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ChooseFI | Financial Independence Podcast
606 | Deep Dive: Target-Date Retirement and Bond Funds | Cody Garrett
01:08:43
Cody Garrett reveals target date fund complexities
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- [00:00]
A
Hello and welcome to Choose a five. Today on the show we have Cody Garrett back for another deep dive. The focus today is there are multiple ways to invest to and through retirement. And today we're going to do a deep dive on some of those strategies. He recently did this deep dive into target date funds and static allocation funds and compared 40 plus fund families. And it was fascinating to see how different these quote index funds can actually be. I think this is going to be really interesting for us especially because there are so many different ways to invest. A lot of us have heard about target date retirement funds and certainly bond funds. And I think what's so great about Cody is he dives deep. We've got a five page outline jam packed with info and knowledge for you to take away from this episode. And of course as always here at choose of High to take action in your life and to make your financial life and your overall life just a little bit better 1% at a time. I think you're really going to enjoy this episode and with that, welcome to Choose Fi. Before we get started, I keep this podcast entirely ad free for two reasons. First, this is a five podcast and I don't want to promote products that I don't want you to buy in the first place. And second, I really like the clean listening experience of a show where, where you don't have to fast forward ads to keep it ad free. All I ask of you as a listener is the next time you open a travel rewards credit card, go to choosefi.com cards and with that onto the show. Cody, as always, welcome back my friend.
- [01:37]
B
Good to see you, Brad, once again, thanks for keep inviting me back after all this time.
- [01:41]
A
You are absolutely one of my favorites. You know that you're just a real resource to the community and this episode is going to be another case in point. So as always, I just kind of help facilitate these deep dives with you. I know you've done a ton of research, so I'll just sit back, ask some questions, synthesize the information where I can and I'm just going to let you roll with it. So why don't we start?
- [02:05]
B
Cool. So I appreciate you and you're kind of starting the show with the idea that there are a lot of ways to invest. Even within the FI community. There are lots of strategies, tactics. Sometimes we're a little too obsessive with the optimization of those strategies. But today we're going to dive deep into kind of two. Two topics. One is on one fund portfolios, also called allocation funds. And they're also going to talk a little bit about target maturity versus constant maturity bond funds. So before you get overwhelmed, we're going to just take one step at a time. Hopefully I can slow down a little bit today. There are a few important points I want to start with one, not just for compliance, but really to make sure that you truly understand the deep dive today and the purpose of it. This is educational only. I'm not a recommendation to implement any specific strategy or fund purchase. You yes, from a compliance standpoint, this is not advice, just education. But also just understand that the things we talk about today, just because you're hearing, you know, quote unquote, experts with letters after their names discuss these things, don't necessarily mean that whatever you define as good strategy tactic, but certainly you don't want to let the product lead the plan. You first need to understand your comprehensive financial situation, your values, desired outcomes before you even considering diving deep into the actual product that you're buying. The second thing I want to mention is I'm using kind of my own trademark here. Keep finance personal. There's a great quote by Mike Piper, cpa. He's a big part of the Bogleheads community, also runs the Oblivious Investor blog. He has a great quote that says there is no perfect portfolio, but there are countless perfectly fine portfolios. So I'm going to mention today the strategies, tactics we talk about today are potentially part of a perfectly fine portfolio. But just keep in mind that there is no perfect portfolio, whether you're looking forward or backward. By the way, if you create your portfolio based on just looking backward, you might make some big mistakes along the way. So we're going to talk about effectively the idea of again, at least my bias here is to be a passive investor, but an active financial planner in your own life. So we're going to look at the idea of passive indexing and some of the misconceptions around some of these product purchases that we might see within our financial plans.
- [04:06]
A
So I got to stop you right there. That was a really interesting way to put it. A passive investor, but an active financial planner in your own life. Let's dive into that before we get into the meat of this.
- [04:16]
B
Sure. Yeah. So I think that I very much am a passive investor. I don't like to have many opinions about the market. There is a lot of data out there that people who are much smarter than me have gone to school for much longer, have Alphabet soup after their names, work at the largest fund companies managing billions of dollars. They believe that there's alpha, like the opportunity to outperform the market if you know more than the other person. But with how quickly data spreads at this point. You know, some of these fun companies like actually pay for like faster Internet to try to get the trades in the information faster, the trades faster that me sitting in my little $450 a month little office space for me to assume that I'm going to kind of be on the same page or even outperform the smart people, that's one thing. And the second is just broadly there's great research from Morningstar and others, so some of those data analysts saying that over, especially over long periods of time, that 95% of active investors underperform the broad index fund. So I'm very much am. Again, I'll just say here that I'm a low cost index passive investor, meaning I try not to have an opinion about how to invest. I even say, not just in choosing index funds, but even my allocation between us international stocks, things like that. I just tried to be passive in that area because I understand that my investor behavior, including how much I contribute to an account, is much more important, especially in the first 10 years of being an investor, than choosing the right portfolio.
- [05:45]
A
I know you talked about these quote, unquote smart people. What's so interesting is it really comes down to success in personal finance and in investing. Comes down more to behavior, vastly more to behavior than it comes down to any type of knowledge or intelligence. In my estimation, like you said, it's somewhere on the order of 90, 95 plus percent of passive funds outperform actively managed funds on a given year, not less. When we're talking about the only timeframe that matters, which is long term. Right. Which is 20, 30, 50 years. Years. It's such an important part of our lives and we've been led to believe that there are these brilliant people somewhere and there might be intelligent people, but they don't outperform, especially net of fees and net of taxes. And that's what's so interesting about being a passive investor and why the vast, vast, vast majority of people in the FI community are passive investors. Because over the only time period that matters, the long term, it's going to perform as well or better than essentially any other investing that you can do. And I just, Cody, I find that so powerful.
- [06:54]
B
Yeah. And I think that I don't know if it's a Warren Buffett or another quote out there. Maybe it's President Lincoln back in the
- [07:00]
A
day said the apocryphal it might be more tween too.
- [07:04]
B
Yeah, like investing is like a bar of soap. The more you touch it, the less there is. Right. So my job here is to create a portfolio that I can live with. And by live with, I mean I don't really invest in stocks for money that I'm going to plan to spend over the next like seven to ten years. So I think to be investor, not a speculator, intelligent investor here I really want to not just choose funds, but choose a strategy that I can stick with. So when I get excited about things like bond ladders, risk parity, things like I bonds, like kind of every year has its thing. I wouldn't say necessarily things are new, but I think when you learn about a new strategy, just know that this is going to be something that you need to stick with over the long term. And another one, a quote by Rick Ferry, cfa, another boglehead is the perfect portfolio, is the one you're going to stick with. Maintaining discipline is the hardest part of investing. So again, before you implement any strategy, you have to say, is this something that I can stick with over a long term? And maybe at the very end. Brad, I have a list of questions to ask yourself. A proposed exercise to design your own portfolio. And one of those questions also would be what assumptions would need to change for you to redesign your portfolio? And also why might somebody disagree with your approach? Because if you can't answer those questions, you might not truly have the confidence to stick with what you chose.
- [08:18]
A
Interesting. Is that a list of questions you maintain at your website or anywhere?
