SavingForCollege.com Top 529 Plan Rankings 2015

sfc5capSavingforcollege.com is a popular privately-run site for researching and comparing 529 college savings plans. They released their updated ratings this month, which represents their “opinion of the overall usefulness of a state’s 529 plan based on many considerations.” The judgement criteria include:

  • Performance. They selected similar “apples-to-apples” portfolios with 7 different asset allocations from each plan and rated them based on historical performance. Rankings are updated each quarter.
  • Costs. Total average asset-based expense ratios among plans are compared, in addition to separately considering program manager fees, administrator fees, and annual account maintenance fees.
  • Features. This includes other factors that affect participants, including the ability of the plan change their investment options quickly if called for; creditor protection under the sponsoring state’s laws; availability of FDIC-insured options; minimum and maximum contribution restrictions.
  • Reliability. The appears to measure the likelihood of a good plan staying a good plan. Do they have experienced program managers? Does the plan have a good amount of assets? What is the quality of the documentation and reporting? How restrictive are the withdrawal and rollover processes?

Here is the full list of 5-Cap Ratings for each state, on a scale of 0 to 5 Caps. Note that there are separate ratings for in-state and out-of-state residents. The following plans received a 5-Cap Rating for in-state residents (alphabetical order):

  • California: The ScholarShare College Savings Plan
  • Colorado: Direct Portfolio College Savings Plan
  • Colorado: Scholars Choice College Savings Program – Advisor Plan
  • Illinois: Bright Start College Savings Program – Direct Plan
  • Iowa: College Savings Iowa
  • Maine: NextGen College Investing Plan – Direct Plan
  • Maine: NextGen College Investing Plan – Advisor Plan
  • Michigan: Michigan Education Savings Program
  • Nebraska: Nebraska Education Savings Trust – Advisor Plan
  • Nebraska: Nebraska Education Savings Trust – Direct Plan
  • New York: New York’s College Savings Program – Direct Plan
  • Ohio: Ohio CollegeAdvantage 529 Savings Plan
  • Rhode Island: CollegeBoundfund – Direct Plan
  • South Carolina: Future Scholar 529 College Savings Plan – Advisor Plan
  • South Carolina: Future Scholar 529 College Savings Plan – Direct Plan
  • Utah: Utah Educational Savings Plan (USEP)
  • West Virginia: SMART529 WV Direct College Savings Plan
  • Wisconsin: Edvest

Out of the 100+ different plans they rated, here are the 4 programs that attained the top 5-Cap Rating for out-of-state residents (alphabetical order):

  • California: The ScholarShare College Savings Plan
  • Maine NextGen College Investing Plan – Direct Plan
  • New York’s College Savings Program – Direct Plan
  • Ohio CollegeAdvantage 529 Savings Plan

Consistently top-rated plans. The last time I noted these rankings was 2012, and the following plans were 5-Cap rated back then and also now: California, New York, and Ohio.

I should point out that the SavingForCollege Top-rated 5-Cap plans are different than the Morningstar Top-rated Gold plans. In fact, there is no overlap at all! Two of my favorite Gold-rated plans, the Vanguard 529 Savings Plan (Nevada) and Utah Educational Savings Plan received 4.5 out of 5 Caps, although I am not exactly sure why.

However, in general the top 15 or so plans are pretty much the same for both. With that in mind, I see nothing wrong with most Morningstar Silver Plans and/or the 4.5 Cap SavingForCollege plans, if their investment options meet your needs. Here were my personal finalist 529 plans and asset allocations.

Finally, here is another resource about comparing the state-specific tax benefits that may be available to you.

Someone Is Doing The Thing That You Decided Couldn’t Be Done

bbootWe are currently planning a 4-week European trip with our young children (age 1 and 3). The most common reactions are “Cool. Wait, you’re not bringing the kids, are you?” followed by “You’re nuts.” At first, we didn’t think it could be done either. It does take a lot of additional planning for car seats, cribs, kid-friendly itineraries, and so on.

While doing some research at a site called My Little Nomads, the author shared a quote by Seth Godin:

One of the under-reported stories of the internet is this: it constantly reports on what’s possible. Somewhere in the world, someone is doing something that you decided couldn’t be done. By calling your bluff and by pointing out the possibilities, this reporting of possibility changes everything.

You can view this as a horrible burden, one that raises the bar and eliminates any sinecure of comfort and hiding you can find, or you can embrace it as a chance to stretch.

That is a great quote that encapsulates why I love the internet. If you want to start your own niche business, pull off home-cooked weeknight meals, take your house entirely off-grid, semi-retire at age 40, or just take your tiny kids on an adventure – someone out there has probably already done it. You may even find an entire online community ready to help you reach your goal. There will be doubters, but all you need to know is that it’s possible.

Vanguard Managed Account Program (VMAP) Review – Cost vs. Benefits

savebuttonbankVanguard is the one of the biggest providers of defined contribution (DC) plans like 401(k) and 403(b) plans, with more than 3.9 million participants. An optional service they provide for these DC plans is managed account advice, where you pay them an asset-based fee and you cede all portfolio control to them. Vanguard Managed Account Program (VMAP) serves as a fiduciary that sets asset allocations, chooses investments, and monitors/rebalances portfolios on a continuing basis. Fees typically begin at 0.40% on the first $100,000 in assets under management.

