Beware trying to time the market. Make sure you’re taking this action, not because you feel that the time is right to switch, but because you’ve carefully analyzed your risk/reward preferences.
That said, yes, there are ‘index fund’ bond investment vehicles, outside of the ETFs mentioned by mattnewport. They generally track the time frame (short, medium, long term) and type of bond (corporate, state, federal). Here are some examples from Vanguard: VBISX (Short Term Index), VBIIX (Intermediate Term Index), VBLTX (Long Term Index), and VBMFX (Total Bond Market Index).
What you’re talking about is Asset Allocation, and it’s the number one predictor of your long term investment results. This generally involves determining your own risk profile and picking bonds vs. stocks appropriately. A rule of thumb is to pick 100 - (your age) as a percentage of stocks, since the younger you are, the more growth you’ll need. If you have less tolerance for risk, then you could go lower.
I’m currently invested 20% bonds and 80% stocks, but the bonds I have access to are the safest in the world (Federal employee G Fund, the same thing that Social Security invests in). Further breaking down AA, general categories include foreign vs. domestic, index vs. actively managed, taxable vs. non-taxed.
Example Asset Allocation:
20% bonds:
100% Medium-Term Securities (G Fund)
80% equities:
25-35% International Index Funds (EAFE, VEIEX)
55-75% Wilshire 5000 Index Funds (C/S Fund 3:1, VTSMX)
Tax efficient fund placement:
Put your most tax-inefficient funds in TSP, 401ks, 403bs, Traditional IRAs and similar retirement accounts.
Put your next most tax-inefficient funds in your Roth(s).
Put what’s left into your taxable account. Try to use only tax-efficient funds in taxable accounts.
List of securities from least to most tax efficient:
Hi-Yield Bonds
Taxable Bonds
TIPS
REIT Stocks
Stock trading accounts
Small-Value stocks
Small-Cap stocks
Large Value stocks
International stocks
Large Growth Stocks
Most stock index funds
Tax-Managed Funds
EE and I-Bonds
Tax-Exempt Bonds
Disclaimers: This advice is US-centric. I invest in Vanguard because they have very low Expense Ratios (ER), low or no purchase costs (loads), and have a large number of high quality index funds. Other investment firms such as Fidelity are also very good, and often have comparable funds.
-Everyone else is trying to do the same thing, so look at your actually expected real rate of return on all this saving you’re planning (negative even before taxes on withdrawls or dividends, over the last 10 years, and with high volatility), and then hang your head and ask why you even bother.
I bring this up because I save a lot and use the tax-advantaged options, but when I look at the numbers, I have to ask, what’s the point? After taxes (which will have to go up as the tidal wave of unfunded obligations comes due) and inflation, you barely get anything out of saving. (Yes, there’s the no-tax Roth, but you get to invest very little in it.) Plus, if you save it for long enough not to be penalized on withdrawl, you have to put off consumption until waaaaay into the future, when it will do less for you.
It just seems like you’d be better off buying durable assets or investing in marketable job skills, which are more robust against the kinds of things that punish your savings.
I’ve been exploiring the “infinite banking” option: mutual universal whole life insurance that you can borrow against and which gets a steady, relatively high rate of return and is tax-shielded and has a long pedigree. Seems a lot better than following the herding into IRAs which will probably have their promises violated at some point.
I don’t believe they are. The vast majority of people I see investing and saving do so in a proactive manner, choosing on a whim, and with a risk horizon of less than a year. They pull out when the market goes down and pile on when hot tips become common (“Real estate can’t lose!”). Even the big firms are doing a significant amount of trading and reformulating on a daily basis (evidence: financial “crisis”).
I put my trust in the people who seem to understand what’s really going on, like Warren Buffet, who says that a passively managed Index Fund is the way 99 percent of people should invest.
And if you’re ready to say that IRA promises will be broken (which I also consider a good probability), then your “infinite banking” scheme is even less likely to remain stable, as they’re backed by private companies rather than the US government.
