Financial Planning

Build an Easy ETF Portfolio

If you want to build an easy ETF portfolio, you're in luck! There are tons of financial products that will allow you to build a simple and efficient portfolio. Today's information rich environment will also allow you to turn the task of building a portfolio into an arduous and time consuming endeavor.

Building a portfolio shouldn't be difficult, and in my experience the time and energy it takes to build a complex portfolio isn't even worth it. Most mutual fund managers lag the market in terms of performance, chances are you will too. So if you're like me and don't want to waste a bunch of time, feel free to follow along and build your portfolio the easy way.

First, Determine the Right Asset Allocation

According to Modern Portfolio Theory, one of the key elements to consider when building an efficient portfolio is the mix of asset classes. Asset class mix can be described as the percent of your portfolio dedicated to particular asset classes.

In this first step we need to determine how much capital we should allocate to stocks, bonds, commodities, options, futures, etc. To keep this portfolio simple we will first look at a portfolio comprised of only stocks and bonds. Then we will discuss other assets classes, such as gold and real estate, that we can add to our portfolio to increase diversification.

The quickest way to determine a "good enough" asset allocation for an individual is the "100 minus your age" rule of thumb. To use this rule of thumb to determine what percent of your capital should be invested in stocks, just subtract your age from 100. The resulting number will be the percentage of your portfolio that should be allocated to stocks. The remaining balance should be allocated into bonds.

Second, Use ETFs for Diversification

Now that you know what percent of your portfolio should be invested into stocks and bonds, its time to find the specific assets to place into your portfolio. As mentioned earlier, the abundance of financial products makes this an easy task. To achieve a "good enough" diversification you only really need to purchase the following Exchange Traded Funds.

Vanguard Total Stock Market (VTI) - Including this fund in your easy ETF portfolio will allow you to track the performance of the U.S. stock market. This ETF includes large, mid, small and micro-cap stocks.

Vanguard Total Bond Market (BND) - This fund will enable you to track the performance of the Barclays U.S. Aggregate Float Adjusted Index. It includes both government and corporate bond issues with a maturity of more than one year.

    I told you this was the World's easiest portfolio! However, if choosing a stock allocation based on your age and only investing in two ETFs is too easy, you can choose to add a few more asset classes to increase your diversification. To add more complexity to your easy ETF portfolio, I would consider dedicating a small percentage of my portfolio to each of the following international, real estate and gold funds.

    Vanguard Total International Stock (VXUS) - This ETF will add international stock exposure to your portfolio. This fund tracks the FTSE Global All Cap and excludes U.S. stocks.

    Vanguard REIT (VNQ) - This ETF will allow you to diversify into real estate investments by tracking the performance of the MSCI U.S. Real Estate Investment Trust (REIT) Index. This index represents roughly 85% of the publicly traded REIT market.

    SPDR Gold Shares (GLD) - Investing in a gold fund will introduce a commodity into your portfolio while providing a good hedge against inflation. The SPDR Gold Shares ETF seeks to track the price performance of gold bullion (net of management fees).

      If you want to get a little more complex and tailor your portfolio's risk and reward profile, you can choose to allocate your stocks based on different sized companies (i.e. small, medium and large capitalization). The following funds can help you customize your easy ETF portfolio based on your individual risk and reward preferences.

      Vanguard Large-Cap (VV) - Include this fund in your easy ETF portfolio if you want an additional allocation to large companies. This fund has a moderate risk and reward profile.

      Vanguard Mid-Cap (VO) - Investing in this mid-cap ETF will increase your exposure to companies with a higher risk and higher reward profile than larger companies.

      Vanguard Small-Cap (VB) - If you want to increase the potential to outperform the S&P 500 and the Dow Jones Industrial Average, increase your allocation to small-cap stocks. Keep in mind that small companies are historically more sensitive to macroeconomic performance.

        Third, Maintain Your Easy ETF Portfolio

        Once in a while you will need to measure how "out of balance" your portfolio has become; in most cases once a year fine. Your easy ETF portfolio will need to be adjusted for two reasons. First, your portfolio's positions will gain and lose value at different rates over time. This will throw your allocation percentages off. Second, as you near retirement you should be reducing your exposure to riskier assets, such as stocks and increasing your allocation to bonds.

        To re-balance your portfolio, determine what percent your stock and bond allocations should be by using the "100 minus your age" rule. Once you have determined where your allocation percentages should be, calculate the size of your current allocations.

        If your positions are larger then they should be you need to "trim the positions". In other words, you will need to sell enough shares to reduce your allocation to where it should be. The gains from trimmed positions should be used to increase allocations (buy more shares) of positions that are smaller than they need to be.