Vanguard published a research paper on the before-and-after results from actual participants called The value of managed account advice [pdf].

Even if you aren’t considering paying for such a service, I figured there would be some worthwhile takeaways from their results. Here are my condensed notes from reading their paper.

Reallocation of company stock. About 12% of participants initially had a concentrated position of 20% or more in employer stock. Holding too much stock in your employer is generally understood to be too risky, so VMAP fixes that. The average allocation to company stock fell from 46% to 4% as a result of managed account advice. This group was probably impacted the most by professional advice.

Personalized advice. Not only do you simply indicate an expected retirement age and desired level of risk, but you can add outside assets to the overall asset allocation evaluation. 35% of all VMAP participants personalized the service in some manner.

Forcing you to make savings rate decision. When you sit down and start this service, you have to talk about your goals and see some projected numbers. Then you must make a decision as to your savings rate. Overall, people saved more once faced with this situation. Specifically, 1/3rd of participants increased their savings rates, 7% decreased them, and the remaining majority maintained contribution rates at the same level. See chart below:

vmap_savings

More appropriate asset allocation. In terms of asset allocation, VMAP made things more appropriate and efficient in relation to the need and ability to take risk. Some people got more equity exposure, some people got less. On average, people were told to hold less employer stock, less cash, and more international stocks. See chart below:

vmap_aa

Net effect on retirement wealth. Let see. On average, VMAP participants saved more money. On average, expected returns on VMAP-advised portfolio rose. On average, expense ratios on VMAP-advised portfolio were reduced by 0.06%. But everyone also paid advisory fees. What happens when you take all the factors together? In their own words:

To summarize the interplay of these effects, we used the change in participants’ projected ten-year real retirement wealth as a benchmark for evaluating advice. This allowed us to observe the true effect of managed accounts, independent of the participant’s starting account balance or asset allocation.

On average, managed account participants experienced a relative increase of 15% in projected retirement wealth over 10 years. I’m a little disappointed in “projected” wealth increase vs. actual wealth increase, but I think that’s the best they could do with their limited data set. In order to better see how this works, they broke things into ten equal groups, or deciles, based on the change in retirement wealth. This chart includes the 88% of participants that didn’t have a huge chunk of company stock to start with.

vmap_deciles

As you can see, the bottom decile is mostly affected by the fact that they simply chose to save less money (lower annual contribution rate) and they lowered their stock exposure (lower expected real return). I can only guess that these folks needed to lower their risk levels to a more appropriate level. The top decile both chose to save more money and increased their stock exposure.

Summary. Each of the factors listed above could all be converted to standard advice, i.e. “Things an Investor Should Do”. You should make sure not to hold too much company stock. You should assess your situation, and increase your savings rate if needed. You should make sure your asset allocation is appropriate for your age and risk requirements. Yes, a DIY investor could certainly do these things for themselves. But have you? Will you?

This part is purely my opinion, but how about a general rule, if you haven’t done these things in the last 3 years, perhaps paying for advice may just be worth it? For example, if you’re holding more than 30% of your portfolio in company stock, and haven’t gotten rid of it in the last 3 years, maybe you need someone to do it for you.

TurboTax Desktop Software 2015 Deals, 40% Off at Amazon

turbodeskflavors

Tax prep season is coming up soon, and Amazon has some deals going on for desktop versions of Intuit TurboTax for Tax Year 2015. Here are some reasons that you may choose the desktop software version (CD or download) over their more-popular TurboTax.com online version:

  • With desktop software, you keep all your sensitive data (Social security number, income, etc.) on your own home computer instead of on someone else’s cloud server.
  • The desktop software allows up to 5 Federal tax returns (including 5 separate e-Files) per product purchase. So if you have extra family members or close friends, you can share it and save money.
  • Depending on the promotion, buying the download/CD version can be cheaper than using the online version. Note when comparing prices: If the download/CD version only says State download is included and not explicitly State e-File, then you can complete a state return, but the State e-File will be an additional cost of $19.99 per return. (By contrast, the TurboTax.com online version charges $36.99 for the state software add-on, but it includes one state e-File.) My suggestion is to simply print out your return, mail it in for the cost of a stamp and envelope, and pocket the savings.

There are two separate Amazon promotions going on right now. First, receive up to 40% off the desktop software versions of Intuit TurboTax 2015 (either Mac or PC, download or physical CD). You can get only Federal or Federal + State. Promotion link. Expires January 30th, 2016. Example prices:

Buy a bundle including both Intuit TurboTax and Quicken on CDs, and save $20 on the entire bundle. You have to add to cart and go to Checkout in order to see the discount. Note that this is physical CD only, but both Mac and PC versions are on the TurboTax CDs. However, Quicken for PC and Mac are different prices. Promotion link. Example prices:

(Note: Please verify prices, as they have been changing. Pretty annoying actually, as only the $20 off is set, but they keep changing the original price of the bundle instead.)

