The Bogleheads' Guide to Investing

the bogleheads.org website is a place where you can see a list linking to the most recent conversations, learn more about the Bogleheads, and find answers to frequently asked questions. Participation is open to the public. You can read conversations and post on the Bogleheads Investment Forum at no cost.

if you are self-employed or work in a profession where layoffs are common, you may want to have as much as a year’s worth of living expenses stashed away. For most people, six months’ living expenses is probably adequate. Keep your emergency fund in an account that is safe and liquid. Bank savings accounts, credit union accounts, or money market mutual fund accounts are all satisfactory.

The Rule of 72 is very simple: To determine how many years it will take an investment to double in value, simply divide 72 by the annual rate of return. For example, an investment that returns 8 percent doubles every 9 years (72/ 8 = 9). Similarly, an investment that returns 9 percent doubles every 8 years and one that returns 12 percent doubles every 6 years. On the surface that may not seem like such a big deal, until you realize that every time the money doubles, it becomes 4, then 8, then 16, and then 32 times your original investment.

there are times when carrying a mortgage on your home is a better option even when you have the funds to pay it off. Let’s assume you are borrowing at an effective, fixed rate of 5 percent. At the same time, you believe that you can earn an average annual return of 8 percent in a balanced portfolio over the long term. Paying off the mortgage is a can’t-miss 5 percent return. However, investing the money at 8 percent earns an average of 3 percent more per year. With the money invested in liquid assets, you have access to it if needed, and the value of the house will likely appreciate whether it’s mortgage-free or not.

Even though EE and I Savings Bonds are purchased with after-tax money for your taxable account, they are tax-deferred for up to 30 years. This makes Savings Bonds an ideal candidate for your portfolio when you need to hold bonds in your taxable account, but don’t need current income from your bond holdings. Like other Treasury issues, Savings Bonds are free from state and local taxes.

For investors who live in a city with a local tax, owning municipal bonds issued by their local government can be triple tax-free, since they’d pay no federal, state, or local taxes on the income from those bonds. Because of these tax advantages, municipal bonds, which normally yield less than comparable taxable bonds, can make sense for investors in the higher tax brackets (usually 25 percent and above). However, you’d need to check the tax-free bond’s yield against other available taxable bond choices to see which would give you the greatest after-tax return. Since there are federal, state, and possibly even local tax issues at play in an investor’s decision, covering every possible scenario is beyond the scope of this book. Rather, you should consult with your tax advisor or use an online calculator to determine if municipal bonds make sense for you. Here are two free online calculators that can help you determine which type of bond or bond fund (muni or taxable) would give you the greatest after-tax return: Visit https:// investor.vanguard.com/ home and search for “taxable-equivalent yield calculator” (without the quotes). Visit www.TRowePrice.com and search for “Tax-Free Equivalent Yield Calculator” (without the quotes).

It’s important to understand that bonds and bond funds have a low correlation (they don’t always move in the same direction at the same time) to stocks, so bonds can be a stabilizing force for a portion of your portfolio. For example, in the bear market of 2008, while equity fund losses of 30 percent to 60 percent were common, Vanguard’s Total Bond Market Index Fund gained 5.05 percent.

Mr. Bogle suggests that owning your age in bonds is a good starting point. So, a 20-year-old would hold 20 percent of his/ her portfolio in bonds. By the time this investor reaches 50, the bond portion of the portfolio would have gradually increased, in 1 percent increments, to now represent 50 percent of his portfolio. Increase your percentage of bond holdings if you are a more conservative investor, and decrease your percentage of bond holdings if you want to be more aggressive with your portfolio.

Read the Prospectus. The mutual fund prospectus is the single best way to find out about the objectives, costs, past performance figures, and other important information about any mutual fund you’re considering investing in. Although reading a prospectus may cause your eyes to glaze over, it’s a very important step to help you determine if a particular fund satisfies your investment objectives (risk, return, etc.). Since you are planning on investing for the long-term (you are, aren’t you?), reading a prospectus and understanding what you’re investing in will be well worth the time and effort. We can’t emphasize it enough: Read the fund’s prospectus and understand what you’re investing in!

