Author Topic: advice on index funds allocation  (Read 6069 times)

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advice on index funds allocation
« on: January 24, 2014, 06:42:57 PM »
I'm having problems deciding on which index funds to use, mainly because I'm not too sure how to decide my portfolio...
Currently I have my 401k in vanguard 2050 target fund, roth ira in vanguard's lifestyle fund, taxable on vanguards VTI ETF. I prefer etf over admiral shares if possible but I'll buy admiral shares if there isn't an ETF version.

But aside from just pumping more into these three, what am I missing out on? I mean, I know I'm not getting much in world stocks but I don't want them per say (or do I?)... Neither am I too interested in having a lot of bond coverage. What I got with the target/lifestyle funds I thought would be good but am I wrong? I'm in my mid-20s so I'm not exactly "near" retirement. Though I would like to hit 1m somewhere in my early 40s then retire at this point.

I also have MVO in my taxable for the dividend but I'm not 100% sure I'll be holding this more than the next few years. I got it before I got into vanguard and haven't felt a need to change it out.

I make $50k/year and I max out my 401k/roth ira each year and plan to put another $5k into the taxable account. And I should be saving another $5-10k/year on top of all this. If I have this extra savings at end of year, I'll put it into taxable account, but I'm not counting it as my investment money until I know how much I have at end of year. I have $20-30k "emergency" fund but I won't be touching it much. I invest another $10k when it goes over $30k but I don't ever let it drop below $25k if possible. I know some people consider this too much, but I want a year's worth of living cash just in case. Not too sure why I included this in the post, mainly to say that I'm okay with the risk of holding mostly stocks?

I'm asking this just as the stock market is dropping again :( poor investments been losing money these last weeks. But I want to keep buying and since I've built up another $10k to invest, I just didn't know which to put it into.
« Last Edit: January 24, 2014, 06:53:35 PM by eyem »

krick

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Re: advice on index funds allocation
« Reply #1 on: January 24, 2014, 10:43:11 PM »
Bogleheads.org has been critical to my investment planning, particularly the extremely helpful folks in the "help with personal investments" forum...
http://www.bogleheads.org/forum/viewforum.php?f=1

...who lead me to the "three-fund portfolio" concept...
http://www.bogleheads.org/wiki/Three-fund_portfolio

...which I've been working on implementing across my various investment accounts since the beginning of this year. The core idea is a simple to maintain portfolio with maximum diversity and minimum fees. They really opened my eyes to the world of low expense ratio index funds.

The three-fund portfolio is conceptually very close to what Vanguard does in their Target Retirement funds, except they toss in a dash of international bonds to make it a four-fund portfolio.

Regarding your aversion to bonds, the idea of bonds in your portfolio is to dampen the swings of the stock market.  You don't need a lot.  Most of Vanguard's retirement funds have 10-20% until you get close to retirement when they jack the bond percentage way up to reduce risk.

Regarding your holding MVO... Have you looked into the tax implications of holding a royalty trust?  It may be more hassle at tax time than it's worth if you plan to do your own taxes.  Also I believe that distributions from Royalty Trusts are taxed at your full tax rate instead of the reduced 15% rate for qualified dividends.

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Re: advice on index funds allocation
« Reply #2 on: January 24, 2014, 11:26:47 PM »
I didn't know about royalty trust tax but from what I just looked up, it doesn't seem to matter much for me? since it would be taxed at personal income levels which for me is in the 15% or close since I max my 401k which drops me down to the lower bracket. But again, wouldn't this work in place of having bonds for stability? From what I've seen, the payout of it doesn't "drop" to zero even in bad times, so if I keep enough of it to get say $30k dividends/year, I'd be taxed at 15% income bracket, I could live off it before I make draws on other investments. Note, I don't have that much invest in the trust, I get maybe $250/year out of it. It was just something that I was considering for a direction I wanted to go, which was what lead me to buying it in the first place. Though now that I know about the tax issues with it, I may move it into my IRA so it won't be taxed if I buy more of it.

I knew about the 3-fund portfolio and I was looking into that route. I'm just not sure why the international market has that big of an importance. Since the all seem to follow each other with a 6 month lag in some cases. But I don't plan to need money in 6 months time so I can ride out any "lag" time. If the US crashes, the world would crash 6 months later or at some future time. If the world rises, eventually it'll make its why back to the US. Sure, it might not be a proportionate 10% up/down for both the US and World in that if the US falls 10% the world may only fall 8% but on the other hand the US could rise 10% instead of 8% too.

