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SHAPE UP YOUR FINANCES AND MAKE YOUR MONEY LAST A LIFETIME

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Archives for August 2017

When target date funds miss the mark…

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A target date fund is a type of mutual fund that is popular in retirement accounts like 401k’s. The way they are supposed to work is that you select the fund with the date closest to your retirement year and the fund will adjust itself over the years to become more conservative in its investment allocations as you get older. They funds have names like:

  • Vanguard Target Retirement 2050
  • Vanguard Target Retirement 2045
  • Vanguard Target Retirement 2040
  • Vanguard Target Retirement 2035
  • Vanguard Target Retirement 2030
  • Vanguard Target Retirement 2025

While it simplifies the choice of allocating your 401k investments, they may not be what’s best for you.  Here is an analogy: Let’s say you are not feeling well and go to the doctor. He asks how old you are. You tell him your age and he says, “Ok, I’m going to give you this medicine because that’s what I give to all of the people that age.”

Everyone is different and age is just one of the things that should go into what determines your investment allocations. You also have to consider:

  • Your job
  • Your spouse’s job
  • If you have kids & perhaps their age(s)
  • How much risk with your investments you are emotionally comfortable with
  • How risk with your investments you may need to take to hit your goals
  • Any inheritance you may receive
  • Other assets you have saved up
  • Your projected expenses in retirement

Whenever I put together a portfolio allocation for someone I like to see how it would have fared during the 2008 and 2009 financial crisis. History doesn’t mean it’s going to repeat itself, but it’s interesting to look at. Studies show that many of the 2010 target-date funds were found to be too aggressive when the markets crashed in 2008.

In 2008, a 2010 Target Date Fund was aimed at people with retirement just two years away. The risk in their 401k’s should have shifted to being more conservative with lower risk investments. Many didn’t. Morningstar did an industry survey that gathered the 2008 returns of 27 funds with a 2010 target date. Some of the losses were very significant. Oppenheimer’s Transition 2010 fund fell by 41.3% in 2008. Alliance Bernstein’s 2010 Retirement Strategy Fund dove by 32.9% and Goldman Sach’s Retirement Strategy fund fell by 30.8%.
There are worse investment decisions that you can make that allocating to a target date fund, but depending on your situation there may be much better ones too.

Wide Moat Investing

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Wide Moat Investing is a strategy of buying the stock of companies that have a sustainable competitive business advantage.  This advantage makes it difficult for competitors to wear down and take market share and profit. This term is taken from a moat around a castle. The larger the moat the harder it would be for an enemy to attack the castle.  The term wide moat investing was coined by Warren Buffet.
There are five characteristics that a company must possess for it to be considered having a Wide Mode.
Intangible Assets
These will include brands, patents and regulatory licenses. A strong brand name will increase the customers willingness to pay up for their products. For example, Coca cola has a strong brand name that helps it receive a better return from other companies that sell the exact same product. Patents will protect the entrance of competitors into their market. An example would be a pharmaceutical company holding a patent for a specific drug only they can make and sell. Government Regulation will also hinder competition from entering the market.
Switching Cost
When the cost of switching exceeds the expected value and benefit of not changing. This doesn’t have to only be determined by price. An example of this is software that you may be able to find cheaper from another company. But because of the hassle of switching and training time it takes to get the new software up and running it may not be worth it for you to change.
Network Effect 
When the value of a particular good or service increases for both new and existing users as more customers use that good or service. A good example of this is Facebook. When it started it didn’t have a very large network, whereas now they have one of the largest networks in the world. You can also look at the credit card network and how they have increased over time to the power houses they currently are.
Cost Advantage
Companies with wide moats have sustainably lower costs than their competitors. Sustaining these low costs can come about in a number of ways. An example is economies of scale driven by large operations. The more units produced the lower the cost per unit.
Efficient Scale
When a niche market is effectively served by one or a small handful of companies, efficient scale may be present. For example, midstream energy companies such as Enterprise Products Partners EPD enjoy a natural geographic monopoly. It would be too expensive to build a second set of pipes to serve the same routes; if a competitor tried this, it would cause returns for all participants to fall well below the cost of capital.

What are the Positives of a Wide Moat?
Wide Moats have long duration’s of positive returns.  Wide Moats Focuses on outperforming the Market Over time of which it has done so.

Also Wide Moats reduce risk by investing in mostly in large Cap companies (large cap companies are companies with a market cap of 10 billion or higher) tend to be less volatile especially in tough times.

 

Over the years this theory has been performing as predicated you can take a look at the comparison of Wide Moat Focus vs the US Market you can see how over time the return difference keeps getting larger and larger.