Archive for May, 2007
A reader e-mailed me an interesting article about index funds from today’s Wall Street Journal entitled A Close Race, a Surprising Finish. It’s only available for 7 days, after that a subscription is required.
The basic idea was to try and compare after-tax returns of index mutual funds and index ETFs, due to the often-touted tax-advantages of ETFs. The article summarized these theoretical benefits well:
The tax-related advantages of ETFs stem from their unique structure. ETFs are created when securities brokerages or specialists assemble baskets of stocks that match an ETF’s underlying index and exchange them with the fund for ETF shares that the brokerages can either hold or sell to small investors. These ETF shares can be bought and sold any number of times without the underlying stocks they represent being touched. When the brokerages opt to take ETF shares off the market, the fund hands over stock, rather than cash. This allows the ETFs to avoid selling their underlying stocks to accommodate investor traffic.
(This explains why many mutual funds have purchase or redemption fees to discourage active trading, while ETFs can be bought and sold all day long.)
For this study, commission costs for both were assumed to be zero. So who won?
Big, low-cost index funds from Boston-based Fidelity Investments and Vanguard Group Inc., Malvern, Pa., outperformed the ETFs in most of the comparisons we set up. For the 40 time periods studied, the mutual funds prevailed in 34 — including a sweep of the one-, three-, and 10-year after-tax categories.
Why is this?
The lesson for small investors: Whatever structural differences ETFs may have in the way of tax advantages, other factors — such as a fund’s expense ratio and management philosophy — can be equally important in determining performance in the competitive index-tracking business.
ETF tax advantages pertain, by and large, to capital gains, not dividend distributions. And, as noted, ETFs almost never sell their funds’ underlying securities, so capital-gains taxes are rare… But S&P-500 index mutual funds are pretty efficient, too. They don’t trade holdings as often as mutual funds run by stock pickers, so they rarely distribute capital gains either.
The lack of significant tax advantages for index ETFs is especially true in the case of Vanguard ETFs and mutual fund equivalents, as they are just different share classes of the same investment holding. I believe Vanguard does this so they can use the ETF “side” to keep their taxable events to a minimum, benefiting the mutual fund costumers as well. Here, the only difference in raw performance should be due to the different expense ratios.
Added
Management philosophy? Why does this matter in an index fund? Well, this is another area that may surprise some - it takes skill to manage an index fund!! A good index fund manager can eek out a few more basis points of return. From the article:
In addition, tactical moves by index-fund managers can boost results. While an index fund should, in theory, trail its benchmark by at least the amount of its expense ratio, fund managers can reduce at least some of the cost through techniques such as lending out the fund’s underlying stocks for payments, and buying stocks ahead of anticipated additions to their index.
From Vanguard:
Not all index fund managers have equal skill in tracking target benchmarks. Skilled managers may, for example, be able to minimize the transaction costs associated with managing the portfolio.
Vanguard and Fidelity both seem to be adept managing index funds well. Here is an article from Efficient Frontier (see, I told you it has some good stuff.) that discusses this further, calling it transactional skill, as opposed to stock selection skill.
Summary
This article is intended for people who have already decided that index funds are best for them, and they are just wondering how to best implement it. As the title says, it was a close race and there was no runaway winner. This is important! It’s unlikely you’ll end up in the poor house due to picking over the other.
Now, if you do want to optimize, the article indicates that while low expense ratios, structural tax advantages, and good management are all important, any one by itself won’t guarantee the absolute best performance. You have to find the best combination of all three, as well as consider things like fees, commissions, and minimum balance requirements.
Posted in Investing | 10 Comments »
About My Credit Card Debt
Newer readers may be alarmed by my high levels of credit card debt. In short, I’m borrowing money for free and keeping it in safe investments while earning me 5-6% interest. Along with other things, this helps me earn extra side income of thousands of dollars a year. Recently I wrote up a series of step-by-step posts on how I do this. Please check it out if you are curious.
Commentary
- The stock market apparently went up this month, again confounding many experts and increased our IRA balances. I continued my monthly contributions towards buying FSTMX within my Self-Employed 401(k).
- I moved $1,050 into my Zecco brokerage account and made a few free experimental ETF trades. I’ll share the details in the 2nd part of my Zecco review.
- Another good month of controlled spending gets us to $66,520 of non-retirement funds, reaching 67% of our midterm goal of house downpayment. Total cash is now $56,025.
