In response to my post detailing our portfolio, a reader named James asked the following:
Why not a LifeStrategy fund? Because of lack of space in tax-deferred?
That’s a great question. Why not simplify and use a single fund instead of three or four?
Well, James hit on the biggest reason. Our portfolio is considerably larger than our tax-advantaged space so we have a sizable chunk in a taxable account.
For those that are unaware, a “LifeStrategy” fund is an all-in-one mutual fund from Vanguard that provides instant diversification. These funds come in slightly different flavors for people with different time horizons.
At one extreme is the LifeStrategy Income Fund (VASIX), which has a 20/80 allocation of stocks/bonds. At the other extreme is the LifeStrategy Growth Fund (VASGX), which has an 80/20 allocation of stocks/bonds.
The 60/40 portfolio that we’re holding could be achieved (more or less) using the LifeStrategy Moderate Growth Fund (VSMGX). There are some differences, of course. Not the least of which is the absence of TIPS from the LifeStrategy fund.
But even if you’re okay with those differences, there are (in some instances) good reasons to shy away from all-in-one funds like this. The first is having a limited amount of space in tax-advantaged accounts.
When your stocks and bonds are all rolled up into a single fund, you can’t pick and choose your where you hold your different asset classes. If your investment portfolio is held entirely within retirement account this isn’t a big deal.
But if you have taxable holdings, too, you can achieve better tax efficiency by separating things out.
Another big issue (at least to me) is that you lose control over your allocation decisions when you buy an all-in-one fund. With a LifeStrategy fund, you’re committing to a single allocation until you sell.
Here again, if you’re holding the fund in a retirement account, that’s no big deal since you’ll be able to change things up with no tax consequences. But in a taxable account, you lose this flexibility.
With a DIY portfolio, this is much less of an issue. Sure, you might want to change your allocation over time, but you can tweak things without selling out your entire position. So, here again, better tax efficiency.
And yes, I do realize that many fund families offer Target Retirement funds with allocations that adjust over time. That’s a nice option, but your preferences might not match up with those of the fund manager.
For example, the portfolio might match your desired allocation today, but it could get conservative too quickly (or stay aggressive too long) for your tastes. Rarely does one size truly fit all.
It’s also important to keep in mind that the managers of such funds can (and sometimes do) change their strategies. For example, Vanguard changed their Target Retirement funds to make them much more aggressive back in the fall of 2006.
Great timing, huh?
So there you have it. Our decision to roll a DIY portfolio instead of taking an all-in-one approach was largely based on tax considerations.