        Developing Your Life's Vision and Mission

        Many of us seek knowledge and fulfilling experiences in the expectation that it will enable us live a great and meaningful life. However, for many this exercise usually occurs in the subconscious and it’s power is never fully leveraged. A popular way to take this effort to the next level is to develop a personal vision and mission statement. Your vision and mission statements will help you clearly articulate the things in life that are most important to you. These statements will also help you steer your life in the direction that you want it to go. In addition your life’s mission and vision will assist you develop your financial plan's goals and objectives, which are an important element in the financial planning process.

        When all is said and done, your personal vision and mission statement should be the focus of your financial plan. This is due to the fact that your financial plan is a tool that will help you gather the financial resources needed to live your life the way you want to. Thus before you develop your financial plan, you need to have a good idea what you want to accomplish in life.

        Determining Your Life's Vision

        A vision statement is an inspirational description of your life's overarching purpose and values. When illustrating your vision you can choose to focus on describing the person you want to be. This includes areas in life such as family, leisure activities, education, community involvement and personal relationships. Here are a few examples of a vision statement for inclusion in your financial plan:

        "I am a hardworking and dedicated small business owner who believes in spending quality time with my closest family and friends."

        "I am a nurturing Mother of 3 who values education, loyalty and giving to those less fortunate."

        "We are a strong, yet independent couple, who believes in building successful careers and enjoying travel to exotic locations."

        When developing your vision statement remember it’s important to focus on the values that are most important to you. Our values influence our financial decision making process and help form our priorities. When using a list of your values to guide the development of your goals and objectives you will effectively steer your life in the right direction.

        Determining Your Life's Mission

        Your mission statement should be a declaration of what matters to you the most and what you are setting out to achieve. When writing your mission statement there are a few key factors to consider. First, what are a few of the most important things in your life? What do you value the most? Second, what does success look like? Describe what you are working towards. Below are a few examples of a mission statement for financial planning purposes:

        "My mission is to increase the standard of living of my family through financial discipline and providing the best education available."

        "My mission is to become a respected proponent and spokesperson for disabled Veterans and their families."

        "My mission is to increase the adventure in my life through engaging in a variety of outdoor activities."

        The critical element in your mission statement is a description of what you want to achieve, or in other words, what should be the results of your life’s work. Your mission should be a concise statement of your sole purpose.

        Developing your personal vision and mission statement will help you live a fulfilled and enriched life. By understanding your values and purpose in life you can increase your chances of accomplishing your personal goals and objectives.

        Retirement Planning in 2014

        Planning for retirement is one of the most important aspects in the financial planning process. However, only 64% of us actually takes the time to plan and save for retirement. There’s no doubt that planning for retirement can be a daunting endeavor, however not having enough resources to live comfortably during retirement is a far worse alternative. Many of us postpone retirement planning due to the perception that we will have plenty of time in the future. This is not usually the case as many retirees wish they started to save for their retirement sooner. As we start or adjust our retirement plans in 2014, it’s important to remember that we control our ability to plan and save for retirement.

        Despite the fact that we can control some aspects of our retirement, there are a few that we can’t. This includes elements such as economic growth, inflation and retirement plan contribution laws. These limits can change year to year as they are dictated by Congress. In 2014 ensure that you consider the following limits in your retirement plan and adjust if necessary.

        Contribution Retirement Plans Limits in 2014

        Contribution retirement plans are employer sponsored investment accounts. These accounts are funded through automatic paycheck deductions. In these plans a employer sets a matching contribution policy in which they will invest a percentage of an employee's income as a retirement plan investment.

        If your employer offers a contribution retirement plan, it is in your best interest to participate. Not only do these plan offer you a quick and easy way to build your portfolio, it also provides great tax advantages. Your personal retirement account contribution is deducted from your paycheck before taxes are calculated. This helps you reduce your annual tax bill.

        In order to limit the amount of tax that is deductible from these retirement plans, Congress caps the amount in which can be contributed to these accounts on an annual basis. In 2014 you will be able to contribute up to $17,500 in your 401(k), 403(b) and most 457 plans. In addition if you are 50 years or older you qualify for a retirement “catch up” contribution of $5,500. This will set your total contribution limit at $23,000 a year.

        Individual Retirement Plans Limits in 2014

        Individual Retirement Plans or IRAs, are tax advantaged investment accounts. These common retirement plans are usually managed by the individual and can be opened at most financial and brokerage firms. While IRAs have a few advantages over contributions plans, such as investment flexibility, they do not include an employer contribution.

        Individuals can contribute up to $5,500 to their IRA in 2014 and if over the age of 50 they qualify for the additional $1,000 “catch up” contribution. While the contribution limits to IRAs are limited, maxing out your contribution to your IRA is better than not having any retirement savings at all.

        In addition to the limits for IRA contributions, the tax advantages are also capped by your Adjusted Gross Income or AGI. In 2014 the traditional IRA tax deduction is phased out for single taxpayers with a retirement plan at work when their incomes are between $60,000 and $70,000. However this limit is raised for married couples when their combined incomes are between $96,000 and $116,000.