- Two things that helped boost our savings were the $350 from Vegas gambling winnings and $520 from optimizing credit card cashback on my Citi Driver?s Edge Mastercard.
You can see all my previous net worth updates here. Looking ahead to future expenses, we need to start looking into moving companies.
Posted in Goals | 24 Comments »
Most of this post was originally published last year when I was a guest writer at the Get Rich Slowly blog. I have since made some revisions and added some more material below.
One common thread through my How much house should I buy? post is that whatever size house you get, you’ll expand to fill it up. This reminded me a lot about what I call “lifestyle inflation” - the phenomenon where no matter how little or how much someone earns, their spending tends to match their income.
When you were a student, your friends were also broke, and it was easy to eat frozen pizza for dinner and manage without a car. That was probably one of the funnest periods in your life! But when you have more money, you start looking to upgrade: a nicer car, a bigger house, brand name clothes, cooler gadgets. Why? Call it peer pressure, entitlement, or simply money burning a hole in your pocket.
As we progress along our career paths, here are a couple of things that my wife and I are trying to do in order to keep our lifestyles in check:
- Put saving first. You?ve heard it before, but that?s because it?s works. Pay yourself first. If you get a raise, immediately increase the percentage going into your 401k, IRA, or brokerage account. The less that?s ending up in your bank account, the less you?ll have the urge to spend.
- Put debt last. Making more does not mean you should borrow more, contrary to what the credit card companies or other lenders may suggest. If you have debt, pay it down. If you don’t, keep it that way.
- Living on one income. Our dream goal has always been to be able to both work half-time in order to have more time to raise our future children. If this can?t happen, then one of us will work while the other stays home. This is a conscious decision to actually make less money, in order to focus on the more important things in our life. Of course, we’ll have to work double-hard now in order to make our hourly income high enough to pull it off!
In the meantime, even though both of us are currently working, we are still trying to live as if we only had one income. Over the last 12 months, we saved 43% of our after-tax income.
- Buy an affordable house. For most people their largest monthly expense is housing. Affordable does not mean what the bank will let you borrow! By simply buying the biggest house possible, you?re also inflating many other things. You have to furnish all those extra bedrooms, heat them every winter, cool them every summer, and insure them. As we plan to live in a very expensive area, this rule will probably be the hardest for us not to break, especially on one income.
- Be realistic about cars. Probably the second largest monthly expense for many, I am always amazed when people’s car payments are more than half of their housing payments!! But I also know that a new luxury car means more than just higher monthly payments. It means higher insurance premiums, maintenance costs, and repair costs. It also likely has a bigger engine, which means less fuel economy, and may even require premium-grade fuel. Neither of us have ever owned a new car before, which helps keep our expectations low.
It may seem contradictory that we are moving to an area where the median home price is over $600,000, but that choice is predominantly due to a desire to live near family. In the end, we are trying to define a comfortable, simple lifestyle that focuses on what is really important to us. (Of course, we will won’t lead completely spartan lives…) The things that we buy on a $75,000 salary shouldn?t be much different than if we had a $750,000 salary. For example, my wife cuts my hair because I like having a simple haircut, it?s not difficult, and she does it how I like it. Even if we become millionaires someday, I think she?ll still cut my hair. I’ll let you know when we get there 
Posted in Frugal Living, Retirement | 33 Comments »
I opened up an online savings account at FNBO Direct this week for their 6% APY until 9/28. Here are my experiences so far as well as some first impressions of the account.
Legitimacy and FDIC Insurance
FNBO Direct is a division of the First National Bank of Omaha, which is a member of the FDIC. If you call the First National Bank of Omaha, they will confirm this link and the website. For the techie folk, the nameservers and IP address range of FNBO.com and FNBODirect.com are the same. Combined with the fact that this account has been around for months, I see no need to worry about the legitimacy of this bank. Many banks choose to distance their online branches from their existing customers, as they are trying to gain new money and low-cost customers who are comfortable with things like electronic statements and online banking.
Opening Process Overview
The opening process went very smoothly. The CashEdge-based application is similar to that of HSBC Direct, but unlike with HSBC there is nothing to wait for in the mail. Nothing to send in either; No paper needed at all!
