Many investors, both new and seasoned, think they have to spend every waking hour following their investments in order to retire wealthy.
However, there are a few reasons that hands-off investors, otherwise known as "indexers," may have the upper hand when it comes to investing for retirement.
- In the long term, index funds perform just as well as managed funds, if not better.
- Compared to index funds, managed funds can cost investors huge amounts of money over time. Frequent trading incurs additional fees.
- You only need some basic knowledge to make good choices that yield excellent returns in the long run.
That is good news for your average investor. According to a study conducted by the Employee Benefit Research Institute, the average American investor spends more time planning a vacation than he or she does for retirement. Therefore it's fair to assume that a low-maintenance portfolio would be an excellent choice for investors who are simply not interested in spending a lot of time maintaining retirement accounts.
Assembling your lazy portfolio
The good news is that you can do just as well, and often better, than active investors with just three ETFs in your portfolio.
A total U.S. stock market index ETF is a good starting point. For example, Vanguard Total Stock Market ETF (NYSEMKT:VTI) gives you 98% U.S. stock market exposure, with a very small percentage allocated to international stocks and cash. This fund offers a nice balance of large-cap (72%), mid-cap (19%), and small-cap (9%) stocks. The expense ratio is extremely low at 0.05%, and this highly liquid fund rarely trades with a bid/ask spread of more than $0.02. This means that less-experienced investors are protected from being burned on fees or other expenses associated with trading ETFs.
An international fund is a good choice for your second fund purchase. One of the easiest ways to assemble a lazy portfolio is to stick to a single fund family, such as Vanguard, iShares, or Schwab, but it is perfectly acceptable to mix and match fund families according to your needs. Vanguard Total International Stock ETF (NASDAQ:VXUS) pairs nicely with the U.S.-focused ETF because there is little overlap between holdings. The Total International Stock ETF holds almost exclusively international stock funds, making it easier to balance a portfolio. International funds can be quite expensive, but this fund is a steal with a 0.16% expense ratio.
Investors should always be aware of the asset allocation of each ETF they hold. For example, Vanguard Total World Stock Index (NYSEMKT:VT) is another excellent ETF that holds international stocks and can complement the Vanguard Total Stock Market ETF nicely. However, investors should be aware that this fund holds approximately 50% international stocks and about 48% domestic stocks, as compared with the 100% international exposure of the Vanguard Total International Stock ETF. While the total-world ETF is a good way to gain international stock exposure, it's more complicated to rebalance in conjunction with other funds, however. Funds exclusively invested in a single asset class are easier to rebalance -- and after all, ease is what we're aiming for.
For the laziest investors, two funds can suffice. However, a third fund can help investors control risk depending on how many years they have until retirement. Investors 20 or more years from retirement should be comfortable with 100% stock exposure. Investors closer to retirement may want to consider adding a bond ETF, such as Vanguard Total Bond Market (NASDAQ:BND). This bond ETF is another fund that is nearly 100% invested in its asset class, which will simplify rebalancing. With a 0.1% expense ratio, this fund gives investors access to the entire bond market with little effort or expense.
A little effort goes a long way
Once assembled, a lazy portfolio requires very little maintenance. If you can muster just a little bit more effort, however, these two tips will help you achieve your goals:
- Rebalance once a year. Over time, certain asset classes will outperform others. Once a year, assess your asset allocation and risk tolerance, and buy and sell to stay within a few percentage points of that goal. If you never rebalance, your asset allocation will become skewed over time.
- Occasionally check your funds to make sure fees, expenses, and asset allocation are still acceptable. Sometimes funds will begin tracking a different index. Shop around once a year to see if a better product is available.