Because of their high costs and surrender fees, and the decreased tax benefits of annuities in relation to more tax-efficient investments available, annuities really don’t have much to offer most investors. It’s probably safe to say that most annuities are sold and not bought.

Exchange-traded funds (ETFs) are basically mutual funds that trade like stocks on an exchange. They are bought and sold continuously throughout the day when the stock market is open. The ETF’s stocklike features appeal to a wide range of investors, including long-term buy-and-hold investors, as well as short-term traders. Perhaps one of the biggest benefits of owning ETFs is the low cost. ETF expenses can be as low, or even lower, than many mutual funds that track the same index.

Vanguard offers their low-cost ETFs commission-free, eliminating the previously mentioned downside associated with having to pay commissions to buy and sell ETFs. When used properly, low-cost ETFs can certainly play an important role in a long-term investor’s buy-and-hold portfolio. On the other hand, investors are likely to shoot themselves in the foot if they plan to use ETFs as day trading or market timing vehicles.

it’s possible that some investors who buy I Bonds with very low guaranteed real return rates and then cash them in when they’re in a high tax bracket could possibly end up with less spending power than they started with. However, since I Bonds are tax-deferred for up to 30 years, many investors should be able to postpone cashing in their I Bonds until after they’re retired and are in a lower tax bracket.

TIPS-guaranteed rates are usually higher than I Bond fixed rates. Therefore, if you have room for them in your tax-deferred account, that’s where they should go, because you’d get tax-deferred inflation protection without risking principal. This assumes that you purchase them at auction and hold them to maturity. If you buy or sell TIPS in the secondary market, you may get back more or less than you paid.

Let’s assume someone puts $ 10,000 in a mutual fund, leaves it there 20 years, and gets an average annual return of 10 percent. If the fund had an expense ratio of 1.5 percent, the fund is worth $ 49,725 at the end of 20 years. However if the fund had an expense ratio of 0.5 percent, it would be worth $ 60,858 at the end of 20 years. Just a 1 percent difference in expenses makes an 18 percent difference in returns when compounded over 20 years.

Only consider investing in no-load funds with annual expense ratios of 0.5 percent or less, the cheaper the better.

It’s common for actively managed funds to have great before-tax returns and not-so-great after-tax returns, due to the trading that goes on in actively managing the funds. For that reason, we recommend keeping any actively managed funds in tax-deferred or tax-free accounts, such as 401( k) s, SEPs, Keoghs, or Roth IRAs.

Jack Bogle’s rough guide is that bonds should equal our age.

we suggest that your total allocation to sector funds not exceed 10 percent of the equity portion of your portfolio.

As your portfolio increases in size, it’s time to consider adding a different type of bond—Treasury Inflation-Protected Securities (TIPS). TIPS provide diversification and protection from unexpected inflation. Vanguard offers two TIPS funds—an intermediate-term fund (VIPSX) and a short-term fund (VTAPX). If you decide to include a Vanguard TIPS fund in your portfolio, you can choose between VIPSX ($ 3,000 minimum) with its higher expected risk and return, and VTAPX ($ 10,000 minimum) with its lower expected risk and return.

We assume the investor has emergency cash savings elsewhere equal to 3 to 12 months’ income.

High-income taxpayers should consider tax-exempt (municipal) bonds when tax-advantaged accounts are full.

A Young Investor Using Vanguard Funds Total Stock Market Index Fund 80% Total Bond Market Index Fund 20% A Middle-Aged Investor’s Asset Allocation Large-cap domestic stock fund 30% Small/ mid-cap funds 15% International funds 10% REITs 5% Intermediate-term bond fund 20% Inflation-Protected Securities 20% A Middle-Aged Investor Using Vanguard Funds Total Stock Market Index Fund 45% Total International 10% REIT 5% Total Bond Market Index Fund 20% Inflation-Protected Securities 20%

the only way to know which of these fees and expenses you will be paying is to read the fund’s prospectus. The SEC requires that fee and expense information be displayed in the first few pages of the prospectus.

in 2013, 95 percent of the dividends in Vanguard’s Total Stock Market Index Fund qualified for the lower rate. Total International Stock Index Fund dividends were only 68 percent qualified, but international stock funds are eligible for a Foreign Tax Credit as an offset. Both of these total market index funds are very tax efficient and therefore are excellent candidates for taxable accounts.

