For a large portion of May, we were fortunate to be able to vacation in a nice warm location. Ok, you may have guessed it, it was Florida again. It seems to be the go-to spot for families from the east coast of Canada who get very little Spring weather. Or at least that’s our excuse for our once a year indulgence.

During our vacation, we met some really great people that we consider good friends – for the sake of this article and anonymity, we’ll call them Mr. and Mrs. Orlando (original right?). They have a couple of young kids the same age as ours, and we share similar values.

During our conversations, finances came up a number of times. While I try to take a break during vacation time, financial conversations seem to follow me along. Perhaps it’s because I’m usually seen checking my portfolios on my phone, or maybe being a financial blogger just emanates from my skin. Whatever the case, Mr. and Mrs. Orlando are looking to improve their finances and start a retirement fund.

Financial Background

A little background about their finances – they are in great shape in terms of keeping life simple and keeping lifestyle inflation at bay. Mr. and Mrs. Orlando are small business entrepreneurs and do fairly well. From my conversations with them, I would consider them relatively frugal with positive cash flow after expenses and have cash in a savings account. Their principal residence is modest but they splurged a little on a vacation condo. Either way, they have relatively small mortgages on both properties and very little other debt. The catch, they don’t have any pensions or retirement accounts.

When we started to talk finances, they mentioned their confusion with investing and were really motivated to get started. They are both in their 30’s, which is great as they have a 30+ year investment horizon – the longer the better.

The Simplest Investing Strategy of All

So I started my sermon on the benefits and simplicity of index investing. I talked about the paramount importance of keeping investing fees low, and that passive investing will statistically beat active mutual funds over the long term. Once I finished, they wanted more help on the next step.

Since they haven’t started a tax-sheltered retirement account, they knew little about the available options. Being from Canada, I was also in the dark about U.S retirement accounts. With the help of Google and U.S-based financial blogs, I was able to decipher the code on the various accounts available.

U.S Tax Sheltered Accounts

If they were Canadian, I would introduce them to RRSPs and TFSA’s right away. They would have accumulated a bunch of contribution room and could get that lump sum savings into the market and compounding right away.

However, the system is slightly different in the states. In the U.S, they have traditional 401k’s, ROTH 401k’s, traditional individual retirement accounts (IRA), ROTH IRAs, SEP-IRAs. I will admit that I’m not an expert in these accounts, but I do have an understanding at a high level.

  • Traditional 401k – This is an employer-sponsored plan that is similar to RRSP matching plans offered by employers in Canada.  They are similar to an RRSP where your contributions are tax deductible, investments grow tax-free, but withdrawals are taxed as income.
  • ROTH 401k -This is also an employer-sponsored plan that is similar to TFSA matching plans offered by some employers in Canada.  This type of account is very similar to our TFSA where contributions are made with after-tax dollars, investments grow tax-free, and withdrawals are also tax-free.
  • Traditional IRA – This is similar to an RRSP where your contributions are tax deductible, investments grow tax-free, but withdrawals are taxed as income. The difference here is that the maximum annual contribution limit is $5,500 and eligibility for this account depends on family income (or single income). Essentially for Mr. and Mrs. Orlando, they would need to make a combined income of less than $186k to qualify for an IRA.
  • ROTH IRA – This type of account is very similar to our TFSA where contributions are made with after-tax dollars, investments grow tax-free, and withdrawals are also tax-free. Like the traditional IRA, there is a maximum contribution limit of $5,500 with the same eligibility rules.
  • SEP IRA – This is an IRA for small business entrepreneurs and allows for large lump sums to be deposited into a tax sheltered account.  The guidelines can be found here.

The Portfolio

As I endorsed indexing to our friends, I went on the hunt for the best low-cost indexing products available in the U.S. As it turns out, there are a lot of choices available but I kept getting pulled into the Vanguard direction. Although they may not be the absolute cheapest option, they are a large reputable company that has created some very good index products over the years.

For a Canadian, you could get global equity coverage by simply buying two Vanguard ETFs: VCN and VXC  (an alternative is through iShares ETFs XIC and XAW). Both sold in Canadian dollars.

For an American in the US, they can get global coverage at ridiculously low fees through two Vanguard ETFs: VTI and VXUS (in USD). Canadians can also buy these ETFs (I own them), but you need to convert your CAD to USD first.

My first thought was to create a portfolio for our U.S friends using VTI and VXUS, but that still required rebalancing and making equity trades through a discount broker. Although that may be simple to some, I wanted an even simpler solution.

That’s when I came across Vanguard’s Target Retirement Funds that are simply genius and only charge a MER of 0.16% annually. The target funds are an all-in-one balanced fund that uses Vanguard’s low-cost index products.   The funds essentially hold three indexed positions: U.S Equity, International Equity, Bonds.

However, the Target Funds are different than a typical balanced fund in one important aspect.  Instead of keeping the ratio of equities/bonds constant like most balanced funds, the Vanguard target fund increases the bond allocation automatically as you get closer to retirement. So if you are a 30-year-old, you could pick the 2045 target retirement fund which would hold about 10% bonds, increasing as it gets closer to 2045. So essentially, it’s as easy as setting up automatic monthly contributions and forget about it.  All of this for a cost of 0.16%, you can’t beat it.

The Discount Brokerage

After reviewing the different types of accounts and investment options, I had to find a reasonable low-cost discount brokerage (or robo-advisor) in the U.S. Similar to Canada, there are a lot of good options, but my criteria was that it had to have low fees, and preferably the ability to buy Vanguard products for no trading commission.  Ideally, I would find a U.S discount brokerage similar to a Canadian brokerage that offers commission-free ETF trading.

Through my search, I determined that Vanguard itself offered a trading account without any fees if buying Vanguard products. So essentially, Mr. and Mrs. Orlando can have a diversified portfolio with proper asset allocation for 0.16% per year, everything included. Not bad if you ask me.

Final Thoughts

Although there are many options for index investing for Americans, our particular friends require something that is automated and super easy to follow.  The easiest low-cost solution that I could find was the Vanguard Target Retirement Fund.  These low-cost index all-in-one funds allow you to choose a retirement age, make a contribution and the fund will do all the re-balancing for you.  Not only will the fund re-balance on an annual basis, it will increase your bond allocation automatically as you get closer to retirement.  Almost like a robo-advisor, but cheaper!

If you have other suggestions on super easy indexing in the U.S, let me know in the comments.

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  1. Leo T. Ly @ on May 23, 2017 at 6:29 pm

    Investing in index ETF is a great idea for novice investors. In addition, I would also add that the tax efficiency of their contributions and the maximization of the dollar value when the contribute to their investment accounts should be considered.

    When making contribution to my retirement accounts, I want to get the maximum tax refund and use the refund to further compound my saving.

  2. Joel on May 29, 2017 at 4:24 am

    Hi, could you please advise if Vanguard offers these same retirement date funds in Canada? I have checked their site and can only find info on “institutional” not “retail” clients such as myself.

  3. Northeast on June 1, 2017 at 6:27 pm

    There is also the 403(b). I understand it is treated the same as a Traditional 401k but is for people in public education. I never understood why the difference names exist.

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