The end of the year is full of things to do: Celebrate the holidays with family, prepare for the winter, get your tax information together, etc. But one very important chore we often forget to perform is re-evaluating our investment portfolios. Unless you review them, how do you know if the investments you own are performing well? Are they still helping you to reach your goals? Are there better choices out there?
This is exactly what I’m looking to do with our Roth IRA funds. Both my wife and I both have a Roth IRA through Vanguard which we max out every year. Our belief is that these Roth IRA’s will help us to get tax-free income during retirement or possibly serve as a vehicle to help us fund our early retirement.
To a new or inexperienced investor, seeing a huge list of investments and technical information can be extremely overwhelming. I know I was the first time I tried to make sense of mutual funds. But fear not. Whether you’re like me and looking to re-evaluate your portfolio, or simply looking at funds to buy for the first time, I believe this post can help you. So walk with me through my process as I make my picks from Vanguard mutual funds and evaluate which ones I will include in my portfolio for next year.
Why Vanguard Mutual Funds?
Under no uncertain terms, I’ve been a customer and supporter of Vanguard mutual funds for a number of years now. I mention their funds pretty regularly throughout my posts. The main reasons I like them are because:
1) They have reliable performance and are often recognized as some of the
2) They have extremely low cost; much less than what the other brokers charge.
My first Vanguard mutual fund purchase was the STAR fund (VGSTX) which is a balanced fund of stocks and bonds. It is a great introductory mutual fund (especially for your kids) with a $1,000 minimum investment and 0.34% expense ratio.
Picking the Best Mutual Funds – Step 1:
The first thing I do for picking mutual funds is to look at which ones beat the market index annualized return of 8% per year. Now remember – any financial adviser will tell you:
- Past performance is not a guarantee of future performance.
So then why bother with past performance numbers at all? Well, consider that colleges look at a student’s past grades to determine if they should be accepted next year. Sports teams look at an athlete’s score record to see if he should make the team and play next year. The idea here is not to duplicate the same investment returns but to rather to find winners who have proven themselves over time. When it comes to investing, I prefer to go with winners.
With that said, I can easily make a list of all the funds that surpassed the market index annualized return rate of 8% by looking at the “10-Year” and “Since Inception” returns (with emphasis on the Since Inception number). The reason I look at these numbers over such a long period of time is because lots of funds do better than average for 1, 3, or 5 years at a time. But very few can keep up such grand performance over a +10 year stretch. In my assessment, I want the ones that can deliver stellar returns over the long haul.
One aspect of picking new investments that is often overlooked are the expense fees (often expressed as a ratio rather than a whole number). As you can guess, costs can eat away at the performance of any investment. Usually this is less of a problem with Vanguard mutual funds, but it should still be part of your process.
To figure this out, simply subtract away the expense ratio from the long-term Since Inception return figure to get the net return.
Now that I know which mutual funds are truly the top performers after fees, my next step is to consider my asset allocation (how the money will be divided up between bonds, stocks, large-cap, small-cap, etc). Often this choice is more of a personal preference (based on such factors as your tolerance for risk) rather than having some cook-book formula to follow. The important thing to remember is that you NEVER want to be too heavy in one particular area or another because this will leave you vulnerable to risk.
For example, my preference is to go with:
- Large cap value U.S. stocks and
- Mix them with the stability of bonds to create stable returns.
To further fortify my defense against risk, I then also like:
- To put a small amount into international stocks and
- Other alternative sectors like real estate, health care, etc.
Again, my opinion is certainly not a one-size fits all solution. Ask 10 different investors what kind of funds they like have in their portfolios and you’ll probably get 10 different answers.
The final things that you need to consider are the minimum investment required and outside ratings and rankings.
The minimum investment amount is important because you may not meet the minimum dollar amount required to invest in the fund. Most Vanguard mutual funds seem to start around $3,000 as an opening minimum. Some of the exclusive “Admiral Shares” versions of the funds require as much as $10,000 to $50,000 to begin investing. However, they also are much more attractive because they have lower expense ratios and better dividend payouts.
Finally, it never hurts to get an outside opinion. If you want to see what the experts have to say about the fund, go over to Morningstar and lookup (for free) the Morningstar rating for your Vanguard mutual funds. The Morningstar rating is a highly publicized and respected rating system where the mutual funds are graded on a 1 to 5 star system; with 5 stars being the best.
Although a high Morningstar rating is no guarantee that you have found a solid winner and make a lot of money in the future, it certainly doesn’t hurt to see what the experts have to say about the fund. The Morningstar rating ranks funds according to a large variety of characteristics and factors; far more things than I would ever think to consider.
Conclusion – My Next Batch of Mutual Funds:
So after all that, here are the mutual funds from Vanguard that I’ll be going forward with for next year:
All in all I think this will serve as a solid portfolio going forward with a strong proven performance history, good mix of assets, low cost, and favorable Morningstar ratings. Going forward, I am excited that the next year we get to raise our Roth IRA investment maximum to $5,500 each ($11,000 total) and put more funds into this. Here’s to looking forward to making more money!
Disclaimer: I am not a financial planner, so don’t just pick these funds because I did. Make decisions based upon your own situation or consult a professional.
Readers – Do you use Vanguard mutual funds for your investments or retirement accounts? How do you go about updating your portfolio to pick the best options possible?
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