Dumping Active strategy for passive

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Galaxy8
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Dumping Active strategy for passive

Post by Galaxy8 » Tue Dec 27, 2016 4:08 pm

I am currently working on bolstering my financial education. When my wife and I graduated school this year, we were referred to a local CFP who provides his services to graduates, without charge, for 3 years. We established some insurance through him, but also set up Roth IRAs with the American Funds Target Date 2055 A (AAMTX), with a 5.75% load and ER of 0.78%. We were sold on active management, specifically with American Funds, significantly outperforming the S&P500 index.

I’ve recently been reading to advance my financial knowledge -- threads on this forum similar to my situation, White Coat Investor and Bogleheads guide, and next up is The Only Investment Guide You’ll Ever Need (Tobias). I did not realize no-load funds even existed before reading these books, and now I feel duped. I’ve run the numbers through excel spreadsheet, and the active fund would have to do far better than the passive fund to negate the fees.

I am tentatively planning to move our Roth’s to Vanguard and follow either the simple three-part portfolio, or a Vanguard Target Date fund until we have enough to invest in admiral shares funds.

My real reason for posting here is to affirm that I’m not crazy to move accounts, against my CFP’s advice. I’m a very hands-on person and actually enjoy budgeting, financing, and planning, so I think a DIY approach would be appropriate.

Other details:

Age: 26
Income: ~$50k each for myself and my wife. My income will at least quadruple in 2.5 years and hers will quadruple in 5.5 years.

Our only debt is student loans:
Mine: $425k, not be eligible for forgiveness
Hers: $225k, eligible for forgiveness

Emergency fund: ~$17k
Roth’s ~$4300 each (after fees and losses for the year)
Bonds: $5300 at 3.4% average

My plan for now:
1) Put 33% of our take home pay towards investments and debt. We’ve been doing this already.
2) 1st priority is fully funding Roth IRAs.
3) Next priority is paying the minimum payment on my wife’s loan, and as much as possible towards mine. I’ve deferred required payments on my loans so that I can selectively pay down the highest interest portions first (7.9%).
4) Reconsider my investment and debt payment plan when I move into a new job in 2.5 years, depending on the investment opportunities through the new job.

lazylarry
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Re: Dumping Active strategy for passive

Post by lazylarry » Tue Dec 27, 2016 7:37 pm

Yup passive definitely outclasses most active investing strategies. Glad you are working on this.
My real reason for posting here is to affirm that I’m not crazy to move account
Not at all. This is entirely reasonable. A load of 5.75% an ER of 0.78% is a good way to make other people (not named Galaxy8) money.
Emergency fund: ~$17k
This is quite a large emergency fund (most recommend for 6mo - 1 yr). And correct me if I wrong, you and wife appear to be residents? In which case you will have a stable income and probably don't need this large of Emergency fund. Unless there is a plan for car/house/big expense or something of that nature. You also will have much easier loan opportunities including physicians loan based on your desired purchases.
Roth’s ~$4300 each (after fees and losses for the year)
Would maximize your Roth IRAs as you have stated. Consider backdoor Roth in that time period when you're wife hasn't quite stepped up in income yet.
Bonds: $5300 at 3.4% average[
You're young and can afford to wait for things. Unless there is some reason to be conservative, I don't think you need this much allocation to bonds.
My plan for now:
1) Put 33% of our take home pay towards investments and debt. We’ve been doing this already.
2) 1st priority is fully funding Roth IRAs.
3) Next priority is paying the minimum payment on my wife’s loan, and as much as possible towards mine. I’ve deferred required payments on my loans so that I can selectively pay down the highest interest portions first (7.9%).
4) Reconsider my investment and debt payment plan when I move into a new job in 2.5 years, depending on the investment opportunities through the new job.
Seems like a solid plan. WCI is a good place to go, I assume you have done things like refinancing etc if possible. Only other thing would be try to hit the company match in your 401k if that's available. Good luck!
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livesoft
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Re: Dumping Active strategy for passive

Post by livesoft » Tue Dec 27, 2016 7:42 pm

Galaxy8 wrote:..., specifically with American Funds, significantly outperforming the S&P500 index.
Hmmm, I've never heard that before. :) Is that Fake News?
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Grt2bOutdoors
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Re: Dumping Active strategy for passive

Post by Grt2bOutdoors » Tue Dec 27, 2016 7:52 pm

Is this what you mean - significantly outperforming the S&P Target 2055 index?

The American Funds website shows a different story completely when including the effect of the sales charge, performance is actually below that of the target index. Have the CFP explain that one to you......i'd like to be a fly on the wall when you have that conversation. :twisted:
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

Galaxy8
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Re: Dumping Active strategy for passive

Post by Galaxy8 » Tue Dec 27, 2016 7:58 pm

Thanks for such a quick response. I unfortunately will have to purchase a new car next year. My car is 11 years old and is on it's last legs (the a/c recently broke), so I plan to replace it with a new 2017 Audi R8. Just kidding, I'm planning for a used and reliable Honda under $18k. And I can get fairly good rates through USAA (2.0% over 60 months).

