2SmallFish

Six years ago, I worked with iShares to launch their Portfolio Construction Tool, an online application that helped financial advisers build client portfolios using iShares (Barclays Global Investor’s branded ETFs). A few years later, we did the same for State Street Global Investors and two other large money managers, covering over 80% of the ETF market. Tens of thousands of advisers have used the tool since then.

In January, 79% of advisers named ETFs their top investment option for the next six months, according to a Charles Schwab survey. It is clear that professionals loves ETFs, and you should too.

What ETFs have going for them:

1. They are cheap: As I emphasize over and over again, it is hard to predict returns, but expenses are totally predictable.  The fact is that fees and expenses take a huge bite out of your portfolio returns over the long run, so stick with the cheap stuff.  The average expense ratio for ETFs is 0.56% vs. 1.44% for the typical actively managed mutual fund.
2. They are simple: The index ETFs track well known indices and can be traded on the exchanges like stocks, so with just a couple of ETFs you can have enjoy wide diversification in the U.S. and abroad at rock-bottom prices.  (You pay commissions every time you trade so you should do it in big lump sums rather than monthly).
3. Everyone is doing it: Investors poured nearly $150 billion into ETFs in the second half of last year, even as they drained more than $250 billion out of regular stock and bond mutual funds.  Perhaps individual investors are finally wising up and realizing that they do not have the skill sets to pick individual stocks.

Rescuing your Portfolio:

If your portfolio took a beating last winter, this might be the right time to rebuild it if you haven’t already.  If you do not have a lot of time then just keep it simple.  For example, here is what I did with my 529 College Savings Account: A diversified mixed of 60% stocks, 40% bonds using 5 low-cost ETFs. (You can get much fancier with more niche ETFs, but that just makes rebalancing more complicated later.)  By the way most of these have expense ratios less than 0.1% per year.

• Stock: US Stock (35%) – Vanguard Total Stock Market (VTI) or something similar
• Stock: Foreign Stock (20%) – Vanguard FTSE All-World ex-US (VEU) or something similar
• Stock: US Real Estate (5%)- Vanguard REIT (VNQ) for that inflation hedge
• Bonds: Intermediate Bond (30%) – Vanguard Total Bond Market (BND)
• Inflation Protected Bond (10%) – iShared Barclays TIPS Bond (TIP), with all that deficit spending, inflation will come sooner or later

Post was inspired by an article by Penelope Wang in the Professional user’s Guide to Money Speical Report

Many value-oriented (and financially savvy) households stick to the adage of “buy term insurance and invest the difference”.  The idea is that instead of buying the more expensive permanent insurance such as whole life, you can buy term insurance and invest the difference.

For example, a 30-year term life policy for a 33-year-old man may cost $939 in annual premiums, compare that to $11,290 for a whole-life policy.  So instead of choosing the whole-life, he invests the $10,351 annual difference in a portfolio with a net after-tax return of 5.19%.  In 30 years, the invested money grows to $746,997.  However, if you still need coverage after the term-life expires, the annual premium might be something like $29,589.

Professionals disagree on which option is better.  Some argue that “buy term insurance and invest the difference” does not work so well when the market craters, like last year; but I think that really depends on how you are investing that money.  The way to think about it is what does the insurance company do with my money when I buy the whole-life?  They go and invest it in conservative instruments to match their long-term liabilities, not in a 80% equity portfolio.  We can do the same.

In fact, to make things simple, buy term (ladder them if expect expense needs to change over time) and invest the difference in a target date fund with the same date as when the term-life policy expires.  Hopefully you will be smiling happily to know 10, 20, or 30 years from now that you’ve pocked the compounded difference instead of your friendly insurance company.

Two-thirds of affluent parents with children under 18 aren’t using Section 529 college savings plans, according to a recent report.  Most industry executives and financial advisers are startled by the report’s findings.  Especially since most consider a 529 to be a no-brainer for the well-to-do.

One financial adviser from RBC Wealth Management said, “I would think that 529s would be part of financial planning for affluent parents, especially with the tax benefits.  We certainly recommend them, and as a vehicle, I’ve found them to be solid gold.”

So why aren’t more parents saving for college through this great tax vehicle?  Having worked with financial advisors for ten years, the first thing I thought of was: the commissions must be low.  Indeed, there is a general lack of enthusiasm among advisers because of the relatively low commissions the plans generate.  (In our opinion the commissions embedded in the adviser-sold 529 are already too high – costing you hundreds or even thousands over a few years.)  So the problem comes down the education and distribution.  It is a great financial product that so many parents can benefit from.  We at 2SmallFish are working hard to make it easy and truly a no-brainer.