I felt I had enough bond coverage with the target/lifestyle funds, brings me to about 10-15% if I include the taxable amount.

I'll look more into the 3 funds, I want to find more info on how having international/bonds would benefit me :S Aside from "stability" since I view having a rental/dividend to be "stable". I have no rentals but once I get my IRA built up enough, I may convert it to a rental one?

edit: eh... not to jump the gun, but I may put the $10k into the VT etf for international. I'm heavy on the VTI side anyways for this round of investing. I'm just not convinced that it's needed, but I see no reason why it would hurt either so I'll give it a shot. And see how I feel about it in a years time or until I have another $10k.
« Last Edit: January 24, 2014, 11:41:52 PM by eyem »

hoppy08520

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Re: advice on index funds allocation
« Reply #3 on: January 25, 2014, 11:25:35 AM »
The reason to add international stocks to your portfolio is to make it more diverse and to reduce volatility. Even if there is a correlation between US and international stocks, that correlation isn't exact so there is a benefit to having 20% to 40% of your stocks in international stock funds.

Read this for more explanation: https://institutional.vanguard.com/iam/pdf/internationalbrief.pdf

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Re: advice on index funds allocation
« Reply #4 on: January 25, 2014, 01:51:25 PM »
Hm, after reading more on the 3 fund idea on bogleheads, how do you guys feel about it, if you use it? I forgot the thread since I read a few, but someone pointed out that they wanted a 50/50 split because they are in the US so they wanted half their stocks in home country. But someone pointed out that if they were in the UK, would they insist on having a 50 UK/50 world split? It didn't seem to get answered, but it brought my attention to why do I want US stocks at all in this case? If the world market has US stocks as well, wouldn't a 2 fund portfolio of World stocks + bonds be better? I'm still trying to decide if I want dividends vs bonds for stability though. This is something I'll research more into.

I also just don't know "why" bonds are more stable than stocks? I understand stocks are volatile by nature, but a government/company that issues bonds has to be on good standing to be trusted. If I bought that company's stock, if it goes bankrupt, the bond would go up in smokes too right? While I understand governments don't go under as easily, with local ones filing bankruptcy, are they still "stable"? Since a national government will do what it can to save it's stock market, I don't see a stock market going broke any more than if a government went under. But yes, I could see losing half my stock's value if I didn't hold bonds... but if the stock market fell 50%, I'd still have 50% left. If I had a 50 stock/50 bond ratio, the drop would mean I only lose 25% assuming the bonds didn't change at all (which would as well), I'd have 75% of the investment instead of 50%. But does 25% difference mean a lot to me? At my current level, 25% would mean about $18k difference. Since I'm holding that much as emergency cash, I fail to see myself needing that 25% "safety" net. Unless the stock market is going to be down for another decade that is... And even then, I'm holding down a job and not relying on the bonds to contribute to my income.

Richard3

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Re: advice on index funds allocation
« Reply #5 on: January 25, 2014, 07:43:41 PM »
Hm, after reading more on the 3 fund idea on bogleheads, how do you guys feel about it, if you use it? I forgot the thread since I read a few, but someone pointed out that they wanted a 50/50 split because they are in the US so they wanted half their stocks in home country. But someone pointed out that if they were in the UK, would they insist on having a 50 UK/50 world split? It didn't seem to get answered, but it brought my attention to why do I want US stocks at all in this case? If the world market has US stocks as well, wouldn't a 2 fund portfolio of World stocks + bonds be better? I'm still trying to decide if I want dividends vs bonds for stability though. This is something I'll research more into.

I also just don't know "why" bonds are more stable than stocks? I understand stocks are volatile by nature, but a government/company that issues bonds has to be on good standing to be trusted. If I bought that company's stock, if it goes bankrupt, the bond would go up in smokes too right? While I understand governments don't go under as easily, with local ones filing bankruptcy, are they still "stable"? Since a national government will do what it can to save it's stock market, I don't see a stock market going broke any more than if a government went under. But yes, I could see losing half my stock's value if I didn't hold bonds... but if the stock market fell 50%, I'd still have 50% left. If I had a 50 stock/50 bond ratio, the drop would mean I only lose 25% assuming the bonds didn't change at all (which would as well), I'd have 75% of the investment instead of 50%. But does 25% difference mean a lot to me? At my current level, 25% would mean about $18k difference. Since I'm holding that much as emergency cash, I fail to see myself needing that 25% "safety" net. Unless the stock market is going to be down for another decade that is... And even then, I'm holding down a job and not relying on the bonds to contribute to my income.

