Do target-date retirement funds live up to the hype? How do I know if a Roth conversion is right for me? If I want diversification, am I better off investing in ETFs or mutual funds? Is my money at risk if I keep it at one single investment firm?
Questions like these come up time and time again on our discussion boards, around the Fool water cooler, and, yes, occasionally at cocktail parties, parent-teacher conferences, and brises.
Most recently, Fool readers asked these questions during a live Fool.com chat with Sheryl Garrett, the founder of the fee-only Garrett Planning Network, which offers pay-as-you-go, as-needed financial planning advice. (See the special discount offer for Fools at the end of this article.) Like The Motley Fool, The Garrett Planning Network was created to serve individual investors of all means, offering an alternative in an industry that catered mostly to institutions and only the wealthiest individuals.
Garrett advisors share a common philosophy: that financial planning advice should be free from conflicts, that products should be sold without commissions, and that service should be billed on an hourly or per-project basis, rather than basing fees on the client's net worth. And, like Fools, they value diverse points of view; when weighing alternatives for their clients, they have a community of fellow Garrett colleagues on call via the company's private intranet.
During our chat, we got a glimpse into that world. Dozens of Garrett financial planners were on call to field Fools' questions. Here's how Sheryl and her team answered some of the Fool community's queries.
Q: I have 100% of my retirement money in a target date fund. Do you consider that diversified enough or not?
In theory I think the target date funds make a ton of sense for the investor who has a limited nest egg and/or doesn't want to spend any time or energy managing their own retirement account or outsourcing the management to a professional advisor. The last couple of years have shown that there is a drastic difference in target date funds. They are not necessarily a vehicle that you can purchase and ignore for life.
My colleague Frank Boucher, Reston, Va., adds in his comments:
It depends on the fund. Most of the target date funds I've seen are well diversified but the problem I see with them is that the allocations vary widely among fund companies. The other problem I have is that the reallocations that take place as the target date gets closer also vary. I only recommend them for investors who show little interest in investments or who tend to do bad things like buy high and sell low. If you're a Fool, you don't fit either of the criteria and I think you would be better off setting up a mix that makes sense for you.
Q: When is a Roth IRA a better fit than a traditional IRA?
The following are a couple of responses from my colleagues in the Garrett Planning Network discussing some of the key issues to consider with regard to the Roth decision. I concur with their responses.
David McPherson, from Falmouth, Mass., says:
In general, a Roth IRA is a good fit if you are a long way from retirement. The younger you are, the more time you have to come out ahead on the back end in retirement for the higher taxes you pay on the front end with a Roth IRA.
Also, a Roth is a nice fit if you expect to be in a higher tax bracket in retirement. Some argue a Roth is a good bet because sooner or later taxes in this country are going up to cover the federal budget deficit and a Roth can help blunt the impact from that.
Overall, I think it's good to have a bit of money in both Roth accounts and traditional IRA accounts. It's called tax diversification, covering all possibilities.
And here are some thoughts about Roth contributions and conversions from Leisa B. Aiken:
Contributions to Roth IRAs are better for very low earners (young and others) who expect to be higher earners some day, those who want "tax diversification"), those who want have estate planning goals with young beneficiaries for the Roths. They are great for high school workers, for example, though they must opened as Custodial accounts for minors.
Roth conversions are particularly good for those whose taxable income is lower in the conversion year than most years -- early retirees who are delaying pensions or social security and IRA withdrawals by spending down taxable investment accounts, low earners, those who have mostly nondeductible contributions in their IRAs, and those who want to leave their IRAs to beneficiaries and are willing to pay income taxes for them.
Q: Do you tend to recommend mutual funds, ETFs or individual stocks as a general rule for individual investors? I have heard arguments for all of them but I am curious what your opinion would be.
As a financial planning professional rather than an individual portfolio manager, I tend to recommend low-cost, high-quality diversified mutual funds and exchange-traded funds overwhelmingly for the equity component of a client's portfolio. We would augment the equity positions at times with individual fixed income products and sometimes with mutual funds or exchange-traded funds or combination of the three for fixed income.
I've worked with a number of clients over the years who had a portion of their portfolio in individual stock positions and we focused on designing the balance of the portfolio to work in coordination and to complement the individual stock positions. We focus on the overall portfolio allocation, tolerance for volatility, cash flow needs, and the investors' interest in and desire to invest in individual stocks.