        If you do not have a retirement plan for 2014, it’s never too late to start. Many put off saving for retirement for a variety of reasons. Retirement is enviable and postponing preparing for it makes it more difficult.

        Financial Planning for Newlyweds

        The joining of two people in marriage is quite a significant event, not only for the families of the newlyweds, but for their finances as well. While bringing together two incomes is a pretty straight forward endeavor, bringing together various expenses, assets, liabilities and the possible emotion connection to them can be tricky.

        In my previous post “You’re Engage, Create a Financial Plan”, I discussed some of the advantages of having a financial plan before you’re actually married. In short, creating a financial plan can help you and your future spouse explore your life’s goals and objectives before tying the knot. This will help significantly reduce the possibility of disagreements when managing your finances in the future.

        If you are a newlywed or recently became engaged, start the financial planning process by defining your combined goals and objectives. Once complete, the following steps will help you merge your finances and create a joint financial plan.

        Data Collection and Analysis

        During this memorable time in your lives, it’s important to locate all of the data that will impact your financial well being. This information will be used to construct your financial planning statements and determine the strengths and weaknesses that exist in your current financial situation.

        The first step is to gather your qualitative financial planning data. This information will help you explore and document your risk tolerance, past experiences with money, feeling towards different investment products and your retirement expectations. This data is mostly used in the consideration of shared values and the emotional connection to various financial decisions.

        In contrast, quantitative financial planning data is more numerical in nature. Gathering this data can be accomplished by listing the title and value of your cash accounts, insurance policies, estate planning documentation, and historical tax returns. This data will be used to develop forecasts and determine the affordability of your goals and objectives.

        Once you have gathered and listed all of your financial planning data, it’s time to determine which accounts and policies should be merged, eliminated or simply left alone.

        Merging Accounts and Financials

        The decision to merge accounts and other financial planning tools, can be difficult. This is not only due to the volume of forms that will have to be filled out, but also the fear of losing control over a very important aspect of your personal life.

        To begin merging accounts, it’s important to understand the advantages and disadvantages of each one. This will help determine if there could be any savings or added complexity from merging accounts (such as consolidating insurance policies or changing beneficiaries).

        Once all of your options have been laid on the table, it’s time to merge the accounts that have the most advantages. When merging accounts, remember you don’t have to do it all at once. As long as there is open and honest communicate accompanied by a clear action plan, you can merge your financial accounts when it’s best for you and your schedule.

        In today’s fast moving and advanced world, marriage is more than a romantic commitment to the person you love, it’s a business arrangement as well. Newlyweds should take the time to create a financial plan. This will ensure that the business side of you relationship is healthy and moving in the right direction.

        You're Engaged, Create a Financial Plan

        It’s no secret that financial issues can place a severe strain on a marriage. Despite the fact that disagreements over the use of financial resources can stem from an underlying conflict of values within the couple, the cause of the argument is usually blamed on money. Studies have shown that financial issues and lack of preparation are two of the most common causes of divorce in the United States. With that said, I’m going to proclaim that a financial plan can help strengthen a marriage even before the couple walks down the aisle.

        The financial planning process includes the exploration of shared values, goals and objectives. A couple’s understanding of these individual characteristics are critical when planning to share the rest of their lives with someone else. Making the decision to create a financial plan before you get married is an excellent way to prepare for the future, both mentally and financially.

        Getting Started with Your Plan

        Sitting down with your future spouse to develop a list of goals and objects can be perceived as a less than romantic endeavor. While I agree that conducting a business-like meeting with the love of your life is not the ideal evening, I will argue that it will empower your relationship in the long-run.

        To get started, grab paper and a pen and gather somewhere comfortable. One of you will have to take the lead and write down the critical points of your conversation. During this exercise remember that developing a financial plan will take many iterations. So you should just aim to create a rough draft in your first meeting.

        With all of that said, develop a list of your individual and future family’s goals and objectives. You should keep in mind that these are your personal life goals, not your financial aspirations. At first it will be difficult to separate the two as we often constrain our goals on our ability to afford them, however there’s no pressure as this is just a draft.

        Prioritizing Your Goals and Objectives

        Chances are pretty good that you will not be able to afford all of your goals and objectives when starting a new family. This is quite a common challenge as young families have many large expenses in their early years (mortgage, school loans, children, etc.).

        With that in mind, you will most likely need to sit down with your future spouse and prioritize your goals and objectives. The prioritization of your future goals and, consequently, the focus of your financial management process is important to mutually agree on. This will help reduce the potential for misunderstandings and disagreements in the future.

        To begin, take your completed list of goals and objectives and determine which is the most and least important to you and your future spouse. These will be your guides as you question which goals should be a higher or lower priority. Once complete you will be able to easily determine the ones that require funding before the others.

        Creating a financial plan before you get married is a great way to get a deep understanding of your future spouse’s goals, objectives, priorities and financial management savvy. This plan doesn't have to be robust to be effective, just having the conversation is important.