I don’t believe they are. The vast majority of people I see investing and saving do so in a proactive manner, choosing on a whim, and with a risk horizon of less than a year. They pull out when the market goes down and pile on when hot tips become common (“Real estate can’t lose!”). Even the big firms are doing a significant amount of trading and reformulating on a daily basis (evidence: financial “crisis”).
Nice stereotype, but I didn’t do any of that, and still lost a lot from the time I started investing (mid ’06), despite concentrating on low-cost index funds (to the extent permitted by the 401k). As did anyone else who started in the decade before that.
Keep in mind, there’s a certain cognitive capture going on here: in the popular mind, long-term saving is equated with using the 401k/Roth options, which require you to invest in a very specific class of assets. Even with all the whimsy you refer to, that’s building in an unjustifiably low risk premium that has to change eventually.
And if you’re ready to say that IRA promises will be broken (which I also consider a good probability), then your “infinite banking” scheme is even less likely to remain stable, as they’re backed by private companies rather than the US government.
Wha? What “backing” are you referring to, and is your comparison apples-to-apples? The government doesn’t “back” IRAs, it just has a promise they will have certain tax privileges. The assets in the IRAs, where it gets its value, are managed by private companies, just like for mutual whole life insurance (which are member-owned if that matters). Yes, the government could lift their tax privileges too, but this would require breaking an even stronger, longer tradition of not taxing life insurance benefits, which is the (ostensible) purpose of these plans.
ETA:
I put my trust in the people who seem to understand what’s really going on, like Warren Buffet, who says that a passively managed Index Fund is the way 99 percent of people should invest.
Buffet hasn’t actually worked out the nuts and bolts of how to get the meaningful diversication you need, starting with much smaller sums than he has, and adhering to account minimums and contribution limits. That advice seems like more of a vague pleasantry than something you can benefit from. And, it’s not what he does.
In case it may help you to know, I’ve felt the same on a couple occasions when I engaged Silas in argument.
I’ve chalked it down to poor skill at positive sum self-esteem transactions on Silas’ part, at least when mediated by text. I don’t think it’s deliberate, as on some other occasions I concluded on a genuine desire to help on his part.
Could you please at least explain what you had in mind by your claim that infinite banking is backed by private companies rather than the US government (as you presumably meant to say IRAs are)? I promise not to reply to that comment.
I was incorrect in determining the impact on each type of investment from the government considering private companies manage both. At the time, I was thinking that the government created IRAs through law, and I didn’t think that was the case with insurance, and thus the insurance plans seemed more likely to be subject to change by profit motive. However, I don’t know enough about the particular form of life insurance you’re suggesting to feel comfortable making further claims.
look at your actually expected real rate of return on all this saving you’re planning (negative even before taxes on withdrawls or dividends, over the last 10 years, and with high volatility), and then hang your head and ask why you even bother.
As Rain said, asset allocation is important. The standard advice to put most of your savings in low cost index funds has the merit of simplicity and is not bad advice for most people but it is possible to do better by having a bit more diversification than that implies. Rain suggests a percentage allocated to international index funds which is a good start. US savers with exposure to foreign index funds, emerging market funds, commodities and foreign currencies (either directly or through foreign indexes) would have done better over the last 10 years than savers with all their exposure concentrated in US equities.
Diversification is the only true free lunch in investing and by selecting an asset allocation that includes assets that are historically uncorrelated or negatively correlated with US equities it is possible to get equal or better average returns with lower volatility over the long term.
If I were in the US I would share your concerns about future tax increases and raids on currently tax protected retirement accounts but I’d argue that just suggests a broader view of diversification that includes non-traditional savings approaches that are less exposed to such risks.
I think most investors (and particularly US investors) are over-invested in their home countries. Since most people’s individual economic circumstances are correlated with the performance of the economy as a whole this is poor diversification. Similarly I think it is unwise for people to have significant weighting in sectors or asset classes strongly correlated with the industry they personally earn a living in. Programmers should probably not be over-weighted in tech related investments for example and it is probably a bad idea to retain significant stock in your own employer for most employees. I believe Rain is a government employee and so I would suggest that a lower than normal allocation to government backed investments would be appropriate in that situation for example.
