Archives for April 2016

Berkshire Hathaway 2015 Annual Letter by Warren Buffett (Live Webcast Reminder)

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Reminder: BRK Annual Meeting Live Webcast starts Saturday, April 30th at 10am Eastern. Always wanted to attend the Berkshire Hathaway Shareholder Meeting? This year, anyone can watch the Buffett and Munger Q&A session live without flying to Omaha, Nebraska. I don’t know if it will be available for later repeated viewing.

Charlie and I have finally decided to enter the 21st Century. Our annual meeting this year will be webcast worldwide in its entirety. To view the meeting, simply go to https://finance.yahoo.com/brklivestream at 9 a.m. Central Daylight Time on Saturday, April 30th. The Yahoo! webcast will begin with a half hour of interviews with managers, directors and shareholders. Then, at 9:30, Charlie and I will commence answering questions.

Rest of original post:

Berkshire Hathaway (BRK) released their 2015 Letter to Shareholders [pdf] over the weekend. As always, the letter is written in a straightforward and approachable fashion. Even if you aren’t interested in BRK stock at all, reading the letter can be educational for individual investors of any experience level.

I’m sure many people smarter than me will offer their responses to this letter, but here are my notes.

Berkshire share value. As usual, the letter addresses the different ways to value BRK shares. First, there is the market value, as seen on any BRK stock quote. Second, there is the book value, which is an accounting term defined as total assets minus intangible assets and liabilities. Third, there is the intrinsic value, which is what Buffett believes is the true value. Buffett has repeatedly stated that BRK will buy back shares if the market value drops to 120% of book value.

Over time, this asymmetrical accounting treatment (with which we agree) necessarily widens the gap between intrinsic value and book value. Today, the large – and growing – unrecorded gains at our “winners” make it clear that Berkshire’s intrinsic value far exceeds its book value. That’s why we would be delighted to repurchase our shares should they sell as low as 120% of book value. At that level, purchases would instantly and meaningfully increase per-share intrinsic value for Berkshire’s continuing shareholders.

This suggests that Buffett believes BRK is worth signficantly more than 1.20x book value. As I write this, the BRK stock is roughly 1.3x book, and it has dropped as low as 1.25x book in January 2016. As a (tiny) shareholder, I also use this as a rough measure of whether the company is under- or over-valued (or out-of-fashion vs. in-fashion). My holdings are mostly meant as a future educational tool for my children. I don’t know how BRK will perform as compared to the S&P 500, but it is great example of a money-making machine.

Individual stock holdings. As BRK has moved from mostly holding parts of public companies to holding entire private companies, there is less for the individual stock picker to sift through. For example, you and I can no longer buy shares of Precision Castparts or BNSF Railroad directly. He is still confident in his “Big Four” investments of American Express, Coca-Cola, IBM and Wells Fargo:

These four investees possess excellent businesses and are run by managers who are both talented and shareholder-oriented. Their returns on tangible equity range from excellent to staggering. At Berkshire, we much prefer owning a non-controlling but substantial portion of a wonderful company to owning 100% of a so-so business. It’s better to have a partial interest in the Hope Diamond than to own all of a rhinestone.

Even though the outlooks for AmEx and IBM is not as positive as they were few years ago, Buffett must still view them also as reliable money-making machines. Reading through this and older letters are a great way to learn about important concepts like earnings growth, dividend payouts, and share buybacks.

Optimism. A good portion of the letter was devoted to optimism about the American economy.

It’s an election year, and candidates can’t stop speaking about our country’s problems (which, of course, only they can solve). As a result of this negative drumbeat, many Americans now believe that their children will not live as well as they themselves do.

That view is dead wrong: The babies being born in America today are the luckiest crop in history.