Our emergency fund is about 3 months of take home pay, which is about 5 months of expenses. Perhaps reducing that to 3 months of expenses would be appropriate, as three months is the time before our disability insurance will kick in? That wound be about $11k.

The bonds I have were inherited EE bonds. Would it be better to use them to pay down debt that sit around at ~3.4%?

We are both first year residents. Unfortunately, I cannot refinance my loans because the monthly payment would exceed my income. Instead, I'm selectively paying on the 7.9% portion ($50k), and I think I can knock it out during residency. I will refinance as soon as I can when I'm done.

Our hospital does not offer a match, and the options in a Roth IRA are much broader than the hospital's 403(b).

Thanks for the quick help!

lazylarry
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Re: Dumping Active strategy for passive

Post by lazylarry » Tue Dec 27, 2016 8:18 pm

Galaxy8 wrote:Thanks for such a quick response. I unfortunately will have to purchase a new car next year. My car is 11 years old and is on it's last legs (the a/c recently broke), so I plan to replace it with a new 2017 Audi R8. Just kidding, I'm planning for a used and reliable Honda under $18k. And I can get fairly good rates through USAA (2.0% over 60 months).

Our emergency fund is about 3 months of take home pay, which is about 5 months of expenses. Perhaps reducing that to 3 months of expenses would be appropriate, as three months is the time before our disability insurance will kick in? That wound be about $11k.

The bonds I have were inherited EE bonds. Would it be better to use them to pay down debt that sit around at ~3.4%?
Maybe the Audi R8 can be your next car :). But, I think it's reasonable to have 5 months of expenses, you don't know if something will happen - e.g. illness in family, new car breaks down, etc. I honestly don't know a ton about particular bonds types, but a 3.4% interest is pretty low and would thus use them to fund your Roth IRA or pay down your higher interest debt. I know you mentioned that the 403b has fewer options, but just would make sure you have investigated and found no low-cost broad index funds or target funds. Mine has fewer options as well but there are pretty solid options.
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Duckie
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Re: Dumping Active strategy for passive

Post by Duckie » Tue Dec 27, 2016 8:23 pm

Galaxy8 wrote:we were referred to a local CFP who provides his services to graduates, without charge, for 3 years. We established some insurance through him
What kind of insurance?

NancyABQ
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Re: Dumping Active strategy for passive

Post by NancyABQ » Tue Dec 27, 2016 8:39 pm

Galaxy8 wrote: Our emergency fund is about 3 months of take home pay, which is about 5 months of expenses. Perhaps reducing that to 3 months of expenses would be appropriate, as three months is the time before our disability insurance will kick in? That wound be about $11k.

The bonds I have were inherited EE bonds. Would it be better to use them to pay down debt that sit around at ~3.4%?
Personally I think 3.4% on EE bonds is great! I would keep them, but maybe since they are fairly liquid (assuming they are more than 1 year old) you could consider them to be part of your emergency fund and reduce the cash in your current emergency fund accordingly?

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Bogle_Feet
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Re: Dumping Active strategy for passive

Post by Bogle_Feet » Tue Dec 27, 2016 8:47 pm

My real reason for posting here is to affirm that I’m not crazy to move accounts, against my CFP’s advice.
In study after study, year after year, it has been shown that the vast majority of actively managed mutual funds underperformed their benchmark index funds. Ignore Mr. Advisor who is in the business of selling commission-based products.

jvini
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Re: Dumping Active strategy for passive

Post by jvini » Tue Dec 27, 2016 8:56 pm

First of all, you are not crazy at all. After graduating law school and then switching careers, I decided I better start investing for my and my family's future. I read a lot and spoke to various people and started to do all sorts of research and even subscribed to news letters in order to buy individual stocks and managed funds (although they were always no load!)

After a few years of continuing to research what's most effective and realizing I didn't have the time for a full time job and managing a portfolio I discovered passive investing. That was about 20 years ago, and I've never looked back.

The key for me was to be as dispassionate and robot-like when it comes to investing. I developed rules of thumb that I follow fairly religiously and it has very much paid off.

Dollar cost average monthly. Rebalance annually. Stay diversified in index funds made up of U.S. equities, international equities, a REIT index (much smaller allocation), and a bond index. Whether you go with Vanguard or Fidelity or whomever, make sure you can buy the ETF's at no cost (Vanguard lets you buy their ETF's for free, Fidelity lets you buy ishares, which are now actually even cheaper than Vanguard's, but they are both great.)

My personal formula (so you'll have something to compare with) is- Age-13 in bonds. (But only once I reached 30, since there is a lifetime ahead to make up for losses in your 20's). The remainder is then divided between a U.S. equity ETF 70% (to be honest, I break that up between small, mid, and large cap ETF's from ishares since statistically it has the same risk as all large caps but about 2% higher returns over the long term which adds up to quite a bit-Morningstar has some great white papers on this), 20% International ETF, and 10% REIT ETF. I later discovered this was similar to what Ric Ferri, who's on these boards and is a great investor, refers to as the core four.

