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iShares Core Allocation ETFs vs. Vanguard’s LifeStrategy Funds

A reader writes in, asking:

“I noticed that iShares seems to have a platform of 4 ‘core allocation’ funds, e.g. AOM, AOK, AOR, AOA. I’m curious if you feel these are comparable to Vanguard’s LifeStrategy funds?”

For anybody who hasn’t encountered the iShares Core Allocation ETFs before, they’re funds that (like the LifeStrategy funds from Vanguard) offer a static, diversified allocation. In other words, they seek to offer a diversified portfolio in a single fund.

As far as differences, first and most obviously, they’re ETFs rather than traditional mutual funds. The differences between ETFs and traditional mutual funds are very small though for most individual investors. (Personally, I have a very slight preference for regular mutual funds, because I like to be able to place orders for round dollar amounts without having a few dollars of cash sitting around left over.)

As far as costs, the iShares Core Allocation ETFs have expense ratios of 0.25%. That’s somewhat higher than the 0.12-0.15% expense ratios for Vanguard’s LifeStrategy funds (which are themselves somewhat more expensive than what you’d pay with a DIY portfolio of individual index funds), but it’s still well below average for mutual fund expenses in general.

As far as asset allocation, the overall stocks/bond allocations are as follows:

  • iShares Core Aggressive Allocation ETF (AOA): 80% stocks, 20% bonds;
  • iShares Core Growth Allocation ETF (AOR): 60% stocks, 40% bonds;
  • iShares Core Moderate Allocation ETF (AOM): 40% stocks, 60% bonds; and
  • iShares Core Conservative Allocation ETF (AOK): 30% stocks, 70% bonds.

If you’re familiar with the LifeStrategy allocations, you’ll notice that this is very similar, with the one difference being that they only go as low as 30% stocks, whereas the LifeStrategy Income Fund has a 20% stock allocation.

Key point: As with target-date funds, it’s best to ignore the names and focus instead on the allocation. For instance, the iShares Core Growth Allocation ETF (AOR) is closer in asset allocation to Vanguard’s LifeStrategy Moderate Growth fund rather than Vanguard’s LifeStrategy Growth fund.

With regard to the actual underlying holdings, it’s pretty run-of-the-mill stuff. Nothing esoteric in any way. For instance, here’s the underlying allocation of the iShares Core Aggressive Allocation ETF (AOA), according to Morningstar as of 3/15/2017:

  • iShares Core S&P 500 39.76%
  • iShares Core S&P Mid-Cap 3.27%
  • iShares Core S&P Small-Cap 1.43%
  • iShares Core MSCI Europe 17.35%
  • iShares Core MSCI Pacific 12.23%
  • iShares Core MSCI Emerging Markets 7.64%
  • iShares Core Total USD Bond Market 9.23%
  • iShares US Treasury Bond 3.55%
  • iShares US Credit Bond 2.63%
  • iShares Core International Aggregate Bond 2.75%

You may notice from the above that the iShares funds have relatively higher international stock allocations and relatively lower international bond allocations than the LifeStrategy funds. Specifically:

  • The iShares funds have about 45% of their stock allocation in international stocks and about 15% of their bond allocation in international bonds, whereas
  • The LifeStrategy funds have about 40% of their stock allocation in international stocks and about 30% of their bond allocation in international bonds.

Frankly, I like the iShares funds ever so slightly better in that regard.

As I’ve written several times in the past, while I don’t think performance charts are especially useful for deciding which of two funds is better than the other, I do think such charts are helpful for showing how similar (or dissimilar) two funds are. The chart below shows the Vanguard LifeStrategy Moderate Growth Fund (in blue) as compared to the iShares Core Growth Allocation ETF (in orange) since December 2011 (i.e., the point at which Vanguard switched the LifeStrategy funds so that they no longer include actively managed mutual funds).

iShares Vanguard

As you can see, they’re very similar — almost indistinguishable.