Indeed, most of today’s children are doing well. All families in my upper middle-class neighborhood regularly enjoy a living standard better than that achieved by John D. Rockefeller Sr. at the time of my birth. His unparalleled fortune couldn’t buy what we now take for granted, whether the field is – to name just a few – transportation, entertainment, communication or medical services. Rockefeller certainly had power and fame; he could not, however, live as well as my neighbors now do.

Shareholder letters from 1977 to 2015 are available free to all on the Berkshire Hathaway website. You can also purchase all of the Shareholder letters from 1965 to 2014 for only $2.99 in Amazon Kindle format. Three bucks is a very reasonable price to have an official copy forever stored in electronic format. (Updated paperback will be re-stocked in mid-April for about $20. Don’t overpay for a stale physical copy.)

The 2014 Annual Letter discussed the power of owning shares of productive businesses (and not just bonds). The 2013 Annual Letter included Buffett’s Simple Investment Advice to Wife After His Death.

Santander Bank extra20 Checking: Ending July 1st for Existing Customers

Update April 2016. I originally wrote about this promotion in October 2013, and many readers have been getting $20 of interest every month on a relatively low balance (worked out to 16% APY on $1,500 average balance). With a 1% APY savings account, you’d need $24,000 to get the same amount of interest! Unfortunately, Santander Bank recently announced that this promotion will end and accounts will be converted to a Simply Right checking account later this year (reports include either July 1st or December 1st, 2016).

I would note that this deal lasted for over 2.5 years, longer than I thought it would. Just like with 5% APY Netspend prepaid cards, you can’t really predict how long deals will last. Some end earlier than you think, some end later. Don’t forget to close your account in July, unless you’ve gotten attached to your Santander account (which was always the idea!).

Original post from October 2013 (deal is no longer available):

[Read more…]

Real Estate Crowdfunding Experiment #1: Patch of Land Final Update

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pol_final0My first investment into real estate crowdfunding has completed. In April 2015, I invested $5,000 into a fix-and-flip loan at the site Patch of Land. There are more details in my initial update, but here’s a quick recap of the loan details:

  • Single-family home in West Sacramento, California
  • Loan secured by property, in the first position. Backed by personal guarantee from borrower.
  • 6-month expected term (roughly April 15th to October 15th). Fix-and-flip.
  • Loan-to-value is 75% per independent 3rd-party appraisal.
  • 11% APR interest, paid monthly.
  • $5,000 invested.

Here are the initial and final numbers on the property itself:

  • Developer Purchase Price: $155,000
  • Estimated Remodel Costs: $55,000
  • Developer Contribution $31,000 + closing costs + origination fee
  • Developer Loan Request: $179,000
  • Independent 3rd-party After-Repair-Value: $238,000
  • LTV based on Independent ARV: 75%
  • Developer estimated selling price: $275,000 to $300,000
  • Actual selling price: $300,000

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Here are the final numbers for my partial investment:

  • 4/20/15 – $5,000 invested.
  • Proceeded to collect $45.83 of interest on the 15th of every month (pro-rated on partial months).
  • 9/23/15. Loan extension granted.
  • Kept collecting $45.83 of interest on the 15th of every month (pro-rated on partial months).
  • 3/15/16. Notified that house in under contract for $300,000.
  • 3/30/16. Loan was paid in full.

The loan term was supposed to be for 6-months (one of the main reasons I chose it) but the process took longer than expected and the total loan period ended up being nearly 12 months. My total interest payments were $517.91. I also received an additional $75 fee for the loan extension. I thus received a total of $5592.91 over 346 days, for an annualized return of 12.5%. Without the extra $75 penalty fee, my interest payments would be right at the promised 11% APR.

