What equities fund should I add to my Target Date Fund?

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necroman
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What equities fund should I add to my Target Date Fund?

Post by necroman »

Hello,

I have a 2050 Target Date Fund (TDF) in my Roth IRA. Recently, I have read some threads about adding certain funds to the TDF for more equity exposure. It seems like a lot of the recommendations are for small cap value (SCV), but just as many posts say that it's too risky, or that SCV has had its day in the sun and the small cap premium no longer exists.

This IRA is more of a supplement in my retirement portfolio rather than the main piece. Most of my retirement savings (about 11.5% per paycheck) go to the AZ pension system for teachers, of which I should earn 60% of my salary in retirement. I deposit an extra $150 a paycheck in the Target Date fund in the IRA. I think I would like to be a bit more aggressive with this IRA, to maybe maximize the account's value, but I'm not sure how to go about doing it.

I recently learned about Paul Merriman and his assertions that small cap value holds considerable long term returns, but with a greater risk of underperformance in long stretches. There was an article he and Chris Pedersen wrote called "2 Funds for Life," a way of having a TDF and a SCV fund in a certain allocation based on your age. I was interested in that, until I read a lot of posts about how risky and underwhelming SCV has been in recent decades.

So my questions are as follows:

1. Has anyone heard of the "2 Funds for Life" portfolio, and what are your general impressions of that strategy?
2. Is SCV the most popular choice to add as a supplementary fund, or are there other good choices?
3. Maybe most importantly, am I overthinking this? Should I be happy with the general exposure and returns the Vanguard Target Date Fund gives me, or should I try to maximize the value of my retirement?

Thank you very much for your help.
The oldest and strongest emotion of mankind is fear, and the oldest and strongest kind of fear is fear of the unknown. --H.P. Lovecraft
lakpr
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Re: What equities fund should I add to my Target Date Fund?

Post by lakpr »

I would simply choose a 10-year later target date fund. Nothing says just because you plan to retire around 2050, you MUST choose the 2050 fund. Nothing prevents you from choosing a 2060 fund, for example, which allows for 10 more years of high equities exposure before the glidepath begins. You can afford that risk since you have a pension that you are contributing to and can look forward to.
000
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Re: What equities fund should I add to my Target Date Fund?

Post by 000 »

lakpr wrote: Mon Apr 12, 2021 12:53 am I would simply choose a 10-year later target date fund.
+1
Doctor Rhythm
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Re: What equities fund should I add to my Target Date Fund?

Post by Doctor Rhythm »

A typical 2050 fund like Vanguard’s is already 90% equity. You really can’t get meaningfully more exposure than that. Later target date funds generally won’t be more aggressive (none of them will put you at 100% equity) but will delay the start of the glide path, so you’ll stay at that level for longer.

If you want to tilt to SCV or anything else, you should ask yourself how much conviction you have that it will outperform the total market. Frankly, “Other people are doing it” or “I heard someone who knows more than me say it’s a good idea” doesn’t cut it. You should understand the rationale and the counter arguments and decide the tilt makes sense to you, so that you’ll keep your tilted portfolio even when it underperforms for many years.

So, my answers are:

1. It’s fine, but it’s not clearly better than one fund or 3 funds in an IRA.
2. Popularity is over rated. See above.
3. You should try to maximize the value of your savings within the parameters of your risk tolerance. I’d say you are either overthinking it if you’re not inclined to tilt your portfolio or under thinking it if you want to tilt based on reading an article or two about it.
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zincTwo
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Re: What equities fund should I add to my Target Date Fund?

Post by zincTwo »

necroman wrote: Sun Apr 11, 2021 10:06 pm 1. Has anyone heard of the "2 Funds for Life" portfolio, and what are your general impressions of that strategy?
2. Is SCV the most popular choice to add as a supplementary fund, or are there other good choices?
3. Maybe most importantly, am I overthinking this? Should I be happy with the general exposure and returns the Vanguard Target Date Fund gives me, or should I try to maximize the value of my retirement?
1. I use 2-funds-for-life for my+spouse RothIRA accounts. We only add to those accounts annually, and based upon assets in other accounts, we'll draw on the RothIRA 20+ years after retirement. So, due to the amounts and desire to not have to rebalance them, I have them in 2 funds-4-life, with a "target" date ~18 years after expected retirement. disclosure: I use Merriman's 10-fund UBH portfolio for my taxable+401K accounts.

2. I use SCV. Specifically, I use IJS, though on Paul's ETF page, he has other options. I may change to Avantis, but I'm not feeling the need to change. From Paul's analysis, a tilt with other classes hasn't had the same benefit as SCV. If you start adding more tilts, then you are in the range of his 4-fund Combo, or 10-fund UBH.