Your expenses are most closely tied to your home economy and its currency. Being overweight in that sharemarket helps ensure you will keep up with the economy you are in. I am gradually moving towards 33% or so in NZ stocks which is overweight by at least one order of magnitude. But if the NZ economy grows fast and prices go up, and the NZD gets stronger then I will be glad at least some of my portfolio has gone up with it.

Bonds are safer than stocks (everything else being equal) because they have more security so if repayments cease you stand a chance of getting something back (and therefore the issuer has more incentive to keep paying). If a company goes bankrupt, bondholders are near the front of the queue to get paid, shareholders are right at the end. Very few corporate bankruptcies result in bond holders (especially senior bonds) getting screwed.

The riskier the bond issuer the higher interest they offer, so these local governments that go bankrupt (although again, see above about bond holders getting the least bad screwing when something goes bankrupt) would likely have been paying higher rates than more credit-worthy organisations.

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Re: advice on index funds allocation
« Reply #6 on: January 26, 2014, 07:41:45 AM »
hm but once I'm in retirement, partial retirement, I'll be in Taiwan for a half the year since my family is there... Wouldn't that mean that I'd want half Taiwan stocks then too? But I don't want to keep Taiwan currency... Since USD seems to be the international currency if there is one, I'd like to hold that more than other currencies... But how does currency come into play on stock market? Since I can buy/sell stocks in any currency, the return would be the same right?

I didn't know that about bonds though. Making me reconsider having them... now I have to decide what is a good proportion :( My target/lifestyle funds are at 20%. I may just buy the 80/20 lifestyle fund on taxable account as well instead of trying to do all this balancing. But then I feel like I'm putting 'all my eggs' in a single basket because I have the 80/20 lifestyle fund on roth ira already. Does this concern people? I mean having too much in a fund like this?

daverobev

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Re: advice on index funds allocation
« Reply #7 on: January 26, 2014, 10:43:28 AM »
Thing is, the US has more than its fair share of *global* businesses. To contrast, the Canadian headline index - S&P/TSX Composite - is concentrated in 3 sectors.

IOW, 'you can't lose' if you go with US stocks because they have global built in. Canada, not so much. What I'm saying is - it's fine to be very overweight in a diverse index, less so in a concentrated index.

The UK has a lot of heavyweights in the FTSE 100. The FTSE 250 is much more domestic.

I would not just go large-cap US, UK, EU because the companies in those indexes follow the *global* economy. Having some mid cap going on is good. Having a good share of emerging is good.

Have a look at VXUS - I think it's 60% developed/40% emerging or thereabouts (excluding US), and it does include thousands of smaller cap companies.

HTH.

Richard3

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Re: advice on index funds allocation
« Reply #8 on: January 26, 2014, 11:57:52 AM »
You wouldn't want half Taiwan stocks even if you lived there. But yes, if you're going to have significant exposure to Taiwanese expenses you will want more Taiwanese companies than me. I use the country of a stock to denote where most of the companies revenue comes from not necessarily where it is listed (because I pick individual stocks rather than buy indexes). So the Taiwan mobile company that is listed on US exchanges would be a Taiwanese stock in my mind.

Let's say I own Tesco (major UK supermarket chain). It does really well and the share price goes up from GBP5 to GBP 10. Sadly the British economy does really badly, they print lots of money and the pound halves in value. If I sell my Tesco shares I have actually not made any profit in my home currency. 

I wouldn't worry much about having everything in an 80/20 fund if I liked that split and the underlying allocations (country, industry etc). It's one super basket with a load of smaller baskets inside it. Well, I would because I'm a tinkerer but you shouldn't.

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Re: advice on index funds allocation
« Reply #9 on: January 26, 2014, 06:12:46 PM »
Wait wait, I followed you on the currency thing up to the point that if the pound dropped by half, you didn't make any profit... Using your example, if you bought Tesco in pounds, how does deflation of the pound mean you don't make any profit? I mean, if you had bought a non-UK company stock, still in pounds, you'll still get pounds back. Or are you saying because the company deals with pounds, it'll make less profit than another company dealing with another currency? But doesn't this just point to having an international fund/world fund worthwhile? If so, I can see how keeping world funds being beneficial. Now I'm just not seeing why any one country's market would be preferred :S With the exception that the US market is so freaking hugh... Not just US companies dealing internationally, but foreign companies also list on the US market. By huge, I'm comparing it's GDP to others, and 2nd place China doesn't even come close by being about half. Or it takes the entire EU to match the US. Which yes, I know EU would be about the same size as the US but they don't all "play" well with each other https://en.wikipedia.org/wiki/List_of_countries_by_GDP_%28nominal%29