Takeaways from the process:

  • Be patient but decisive when selecting your investment. You should be comfortable with the local market situation as well as the numbers like loan-to-value ratio. You should know what you want, ignore anything that doesn’t fit your criteria, and act quickly when you see something that does. This is really the only part of the process where you have control, so use it wisely.
  • Understand the contract. Just because there is a “6-month expected term” doesn’t mean you’ll get your money back in 6 months. You should read the terms carefully to see what options are available to the borrower if they can’t make that date. Is an extension automatically granted? Is there an increased interest rate? How long does the extension last?
  • Liquidity and more patience. One of the defining features of this type of investment is that it is highly illiquid. If I buy a mutual fund, I can sell the entire thing and get fair market value as cash in my bank account in a few business days. With an investment like this, the borrower could pay it back early, take their sweet time, or even default entirely and they’d have to liquidate the home before I get my principal back. That could take another several months. You should not need this money any time soon.
  • Low-maintenance. The good part of having no control is that you don’t have to do anything. I just sat back and had the interest automatically swept to my bank account each month. I received a simply 1099-INT for the interest earned through this loan, and it was quite easy to deal with at tax time.
  • Updates. I did not receive constant updates on this loan, but I think the updates were adequate. I was given a couple of photos on the remodel progress and updates on loan extension, house listing, house listing changes, and house being under contract. You do not have any two-way contact with the developer.

I will admit that I was nervous for a little bit on this house. I could track the house listing on real estate sites like Zillow and I questioned some of the cosmetic choices that the developer made, including painting the house an gunmetal-grey stucco. I also questioned the high listing price of $325,000, which I thought they’d never get and would scare off potential buyers. It all ended well as the house was repainted into a neutral beige and the developer agreed to sell at a good price.

Will I invest again? Well, I can’t help but be satisfied with my 12%+ annualized return, but things could also have dragged out a lot longer. I will probably invest again, but at a different real estate site, if only to see how they might handle things differently. I’m in it to make money, but I’m also in it to learn as this is my “experimental money” fund (even Burton Malkiel and Jack Bogle have such accounts).

Account screenshot:

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Reminder: Check your IRA Beneficiary Designations

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According to the stats, you probably funded your Individual Retirement Account (IRA) at the last moment this month (assuming you fund them at all). If we tend to procrastinate about saving, then we also probably put off estate planning. One of the simplest aspects of estate planning is to designate beneficiaries of your IRA.

I am not an estate-planning attorney, but here are some tidbits I picked up from various sources including a review copy of new book The Overtaxed Investor by Phil DeMuth.

Why is this important?

  • The person, trust, charity, or estate that you pick as your beneficiary overrides any will. So if your sole IRA beneficiary is set up as your ex-spouse, and your will says everything goes to your current spouse, then your ex-spouse will still get your IRA (at least without a long legal battle).
  • If you name an individual instead of an estate, the inheritor can space out withdrawals over their (actuarial) lifetimes, prolonging the tax-deferred growth benefits of IRAs. A trust or estate does not get this feature by default (a trust may be carefully constructed to preserve some of these characteristics).
  • You may still want to pick a trust if you have sizable assets and are leaving them to young children. You can then outline rules and a trustee to manage how the money is spent. This route involves extra costs, however.
  • Secondary beneficiaries can also be chosen. If no secondary beneficiaries are named, your assets may pass to your estate – exposing them to the probate process, estate expenses, and creditor claims. In many cases, people pick their spouses as primary and their children as secondary.

How should you do it?

  • Contact your IRA custodian. I use Vanguard, and you can either fill out this paperwork kit or do it all online under Account Maintenance > Beneficiaries. They use some language to simplify the process. For example, I set my primary beneficiary as the “person I am married to at the time of my death” and my secondary beneficiary as “To my descendants who survive me, per stirpes”. I may change this later. Find out what per stirpes means and more with this Vanguard guide.
  • Keep a physical copy in your personal files. Keep copes in your home safe, safety deposit box, and/or digital safe.
  • Tell your beneficiaries where the form is and what is on it. Vanguard won’t contact anyone upon your death, so it is up to your beneficiaries to contact Vanguard. I suspect many other brokerages operate in a similar manner. There are millions of dollars in unclaimed IRAs every year.