Bond dividends are not IRS qualified for the lower tax rate. Accordingly, dividends from taxable bond funds in taxable accounts are taxed at the investor’s marginal income tax rate—up to 39.6 percent. What do tax-savvy investors do? They place taxable bonds in their tax-sheltered accounts whenever possible.

Tax rates for short-term and long-term capital gains are not the same. It’s very important for tax-savvy investors to understand the difference. Short-term capital gains are taxed as ordinary income at the shareowner’s highest marginal income tax rate, while long-term capital gains enjoy a maximum tax rate of 15 percent—approximately half. One of the easiest and most effective ways to cut mutual fund taxes significantly is to hold mutual funds for more than 12 months. Buy-and-hold is a very effective strategy in taxable accounts.

We suggest that the best solution to this problem in taxable accounts is to use low-cost, low-turnover, tax-efficient index funds that do not depend on the skill (or luck) of stock-picking managers. They are tax efficient and low cost, reflect their benchmark index, and can be held indefinitely.

How to Find Hidden Fees and Expenses If your plan permits you to direct the investment assets in your account, the plan administrator should provide you with a copy of the prospectus, which will show all the fund administrative expenses, including sales charges. Your plan administrator should provide you with a description of any other transaction fees and expenses that will be charged. Account statements are usually provided at least once a year. If a yearly statement is not forthcoming, ask for it. Failure or delay in receiving account statements is a warning sign that your company plan may be in jeopardy. Your 401( k) Summary Plan Description (SPD) will tell you what the plan provides and how it operates. It may tell you if administrative expenses are paid by your plan (you) or by your employer.

The Tax Increase Prevention and Reconciliation Act, signed into law in 1996, removed the modified gross income limitation on rollovers from a traditional IRA (TIRA) to a Roth IRA. Because of this change in the law, high-income individuals who are not eligible to contribute to a Roth IRA can now directly do what’s become known as a back-door Roth. Here’s how it works. If the investor doesn’t have an existing TIRA because they weren’t eligible to contribute to one due to the income limitations, they would first contribute to a nondeductible IRA and then immediately convert that to a Roth IRA, effectively working around the income limits on a direct Roth IRA contribution. Now you understand why it’s called a “back-door Roth.” Roth IRAs The Roth IRA, like the traditional IRA, is also a personal saving plan, but operates somewhat in reverse. For instance, contributions to a Roth IRA are not tax deductible, while contributions to a traditional IRA may or may not be deductible. For both IRA types—traditional and Roth—securities that remain in the account are not taxed. However, when money is withdrawn, traditional IRA withdrawals will be fully taxed, nondeductible IRA withdrawals will be partially taxed, and Roth IRA withdrawals will not be taxed at all.

You or your advisor should decide which IRA is best for your particular situation. Fortunately, you can get help on the Internet in the form of IRA calculators. Two IRA calculators that we like can be found at www.morningstar.com (look under “Tools”) and at www.vanguard.com (use “Search”).

The rule is simple: Place your most tax-inefficient funds into your tax-deferred accounts, then put what’s left into your taxable account. The following list provides different type assets in the approximate order of their tax-efficiency, from the least tax-efficient (at the top) to the most tax-efficient. High-yield bonds International bonds Taxable domestic bonds Inflation-protected securities (TIPS) Real estate investment trusts (REIT) Balanced funds Stock-trading accounts Small-value stocks Small-cap stocks Large-value stocks International stocks Large-growth stocks Most stock index funds Tax-managed funds EE and I bonds Tax-exempt (muni) bonds

We suggest 14 tax-reducing ideas for tax-savvy investors. Most are easy to understand and to implement. We can think of no better way for most taxpayers to maximize their after-tax returns. Use tax-advantaged accounts (401( k), 403( b), IRAs, 529 tuition plans, etc.). Buy fund shares after the distribution date. Place tax-INefficent funds in retirement accounts, and tax-Efficient funds in taxable accounts. Use tax-managed or tax-efficient index funds in taxable accounts. Avoid balanced funds (stocks and bonds) in taxable accounts. Keep taxable fund turnover low to avoid capital-gains taxes. Avoid short-term gains by holding for more than 12 months. Sell losing shares before year-end (tax-loss harvest). Sell profitable shares after the new year (to delay tax payment). Determine the most favorable tax-basis method before selling fund shares. Consider municipal bonds and U.S. Savings Bonds for taxable accounts. During years of low income, consider converting to a Roth. Consider gifts to charities of securities with large capital gains. Appreciated holdings in taxable accounts are capital gains and income tax free if left to heirs.

