Forum Mailbag: Warren Buffett, Bond Funds, Basic Fidelity Portfolios, And More!

There is so much great information on personal finance forums. I regularly participate on several message boards, including Bogleheads, White Coat Investor, Mr. Money Mustache, Rockstar Finance, and Reddit. This is a roundup of my favorite discussions happening around the internet.

1. Rockstar Finance: Warren Buffett Is (Not) Wrong On Passive Investing

Question: MrROB posts a CNBC article where the head of leading active management mutual fund provider American Funds argues for active management over passive management (advocated by Warren Buffett). This article lead to some excellent discussion.

WSP’s Take: Tim Armour, chairman of American Funds, argues that while the average actively managed mutual fund has underperformed the S&P 500 after fees, many individual funds have done significantly better. Unfortunately, picking which mutual funds will do better than average is no easier than picking winning stocks. All mutual fund managers are smart and have access to excellent research, yet most still underperform.

Mr. Armour argues that it is simple to pick winning fund managers. His company did extensive research on identifying winning fund managers, and found that two simple filters were associated with higher returns. These filters were funds with lower expense ratios and high manager ownership. They found that funds that had these two characteristics performed better than their benchmark indices.

It is no surprise that low expense-ratio funds will do better than high expense-ratio funds. There also is some rationale that funds with high manager ownership would perform better. However, Mr. Armour’s analysis is the equivalent to a retrospective study in medicine, with all of its inherent limitations. Who knows how many other criteria were tested before American Funds found high manager ownership to be associated with improved returns? As they like to say in retrospective studies that are published in medical journals: these results should be considered hypothesis-generating, and randomized controlled clinical trials are necessary before actively managed mutual funds can be recommended for use in routine clinical (financial) practice.

2. White Coat Investor: Which Bond Index Fund Should I Pick?

Question: Slav4ikMD is currently selecting his bond funds for his portfolio. As a New York resident, he wonders whether he should invest in the New York tax-exempt bond fund or in a Vanguard total bond market fund.

WSP’s Take: The decision depends on whether he plans to invest in bond funds within a taxable or tax-deferred account. In general, I prefer to invest in bonds through a tax-deferred account such as a 401k or IRA.  In a 401k or IRA, I would recommend against a tax-exempt bond fund, as the account already has tax benefits. In general, returns in tax-exempt bond funds are lower than in standard bond funds because of the beneficial tax treatment of tax-exempt bonds. I would instead use a total bond index fund such as VBTLX (Vanguard) or FSITX (Fidelity).

If he chooses to invest in bonds within a taxable account, the Vanguard New York Long-Term Tax-Exempt Fund is a reasonable option, although I would prefer the Admiral shares (VNYUX) over the Investor shares (VNYTX) because of VNYUX’s lower expense ratio.

3. White Coat Investor: Starting To Invest In Taxable

Question: Joehospitalist and his wife are young attendings who are maxing out their 403(b)s, Roth IRAs, and saving an additional $60,000 a year that could be invested in a taxable account. They desire an 80/20 stock/bond ratio. They want to start moving this extra savings from a bank account into a taxable investment account.  They want to know which funds to invest in, as well as whether to invest it all at once or slowly over time.

WSP’s Take: 

First of all, congratulations to Joehospitalist and his wife for having such a high savings rate as new attendings. They are well on their way to financial success. In terms of how he should invest his taxable account money, it is important for him to choose his fund wisely, and I would recommend a Total Stock Market index fund. He seems to be interested in investing and personal finance, so I would not recommend a target-date fund.

In terms of investing his money all at once or slowly over time, I am a strong advocate for lump sum investing. On average, this approach will allow you to purchase shares at a lower price than a dollar-cost averaging approach.

4. Mr. Money Mustache: Basic Portfolio Using Fidelity Funds

Question: MrMoneySaver is a 40-year-old investor who is hoping to retire in his early 50s. Currently, he has a 2040 target-date fund in IRAs. Since his account is at Fidelity, he would like to know the specific funds he should use to invest in a three-fund portfolio.

WSP’s Take: For an investor who would frequent blogs and forums such as Mr. Money Mustache, I would favor a three fund portfolio over a target-date fund. At Fidelity, the index funds I prefer for a three-fund portfolio are:

1. FSTVX: Fidelity® Total Market Index Fund – Premium Class (Expense Ratio 0.045%)
2. FSIVX: Fidelity® International Index Fund – Premium Class (Expense Ratio 0.08%)
3. FSITX: Fidelity® U.S. Bond Index Fund – Premium Class (Expense Ratio 0.05%)

Some investors who prefer small cap international or emerging markets exposure will choose FTIPX: Fidelity® Total International Index Fund – Premium Class (Expense Ratio 0.11%) as their international fund.

Wall Street Shares: 5 Articles I Enjoyed Reading This Week

1. Future Proof, M.D.: Why I Opened an SEP IRA – a nice introduction to the SEP IRA (by a radiology resident!)
2. Full Time Finance: Getting Others to Change their Mind through Active Listening – the title says it all. In short, the other side needs to think you’re understanding their argument before they will (maybe) listen to you.
3. Dads Dollars Debts: Debt Is The Great Equalizer – an interesting spin on the “debt is evil” argument.
4. Picky Pinchers: What’s The Weirdest Thing You’Ve Done To Save Money? – physicians shouldn’t have to resort to these money-saving tips, but maybe you can take the few extra steps to get that free breakfast in the Doctor’s Dining Room.
5. White Coat Investor: Investing Doesn’t Have To Be Complicated – unless you have an edge (and few physicians do), keep it simple.

What do you think? Do you agree or disagree with any of my responses? What’s your take on the topics in this week’s forum mailbag?