In short, the iShares Core Allocation ETFs are perfectly fine, boring funds. They’re slightly more expensive than the LifeStrategy funds, with slightly different allocations. And they’re ETFs rather than traditional mutual funds (which probably doesn’t matter to most people). So if you’re looking for a one-fund solution that provides a static allocation (as opposed to target-date funds which shift toward bonds over time), they’re a perfectly reasonable choice.

Investing Blog Roundup: Individual Investors — Not So Dumb After All?

For many years, people in the financial industry have referred to DALBAR’s “Quantitative Analysis of Investor Behavior” studies to show that investors dramatically underperform their own investments due to poor decisions about when they buy and sell mutual funds. (You can read the 2016 edition of the report here, for instance.) The DALBAR reports consistently show large underperformance figures — often in the range of several percentage points per year.

This week, Wade Pfau published an article asserting that DALBAR is simply making a math error in their calculations — an error that makes the average investor’s performance look much worse than it actually is.

Pfau’s article is rather technical, because it’s dealing with a math dispute. But it’s interesting reading. In brief, his argument is that DALBAR doesn’t account for the fact that investors invest over time. For example, for an investor who invests a total of $10,000 over the 20-year period ending 12/31/2016 (i.e., $41.67 per month for 240 months), Pfau writes that, “the DALBAR methodology ignores the dollar-cost averaging component of these systematic investments and instead assumes that the entire $10,000 was invested at the beginning of 1997.”

John Rekenthaler of Morningstar also wrote on the topic this week, sharing Morningstar’s methodology for how they calculate investor returns (and how those differ from investment returns).

Investing Articles

Thanks for reading!

What Types of Pensions Trigger Social Security’s Windfall Elimination Provision (WEP)?

A reader writes in, asking:

“I work in a job where I do not pay social security taxes. I heard second hand through a coworker that our HR department says we’ll be affected by social security’s “windfall elimination provision.” I thought that only applied when you get an actual pension. My employer provides a 401-K plan but not a traditional pension. Is this something I need to be thinking about?”

As a bit of background for those unfamiliar with the topic: the Windfall Elimination Provision (WEP) applies when you receive a pension from employment that was not covered by Social Security (i.e., work for which you didn’t have to pay Social Security tax). The effect of the WEP is to reduce the size of your primary insurance amount, thereby reducing your retirement benefit, as well as the your spouse’s or children’s benefit on your work record.*

So for example if you work 20 years in one profession (in which you do pay Social Security taxes) and 20 years in another profession in which you don’t pay Social Security taxes (and from which you receive a pension), the WEP will reduce the Social Security benefit you’ll ultimately receive from the work you did that was covered by Social Security.

You can find the general rules regarding the Windfall Elimination Provsion here and exceptions to those rules here. But what we’re concerned with at the moment is what is considered to be a pension for WEP purposes.

What Counts as a Pension?

With regard to what, exactly, counts as a pension for WEP purposes, the rules and exceptions can be found here.

The general rule is that:

  • If the amount you ultimately receive from the plan is based only on employee payments (plus interest/dividends) then the plan only counts as a pension subject to WEP if it is the employer’s primary retirement plan.
  • If the amount you ultimately receive from the plan is based on employer payments (or a combination of employee and employer payments), then it will generally be considered a pension subject to WEP.

There are special rules for one-time payments from the plan:

  • Withdrawals of the employee’s own contributions and interest made before the employee is eligible to receive a pension are not pensions for WEP purposes if the employee forfeits all rights to the pension.
  • Withdrawals of the employee’s own contributions and interest made after the employee is eligible to receive a pension are considered a lump-sum pension for WEP purposes.
  • Any separation payment or withdrawal consisting of both employer and employee contributions is a pension for WEP purposes, whether made before or after the employee is eligible to receive a pension.

But again, all of the above is only relevant if the possibly-a-pension-retirement-plan is from employment you did for which you did not pay Social Security tax. If you paid Social Security tax for the work in question, the WEP does not apply.

