Our Simple Investment Strategy

We’ve been aggressively saving money for the past few years, specifically after discovering financial independence (FI).  Not only are we putting aside a large percentage of our income each month, but it’s important to make sure that money continues to grow, particularly in a safe, long-term fashion.  The places that we invest our money in today will determine both how long we need to continue working full time jobs, and what kind of lifestyle we’ll be able to live once we walk away.

Upon starting our first real jobs out of college and entering the adult world, the only standard advice out there seemed to be “set aside 10-15% for retirement” and “be sure to max out your employer’s 401k match”.  The 401k part was easy and we set up that 2-4% investment right out of the gate, but the other part just kind of happened naturally as we adjusted from a cheap college lifestyle into the world of real paychecks.  Unfortunately, the money accumulated via this natural frugality pretty much just sat around in a checking account without any purpose, and we would slowly take chunks out of it for new furniture, trips, and other miscellaneous purchases.

Luckily we didn’t inflate our lifestyles too drastically before stumbling upon FI and a real purpose behind setting aside that extra money, the ability to buy our freedom!  Once we realized retiring in our 30’s was achievable, it didn’t take long to start looking a little closer at our investments.  After reading a ton of material both online and in books, it turned out that the most consistent, long-term performing investments also seemed to be the absolute simplest!  By spreading our money over the entire market via index funds, we could simply ride the average growth across all businesses and industries around the world at a very low cost.  I’ll break down exactly how we execute that strategy both inside and outside our retirement accounts, adding money monthly, and setting ourselves up for a potential early exit from the 40-hour per week working world.

The Strategy – Low Cost Index Funds

If there is one consistent truth across almost everything I’ve read about investing, it’s that you almost certainly can’t beat the market.  “Almost certainly” leaves a little to the imagination as there is always someone you can point to that did it, but the overwhelming amount of data indicates that you specifically will not.  For every person that pulled it off, there are many many others who managed to under-perform.

One of the best market beaters alive, Warren Buffet, issued a “million-dollar bet” directly challenging hedge funds to beat the market over ten years.  “The market” being Vanguard’s low cost S&P 500 index fund.  Nine years into the ten year bet, Buffet is currently way ahead.  Keep in mind that the competition here is huge hedge funds armed with a crazy amount of resources and information that isn’t even available to the average investor!  How can anyone expect to compete on this playing field with the occasional glance through the latest market headlines?

Lucky for us, you don’t have to try to beat the market yourself and can quite literally just join it.  The idea was considered a bit crazy decades ago, but now almost every reputable investment firm offers funds that simply attempt to mirror the market by owning every stock in it.  No fund managers to make decisions (or mistakes!) or analyze data in order to choose whether or not to buy or sell, and no reason to pay them outrageous fees to do so.  Owning the market in equal weight to the size of each part of it is so simple that most of it can be automated, bringing the cost of actually participating down to rock-bottom levels.

Vanguard was the first to offer these types of low-cost index funds, but now they are prevalent across most major companies.  Charles Schwab and Fidelity are frequently competing with Vanguard to have the absolute lowest percentage cost for each fund, but at this point they are all viable options.  One notable exception is that Vanguard is owned by the funds themselves (which are in turn owned by you), whereas most other companies primary goal is to make a profit off of the investment holders, often by encouraging them to unnecessarily “diversify” out of these low-cost funds into more actively managed options.  The “funds owning the company model” helps minimize the chances of conflicts of interest potentially costing the customers (you) any extra money in fees.

That is the main reason we stick to Vanguard, but a disciplined investor should do just fine with the equivalent funds in several other investment companies.

Alright, so that explains the basic philosophy behind the choice of index funds for our investments, but let’s look at how we actually put that in practice.

The 7 Accounts That Hold Our Investments

In an ideal world, we would put all of our excess cash into a single account and would own the 3 different funds that make up our 3-fund portfolio (which I’ll explain more of below) in the exact ratio we determined works best for our goals.  Unfortunately, that is far too simple of an approach if you want to get the best return for your dollar.  The main reason being the various tax-advantaged accounts that we have access to that save us a serious amount of money.  These include IRAs, 401ks, and HSAs between the two of us.

