SSgA 401k, Leaving Financial Advisor

1. Reader Question

Hi LTR, In your post "Selecting Investment Strategy" You posted a graphic with 4 investment choices. 3 Vanguard funds and Cash is savings and CD's. I'd very much like to follow your advice, however, we want to take advantage of our 401k company match. We don't have those funds as options, and I was wondering if you could help me choose an asset allocation that would best correspond to your "risk taker" strategy. We are in our early 20's, and just built up our emergency fund to where we would like it to be. I belive your strategy here was: 45% VTSMX, 30% VGTSX and 25%VBMFX. The funds I have available:
SSgA S&P 500 Fund - Net Expense 0.09%
SSgA Russell 2000 Fund - Net Expense 0.10%
SSgA S&P 400 Mid Cap Fund - Net Expense 0.10%
SSgA Russell 3000 Fund - Net Expense 0.10%
SSgA MSCI EAFE Fund - Net Expense 0.12%
SSgA MSCI Emerging Market Free Fund - Net Expense 0.22%
SSgA Barclays Aggregate Bond Fund - Net Expense 0.10%
SSga Barclays US TIPS Fund - Net Expense 0.10%
SSgA DJ/UBS Roll Select Commodity Index Fund - Net Expense 0.25%

As I said, if the Vanguard funds were available to me, I would follow your suggested asset allocation for a "Risk Taker." All funds listed above appear to perform right inline with the index they seek to mirror (before expenses of course) If you need more information on specific funds I can pull the prospectus or the Lipper info page. I'd like to know what you would recommend to most closely match your vanguard "risk taker" model using the above listed funds. Thank you for the solid investment advice, and knowledge.

My Reply

You have a great 401k lineup and will have no problem replicating those Vanguard-based portfolios I suggested. Here's an extremely close equivalent of 45% VTSMX, 30% VGTSX and 25%VBMFX using your 401k:
45% SSgA Russell 3000 Fund
22% SSgA MSCI EAFE Fund
8% SSgA MSCI Emerging Market Free Fund
25% SSgA Barclays Aggregate Bond Fund

The only difference would be the lack of Canadian stocks which are included in VGTSX but not in either of your 401k's SSgA international funds (EAFE and Emerging). With all due respect to our friends up North, this omission will make zero difference.

If you notice that either the 45%, the 25%, or the combined 22%+8% have over time either increased or decreased by a lot, then you could change your contributions to bring them back in line. What exactly is "a lot" is subjective and not very important. For example you could allow the fund slated to be 45% of the portfolio to bounce between 40% and 50%, but change your contributions to bring it back in line if it gets outside those boundaries. Similarly, you could allow the 25% to bounce between 23% and 27%, and the combined (22%+8%) between 27% and 33%. Again, the exact boundaries are not particularly important, just as long as you don't let the percentages deviate indefinitely. If the percentage drifts too high up, reduce contributions to that fund and increase contributions towards others. If the percentage drifts too low, increase contributions to that fund and decrease them towards others.



2. Reader Question

Hi LTR, stumbled across you blog about a month ago and have been reading it every day since. It has been an eye-opener and incredibly helpful. I have been a passive investor for years, but since I'm about to turn 40 I've begun to take a closer look at my situation. My wife and I have 2 tax deferred accounts and 2 taxable accounts with MS. For our taxable account, our "advisor" has us in LBSAX and two ETFs (ADRA, DVY). Our IRA's -- mine is a traditional and her's is a Roth she had prior to us getting married -- are invested in various Lord Abbott's funds (LDFVX,LBNDX) and LBSAX. In total, we have a little over 215k in the accounts. I have two questions. 1) How would you recommend I clean up this situation. 2) We currently have 50k to invest and could really use some direction. Thanks for the invaluable insight.

My Reply

Very glad you found my blog helpful. First let's look at what you have now... In your taxable accounts you are 100% in stocks. Your IRAs are in a mix of stocks and junk bonds, which are nearly as risky as stocks. The first thing to decide is whether you really want to continue with this level of risk in your overall investments. The all-stock portfolio has been a great one to hold for the past 4 years, but if you remember the 2008 plunge it was an absolutely awful one to hold back then. From the 2007 peak to the 2009 bottom you would have seen losses of around 40% of your portfolio's value. If at any point in time you lost your nerves and decided to sell what was still remaining then you would have locked in those losses permanently.

