personal finance
Size Does Matter (For Your Expense Ratio)
Whether you are managing your investments by yourself or getting help, you need to understand one critical concept, the expense ratio of your investments. Every mutual fund and exchange-traded fund (ETF) has an expense ratio, and keeping it as small as possible is key to your long-term financial success. Size does matter.
What is an Expense Ratio?
An expense ratio is the percentage of a fund’s assets that is used for expenses. In other words, if you invest in a mutual fund with a 1% expense ratio and that fund makes 10%, you’ll only get a 9% return on your investment because 1% goes to pay expenses. The less of your return you use to pay expenses, the more you get to keep.
What is an average expense ratio? An average stock mutual fund has an expense ratio of about 0.60%, but the expense ratios for mutual funds that are similar in their composition can vary wildly. For example, if you look at a list of Standard & Poor 500 index funds offered by investment companies, you’d find low expense ratios like 0.03% and as high as 1.36% (or even higher). While 1.33% does not seem like that large of a difference, keep in mind that costs last forever and that small differences compounded over years will cost you a lot of money. That is one of the major benefits of the TSP – its industry leading low cost – where nearly all the funds have expense ratios of 0.04%.
Love Your Grandparents
Let’s pretend that when you are 25 years old your grandparents give you $10,000 to invest in an S&P 500 index fund for 50 years, during which you earn a 9.5% return. If you invested in an index fund with the 1.36% expense ratio, you would have $500,000. That sounds pretty good! However, if you invested in a low cost fund with a 0.03% expense ratio, you would have $921,000.
That 1.33% difference in the expense ratios cost you $421,000!
Small differences in expenses can make huge differences in long-term investment returns, so you need to pay attention to the expense ratios of your investments.
This difference is even more dramatic when you compare actively managed funds to passively managed index funds. Because actively managed funds have higher expense ratios than index funds, it is very difficult for an active manager to beat his/her comparative index over the long-term. This is why I invest 100% in index funds, like they have in the TSP.
Shop Around
When you are picking your investments, keep in mind that you can’t control what happens to the market, but you can control which investments you choose and the expenses that they charge. Any time you are looking to invest in a mutual fund or ETF, you should search for similar funds and compare expense ratios, which you should try to keep below 0.5% (or even 0.25%, if possible).
When investing outside of the TSP, make sure that at a minimum you take a look at the Vanguard version of the investment you are considering since their expense ratios are the lowest in the industry and they never charge extraneous fees, like loads.
There is no reason to pay more expenses for what is essentially the same investment product. The size of your expense ratio matters. It could cost you A TON of money over the long-term.
How Much Do You Get Paid as a Navy Doctor?
I received a few e-mails asking for help figuring out physician pay in the Navy, and this is a long overdue blog post. In the spreadsheet below is the pay info for the various stages as you move throughout your Navy Medical Corps Career. I’m making a few assumptions:
- These are FY20 pay numbers (since the FY21 pay plan is not out yet).
- You promote at the normal times (O4 at 6 years, O5 at 12 years, and O6 at 18 years).
- Basic Allowance for Housing is with dependents in San Diego. You can personalize this here.
- The specialty is Emergency Medicine. You can look at the different amounts for other specialties here.
- You pass your boards and become board-certified after residency.
For those who don’t want to look at the spreadsheet, here are the bottom line annual salaries:
- New O3 intern – $95,976
- O3 GMO – $121,803
- Mid-grade O3 EM Resident – $120,348
- New O4 EM Attending – $180,249
- O5 EM Attending on a 6-Year Retention Bonus – $264,665
- O6 EM Attending on a 6-Year Retention Bonus – $287,878
Here’s the spreadsheet with hyperlinks:
Winning the Game
By all accounts, I’ve won the game. I know the income my family needs to live our desired lifestyle. I have an inflation-adjusted Navy pension in my future. I have two children and two GI Bills, one for each child. My house is paid off and I’m debt-free. Combine all of this with the 4% rule, and it seems I have enough to produce our desired income for the rest of my life. I have “won the game.”