The application does include an identity verification test based on information from your credit reports. This is identical to what Washington Mutual does for its online savings account. If you have troubles with this, I recommend checking your credit reports for errors. However, a hard credit pull is not performed so it won’t affect your credit.
You can fund via wire transfer, online transfer, or by mailing a check. Here was my timeline:
- Day 1: Apply online, pass identity verification. Receive e-mail that application was approved. I chose to do an online transfer. Trial verification deposits were sent to funding bank.
- Day 2: Trial deposits received, and verified (free 57 cents!). FNBO Direct initiates funding transfer.
- Day 3: I receive my new account number via e-mail, and enroll for online account access. Initial deposit hasn’t showed up, but should go in on Monday (see below). I can add link additional accounts (max of 3) and initiate other transfers.
Account Features, Transfers and Usability
Features
Overall, your basic ING Direct clone - $1 to open, no monthly fee, no minimum balances. Otherwise, it’s pretty barebones. No checks. No ATM rebates. You can request an ATM card, which I did, but since it costs $2.50 for each cash withdrawal, I never plan on using it. Here is their complete fee schedule.
Of course, we all know the best feature is the 6% APY interest rate
Transfers
Again this is the familiar CashEdge interface behind the online fund transfers of banks like Bank of America, Presidential Bank, and HSBC Direct. All transfers are free, and the transfer limits are very generous. The transfer schedule appears to be identical to that of HSBC Direct, and takes three business days. (Worst case: If you initiate on Thursday, money is taken out on Friday, but deposit won’t show up at receiving bank until Tuesday.) I know many people dislike these slow transfers, so you should be aware. Here is a screenshot of the schedule:
Note that your initial deposit will not be available for withdrawal for six business days, probably for security reasons.
Usability
The interface is very simple and utilitarian. I like it. There are only three tabs - View Accounts, Account Services, and Transfer Funds. (Click for a full screenshot of the interface.)
More Information
Customer Service: 877-370-3707, open 24/7.
I’ve called customer service a couple of times, and they do answer and are helpful. Hold times may last a few minutes, but it’s probably due to the recent rush of applicants.
Number of external bank account links allowed: 3
ABA Routing Number: 104000016
I asked them if I could set up third-party transfers like paying my credit card bill with the routing and account numbers, and they said that would be fine. Hopefully it stays that way…
Download formats available: I see no options at all for this. No MS Money, Quicken, or even .csv options.
Interest compounding frequency: Interest is calculated daily and is compounded and credited monthly. Remember, how often interest is compounded really matters very little, especially if you are comparing APYs.
If you have any other experiences or questions, I’ll try to address them in the comments if I can.
Posted in Banking | 253 Comments »
Want more to read about investing? Here are two sites that have supplied me with a lot of good food for thought. I find these intriguing because while both are written by men well known for their financial acumen, they often sway far from those topics and can touch on politics, family life, and the pursuit of happiness in general.
Warren Buffett - Berkshire Hathaway Shareholder Letters
Every year, Mr. Buffett writes a letter to shareholders that discusses his company’s successes, mistakes, future moves, and a bit of everything else. Although I don’t view him as a deity like many others do, and have no plans to buy any BRK stock, I do find his writing to be easy to follow and often offers fascinating insights to a successful investor’s thought process.
However, I think one thing that people overlook is that Warren Buffett gets very intimate with many of the companies that he invests in, either with close relationships with the management or even by becoming the management for a while. He knows these companies inside and out, and can affect change within them. That’s something the common investor can’t easily emulate.
William Bernstein - EfficientFrontier.com Articles
In addition to being a practicing neurologist, starting a portfolio management company, and writing one of my favorite books on investing - The Four Pillars of Investing, Mr. Bernstein also writes a quarterly article on his website EfficientFrontier.com. It mainly discusses asset allocation, such as his thoughts on commodities, but has also wandered into areas like the housing market and estate taxes.
Here’s an excerpt from this most recent article:
If you want to pick your own stocks and bonds, be my guest. Just don?t imagine that making your decisions on the basis of publicly available information and analysis will lead you anywhere but to the poor house. You?re going to have to look at the primary data and analyze it entirely by yourself. And you?d better be good at it.
Posted in Investing | 7 Comments »
Housing bubble concerns aside, we’re starting to look at some homes on the internet to get an idea of what prices are like right now. One thing we need to decide is what size of place to look at. I was going to title this post “How big a house do we really need?”, but I realized that too often the word “need” is used when we really mean “will be satisfied with as the spoiled people that we are”. 