At the time of writing this post, it works out to getting Quicken 2016 PC for about $10 extra. If you turned around and sold the Quicken on Amazon Marketplace or eBay, you’d probably get more than $10, which means your net price for TurboTax would be even lower than the first promotion (in exchange for some extra work).

RadPad: Pay Rent With MasterCard Credit Card at 1.99% Fee

rp_logoRadPad is a startup trying to be both a better apartment search engine and a better rent payment service. Of course, this translates to: Find apartment on your smartphone. Pay rent on your smartphone. Tap tap done. 🙂

I haven’t learned much about their rental marketplace, other than it is free for landlords to list. However, RadPad recently altered their fee structure:

  • No fee for debit card payments (Visa and MasterCard debit, under $5,000).
  • 1.99% fee for paying with MasterCard credit card or their Masterpass digital wallet.
  • 3.49% fee for Visa, American Express, and Discover credit cards.
  • Works with Apple Pay.

Your landlord or management company doesn’t have to sign up for anything, Radpad will mail them a paper check. RadPad also guarantees that you won’t be subject to late fees (they require 4 business days lead time). They’ll even send you an alert when the check is deposited by your landlord.

If you write and mail a check now, then you most likely have a debit card already. You can pay no fees, but gain in convenience (and perhaps save a stamp?). Much fewer debit cards offer significant rewards after the Durbin Amendment.

(The notable exception is the PayPal Business Debit card, which gives you 1% cash back on online “signature” purchases. If that is how it is processed, you can net 1% and the money is drawn from your bank account. However, for existing cardholders after 2/1/16 and all new cardholders, PayPal will not pay cash back on “PIN-less debit” transactions. This is a fine distinction, but if that is how the transaction is processed, then you won’t get the 1% cash back. Honestly, nobody really knows until someone tries it after 2/1.)

The lower 1.99% MasterCard fee also opens you up to paying rent with a rewards credit card like the Citi Double Cash card (issued as a MasterCard). Alternatively, you may be working on a spending requirement on a credit-card sign-up bonus. If, for example, you get $500 in rewards after making $3,000 in purchases like the Citi ThankYou Premier card (issued as a MasterCard), then that works out to over 16%.

rp_payscreen

Note: Plastiq offers a similar service. It works with a wider variety of payments (not just rent), but the default fee is 2.5% for credit card payments. If you catch them during a promotion, the rate may be lower.

Exceeding $500,000 SIPC Insurance Limit at Vanguard (or any Brokerage)

sipcThis post is for the fortunate folks who may possibly exceed the often-quoted $500,000 limits for SIPC insurance ($250,000 for cash). The way this insurance works wasn’t necessarily obvious to me, and although it is often compared to the FDIC insurance of banks, there are many important differences.

The Securities Investor Protection Corporation (SIPC) is a federally-mandated and member-funded organization that provides insurance to customers against the insolvency of broker-dealers. If needed, the SIPC can borrow from the US Treasury to meet its obligations. All broker-dealers are required to be members, including Vanguard (brokerage accounts, not mutual fund-only accounts), Fidelity, Schwab, TD Ameritrade, E-Trade, TradeKing, Robinhood, Betterment, Wealthfront, and so on.

Your assets, for examples shares of Apple stock or an S&P 500 mutual fund, are required by federal law to be held separately from the broker’s assets at all times. Broker-dealers are subject internal and external audits, surprise regulatory examinations, and weekly and monthly reporting requirements. Thus, in the vast majority of cases, there are no missing securities and the primary role of the SIPC is to oversee the transition of assets from the failed brokerage firm to another solvent firm. If there are missing assets, then the SIPC will cover of up $500,000 of missing assets ($250,000 maximum for missing cash), per legal entity.

What is a separate legal entity? Per Wealthfront:

The following would qualify as separate legal entities, each subject to the $500,000 limit: your individual account, your trust, your IRA, your spouse’s individual account, trust and IRA, your joint account, as well as a custodial account for a child. Two IRA accounts held by the same client would be considered one legal entity and thus are combined for purposes of insurance coverage. The same combination occurs when a single client holds two individual taxable accounts.

Another way is to simply hold your assets at two different broker-dealers. If you had an individual taxable account at TD Ameritrade and another at Fidelity, that would be two accounts with $500,000 at each.

How often has SIPC insurance actually been exceeded? Only in less than 0.1% of claims. Here are some stats from a Betterment article based on the SIPC 2014 annual report [pdf]:

Since the inception of SIPC in 1971, fewer than 1% of all SIPC member broker-dealers have been subject to a SIPC insolvency proceeding. During those proceedings, 99% of total assets distributed to investors came directly from the insolvent broker-dealer’s assets, and not from SIPC. Of all the claims ever filed (625,200), less than one-tenth of a percent (352) exceeded the limit of coverage.