- [08:22]
B
Yeah. By the way, if you go to measure twicemoney.com choosefi I will have that list of 10 questions. That proposed exercise of how to design your retirement portfolio.
- [08:34]
A
I love that. I also love how you always have that webpage updated. So measure twicemoney.com choosefi and yeah, you can always find the resources for this most recent episode. Cody, I'm assuming you get rid of the. The prior ones, but who knows? Maybe they're. They're there. And a list.
- [08:50]
B
Some of them are there. Yeah.
- [08:51]
A
15, 20 episodes you've been on at this point. All right, let's keep pushing forward. Why don't you do an intro to these allocation funds?
- [08:58]
B
Sure. So most people start investing and most people have the most amount of their investments in workplace retirement plans. So those workplace retirement plans include your 401k, 403b, 457 governmental, if you're lucky out there. But the idea is that you're given this option to kind of choose your own fund. Kind of like drive the car yourself. You can choose, maybe you choose a few index funds. Maybe most 401ks by this point have, hopefully they're going to have some index funds for like broad US market, international market, bonds, etc. But you might also have what I call the chauffeured approach. It's actually an automated selection. Now as a default within 401k plans, which is around the age there's in 5 year increments around the year you're going to turn age 65. It's kind of like getting into a limousine and telling the driver, hey, I want you to drive me to age 65. I'm just going to sit back and enjoy the ride. They're going to drive you there. Right? So it's the idea of a target date fund. I'll step back a little bit here. First off, the default. These target date retirement plans, as I mentioned, they have become a default option due to regulatory changes. But also retirement plans have increasingly moved to what's called auto enrollment. So when you join a company, you might be auto enrolled in a retirement plan. Hopefully you know, if you are or not, you'll get some paperwork about it. But they'll most likely auto enroll you not just in the plan, but also in these target date retirement plans. And the way these funds generally work is that you start with a pretty aggressive asset allocation between stocks and bonds or equity and fixed income. And until about 25 years before retirement, you're probably going to be at about 90% stock and 10% bonds and cash. And then as the years go by, about every five years that portfolio is going to be automat, you know, actively managed for you by the fund company until you reach your target year. Right. And once you reach your target year, your asset allocation in that fund will be between 40% and and 50% equity usually, which may or may not be too aggressive, too conservative for you as an investor. So but again, this is not a personalized approach. But just hey, I'm going to retire in this year or plan to. I want you to slowly get more conservative over time so that by the time I reach retirement I have a good mix, a balanced mix of stocks and bonds. So it's a smoother ride once I get there.
- [11:19]
A
Okay, that makes sense. And I actually didn't realize that these are now the default option that you said the legislation has changed. But I do love this is certainly not the worst of all options. Let's be clear before we get into the analysis of it I mean, for me, a standard S&P 500 fund or total stock market index fund would probably be the ones that I would prefer in a perfect world. But there are a whole lot of worse options in terms of expense ratios and keeping things low cost, which is a tenant of what we talk about here in the five communities. So it could be a lot worse. And this reminds me of like the economist Richard Thaler and behavioral economics and nudge. Right. So like, auto enrollment is a huge thing. I mean, Cody, like, we should be really cheering a lot of these things. Right? So this is way better than, you know, the dark ages when you and I started, got out of college and started our first jobs.
- [12:14]
B
Yeah, that's right. So the benefits of these allocation funds, target dates included, is the simplicity of a one fund portfolio. One thing that's nice about having a one fund, potentially, again, whether or not you choose this, is when you have one fund, you're not comparing your funds to see which one's doing better. Right. So sometimes when you, let's say you own three different funds and like one's doing better than the other over the last year, you're going to be tempted potentially to move all the ones that had a lower return to that one. Say, oh well, like I might choose the one that did best last year. Right. And again, that's an active decision that's playing with the bar of soap, the analogy. So one benefit is the simplicity of a one fund. Just one thing in your portfolio that's broadly diversified, including stocks and bonds and potentially other asset categories. Also, no manual rebalancing, by the way. This is whether you own this in a workplace retirement plan or your own, like ira, for example, or even a taxable brokerage account, there's no manual rebalancing so that that manager actively rebalances for you over time so you don't have to make a behavioral decision about, well, you know, I wanted to be 70, 30, but now that stocks have outperformed, like, maybe I just want to ride this momentum. Right. So, so even choosing to like ride the momentum of a stock market increase or, or kind of pause yourself because the market's down, those are active decisions that could potentially kind of underperform when you're doing that over time. So no manual rebalancing.
- [13:33]
A
Right. I mean, anytime you can take your brain out of any financial activity, it's going to be to your significant benefit. And just to take a real quick step back, Cody, so you said these funds eventually end up, I think we all like to Think there are just, there are funds. This is a total stock market fund and that's identical at every single brokerage. It's, you know, substantially identical, but it's, it's not exactly. And especially I would imagine with target date funds, they're not going to be identical either with how it transitions from X percent equity is, let's say 80, 90, 100% when you're 20 years old to 40, 45, 50%, whatever it may be when you're 65. I suspect that'll differ. And the makeup of the individual funds I also have to suspect is different as well. What makes up these target date funds? So you said equities, which would, for you know, another layman's term is just stocks. For that I assume bonds and then cash and equivalents or T bills or something like that. Are there just like a couple of broad categories that, that we could touch on.
- [14:37]
B
So I'd say kind of in all target date funds, you're going to have U.S. equity and non U.S. equity, kind of foreign equity outside of the U.S. the ex U.S. with that said, we're going to see how those differ. Broadly. Yes, all of them have stocks, bonds and cash. Also cash for the sake of rebalancing, which could be a potential downside to having cash drag on a portfolio. But broadly, you're going to have stocks and bonds. You might also have REITs, you might have commodities bonds. That's a big word. So you might have like short, intermediate, long duration. You might have high yield bonds, you might have treasury bonds, you might have tips, you might have the treasury inflation protected securities. We really have to go under the hood to understand, okay, we broadly know asset allocation. We kind of think of that as like stocks and bonds, but there's a lot more under the hood that could drive your returns.
- [15:23]
A
Very interesting. And just last thing before we move on is, so you're talking about this rebalancing, right, that it's happening automatically and that's obviously a huge positive. When you hold these funds in retirement accounts, naturally there's no tax ramifications. But if you're holding them in taxable brokerage accounts, are there underlying tax issues like capital gains distributions and such that are more significant than we're used to with a VTI as an example?
- [15:52]
B
Yeah, absolutely. When you own a target date fund or any asset allocation fund where there's rebalancing that what they call turnover within the account. If you own a mutual fund, by the way, most of these target date funds are mutual funds. There's actually, iShares actually has an ETF version, which is kind of fascinating, which we won't go too deep into. But, you know, just naturally you can assume that when there's capital gain distributions, right? Interest capital gain distributions within a mutual fund, that you're going to be exposed to that from a tax perspective. So generally, again, not advice for you, but generally these allocation funds, target date and static allocation funds are most notably going to be held in retirement accounts to avoid being hit with a tax consequence on an annual basis when the portfolio is being turned over based on the overall process that the manager is following.