By channeling money through these different accounts, we are able to save a lot of money on taxes, both now AND in the future.  In fact, a good percentage of the money we defer taxes on now, while in the earning phase of our FI journey, can potentially be withdrawn later without any taxes being paid on it!  This is thanks to the number of “in-between” years that fall between the time we “retire early” and traditional retirement age where we can take advantage of things like a Roth Conversion Ladder.

The List of Accounts:

  • Noah’s 401k
  • Becky’s 401k
  • Noah’s Traditional/Roth IRA Combo
  • Becky’s Traditional/Roth IRA Combo
  • Noah’s HSA
  • Becky’s HSA
  • A Shared Brokerage Account

The 401ks are pretty simple and are set up through our respective employers.  Each offers a moderate match and we choose to go beyond that by deferring the maximum amount possible out of our paychecks, $18,000 per year per person.  These contributions and the matches end up as tax-deferred holdings in a Traditional 401k account.  In theory, we will owe taxes on the money when it is eventually withdrawn, but thanks to the standard deduction and personal exemption during our non-working years, we can potentially avoid paying any taxes at all.  Also, this money is theoretically “locked up” until we are 59½ years old, but there are a couple ways to access the money early and penalty free if necessary.

The HSAs are also pretty simple and are again set up through our respective employers.  Both employers put in a fixed amount of money at the beginning of each year and we are free to max out the remaining allowed amount up to $3,400 per person directly out of our paychecks.  Once again, this money is tax-deferred but has the additional benefit of also avoiding FICA taxes upon entry.  The HSA is also different in that money can be taken out penalty and tax free for medical expenses, or treated like any other Traditional retirement account after the age of 65 (owing taxes on anything withdrawn).  Both of our HSAs allow us to invest the money in the account, so we currently chose to pay our medical expenses out of pocket while letting that money grow tax-free.

The IRAs are a little more complicated because we are in the fortunate situation of making too much money to contribute to them directly for any benefit.  Thanks to a well-known loophole, known as the “Backdoor Roth IRA”, it is still possible for us to each get money into a Roth IRA each year.  By placing post-tax money into a Traditional IRA, then rolling that money over into a Roth IRA, we essentially get the same benefit one would by contributing directly to a Roth IRA.  Be sure to research a little before trying yourself, it gets a little complicated and messy if you have more than $0 already in a Traditional IRA.  Each year, we move the maximum of $5,500 per person into our IRA.  As this money ends up in a Roth account, we’ve already paid taxes on it, but will be able to withdraw it and any gains in the future completely tax-free.  Gains on the contributions are pretty much locked up until 59½, but the contributions can be taken out earlier for no penalty.

The Shared Brokerage Account is the catch-all for any extra money we have that we want to invest.  There are no tax-advantages to using this kind of account, so that’s we make sure to fill up all of the above accounts first, but it does have the advantage of simplicity and no caps.  Any money in this account can be withdrawn at any time for any reason at any age with no fees or penalties of any kind.  The money invested in this account has already had taxes paid on it, but we will potentially owe additional taxes on any gains that are withdrawn in the future.  Once again, any years between early retirement and traditional retirement age are a good opportunity to access these gains tax-free thanks to a 0% capital gains tax for lower incomes.

Having 7 different accounts makes things a little complicated, but it’s not too hard to manage.  The accounts themselves are simply containers for our investments, so now we should take a look at what investments we actually fill those containers up with.

Our Target Investment Allocation

As I detailed above, our investment strategy is based around low-cost index funds.  There are a few different ways to invest in these types of funds, the simplest being an indexed “Target Retirement Date” fund.  This is usually my go-to recommendation for someone who asks me what to invest in because they are extremely simple.  It’s a one-stop shop that encompasses the entire world market, automatically rebalances, and slowly adjusts to a more conservative asset allocation over time.  You simply pick the year you plan to retire, throw all of your investments into that single fund, and there isn’t even a third step!