Rain suggests a percentage allocated to international index funds which is a good start. US savers with exposure to foreign index funds, emerging market funds, commodities and foreign currencies (either directly or through foreign indexes) would have done better over the last 10 years than savers with all their exposure concentrated in US equities.
Okay, but in a 401k, you’re stuck with the choices your employer gives you, which may not have those options. (usually, the choices are moronic and don’t even include more than one index fund. Mine has just one, and I reviewed my cousin’s and found that it didn’t have any. Commodity trades? You jest.)
And if you’re talking about a Roth, well, no mutual funds, not even Vanguard, will let you start out your saving by dividing up that $4000 between five different funds; each one has a minimum limit. You’d have to be investing for a while first, complicating the whole process.
And if you mean taxable accounts, the taxable events incurred gore most of the gains.
If I were in the US I would share your concerns about future tax increases and raids on currently tax protected retirement accounts
The US is not alone in that respect—other, long-developed countries have it even worse.
but I’d argue that just suggests a broader view of diversification that includes non-traditional savings approaches that are less exposed to such risks.
Right, that’s what I was referring to: investing in job skills so you can high-tail it to another country if things become unbearable (and hope they don’t seize your assets on the way out).
Okay, but in a 401k, you’re stuck with the choices your employer gives you, which may not have those options. (usually, the choices are moronic and don’t even include more than one index fund. Mine has just one, and I reviewed my cousin’s and found that it didn’t have any. Commodity trades? You jest.)
I’m not in the US so I’m not fully familiar with the retirement options available there. Here in Canada we have what seems to me a pretty good system whereby I can have a tax sheltered brokerage account for retirement savings. In many cases it is hard to argue with the ‘free money’ of employer matched retirement plans and the tax advantages of particular schemes but I think it is wise to be mindful of all the advantages and disadvantages of a particular scheme (including things like counterparty risk regarding who ultimately backs up your investments) and take that into consideration when weighing options.
And if you’re talking about a Roth, well, no mutual funds, not even Vanguard, will let you start out your saving by dividing up that $4000 between five different funds; each one has a minimum limit. You’d have to be investing for a while first, complicating the whole process.
This is definitely an issue when starting out. Transaction costs can make broad diversification prohibitively expensive when your total assets are modest. I see it as something to aim for over time but you are absolutely right to be mindful of these issues. If you have a reasonable choice of mutual funds you can look for ones that are diversified at least internationally if not across asset classes outside of equities and fixed income.
And if you mean taxable accounts, the taxable events incurred gore most of the gains.
This is why I like the options available in Canada. Between self-directed RRSPs and the new TFSA the tax-friendly saving options are pretty good.
The US is not alone in that respect—other, long-developed countries have it even worse.
Indeed, and this is one reason I’m working towards my Canadian citizenship. It has relatively healthy finances compared to the UK where I grew up. I don’t think the necessity for some form of default on the obligations of most developed countries’ governments is widely appreciated yet.
Right, that’s what I was referring to: investing in job skills so you can high-tail it to another country if things become unbearable (and hope they don’t seize your assets on the way out).
This is in line with the broader view of diversification I am advocating. Over the typical individual’s expected lifespan this is an important consideration. I think it is a sensible long term goal to diversify in a broad sense so that you maintain options to take your capital (human and otherwise) wherever you can expect the best return on it. Assuming that this will always be the same country you happen to have been born in is short sighted in my opinion.
On a diversification related note, this proposal from Ian Ayres and Barry Nalebuff is an interesting take on the merits of diversification across ones own lifespan.
Put your most tax-inefficient funds in TSP, 401ks, 403bs, Traditional IRAs and similar retirement accounts.
Put your next most tax-inefficient funds in your Roth(s).
Back up: you can make maximum Traditional & Roth IRA contributions in the same year? (I live in the U.S., and have only been putting funds into my traditional IRA.)