Example of meeting and/or exceeding SIPC limits. So for example, you could have $2 million of non-cash assets at a failed firm in a single taxable account. If 75% of assets are recovered from the failed firm, you get $1.5 million back from the firm and $500,000 from the SIPC. If only 50% of the assets are recovered, that’s $1 million back from the firm, $500,000 from SIPC, and you’d be out $500,000 unless there are additional recoveries in the future.

Again, a recovery rate as low as 50% is highly unlikely based on historical failures. Per the SIPC annual report, the average recovery rate for insolvencies is 99%. Most examples that I’ve seen use a 90% recovery rate as a conservative example.

However, if you altered the scenario above to have your $2 million separated in to $500,000 in your individual taxable account, $500,000 in your spouse’s individual taxable account, and $1,000,000 in a joint taxable account, then even in that unlikely 50% recovery rate you’d be made whole.

Situations covered by SIPC insurance

  • Brokerage firm insolvency or bankruptcy.
  • Unauthorized trading. SIPC covers securities may have been “lost, improperly hypothecated, misappropriated, never purchased, or even stolen” by the broker-dealer.

Situations NOT covered by SIPC insurance

  • Market price drops. Fluctuations in the market value of your investments are not covered. In the event of a claim, you will receive the value of the securities held by the broker-dealer as of the time that a SIPC trustee is appointed.
  • Claims in excess of insurance limits. See above.
  • Certain investment types are not covered. As summarized by FINRA:

    Not all investments are protected by SIPC. In general, SIPC covers notes, stocks, bonds, mutual fund and other investment company shares, and other registered securities. It does not cover instruments such as unregistered investment contracts, unregistered limited partnerships, fixed annuity contracts, currency, and interests in gold, silver, or other commodity futures contracts or commodity options.

  • Certain other types of fraud. For example, if a scam artist tricked you into buying a penny stock which is now worthless, that is not connected to an insolvency by the broker-dealer, and is thus not covered by SIPC insurance.

Excess of SIPC Insurance. Many brokerage firms pay for optional, additional insurance on the private market for their clients called “excess of SIPC” insurance in the unlikely situation where a client may exceed SIPC insurance limits. You should contact your brokerage firm or look through their boring annual notices.

For example, I have the majority of my assets held in a new “merged” account at Vanguard Brokerage Services. Looking through their VBS semi-annual notice, you can find the following:

VMC [Vanguard Marketing Corporation] has secured additional coverage for your account, which applies in excess of SIPC, through certain insurers at Lloyd’s of London and London Company Insurer(s) for eligible customers with an aggregate limit of $250 million, incorporating a customer limit of $49.5 million for securities and $1.75 million for cash.

Note the total aggregate limit of $250 million, though. Last time I checked Vanguard mutual funds had over $3 trillion in assets under management. $250 million divided by $3 trillion is only 0.01%. Of course, most of those assets are not held in Vanguard Brokerage Services (but in institutional funds and other mutual fund accounts outside of VBS). Still, $250 million across all of their accounts doesn’t seem like very much. A few big fish with $50 million accounts and most of that would already be used up.

Additional ways to reduce your risk. The basic idea here is that the only way you’ll lose a big amount of money is a spectacular failure. In the past, the brokerage firms that have had spectacular failures have shared a few common traits – bad behavior. Don’t do anything that would foster such bad behavior.

  • Don’t hold your money at a firm that does proprietary trading. If a broker-dealer trades with their own money, there is a greater chance a bad trade will bankrupt them. Also, there may be a greater temptation to “borrow” some client funds to cover any unexpected cashflow needs.
  • Don’t use margin accounts, stick with cash accounts. In a margin account, technically your broker is often allowed to “borrow” your securities for their own purposes (usually loaning it to other broker-dealers). In a cash account, there is no such permission given. This is a bit extreme in my opinion, but perhaps something to consider.
  • Don’t invest in exotic, non-transparent strategies. If your brokerage firm only sells plain vanilla investments, it is much harder to hide any shady business. Mutual funds and ETFs are highly regulated by the SEC. Hedge funds are not nearly as closely-regulated.
  • Keep good records. You should keep copies of trade confirmations. You should keep copies of your latest monthly or quarterly statement of account from your brokerage firm. A trustee may ask you to supply copies of these documents in the case of erroneous statements or trades.

My two cents. Purely my opinion, but this is how I see it:

  • Keeping your accounts to each stay under the $500,000 limit (and not hold cash in excess of $250,000) is the only way to know that you’ll be 100% covered in the cases listed above. Just because something hasn’t happened in the past, doesn’t mean it won’t happen. Unlikely is not impossible.
  • If your account has between $500,000 and $5,000,000 in it, and you’re holding traditional mutual fund or ETFs inside, you’d need a bankrupt firm with less than a 90% recovery rate to lose any money (possibly much less). That is admittedly quite rare. You will have to weigh the risk against the added hassle of splitting your accounts by either institution or legal entity.
  • If you have more than $5,000,000 at a single account type at one broker-dealer, I think it starts to definitely become worth the extra effort to split your assets by either institution or legal entity. The risk may be small, but the potential losses are big. If you have this much, why mess around?
  • I wouldn’t put too much faith into excess SIPC insurance. They usually come with an aggregate limit and you have no idea how close the firm’s current assets are to exceeding that value. The amount of protection you’d receive is not under your control.