3. I don't think you are overthinking. There is no way to predict the future. SCV is falling out of favor recently, but any guess on the future is just that, a guess. We do have past data, and that has shown that there is a benefit, if you want to add the risk. For that matter, choosing an SP500/TSM could also be considered "predicting the future, based upon past results" -- assuming that the equity market is a better investment than under a mattress, or only bonds.

I've looked at Paul's research, the Callan Periodic Table, Tell-tale chart by both Bogle and Merriman, other authors, and comfortably arrived at my own IPS plan.
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necroman
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Re: What equities fund should I add to my Target Date Fund?

Post by necroman »

Bro Ice Cream,

When you say "2 Funds 4 Life" in your Roth IRA, do you mean the whole "1.5 x your age in the TDF and the rest in SCV," where your SCV allocation slowly disappears the closer you get to your end date, or something like 80% TDF and 20% SCV? Thank you for your thoughts on this concept. It seems like Merriman and Pedersen's backtesting on the "2 Funds for Life" was very thorough, but again, past performance doesn't guarantee future results. I guess it's always a gamble some way or another.

Thank you again for your perspective.

Necroman
The oldest and strongest emotion of mankind is fear, and the oldest and strongest kind of fear is fear of the unknown. --H.P. Lovecraft
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necroman
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Re: What equities fund should I add to my Target Date Fund?

Post by necroman »

Lakpr, 000, and Doctor Rhythm,

Do either of you have any concerns about the TSM or SP 500 being market weighted, where you feel like you might miss out on the specific value of a factor like small caps due to their ratio within the index fun, or are you generally pleased with the returns from TSM or SP 500?

Thank you for your perspectives.
The oldest and strongest emotion of mankind is fear, and the oldest and strongest kind of fear is fear of the unknown. --H.P. Lovecraft
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ruralavalon
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Re: What equities fund should I add to my Target Date Fund?

Post by ruralavalon »

Doctor Rhythm wrote: Mon Apr 12, 2021 5:32 am A typical 2050 fund like Vanguard’s is already 90% equity. You really can’t get meaningfully more exposure than that. Later target date funds generally won’t be more aggressive (none of them will put you at 100% equity) but will delay the start of the glide path, so you’ll stay at that level for longer.

. . . . .
+ 1.

A target date fund is best used by itself. It's already very aggressive. Keep it simple.
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link: Bogleheads® investment philosophy
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necroman
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Re: What equities fund should I add to my Target Date Fund?

Post by necroman »

Thank you for your perspective, ruralavalon. That's what I'm struggling with--just keeping it simple and taking whatever the TDF gives me, or by taking an educated gamble in hopes of capitalizing on some higher returns.
The oldest and strongest emotion of mankind is fear, and the oldest and strongest kind of fear is fear of the unknown. --H.P. Lovecraft
Texanbybirth
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Re: What equities fund should I add to my Target Date Fund?

Post by Texanbybirth »

I just put $100 at M1 Finance into the Golden Butterfly portfolio. I'm gonna track it for a while as play money. I like M1's "pie" functionality. However, I've already refreshed the portfolio like a dozen times today so I don't think this stuff is good for me.

Our only investments are TDFs (in tax-advantaged accounts) and Vanguard's LS Growth Fund (VASGX) in taxable. I prefer to keep it simple because I'm really bad at re-balancing. :beer
“The strong cannot be brave. Only the weak can be brave; and yet again, in practice, only those who can be brave can be trusted, in time of doubt, to be strong.“ - GK Chesterton
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zincTwo
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Re: What equities fund should I add to my Target Date Fund?

Post by zincTwo »

necroman wrote: Mon Apr 12, 2021 2:42 pm Bro Ice Cream,
When you say "2 Funds 4 Life" in your Roth IRA, do you mean the whole "1.5 x your age in the TDF and the rest in SCV," where your SCV allocation slowly disappears the closer you get to your end date, or something like 80% TDF and 20% SCV? Thank you for your thoughts on this concept. It seems like Merriman and Pedersen's backtesting on the "2 Funds for Life" was very thorough, but again, past performance doesn't guarantee future results. I guess it's always a gamble some way or another.
For me, I am doing the (1.5xage TDF)+SCV model with two adjustments for that RothIRA (since it will not be touched). 1) I'm assuming my "age" is adjusted to the TDF date (i.e. if I was 66 at that date). Perhaps when I approach the "date", I may retain a permanent 10% SCV ratio.

I've been able to do this without "rebalancing" -- when I do my annual backdoor roth contribution, I just add the new $$ to meet the planned ratio. Last year, most went into the TDF, since SCV jumped way up last year.
000
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Re: What equities fund should I add to my Target Date Fund?