- [16:38]
A
Okay, that makes sense. And yeah, just for anybody who doesn't really understand exactly how this works, I'll leave the full explanation to you. The fund owns assets, let's say, as it's transitioning from stocks. Let's say you're mostly in equities and stocks. Okay. They need to get from, let's say 100% stocks to 90% stocks, 10% bonds. I'm just making this up. But there have to actually be sales in the underlying. If on day one to day two it went from 100% equities to 90% equities. And of course it's not going to be as simplistic as this, let's be clear. But for, for the sake of the podcast. Well, naturally some stocks are going to have to be sold and they want to keep their desired allocation of stocks. It's while you would hope that they're doing this to maximize and lower taxes, sometimes that's just not possible. So literally those stocks are sold and if they are sold at a gain, there is a capital gain distribution that is passed through to you, the owner of this larger mutual fund, which really is the owner of these individual stocks. So you, at the end of the year you will get a 1099 that has capital gains distribution and that goes on your tax return this year, even though you might not have sold, it's just the underlying funds sold. So this is why when we talk about tax efficiency, when it comes to different investments, it matters where you hold it. Like Cody said, a lot of these funds people hold in retirement accounts and none of those capital gains or dividend distributions are applicable for your current year tax return. It's only when you pull the money out. Whatever you pulled out is ordinary income. If it's a traditional retirement account or 401k, these are not quite as tax efficient as other investments that we talk about here in the FI community.
- [18:28]
B
And that's right. Especially with a target Date fund. Right. As you're intentionally making the portfolio less aggressive, you're selling the things that are probably more up. Generally we expect stocks to outperform bonds. As the target date is becoming more conservative, you're seeing that naturally they're going to be realizing those capital gains which a mutual fund is a pooled investment where you're participating even if you don't sell your fund. Right. You're participating in that fund management by being a part. You're just, you're joining the club and you're participating in those capital gain distributions. So one of the fun questions here, let's assume that two investors, so two people at two different companies, they both choose a target date fund of the same target year. Let's say they both buy like the 2025 Target Date Fund. And let's assume they bought this 15 years ago just for fun, you know, two investors, they bought the 2025 Target Date Fund 15 years ago. They work at different companies with different 401k administrators. And I'm not going to name the fund managers, but let's assume that they're one of them owns a, you know, a lifetime fund and one owns a smart retirement fund. You'll notice with these target aid funds, they have funny product names like they have Target, Target Date Retirement, Lifetime. Freedom Fidelity is known for their freedom funds, Smart Retirement, one choice. So again, the products have these kind of fun names. But let's assume those two investors, they choose the same target year, but they're using funds with different managers. So they're both using a 2025 fund bought 15 years ago. I'll tell you that there are over 40 target date fund options to begin with across 10 plus managers. I'll just tell you that just to start with returns, 15 year annualized returns for the 2025 Target Date Fund range from 5.9% to, to 8.4% annualized. And as you know, right. Compounding over multiple years or decades, over 15 years, that's a 40% difference in total return for those two different investors who thought they bought the same fund, they both bought the target 2025 at their 401ks. And then they came back to each other 15 years later and they're like, wait a minute, you have 40% more money or less money than I do. Like I thought we bought the same thing, right?
- [20:36]
A
Literally your net worth is going to be 40% different if hypothetically you held it all in this fund. It's a one fund, right, Cody? It's just, hey, set it and Forget it. It's one fund. Okay, how is that possible? Are these just active funds in another name?
- [20:52]
B
The first difference is there are actually four different types of target date funds. Yay. Right? Like, way to make a default more confusing for people who are maybe starting with their first investment in a 401. So we have target date index funds, we have target date active funds. We have target date active index called blend funds. And then we have target date ESG funds, which are those environmental, social governance, kind of aligning your investing with your values potentially. So there are four types of target date funds, but you might assume, okay, well maybe the person who got like the better performance was in the index fund version versus the other person was an active fund. What we're going to realize today is that the word index is kind of misleading in this context that in a target date fund there's an active manager very actively managing underlying index funds. Right. So the, the underlying funds in the fund itself is they might be using like, you know, US Stock market index fund or the international stock market index fund or the REIT index fund. How they're packaging together, they're kind of buying all those ingredients. But how they're making the recipe of the fund varies dramatically across fund companies. And again, potentially with some conflicts of interest, especially when they're using their own funds. I want to use just three examples here. We're not going to go through all 40 here, but just three examples of target date index funds. They're going to invest based on manager between four and ten underlying index funds. Of course they're going to eat their own cooking. So Fidelity is going to buy Fidelity funds, Schwab is going to buy Schwab funds, etc. But you know, just comparing the three major ones that we think about, Fidelity, Schwab and Vanguard. So Fidelity is called the Freedom Index Fund. It maintains a global equity allocation. Right. So that effectively means we're owning about 62%. Just based on today, about 62% of our equity is in U.S. stocks and, and about 38% in international. And as the glide path gets less aggressive or more conservative going from stocks to bonds, they keep that global allocation. Right. So they don't make an active decision on saying, okay, as we get closer to retirement, we're going to switch our balance between US and international stocks within the, the stock sleeve. Fidelity and Vanguard both maintain a global equity allocation. Another thing about Fidelity is, is they emphasize long term treasury bonds. Right? So when you think about long term treasury, that's kind of two parts there. The Long term means there's high sensitivity to interest rate changes. But the treasury bonds means there's again historically a negative correlation to stock. Right. During downturns, if you're owning long term Treasuries, you would assume that you might get some volatility due to interest rate risk, but you also might have more of a ballast, kind of like a stability risk when the stock market crashes. So again, at least Fidelity, even in their index fund, they, they actively decide to own those long term Treasuries. The next part here is that Fidelity gradually reduces the international bond exposure. So they own US Bonds and international bonds, but as it gets closer to retirement, they reduce the international bonds and increase the U.S. bonds. Right. So what you're seeing here is a pattern of, yes, they're using index funds for those, those asset classes, but they're making active decisions on how much they own of each and also like how they shift those over time.
- [24:13]
A
Okay, these target date index funds, let's say towards the. Well, it doesn't even matter which aspect of the glide they're in. And when we say glide, it's like, all right, that's the transition from more equities to a smaller percentage of equities and a higher percentage of bonds and other fixed income. But you're saying they are invested in four to ten underlying index funds. Can you just give rough examples? So I guess naturally we're saying, okay, S&P 500 fund and a global diversified market or emerging markets, things like that. Fidelity, for instance. Fidelity has the famous contra fund. Is it possible, I'm not asking does one of these invest? But like, could they conceivably invest in that fund or any other fund they want? Like, is there, is there anything that precludes these target date funds from investing in very significantly actively managed funds?
- [25:11]
B
Well, so, yeah, those have different, they're trying to achieve different objectives. So I would say that like a contra fund or like some of those others, like, in a way, those are actually kind of allocation funds. Those are like different types of allocation funds. Just know though, these funds I'm talking about, like the index funds, yeah, they're not buying their own actually managed funds,
- [25:30]
A
like underlying funds, they are buying index funds. But I want you to talk about this real quick. People hear index funds. I think the vast majority of people think, okay, index funds, that means S&P 500 or total stock market index fund. But there are many, many, many dozens, hundreds, whatever the numbers of indices that can be tracked with an index fund.