As I made more money, I was able to dollar cost average into these each month (after maxing out my 401K) and rebalance each year around the same date. I still do that and once I reach a 60/40 split, plan on maintaining that through retirement, although 50/50 may be where I end up some day well into retirement.

I've done this through booms and busts. My return has been very good and I can sleep at night knowing that I'm diversified. I'm with Fidelity so I buy ishares, but again, Vanguard is good too.

I hope this helps a little. Good luck.

Galaxy8
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Re: Dumping Active strategy for passive

Post by Galaxy8 » Tue Dec 27, 2016 9:08 pm

Duckie wrote: What kind of insurance?
We only purchased long term own-occupation disability through our CFP.

Otherwise, through USAA: Auto ($500k/$500k) and renters with $1m liability. We may purchase a $1m umbrella as well.
Last edited by Galaxy8 on Tue Dec 27, 2016 9:13 pm, edited 1 time in total.

MorningstarFan
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Re: Dumping Active strategy for passive

Post by MorningstarFan » Tue Dec 27, 2016 9:09 pm

Galaxy8 wrote:I am currently working on bolstering my financial education. When my wife and I graduated school this year, we were referred to a local CFP who provides his services to graduates, without charge, for 3 years. We established some insurance through him, but also set up Roth IRAs with the American Funds Target Date 2055 A (AAMTX), with a 5.75% load and ER of 0.78%. We were sold on active management, specifically with American Funds, significantly outperforming the S&P500 index.
Good for you for gaining financial knowledge! I am also in a similar age as you and I can tell you that many people in our age are clueless with your investment.

Here is my thought with your investment:
1. American Funds provide solid mutual fund lineups and AAMTX is certainly not a bad choice. Since this is a fund of funds, I went to look what's inside it. I can tell you the ingredients, or the individual funds, are also decent.
2. You mentioned that is has outperformed S&P500 index. I just want to note that active funds do not always outperform. Good active mutual funds do not always outperform either.
3. However, my only hesitation is the front load fee (5.75%). You may look into the Vanguard Target Retirement 2055 Fund (VFFVX). The expense ratio is only 0.16% (and should decrease as more people invest). This target date fund is only comprised of index funds (passive).

These are just my thoughts. Have a good new year!

pkcrafter
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Re: Dumping Active strategy for passive

Post by pkcrafter » Tue Dec 27, 2016 9:48 pm

Gaxaly8, welcome,
My real reason for posting here is to affirm that I’m not crazy to move accounts, against my CFP’s advice.
I'm shocked by your CFP's suggestion. You are here, and that's the best thing you could possibly do. Maybe your advisor has something else in mind in handling your money when income goes way up. Have you read the White Coat Investor's Website?

As for the American TR fund, Morningstar does not adjust for front end load when calculating returns. Secondly, American funds TR 2055 is strongly tilted to growth, which has been outperforming value for the past 6 years, but that will reverse. Vanguard TR 2055 is pretty balanced.

What is your overall target asset allocation?

Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.

Galaxy8
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Re: Dumping Active strategy for passive

Post by Galaxy8 » Tue Dec 27, 2016 10:42 pm

jvini wrote:I hope this helps a little. Good luck.
This is fantastic. I'm learning a lot buy seeing how other professionals are setting up their investments and trying to understand the reasoning behind the differences.
pkcrafter wrote: Have you read the White Coat Investor's Website?
I am slowly working my way through it. I have read the book, and when there are things I don't understand, WCI is my first resource for looking them up.
pkcrafter wrote:
As for the American TR fund, Morningstar does not adjust for front end load when calculating returns. Secondly, American funds TR 2055 is strongly tilted to growth, which has been outperforming value for the past 6 years, but that will reverse. Vanguard TR 2055 is pretty balanced.

What is your overall target asset allocation?
I have made my own tables to adjust return, and the Morningstar stated 5yr monthly return on AAMTX is 10.92%, but adjusting for the front load, the 5 year return is 8.51%.

I really don't know enough to determine a target asset allocation. The amount I will be investing in my 20s is much less than in my 30s, and if I lose some I'm not that worried about it. I'd rather learn from my losses now, when I'm investing $10k a year, than when I'm investing 5 times as much.

I think the best way to have a diverse portfolio at the moment is through a target date fund. We don't have enough invested in our Roth's at the moment to meat the minimums for some of the Vanguard funds I've looked at. I do plan to max out the Roths for 2016 (my understanding is I have until April to do this), and continue to max them out. We will likely have enough invested to access other funds in a year or two.

I plan to keep reading all that I can to learn what my targets should be.

Galaxy8
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Re: Dumping Active strategy for passive

Post by Galaxy8 » Tue Dec 27, 2016 10:46 pm

Another question,

Now that we've paid this load of 5.75%, does the money that goes into the load count towards the IRA max yearly contribution?

For instance, if I put $5500 into my account, after the load it is $5183.75. So if I put $5816.25 into my IRA, after the load fees it would be $5500.

MorningstarFan
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Re: Dumping Active strategy for passive

Post by MorningstarFan » Wed Dec 28, 2016 12:42 am

I believe the front load counts toward $5,500 IRA contribution, because you invested $5,500 up front.

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