Post by 000 »

necroman wrote: Mon Apr 12, 2021 2:45 pm Do either of you have any concerns about the TSM or SP 500 being market weighted, where you feel like you might miss out on the specific value of a factor like small caps due to their ratio within the index fun, or are you generally pleased with the returns from TSM or SP 500?
Not in a portfolio holding a good helping of international stocks (which the target date fund has). I think that is plenty of diversification within stocks and if I felt concerned I would look for diversification into other asset classes.

If international stocks were unavailable for some reason, then yes I could see the value of a SCV tilt.
ZWorkLess
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Re: What equities fund should I add to my Target Date Fund?

Post by ZWorkLess »

I have added some Total Stock Market to our retirement accounts as I did want more equity exposure than our TD fund. The way I did it was to just split new money 50/50 a few years ago, so as to gradually shift the exposure and to some degree moderate the TD glide path. This is working well for us.

Right now, we're around 88% TD2035 and 12% TSM in our retirement accounts. That nudges our equity exposure up to a level I'm happier with than the 2035 fund, and will do that even more so as it starts gliding down more steeply in coming years. Depending on how things go, I'm guessing we may be at 25/70 by the time we are close to retirement. If we got close to 25% before retirement, I'd probably shift new money all to the TD fund to prevent it going further than 25/75. That's enough for me. :)

It's easy to change if I want to, but I'm guessing I'll leave it be and just sell off one vs the other when we start making withdrawals, depending on how much equity exposure I want at that point. I'm pretty comfortable with the ups and downs, and honestly I'd probably be 100% stocks if I just went with my gut, but I try to stick reasonably close to basic principles that experts have developed. AND, when I hit 65-70, I'll be moving everything to TD2035 (or maybe a LifeStrategy fund) and committing to maximum simplicity for our finances so that if I get dementia and/or die early (both run in my family), my spouse will have an easy time handling things, as he's not interested in finance.
jimkinny
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Re: What equities fund should I add to my Target Date Fund?

Post by jimkinny »

OP, have you actually any idea of what return you expect over the next 10-20 years on a fund like a small cap value fund. Is it 2% above a total market index fund or 1%. Have you looked into how long you should expect to hold a small cap value fund in order to obtain that return? Also, there is evidence that whatever premium is claimed for small cap value, it has gotten smaller oveder the years. If you have heard about it, how many others have heard about it and once widely known do you think that the premium will coninue to exist. Maybe i suppose.

If you want more risk, just add more equity exposure in the form of a total market fund. If you have 95% equity do you think your long term expected return will be hihger than 90% equity. If you try small cap value be prepared for long periods of less than stellar performance and maybe you will be rewarded if you hang on.

Look into the boglehead wiki article on the the need, ability and willingness to take risk.
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Re: What equities fund should I add to my Target Date Fund?

Post by Doctor Rhythm »

necroman wrote: Mon Apr 12, 2021 2:45 pm Lakpr, 000, and Doctor Rhythm,

Do either of you have any concerns about the TSM or SP 500 being market weighted, where you feel like you might miss out on the specific value of a factor like small caps due to their ratio within the index fun, or are you generally pleased with the returns from TSM or SP 500?

Thank you for your perspectives.
I do not share that concern, but I’m not particularly prone to FOMO. Let me rephrase your question and see if it resonates at all:

Are you reassured that you won’t be overly impacted by the underperformance of a factor like small caps due to their ratio within the index fund?
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ruralavalon
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Re: What equities fund should I add to my Target Date Fund?

Post by ruralavalon »

necroman wrote: Mon Apr 12, 2021 3:01 pm Thank you for your perspective, ruralavalon. That's what I'm struggling with--just keeping it simple and taking whatever the TDF gives me, or by taking an educated gamble in hopes of capitalizing on some higher returns.
Simple can produce higher returns.

An allocation fund seems to insulate investors from behavioral errors, and so increases investor returns. Morningstar (8/15/2019) "Mind the Gap 2019", link. Please see the wiki article "Behavioral pitfalls", link

"On the one hand, allocation funds produced a positive gap of 0.22% on annualized returns of 5.54%. A positive gap means a majority of the money going in was well-timed."

Sector bets (trying to pick areas of the economy of types of funds that may outperform) is not possible with any degree of certainty. Wiki article "Callan periodic table of investment returns", link. This table covers nine types of funds over 20 years, showing that the best performing type of fund changes frequently from year to year, there is no pattern, it is random.
"Everything should be as simple as it is, but not simpler." - Albert Einstein | Wiki article link: Bogleheads® investment philosophy
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