What funds do I invest in?   1 comment

(Before I start this post, I thought I’d mention – I updated the post on investment vehicles to cover two patented advantages that Vanguard funds have over their competitors).

So finally, I think I have explained enough about investing to explain what funds I use. Although it took me a decent amount of time to figure out how to invest and what I wanted to invest in, once I figured all of that out, it has been incredibly simple to maintain. I only use three funds. It doesn’t get much simpler than that. My school lets me split my paycheck into three bank accounts. Using Vanguard’s direct deposit service, I can directly deposit a portion of my paycheck into my Vanguard account, and have it automatically invested into those three funds (or If I wanted to, any fund they offer).

But before I explain these funds, I do have a disclaimer. Do not just blindly follow my fund selection. You should read my previous posts first. And do not just open an account right now and get started. There are tax advantaged accounts you should use first, which I will explain in a future post.

Why Vanguard?

I only use Vanguard funds. They are the only mutual fund company I recommend you do business with when you have the choice (in 401ks, you may not have Vanguard funds available, at which point you’ll just have to make do with what you have). This is because of Vanguard’s special structure.

Back in the 1970s, John Bogle saw what the mutual fund industry was doing, and wanted to do something different. He saw a contradiction in the way that such companies did business – they took money from their clients and charged a relatively large percent of the profits for investing it. Because of their structure, they were designed to earn a profit at the expense of the investor. And the employees who sold the funds to their clients had an incentive to sell funds that were not in the best interest of the client, but in the best interest of the company. He saw all this, and founded a new company, Vanguard, that would eliminate this incentive. He set up the company with a special structure: the mutual funds Vanguard offers own the company. And the clients own the mutual funds. Hence, the only way to effectively own a part of Vanguard is to buy their mutual funds and have indirect ownership. No one at Vanguard, including their CEO, owns any explicit shares of Vanguard. Such shares do not exist. And hence, the customer is also an indirect owner of the company. The company’s interests are also that of the client. This not for profit structure is unique in the industry. John Bogle is a financial saint, and when I amass a substantial investment portfolio, it will be largely in part to him. Because not only did he found the client beneficial company Vanguard, but he also created the first low cost index fund. It’s quite possible that without his leadership, others in the industry would not have followed.

Now of course, there are other companies that offer index funds that are very similar to Vanguard’s in terms of cost (expense ratio) and management style. And sometimes, you will be forced to use them (namely, in a 401k – more on this in a future post). But other companies do not have your interests in mind. They have to answer to their shareholders (or in the case of Fidelity, to the owners – they’re a private company), who will want profits that come at your expense.

Additionally, Vanguard is very good at keeping capital gain distributions to a minimum (typically zero after the first couple years of fund inception), and trying to make sure that as many of your dividends are qualified dividends (I’ll explain why both of these are desirable once I explain taxes). As explained in my updated post on investment vehicles, Vanguard holds a patent on being able to do this.

And without further ado, my funds and asset allocation.

My funds

  • VTSAX – Vanguard Total Stock Market Index Fund Admiral Shares
    • Expense ratio of 0.05%
    • Investment minimum of $10,000
    • Tracks the CRSP US Total Market Index
    • Diversified across all sectors of the US economy (consumer goods, consumer services, health care, etc.)
    • Diversified across small, mid, and large cap stocks
  • VTIAX – Vanguard Total International Stock Market Index Fund Admiral Shares
    • Expense ratio of 0.14%
    • Investment minimum of $10,000
    • Tracks the FTSE Global All Cap ex US Index
    • Diversified across 46 countries from all regions of the world
    • Diversified across sectors
    • Diversified across market capitalizations
  • VBMFX – Vanguard Total Bond Market Index Fund Investor Shares
    • Expense ratio of 0.20%
    • Investment minimum of $3000
    • Tracks the Barclays US Aggregate Float Adjusted Bond Index
    • Diversified across bond types – US government and corporate bonds
    • Diversified across maturities – short, intermediate, and long term issues

My asset allocation is age-10 in bonds, and 30% of my stock allocation in international stocks. To decide on my international allocation of my stocks, I read Vanguard’s recommendation: somewhere between 20-40% of your stocks. I just settled on the median at 30%.

These funds cover my desired asset classes: US stocks, international stocks, and US bonds. These are the only asset classes you really need (though some would argue for real estate (REITS)). They are a fine diversification asset class as well. But I’d rather consolidate my money into fewer funds to reach Admiral shares more quickly (explained below). Also, REITS are not as tax efficient, and hence should be held in a tax advantaged account (to be explained later).

Based on my asset allocation, my overall weighted expense ratio is just 0.0942%. The industry asset weighted average is 0.58%, and the simple average is 1.07%. While that difference of up to 1% doesn’t sound like much, over time it really adds up. The same way that your investments grow rapidly because of compounding returns, the cost of a mutual fund from the expense ratio grows rapidly because it is a compounding fee.
With an initial investment of $10,000

Fund Average Annual Return Expense ratio Value in 25 years Value in 50 years
Fund A 6% 0.09% $105,937 1,122,276
Fund B 6% 0.57% $93,995 $883,510
Fund C 6% 1.07% $83.035 $689,479

Now imagine multiplying the values in this table by at least 10, as you will need to invest far more than just $10,000 for financial independence and retirement. The difference between funds B and C can mean the difference of retiring a couple years earlier. And between Funds A & C? It’s hardly a worthwhile comparison!

These differences become more dramatic when you increase the average annual return (and of course, increase the expense ratio of the worst funds). I cannot overstate the importance of keeping your expense ratio low.

Investor vs Admiral Shares

Virtually every Vanguard fund has an investor and admiral version. The investor version requires a $3000 investment minimum, and the admiral version usually requires a $10,000 investment minimum. The admiral version always has a lower expense ratio. Once you reach $10,000 in the investor shares of the fund, you can ask them to upgrade your shares to admiral shares, without any tax consequences (they’re clever like this). (This should happen automatically, but I hear it may take a while for the automatic process to trigger).

If your admiral shares fall below $10,000 in value because of market fluctuations, they will not downgrade your shares to investor shares. However, if your investor shares fall below $3000, they will cash out your shares.

And there you have it. My fund selection. It’s incredibly simple. And with Vanguard’s direct deposit service, I’m automatically investing with every paycheck!
Next time, I’ll discuss taxes, as there are several topics that I have not been able to discuss in detail because they won’t make sense without a discusison of taxes.


Posted January 11, 2015 by Fiby in Uncategorized

One response to “What funds do I invest in?

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  1. Pingback: Target Date Funds and Tax Efficient Asset Placement | Financial Independence by 40

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