Case Study: Switching Phases in Retirement

Older Couple Holding HandsImagine for a moment you are 87 and your wife of 60 plus years is 84. You did a great job of saving for retirement while working at the same company for 30 plus years and then retired with the gold watch at 65. You’ve crossed the finish line, and have been enjoying retirement ever since.

To keep yourself busy in the next phase of your life you built upon an already budding interest of investing in dividend stocks. Each week you religiously read the Baron’s Report watching the movements of your favorite companies. Your retirement account has continued to grow as your knowledge expanded.

Then one day things start to get a bit fuzzy. You initiate a trade, selling some stock to switch positions from one company to another. Discussing the details of your trade later in the day, when asked which company you sold, and scratching your head, you reply that you can’t remember. Uh oh.

Eventually other family members step in and pass your accounts over to a professional money manager. He liquidates positions you’ve treasured and held for many years, paying ever increasing dividends. He spreads your accounts out over a bundle of US treasuries, bond funds, and volatile individual stocks, many of which you’ve never heard of. As time goes on he begins to sell certain stocks, buy others for reasons you can’t understand, and at the same time generating fees as he churns over your portfolio. That is on top of the 1-2% he’s charging you annually to manage your account.

You begin to get frustrated. You’re not in the position to be able to manage your own accounts anymore, but you still have enough where with all to be mad when someone is following a whacky investment philosophy that only seems to generate fees for the money manager in charge.

Your wife, picking up on your frustrations, becomes deeply unsettled every time the market takes any kind of dip. She thinks he’s either losing their money or pocketing it through his complex method of charging management fees.

What to do?

This was the exact position a dear couple I know found themselves in recently. Below I’ll share the advice I offered up for them and the reasons behind the move I believe they should make, and how each of their concerns were addressed.

So, what’s the best way to reign in management expenses, and remove the portfolio manager altogether. At the same time we want to bring in some kind of dividend income, smooth out the overall volatility of the market, and ensure a steady return to support you and your family for the rest of your days.

The answer I gave them is Vanguard Index Funds.Vanguard Logo

Why Vanguard? Vanguard is set up uniquely as a company, the Vanguard funds own Vanguard, and the investors own the funds. So as an investor in a Vanguard fund, you would own a piece of Vanguard. There are no stock holders demanding for quarter after quarter of net profits, and extra fees and expenses to drive up those net profits. This is one of the biggest reasons they can offer funds with some of the lowest expense ratios out there.

Why index funds? Index funds simply track to a market average. One market index you may have heard of is the S&P 500, which tracks the 500 largest companies listed on the NYSE or NASDAQ. The S&P 500 Index Fund is made up of those same 500 companies, and the number of shares of each company the index fund owns depends on its market capitalization which is just a fancy way of saying the total number of shares outstanding multiplied by the price per share.

Gordon GekkoBecause the index fund’s components are selected by a few simple calculations there is no need to pay a Charles Schwab type character an outrageous salary and bonus every year to manage the fund. These savings are passed directly to the investors who own the index funds. One that I personally own is the Vanguard Total Stock Market Index Fund, VTSMX, that has an expense ratio of 0.05%.

Next up was to iron out the volatility of the market, or more accurately insulate the investors from the market going up and down while providing a steady income. In order to do this I suggested a fund made up of a majority of bonds. Bonds, in the long term, do not have the same return as stocks, but do offer a much smoother road. A little less return is traded for less risk.

Lastly, how to package it all together? Vanguard offers a couple of income funds that are sometimes called funds of funds. This means that each income fund is comprised of four or five different index funds. The two in particular that I suggested were the Vanguard Target Retirement Income Fund, VTINX, and the Vanguard Life Strategy Income Fund, VASIX. Both had expense ratios under 0.2%, and offered an annual divided of around 2%. Additionally, both were comprised of 70 or 80% bonds.

VTINX – Target Retirement Income Fund:
30% Stocks, 70% Bonds
Made up of 5 funds:
VBTLX – Vanguard Total Bond Market Index Fund (39.3%)
VTSAX – Vanguard Total Stock Market Index Fund (21.1%)
VTAPX – Vanguard Short-Term Inflation-Protected Securities Index Fund (16.8%)
VBTAX – Vanguard Total International Bond Index Fund (14%)
VTIAX – Vanguard Total International Stock Index Fund (8.8%)
Expense Ratio 0.16%
10 Year Historical Return: 5.52%
Dividend Yield per Year 1.67%


VASIX – Vanguard Life Strategy Income Fund:
20% Stocks, 80% Bonds
Made up of 4 funds
VBTLX – Vanguard Total Bond Market Index Fund (64.2%)
VBTAX – Vanguard Total International Bond Index Fund (16%)
VTSAX – Vanguard Total Stock Market Index Fund (13.9%)
VTIAX – Vanguard Total International Stock Index Fund (5.9%)
Expense Ratio: 0.14%
10 Year Historical Return: 4.86%
Dividend Yield per Year: 2.03%

But how do you choose between the two? To answer this question I suggested they ask themselves how much risk they would like to accept in order to hold out for a larger return in the long run. The fund that had 30% stocks had a slightly higher 10 year historical rate of return than the fund that only held 20% stocks.

In the end both were great options for someone in their specific set of circumstances, and they will be just fine should they choose either fund. That final decision I left up to them.


One thought on “Case Study: Switching Phases in Retirement

  1. This seems like a big improvement in management fees and transaction expenses. Also, they probably needed a less risky portfolio in general if the wife is “deeply unsettled every time the market takes any kind of dip.” However, I would also keep in mind that at these interest rates, bond funds may also lose substantial value if rates rise significantly in the next few years. (Not sure what the average duration is on the bond funds above, but that is something to consider.)

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