Bruce and Mark work for a mid-sized technology company and they both have been contributing to 401k for years together . They learn at the year-end benefits meeting that a low fee Index fund will be added to their 401k plan from beginning of the next year. Bruce says “I am going to transfer all the money in my current fund to the new index fund in the beginning of the year and also direct my future contributions to the new index fund.”. Mark says “ I’m going to invest all my future contributions to the new index fund but not sure about timing the fund transfer.”.
We all had to make these decisions at some point of time since benefits meetings happen every year and whenever there are changes, we think what is best for our investment. After careful analysis if we decide that the new fund is better than the old fund, we need to decide when to transfer money from the old fund to the new fund. Here are the following factors one thinks about.
- Expense ratio – If the expense ratio of the new fund is lower than the old fund, why pay the old fund more fee which can be saved and reinvested into the new fund. Now is the time. If both of them have the same expense ratio, then you will have to consider the other factors.
- Dividend yield – If the dividend yield of the new fund is greater than the old fund assuming expense ratio of new fund less than or same as the old fund, move your investments to the new fund at once. If the dividend yield of the new fund is same as the old fund assuming expense ratio of new fund less than the old fund, move your investments to the new fund at once.
You may want to reconsider why you would want to move your money to new fund if the dividend yield together with expense ratio of the new fund costs you more than the old fund.
- Risk/Reward Ratio – If dividend yield and the expense ratio are the same, you need to consider diversification and returns. You need to look for the right balance. As diversification increases, returns go down. Here is an example below, VTI provides more diversification than VOO and it slightly costs you more. VHGEX has even higher diversification but its expense ratio is 16 times that of VOO & VTI. Its Return and Dividend yield is way lower. In the long term, it will compound to huge amount. I guess you get the point.
| 2019 | VOO (S&P 500) | VTI(Total Stock Market Index) | VHGEX(Global Market) |
| YTD Return | 29.79% | 29.12% | 24.24% |
| Dividend yield | 1.88% | 1.71% | 1.21% |
| Expense Ratio | 0.03% | 0.03% | 0.48% |
- Market Overbought or Oversold – This should not be a factor at all. If market is overbought or oversold both the funds are affected in similar way give or take a few percentage points. In the long term market timing doesn’t have significant impact.
Just Do it!
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