Most of the credible studies of 30-year portfolio survival rates conclude that you can withdraw from 4 to 6 percent of the portfolio value per year with a good chance of not exhausting the portfolio, depending on your portfolio’s asset allocation. However, once spending rates rise over 6 percent, the odds of survival diminish rapidly.

Term insurance is purchased at a fixed rate for specified periods of time such as 5, 10, 15, or 20 years. The longer the period, the higher the rates will be. Buy the longest period that you can afford and need. Make sure the policy is guaranteed renewable, meaning that you will be able to purchase future coverage regardless of your health.

Here are some tips on buying disability coverage. First, buy as much disability coverage as you think you’ll need. The maximum amount you can purchase is usually 60 percent of your income. Second, consider purchasing your own policy with after-tax dollars instead of buying one through your employer. Then, if you ever need to draw disability, the income from the personal policy would be tax-free. With the way jobs come and go in today’s free-agent economy, you might not want to depend on your employer for disability coverage. If you lose the job and become disabled, you’re in big trouble. Here are some other features a good disability policy will have: It covers your inability to work in your own occupation. It requires a waiting period of no more than 90 days before coverage begins. It carries a cost-of-living adjustment. Benefits are provided for partial disability. It provides the longest benefit in your own occupation for as long as possible or at least until age 65. If you’re still thinking, “I don’t need disability,” please consider these statistics: There’s a 20 percent chance that a 35-year-old will become disabled before age 65 and a one in seven chance that he or she will be disabled for at least five years. The odds of becoming disabled are far greater than the odds of dying prematurely. When you consider just the income lost, a year of total disability can erase 10 years of saving for someone who saves 10 percent of his or her income. Don’t fail to insure your greatest financial asset.

An even better and quicker way to document your possessions is to go through the house with a video camera and take pictures of everything you own. Update the video once a year and store it somewhere other than your domicile. It will be extremely useful if you ever have to make a claim.

If you have a good health care plan you can skip coverage for medical payments too. You can reduce the cost of homeowner’s, renter’s, and auto insurance by taking the largest possible deductible you can afford. You’ll also probably be entitled to a discount if your home has a security system, smoke detectors, or fire sprinklers. Auto insurance discounts are often given when your car has a security system, antilock brakes, or certain types of air bags. Be sure and tell your agent if your car has them. Third, you need to protect yourself against potential lawsuits that could wipe you out. In our litigious society, it’s an absolute must. Purchase a personal liability umbrella policy of at least $ 1 million, or an amount to cover your total net worth. Umbrella policies are relatively cheap for the amount of protection and usually sold in $ 1 million increments.

If you find yourself with liquid assets of between $ 200,000 and $ 2 million when you reach your mid-to late fifties, give serious consideration to buying long-term care policies for you and your spouse. With continuing advancements in health and medical care, more of us will be living longer. Add 76 million baby boomers who have retired or will be retiring to the mix, and it’s a sure bet that many more people are going to require nursing home, assisted living, or home health care for extended periods of time. In the early years of retirement, long-term care protects against the loss of earnings from investments in much the same way that long-term disability protects against lost income from the inability to work.

