Automatic Rebalancing - A Lifecycle Fund Bonus

Today there was an article I came across on CNNMoney.com that caught my interest about the benefits and perils of rebalancing your portfolio. The article specifically mentions the Charles Schwab Lifecycle Funds that I talked about in my last post about one fund investing. It seems that I forgot to mention the important benefit of automatic, professionally directed rebalancing that is an inherent part of Lifecycle funds.

The idea of rebalancing is to keep the asset allocation close to its target. The benefits of this strategy are three fold, 1) it keeps your level of risk in sync with your tolerances, 2) it forces you to sell asset classes that have had a run-up in price and buy assets classes that are selling at a discount, and 3) your portfolio is on autopilot as it is regularly rebalanced automatically in line with a professionally determined asset allocation that is appropriate for the time horizon of the fund. In my case as I approach my retirement around 2040 the asset mix is gradually adjusted to be more conservative. The disadvantages of rebalancing are the potential capital gains taxes and transaction fees that you will incur. Both of these negatives can be completely avoided by using an tax sheltered account such as a 401(k) or IRA and investing in a fund like the Schwab 2040 (SWERX).

If you aspire to wealth like I do then starting a Roth IRA and investing in a Lifecycle Fund is a great way to start your on a path to wealth.

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One Fund Investing

I recently opened my Roth IRA with a brokerage firm and now hold a fully diversified portfolio contained in a single fund called a Target Date Fund. I started with a balance of ZERO and have resolved myself to save $100 per paycheck (bi-weekly) with an automatic withdraw. When I was selecting the brokerage my first priority was to find one that had low minimum investment ($100) and low minimum deposits (again $100). I was also looking for access to a wide array of index funds. I am a convert to the passive investment style based on a number of great books, academic papers, and blog articles that I've read. I suggest starting with Are Index Funds the Best Investment? over at Get Rich Slowly or Walter Updegrave's CNNMoney columns.

Considering these factors, I opened my account with Charles Schwab. Once I have saved enough to create a diversified portfolio of index funds with Vanguard I will likely move my money in order to have access to funds with even lower expense ratios. So far I have been relatively happy with my choice but at this point it has only been two months. I'll write a follow up with my results and a review of Charles Schwab as a brokerage after I've been there for a while longer.

When I selected the fund to invest in I ended up choosing a Target Date Fund to hold. I put my money into the Schwab 2040 Target Fund (SWERX). The fund offers me a nearly complete diversified portfolio holding cash, bonds, foreign and domestic stock, large and small cap stock, growth and value, and real estate. I like that I can hold ONE FUND with low minimums and have exposure to nearly all of the asset classes I need. After reading the full fund prospectus from Schwab and looking at the asset allocation breakdown they provide, there are a few issues I've found. First, it is not a true index fund. Some of its holdings do use active management or deviate more than I would like from their target index. The 2040 Fund also holds more cash (6.63%) and more bonds (9.35%) than I need for my 38 year time horizon. I would also prefer a small amount of exposure to commodities and inflation protected bonds. My final gripe is that the expense ratio is 0.94% which is higher than an equivalent fund from Vanguard or Fidelity (but is still lower than 75% of its peers).

All in all I'm happy with my Roth IRA selection. Check back regularly to read more about my investment decisions and investment results as I... Aspire 2 Wealth!

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