We then take the same approach one step further by looking at what the target date fund invests in and copying it ourselves across the same underlying funds.  This saves us a small amount on fees and also opens up the potential for tax-loss harvesting, but otherwise is an almost identical approach.  We trade off a small amount of work to save a small amount on fees, but I would understand if someone were to take the opposite approach in the name of simplicity.

If our goal is to copy these target date funds, let’s take a look at one.  Specifically, let’s look at Vanguard’s 2050 fund (VFIFX):

As you can see, VFIFX simply holds 4 of Vanguard’s core index funds in different percentages and carries an expense ratio of 0.16% on invested funds.  Our approach is to simplify this slightly by removing the small percentage of International Bond holdings and sticking to the old-school Boglehead 3-fund Portfolio.  The International Bonds will be replaced with more US bonds and for no reason other than ‘Merica, we also shifted a little heavier towards US Stock versus International Stock.

That makes our goal asset allocation:

  • 60% Total US Stock Market
  • 30% Total International Stock Market
  • 10% Total US Bond Market

The 5 Funds in Our “3-Fund Portfolio”

Similar to the above reason of why we have 7 different investment accounts, we also have more than the 3 funds that are necessary in our goal asset allocation.  This is because each of the different accounts has access to different funds.  While our IRAs and brokerage account can be invested in just about anything, each of our 401ks and HSAs are more restricted in investment options.  Luckily, they each have appropriate funds that match our target allocation and have low fees, so we simply have to slice together the right combination.

Initially, I simply attempted to replicate the 60/30/10 investment split in each account, but this proved to be inefficient over time.  Our tax-advantaged accounts all offer free trades that don’t trigger any taxable events, but once we were able to add additional funds in a brokerage account, this “fund-swapping” was no longer possible with any efficiency.

At that point, I evaluated the different fund options in each account and set a goal dollar amount for each of our 3 assets based on the total amount we had invested at the time.  Add in a little tax-efficient fund placement theory (which is beyond the scope of this post, but you can read about HERE if interested) and this is the split we ended up with:

  • Total US Stock Market Funds – 60%
    • VIIIX – Vanguard Institutional S&P 500 Index Fund – 0.02% expense ratio
    • VTSAX – Vanguard Total US Stock Market Index Fund – 0.05% expense ratio
    • VTI – Vanguard Total US Stock Market ETF – 0.05% expense ratio
  • Total International Stock Market Fund – 30%
    • VTIAX – Vanguard Total International Stock Market Index Fund – 0.11% expense ratio
  • Total US Bond Market – 10%
    • VBMPX – Vanguard Total US Bond Market Index Fund – 0.04% expense ratio

You’ll notice that a portion of our “Total US Stock” allocation is in an S&P 500 fund which only tracks the top 500 companies in the US rather than the entire market as a whole.  Those top 500 companies do currently comprise ~80% of the total market, and there is no shortage of articles comparing the two options against each other.  The jury is out on which approach is better (S&P500 vs. Total Market), but pretty much everyone agrees they are very close and the historical performance matches that conclusion.  We only chose this particular S&P500 fund because there wasn’t a comparable total market fund in the specific 401k, and it’s hard to beat that 0.02% expense ratio!

The selection of Vanguard for most of our funds was partially a choice and partially what we had access to in our respective tax-advantaged accounts.  As mentioned above, I prefer Vanguard to the other big firms due to the ownership set-up of the company, but a disciplined investor would do just as well with the low-cost index offerings of Schwab, Fidelity, or other similar firms.

As you can see from our expense ratios above compared to the expense ratio of the comparable target date fund (VFIFX at 0.16%), we are saving a moderate amount by doing the underlying allocation ourselves.  Even the most expensive fund we own (the International Stock portion at 0.11%) comes in under the target date fund, while some of the other options come in much much lower.

According to Personal Capital (which we use to track our investments across all of our accounts), the current overall expense ratio across all 5 of our funds across all 7 accounts is 0.06%.  Therefore, the benefit of taking the DIY approach versus the target date fund approach is ~0.10% per year.  According to an expense ratio calculator I found via Google, this will amount to a difference of ~$68,000 over the next 30 years!

