, then your returns are predetermined, but (I think) usually you’ll be buying and selling bonds from other traders, for whom the anticipated future interest rates play a big factor. If interest rates go up, then that bond you own which gives you a 3% return looks a lot less attractive to potential people who might want to buy that bond from you, so the price takes a severe hit.