Teaching Kids About Money: Bi-Rite Market Owners, Father and Son

brite_marm

This Narratively “longread” about the history behind the hip Bi-Rite Market in San Francisco’s Mission District was an intriguing father-son story.

Part of it involved entrepreneurial parents trying to pass on important financial skills to their children, like this excerpt involving the father Ned:

Every day, a group of homeless would line up outside the store, and Ned would feed them a sandwich and soda. No questions asked; no thank you needed. He was generous to his kids, too, but not without strategy or purpose. He’d pay them twenty dollars a day for their work at the market, a decent wage in the ’70s. If the kids agreed to save their earnings in the bank, Ned would double it. If they didn’t, that was all they got. Over the years, each child managed to save $20,000, thanks to Ned’s matching practice. “That’s how I encourage them to work and save money,” Ned says. “Sometimes you have to do your tricky things if you love your children.”

I found it amusing that when his son Sam decided to start his own small business, instead of worrying about him going broke, that actually made him feel more at ease.

“He was excited that I was going to be in control of my own destiny, even though it was a restaurant,” says Sam. “Pursuing entrepreneurship was following a path that he knew, that he was comfortable with.”

I would think most parents would rather their kid go the “safe” route of relying on a professional degree like lawyer, doctor, finance, or engineer.

I enjoy collecting anecdotes like this. Here are past related posts:

Free SAT Test Prep from Khan Academy

khan_satWhile catching up on some reading, it was refreshing to see Bill Gates offer a more positive spin with his Top 6 Good-News Stories of 2015. One of them was that the College Board announced free, high-quality SAT practice at Khan Academy.

This past June, the company that created the SAT helped the Khan Academy launch a free online learning portal for any student who wants help getting ready for the SAT or PSAT. Check out the site for yourself. If you’re like me, you’ll look at these interactive tools and video lessons and wish they had been around when you were in high school. I’m very excited about this development because of what it means for kids who can’t afford expensive test-prep classes and tutors.

The interactive software offers both short diagnostic quizzes and full exams, along with feedback and interactive tutorials to make improvements. Apparently, the SAT is being revamped again in March 2016 and reverting back to the older 1600 point scale + optional essay. Ah, fun times.

Amazon Prime Discounts and Promotions

Update: This Amazon promotion has expired.

To celebrate their Golden Globe awards, Amazon is offering a discount on Amazon Prime for new members. Here is the promotion landing page. Join Amazon Prime for $73 (normally $99) and save $26 on your first year’s membership. Offer valid through 11:59pm PT on Sunday, January 17th.

Until Sunday, January 17th at 11:59 p.m., PT, new members can join Amazon Prime for $73 for the first year and enjoy member-only benefits and content, including our Golden Globe Award-winning series, Mozart in the Jungle. Although the price in your cart will show $99, the promotion discount will be applied at checkout. You will be charged when you place your order.

Promo does not apply for renewals or gift memberships.

Sick in the Head by Judd Apatow: Comedians and Financial Freedom

apatow_book160I’ve never really identified with comedians. I’m not funny, and I always avoid large crowds. But after reading the fascinating notes at The Waiter’s Pad, I had to read the new book Sick in the Head: Conversations About Life and Comedy by Judd Apatow (Knocked Up, This is 40, Freaks and Geeks). It is not an autobiography, but instead a collection of intimate conversations with famous comedians including Mel Brooks, Jerry Seinfeld, Jon Stewart, Roseanne Barr, Louis C.K., Chris Rock, Amy Schumer, Seth Rogen, and Lena Dunham.

Comedians are virtually required to be nonconformist and view the world differently than everyone else. Otherwise, they wouldn’t be funny. Those are also important traits to have for a person who want to be financially independent, at least before the Social Security checks start arriving. I found myself relating to their stories on many different levels. Here are some selected quotes and my takeaways from this book.

Find people who encourage your voice and originality. Find your tribe. Judd Apatow started working at comedy clubs when he was 15 and spent several years as a stand-up comic before becoming a well-known director and producer. He knew he was different, and so he started interviewing his idols for his high school radio station. After high school, he moved to the LA comedy scene and became roommates with people like Adam Sandler. I often see “tribe” defined as “followers” or “hardcore fans”, but I think it is enough to find people with similar interests and passions.

For example, most people will never really consider financial freedom. Most people just want to be like everyone else, except maybe a bit richer. That or hit the lottery. The reality is that you have to be different and embrace it. The good news is the internet allows you to find people who are different just like you, or at least close enough that you can learn an enormous amount.

Hard work with focus. To be successful at anything, you need a combination of hard work, talent, and the ability to maintain the proper focus.

In the book, multiple comedians use Jerry Seinfeld as an example of the rare combination of very talented and very hard-working. Most comedians try to get by with only one or the other. As shown in an early 1983 interview, he also showed his high standards for where to point his energy.

Judd: And what kind of vehicles are you looking for?