I think I'm going to adjust my plan once again :( Make it a 20% world bond + 80% world stocks (but I may pick VT over VXUS because I value the US currency?)
« Last Edit: January 26, 2014, 06:17:25 PM by eyem »

daverobev

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Re: advice on index funds allocation
« Reply #10 on: January 27, 2014, 06:18:31 AM »
Wait wait, I followed you on the currency thing up to the point that if the pound dropped by half, you didn't make any profit... Using your example, if you bought Tesco in pounds, how does deflation of the pound mean you don't make any profit? I mean, if you had bought a non-UK company stock, still in pounds, you'll still get pounds back. Or are you saying because the company deals with pounds, it'll make less profit than another company dealing with another currency? But doesn't this just point to having an international fund/world fund worthwhile? If so, I can see how keeping world funds being beneficial. Now I'm just not seeing why any one country's market would be preferred :S With the exception that the US market is so freaking hugh... Not just US companies dealing internationally, but foreign companies also list on the US market. By huge, I'm comparing it's GDP to others, and 2nd place China doesn't even come close by being about half. Or it takes the entire EU to match the US. Which yes, I know EU would be about the same size as the US but they don't all "play" well with each other https://en.wikipedia.org/wiki/List_of_countries_by_GDP_%28nominal%29

I think I'm going to adjust my plan once again :( Make it a 20% world bond + 80% world stocks (but I may pick VT over VXUS because I value the US currency?)

I think.. they were meaning in the case that you didn't care about pounds. I *do* care about pounds.

If you transferred US$ to GBP at $2:1GBP, bought TSCO at 5GBP a share, then the pound collapses to $1:1GBP but TSCO is up to 10GBP - you're at square 1, right? *Assuming* you only care about USD.

You want your bonds to be in your primary currency, because they will follow inflation, mostly. If you're going to live 6 months US, 6 months Taiwan, I'd say do half/half each country's bonds - *assuming* you can get them tax-sheltered. If not just use a high interest savings account, probably. Or if you have a mortgage, that performs as bonds do.

US is high. So is the UK, Eurozone, etc - based on where they were 5 years back. Everything is high. Doesn't matter. You pick your *strategy* and stick to it - don't change allocation when the market changes, that's market timing!

Richard3

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Re: advice on index funds allocation
« Reply #11 on: January 27, 2014, 11:09:17 PM »
OK, another way of looking at it.

Whenever you buy an asset denominated in a foreign currency you are simultaneously long that asset and (in effect) long the same amount foreign currency vs your home currency (because you now do better when the foreign currency gets stronger as it buys more of your home currency). So, in my example you make 500 profit on the stock, and 500 loss on the implicit currency trade. Does that help explain it or did I just make things sound more complicated?



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Re: advice on index funds allocation
« Reply #12 on: January 28, 2014, 05:36:36 PM »
I understand your example of how if the stock goes up twice, but the currency is halved, you net zero gain... what I'm lost at is how if you bought a fund for X currency, and that currency is halved, but the fund covers outside of the home country and goes up twice, you still gain zero profit since you'd still sell the fund in your own currency

I mean if the US dollar dropped by half, that means currencies like Euro or China's Yen? could buy twice as many American goods... But if people are spending twice as much buying American goods, then American companies will make that much more profit because well, lets face it, the goods aren't going to drop in price by half. If it was the other way around, and the dollar got stonger, sure then an international fund could buy up more of the foreign market and grow at that rate but this is only due to the currency increasing in value and not decreasing :S

So, yeah... I'm a bit confused still :S I'm no econ/etc major or anything but I just don't see how you can invest based off of your currency rates. Only thing I could think of is buying a lump sum of Euro when the Dollar is strong and when I'm over seas and dollar is weaker, then I would draw on the Euro. But you can't buy an international fund in the US then ask for it to be sold in Europe and get Euros out of it.