A good advisor's role is to keep his or her client from both having an asset allocation that can lead to such bad emotional decisions and to to help the client work through the emotions that will inevitably bubble up -- both the fear of losing everything in a bad bear market and the greed of wanting to be in the most aggressive stocks in a bull market. I obviously have no idea of your past history with this advisor, but a decent test of your advisor's quality is to think about to that 2007-2009 plunge and reflect on why and how your advisor acted.

Were you in 100% stock and junk bond portfolio in 2007 as well? If so, why? Was it your insistence that you wanted to invest as aggressively as possible or was it the advisor's decision? If the latter, then it's a strike against the advisor. On the other hand if your advisor prudently had you invested in a more conservative portfolio at the time and only switched to the current aggressive one when stocks became cheap, then he or she added a whole lot of value.

Tied into the same consideration is how did you yourself react during the 2007-2009 bear market. Were you scared witless and on the verge of selling what little remained? Or did you see bargains everywhere and wished you had more money to buy? If the former, then it's a sign that you simply should not be invested anywhere as aggressively as you are now. If the latter, then maybe such an aggressive portfolio is appropriate for you.

By analyzing what happened and how both you and your advisor acted you should come to reasonable conclusions about both the appropriateness of a nearly-100% stock portfolio for yourself and the value or lack of value in your advisor.

Gauging the appropriate portfolio risk for yourself is extremely important -- and quite difficult. A good advisor's greatest contribution  to your financial well-being would be to do a good job at that, but not too many do in my opinion. Here is an article that will hopefully be helpful when thinking about this subject: http://www.longtermreturns.com/2012/03/selecting-investment-strategy.html

One way or another, either by yourself or with the help of the advisor you will need to decide whether you wish to continue with the all-stock/junk bond portfolio. As I said, it has been a great one to hold for the past four years. I fully expect stocks to continue to outperform bonds over time going forward. But the stock market ride is all but guaranteed to be very bumpy. Sooner or later we will have another major bear market and it may feel every bit as bad or even worse than the 2007-9 one. Not only that but there is a real chance that my (and others') expectations simply do not materialize and that the economy and the market stay lousy for decades and stocks fail to beat bonds even over the very long time period. Not likely, but could happen. Nobody in the world knows with certainty which of these scenarios will play out, though plenty will claim that ability. Unless they are making their prediction in a joint press conference with Warren Buffett, I recommend you ignore their opinion. All we can say about the future is that it's likely to be similar to the past -- but may end up very different. Not very helpful, I know, but that's the truth.

Because of this uncertainty about what the future will hold, I think it's a very good idea for most investors to have both stocks and bonds (quality bonds, not junk bonds which are more like stocks) in their portfolios. Moving from 100% stocks to, say, 80% stocks and 20% bonds will not harm your long-term returns by a whole lot if things go well, but will reduce volatility and the pain of inevitable bear markets by quite a bit. Many people find even more conservative portfolios -- say, 60% stocks + 40% bonds -- more palatable. But only you can and should ultimately make the decision on the right stock/bond mix for you. Your advisor, if you are keeping him or her, should help with this decision, of course. Continuing into the future with 100% in stocks/junk bonds seems dicey to me, though perhaps you feel it's right for you.

Once you settle on the exact stock/bond strategy then you will need to decide how to put it into action in your portfolio. Here things get simpler... If you wish to keep your financial advisor, then you should expect to follow his or her specific recommendations which, I'm guessing, will include keeping those same mutual funds you have now. If based on your reflection on the past N years you decided that your advisor was not helpful (or outright harmful) then you will need to either find a new advisor or go the do-it-yourself route. I am obviously biased to the do-it-yourself route because it's not particularly difficult and will likely save you at least 1% or more annually in advisor-related expenses. 1% is next to nothing in any one year but adds up to huge amounts over your lifetime -- see http://www.longtermreturns.com/2010/12/how-much-investment-expenses-really.html for example.