Jerry: Quality. That’s my only real consideration. It could be anything, as long as the people are trying to do something good. I don’t want to do a piece of junk. I’m not starving, you know.

This was before the TV show Seinfeld, which started in 1989, so he wasn’t rich or famous yet. Yet he was already using the word quality. In a later interview, he reveals that the reason he ended the show was also quality. He couldn’t keep on going without compromising the quality, so he ended it.

In a 1984 interview, Garry Shandling laid out every single thing he intended to do the rest of his career. Looking back today, Apatow realized that Garry Shandling went on to accomplish everything he said he would. Apatow:

The lesson here, for me, was that you have to have a dream before you can execute it. That the people who succeed are the ones who think through what the next stages of their careers might be, and then work incredibly hard, day after day, to attain their goals. They don’t just flop around like fish. They have a vision, and they work their asses off to make it a reality.

Jay Leno is another example of a comedian known as a hard worker. It’s hard to appreciate how difficult it is to produce good material. Here I will paraphrase Leno from a 1984 interview:

To find the really good jokes, you have to go somewhere awful and if they laugh there, then they will laugh when you use them on Dave Letterman. You just get better the more you do. Throw out what doesn’t work, and keep refining what does work.

Motivation, keeping the spark, and being true to yourself. In a 2014 interview with Jerry Seinfeld, they landed on the topic of motivation.

Judd Apatow: “I wanted to be a comedian and I wanted to work from a very young age because I was afraid of being broke.”

Jerry Seinfeld on his motivation: “To never have to do anything else. I learned very young in this business that you bust your ass or you get thrown out of the kingdom. My motivation was not wanting to leave the kingdom. Plus, I just love the life of it. I love my independence and the joy of hearing laughs and making jokes. It’s as simple as that.”

Again, paraphrasing Jay Leno:

It’s a job, but you should have fun doing it. If you can’t get up for it, then get out of the business. It [Comedy] doesn’t get boring for me. I really like it.

From a 2013 interview with Eddie Vedder:

I just try to always remember where that initial spark came from. It’s like a pilot light, and you try to make sure it doesn’t go out.

Even Judd Apatow recently went back and started doing stand-up just for fun. He doesn’t have to. He doesn’t do it for money, he doesn’t do it with a career goal, he just does it because he wants to. He wants to get good at something that he loves, something that he was only okay at before. He calls it “unfinished business”.

Here’s an excerpt from a 2015 interview with Jimmy Fallon about the early stages of his show:

We just went in knowing that we might get canceled. And if you’re going down, you have to go down going what you like doing and what’s fun for you, because I don’t ever want to do something painful and then have everyone go, “Hey, that works. Keep doing that painful thing for years.”

How many of us went down exactly down that route, or at least could have? “I’m reasonably good at this, even though I don’t like it much, but it pays the bills so I guess I’ll have to do it forever…”

Low overhead. Here’s Sarah Silverman (2014):

I’ve always kept my overhead low so I could do whatever I want. I think of myself as lazy with spurts of getting a lot done. I find myself rooting against things sometimes because I get excited at the thought of a clean slate. I also really like sleeping. My friends make fun of me because, you know, I love hanging out but I always hit a point in the night where I just want to get home and sleep. I have a very active dream life and I have to be there a lot.

This last bit wasn’t in the book, but Jay Leno never spent any of the paychecks he received from hosting The Tonight Show. He only spent the money from his other jobs – stand-up comedy, paid personal appearances, and endorsement deals. His philosophy was Bank one paycheck, Spend one paycheck. From USA Today:

I had two jobs as a kid, one at a fast-food restaurant and one at a Ford dealership. And I’d put the money from one job in one pocket and spend it. And the other paycheck I’d save. I do that now. I have always banked my Tonight Show money and lived off the stand-up. I have one credit card, no mortgage, and I don’t lease.

How To Generate and Issue Your Own 1099-MISC Forms

1099blanksDid you as a small business pay another person or unincorporated business more than $600 total in the last year for services rendered? You may have to provide them a 1099-MISC form.

Here are the specific rules as laid out in the official IRS Form 1099-MISC Instructions [pdf]:

The Internal Revenue Service (IRS) requires businesses (including not-for-profit organizations) to issue a Form 1099 to any individual or unincorporated business paid in excess of $600 per calendar year for services rendered. This is required whether these payments are spread out over the course of the year or are paid in one lump sum payment. The most effective way to obtain the information needed to prepare the Form 1099 is by requiring that an IRS Form W-9 be completed prior to any payment being made. The penalty for failure to file Form 1099 can be as much as 50% of the amount paid for services.

Note that last sentence: The penalty for failure to file Form 1099 can be as much as 50% of the amount paid for services.

The 1099-MISC forms must typically be sent out to independent contractors by January 31st following the end of the tax year in which you made the payments. (As 1/31/16 is a Sunday, the deadline is February 1st for 2016.) You must also file a Form 1096 and submit the information to the IRS by March 31st.