No, you cannot max both a Traditional and a Roth; it’s either/or. Which one you choose depends on several factors, including length of investment and the income you predict you’ll have during disbursement. Traditional is better if you expect low income in retirement, or a shorter time frame until retirement; Roth is better if you expect higher income or a longer time frame.
How do you pick when to switch, then? I assume tax-efficiency, but how tax-efficient should income be before you put it into Roth rather than Traditional? And how do you measure tax-efficiency of income?
I apologize if this is overly off-topic, of course.
It’s been a while since I did primary research on the topic; I decided on a Roth for my personal circumstances and dumped most of the other knowledge afterward, so I’ll be deferring to references: here are a couplearticles about the topic of choosing between them, one which links to a calculator.
You measure tax efficiency by what percentage of the money you get to keep after it’s been taxed in the context of your other income and investments. Putting tax-inefficient funds in tax-efficient formats like an IRA lets you keep a (hopefully much) larger percentage.
And I don’t see how it’s off topic in an Open Thread.
Beware trying to time the market. Make sure you’re taking this action, not because you feel that the time is right to switch, but because you’ve carefully analyzed your risk/reward preferences.
That said, yes, there are ‘index fund’ bond investment vehicles, outside of the ETFs mentioned by mattnewport. They generally track the time frame (short, medium, long term) and type of bond (corporate, state, federal). Here are some examples from Vanguard: VBISX (Short Term Index), VBIIX (Intermediate Term Index), VBLTX (Long Term Index), and VBMFX (Total Bond Market Index).
What you’re talking about is Asset Allocation, and it’s the number one predictor of your long term investment results. This generally involves determining your own risk profile and picking bonds vs. stocks appropriately. A rule of thumb is to pick 100 - (your age) as a percentage of stocks, since the younger you are, the more growth you’ll need. If you have less tolerance for risk, then you could go lower.
I’m currently invested 20% bonds and 80% stocks, but the bonds I have access to are the safest in the world (Federal employee G Fund, the same thing that Social Security invests in). Further breaking down AA, general categories include foreign vs. domestic, index vs. actively managed, taxable vs. non-taxed.
Example Asset Allocation:
20% bonds:
100% Medium-Term Securities (G Fund)
80% equities:
25-35% International Index Funds (EAFE, VEIEX)
55-75% Wilshire 5000 Index Funds (C/S Fund 3:1, VTSMX)
Tax efficient fund placement:
Put your most tax-inefficient funds in TSP, 401ks, 403bs, Traditional IRAs and similar retirement accounts.
Put your next most tax-inefficient funds in your Roth(s).
Put what’s left into your taxable account. Try to use only tax-efficient funds in taxable accounts.
List of securities from least to most tax efficient:
Hi-Yield Bonds
Taxable Bonds
TIPS
REIT Stocks
Stock trading accounts
Small-Value stocks
Small-Cap stocks
Large Value stocks
International stocks
Large Growth Stocks
Most stock index funds
Tax-Managed Funds
EE and I-Bonds
Tax-Exempt Bonds
Disclaimers: This advice is US-centric. I invest in Vanguard because they have very low Expense Ratios (ER), low or no purchase costs (loads), and have a large number of high quality index funds. Other investment firms such as Fidelity are also very good, and often have comparable funds.
You forgot to add:
-Everyone else is trying to do the same thing, so look at your actually expected real rate of return on all this saving you’re planning (negative even before taxes on withdrawls or dividends, over the last 10 years, and with high volatility), and then hang your head and ask why you even bother.
I bring this up because I save a lot and use the tax-advantaged options, but when I look at the numbers, I have to ask, what’s the point? After taxes (which will have to go up as the tidal wave of unfunded obligations comes due) and inflation, you barely get anything out of saving. (Yes, there’s the no-tax Roth, but you get to invest very little in it.) Plus, if you save it for long enough not to be penalized on withdrawl, you have to put off consumption until waaaaay into the future, when it will do less for you.