- [25:52]
B
Right. So let's say somebody Talks about the Total Stock Market Index and they're talking US Total Stock Market Index Fund. That's one version of an index fund that's cap weighted. Like the larger valuation companies have larger percentage within the index. It's broadly diversified. You can own for example, a US Total Stock Market index Fund. But you could also what I call a Humpty Dumpty portfolio. Let's say that you took that Total Stock Market index fund as an egg and you threw it on the ground and it broke into multiple pieces and then you put it back together. That means you could kind of effectively create your own total Stock Market index fund by owning a large cap index fund, a mid cap index fund, a small cap index fund. So you can go into blend and growth and value. There are index funds within each asset category and then you can buy more broadly index funds for the more broad category. So there are many, many ways they can own an index fund, whether as broadly as here's the most broad example of an index fund is vt, which is the Total World Equity Fund. That's a Vanguard fund. Again, you know, go research it yourself. But effectively you say, I just want to buy the whole world stock market. Again, not making an active decision on how much I hold and blah blah, blah. Just market Cap Weighted global index fund VT. Or you can break that into 20/ right. Index funds within each asset category, trying to track the same thing.
- [27:12]
A
This is really confusing. How would I know? Even amongst like you're highlighting here on our sheet, Fidelity, Schwab and Vanguard, which I consider the three good guys might be a stretch, but the three good guys in the brokerage game, and yet their target date funds are vastly different. How is the average investor supposed to know what to pick if they're making the right decision? Even picking one of these funds, how would they even know how to know if they're making the right decision? They don't realize they're making an active decision, but yet they are.
- [27:44]
B
Yeah. I just want to say like, you know, part of this conversation is a deep dive usually is there's somewhat of a righteous trick here, right, to show you how complex these are so that you can step back and say, okay, well now I'm confused. This is way more complex than I thought. That's kind of the point for you to step back and be like, okay, how can I make this simple? Or how can I make a well informed decision that feels simple and actually is simple versus just feels simple and actually is very complex, as you know with Fidelity. Right. So making active decisions on Kind of how much to hold in certain types of bonds. Changing allocations to international bonds. Schwab's interesting, Schwab actually starts declining the equity even 40 years before retirement. So they have like more of a continuous glide path versus waiting until you're 25 years out. They also, it's funny, they own gradually reduce international and small cap equity exposure. So like they own international index funds and small cap stock index funds within the funds, but they change the allocation of those as the years go by. So again, making an active decision using index funds as the underlying funds. And then Schwab, they own emerging markets index fund inside the funds, but then they eliminate emerging markets once they get to the target retirement date. And lastly here they exclude international bonds entirely the whole way. So what I just want to mention here is you just immediately think about the difference between Fidelity and Schwab there and you're saying, okay, I see them and they just say target index fund is the name of the fund. But I just want to clarify, like, if you want to truly understand what you own, right, don't invest in what you don't understand. Maybe go to morningstar.com and look at just the portfolio tab to understand the basics of what these funds hold. And by the way, you can get a free trial to Morningstar if you want to actually understand the individual underlying funds they own.
- [29:31]
A
Okay, interesting. I wonder if in your deep dive, did you create any charts that compare these 40 funds?
- [29:40]
B
Of course. I have spreadsheets for all of it. Yeah, so maybe I'll make some of those spreadsheets downloadable at the website there.
- [29:45]
A
That'd be really cool. Measure twicemoney.com ChooseFi yeah.
- [29:49]
B
So you know how you were talking about like Fidelity, Schwab, Vanguard being like the gooder guys within the industry, the good guys or gals. I want to mention that some people think of Vanguard, Vanguard's from the third. I'll mention here that Vanguard seems to be kind of the least opinionated and how they manage their index funds, including the target date. So I'll just mention that again, not to say that you should buy Vanguard over others, but just to know how they think. Vanguard is the most simple of the ones that I'll discuss here that Vanguard maintains that global equity allocation regardless of the target year. They maintain a global bond allocation. Between us, it's about 70% U.S. bonds, 30% international bonds. And again, that stays as you get closer, the bond and equity allocation doesn't shift. It shifts in terms of equity versus bonds. But within the equity and bond Sleeve do not shift.
- [30:38]
A
Okay.
- [30:39]
B
And then lastly, Vanguard, the glide path actually continues past your target retirement date. So if somebody owns the 2025 fund today, in 2026, if they own that for another about 10 years, it actually will continually get more conservative. It won't actually stop at like the 5050 portfolio. It'll continue to get more conservative over time.
- [30:59]
A
What do you think about these funds? Put aside all the research you did to me, owning something like this, there's clearly positives in that. It's doing the rebalancing for you. You don't have to think about it. It's. If you believe in that type of glide path and rebalancing, it's doing it for you. You don't have to be involved. But I never like things that remove flexibility. For me, when part of the fun of being in the FI community is, is having a ton of flexibility. We've talked about this on so many episodes in terms of there's so many fun things you can do to maximize your tax return and lower your total tax liability when it comes to having traditional IRAs and 401ks, Roth and AS, as you've talked about with me, the long term capital gains and your taxable brokerage accounts. Like, I love having like a little bit of everything, which is part of why I don't love the whole dividend investing strategy. There's many reasons why I don't love the whole dividend investing strategy. I think it's suboptimal at best. But just the lack of flexibility in that, man, I'm getting this forced taxable event every year is similar to this. My natural bias is against these funds in that it's happening without my say. And I don't. Even though I guess you could make an argument that I. It was my say when I purchased it. Anyway, what are your thoughts on these funds?
- [32:21]
B
Yeah, so my kind of quote here that I believe that once you understand what a target date fund is, you no longer need one. Ooh. The more I researched this analysis, the more heavily I felt like target date funds. Yes, they're simple. Yes, there's no manual rebalancing. But the disadvantages here, the glide paths can be too conservative. Even if you buy the 2060 fund today, you're not going to be 100% equity, which is probably what your risk capacity is. Right. So you're never going to have potentially the right asset allocation for you because it's not personally managed. This is the fun part. Management isn't free. We already kind of knew that when you get into limousine for the chauffeured approach, you're going to pay more for that. So just the index fund options here. Vanguard is 35% more expensive, Schwab is 2 times more expensive, and Fidelity is 4 times more expensive than than purchasing those same underlying funds yourself.
- [33:17]
A
Wow.
- [33:18]
B
Fidelity. For this example, let's say you bought like those 4 to 10 underlying funds in a retirement account. You bought those index funds separately yourself versus bought the Fidelity Freedom Index Fund with the target date version. You'd be paying four times the cost versus going into your account, choosing those underlying funds, choosing automatically rebalance annually in my 401 and still not having to like, kind of touch that account over time.
- [33:45]
A
And when you say more expensive, you're talking about the expense ratio as part of the fund, correct?
- [33:50]
B
Right. The expense ratio is four times more expensive in that example of choosing the Fidelity Index target date versus choosing the Fidelity index funds individually within your retirement account and then going in every five years to manage how the equity and fixed income change over time.