Noted investment manager, neurologist, and author Bill Bernstein recommends that—once you’ve won the game—you should stop playing. What exactly does that mean? Bernstein suggests you dramatically reduce the risk you are taking with your retirement portfolio. To him, there’s no sense in taking risk you don’t need to take.
Although his advice makes sense, I find it hard to implement. First, I won the game by playing. I’m used to playing. I like playing. I want to play more. I’m only 45 and too young to stop playing. If I stop playing, I’ll be bored. As I mentioned, I have an inflation-adjusted military pension coming my way. The pension has no principal left over after my wife and I die, but it is a government guaranteed, inflation-adjusted source of income. What exactly does Bernstein mean when he says “stop playing”?
In a 2015 article that Bernstein wrote for The Wall Street Journal, he said, “You’ve won when you’ve acquired enough assets to provide your basic living expenses for the rest of your life.” Simple enough. My military pension, investments, and Social Security seem to meet this requirement. I guess I’ve won.
To stop playing, you reduce the risk you’re taking with your retirement portfolio. Once you’ve accumulated enough to support your retirement, Bernstein suggests you purchase a TIPS ladder. TIPS are Treasury Inflation Protected Securities, government-issued bonds that increase in value along with inflation, while also paying a little interest on top of that (although currently TIPS yields are negative). You can create a TIPS ladder by buying individual bonds at TreasuryDirect.gov.
For example, if you needed $60,000 per year for your basic expenses, you might take five years of required spending—or $300,000—and buy five $60,000 TIPS, with one maturing in each of the next five years. When one matured, you’d use that money for your expenses for the next year. At the same time, you’d purchase another $60,000 bond that matures five years from now. Rinse, wash and repeat.
If you didn’t want to buy individual bonds and were okay with the small fees they charge, you could likely get the same effect by investing $300,000 in the Vanguard Short-Term Inflation-Protected Securities Index Fund Admiral Shares (VTAPX) or a similar low-cost offering at another investment firm. Bernstein doesn’t recommend this, because of the fees.
I’ve decided my inflation-adjusted military pension is the equivalent of a TIPS ladder, which means that according to Dr. Bernstein I’m no longer playing.
Are you staying in long enough to get the pension? Maybe you’ve won the game too.
Change to TSP Catch-Up Contributions and Finance Friday Articles
Catch-up contributions are changing — Starting in January 2021, the process for catch-up contributions will be easier for TSP participants. If you’re turning age 50 or older, you’ll no longer need to make separate catch-up elections to your TSP account to contribute toward the catch-up limit.
Here’s how it will work:
- If you reach the IRS elective deferral or annual addition limit before the end of the year and keep saving, your contributions will automatically continue toward the catch-up limit.
- Contributions spilling over toward the catch-up limit will qualify for the match on up to 5% of salary.
- The contribution amount you choose will continue each year unless you change it.
Learn how to make catch-up contributions next year.
Also, there is an image at the end of the post to help.
Here are this week’s articles:
- 5 Reasons I Prefer Real Estate Over Stocks
- 10 Ways to Pay Off a Mortgage Quickly
- For Goodness Sake
- How To Become a Successful Landlord as a Physician
- How to Score Cheap Flights
- The Most Important Assumption
- Trends That End
- What’s wrong with Target Date Funds?
Throwback Thursday Classic Post: TSP Fund Deep Dive – The G Fund – Free Lunches Do Exist
There are only five investments available in the Thrift Savings Plan (TSP), so let’s take a detailed look at them one at a time. In this post we’ll cover the G Fund.
The G Fund is proof that free lunches do actually exist because in the G Fund the government is paying you more interest than they actually should. Read on to find out how and why.