It just seems like you’d be better off buying durable assets or investing in marketable job skills, which are more robust against the kinds of things that punish your savings.
I’ve been exploiring the “infinite banking” option: mutual universal whole life insurance that you can borrow against and which gets a steady, relatively high rate of return and is tax-shielded and has a long pedigree. Seems a lot better than following the herding into IRAs which will probably have their promises violated at some point.
I don’t believe they are. The vast majority of people I see investing and saving do so in a proactive manner, choosing on a whim, and with a risk horizon of less than a year. They pull out when the market goes down and pile on when hot tips become common (“Real estate can’t lose!”). Even the big firms are doing a significant amount of trading and reformulating on a daily basis (evidence: financial “crisis”).
I put my trust in the people who seem to understand what’s really going on, like Warren Buffet, who says that a passively managed Index Fund is the way 99 percent of people should invest.
And if you’re ready to say that IRA promises will be broken (which I also consider a good probability), then your “infinite banking” scheme is even less likely to remain stable, as they’re backed by private companies rather than the US government.
Nice stereotype, but I didn’t do any of that, and still lost a lot from the time I started investing (mid ’06), despite concentrating on low-cost index funds (to the extent permitted by the 401k). As did anyone else who started in the decade before that.
Keep in mind, there’s a certain cognitive capture going on here: in the popular mind, long-term saving is equated with using the 401k/Roth options, which require you to invest in a very specific class of assets. Even with all the whimsy you refer to, that’s building in an unjustifiably low risk premium that has to change eventually.
Wha? What “backing” are you referring to, and is your comparison apples-to-apples? The government doesn’t “back” IRAs, it just has a promise they will have certain tax privileges. The assets in the IRAs, where it gets its value, are managed by private companies, just like for mutual whole life insurance (which are member-owned if that matters). Yes, the government could lift their tax privileges too, but this would require breaking an even stronger, longer tradition of not taxing life insurance benefits, which is the (ostensible) purpose of these plans.
ETA:
Buffet hasn’t actually worked out the nuts and bolts of how to get the meaningful diversication you need, starting with much smaller sums than he has, and adhering to account minimums and contribution limits. That advice seems like more of a vague pleasantry than something you can benefit from. And, it’s not what he does.
I don’t like arguing with you, SilasBarta. It feels very combative, and sets off emotional responses in me, even when I think you have a valid point.
As such, I’m tapping out.
In case it may help you to know, I’ve felt the same on a couple occasions when I engaged Silas in argument.
I’ve chalked it down to poor skill at positive sum self-esteem transactions on Silas’ part, at least when mediated by text. I don’t think it’s deliberate, as on some other occasions I concluded on a genuine desire to help on his part.
Could you please at least explain what you had in mind by your claim that infinite banking is backed by private companies rather than the US government (as you presumably meant to say IRAs are)? I promise not to reply to that comment.
I was incorrect in determining the impact on each type of investment from the government considering private companies manage both. At the time, I was thinking that the government created IRAs through law, and I didn’t think that was the case with insurance, and thus the insurance plans seemed more likely to be subject to change by profit motive. However, I don’t know enough about the particular form of life insurance you’re suggesting to feel comfortable making further claims.
As Rain said, asset allocation is important. The standard advice to put most of your savings in low cost index funds has the merit of simplicity and is not bad advice for most people but it is possible to do better by having a bit more diversification than that implies. Rain suggests a percentage allocated to international index funds which is a good start. US savers with exposure to foreign index funds, emerging market funds, commodities and foreign currencies (either directly or through foreign indexes) would have done better over the last 10 years than savers with all their exposure concentrated in US equities.
Diversification is the only true free lunch in investing and by selecting an asset allocation that includes assets that are historically uncorrelated or negatively correlated with US equities it is possible to get equal or better average returns with lower volatility over the long term.
If I were in the US I would share your concerns about future tax increases and raids on currently tax protected retirement accounts but I’d argue that just suggests a broader view of diversification that includes non-traditional savings approaches that are less exposed to such risks.