If you’ve got your own accountant or payroll service, then you can pay them to generate the proper forms and send out these 1099s. However, I have done it myself as well, it is not very difficult. Here are your options for generating and issuing a Form 1099:

  • You can order physical, blank 1099 forms from the IRS for free, but it may take up to 4-6 weeks. Here is the IRS.gov order page. You’ll need at a minimum, Form 1099-MISC and Form 1096. You then print it out yourself and mail it. Cost: Free.
  • You can buy physical, blank 1099 forms at an office supply store like Staples or OfficeMax. You then print it out yourself and mail it. Cost: ~$30 for a kit of 24.
  • You can order physical, blank 1099 forms online. Here is the top-reviewed blank 1099-MISC kit from Amazon.com which includes multiple copies, envelopes, and 1096 forms. You then print it out yourself and mail it. Cost: ~$22 shipped for a kit of 25. You can get it with the printing software for about $35 shipped.
  • You can use a 3rd-party online service where you fill out the information online and they’ll create a PDF for you. The most popular is Intuit’s version (they make TurboTax). You will still need to print it out and mail the 1099 forms to your independent contractors, but they will e-file the information to the IRS. Cost: ~$15 for up to 3 forms, $4 each additional.
  • You can use 3rd-party desktop software where you will be guided as with tax software as to how to fill out the appropriate forms. The most popular is TurboTax for Business (not the personal edition), which will provide guidance and generate both 1099-MISC and W-2 payroll forms for you. It comes with a 60-day money back guarantee from Intuit, so if it doesn’t work to your satisfaction, you can return it within 60 days for a full refund. Cost: ~$105 for tax filing software which includes unlimited 1099 and W-2 forms.

You can fill out the physical forms with a typewriter or printer. There are various ways to get the numbers “set” correctly for printing including some free homemade templates out there, but I can’t vouch for any specific one (they may contain viruses or malware, etc). You can also buy forms + software packaged together to fill them out. Don’t forget to fill out the red copies for the IRS.

Note that you cannot use the blank 1099 PDFs that you find online; they are only examples.

Finally, remember that your first job is to get a W-9 form [pdf] filled out by the person you paid, so that you’ll have their Tax ID to enter onto your tax forms.

Prosper Review for Investors: Understanding Risks and Returns

lcreview_logo200I lent out my first $25 to a stranger on Prosper nearly 8 years ago, in October 2007. Since then, the peer-to-peer (P2P) lending environment has undergone a variety of changes. I’ve made hundreds of P2P loans both hand-picked and algorithm-driven, sold them on the secondary market, and experienced the effect of defaults on my returns.

I’ve written several posts along the way, but here is my condensed (but still detailed) overview. Many of the other Prosper reviews tend to focus on the positives. While Prosper certainly has potential, I’d rather go deeper into the possible risks to an investor’s hard-earned money.

The attraction: Be the bank. Earn high interest rates. We’ve all seen the big banks charge mountains of interest, while us regular folks pay it. The average interest rate on credit card loans remains around 15% APR. The basic model for P2P loans is that anyone can become that bank and invest in loans to other individuals. Prosper will take a little cut for helping out, but the bulk of the interest (and risk) goes to the investor.

The reality: Higher net returns than other alternatives, but the risks hide in the details.

Detail #1: Significant loan defaults occur over time. The good news now that P2P loans have been around for a while is that you have more historical performance numbers to consider. Prosper lets you see this historical data in great detail, but you have to look carefully. Here’s a snapshot of what you’d see now at Prosper.com/Invest, labeled “Seasoned Returns*”.

lcreview_returns_10mo

Here’s what that asterisk means:

*Seasoned Return calculations represent historical performance data for the Borrower Payment Dependent Notes (“Notes”) issued and sold by Prosper since July 15, 2009. To be included in the calculations, Notes must be associated with a borrower loan originated more than 10 months ago; this calculation uses loans originated through May 31, 2012. Our research shows that Prosper Note returns historically have shown increased stability after they’ve reached ten months of age. For that reason, we provide “Seasoned Returns”, defined as the Return for Notes aged 10 months or more.

The initial interest rate on your notes is only a theoretical maximum return. For example, for the last quarter of 2015, the average interest rate was 11.06% for 36-months 15.47% for 60-month loans. Every time a borrower defaults – and trust me, if you buy any meaningful amount of notes, some will default on you – your return will go down. With loans as little as 10 months old, their quoted “increased” stability is not the same as stability.

Here’s a chart from competitor LendingClub showing how net annualized return has decreased with loan age (for different vintages of past loans). Note that the net return numbers still keep going down after 10 months.

lcreview_returns_vint

If anything, I would prefer to use this alternative table provided by Prosper. These estimated net numbers are more realistic. The table also includes a daily snapshot of their current inventory, which may give you an idea of relative availability by rating. Note that there are much fewer of the highest-risk, highest-expected return loans available.

prreview_returns_available

Finally, don’t forget that not everyone gets the average. You can’t buy a “Prosper index fund”. You may be above average, but be prepared for below-average returns as well.

Detail #2: Liquidity concerns. When you buy traditional mutual fund that holds investment-grade bonds, with just a few clicks, you can sell that investment on any given trading day. You will get a fair market price, and you will find a buyer for all of your shares.