- [34:04]
A
So. Right. You are clearly paying a price for someone to hold your hand through this.
- [34:08]
B
That's right. So, yeah. And the cash drag I mentioned a little bit. And then also just knowing that even if it was an index fund, index fund in quotes, the glide path, the asset class selection and the fund weightings over time are active decisions by the active manager. So like you said, even if it's an index target date, you're giving up that flexibility to an active manager who's deciding what to do with that fund over time. And I would rather not have to log in over time to say, okay, what have they changed? What are they doing differently? Is this aligned with my values and how I want to invest? So I'll step back and just say that once you understand what these are, and again, you have what I call the time, the temperament and the talent, the three T's to simply go into your 401k once every couple of years to just kind of check on things. Right. Ask yourself the question, when do I expect to spend this money? Which should be your number one question you ask when investing. I think that you could easily manage your own 1, 2, 3 fund portfolio in your 401k with less cost and a lot more flexibility.
- [35:10]
A
All right, so that's the ultimate MIC job answer here. But I suspect I jumped ahead a little bit. So was there anything else that you wanted to talk about with these active funds? Things that people need to consider?
- [35:21]
B
Yeah. Be careful about the names of these funds. For example, if you the Fidelity Freedom Fund. Freedom sounds like a great word, especially, you know, in America. America, right. Fidelity Freedom, for example, versus Fidelity Index. You can see that some of these actually are four to seven times more expensive, the active versions versus the index versions. We talked about the index version potentially being four times more expensive than choosing the underlying index funds yourself. But then on top of that, four to seven times more expensive to get the active target date versus the index target date. So just another way of saying that the name of the product won't necessarily say if it's. It won't say active in the name. It'll say kind of the name of the product itself. You typically will use find the word index in the target date. If it's an index, except for it's funny. Vanguard, their index, one doesn't say the word index. So just know that the product names are very misleading and convoluted as well.
- [36:17]
A
All right, Cody, what about these static allocation funds?
- [36:21]
B
So we talked about target date funds. Again, they're changing the allocation that glide path to become more conservative over time. Alternatively, you can buy a one fund portfolio called a static or fixed allocation fund. A really good example of this is if you see something called a balanced fund. If you ever see something like, you know, Vanguard balanced fund or something like that, that's going to have a static allocation, which means it's going to maintain the same asset allocation between equity and fixed income over time, regardless of your age. Again, it's going to maintain a 60, 40 or an 80, 20 or even something like a 2080 portfolio between stocks and bonds. So you'll typically see these called conservative balanced growth, aggressive growth. These are also available as mutual funds and also ETF versions. If you go do your research on these funds, whether target date or static allocation, and understand how they're investing and feel good about it, you can still get those benefits of the one fund portfolio with no manual rebalancing over time.
- [37:18]
A
You mentioned something about ESG funds. I think, how do those play into this?
- [37:22]
B
Yeah, so the ESG funds are typically they have underlying ESG index funds. So without going too far here, there are two ways to kind of invest in alignment with your values. You can invest kind of with an inclusionary approach or an exclusionary approach. The way I see this is these ESG funds, they're excluding buying companies that don't align with the environmental, social or governance screening that these managers are actively doing. Most investors I work with who want to invest in alignment with their values, they choose the basic index option. But Then they're more thoughtful about spending their money with inclusionary, like, for example, investing in, like, their local community, spending their time, energy, and financial resources toward, you know, local charitable organizations rather than changing their investment strategy based on their values.
- [38:13]
A
Yeah, these are tough. I always struggle with this because I love the concept of environmental, social governance. I mean, it makes sense. Like, you don't want to send your money to invest in companies that you fundamentally not only don't agree with or you fundamentally disagree with. So I get that, but, man, it just, it veers so much into active investing. And I think, Cody, that's why I never speak that highly of these ESG funds. I just, I struggle with them deeply because, I mean, you could make an argument against almost any company, and then, then we're getting into, like, splitting hairs between, is this company good, is it bad, did they do one bad thing, and therefore they're X marked forever. It's like you can go down a really significant path of, I don't know, just way too much active investing. And so if you ask me what's my preferred, it's, I want to maximize my net worth as much as I can and then spend it and allocate it and donate it where I see fit. That helps me sleep at night. But of course, everybody thinks differently, and I think that there's a lot of room for that here.
- [39:18]
B
Yeah. And lastly, in the esg, there's a lot of marketing around this. And the two downsides is, one, the screening is subjective based on the manager and how they change their screening. You don't get to choose what they screen for. You get to choose the manager. And second, that screening can actually create structural differences, so you can actually end up with like a very growth or very value tilted portfolio, maybe unintentionally, by excluding certain even sectors. Right. For example, like energy sectors, or maybe going too far into tech or not too far into tech. This is a good reminder that the word index doesn't mean passive necessarily. So just because you own an index fund, it's like you have to kind of look at the layers of who's being active and passive and each of these layers of the manager, me as an investor along the way, is there
- [40:09]
A
a quick way for the average person listening to this, which is me, is there a quick way for me to determine, hey, when I look at my 401k list at my company and there are 20 options, and let's say I don't see AN S&P 500 or a total stock market fund, yeah, we'll put those aside. How do I know if these are actively like, what's the 20 minutes I could spend to figure this out?
- [40:33]
B
I would say that the two seconds you could spend is by sorting by expense ratio. The index funds will be the cheapest funds available to you. By the way, if, if your 401k does not provide an index option for like US stock market, international stock market, please talk with your plan administrator. They have a fiduciary standard to act in the best interest of their employees. So please mention to your plan administrator, hey, I, I don't see these low cost passive index funds outside of the target date. Could you please add these to the fund lineup? Just because you don't see it doesn't mean it can't be added to your fund.
- [41:08]
A
Okay, that's great advice, that piece. But the more important one is that two second analysis that is going to be broadly true. Of course, of course, of course. Please do your own research. You need to make sure what you're investing in. You can't listen to two guys on a podcast and just blindly close your eyes. But man, Cody, I mean, from my experience, that's the best advice that I've heard, which is, yeah, you look at the expense ratio. So everybody out there just look for the column. Hopefully it'll say expense ratio. But you look for the column where it's like, okay, there's some that are 0.05%. There are some that'll be 1.25%. Because when you look at these 401k lists, it's a whole lot of numbers. And most people look at that and just recoil and run away. But yeah, look for that one column that says expense ratio. And yet ultimately, the lower that expense ratio, the higher likelihood it is that is passive. There's not some fancy fund manager sitting there twiddling and doing their thing. And that's where the cost to you comes in. In terms of like a broad heuristic for investing, the lower the expense ratio, the better chance there is certainly that it's an index fund and the better chance there is that it's not actively managed, et cetera. So I think that's where a lot of us in the fight community go. But Cody, again, it's. It's all about action, right? Somebody who's sitting there who doesn't see an S&P 500 fund or an index or a total stock market index fund, and they went and talked to their HR and let's say they can't right now, okay, Just for Whatever reason, just suspend disbelief that that can't happen in the next couple months. People still need to know how to take action. In all of your analysis of these target date funds, is there a conceivable chance that that is just somebody's best option in a 401k account and should they be worried about that? Is that a good option? Is it a bad option? Like, where do you come down personally if you were giving advice to a family member?