I think most investors (and particularly US investors) are over-invested in their home countries. Since most people’s individual economic circumstances are correlated with the performance of the economy as a whole this is poor diversification. Similarly I think it is unwise for people to have significant weighting in sectors or asset classes strongly correlated with the industry they personally earn a living in. Programmers should probably not be over-weighted in tech related investments for example and it is probably a bad idea to retain significant stock in your own employer for most employees. I believe Rain is a government employee and so I would suggest that a lower than normal allocation to government backed investments would be appropriate in that situation for example.
Okay, but in a 401k, you’re stuck with the choices your employer gives you, which may not have those options. (usually, the choices are moronic and don’t even include more than one index fund. Mine has just one, and I reviewed my cousin’s and found that it didn’t have any. Commodity trades? You jest.)
And if you’re talking about a Roth, well, no mutual funds, not even Vanguard, will let you start out your saving by dividing up that $4000 between five different funds; each one has a minimum limit. You’d have to be investing for a while first, complicating the whole process.
And if you mean taxable accounts, the taxable events incurred gore most of the gains.
The US is not alone in that respect—other, long-developed countries have it even worse.
Right, that’s what I was referring to: investing in job skills so you can high-tail it to another country if things become unbearable (and hope they don’t seize your assets on the way out).
I’m not in the US so I’m not fully familiar with the retirement options available there. Here in Canada we have what seems to me a pretty good system whereby I can have a tax sheltered brokerage account for retirement savings. In many cases it is hard to argue with the ‘free money’ of employer matched retirement plans and the tax advantages of particular schemes but I think it is wise to be mindful of all the advantages and disadvantages of a particular scheme (including things like counterparty risk regarding who ultimately backs up your investments) and take that into consideration when weighing options.
This is definitely an issue when starting out. Transaction costs can make broad diversification prohibitively expensive when your total assets are modest. I see it as something to aim for over time but you are absolutely right to be mindful of these issues. If you have a reasonable choice of mutual funds you can look for ones that are diversified at least internationally if not across asset classes outside of equities and fixed income.
This is why I like the options available in Canada. Between self-directed RRSPs and the new TFSA the tax-friendly saving options are pretty good.
Indeed, and this is one reason I’m working towards my Canadian citizenship. It has relatively healthy finances compared to the UK where I grew up. I don’t think the necessity for some form of default on the obligations of most developed countries’ governments is widely appreciated yet.
This is in line with the broader view of diversification I am advocating. Over the typical individual’s expected lifespan this is an important consideration. I think it is a sensible long term goal to diversify in a broad sense so that you maintain options to take your capital (human and otherwise) wherever you can expect the best return on it. Assuming that this will always be the same country you happen to have been born in is short sighted in my opinion.
On a diversification related note, this proposal from Ian Ayres and Barry Nalebuff is an interesting take on the merits of diversification across ones own lifespan.
Back up: you can make maximum Traditional & Roth IRA contributions in the same year? (I live in the U.S., and have only been putting funds into my traditional IRA.)
No, you cannot max both a Traditional and a Roth; it’s either/or. Which one you choose depends on several factors, including length of investment and the income you predict you’ll have during disbursement. Traditional is better if you expect low income in retirement, or a shorter time frame until retirement; Roth is better if you expect higher income or a longer time frame.
How do you pick when to switch, then? I assume tax-efficiency, but how tax-efficient should income be before you put it into Roth rather than Traditional? And how do you measure tax-efficiency of income?
I apologize if this is overly off-topic, of course.
It’s been a while since I did primary research on the topic; I decided on a Roth for my personal circumstances and dumped most of the other knowledge afterward, so I’ll be deferring to references: here are a couple articles about the topic of choosing between them, one which links to a calculator.
You measure tax efficiency by what percentage of the money you get to keep after it’s been taxed in the context of your other income and investments. Putting tax-inefficient funds in tax-efficient formats like an IRA lets you keep a (hopefully much) larger percentage.
And I don’t see how it’s off topic in an Open Thread.