Friday, September 13, 2013

My New Employer's Retirement Program

As regular readers of this blog are aware, a short while ago I started a new job. Last week I enrolled in my new employer's retirement program and the first contributions should occur at the end of this month. The retirement program will represent a part of my investing going forward, so I wanted to share some of the details about the program.

The retirement program involves two accounts. The first account is a 403(b) defined contribution retirement plan, to which my employer will make contributions equal to 10% of my annual pre-tax salary (note that these contributions are separate from my salary). The second account is a 401(a) mandatory retirement plan, to which I am required to contribute 4% of my annual pre-tax salary (these contributions are deducted from my salary). As someone who maintains a relatively high savings rate and likes the freedom of deciding where, when, and how to invest my savings, I do not like having to make mandatory contributions. However, I suppose one could view it as an acceptable tradeoff for getting larger contributions from my employer, even though the two types of contributions are separate; that is, they are not "matching" contributions that occur in some 401(k) plans. Thus, total contributions equal to 14% of my annual pre-tax salary will go into the two accounts; based on my current salary, that works out to a little over $10,000 per year.

Regarding investment options, my choices are rather limited. There are four "tiers" of investments available to me:
  1. Target-date funds: A mix of various stock and bond funds based on an individual's age. For someone my age (31 years old), a typical mix is 90% stocks and 10% bonds. The mix becomes more conservative over time, with a decreasing percentage of stocks and an increasing percentage of bonds.
  2. Index funds: Passively managed funds that track various stock and bond market indices.
  3. Actively managed funds: Funds managed by investment professionals and usually geared toward specific investing styles (e.g., value vs. growth, domestic vs. international, etc.). Fees are higher than in the other tiers, even though higher returns are by no means guaranteed. In fact, history shows that most actively managed funds tend to underperform passively managed market index funds.
  4. Brokerage account: Provides a much broader selection of investment possibilities, except it is restricted to investment in mutual funds and there are transaction fees. The purchase of individual stocks is not permitted.
Given these options, I decided to focus on index funds. Unfortunately, there are only five funds available for investment. Fortunately, they are all Vanguard funds with very low expense ratios. The funds are listed in the table below, with each ticker symbol linked to Vanguard's web page for the fund.

Symbol Name Index Tracked Expense Ratio
VINIX Vanguard Institutional Index Fund S&P 500 Index (Large-Cap Stocks) 0.04%
VIEIX Vanguard Extended Market Index Fund S&P Completion Index (Small- and Mid-Cap Stocks) 0.12%
VFWSX Vanguard FTSE All-World ex-US Index Fund FTSE All-World ex US Index (International Stocks) 0.12%
VBTIX Vanguard Total Bond Market Index Fund Barclays U.S. Aggregate Float Adjusted Index (U.S. Bonds) 0.07%
VIPIX Vanguard Inflation-Protected Securities Fund Inflation-Indexed U.S. Bonds (i.e., TIPS) 0.07%

I am not keen on the bond funds for two reasons. First, as a young investor with a long time horizon, there is not much need for bonds in my portfolio. I do not mind taking the "riskier" approach of having the bulk of my investments in stocks. Second, the two bond funds focus on U.S. bonds, and anyone paying attention to the news this year knows there is a lot of talk about rising interest rates in the U.S. When interest rates rise, bond values fall, so bond funds do not strike me as good investments for the next few years.

Regarding the stock funds, I tend to view the domestic vs. international categorization as a misleading dichotomy. Many U.S.-based companies, especially the large-cap ones, do business in dozens or hundreds of countries around the world, including both developed and emerging markets. For that reason, I see no compelling need to own an international stock fund.

Given that large-cap U.S. companies represent the most stable stocks in which to invest, and the S&P 500 companies have produced a decent rate of return for decades, I decided to allocate 100% of the contributions in both retirement accounts to VINIX, which tracks the S&P 500 index. I get exposure to a diversified group of some of the best companies in the world while paying the lowest expense ratio of all available investment options.

Of course, I am free to change my investment allocation in the future, so this decision is not set in stone. Each year I will take some time to re-evaluate my investment options and decide whether an alternative allocation is preferable. For example, after interest rates eventually rise and plateau, it might be worthwhile allocating a portion of my contributions to a bond fund. For the time being, though, I will simply let my retirement accounts track the S&P 500 index.

Once the first contributions are made to my retirement accounts, I will start reporting their status in my monthly reviews, most likely beginning with my October review.

14 comments:

  1. Nice post. If you didn't care about of risk because of all the time you have, why not get VIEIX?

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    1. FFDiv: Even though small-cap stocks tend to outperform large-cap stocks in the long run, I prefer to have my retirement accounts centered around stable, mature companies that are likely to be around in the long run.

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  2. I never heard of someone being forced to contribute to a 401k. Is that just a requirement to get the match? Personally, I hate my employer's program and have talked to HR several times about it to no avail. I contribute the minimum to get the employer match and the rest goes to dividend stocks.

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    1. Steve: The program is structured in a curious way. I would actually prefer an alternative where I could voluntarily contribute only up to an employer match. However, if the tradeoff for a 10% employer contribution is a 4% mandatory contribution from me, then I suppose I can live with that deal.

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  3. Good article and good luck with the new plans. If nothing else, you're probably most excited about the matching contribution from your employer.

    I'm 100% in agreeance with you on your choice. When I worked for the State of MD - I put the bulk of my cash contributions into Vanguard's Large Cap flavor fund that they offered and it has outperformed the small and midcap Vanguard flavored options available. I did split the cash up between large/mid/small - just for diversification purposes. To heck with bonds. I agree on that one too. You'd be just as well of buying CD's at your local bank or credit union.

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    1. Anonymous: Thanks for the feedback. The employer contribution is indeed nice; over time it should result in a decent-sized retirement account that will supplement my other investment accounts.

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  4. There is a lot to like about Vanguard's funds. Given your investment style, I am surprised you did not give VDAIX (dividend appreciation) a closer look. It is not an index fund, the expense ratio is 0.2%, and it is essentially a dividend growth strategy fund.

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    Replies
    1. nostra: Thanks for your comment. To buy something like VDAIX I would need to go through the brokerage account option, which involves transaction fees and additional complications. (And that's assuming that VDAIX is among the funds available via the brokerage account option.)

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  5. I think the retirement plan is good. Plus, it is still a kind of savings disguising in the form of an obligation. And that is what makes you and other employees a bit uncomfortable. You just got to give it time and you'd surely get used to it.

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    1. Donte: I think the mandatory contributions are good for people who have difficulty saving and investing for retirement. By forcing them to do it, it will likely help them down the road. However, for people like me who have good financial discipline, it is a bit annoying not to have any say about those contributions.

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  6. Are you paying into to Social Security as well or is the 4% mandatory a replacement for that? If so, that is not a bad deal at all since SS is not $ for $ your money like this will be. Correct? Overall 14% savings is great. My employer matches 6% (so I put in 6%) and then they give an annual 4% "retirement contribution" - all together that is 16% of my salary I'm saving each year. I enjoy your blog thanks for sharing your ideas!

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    1. txwhitedoug: Alas, I still have to pay into Social Security. The 4% mandatory contribution is on top of that. However, as I mentioned, one could view it as an acceptable tradeoff for getting a 10% employer contribution.

      I'm glad you enjoy my blog -- thanks for stopping by!

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