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 top mutual fund picks.
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?
1) How to Pick Good Mutual Funds for Your 401k or Retirement Plan
2) What are Mutual Funds and How Do I Invest in Them?
Image Credit: Microsoft Clip Art
[email protected] says
Do you buy these funds directly from Vanguard or do you use a thrid-party site like Scottrade? Do you have a particular online broker you like?
Greg, good question. I buy them DIRECT through Vanguard. Compared to Fidelity, I actually think the process is easier because you don’t have to setup a brokerage account. You simply just deduct the money out of your checking account. My IRA deductions are automatically taken right out of my bank account each month.
Lance @ Money Life and More says
Interesting way to look at it… now I need t check my investments. Thanks for the reminder!
I am a big fan of Vanguard for a long time now. I have one suggestion. Why don’t you show actual fund inception date so that readers can make subjective decision. I like fund to perform consistently for a long haul, so I would rather pick a fund with the net return of 8% (10 years since inception) vs fund with net return of 10% (only 2 years since inception).
Excellent point Shilpan! First off, the Since Inception return for all of these was +10 years. In the original chart, I had included this, but for some reason edited it out. Just like an employee candidate with many years of experience, I am also of the mindset that I won’t go with a fund unless it can demonstrate a proven track record of performance!
I love reading your step-by-step posts. Like you said: pick several investors and they’d have different picks. Me? I wouldn’t have chosen Wellington. The combo of the investment grade bond fund coupled with your equity income does what you want cleaner and that duo has a better long term track record. Some people get fooled by the star ranking (Wellington looks like it has a “bettter” one). Remember that star rankings are grouped according to asset class. I’ve seen people pick 5 star funds in the completely wrong asset class for them and get schooled. I don’t think this is the case with your Wellington pick….I just wouldn’t have gone that direction.
Thanks Joe! I’m glad you enjoy these, and I appreciate input from the Money Man. I’ve got to admit that I am partial to Wellington because it has been in my portfolio for a while and done well. In fact, it has been picked a few times over the year as a top performer by the magazines. Although my bond and stock choices will accomplish the same thing, I was hoping to spread my risk by letting someone else do the asset allocation with Wellington.
I’ve invested in the Vanguard International Growth fund and I can’t remember the exact name of the others off the top of my head but I know one of them is a large cap growth fund. I’ve been pretty happy with them.
I’m pretty sure I’ve had that one in the past too. You seem to have a taste for the Growth-type funds!
[email protected] says
I have my retirement in Vanguard as well and think they are very easy to work with. I recently reallocated my funds because they were all in stocks. I went with the broad index funds with a mix between foreign and domestic stocks, some bonds and about 5% in REIT. Love your breakdown. Well done, as always.
Thanks Kim! You’ll probably do just fine with that allocation. Even though I like stocks, its probably smarter to go with index funds because the mutual fund can constantly update for such a low cost.
I love my vanguard funds. My question is why didn’t you consider using their ETFs? You can trade them for free on vanguard.com and many having lower expense ratios and no minimums…
Good question! I think I’ve somewhat dated myself recommending mutual funds. The truth is that since I haven’t used ETF’s yet, I can’t really endorse them or say how well they’ve performed. But I’m not opposed. Does Vanguard really let you trade them for free?
Aren’t you worried that the Health Care fund manager Owens is retiring end of this year? He has indeed delivered great results over many years, but it is wise to put money in exactly the time of management change? I was looking at this fund and decided not to risk it until the new manager has shown she can stay the course.
Thank you for bringing that to my attention. I was not aware that there was a management change, and I understand your concern. One other reason why I favored the Health Care fund (which I did not highlight in the article above) is because I do not see this industry slowing down at all. Health Care is more important than ever given our increasing population and aging generations. Even though there are always big discussions in the US about changes to policies, the Health Care industry as a whole has extreme control and money to steer politics. I don’t see prices or profits going down anytime soon.
Lindsay Dalton says
It would be helpful if you provide current returns, expense ratios and Morningstar ratings for Vanguard Funds you favor. Thank you.