Screenshots:

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Secret Shame: Will We Ever Talk Openly About Money?

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We may not like to talk about our own money, but we sure like to read about other people’s money. The May 2016 cover story for The Atlantic magazine is The Secret Shame of Middle-Class Americans by Neal Gabler:

The Fed asked respondents how they would pay for a $400 emergency. The answer: 47 percent of respondents said that either they would cover the expense by borrowing or selling something, or they would not be able to come up with the $400 at all. Four hundred dollars! Who knew?

Well, I knew. I knew because I am in that 47 percent.

The essay has definitely hit a nerve, with over 3,000 comments, a handful of formal reader letters, and several financial experts all weighing in with their responses.

As someone who used to openly share his net worth, I have to give Mr. Gabler credit for candidly sharing about his financial “impotence”. Most people would rather undergo a root canal than share intimate details about their financial insecurities.

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I also recommending reading this Esquire piece: 4 Men with 4 Very Different Incomes Open Up About the Lives They Can Afford – From a father on the poverty line to a CEO millionaire. It is interesting to note that despite the disparity in both their current and desired future incomes, all four men are both mostly happy and plan on working into their 60s or longer.

You can see why people choose silence, as it is an exquisite sort of pain to have strangers publicly break down all of your mistakes and diagnose your underlying personal failings. But I think more discussion is exactly what we need, not less. Hopefully despite the judgment, Mr. Gabler will eventually be better off for it. We need to talk it out, share both our struggles and solutions, and face up to the problems instead of just hiding it and hoping it magically goes away.

Let’s put away the snarky internet comments and try a civil discussion with empathy and detail. I’d like that a lot more than reading another article about disappearing pensions or debt statistics.

Higher Savings Rate vs. Higher Risk Portfolio

An article on the Vanguard Advisors Blog discussed the trade-offs involved in adjusting an investor’s savings rate and the risk level of their portfolio – Investor success: Measured in dollars, not (per)cents.

A portfolio’s value can grow through both capital contributions and return on capital, but only capital contributions can grow wealth reliably. Saving is our contribution to our own investment success and, importantly, unlike the investment returns we seek, its benefits are both more certain and within our control.

The chart below shows projected outcomes based on savings rate (4% or 6%) and portfolio risk level (conservative, moderate, or aggressive). You can see visually that the combination of 6% savings rate and moderate risk (50% stocks/50% bonds) has both a higher average outcome and fewer poor outcomes than the combination of 4% savings rate and aggressive risk (80% stocks/20% bonds)

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Part of this should be expected – you’re saving 50% more in dollars when going from a 4% to 6% savings rate. But on an absolute level, perhaps that amount of dollars is something you can swing.

Vanguard did a similar study called Penny saved, Penny earned back in 2011 that compared three levers: savings rate, portfolio asset allocation, and also starting to save earlier. Take the following baseline scenario:

  • Investor begins working at 25, but starts saving at age 35.
  • 12% savings rate
  • Moderate asset allocation (50% stocks and 50% bonds)
  • Salary starts at $30,000 but increases with age

Now, here are three ways in which a worker could increase their final savings balance at retirement (age 65).

  • Option #1. Invest more aggressively with an asset allocation of 80% stocks and 20% bonds, while keeping your 12% savings rate and starting age of 35.
  • Option #2. Raise your savings rate to 15%, while keeping your starting age of 35 and 50/50 asset allocation.
  • Option #3. Start saving at age 25 instead of 35. while keeping your 12% savings rate and and 50/50 asset allocation.

Which single option do you think has the most impact? The results are based the median balance found after running Monte Carlo computer simulations based on 10,000 possible future scenarios for each option.