- [43:01]
B
Yeah, so when you sort by expense ratio, look for the word index. Also avoid what's called stable value. By the way, when you ever see stable value, that's a cash equivalent, people like, oh, I want something stable that's kind of like cash in your 401k. Those legislative changes, those regulatory changes, it's called the Pension Protection act of 2006. They added these things called qualified default investment alternatives, the qdia. These are safe harbors to ensure that the advisors on these plans are acting in a fiduciary standard. Your plan administrator is acting as a fiduciary. Just know that if you're sorting by expense ratio and locating the word index, if you cannot see an expense ratio lower than 0.1% and you don't see the word index in your lineup, I'd immediately go to your plan administrator to ask why that's not included. If the only option is target date funds, I would naturally go toward the index option. But if you don't have those options, you know, send me a message and I'll help you look at your fund lineup because that should definitely be included at this point. There is a great choose fi episode, I think, Brad, you might remember you were in that episode, episode 556 with our amazing friend Rachel Camp, CFP. So episode 556, it was a mailbag episode and the first question was from Stephen and it asked about the idea of buying individual bonds or a bond index fund. She explained very well the idea of interest rate, risk and duration when looking at bonds. And one thing that we talked about is, hey, you can buy these kind of what they call constant maturity bond funds like A, B and D, like the total Bond Market Index, where it's holding hundreds of diversified bonds, by the way. For example, BND, that total bond index is about 50% treasury bonds, 25% corporate bonds, and 25% securitized bonds like mortgage backed securities, et cetera. So it's diversified with hundreds of bonds. But as those bonds mature, as the individual bonds mature within the fund, the manager of the fund is maintaining the desired target bond maturity indefinitely. So for example, bnd, the total bond market index, currently has an effective maturity, kind of an average effective maturity of eight years. Like buying an eight year bond. There are zero to five year bonds, six to 10, even 21 plus year bonds within that fund. But they all kind of package together to average to like an eight year maturity. And the alternative to that, rather than holding just a constant maturity bond fund, is owning individual bonds and laddering them out saying, hey, the money I need next year I'm going to buy bonds that are going to mature in one year and two years, two year, three year, three year, and this is called asset liability. Matching that, the liabilities, the spending that I need, the distributions I'm going to take from my portfolio in the next, let's say seven years, I could actually buy individual bonds that are going to mature in those years. So that when I need the cash, the cash is literally sitting in my account because those bonds have matured, they've redeemed and the bond is no longer there. It's now just cash ready in my account for me to distribute. But one thing that you mentioned, Brad, is that you said I'm buying the bonds with eyes wide open, that when you buy an individual bond you can say, okay, what is my, what they call a net acquisition yield? So if I buy this bond today at this price and I don't sell it, regardless of what happens with interest rate or price changes, I hold to maturity, I'm effectively locking in again, assuming that it's not called or you get your yield, let's say you're locking in like a 4 or 5% yield for the next five years annualized, that as long as I buy it today and hold it to maturity, that I'm kind of locking in this yield that Conversation talked about. You could either buy constant maturity bond funds or you can buy individual bonds and create those bond ladders. But the one thing I want to mention today is this idea of actually buying target maturity bond funds. So it's in a way kind of the best of both worlds where, hey, I want to invest in bonds that all the bonds within the fund are going to mature in the same year. But I still want the diversification of holding hundreds of bonds, not going into the marketplace and having to buy individual bonds and potentially not being diversified. So today I want to talk a little bit about some of those target maturity bond funds and the pros and cons of using that approach instead.
- [47:20]
A
Okay, great. And that was episode 556 with Rachel Camp, who, as you said, she's a wonderful friend and just a brilliant, brilliant woman. Yeah, I like that you called back a quote of my own. Buying the bonds with eyes wide open, Cody. And that's a really important one because I think a lot of people get bogged down in, oh, where are interest rates now? Are they up, down? Is my bond worth less or more? And like, I would look at it personally, not as like a trade, but as a, hey, I purchased this bond, it's giving me this percentage yield. And at the end of that term, period, whatever the term is for that bond, I get the amount of money that I invested back. That's a really interesting aspect of bonds, if they are held to maturity. I think that's an interesting distinction. I don't think most people realize exactly how that works.
- [48:08]
B
Yeah. And I think that when people are asked about, hey, how are you going to invest in retirement, especially 2022, bonds and stocks went down. Those bonds went down to interest rate risks as the interest rates went up and the bond prices went down. And some people said, I'm never buying bonds again because they went down in 2022. And they generally think stocks are risky, bonds are safe, which is a big generalization. One of my favorite choose fi episodes, I probably send it to somebody once a week, is the role of bonds in your investment portfolio with Frank Vasquez, episode 194, going way back to 194, that focused on diversification of, hey, if you're owning bonds, you're going to be owning them for one or a combination of three purposes for stability, income or diversification. What I notice is that in retirement, that's when most people are adding bonds to their portfolio is saying, hey, I'm going to. I'm about to start spending this money soon. Right? And we ask this question, I always use this phrase, you know, we want to give every dollar a job and an anticipated use by date. So before I tell anybody how to invest, let's say somebody, Brad, you come to me with, you have $1,000 in cash. You say, cody, how should I invest this? The first question I'm going to ask you is, when do you expect to use this money? For example, Brad, let's say you come to me and say, hey, I have this money. I'm going to buy. I plan to buy a house in five years. This money, I want this money to be used for my down payment. Cody, how should I invest this money? I'm immediately going to choose an investment with the risk capacity. Maybe we'll Step back a little bit in a moment here but it's the idea of how can I invest in something where the degree of asset loss that can be sustained without jeopardizing my ability to meet these goals. If I have a five year time horizon with this money personally, I'm not putting that money in the stock market. I might be looking at hey maybe I'm going to buy a bond that's going to mature in four years so that in year five that cash is available in my account to put that down payment on that house. And along the way I'm going to get yield from buying that bond, I'm going to get that interest, those interest or non qualified dividend payments along the way. But in year five I know that I have the money I started with plus a little bit of interest that I gained along the way. So there's that level of stability and security in knowing that the money is going to be there when I need it.
- [50:31]
A
Yeah, it's so important. Again you are a cfp, so you do talk to people about, about these real in depth questions. When do you expect to use this? Money is a real interesting one. Okay, if the money, if you need it in the next five years, maybe you don't invest in the stock market depending on a whole host of factors. But where do you consider that line Cody, in terms of. I don't know if you consider it long term, short term, if it is so situational that you couldn't even give a back of the envelope.
- [50:59]
B
I usually avoid rules of thumb when I do comprehensive financial planning but I've come up with my own. That feels pretty good. Which is Brad, you know how people always explain their asset allocation? Stocks first they say like 80, 20, which means 80% stocks, 20% bonds.
- [51:13]
A
Yes.