If you go shopping for long-term care, here are some of the features a good policy will contain: The daily benefit should equal the current daily cost of a nursing home in the area where you live. The higher the benefit, the higher your premium will be. Inflation protection of 5 percent per year, compounded to keep your daily benefit current with rising costs of care, should be built in to the policy. The benefit payment period should be at least three to five years. A lifetime benefit payment period is best. An elimination period should be affordable. The elimination period is like a deductible. The longer you can pay out of pocket before the benefits kick in, the cheaper your premium will be. Medicare will pay for the first 25 days. One hundred days is a good elimination period for most people. Coverage cannot be canceled for any reason other than for failure to pay premiums. The policy should cover both skilled and nonskilled care. Benefits should also cover home health and assisted living care without requiring a prior hospital stay. There should be no exclusions for particular illnesses such as Alzheimer’s disease and dementia. Benefit triggers specify when coverage begins. The inability to dress or bathe are examples of benefit triggers. In the best and most expensive policies, proof of cognitive impairment such as Alzheimer’s is a benefit trigger even if the person is able to dress and bathe himself. Waiver of premium, which allows you to stop making payments when coverage begins. Your annual premium cannot be raised unless it’s raised for every policy holder living in your state. The policy is tax qualified. With a qualified policy the premium may be tax deductible and any benefits you receive will not be subject to federal taxes. It’s a good idea to purchase long-term care before age 60. If you wait until age 70, your premiums will be about 2.5 times higher than at age 60. Furthermore, the longer you wait the greater the risk you will contract a chronic illness and become uninsurable.

For more than a century, the A. M. Best Company has rated insurance companies from A + + on down. We recommend buying insurance from a company with an A. M. Best rating of A or better. To check the financial strength and overall quality rating of an insurance company, go to www.ambest.com. Other companies that provide insurance ratings are Fitch Ratings (www.fitchratings.com), Moody’s Investor Services (www.moodys.com), and Standard & Poor’s (www.standardandpoors.com).

You can also screen by professional credentials: Chartered Property Casualty Underwriter (CPCU) Chartered Life Underwriter (CLU) Certified Insurance Counselor (CIC) Such designations indicate that the person has dedicated many hours to study and has passed rigorous examinations in his or her respective field. That demonstrates a serious commitment to professionalism. You can search for a CPCU in your area online. Go to: www.cpcusociety.org and click on the “Interest Groups” tab and then the link to “Agent & Broker.”

You should have a will, even if you have a trust. If you have minor children, here’s where you’d name the person you want to designate as the children’s legal guardian in the event that both you and your spouse are deceased. Your will also instructs your executor how you want your assets distributed. It takes care of the distribution of any assets individually owned by you that are not included in a trust or distributed by title, such as payable on death (POD) or transfer on death (TOD), or by beneficiary designation.

There are a number of ways to avoid probate, including placing your assets in a trust; distribution by title (joint accounts, POD or TOD, for example); and having a beneficiary and contingent beneficiaries listed on your tax-deferred accounts, such as an IRA or annuity.

The assets in a living or revocable trust avoid probate in your state of residence and also in other states where you might own property, if the out-of-state property is placed in the trust. After your death, the trust is similar to a will in some ways, in that the successor trustee will distribute the assets according to your wishes. However, since the trust assets don’t go through probate, your affairs are kept private. With a trust, there is a much smoother transition after your death, and the disposition of assets can start immediately. However, trusts are more costly to create than wills, so you need to be sure a trust is warranted in your situation. If you do decide to create a living trust, you’ll need to retitle and transfer your assets into the trust. You can name yourself as the trustee while you’re alive, which means that you’ll still retain full control over the trust’s assets, just as you did when you owned them outside the trust. If you want, you can also name your spouse as a cotrustee, in which case you’d both retain control over the trust’s assets. You’d also want to name a successor trustee. The person you select (spouse, child, good friend) should be someone you trust and who you have complete confidence in to carry out your expressed wishes in an honest and efficient manner in the role of successor trustee. The successor trustee would also manage the trust assets if you should become mentally incompetent.

A living trust doesn’t eliminate the need for a will, since the will would handle the disposition of any of your individually owned assets that were not yet transferred into the trust’s name or otherwise disposed of by title or beneficiary designation at the time of your death.

An advance health care directive conveys your specific wishes to medical personnel regarding certain medical treatments and life-prolonging efforts when you’re unable to communicate your wishes to them. This document is also known as a living will or a medical directive.

Currently, an individual can give $ 14,000 per year to an unlimited number of people with no tax consequences.

One final document that you should prepare is a letter that contains your desires and instructions regarding your funeral arrangements or cremation and possible organ donations, that gives the location of any important papers, and perhaps contains final messages for those you’ve left behind. Once you’ve prepared this document, be sure to give it to the person you want to carry out these instructions.