Diversification - a new take

[Gone4Good]

Hi all. I've been a lurker here for some time and wanted to post a question I haven't seen addressed anywhere else. I'm a huge proponent of asset class diversification but I've recently noticed a growing concentration of risk in my portfolio. I have approximately 80% of my liquid net worth held at Vanguard. I'm beginning to think I need redirect future savings to another financial institution - although I prefer Vanguard for a number of reasons and like the convenience of "one stop shopping."

Has anyone else given this any thought and does anyone have suggestions for a "Vanguard replacement"?

 

[Red_y]

The bulk of my retirement funds are also at Vanguard. My 401(k) is held at Fidelity and I'm thinking of just leaving it there when I retire, for exactly the reasons you mention.

I have shied away from Fidelity over the years based on their fees and load structure, but apparently they have reformed and are looking  to compete in Vanguard's space for the Do-It-Yourself investor with very low-expense index funds, no-load funds, etc. The convenience of consolidating all my retirement assets at the one financial house (Vanguard) may not be worth the risk.

The other fund family I would recommend looking at is Third Avenue. They are shareholder-friendly and have a small stable of very highly regarded funds.

 

[Gone4Good]

Thanks - I'll look into Third Avenue. Fidelity was my default option but I had a bad experience with customer service at Fidelity while trying to roll-over DWs 401(k) into an IRA. I'm hesitant to place more money with them, but am tempted by their size and product offerings.

 

[wildcat]

Allocation among institutions has nothing to do with diversification. Allocation among asset classes is diversification. Most people can get access to pretty much every asset class via Vanguard. Low expense ratios are also one of the most important factors you should consider. You don't have to dump Vanguard to buy other funds. If you want to add Third Avenue Value Fund you can get it without a fee via Vanguard. I say stick with Vanguard and check your "true" allocation among asset classes.

 

[Gone4Good]

Thanks Wildcat - but the type of diversification you're talking about doesn't protect me from fraud at Vanguard. Perhaps a small risk but who knows? And it is my life's savings we're talking about!

I would never sell assets to do this (pretty hefty tax penalties) but I'm saving rapidly and should be able to double my portfolio's size in 4 yrs (assuming zero ROI). So I'm considering directing new investments somewhere else.

Another consideration is Vanguard's "Admiral Share" fee discount for fund holdings in excess of $100K. I may want to plan around this a little bit but I still think it might make sense to have at least half of my liquid assets held somewhere other than Vanguard.

 

[Red_y]

The original poster seemed to be well-versed in asset allocation. I am as well--I have a spreadsheet that monitors my holdings across all my taxable, IRA, Roth, 401(k), real estate etc. totally ignoring which institution the individual holdings reside at, just what asset class they belong to.

I think the point was "If I have every single penny of my retirement nest egg at Vanguard, what if they suffer some sort of scandal, internal collapse, accounting fraud, etc. that puts the integrity of the firm at risk?"

Not putting all your eggs in one institutional basket seems to make sense, esp. if it can be done in such a way to enhance picking "best of breed" in asset classes. You have more choices vs. sticking to one fund family or Fund Access list. E.g. picking the Fidelity Real Estate Income fund + Third Avenue Value Real Estate fund instead of the Vanguard REIT index, which is what I do.

 

[wildcat]

Well, whatever floats your boat I guess. If you are more comfortable with that strategy and don't mind paying extra in expenses for the same exposure + don't mind managing a portfolio of 10-20 funds from different fund fams. I don't consider Vanguard to be in the fraud watch category. Most firms get that big by being very good at what they do.

Not putting all your eggs in one institutional basket seems to make sense, esp. if it can be done in such a way to enhance picking "best of breed" in asset classes.

Hmmm...Any proof of that?

 

[Craig]

My comfort in institutions always being around disappeared with Arthur Andersen ... never expected that firm to disappear.

We too focus on Vanguard, but do have investments with some of their competitors. Doesn't cost that much to hedge.

 

[Spanky]

I have accounts with three firms: Vangaurd, Fidelity and E*Trade.

 

[TromboneAl]

Welcome YTG,

I thought about this a few years ago, but decided the very, very small risk from having everything at Vanguard was outweighed by the advantages and convenience. 

Here's what Vanguard has to say about this (full link here):

Diversifying by fund family: Limited benefits

Another misapplication of Sancho Panza's advice is investing with more than one fund company to protect against the risk that financial troubles in one fund will infect the fund family's other funds.

Such a scenario is impossible. Each mutual fund is its own corporation. A problem at one mutual fund wouldn't affect another, even if both were managed by the same company. If you own two funds from the same fund family, you have, in effect, put your eggs in two different corporate baskets. In addition, mutual funds are required by law to keep fund assets with a third-party custodian, large well-capitalized banks hired to safeguard shareholder assets. Daily checks are made between mutual funds and their custodians to make sure that assets are where they're supposed to be. The custodian banks, in turn, carry insurance coverage on their own to cover losses of securities and cash in their possession. And Vanguard, like most mutual fund companies, carries substantial insurance resources to protect against any illegal acts. (Thanks to Vanguard's vigorous fraud-protection efforts, though, we have never had to draw on this insurance.)

What about risks to your fund company's recordkeeping and administrative operations? Vanguard's approach has been to develop extensive contingency plans, backup systems, and multiple geographic locations. The Vanguard® funds' trustees are continually working with Vanguard's leadership to ensure that our operations are the industry's most secure.