- [51:14]
B
In retirement planning I always solve for the fixed income first. If you're doing your own asset allocation of like how much should I have in stocks versus bonds? I would always solve for the bonds first. For risk capacity. And the question I ask clients is what percentage of your portfolio? Well you always, sorry, you always start with a dollar amount. That kind of gives you the percentage. But as a dollar amount, how much of your portfolio do you plan to spend over the next seven years? The answer to that question is where I start with kind of helps me determine from a risk capacity perspective how much fixed income, how many, how much bonds they have in their portfolio. So a really good example of this is let's say somebody has a million dollar portfolio and let's say that they're going to pull $40,000 a year from that, right, for the next seven years. So do that math for me, Brad. What's. What's seven times four there?
- [52:07]
A
28.
- [52:08]
B
There we go. So that would mean that potentially from a risk capacity perspective, they might have a portfolio with 28% in fixed income and 72% in stocks, which is kind of like that 70, 30, moderate portfolio that a lot of people retire with generally. So in a way, we've kind of solved for risk capacity. This person might be, again, not advice for anybody here, but generally, hey, it might be appropriate for that person to have a 7030 portfolio today. Let's say a few years goes by and, and their life has changed. They're like, hey, we're in the go go years of retirement. We're spending more from our portfolio. But hey, guess what? But Social Security starts three years from now, and that's going to support some of my income needs, right? So you can just do that same calculation every year saying, okay, how much of my portfolio do I plan to spend over the next seven years? And that amount will go up as you spend more, it'll go down as other income sources supplement your income needs. So ironically, a lot of people I work with who are retiring early, let's say at 55, they'll actually have like a 6040 portfolio when they retire. And then maybe 10 years later or 20 years later, they'll actually have like an 8020 portfolio. So they might even actually increase their equity. Sometimes they call this a bond tent, where you kind of start with a conservative portfolio and actually build the equity over time. But rather than just basing it off of some general somebody's portfolio strategy, I step back and just say, hey, I'm going to base my portfolio allocation on when I'm going to spend my money. And I have found just overall that when clients, for example, say from a risk capacity perspective, seven years in fixed income, and then they add. There's a kind of a subjective line to this, which is risk tolerance, right? Which risk tolerance is the amount of market volatility and potential asset loss you are emotionally and behaviorally willing to endure. When I work with a client, we'll start with the seven years of bonds or cash and bonds. And then some of them will say, I feel pretty good about that, but I'd feel more comfortable having 10 years instead of 7 years. Again, kind of going from a more of an objective capacity question to, hey, I feel like I want a little bit more conservative from a risk tolerance perspective. They might go to 10 years of bonds. So again, that person, let's say pulling 40,000 a year for 10 years. Right. Instead of having a 7228 portfolio, they might have a 6040 portfolio. Right.
- [54:32]
A
So in general terms, we just take the number of years multiplied by four and that's the percentage that you want to have in bonds, correct?
- [54:40]
B
Well, that 4 is based off of like you taking 4% out of your portfolio.
- [54:43]
A
Oh, gotcha, gotcha, gotcha.
- [54:45]
B
So it's really just saying on a spreadsheet, say over the next seven years, kind of put in each row, say, how much money do I plan to take out of my portfolio? Let's say, hey, I'm buying a car in three years from now, so that year we'll have more money that I need in that year. So just create seven years worth, add that up, and that might give you an general idea of how much fixed income you have in your portfolio. And then the next step is, okay, well, what do we buy for each of those years of income needs from the portfolio? And this is kind of where we come into this idea of, well, maybe I can kind of create a bond ladder for, you know, I create a rung of the ladder for each of those years that I'm going to put money in. I'm going to get, you know, an expected yield over that time. And also if I, you know, the goal is to get the money back that I put in, you know, generally. And one of the products that you can use, again, I'm not selling products here, but there are actually target maturity bond funds. The most common ones, iShares has something called Ishares I Bonds, which is a product not to be confused with I bonds from Treasury I Bonds, which again, just complexity. There's Ishare I Bonds, there's Invesco bullet shares. Vanguard just came out with a new one called Vanguard Bond builder, target maturity ETFs, and State street has my income ETFs. So again, these are all proprietary funds that they do their own thing. But the goal is you can just choose, hey, if I need money at the end of 2028 that I'm going to spend in 2029, I can, for example, buy the 2028 Bond Ladder ETF fund. Buy one fund that holds hundreds of diversified bonds with it. I can either choose investment grade corporate bonds, high yield corporate bonds, treasury bonds, tips, or municipal bonds. So you kind of choose what type of bonds you want. But you can buy one fund that holds hundreds of bonds that are all going to Mature in that same year so that at the end of December that year, that bond fund will effectively evaporate, and then that cash will be ready in your account for you to spend in that year that you anticipated.
- [56:45]
A
Gotcha. That's really interesting. Now, you had talked about the other types of bond funds, Constant maturity bond funds. What else should we be thinking about in terms of bonds?
- [56:56]
B
Yeah. So I think going back to the top of, you need to implement a strategy that you can stick with. There is a debate on whether or not building your own ladder versus buying like bnd, like, are you really, like, doing better or are you doing worse than that? I really think it comes down to this thing that often comes up in the FI community is this kind of I'm scared to sell securities. In 2022, when bonds and stocks were going down, somebody, like, when people had to live in retirement, they had to sell something, right? And there was a lot of fear of, like, maybe I'll just stop spending money this year because stocks and bonds are down. And at the same time, this is mostly a behavioral, emotional strategy. There's definitely evidence, and, you know, it can help to kind of match your assets with your liabilities. But these target maturity bond funds are one example of what have given retirees the clarity and confidence to actually spend money in retirement. So rather than having to sell a bond fund, when they logged into their account, you know, at the end of December, that cash was ready in their account to spend. They didn't have to go in and sell the bonds. The bonds had matured for them. Right. So again, it's like an emotional behavioral tactic to say, hey, I'm scared to sell funds, so I'm going to own a bond that kind of matures for me so that when I log into my account, my money's there. So again, there are, by the way, I've worked with people who have $20 million in investments who cannot sell a fund. They are struck with fear. They're working through therapy. They're cognitive behavioral therapy, acceptance commitment therapy. But to be able to give them the confidence to actually go out to eat tonight or take that trip with their family this year, they need to use some type of strategy or tactic or potentially a product to help them, at least temporarily get them through. And I'll just mention, Brad, this is an example. In therapy, sometimes people use medication as a short term way to say, hey, we're gonna, we're gonna use medication in the short term as we work through the emotional behavioral elements of improving. So that in the Future, maybe you don't. Again, not going into like, you know, I'm not a psychiatrist here, but I think sometimes these products can be used even sometimes in a short term as people are gaining the confidence to use other strategies that might be more beneficial to them quantitatively.
