When I had my deferred compensation plan at work (like a 401k, but technically a 457b), I would think of an investment mix I wanted and rebalance every quarter. I wanted some exposure to foreign stocks, so I might put 30% in that. Then I would want something in cash or bonds so I might put 20% in there. The rest would be US stocks, so I would 40% in large cap stocks and 10% in small cap stocks. That was a reasonable diversified portfolio. Then by rebalancing you make sure you stick with that mix, but I also like that if foreign stocks did really well, you would end up selling some of that at a high and distributing it to the others that didn’t perform as well, so it was kind of a way of doing market timing, which I was never able to do successfully otherwise. The fallacy of that was that investing 100% in stocks always seemed to do better over the long run than watering it down with bonds or even foreign stocks, which seem to generally underperform domestic stocks. I never liked bond mutual funds because rather than really getting nice safe fixed income, it seemed like you were actually betting on interest rates, which would fluctuate.
This past year I did a rollover where I put all of my deferred comp funds into a conventional IRA at Vanguard. Both accounts are funded with pre-tax salary and will have taxes when I withdraw the funds, so no taxes were due because of this transaction, but I will still pay taxes later.
The neat thing about moving the funds to Vanguard, is that I stopped using my Deferred Comp spreadsheet and put everything into my Investment spreadsheet where I keep up with brokerage accounts (taxable), Roth IRA (not taxable), and IRA (tax deferred). I wanted to continue the asset allocation strategy I had been using with deferred comp, so I would set goals, generally very similar, at my brokerage, Roth, and IRA. Rather than wait for the quarter, I would just see when they got a little out of whack and tweak the holdings to get back to where I wanted to be. Since I am retired, I made the fixed income portion a more conservative 30%, but part of that is I also feel like the market is overvalued and I want some money on the sidelines if there is a crash (part of my always ineffective market timing strategy). Another wrinkle to this was that my actively managed funds at Fidelity always had big taxable distributions at the end of the year while my index funds at Vanguard had hardly any, so I kept Fidelity funds in my Roth where I wouldn’t pay taxes on the distributions and the index funds in my brokerage. I would balance out each of the three types of accounts, which meant sometimes I would buy something and sell it again fairly quickly, so I had to be careful about violating frequent trading policies where I might buy and sell shares of the same fund within a 30-day period. It generally wasn’t a big problem since I wasn’t tweaking that often.
Now that everything was in the same spreadsheet, I thought maybe I could start doing asset allocation across the entire portfolio. One problem is what actually defines a small cap and large cap. The deferred comp plan had a large cap index fund and a small cap index fund, so it was pretty easy to know the holdings met that criteria. But some actively managed funds have a mix and some have foreign holdings as well. Really if I was going to balance correctly, I needed to take that into account for all of my investments, but Yahoo Finance doesn’t seem to show the information that specifically, probably because Morningstar (who supplies the info) needs to provide some reason for people to subscribe to its own services. But I remembered the library lets you access Morningstar for free online, so I was able to get that from them. Then I entered how much of each fund was large, medium, or small cap (Morngingstar does all three) as well as whether they have bonds (none of mine do and cash is not usually more than 1%) and how much is foreign. Fidelity Contrafund is a huge fund and doesn’t trifle with small and medium caps to any significant degree (7% medium). Interesting, Vanguard 500 Index which mirrors a large cap index, is 17% medium cap because Morningstar uses a different definition of large cap (saying 70% of the total market equity is concentrated in large cap stocks) and thinks the S&P 500 has some medium cap companies in it, in fact, quite a few (about 200). I have a Vanguard Mid Cap Index fund, but Morningstar says 16% of it is invested in large caps (0% in small caps). I also have a Vanguard Small Cap Index fund which is 2% large cap, 33% mid cap, and 65% small cap according to Morningstar’s definitions. The nice thing is I can parse it all out so it doesn’t really matter . . . except when I want to rebalance, which I immediately had to do because when I put everything together and used Morningstar’s percentages, I needed some changes. Vanguard has another fund called Total Market Index and, according to Morningstar, 71% of that fund is large, 21% is medium, and 8% is small, even though Morningstar sets their own definition at 70%, 20%, and 10%. I decided to set mine at what Vanguard’s fund is doing so that money I already have in Vanguard’s Total Stock Index would need no tweaking.
Aside:I have a lot of funds across my three types of accounts. I should be able to get that down to a smaller number now that I am looking at everything as one giant portfolio, but also if I am going to tweak things, I need to have foreign, large, medium, and small cap funds separate to do that even though a lot of the money can sit in the total market index or even the 500 index which is where most of the money winds up. I have had some of the funds in my taxable account for over ten years, so selling them to consolidate into fewer funds would make me pay a lot in taxes. So I have 17 mutual funds, though some of those repeat in different account types. I could move everything in my accounts to Vanguard’s Worldwide Index fund, but I do think some funds, like Fidelity’s Contrafund, seem to consistently outperform index funds, so I want some of that. And then that means I need to have balancers. End aside.
I entered an order to rebalance things, which wasn’t too bad, just three funds and that went through yesterday. Unfortunately, when I entered the new totals, I had fixed the foreign imbalance, but still was out of balance on large, medium, and small. I may have been overly ambitious in breaking out medium and small separately, but I was following Morningstar. The problem is I sold some of Vanguard Small Cap (which has a breakdown of 2-33-65), but a lot of it is Medium, which I wanted more of. Also, my mid cap index is in my taxable account, and I want my tweaking to be done in non taxable or tax deffered accounts so I don’t have gains and losses to report, so I opened a new mid cap index fund at Fidelity (which has a breakdown of 2-80-18). So I think I am chasing my tail a little, but I can continue to tweak it until I get close enough. I thought I could enter some fake trades into my spreadsheet to get to the right answer by trial and error without doing a bunch of trades. The other thing is the markets change every day. Mutual fund holdings change over time and so does whether Morningstar thinks a particular company is large or medium. My thought is I will update Morningstar’s composition analysis once a year, which hopefully won’t change by much, especially I think for the index funds which is where most of my money is. So then I will just be tweaking based on changing market conditions during the year. Anyway, this could be interesting, but I think will actually end up being easier in some ways, with much less trading in my taxable account.