Inception Date
1 APR 1987
Fund Management
Unlike the other TSP funds that are managed by Blackrock, the G Fund is managed internally by the Federal Retirement Thrift Investment Board. The G Fund buys a non-marketable U.S. Treasury security that is guaranteed by the U.S. Government. This means that the G Fund will not lose money.
Investment Strategy
The G Fund invests exclusively in a non-marketable short-term U.S. Treasury security that is specially issued to the TSP. The earnings consist entirely of interest income on the security.
The G Fund’s investment objective is to produce a rate of return that is higher than inflation while avoiding exposure to credit (default) risk and market price fluctuations. It is designed to provide investors with interest income without risk of loss of principal.
What is the Risk?
Your investment in the G Fund is subject to inflation risk, meaning your G Fund investment may not grow enough to offset the reduction in purchasing power that results from inflation.
What is the Benefit?
The payment of G Fund principal and interest is guaranteed by the U.S. Government. This means that the U.S. Government will always make the required payments. In other words, your G Fund investment is not subject to credit (default) risk.
The G Fund interest rate calculation is based on the weighted average yield of all outstanding Treasury notes and bonds with 4 or more years to maturity. As a result, participants who invest in the G Fund are rewarded with a long-term rate on what is essentially a short-term security. Generally, long-term interest rates are higher than short-term rates. This is the free lunch that the government periodically talks about getting rid of.
The G Fund is the lowest risk fund in the TSP and will have the lowest volatility, as you can see below. The major benefit is that you are guaranteed not to lose money. In trade for this you are receiving lower returns. Here is all the performance data as of 21 NOV 2020:
Types of Earnings
The G Fund makes money for its investors with interest paid by the U.S. Government.
Expenses
The net expenses paid by investors is 0.043% or 4.3 basis points, which like all the TSP funds is ridiculously low and is a major benefit of the TSP. It costs $0.43 for each $1,000 invested. You won’t find a lower cost U.S. government bond fund anywhere.
How Should I Use the G Fund in my TSP Account?
Consider investing in the G Fund if you would like to have all or a portion of your TSP account completely protected from loss. If you choose to invest in the G Fund, you are placing a higher priority on the stability and preservation of your money than on the opportunity to potentially achieve greater long-term growth in your account through investment in the other TSP funds.
It is the TSP equivalent of a U.S. Treasury bond fund you’d find at Vanguard or other investing firms.
Advice from My Favorite Short Investing Book
Here is what my favorite investing book, The Elements of Investing: Easy Lessons for Every Investor
The U.S. Treasury issues large amounts of bonds. These issues are considered the safest of all and these bonds are the one type of security where diversification is not essential…High quality bonds can moderate the risk of a common stock portfolio by providing offsetting variations to the inevitable ups and downs or the stock market.
If you want to know how to integrate the G fund into your own TSP investments, read the Crush the TSP series. In particular, step 3 tells you how to figure out how much of your portfolio to devote toward bonds.
Invest Your Taxable Account Thoughtfully
Jonathan Clements was a longtime personal finance columnist for The Wall Street Journal, and he offers great advice at the best price you can get (free) on his blog Humble Dollar. Here is one piece of advice from his site:
“INVEST YOUR TAXABLE ACCOUNT THOUGHTFULLY. If you purchase the wrong investments in your taxable account, you may be reluctant to sell, because you’ll trigger capital gains taxes. A good choice: low-cost U.S. and international total stock market index funds, which should be tax-efficient—and which shouldn’t ever lag far behind the market averages.”
For those of us in the military, investing in a taxable account comes into play in a few scenarios…
Scenario #1 – You and your spouse (if you have one) have filled your Thrift Savings Plan (TSP) and all other retirement accounts available including IRAs, yet you want to save more for retirement. In this case, you put the rest in a taxable account with the investment company of your choice (Vanguard, Fidelity, Schwab, etc.). This is what I do when all of my retirement accounts are full, and just like Jonathan mentions I invest purely in broad, low-cost index funds at Vanguard. The only taxable holdings I have are the Vanguard U.S. and international total stock market index funds.