Scenario Median Balance at age 65 % Increase vs. Baseline
Baseline $474,461
Option #1
(Aggressive asset allocation)
$577,133 22%
Option #2
(Raise savings rate)
$593,077 25%
Option #3
(Start saving earlier)
$718,437 51%

 

Between the three “levers” you could pull, starting to save earlier wins by a significant margin, which is an important truth but minus a time machine today is the earliest we can start saving more. After that, a higher savings rate is a more reliable path to improving your odds for success. Investing with significantly more risk performs somewhat similarly on a median basis, but actual results will vary the most widely.

I suppose my version of this is that an investor should keep working hard to maximize their savings rate, but only work hard to find a “good” asset allocation once and then let it be. My definition of “good” asset allocation is one that considers your financial needs, your knowledge, and as a result is something that you can keep forever. Don’t look for the “perfect” asset allocation, as these can only be known after the fact and are constantly changing. Too often, they are based on data mining and recent performance. Look at any asset allocation with growing popularity, and the asset classes that make it hot have probably done well in the past decade. You can quote “long-term” numbers from long periods like 1970 to 2015, but these numbers are still strongly influenced by recent past performance.

Early Retirement Portfolio Income Update, April 2016

dividendmono225I like the idea of living off dividend and interest income. Who doesn’t? The problem is that you can’t just buy stocks with the absolute highest dividend yields and junk bonds with the highest interest rates without giving up something in return. There are many bad investments lurking out there for desperate retirees looking only at income. My goal is to generate reliable portfolio income by not reaching too far for yield.

A quick and dirty way to see how much income (dividends and interest) your portfolio is generating is to take the “TTM Yield” or “12 Mo. Yield” from Morningstar quote pages. Trailing 12 Month Yield is the sum of a fund’s total trailing 12-month interest and dividend payments divided by the last month’s ending share price (NAV) plus any capital gains distributed over the same period. SEC yield is another alternative, but I like TTM because it is based on actual distributions (SEC vs. TTM yield article).

Below is a close approximation of my most recent portfolio update. I have changed my asset allocation slightly to 60% stocks and 40% bonds because I believe that will be my permanent allocation upon early retirement.

Asset Class / Fund % of Portfolio Trailing 12-Month Yield (Taken 4/14/15) Yield Contribution
US Total Stock
Vanguard Total Stock Market Fund (VTI, VTSAX)
24% 1.94% 0.46%
US Small Value
WisdomTree SmallCap Dividend ETF (DES)
3% 2.80% 0.09%
International Total Stock
Vanguard Total International Stock Market Fund (VXUS, VTIAX)
24% 2.82% 0.66%
Emerging Markets Small Value
WisdomTree Emerging Markets SmallCap Dividend ETF (DGS)
3% 3.03% 0.10%
US Real Estate
Vanguard REIT Index Fund (VNQ, VGSLX)
6% 4.21% 0.24%
Intermediate-Term High Quality Bonds
Vanguard Intermediate-Term Tax-Exempt Fund (VWIUX)
20% 2.90% 0.60%
Inflation-Linked Treasury Bonds
Vanguard Inflation-Protected Securities Fund (VAIPX)
20% 0.82% 0.26%
Totals 100% 2.31%

 

The total weighted 12-month yield was 2.31%. This means that if I had a $1,000,000 portfolio balance today, it would have generated $23,100 in interest and dividends over the last 12 months. Now, that is significantly lower than the 4% withdrawal rate often quoted for 65-year-old retirees with 30-year spending horizons, and is even lower than the 3% withdrawal rate that I have previously used as a rough benchmark. I’ll note that the muni bond interest in my portfolio is exempt from federal income taxes.

Given the volatility of stock returns, the associated sequence of returns risk, and current high valuations, I still like the income yield measuring stick. I feel that the income yield number does a rough job of compensating for market valuations (valuations go up probably means dividend yield go down) as well as interest rates (low interest rates now, probably low bond returns in future). With 60% stocks, I am hoping that the overall income will keep up with inflation and that I will never have to “touch the principal”. Over the last 15 years or so, the annual growth rate of the S&P 500 dividend averaged about 5%.