- [59:18]
A
Yeah, and I think that's totally fair. You and I have talked at great length and we will do a follow up episode. I know you're doing a real deep dive on CBT and different types of ways to approach investing and really dealing with clients. Well, I spent a large part of the last year and a half talking here on the podcast about people just have to get over it and sell their assets. A little bit of that is not tongue in cheek, but a little bit. I understand it's a little bit of hyperbole because things can be difficult mentally. They can be. And like you're saying if there's a way without essentially destroying your financial life to do it so that you can like. I still don't think having an entire dividend growth investor philosophy makes any sense. I think that personally is vastly suboptimal. But if there are ways that like you said, almost as for a short term. All right, look, this is a crutch. You understand it's a crutch and you're working to get around this, this psychological issue. Okay, I, I definitely see that. And I don't want to minimize any type of psychological issue that anybody's having, believe me, I'm, I'm would never ever do that. But there are things, it's like it's grasping defeat from the jaws of victory. Right. That person who has $20 million can minimum spend $800,000 a year at the, at a 4% rule and they're worried about going out to dinner. Like that obviously is a psychological affliction that they need to work on and they are working on it. The interesting thing is they could log in to fidelity and sell $10,000 worth of shares and it would be hard for five minutes and they would get over it. You and I know that. And it's easy to say that from a totally detached psychological perspective, but sometimes it's not that easy when you're in the depths of it.
- [61:08]
B
That's right. And just kind of two quick examples of this before we head out today. There was actually a recent Facebook conversation. I'm not going to quote the person, but effectively this is somebody with like about $15 million. And they said they're effectively paralyzed by fear. And the next comment said, you have enough money Just retire. Like, as if their comment, like, would lead them, oh, okay, I'll go retire because you said so. So, yeah, we will cover some of those, like, motivational interviewing and some of those kind of motivations behind sustained talk and growth and change talk that people have. But one thing I want to mention is some people told me, hey, like these bond ladder funds, you're making their life more complex. And ironically, sometimes we can think of like the, the total return approach of just owning like a total stock market and a total bond market fund as being simple. But as you know, when you dig into those funds, just like we do with the target date, there's a lot of complexity within how these funds are managed. And ironically, using a target maturity bond fund is actually a form of simplicity for these clients, that it's actually more easy for them to understand that, hey, the money I need next year is going to be there next year, and the money I need two years is going to be there in two years. Even though they're using a different product that might have a little bit, you know, a little expense ratio added to it, that's actually a form of simplicity that actually hedges their fear versus, like, I think, just stepping back, I think a lot of us assume that the fewer things you have in your portfolio, the more simple your portfolio is. That's true quantitatively, but qualitatively, sometimes having like two or three more things in your portfolio can actually help a client feel like their life is more simple. There's kind of like an irony in that.
- [62:47]
A
That is an irony. Okay, so if I'm hearing you correctly, when we're talking about the target date retirement funds, those are adding complexity. And I don't think either of us in our perfect world scenario would pick that as a best case option. But when we're talking about these target maturity bond funds, you're saying that for at least for a subset of clients. And really, when you're using the word clients, you're a cfp, right? So we're talking a subset of people, actual people, normal human beings listening to this podcast, that actually could be a significantly positive option. I guess this is all about clarity and people taking action. What's the Cody Garrett 2 minute TLDR on bond funds?
- [63:31]
B
Yeah. So I would ask my family member, when do you expect to spend this money? Aligning your money with when you plan to spend it is how I think about investing generally. And I think, just to tell you right now, if I were retiring today, I would have eight funds in my portfolio, which sounds way More complex than what I would have done. But you know what those eight funds would be? One fund of that would be the total world stock market fund. Okay, all my equity would be in one fund and the other seven funds would be bond ladder funds for 2027-2028-2020-2029, 2030. I feel comfortable that, hey, if the stock market crashes tomorrow, by the way, even if the bond market goes down too, if the bond market, stock market crashes tomorrow, that stock fund that I own, I don't have to look at that because that's not for the money that I'm spending over the next seven years. The money that I'm actually spending in the short term that can probably withstand those volatile short to intermediate term market moves. That money's over here. It's similar. Some people talk about the idea of having a bucket strategy of like I'm going to have a few years of cash, a few years of bonds, and the rest in stock market. It's using that similar mindset, but again, locking in the actual purchase of the product or fund to exactly what the money's for. So the money I'm spending this year is in cash, like my money market fund, the money for next year is in the 2026 Bond Ladder Fund, et cetera. So I like the idea of kind of locking in kind of an average yield of 4.2% on those bonds kind of together and knowing that the money in my stocks are not for the money I'm spending in the next seven years. And I can withstand those volatile ups and downs over a one month, one year, even three year period so that I'm not tempted to touch that bar of soap along the way.
- [65:29]
A
I like that. Cody. I think that is such an interesting takeaway because. Yeah, when you said eight funds, I did a double take recoil.
- [65:36]
B
Eight funds, two concepts.
- [65:37]
A
Yeah, well, that's my wrapping it up. Is there anything else that you wanted to get across here in terms of this deep dive or should we save for the next time in terms of the psychological and all the other things we're going to dive into?
- [65:50]
B
Yeah, I think that the realization for me, especially right now, is that just because something looks simple doesn't mean it is. And also at the same time, just because something looks complex doesn't mean it is. So again, whether you own a one fund portfolio or a ten fund portfolio, understand what you own and make sure that you're able to actually stick with the philosophy, the strategy that you're choosing, which kind of comes into that play of the 10 questions my proposed exercise at measure twicemoney.com forward/choose fi.
- [66:22]
A
Brilliant. And Cody, I have to mention your fantastic book tax planning to and through early retirement that you and Sean Malini who is also a many time guest on this podcast you guys put together and it has been a wild success. It's been incredible to see you guys just blow it up with this book. And I mean it's almost like especially when it's on a quote unquote boring topic, right? Like for most people hearing the title of that book they would run as far and as fast as possible. But not people in our community and not people even frankly outside of our community. This has really transcended the FI community. The book is fantastic, as you know. I love it. Huge recommendation to everybody listening. Tax planning to and through early retirement. You can get on Amazon everywhere. Books are sold anywhere else you want to send people.
- [67:07]
B
Cody, just a quick add on to that. The funniest thing about our community because we're frugal is that most people are not buying the book. They're getting it from their local library and there are library systems out there with over 40 holds on the book.
- [67:19]
A
Wow.
- [67:20]
B
Because our community would rather wait a year for a free book.
- [67:23]
A
Oh come on.
- [67:25]
B
I'm not trying to get people to buy. I just.
- [67:26]
A
Of course not. Of course.
- [67:27]
B
I just laugh at about like the money scripts involved in our community. Our book would naturally have a big hold period at a library or like a hoopla.
- [67:34]
A
I mean that is fantastic. I think I saw somebody mention on Facebook or maybe in our choose of a community app that their local library system had something like five or ten copies of the book in in circulation. Which is fantastic. I mean that's like usually withheld for bestsellers. So good for you guys.
- [67:51]
B
I'm excited for the person who has no idea what FI is who gets that book and goes, huh, I'm going to read this.
- [67:56]
A
I love it. Cody, as always. Thank you my friend. This is really, really helpful. If anybody. If you have questions for Cody, if you have follow ups on this episode, we have the ability to comment on the episodes. So you can just go to choose a.com and then the episode number. So this is going to be episode 606. So choose a com 606 and that'll take you right to the episode. You can leave a comment, Cody and I will read all of them and
- [68:24]
B
disagree with my approach. I would love to see your disagreement with my approach.
- [68:27]
A
Yep, that would be cool. So there's going to be a lot of fun, interesting conversation and debate in the comments, so be sure to head over there. Cody, Again, thank you. And until next time, thanks for listening to choose a 5.