Scenario #2 – You are saving for a financial goal that is not related to retirement, such as a downpayment on a home or for a new car. If you’re saving for college, you’d use a 529 plan, but for just about anything else you could use a taxable account. For example, you could put your emergency money and extra spending money in a money market fund among your taxable accounts. The alternative to this is to use a bank and invest in a high-yield savings account (which is what I do), a certificate of deposit (CD), or a money market account. Bankrate.com will show you the best rates for each of these reasonable alternatives.
If you are using a taxable account, there are a few things to consider. If you are investing in bonds, you may want to invest in municipal bonds in your taxable account due to the tax benefits. If you are a fan of target date funds, you may not want to use them in a taxable account because the bond portion will kick off income that is taxed at your full marginal tax rate. This is less of an issue with bond yields being low right now, but most experts feel that bonds are better placed in a tax-advantaged retirement account unless you are using municipal bonds.
Eliminate Duplication
Jonathan Clements was a longtime personal finance columnist for The Wall Street Journal, and he offers great advice at the best price you can get (free) on his blog Humble Dollar. Here is one piece of advice from his site:
“ELIMINATE DUPLICATION. Many folks have multiple bank and brokerage accounts, multiple funds that invest in the same market sector and even multiple advisors. This can make sense if, say, the goal is to increase FDIC insurance. But often it reflects a naïve notion of diversification—that more accounts somehow mean greater safety. Our advice: Simplify—for your sake and the sake of your heirs.”
I totally agree with this, especially after having to deal with my father in-law’s finances after his recent death. My financial life is relatively simple. We only have our investments in three places – the Thrift Savings Plan (TSP), Vanguard, and Fidelity. The last one is only because my wife’s employer uses Fidelity for their 401k. As soon as the job goes, so will that account as I roll it into the TSP or a Vanguard account.
Yes, you can rollover money from other retirement accounts into the TSP. Even if you get out of the military, keep the TSP and use it to rollover accounts. You won’t find a lower cost option anywhere.
To me, you only need to use one investment company in addition to the TSP. While Vanguard is my choice and what I recommend, there are certainly others. Just make sure that you keep an eye on your investment costs. If you use Vanguard, you know they’ll be among the lowest cost investments no matter what you pick. While some investment companies have index funds that are even lower in cost than Vanguard’s, their other funds are probably more expensive than the similar investment at Vanguard.
Finance Friday Post
Here are this week’s articles:
- Check out the most underused veterans benefits in your state
- Don’t Mix Insurance and Investing
- How to Open a Brokerage Account
- How to Save for a Big Purchase
- Private Real Estate Lending Funds
- Should Index Fund Investors Care About Tesla Getting Added to the S&P 500?
- What’s the right emergency fund amount?
Thowback Thursday Classic Post – TSP Fund Deep Dive – The F Fund
There are only five investments available in the Thrift Savings Plan (TSP), so let’s take a detailed look at them one at a time. In this post we’ll cover the F Fund.
Inception Date
29 JAN 1988
Fund Management
The Federal Retirement Thrift Investment Board currently contracts BlackRock Institutional Trust Company, N.A. (BlackRock) to manage the F Fund assets. The F Fund remains invested regardless of the performance of the securities markets or the overall economy.
Investment Strategy
The F Fund is invested in a bond index fund that invests in government, corporate, and mortgage-backed bonds. The F Fund’s objective is to match the performance of the Bloomberg Barclays U.S. Aggregate Bond Index.
The F Fund is a passively managed fund that remains invested according to its indexed investment strategy regardless of securities market movements or general economic conditions.
What is the Risk?
Your investment in the F Fund is subject to market risk, credit risk, prepayment risk, and inflation risk.
Because the F Fund returns move up and down with the returns in the bond market, your F Fund investment is subject to market risk. For example, when interest rates rise, bond prices (and thus, the returns of the index and the F Fund) fall. Conversely, in an environment of falling interest rates, bond prices, as well as the index and F Fund returns, rise.