 

[Alan]

Like TromboneAl, I decided Vanguard was a safe enough bet for for all the reasons he mentions. However, I understand other folks concerns and would recommend keeping careful track of all your funds to ensure prudent diversification whe using multiple institutions. DW and I still have 401(k)'s but I record all the funds and the shares they hold as outside investments and use Vanguard's Portfolio Analyser to keep on track.

 

[Gone4Good]

TromboneAl, thanks for that great link.  I had checked Vanguard's site, and elsewhere, before posting the question but for some reason was unable to find what I was looking for. 

Given that info, I'll probably stick with Vanguard (Admiral Shares  ) and avoid the complication of replicating a duplicate portfolio at another institution.  Phew.

 

[LEX]

This is a topic I have considered.

My US based assets are primarily with Vanguard (90%).  No organization is fraud proof, but Vanguard is about as close as you will get in the US.

I have dealt with institutional risk at the currency/government level, which, based on my years as an international mining professional, are more relavent to preserve assets from the erosion of fraud, inflation (a form of currency fraud, really) and the more frequent losses due to tax and political risk.  You can use Vanguard as a basket to hold US investments without any real basis for concern.  For foreign investments, such as foriegn funds, you could consider holding direct ETF's in country funds, which can also be held in vanguard, or Schwab, Scottrade, or any discounter.  If you want to go full bore to insulate yourself from US political risk, check out UBS, Barclays, or one of the similar international "brand" names for an out of US account and have a world wide access card set up for international ATM access.  This would not be something you should do without your own due dilligence, creates potential US tax review, as there are tax reports and related US side obligations that seem to presume you are forever a servant of the IRS, but it is a country  risk hedge.  Should the US as we know it fall you might want to have a plan "B" such as a home in Sri Lanka  or some similar "safe haven" should catastrophic events unfold in the US and money to fund even if the US freezes assets or the system totally fails (currently unlikely).

The other option is a survivalist camp in the west.  Having lived in mining camps in the middle of remote outposts most of my working life, I suggest Sri Lanka.        

 

[justin]

Not sure about the details. I saw on Vanguard's website that they have $500,000 of insurance through the SIPC (Securities Investor Protection Corporation) and their transaction company, Pershing LLC, has additional insurance through a private carrier. This insurance is like the insurance provided by FDIC for banks or NCUA for credit unions. The insurance protects your account against losses from unauthorized trades on your account or fraud at the institution (Vanguard).

 

[Red_y]

Alan, thanks for the reminder about Vanguard's ability to track outside investments and their Portfolio Analyzer. I recently discovered this feature and started using it--my problem is that it gives simplistic answers and only allows for 3 asset classes (stocks, bonds, and cash).

I have 7 asset classes and right now I am very deliberately targeting 10% for Emerging Markets and 22% for Foreign Stocks, with only 5% to US Large Cap. So the Portfolio Analyzer tells me how risky it is to have so much foreign equity exposure. Not much help.

Justin, good to know about the $500,000 insurance, but that amount will be exceeded by my retirement assets if I roll my Fidelity 401k into my existing Vanguard accounts.

If anyone is interested, here's a link to a comparison of Vanguard and Fidelity:

http://adviserinvestment.com/pdfs/Van v Fid Rep & Chart-BK.PDF

I subscribe to Morningstar and this was available through one of their advertisers today.

 

[justin]

Justin, good to know about the $500,000 insurance, but that amount will be exceeded by my retirement assets if I roll my Fidelity 401k into my existing Vanguard accounts.

Vanguard also had additional insurance. Call them up and ask, I'm sure they can tell you how much insurance they have. I remember seeing on my Edward Jones (I know, I know) statements that Edward Jones has $99,500,000 excess insurance per account over the SIPC limit of $500,000. Vanguard may have the same amount. Dunno.

 

[Gearhead Jim]

Vanguard is probably one of the safest institutions you can use; but the quoted writeup about how safe they are, should be taken with just a little salt. I'll bet that Arthur Anderson had something similar written in their material. No organization is completely safe, each person needs to evaluate the risk-reward situation.

Many of my retired co-workers have their entire retirement accounts with a single "one-stop shopping" company, I plan to split mine 3 ways.

As my wife once said, "It seems like we get a 'hundred-year storm' about every 5 years!"

 

[Danny]

Vanguard is a great outfit and I believe they serve investors interests very well. I have great respect for John Bogle and what he has done for the small investor. I imagine they are a rock solid and trustworthy outfit, although I'm not sure how they rate in the best broker surveys.

A few years back, I had concerns with insurance coverage and accessibility on my accounts.
All my assets were at TDWaterhouse and collectively my accounts exceeded the advertised coverage. The broker showed me a piece of paper that said they had an additional $99.5 million coverage, but the fine print stated that if the insurance co. had claims that exceeded their resources they wouldn't be able to totally cover their obligation.
The other issue was being able to access my accounts when I needed to. I thought that having 2 different brokers would give me a bit more "insurance" to get at funds and also to make trades if one broker was experiencing difficulties.
When I transferred some assets to Scottrade the alarms went off at TDWaterhouse and everybody started calling to find out why. They wanted to know what they could do make me happy. Well, I listed what I wanted and they made it happen. So, I guess I benefited by using 2 brokers.

 

[snowbird]

I too am a little concerned about having most of my eggs in one basket (401k with Fidelity).

Has anyone ever taken out just their company stock from a 401k (not a rollover)?

I understand that you would pay only the average cost basis of the shares, not the current market value. Then when you do sell the shares, the "net unrealized appreciation" or NUA, which is the difference in value between the average cost basis of shares and the current market value of the shares held in your 401k would be taxed at the long term capital gains tax rate not at ordinary income tax rates.

Has anyone done this?

Pete