I can understand WHY someone would want the diversity of the international fund, but I don't understand the reasons to keep domestic funds based on currency

edit: and I can't find a link on google to describe it well, I just don't know the search terms to use
« Last Edit: January 28, 2014, 05:44:50 PM by eyem »

daverobev

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Re: advice on index funds allocation
« Reply #13 on: January 28, 2014, 06:00:25 PM »
I understand your example of how if the stock goes up twice, but the currency is halved, you net zero gain... what I'm lost at is how if you bought a fund for X currency, and that currency is halved, but the fund covers outside of the home country and goes up twice, you still gain zero profit since you'd still sell the fund in your own currency

I mean if the US dollar dropped by half, that means currencies like Euro or China's Yen? could buy twice as many American goods... But if people are spending twice as much buying American goods, then American companies will make that much more profit because well, lets face it, the goods aren't going to drop in price by half. If it was the other way around, and the dollar got stonger, sure then an international fund could buy up more of the foreign market and grow at that rate but this is only due to the currency increasing in value and not decreasing :S

So, yeah... I'm a bit confused still :S I'm no econ/etc major or anything but I just don't see how you can invest based off of your currency rates. Only thing I could think of is buying a lump sum of Euro when the Dollar is strong and when I'm over seas and dollar is weaker, then I would draw on the Euro. But you can't buy an international fund in the US then ask for it to be sold in Europe and get Euros out of it.

I can understand WHY someone would want the diversity of the international fund, but I don't understand the reasons to keep domestic funds based on currency

edit: and I can't find a link on google to describe it well, I just don't know the search terms to use

All these things work together to create the global economy we know. You're right - as some things rise, it pulls other things up with it. As the Yen strengthens, Japanese industrial output declines because it's more expensive to buy Japanese goods.. but more Japanese go on holiday overseas because they can, sending their money overseas and thus weakening it...

In Canada right now: the CAD is weakening back to historical norms, making it more expensive for Canucks to go on holiday abroad (oh no!), making imports more expensive (oh noes!!), BUT making manufacturing more viable as wages (vs the US) have just *all* magically dropped 10%! Cheapo! Whee!

The point is: Buy diverse economies. But have more in your home currency (or currency that it is predominantly linked to, if your currency is tiny and effected by a massive neighbour), because at the end of the day if there is inflation at home, you want your dividends to be inflated in the currency you have to buy bananas in!

With stocks, and inflation, the general idea is that inflation at home directly increases the value of the businesses you own. If inflation is 10%, the stock market goes up 10% to counteract that inflation - the dividends they pay out do the same. So stocks are (sort've) inflation-neutral. But WTF is going on in Australia? Massive deflation (for example)? Oh - you don't care, because those stocks don't impact your domestic ones (for example).

See? Kinda?

the fixer

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Re: advice on index funds allocation
« Reply #14 on: January 28, 2014, 10:56:48 PM »
Maybe the confusing point is this: you can't buy "foreign" companies with a domestic currency. They are considered "foreign" because they are sold only on international exchanges that use a different currency, so this is by definition. This means that any buying and selling you do on those international exchanges introduces currency risk, because no one buys/sells these companies in your currency.

When you buy a share on the London stock exchange, the seller wants GBP in exchange. At the other end, when you sell that share the buyer will give you GBP. What the GBP is worth in relation to your home currency at the time you buy versus the time you sell has a large influence on the gains/losses you incur with those two trades, unless you were going to keep those GBP to buy something else (like if you were going on a vacation to the UK). The same thing happens on a more aggregate and less transparent level with international mutual funds.

daverobev

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Re: advice on index funds allocation
« Reply #15 on: January 29, 2014, 08:38:22 AM »
Maybe the confusing point is this: you can't buy "foreign" companies with a domestic currency. They are considered "foreign" because they are sold only on international exchanges that use a different currency, so this is by definition. This means that any buying and selling you do on those international exchanges introduces currency risk, because no one buys/sells these companies in your currency.

When you buy a share on the London stock exchange, the seller wants GBP in exchange. At the other end, when you sell that share the buyer will give you GBP. What the GBP is worth in relation to your home currency at the time you buy versus the time you sell has a large influence on the gains/losses you incur with those two trades, unless you were going to keep those GBP to buy something else (like if you were going on a vacation to the UK). The same thing happens on a more aggregate and less transparent level with international mutual funds.

Yes but!

For a multinational, their value is factored based on the exchange rate. If you own.. I don't know, Unilever, or Ford, or McDonalds - if they are doing well everywhere but the US, the price in US$ goes up when the US$ falls.

It's like the 'Mars Bar' or 'banana' method of valuation - ok, I work everything out in terms of how many bananas it is worth.

If a Ford share costs 100 bananas, what the US$ does is irrelevant. Yes, the stock is listed in the US, on a US exchange, and is priced in US$. And the dividends are in $. But if the $ is convertable to the number of bananas you need to eat - who cares?