Additional comments from Garrett Financial Network member Angie Grillo, CFP, AIF, Laguna Niguel, Calif.:
I tend to recommend a mixture of ETFs and mutual funds. The main benefits are:
- Low Operating Costs -- ETFs are much less expensive than mutual funds. The average ETF expense ratio is 0.41% versus the average mutual fund expense ratio of 1.57%. That is a good 1% that can be kept in your portfolio.
- Easy Trading -- ETFs trade just like a stock which allows you to buy and sell them throughout the day. Mutual funds can only be purchased at the close of the market without knowing what price you will pay. If many people buy that particular fund, the price will go up and you will pay what you are stuck with.
- Transparency -- ETFs publish their holdings daily, so you are able to see all of the current investments held in your ETF. Mutual funds are only required to update their holdings every 90 days, so you have no way of knowing what the managers are currently doing with the investments.
- Tax Friendly -- If a mutual fund has a good year, you will pay for it with taxable capital gains. You may even have to pay when the fund has had a negative return for the year. Mutual funds have to sell holdings when investors liquidate their shares. This happens frequently and can cause capital gains. ETFs that are indexes do not generate capital gains as much because they DO NOT need to sell holdings for investors. Because an ETF trades like a stock, the funds are transferred directly between investors, not from the ETF.
- Diversification & Risk Reduction -- This is a shared benefit with mutual funds. Holding broad baskets of stocks significantly reduces your portfolio risk. Why gamble large positions in single companies?
Q: For general ease of recordkeeping, we have been maintaining all of our investment assets with one major brokerage firm. I have been told that this is not diverse enough since no one firm can do everything well. What is your feeling on this?
I for one am a big fan of keeping things as simple as they should be but not any more simple. In other words, if I were using a discount broker who could accommodate all of my different types of investing strategies [and] had great investment selections, tools and resources, as well as reporting functionality ... one high-quality discount broker would be sufficient.
However if you're utilizing a brokerage firm and working with a broker who is providing advice and/or managing your portfolio that's quite a different story. Please refer to the additional comments from my colleagues.
David McPherson, Falmouth, Mass., says:
I'd say you're best off working with one of the major discount online brokers that offers a wide array of services at a reasonable cost.
Given that, there might be circumstance where you can't or shouldn't consolidate your accounts at one firm. For instance, if your company 401(k) account is housed at a lousy firm, I wouldn't move your personal accounts there. Instead, find a top quality firm for the personal accounts and then maybe move the 401(k) account into an IRA there when you leave that employer.
In reality, you may have to do business with at least two or three investment firms, but try to keep it to a minimum.
Melody W. Townsend, CFP, says:
Diversification has nothing to do with how many firms handle your assets (although you do want to make sure that your financial firm is stable and check them out via the SEC's Check out a broker tool http://sec.gov/investor/brokers.htm). It has more to do with having the right mix of asset classes.
I have seen both cases where clients have had "everything under one roof" and it not be diversified and I've seen clients have everything spread around everywhere with the investment professionals not coordinating strategies and it being a un-diversified mess!
It is possible to be fully diversified with one investment firm if that investment professional is considering all areas of your financial picture as part of the "portfolio." For example, if you have outside checking accounts/money markets/savings accounts, 401k/retirement plans, real estate holdings, etc. these need to be taken into consideration when viewing the entire portfolio. It is important to make sure that your current investment provider is considering all your assets when building your diversified portfolio.
Cynthia Freedman, San Jose, Calif., adds:
It depends on the firm. I think you can be very well diversified with a firm such as Vanguard. Some advantages to keeping all your funds in the same firm are:
a) easier record-keeping
b) potentially reduced fees, depending on the size of your account
c) easier to keep track of the asset allocation of your portfolio
d) easier to calculate your required minimum distributions (when you are over 70 1/2)
Kim Jones, a Garrett advisor in Denver, Colo., says:
Having all of your investments at one brokerage firm can simplify your record keeping, but you may be putting the cart before the horse. First determine what investments vehicles make sense for your particular situation. Once you've designed a portfolio mix (and determined if you need additional strategies such as annuities or options trading), you can then choose from firms such as Schwab or Scottrade. You may be able to do everything at one firm, or you may need to make one or two choices outside of your primary firm. But the KISS strategy with a trustworthy firm may be all you need.
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