Optimize your retirement investments in 10 minutes a month
I can still remember the utter confusion I felt when I looked at the investing options for the 401k at my first job. 16+ years of schooling hadn’t prepared me for this. I wished for some simple, straightforward advice. Fast forward 15 years and I’m here to provide that straightforward retirement investing advice.
This post outlines a process I’ve refined over the past decade and a half. This isn’t for beginners but the aim is to find a respectable balance of returns and effort. Consider this retirement investing 201.
Retirement investing can be overwhelming, but it doesn’t have to be. You can do better than most by picking a target date fund and moving on with your life.
With a target date fund, you buy the fund that matches your retirement date and the investment company does the rest. For instance, if you were born in 1983 then your full social security age is 67 and you should pick the 2050 fund.
I recommend the Fidelity Freedom Index Funds or the Vanguard Target Retirement Funds. Both of them have low fees and come from well-regarded investment companies.
The first thing to think about when trying to optimize further is to look for the expense ratio. The annual management fee that comes out of your account.
Every year you pay this fee. That isn’t great because who likes paying fees? But it gets worse because that is money that isn’t invested and doesn’t grow the following year. Compounding this over decades as you save for retirement and it can end up having a large impact. This is why I recommended the target date funds above. Both of them have very low expense ratios of less than 0.2%.
But can we do better? Could we drive expense ratios under 0.1%? How about under 0.05% It turns out we can! But to do that we have to mimic the target date fund on our own. We have to create a three-fund portfolio with the same mix of assets as the target date fund for our retirement date.
Keep the balance
It is easy enough to create a portfolio with a specific mix of assets. Open an account and buy the assets in the mix you want. If you want 90% stocks and 10% bonds, do that.
Some institutions will even make it easy to buy assets on a regular cadence (say monthly) with a specific mix. For instance, you could invest $100 a month and set it up to buy $90 of stock and $10 of bonds. Unfortunately, since assets rise and fall your portfolio will always drift from your intended mix.
Let’s take a simplified example where you are trying to keep a 50/50 mix of stocks and bonds. You buy $100 worth of stocks and $100 worth of bonds. If we check back in a month, bonds may have lost value, stocks may have gone up and now you have $110 in stocks and $90 in bonds. You no longer have that 50/50 mix you were looking for.
Some drift isn’t the end of the world but if the drift becomes significant we will want to rebalance the account. There are dozens of different strategies and approaches to rebalancing out there but the approach I prefer is to never have to.
Wait, but how does that work? Well, as you make your regular contributions (say monthly) you buy funds to get you closer to your desired mix. In our previous example, if you have $30 to invest you can buy $20 in bonds and $10 in stocks so the portfolio is back to a 50/50 mix of $120 in both stocks and bonds.
You can even go a step further and do the same thing with any payouts you receive from your investments. Most institutions will reinvest your payouts back into the fund they came from. But, you can usually change that to payout into a holding account and then reinvest them along with your regular contribution.
But how do you know if this approach is enough? The best approach to rebalancing I have come across is to rebalance when one of your assets is more than 20% away from its target. For example, if you are looking to target 20% bonds then you would rebalance if you had less than 16% or more than 24%.
I’ve been using this approach for a few years now and I have yet to need to rebalance my account. It got close during the market crash at the start of the pandemic but even then I didn’t have to.
Putting it together
Ok so that all seems like a lot! I thought this was going to take less than 10 minutes a month? The trick is to automate 90% of the work with a Google sheet.
For each account I have, there is a listing of the assets in that account. For each asset, Google pulls market data to provide a weekly average price. The only data I have to enter is the current number of shares I have in each asset that I enter from my financial institute. The sheet then calculates the value of my shares and the drift from my target mix. I even have it set up so that it marks any assets in red if they need rebalancing.
The sheet also calculates and formats the information I need to use a very nice rebalancing tool. I copy and paste the cells out of the sheet into the rebalancing tool and tell it to have much cash I have to invest (payouts + regular contribution). The tool then figures out how much of each asset I should buy.
The most time-consuming part is entering the buy orders into my financial institute. There are a lot of clicks to make a single order. Financial institutions … do better.
Why it works
We got here by optimizing for reducing the expense ratio. Bad target date funds will have an expense ratio above 0.5% and good ones can have an expense ratio below 0.2%. With the approach above we can drive that expense ratio below 0.05%. And, in the past few years, Fidelity has even released 0% expense ratio funds. But, some other benefits aren’t as immediately obvious.
First, this approach minimizes transaction fees on buying and selling shares. Each rebalance requires selling shares of one fund to buy shares of another fund and if there are transaction fees those would kick in. You should be using “no-load” funds which don’t have these transaction fees. But, if you aren’t, this approach minimizes rebalancing so it minimizes any associated transaction fees.
Second, this approach maximizes “buying low”. This one is a bit more involved so bear with me. Let’s start with a simplified case of investing $50 a month. If you saved up all year and purchased all $600 of shares at the end of the year that would be silly. Not only are delaying your investment but you are gambling on the price of that fund on that day. It could be the lowest price of the year, the highest, or somewhere between.
Instead, you could buy $50 a month. This allows you to invest your money sooner. But also, some months you will buy shares below the yearly average, and some months you will buy shares above the yearly average. With this approach, you are balancing your risk and reward which is prudent for its own sake but it gets better.
If you are investing $50 a month and the share price one month is $5 you will buy 10 shares. If the share price the next month is $10 you will buy 5 shares. After these two months, you will have 15 shares. The average share price was $7.5 across those two months but you spent $100 and own 15 shares meaning you paid an average of $6.67 per share. This seems like magic but I assure you the math works out.
It then gets even better with the full investing approach since you are applying the same principle across many funds. If one fund has gone down in price you may end up buying only that fund in a given month. This doubles down on “buying low”.
That’s it. Use the Google sheet, take your 10 minutes a month, and let me know how it goes. I wish you good investing and eventual happy retirement.