If a small difference of one tenth of one percent adds up that much over time, imagine how much funds that charge 1% or more are making you lose out on!  If you don’t know what the expense ratio of your current investments are, then go check them now and get out of anything above 0.50%, ideally switching to something 0.20% or lower if available.

How We Add Money Going Forward

Now that everything is moved into our target asset allocation, how do we maintain that ratio going forward?

First, I took care of the auto-investments.  Between our 401ks, HSAs and the employer matches, over $40,000 is automatically going into investments from our paychecks throughout the year.  In order to match our 60/30/10 split, I figured out how much was going into each account and chose the respective funds to match our overall asset allocation.  For example, I might have one 401k covering all of the desired bond split with the rest going into the total US market.  The other 401k could then put the bulk into the total US market, with some going into a total international fund.  The HSAs can then top off the international allocation to the correct amount.

This isn’t exactly how I have it set up (considering tax-efficient fund placement again), but hopefully you get the idea.  It’s important to look at all of your investments across accounts when determining how to invest.  There is no reason for each individual account to have it’s own asset allocation, it’s the overall picture that counts.

We can then use the semi-monthly contributions to our brokerage account (which I still do manually) to balance out or top off whatever fund is necessary to get closer to our ideal allocation.  The primary goal being to avoid selling anything in the brokerage account and triggering a taxable gain, while still maintaining our overall asset allocation.  The free trades in the tax-advantaged accounts help with this greatly and should make re-balancing easy so long as they stay a large percentage of our overall investments.

That’s It!

Our investment strategy is now open to the world and you are free to copy it if desired.  We aren’t trying to re-invent the wheel or beat the market, but instead just plan to ride the steady wave of the market upwards over the long term.  There’s no doubt in my mind that the market will crash at some point (it always does), but that doesn’t change our investment strategy at all.  “Time in the market beats timing the market” as they say.  Most of our investments are automated thanks to contributions out of our paychecks which makes things really easy, but we’ve also been disciplined in pushing our extra cash flow into the brokerage account each month regardless of what the market is doing.

Even when the stock market inevitably does a bunch of weird stuff (both up and down), we’ll continue to push money in month after month without paying too much attention.  This has been the tried and true investment method that works best over time and we plan to stick with it.  Many investors lose the most when they panic-sell in a downturn and I hope we have the fortitude to stick to the plan through whatever might come our way in the future.

Hopefully you can stick to your investment plan too!


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29 thoughts on “Our Simple Investment Strategy

    1. If this is all obvious to you, then that’s great! A lot of people I know do not understand the basics of index funds or how to utilize tax advantaged accounts, so hopefully this post was useful to them.

      Thanks for reading!

    2. cause most people don’t know about these accounts or the concept of tax-efficiency, most people don’t know about simple 3-fund investing and the importance of low fees, and most people probably think it’s rocket science when it’s not

    1. The Vanguard funds that we invest in all pay out dividends on a regular basis. These dividends come directly from the underlying stocks/bonds that the index funds own and typiclally happen once per quarter.

      This does trigger a taxable event in the brokerage account, but I don’t think there is any efficient way around that. Once we quit our jobs, we’ll probably stop reinvesting the dividends and will have them go directly into our bank accounts to cover a portion of our spending.

      1. If they’re anything like ordinary dividends and your income (presumably only dividends in retirement) are under $39k/year you will pay $0 in tax on those dividends provided they’re qualified.

        I invest in individual dividend paying stocks, but something like a Vanguard dividend paying fund is very good for the hands off investor since fees are very low and they still pay out a dividend.

  1. Hmm interesting you choose to use the IRA over brokerage since you can’t deduct it. If your plan is to be below the 25% tax bracket when you early retire, then there is no difference between a brokerage or Roth IRA account; both grow for free since gains + dividends will be taxed at zero for the brokerage. And the added benefit of the brokerage account is that you can withdraw dividend income, harvest losses, collect gains etc. if you need to, while letting your Roth account grow.

    But now you’ve got me rethinking, since I had based this comparison on this post: http://www.gocurrycracker.com/roth-sucks/

    but seems like he is talking about straight contributions to a Roth.