As noted previously, a simple benchmark for this portfolio is Vanguard LifeStrategy Moderate Growth Fund (VSMGX) which is an all-in-one fund that is also 60% stocks and 40% bonds. That fund has a trailing 12-month yield of 2.12%. Taken 4/14/2016.

So how am I doing? Staying invested throughout the last 10 years has been good to me. Using the 2.31% income yield, the combination of ongoing savings and recent market gains have us at 88% of the way to matching our annual household spending target. Consider that if all your portfolio did was keep up with inflation each year (0% real returns), you could still spend 2% a year for 50 years. From that perspective, a 2% spending rate seems like a conservative number, even with the many current predictions of modest future returns.

Early Retirement Portfolio Asset Allocation Update, April 2016

portpiegenericIt has been a while, so here is a 2016 First Quarter update on my investment portfolio holdings. This includes tax-deferred accounts like 401ks, IRAs, and taxable brokerage holdings, but excludes things like our primary home and cash reserves (emergency fund). The purpose of this portfolio is to create enough income to cover household expenses.

Target Asset Allocation

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I try to pick asset classes that will provide long-term returns above inflation, distribute income via dividends and interest, and finally offer some historical tendencies to balance each other out. I don’t hold commodities futures or gold as they don’t provide any income and I don’t believe they’ll outpace inflation significantly. In addition, I have doubt that I would hold them through an extended period of underperformance (i.e. don’t buy what you don’t can’t stick with).

Our current target ratio is 70% stocks and 30% bonds within our investment strategy of buy, hold, and rebalance. With a self-directed portfolio of low-cost funds and low turnover, we minimize management fees, commissions, and tax drag.

Actual Asset Allocation and Holdings

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Stock Holdings
Vanguard Total Stock Market Fund (VTI, VTSMX, VTSAX)
Vanguard Total International Stock Market Fund (VXUS, VGTSX, VTIAX)
WisdomTree SmallCap Dividend ETF (DES)
WisdomTree Emerging Markets SmallCap Dividend ETF (DGS)
Vanguard REIT Index Fund (VNQ, VGSIX, VGSLX)

Bond Holdings
Vanguard Limited-Term Tax-Exempt Fund (VMLTX, VMLUX)
Vanguard Intermediate-Term Tax-Exempt Fund (VWITX, VWIUX)
Vanguard High-Yield Tax-Exempt Fund (VWAHX, VWALX)
Vanguard Inflation-Protected Securities Fund (VIPSX, VAIPX)
iShares Barclays TIPS Bond ETF (TIP)
Individual TIPS securities
U.S. Savings Bonds (Series I)

Commentary
In terms of the big picture, very little has changed. I did not accomplish my plan of relocating my holdings of WisdomTree SmallCap Dividend ETF (DES) and WisdomTree Emerging Markets SmallCap Dividend ETF (DGS) into tax-deferred accounts. I pretty much left them where they have been, inside a taxable brokerage account. I am currently leaning towards simply selling them completely and making my overall portfolio more simple. I would just have Total US, Total International, and US REITs for stocks. I would technically still hold a “small value tilt” on my holding in my kid’s 529 college saving plan asset allocation.

As for bonds, I’m still somewhat underweight in TIPS mostly due to lack of tax-deferred space as I really don’t want to hold them in a taxable account. (I noticed that shares of TIP are actually up 4% this year, less than 4 months in). My taxable bonds are split roughly evenly between the three Vanguard muni funds. The average duration across all of them is roughly 4-5 years.

A simple benchmark for my portfolio is 50% Vanguard LifeStrategy Growth Fund (VASGX) and 50% Vanguard LifeStrategy Moderate Growth Fund (VSMGX), one is 60/40 and one is 80/20 so it also works out to 70% stocks and 30% bonds. That benchmark would have a total return of -0.87% for 2015 and +1.42% YTD (as of 3/31/16).