*The WEP only applies while you’re still alive. When you die, your primary insurance amount is recalculated without the effect of the WEP, so if anybody else is receiving benefits on your work record at that time (e.g., your widow/widower and/or children), their benefit will increase.

Want to Learn More about Social Security? Pick Up a Copy of My Book:

Social Security Made Simple: Social Security Retirement Benefits and Related Planning Topics Explained in 100 Pages or Less
Topics Covered in the Book:
  • How retirement benefits, spousal benefits, and widow(er) benefits are calculated,
  • How to decide the best age to claim your benefit,
  • How Social Security benefits are taxed and how that affects tax planning,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"An excellent review of various facts and decision-making components associated with the Social Security benefits. The book provides a lot of very useful information within small space."

Investing Blog Roundup: Looking for an Edge

One thing I’ve observed over the 9 years I’ve spent writing this blog is that it’s super rare for financial advisors to really embrace simple, passive investing. Overwhelmingly they prefer to try to find some sort of “edge” over a boring total market portfolio. This week Jim Dahle takes a look at why advisors are (in most cases) so reluctant to accept market returns.

Investing Articles

Other Money-Related Articles

Thanks for reading!

Social Security Made Simple, 2017 Edition, 50% Off

Social Security Made Simple Front Cover

Just a brief announcement for today. We’ll return to our regular publishing schedule on Friday.

The 2017 edition of Social Security Made Simple is now available. (The prior edition was released in late 2015, immediately after the changes made to the Social Security rules by the Bipartisan Budget Act of 2015.)

The paperback version of the book will be on sale for half-off through tomorrow (Tuesday, March 7). That is, the paperback version will be on sale for $7.50, rather than the usual $15.

For reference, the changes to the book are modest — everything has been updated to use the 2017 figures, and I’ve added a new brief appendix discussing claiming strategies for widows/widowers.

For those who haven’t read the book, the chapter listing is as follows:

  1. Qualifying for Retirement Benefits
  2. How Retirement Benefits Are Calculated
  3. Spousal Benefits
  4. Widow(er) Benefits
  5. Social Security for Divorced Spouses
  6. Child Benefits
  7. Social Security with a Pension
  8. The Earnings Test
  9. The Claiming Decision for Single People
  10. When to Claim for Married Couples
  11. The Restricted Application Strategy
  12. Age Differences Between Spouses
  13. Taking Social Security Early to Invest It
  14. Checking Your Earnings Record
  15. How Is Social Security Taxed?
  16. Social Security and Asset Allocation
  17. Do-Over Options

Conclusion: Six Social Security Rules of Thumb
Appendix A: The File and Suspend Strategy
Appendix B: Widow(er) Benefit Math Details
Appendix C: Restricted Applications with Widow(er) Benefits

You can find the new edition here: https://www.amazon.com/dp/0997946512/

Want to Learn More about Social Security? Pick Up a Copy of My Book:

Social Security Made Simple: Social Security Retirement Benefits and Related Planning Topics Explained in 100 Pages or Less
Topics Covered in the Book:
  • How retirement benefits, spousal benefits, and widow(er) benefits are calculated,
  • How to decide the best age to claim your benefit,
  • How Social Security benefits are taxed and how that affects tax planning,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"An excellent review of various facts and decision-making components associated with the Social Security benefits. The book provides a lot of very useful information within small space."

Investing Blog Roundup: Obamacare Repeal and Early Retirement

Since the transfer of power in Washington earlier this year, the potential (likely?) repeal of the Affordable Care Act (Obamacare) has many people worried about how they will get health insurance. Economist Austin Frakt discusses one such group this week: people who have retired (or who are planning to retire) prior to Medicare eligibility.

Unfortunately, there’s no magical financial planning solution here. If Obamacare is a) repealed and b) not immediately replaced with something that guarantees you coverage, then yes, retiring prior to Medicare eligibility would be a big financial risk unless you have coverage through some other source (e.g., your spouse or former employer).

Retirement Planning Articles

Other Money-Related Articles

Thanks for reading!

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