    What were your thoughts here?

    1. To add, I just realized a Roth might be better for me than a brokerage because I’m paying tax on my dividends (in the 25% bracket even after maxing out my 401k+HSA) and don’t need that (paltry) income right now…

      1. That’s another good argument for Roth, moving some of those dividends out of brokerage and into Roth during your earning years will help avoid paying that extra bit of taxes.

    2. I’ve read gcc’s take on Roth contributions and I agree that it’s more optimal in the current tax landscape for people that plan to live on less than ~$90k per year going forward. While that amount does fit our current spending plan, I think the Roth provides a level of flexibilty that more brokerage contributions does not. Our backdoor Roth contibutions are identical to direct Roth contributions in this context.

      First, there is nothing that guarantees our current spending level will maintain over the next 4+ decades. I actually think it will go down a little over time, but life changes and we’re still really young, so there’s always a chance we deicde to inflate our lifestyle at some point. If we get above the free gains/dividends threshold, having money in Roth will benefit us at that point.

      Second, there is no guarantee that we will have access to 0% capital gains/dividend taxes in the future. If anything in the tax rules change to tax those in the lower brackets, adjust the brackets significantly, or something else, we may end up paying taxes on these gains. One thing I don’t see changing is how Roth accounts work, so putting money in there now protects us a little against these possible changes to the tax code.

      Third, it’s not unlikely that we make some money after retiring! Almost all of the public and non-public FI people I know seem to have turned their blogs or other side gigs into profitable hobbies, and it’s possible we end up going down the same road at some point. I certainly won’t be counting on it for our spending, but it wouldn’t surprise me if this blog or some other hobby of mine ends up making some money after retirement. While I never expect to get to MMM’s $400k+/year level, this extra income would take away room to have tax-free withdrawals from the brokerage account (if we even need them at that point), and having some money in Roth may come in handy.

      Fourth, looking beyond our own financial lives, if we stick to a conservative withdrawal rate, our nest egg is expected to keep growing and growing. Passing some money along to heirs or whoever else may be more protected tax-wise if it comes in the form of a Roth. This is all speculative, but is something that may come into play at some point down the line.

      Bascially, we trade off a little flexibility (gains beind locked up until 59.5) for the potential advantages I listed out above. We may end up not using any of them, but I think having a little Roth diversity in our overall portfolio may be of use at some point.

      Thanks for the great question!

      1. Wow thank you for the breakdown. That all makes immense sense and holds true for me as well. I’m revising my strategy asap!

        Also, had no idea MMM was making that much…sounds like I need to get into blogging haha.

        Cheers

  2. Another question, do you actually have to buy shares in the Trad IRA or can you keep it in the settlement/cash fund and then move directly to the Roth (or is there no settlement fund for an IRA)? Is the “rolling” part of the Roth conversion just selling in the Trad IRA, moving the funds to the Roth, and rebuying (do you rebuy the same? I’m assuming washes aren’t an issue over this short of time span)? I would be doing this in Vanguard, so trying to figure out the mechanics.

    Thanks

    1. You don’t need to buy shares. Anything in the IRA counts. I contribute $5,500/year (or whatever the max is) and that works out fine and I just let it sit there. I’m waiting for stocks to come back down from the stratosphere, but either way it doesn’t matter.

        1. We don’t make enough for something like that to make sense for us. In a few months we’ll be moving to TX which is a lot cheaper than Denver and all of their greedy tax schemes. No state income tax in TX and we will actually be able to afford a house. Plus we should both be making more as well, though we’ll have to hope for the best on that one.

    2. As Ken said, keeping the money in cash or something like a money market fund works just fine. If you do choose to invest in a fund, you will owe taxes on any gains between the time you contribution and convert to Roth. Should be minor unless the market surges in the short period.

      The physician on fire link is pretty much exactly how we execute our own backdoor, nice find.

      1. I think I need to specify here. I have an IRA that I add $5,500/year to (whatever the max is). You can leave the funds in that IRA uninvested or invested in stocks, bonds, whatever and either way you will not be taxed. This is a traditional IRA which is tax deductible when you file taxes for previous year contributions. You’ll pay taxes on distributions and penalties/taxes if you withdraw before retirement age.

