Investment Planning

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
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Investment Planning

Post by Laura »

Welcome to the Bogleheads/Diehards Forum. There are many knowledgeable and helpful people who are part of this online community. Most of these posters are willing to share their time and expertise with new posters who are looking for help, but they can't or won't give advice in a vacuum. We need to know some important things about you, including all the investments you already have. Otherwise, we may be advising you to buy into a fund that overlaps your present holding(s), doesn't fit your asset allocation plan, or, worse, is either too risky or too conservative for your investing temperament. To make sure you get the help you need, we would like to provide a few suggestions.

Educate Yourself

If you have never taken the time to educate yourself on investing basics, you should do that now. There are several easy-to-read books that do not require math knowledge, finance interest, or hours to read. Several authors post on this forum frequently and usually answer questions related to their books. Taylor Larimore, Mel Lindauer, and Michael LeBeouf wrote the excellent The Bogleheads’ Guide to Investing. The series continued with The Bogleheads Guide to Retirement Planning. In addition, Financial Advisor Rick Ferri has a terrific online book available called Serious Money and Larry Swedroe has several easy to read books available, including The Only Guide to a Winning Investment Strategy You'll Ever Need: The Way Smart Money Preserves Wealth Today. Another favorite is The Coffeehouse Investor. All of these books can help you build a base of knowledge in just a few hours. A list of other books is available on the Diehards Reading List.

Investment Plan

After educating yourself, the first step on your investing journey should be to settle on an investment plan that includes your desired asset allocation. Your investment plan should look out into the future and include things like a new car or home purchase in a few years, education expenses for children, and retirement, just to name a few. All of these goals require money in different time frames, and the money should be invested accordingly. Studies have shown that your asset allocation will determine more than 90% of your portfolio return, so you should focus on your asset allocation first rather than on fund selection.

Since risk and return are directly related, your asset allocation should balance your NEED to take risk with your ABILITY to withstand the ups and downs of the market. NEED can be determined in many different ways. If you are young, you have the benefit of many years of compounding, so in one respect your NEED to take risk is low. On the other hand, your portfolio size is probably small, leaving you with a long way to go to reach your retirement goals. As a result, you could argue that your NEED to take risk is high.

For people closer to retirement, it may be possible to more closely determine NEED. First, estimate approximately how much income you will need annually after retirement. For this example, we’ll assume you need $100,000 per year. Next, look at any pensions or social security benefits that will provide a source of income. If a pension provides $30,000 per year and social security provides an additional $20,000 per year, then your portfolio would need to provide an extra $50,000 each year. To prevent running out of money, you should probably start by withdrawing 4% a year or less with an annual inflation adjustment. To generate $50,000 per year at 4% requires a minimum portfolio size of $1,250,000. How close are you to your goal?

Turning to ABILITY, this relates to your ability to withstand the ups and downs of the market without getting nervous and making changes to your asset allocation. Selling in the face of a decline is about the worst thing you can do. Here is a table offered by author Larry Swedroe, based on the 1970s bear market, showing the amount of decline for various stock/bond allocations:

Max Equity - Exposure Max loss

There are other ways to determine an asset allocation, including several rules of thumb:

• Your age in bonds. So, if you are 40 years old, then use a 60/40 (equity/bond) allocation.
• 110 minus your age = equities (110-40 yrs old=70/30 asset allocation)
• 120 minus your age = equities (120-40 yrs old = 80/20 asset allocation)
• Vanguard can also help you Create an Investment Plan and can make an investment recommendation

Asset Allocation

Once you have identified the split between stocks and bonds, you need to focus on whether you prefer to use funds that cover large parts of the market (Total Market funds) or whether you prefer to slice and dice your portfolio into sub-asset classes. For many people, this choice will be determined by the funds available in their 401k-type plans. Others may prefer to have fewer funds that cover larger parts of the market for simplicity of management.

One part of the market that everyone needs to consider is international investing. Many experts recommend investing 20-40% of your equity allocation in international holdings. Some people on the forum believe that 50% is the better number to reflect the position that the US represents in the world economy (approximately 50%). Since none of us can predict the future, the correct number that would return the highest percentage in the next 20 to 30 years could be any of these figures. Like much of investing, the ultimate choice is yours. Pick one number and then stick with it.

Portfolio Construction

After settling on your primary asset allocation you can turn to selecting funds that flesh out your desired asset allocation and placing them in the most tax efficient manner. If you do not have taxable accounts, then tax efficiency isn’t a huge concern but it is still a factor that should be considered. It is usually best to consider all of your investments together. If you are married you should usually blend accounts held by both spouses into one unified portfolio.

The best place to start building a portfolio is by making a list of all your current investment accounts and the investments in each account.
Next, start with the account types that offer the most limited investment choices, which are usually 401k and 403b type plans. These plans normally offer limited fund choices, so starting here and building around the best fund choices is often the best idea. Look at all the funds available in your 401k and list the ones with the lowest expense ratio from each category (US equity, international equity, bonds, etc).

Finally, you must consider the tax consequences of investing, especially in taxable accounts. Generally, the most tax efficient way to use your different accounts is (our thanks to Taylor Larimore and David Grabiner for this list):

1. Invest as much as possible in your tax-deferred and tax-free accounts.
2. Put the most tax-inefficient funds in your tax-deferred and tax-free accounts.
3. Use only tax-efficient funds in taxable accounts.
4. If all else is equal, put funds with higher expected returns in tax-free (Roth) accounts in preference to tax-deferred (traditional 401(k), 403(b), traditional IRA) accounts.

Here is a list of securities in approximate order of their tax-efficiency. (Least tax efficient at the top.):
Hi-Yield Bonds
Taxable Bonds
REIT Stocks
Stock trading accounts
Balanced Funds
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

Investing Priority

The general rule of thumb for investing priority is listed in the wiki: Prioritizing investments

Now that you have established your investment plan you can follow the Asking Portfolio Questions link to learn how to post your portfolio and receive many helpful suggestions.


- August 24, 2017: Investing Priority section revised to link to the wiki -- admin LadyGeek
- October 27, 2022: Revised link to Asking Portfolio Questions -- admin LadyGeek
Last edited by Laura on Sat Oct 15, 2011 6:04 pm, edited 2 times in total.
The views presented are my own and not necessarily those of the Department of State or the U.S. Government.
Alex Frakt
Posts: 11589
Joined: Fri Feb 23, 2007 12:06 pm
Location: Chicago

Post by Alex Frakt »

Bumping this up so it appears before the Asking Portfolio Questions post.