As an F Fund investor, you are also exposed to credit (default) risk, or the possibility that principal and interest payments on the bonds that comprise the index will not be paid.
The F Fund is subject to inflation risk, meaning your F Fund investment may not grow enough to offset the reduction in purchasing power that results from inflation.
Your F Fund investment is also exposed to prepayment risk, which is the probability that if interest rates fall, bonds that are represented in the index will be paid back early thus forcing lenders to reinvest at lower rates.
What is the Benefit?
Although there are several types of risks associated with the F Fund, the overall risk is relatively low in comparison to certain other fixed income investments in the market because the F Fund includes only investment-grade securities. As a result, F Fund investors are rewarded with the opportunity to earn higher rates of return over the long term than they would from investments in short-term securities such as the G Fund. Here is all the performance data as of 14 NOV 2020:
Types of Earnings
The F Fund changes in value as the market price of its bond holdings change. In addition, the F Fund makes money for its investors with capital gains (net of trading costs), interest on notes and bonds, interest on short-term investments, and securities lending income.
BlackRock credits interest income each business day. This income is then reflected in the TSP share prices.
Share Price Calculations
The value of your account is determined each business day based on the daily share price and the number of shares you hold. At the end of each business day, after the stock and bond markets have closed, the total value of the funds’ holdings (net of accrued administrative expenses) is divided by the total number of shares outstanding to determine the share price for that day. The daily change in TSP share prices reflects all investment income (interest on short-term investments, dividends, capital gains or losses, and securities lending income) net of TSP administrative expenses.
Expenses
The net expenses paid by investors is 0.042% or 4.2 basis points, which like all the TSP funds is ridiculously low and is a major benefit of the TSP. It cost $0.42 for each $1,000 invested.
How Should I Use the F Fund in my TSP Account?
In periods of falling interest rates, the F Fund will experience gains from the resulting rise in bond prices. So in the long run, you may expect F Fund returns to exceed those of the G Fund; however, you should also expect greater price volatility (up and down movements).
It is also important to know that higher returns are not guaranteed. This is because losses may occur when interest rates are rising, causing bond prices to fall.
The F Fund can be useful in a portfolio that also contains stocks funds. This is because the prices of bonds and stocks don’t always move in the same direction or by the same amount at the same time. So a retirement portfolio that contains stock funds, like the C, S, and I Funds, along with the F Fund, will tend to be less volatile than one that contains stock funds alone.
Advice from My Favorite Short Investing Book
Here is what my favorite investing book, The Elements of Investing: Easy Lessons for Every Investor
They also say, “Well-diversified portfolios should have holdings of bonds as well as stocks.”
If you want to know how to integrate the F fund into your own TSP investments, read the Crush the TSP series. In particular, step 3 tells you how to figure out how much of your portfolio to devote toward bonds.
Buy the Big Three
Jonathan Clements was a longtime personal finance columnist for The Wall Street Journal, and he offers great advice at the best price you can get (free) on his blog Humble Dollar. Here is one piece of advice from his site:
“BUY THE BIG THREE. The global market portfolio consists of four major sectors, roughly equal in size: U.S. stocks, U.S. bonds, foreign shares and foreign bonds. Arguably, foreign bonds are optional, offering modest yields but wild currency swings. The other three sectors, however, are crucial to a diversified portfolio. Do you have enough exposure to all three?”
It’s a good thing that Mr. Clements considers foreign bonds optional, because they are not available in the Thrift Savings Plan (TSP). The rest of the asset classes are, though. U.S. stocks can be purchased in the C and S funds. U.S. bonds in the G and F funds. The I fund will get your foreign stocks, albeit not in any emerging markets.
In other words, you can get “the big three” very easily in the TSP. If you missed it, you can read about the TSP and all its funds here in my TSP guide.
Joel Schofer's Career Planning Blog 