      2. Yes very helpful.

        I seem to be running in circles in my head now over Backdoor Roth’s vs direct Roth’s, hopefully you can help clarify. Is there any reason to use the Backdoor Roth over directly contributing to a Roth, assuming you make less than the limit for a Roth contribution (e.g. $117k for single)?

        1. There is no reason to do a backdoor Roth IRA if you can contribute directly to Roth IRA, that would just make the tax forms more complicated.

          One thing to keep in mind is that a lot of people contribute to their IRA in January, so they may have to guess as to what their AGI for the year will be. If you’re going to be cutting it close, it might make sense to do the extra steps for the backdoor just to be safe.

          1. Got it, thanks. Sometimes this FI stuff seems so straightforward, other times you got completely confused over something trivial that throws everything you think you know into doubt 🙂

            One more question, my girlfriend is self-employed (sole prop) in the 15% bracket. I’ve been telling her over and over to start contributing to a deductible Trad IRA, however I’m now wondering if instead she should look at a Solo 401(k) in order to contribute more than $5.5k/yr (if she can). Have you looked into that at all?

          2. I haven’t looked into the self-employed stuff myself, but I’ve heard it can be really beneficial. Good luck figuring it all out, I’m sure you can find a good resource for it somewhere online.

    1. I keep all of our VTIAX (international stock) in the taxable because I can then use the foreign tax credit against my taxes each year (although it’s rather small). The additional fund currently in the taxable is VTSAX (US stock).

      I attempt to follow the tax efficient fund placement theory, but the benefit to doing so doesn’t appear to have a large impact:
      https://www.bogleheads.org/wiki/Tax-efficient_fund_placement

  3. What percentage of your salary are you aiming to save? 50%?

    How does purchasing a house fit into your investment strategy?

    Why are you putting such a high amount into bonds at such a young age? Why put anything into bonds at all before 40?

    Thanks!

    1. Our savings goal isn’t percentage based, we simply aim to spend money efficiently by consciously analyzing our purchases with the goal of optimizing overall happiness. That probably sounds extremely broad, but it’s worked well for us so far. Instead of hiding away money from a paycheck right away (aside from our automatic 401k and HSA contributions), we move whatever is left over to investments before the next paycheck arrives (approximately).

      We purchased a townhouse a few years ago and buying another is not currently in our plans.

      I certainly wouldn’t call 10% in bonds a high amount given standard advice, but this is something I’m looking closer at right now. 100% stocks definitely has a higher expected return over the long run, but bonds should help smooth out the ride as we get closer to potentially walking away from our jobs.

  4. Hey Noah,

    Just found your website via a recent Mad Fientist post. Great article. What are your (or the other readers) thoughts on reaching the asset allocation you outlined when your 401K has fees of roughly 1% on most of their funds?

    I invest my IRA, HSA, and brokerage account in Vanguard funds. My 401K does have have an S&P500 and one Vanguard fund( Winsor 2-VWNFX). I invest in a 50/50 split between these two funds, both have expense ratios of about 0.31% The remainder funds have ER of between 0,75-1.25%. Does it make sense to hold most of my U.S. stocks in the “relatively” lower cost 401K funds and international and bonds in IRA/HSA/Brokerage accounts?

    1. Hey Mr. Oregon, thanks for reading!

      As for your 401k situation, I would probably put all of those funds into the S&P500 index fund and ignore the actively managed Vanguard one (VWNFX). The expense ratio itself isn’t a good reason to be in an actively managed fund so long as the S&P500 fits your goal asset allocation. This will depend on the balance in the account versus the rest of your investments.

      I would say it’s perfectly find to have the 401k hold most of your US stocks while balancing the rest of your asset classes elsewhere. In general, it’s best to look at your allocation as a whole across all of your accounts and no put much weight on the allocation of a single account.

      Just be sure to consider rolling the money out of the 401k into an IRA once you leave your job, going from a .31% fee to <.10% could make a big difference over time.

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