I like tracking my dividend and interest income more than overall market movements. In a separate post, I will update the amount of income that I am deriving from this portfolio along with how that compares to my expenses.

RealtyShares Sign-Up Bonus Promo Code

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Update. RealtyShares has a referral program that offers a new customer who is referred by an existing client a $100 gift card after linking a bank account. I am no longer available to provide referrals as I have maxed out the limit, but you may be able to find a referral from existing client elsewhere.

Alternatively, using this link and using the code JONATHANPING25 will get you a free $25 to start.

Be sure to follow the terms and conditions and reply to your bank link confirmation e-mail with the proper promo code:

In order to receive $25 sign up bonus, user must register, connect a bank account, and use the promocode provided in the email they received about the program. Payouts to user will be within 30 days via your linked bank account. RealtyShares reserves the right to stop or modify the referral program at its discretion at any time.

John Oliver on Why The Credit Report Industry is Awful

John Oliver of HBO’s Last Week Tonight did a humorous monologue on why credit reporting bureaus are awful. Appropriately, it was last week and I finally got around to watching the 18-minute video tonight. Here is the full video link, embedded below:

Here’s the condensed version:

  • Your credit report can affect your ability to borrow (and thus buy a home), your ability to rent, the price you pay for all kinds of stuff, and even your ability to get a job. Sheesh, what else is there left?
  • 1 in 20 credit reports have errors that are significant enough to hurt your chances at the rather important things I just listed above. That’s 10 million Americans.
  • In an effort to show Equifax, Experian, and TransUnion how such errors can hurt both reputations and business, they created the three websites Equifacks.com, Experianne.com, and TramsOnion.com. (Warning: I left some of these unlinked because they may be considered NSFW.)

In general, I do not micromanage my credit score, but it is scary than an error outside your control could have such harmful effects on your day-to-day life. Perhaps this information will also motivate you to check your credit and consumer reports if you haven’t done so recently. There are also an increasing number of free and/or ad-supported sources of credit reports, credit monitoring, and credit scores. The bad news is that the error dispute process is still slow and complicated, and after you try patience and perseverance, you may need to lawyer up in order to get their attention.

Savings I Bonds May 2016 Interest Rate Update

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New fixed rate as of May 1st, 2016 is 0.1%, the same as the last 6-month period. The variable inflation-indexed rate is 0.16% (as was predicted). Thus, buying a new I Bond between May 2016 through October 2016 will earn a composite rate of 0.26% for the first six months, and after that 0.1% plus the current inflation-indexed rate updated every 6 months.

Original mid-April post below:

New inflation numbers were just announced, which allows us to make an early prediction of May 2016 savings bond rates a couple of weeks before the official announcement on May 1st. This also allows us the opportunity to know exactly what a April 2016 savings bond purchase will yield over the next 12 months, instead of just 6 months.

New Inflation Rate
September 2015 CPI-U was 237.945. March 2016 CPI-U was 238.132, for a semi-annual increase of 0.0786%. Using the official formula, the variable component of interest rate for the next 6 month cycle will be approximately 0.16%. You add the fixed and variable rates to get the total interest rate. If you have an older savings bond, your fixed rate may be very different than one from recent years.

Purchase and Redemption Timing Reminder
You can’t redeem until 12 months have gone by, and any redemptions within 5 years incur an interest penalty of the last 3 months of interest. A known “trick” with I-Bonds is that if you buy at the end of the month, you’ll still get all the interest for the entire month as if you bought it in the beginning of the month. It’s best to give yourself a few business days of buffer time though, since if you wait too long your effective purchase date may be bumped into the next month.

Buying in April
If you buy before the end of April, the fixed rate portion of I-Bonds is guaranteed to be 0.1%. You will also be guaranteed the current variable interest rate of 1.54% for the next 6 months, for a total rate of 0.1 + 1.54 = 1.64%. For the 6 months after that, the total rate will be 0.1 + 0.16 = 0.26%. 1.64% for 6 months, then 0.26% for 6 months.