If you invest in a Prosper note and you need to cash out before maturity, you will have to sell on the secondary market. Now, if you have pristine loans with a perfect payment history, today you’ll probably be able to sell your notes at near or even slightly above face value. But here are the possible haircuts:

First, you will have to pay a transaction fee of 1% of face value on all sales. Second, if you have loans that have ever been late or has a borrower whose credit score has decreased since loan origination (they track that), you will have a harder time finding a buyer and the price will probably be lower than face value. Finally, for Prosper if your loan is currently late, you can’t sell it on the secondary market for any price. You can’t even offload it for a penny.

In my experience, I liquidated ~85% of my loans at about a 0% net haircut, ~10% were sold at a slight loss due to their imperfect history, and ~5% could not be sold at all. While this is certainly better than having no liquidity at all (like a lot of real-estate crowdfunded debt), it also takes a few hours of work at least to maximize your selling prices on 100 or 200 loans.

All of these haircuts taken together can take a significant hit against your total returns. Also, just because you have buyers today doesn’t mean there will be buyers tomorrow. Therefore, I would not invest if you don’t expect to hold the loan until maturity. Some people try to arbitrage things by buying notes and selling them quickly on the secondary market to residents of states that can only buy notes on the secondary market.

Detail #3. Diversification is critical. A defaulted loan wipes out both principal and interest, resulting in a big hit on your overall return. Therefore, your best bet is to never put any more than the $25 minimum into any one note. Remember this statistic: For Notes purchased since July 2009, every Prosper investor with 100 or more Notes has experienced positive returns. In other words, no investor has lost money overall if they held at least 100 notes! 100 times $25 = $2,500 which I think is the minimum you should invest with.

Detail #4. Taxes. P2P notes are a somewhat different animal, and at year-end you’ll receive some tax forms that will be unfamiliar to most people. These may include:

  • 1099-OID
  • 1099-B (Recoveries for Charge-offs)
  • 1099-B (Folio secondary market)
  • 1099-MISC

If you file your income taxes yourself, it is not impossible to figure out but it will take some extra research and effort. Here is my Prosper tax guide that offers some guidance. If you pay a tax professional, they may charge extra for the added complication.

For the most part, the interest you receive will be taxed as ordinary income, the same rate as interest from bank savings accounts. This can be quite high depending on your income, so you may want to consider holding your Prosper notes inside a tax-sheltered IRA. Looking back, I wish I put my Prosper notes inside an IRA.

Detail #5. Automatic investing. The days of hand-picking loans are pretty much over. I recommend using the Quick Invest feature that Prosper offers in order to automatically filter through and buy the notes that fit your criteria. Loan supply is often limited, and this way you can actually get those loans before someone else buys them.

You can let Prosper pick the loans for you, or you can spend your time looking for “better” filters. There are some free tools out there that help sift through the past performance data. There are even paid services out there that do this for you, but I am uncertain how the cost/benefit would shake out.

Detail #6. Past performance vs. future possibilities. Although past returns are great, another economic recession may have a severe impact on your future loan returns. In the end, these are unsecured loans like credit card debt. If people lose their jobs, they will stop paying. Just because nobody has lost money in the past with 100+ loans, that doesn’t guarantee that you won’t lose money in the future. Unlikely does not mean impossible.

Traditionally, high-quality bonds are a diversifier to stocks. But Prosper notes are more like low-quality bonds. If the economy tanks, defaults will rise and your returns will drop. But if the economy tanks, your stocks will drop too. Are you ready for both to suffer significant drops during times of financial stress?

Detail #7. What if Prosper goes bankrupt? As a company, Prosper Marketplace Inc. (PMI) has historically had a hard time actually making a steady profit themselves. In 2013, Prosper started structuring their notes so that they are held in a new legal entity called Prosper Funding LLC (PFL). This remote entity is designed to stand alone and be protected from any creditor claims in the event that Prosper Marketplace, Inc. goes bankrupt. PFL can keep on running and servicing loans. This is a good move in my opinion, but it is still unknown how well this legal strategy will work, or if future lawsuits can put the assets of PFL at risk.

In other words, don’t put all your eggs in one basket. Due to #6 and #7, Prosper notes should only be a portion of your fixed income assets.

Summary. P2P loans are becoming a legitimate asset class, gathering billions of dollars from Wall Street and other institutional investors. Interest rates remain low, and thus the high yields and competitive past returns from these Prosper notes are still very attractive. Let’s face it, even a tempered expectation of 8% net annual return is hard to ignore! But before you make the jump, make sure you fully understand the risks and how to best mitigate them.

  • Understand that your final returns will be significantly less than your starting yield. Look at historical numbers for guidance.
  • Don’t invest money you will need before the loan ends (3-5 years).
  • Diversify across as many loans a possible (100+ notes).
  • P2P notes should only be a portion of your fixed income assets.
  • Expect to spend extra time to acquire notes and prepare taxes.
  • Consider holding notes inside a tax-sheltered IRA.

I hope that this information helps you decide whether investing in Prosper loans is right for you.