From this point on I'm assuming you are going the DIY route and are permanently leaving your financial advisor... Good news is your actively managed funds LBSAX, LDFVX (both of which are large US stock funds) and LBNDX (a junk bond fund) have actually performed reasonably well. On their own they beat their benchmarks over the past decade -- though not so much over the past few years. Unfortunately you almost certainly paid around 5% load for the privilege to be invested in them, so it's quite likely that after that expense combined with the advisor fees they lost you money relative to their benchmarks. Now is as good a time as any to exit them (along with strange choices of ADRA and DVY ETFs) and invest into lowest-possible cost diversified index funds.

For your IRAs the switch is relatively simple since there are not tax implications. There are many ways to invest in low-cost index funds, but my favorite -- and probably the simplest -- is to pick one of Vanguard LifeStrategy funds. Remember how earlier you settled on the particular stock/bond mix that you like? Simply pick the LifeStrategy fund closest to it. E.g. VASGX is 80% stocks and 20% bonds; VSMGX is 60% stocks and 40% bonds. You may be able to invest in these funds without transferring your IRAs to Vanguard -- but you should look into any fees you might be subjected to if you stay with MS. If there are fees of any kind involved (or if MS does not let you invest in Vanguard), then simply move the whole thing over to Vanguard. You will probably want to call Vanguard first to get a walkthrough of the steps involved. That takes care of the IRAs.

For the taxable accounts things are a bit trickier because selling your current holdings and switching to an index-fund portfolio will be a taxable event. There is a good chance of at least LBSAX and DVY (and maybe ADRA too) to have some unrealized gains. You would be immediately on hook for taxes on those gains -- likely 15% for long-term (over 1 year) gains and your current bracket for short-term ones. The exact math on whether and when the switch is worth it is too tricky to go in details without knowing a lot more about your current and future financial situation.

As a rule of thumb, I would say to go ahead and bite the bullet and make the switch on all current long-term holdings and pay the 15% tax on any gains. In a year (or less) when the remainder of your current holdings reach the "long-term" status you can switch them over as well. Of course, if any of your holdings actually have a capital loss instead of a gain, then you should switch them over immediately.

Finally, what to switch to... One way to go would be the same LifeStrategy fund as you used for your IRA. This would be a very simple choice with just one relatively minor strike against it -- LifeStrategy funds invest in taxable bonds which are less than ideal to hold in taxable accounts. It's nothing terrible, especially since I'm guessing based on your current aggressive portfolio you will choose an aggressive LifeStrategy fund with few bonds. So LifeStrategy in taxable is definitely a reasonable choice but you could do one better with a bit more work...

If you wanted to go an extra step and optimize your bond holdings for taxes, then you could replicate the LifeStrategy fund manually by using VTSMX (US stocks) and VGTSX (international stocks) for its stock components and invest bonds into a mix of, say, VWLTX/VWLUX  (tax-exempt municipal bonds) and I Savings Bonds. Those I Savings Bonds are a very safe and conservative investment that happens to be very competitive on yields as well today -- though you would have to open a separate account with TreasuryDirect.gov to invest in them.

For example, let's say you have $150K in your taxable account and you wish to use 80/20 stock/bond mix going forward (equivalent of VASGX LifeStrategy). One way to do so, of course, would be to simply sell the current holdings that have either don't have capital gains or have long-term capital gains and invest the proceeds into VASGX in taxable. But if you wanted to go that one extra step further to optimize tax efficiency, then you could the following:

1. Take 80% of $150K -- $120K -- and invest about $80K in VTSMX (or actually its lower-fee sibling VTSAX which becomes available with $10K minimum investment) and about $40K in VGTSX (or actually its lower-fee sibling VTIAX). 
2. The remaining 20% of $150K -- $30K -- destined for bonds you could split up to put $20K into I Savings Bonds ($10K for you and another $10K for your wife, since there is annual $10K limit per person) and the remaining $10K into VWLTX Vanguard municipal bond fund (unfortunately its lower-fee sibling, VWLUX requires $50K minumum)

Sorry for the long-winded answer but I hope that gives you some ideas on how to proceed. Good thing is that once you simplify your investments like this and pick your strategy going forward (e.g. 80/20 stocks/bonds or 60/40 stock/bonds or whatever it happens to be) you will never again have to think where to put "new money". You will simply put it into the same 80/20 or 60/40 or whatever mix that you settled on -- either the LifeStrategy fund itself or the DIY version of the same that you set up for your taxable accounts.