FINANCIAL EMERGENCIES have a way of compounding when least expected. This is often coined as a correlated risk. I call it running out of clean underwear.  My father used to profess, in emergencies, that turning pairs inside out was a legitimate way to extend undergarment use under duress. Financially, this is merely extending the life of a depreciating asset.  I am sure my mother would have refuted this concept. Nevertheless, before you judge me too harshly, allow me to share the situational details. Three weeks ago our 7 year old washing machine, an example of aging capital equipment, began exhibiting signs of being possessed. Wash cycles were accompanied with grinding noises and violent walks across the floor. Spin cycles initiated poltergeist-like behavior, with heavy banging and metallic thuds made by nether-world demons. An internet search revealed the probable cause of the machine’s paranormal behavior, which was likely broken suspension rods or damaged shock absorbers holding the inner tub in place. After watching 8 or 9 YouTube videos, I decided that I had the inner fortitude to de-demonize our beloved washing machine. And being thrifty, I wished to avoid the major capital expenditure of replacing the washer. I consider myself handy and even pride myself on the 65% success rate for fixing household appliances. Yes, I freely admit that past performance is no guarantee of success. However, since I was attempting to maintain my existing emergency fund, I ordered new drum springs; at 7 years old it seemed financially responsible to repair rather than replace the machine. Upon arrival of the rods, I subsequently installed them in a mere 3 hours (I like to think of myself as methodical, rather than speedy). With a screwdriver in hand, one bruised elbow, and my pride on the line, I separated the whites from the darks and ran a load. Success! Unfortunately, the clean clothes ran up against another obstacle. Our 10 year old dryer must have been jealous of the attention its utility counterpart received. What are the odds that both a washer and a dryer would malfunction in the same week? Call it correlated asset failure. In my house, in hindsight, the odds were pretty darn high. One appliance repair was manageable. Two was beginning to feel like collusion between utilities. To make matters worse, the washing machine was only functional for two loads. Just because you can purchase parts on the internet does not guarantee long term utility after installment, in essence rendering my original repair invalid. Sunken costs for a depreciating asset. In this case, I probably broke a plastic piece holding the inner tub while replacing the springs. Unfortunately, I was lulled into a false sense of security, and was outside the house when those diabolical mechanical fiends struck again. When I returned, the washer was in full demonic dance, this time mischievously thumping our 17 year old water heater. The water tank wanted no part of the dance, and promptly sprung a supply line leak.  Great. In hindsight, advocating for a larger emergency fund balance would have been prudent for someone like me with a known 35% failure rate. I ran to the big box store to purchase a new pipe and some sealing tape, but silly me, I forgot to take measurements of the tank and valves. I called my wife in the parking lot to assist. My mistake was to ask her to check if the tank’s intake valve was functional. It was not, evident by her high pitched scream and the clear sound of water gushing. Note to self: remember to shut off the main water supply before asking the wife to help with water tank issues.  Did I mention that our daughter’s future in-laws were coming to dinner the next day?  In the end, we purchased a new water heater and were only without water for two days. We also purchased a washing machine, but it took roughly three weeks for delivery, as we required a difficult footprint size to fill the space occupied by the previous device.  Our emergency fund survived, albeit at a lower level than anticipated. As a side note, I was able to fix the dryer, for the most part, so that a full replacement was not necessary.  The experience taught me a few lessons. First, household financial risks may appear independent, yet often this is not the case. It was easy to fathom we had our unexpected events covered with our existing emergency fund. Yet compounding systemic appliance failures pushed the unexpected expenses towards our theoretical limits. Second, my father was only partially correct. Underwear is not a renewable asset. I should also think about establishing a separate Fruit of the Loom reserve account to accompany our current emergency fund. A decision my mother would have approved. Jeffrey K. Actor, PhD, was a professor at a major medical school in Houston for more than 25 years, serving as an academic researcher with interests in how immune responses function to fight pathogenic diseases. Jeff’s retirement goals are to write short science fiction stories, volunteer in the community and spend time in his garden. Check out his earlier articles.