Let’s say we hold for the minimum of one year and pay the 3-month interest penalty. If you theoretically buy on April 30th, 2016 and sell on April 1, 2017, you’ll earn a ~0.97% annualized return for an 11-month holding period, for which the interest is also exempt from state income taxes. This average rate is somewhat lower than what is currently available from the highest 1-year bank CD rates (ex. 1.25% APY at Synchrony Bank as of 4/15/16), but matches the APY of most online savings accounts.

Buying in May
If you wait until May, right now I can only estimate a fixed rate of between 0% and 0.2% plus the variable rate of 0.16% for a composite rate of 0.16 to 0.36% for the first 6 months. The next 6 months will be the sum of an unknown fixed rate plus an unknown rate based on future inflation. Given this low rate for the first 6 months, I would rather buy in April than May, otherwise I would wait and check back in during mid-October 2016 to see if inflation has picked up.

Existing I-Bonds and Unique Features
If you have an existing I-Bond, the rates reset every 6 months depending on your purchase month. Your bond rate = your specific fixed rate + variable rate (minimum floor of 0%). Again, this new rate update is low, but due to their annual purchase limits, you should still consider their unique advantages before redeeming them. These include ongoing tax deferral, exemption from state income taxes, and being a hedge against inflation (and even a bit of a hedge against deflation).

Annual Purchase Limits
The annual purchase limit is now $10,000 in online I-bonds per Social Security Number. For a couple, that’s $20,000 per year. Buy online at TreasuryDirect.gov, after making sure you’re okay with their security protocols and user-friendliness. You can also buy an additional $5,000 in paper bonds using your tax refund (see IRS Form 8888). If you have children, you may be able to buy additional savings bonds by using a minor’s Social Security Number.

For more background, see the rest of my posts on savings bonds.

IRA Contribution Stats: Are You a Non-Procrastinating, Consistent Maximizer Unicorn?

iheartrothBesides being the tax return deadline, Monday April 18th, 2016 is also the last day to make a contribution to a Traditional or Roth IRA for the 2015 Tax Year. For both the 2015 and 2016 Tax Years, the maximum annual contribution limits are $5,500 (if under age 50) and $6,500 (if over age 50).

Vanguard has a whitepaper called Are you an IRA superstar? that examines investor behavior when it comes to IRA contributions. Their teaser line was that only 3% of IRA investors contribute consistently over time, maximized their annual contributions, and made their contributions early in the year. Here’s the graphic they provide:

vg_irafunnel

Here’s how I would summarize the results:

  • Out of Vanguard IRA contributors in 2010, roughly half continued to contribute every year for 5 years (2010-2014).
  • Out of those 5-year “consistent” contributors, roughly half contributed the maximum allowable amount every year.
  • Out of those 5-year “consistent maximizer” contributors, only 1 out of 10 contributed early on in the year, every year (by April 30th).

I must admit that even though I have maxed out my IRAs for over a decade, I don’t always contribute early on in the year. I am a procrastinating, consistent maximizer. I was surprised that 9 out of 10 people in a similar situation also waiting for longer than they need to. The contribution window spans from January 1 of the tax year and closes on the following year’s April tax-filing deadline. Are we foolishly and voluntarily giving up money due to a “procrastination penalty“? Our contribution patterns seem to suggest that we do like to wait until the last minute:

vg_irafunnel2

Upon further thought, one possible reason not mentioned in the Vanguard article is that people may not know if they qualify for IRA contributions due to income restrictions, or if they will need to perform a non-deductible Traditional IRA (to later convert to Backdoor Roth IRA). You may not know your modified adjusted gross income until your tax return is done, which might not be until March or April of the following year. To prevent having to undo anything, you might want to wait. Or we’re just lazy. 🙂