IN 1774, AMSTERDAM businessman Abraham van Ketwich created a new type of investment. After raising money from a group of individuals, van Ketwich built a portfolio of bonds. He deposited the bonds in a metal box in his office, which three people then secured using three different locks. Van Ketwich’s fund could be considered the world’s first index fund. How so? For starters, the bonds purchased were broadly diversified across industries and geography. Second, van Ketwich’s plan aimed to minimize trading, with the box remaining locked for 25 years. Third, his management fee was just 0.2%, modest even by today’s standards. A war in Europe disrupted the plan a bit. But in the end, the fund was successful, and others soon followed using this same model. The first modern index funds started in the U.S. in the 1970s, and initially were very simple. But in the years since, there’s been a proliferation of funds. Now, there are more than 2,000 different index funds covering every corner of domestic and international markets. This poses a challenge for today’s investor because there’s no single, universally accepted “right” way to build a passive investment portfolio. Consider a portfolio that’s invested entirely in an S&P 500 index fund. By most definitions, this would be considered a passive portfolio. But even this simple portfolio is active in at least two respects: The S&P 500 focuses almost exclusively on the largest U.S. companies, and it includes almost no companies from outside the U.S. The reality is that every investment portfolio, even if it consists solely of index funds, has an active component to it. And while it may sound like I’m splitting hairs, the reality is that those who consider themselves passive investors still need to make some active decisions. If you’re building an index fund portfolio, there are three approaches you might consider. The first option would be to cast as wide a net as possible. An index like the FTSE Global All Cap Index—as its name suggests—tries to cover the globe. The U.S. and Canada account for about two-thirds of this index, with the remainder allocated to developed and emerging markets outside North America. A popular fund that follows this index is Vanguard Group’s Total World Stock ETF (symbol: VT). True indexing purists like this fund because it aims to provide global coverage, though in reality it doesn’t cover the entire globe. It excludes dozens of markets, from Argentina to Romania to Slovenia, which are in a category known as frontier markets. But aside from that, it’s as broad an index as there is. This fund certainly offers simplicity, but are there downsides? From a domestic investor’s point of view, exchange rates pose a risk, since a third or so of the investments aren’t denominated in dollars. For that reason, I prefer to minimize international exposure. But others see it differently. They see exchange rates as an additional source of diversification. Another potential downside: To the extent that the U.S. economy has a track record of producing more new, fast-growing companies than other countries, a portfolio like this might end up lagging behind one that’s more U.S.-focused. If you wanted more of a domestic weighting, there’s an easy solution. That brings me to the second approach: You could split your portfolio along geographic lines, owning one fund that covers the U.S. market and another covering international markets. You could then vary the mix between the two. If you wanted to go this route, two funds to consider would be Vanguard’s total domestic stock market fund (VTI) and its total international fund (VXUS). What percentages make sense? I’ve long relied on research which finds that investors can pick up most of the diversification benefit of international stocks with an allocation as small as 20%. Thus, my preferred allocation to international stocks is just 20%. It’s a matter of perspective, though, and there isn’t one right answer. The third major approach to portfolio construction might appeal to those looking for greater customization. On the domestic side, a popular strategy includes greater exposure to value stocks. According to the data, these stocks have outperformed historically. But since that trend may not repeat in the future, value stocks may or may not appeal to you. Personally, I include an overweight to value. On the international side, there’s a number of ways to customize your holdings. Investors will often choose separate developed and emerging markets funds so they can vary the mix between them. In the portfolios I build, emerging markets are always the smallest segment. But ironically, I’ve found it to be the area where there’s the most disagreement. Some investors prefer not to hold any emerging markets stocks, owing to the shaky political structures in many of those countries. Meanwhile, others prefer to have more emerging markets exposure. The logic they cite is that these countries offer more growth potential as they industrialize. I take a different route, avoiding standard emerging markets indexes altogether. Why? The most recent Nobel prize in economics was awarded to a group of researchers who identified a link between countries’ political structures and their level of economic development. In short, countries with autocratic governments have generally not delivered the same level of economic growth as countries with more democratic regimes. Because China, which lacks representative government, is the largest weight in standard emerging markets funds, I’ve opted for a fund (FRDM) which excludes China and other dictatorial regimes, and instead includes only emerging markets where the political institutions are more developed. Those are three approaches you might choose in constructing an index fund portfolio. But there isn’t, as I said, just one right way. What’s most important, in my view, is to be sure the portfolio you build adheres to two key principles: low cost and low turnover. Low fees are important because, as Vanguard founder Jack Bogle used to say, “You get what you don’t pay for.” In other words, when a fund has low expenses, those savings are passed on to the investor. That’s a key reason—and maybe the key reason—index funds have, on average, outperformed actively managed funds. What about low turnover? I’m referring here to how much trading occurs within a fund. This is important—because more frequent trading generally results in higher tax bills for a fund’s investors. Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam's Daily Ideas email, follow him on X @AdamMGrossman and check out his earlier articles. [xyz-ihs snippet="Donate"]