I mean, I spent the majority of my childhood living in an 800 sq. ft. apartment that is smaller than where we live now with half the people. And now I’m complaining about clutter! What happened?
There’s also been some rumblings about the backlash against so-called McMansions, so I decided to look up some stats on average home sizes versus the average number of people in the household. The results were very surprising to me:
Source: U.S. Census BureauSo from 1970 to 2004, the average household shrunk by 27%, but the average square footage grew by 66%. (Using median numbers gave similar results.) Now numbers can be misleading, but just by looking at the layout of older houses, people really do seem to expect more space now.
Right now it’s just the two of us. Kids are a big unknown, it could be a couple years, it could be more. Hard to predict. Our parents are also hinting that we should have an extra guest room too (ahem). Initially, we are looking at detached homes of about 1,500 square feet, which usually results in a kitchen, one living room, one dining area, 3 bedrooms and 2 baths. No formal dining rooms, family rooms, or other such extras. Since I want one room to be a home office, that leaves one bedroom for us and one flexible bedroom that could be a guest room or for children someday. In the future, I could conceivable make the home office convert to a guest room at night
We know the “average” person moves in less than 7 years, but all of our siblings have settled down in their first homes. And the whole reason we are moving is to be near family, so this home might just last us a very long time. Still, we could go smaller and get a 2-bedroom condo for now. This would save some money now, but we’d have to move again later.
It’s a tough decision! Homeowners: How did you decide how much space you wanted to buy? Was it limited to how much you could afford, what was available in the neighborhood you like, what your friends had, or other considerations? Did you buy what you need right now, or did you look ahead to the future?
Posted in Real Estate | 77 Comments »
With all these new online banks which are pretty much just virtual branches of a lot of regional banks, I thought it would be a good idea to look more into this whole FDIC insurance thing we put so much trust into. First some quick basics, taken from the FDIC website:
What Does the FDIC Insure?
The Federal Deposit Insurance Corporation (FDIC) is a government corporation that insures all deposits at insured banks, including checking and savings accounts, money market deposit accounts, and certificates of deposit (CDs), up to the insurance limit. Use this form to find out if your bank is insured.
How Much Does It Cover?
The basic insurance amount is $100,000 per depositor per insured bank. Certain retirement accounts, such as Individual Retirement Accounts, are insured up to $250,000 per depositor per insured bank.
Way To Increase Your Coverage
Since accounts at different banks are insured separately, the easiest way to increase your coverage is to simply keep less than $100,000 at any one bank. You could have $100,000 each at 500 different banks, and be insured for $50 million in total.
You may also qualify for more than $100,000 in coverage at one insured bank if you own deposit accounts in different ownership categories. For example, here is a way that a husband and wife could qualify for $600,000 in total insurance all at one bank:
What Happens If My Bank Really Fails?
First off, I would note that the FDIC does not notify people that their bank is about to fail or has failed. The only way to you find out is when your debit card gets denied or you walk up to your bank and it has a new name. Here is a list of banks that have failed since October 2000, which includes a summary how it was handled.
The Finance Buff has a good post about what happens when your bank goes out of business. The example given is Metropolitan Savings Bank in Pittsburgh, which the FDIC took over just three months ago.
Here’s the timeline: The FDIC announced the bank’s takeover on Thursday. By Monday the deposits have been taken over by another bank, the branches were re-opened, and the insured people have access to their money again.
But, out of the $12 million in deposits in the bank, there were 30 account holders with total assets of $1.2 million not insured by the FDIC. Those people are now creditors to the receivership of the failed bank, and must wait as the FDIC liquidates the bank’s remaining assets. Waiting on the light fixtures to be sold until you can get any of your money back? Not good.
The takeaways here are
- Banks still fail, and without warning.
- If your money is insured, it is unlikely any failure will interrupt access to your funds for long. Either another bank will take over (they all want more deposits), or the FDIC will pay out from their reserves.
- Never exceed FDIC insurance limits, because you may never see your uninsured money again.
Posted in Banking | 48 Comments »
Update: Please see my FNBO Direct Review for more info!
Rate chasers rejoice! Look likes with the expiration of the HSBC Direct 6% APY promotion yesterday, the online bank FNBO Direct has decided to offer the rate of 6% APY until September 28, 2007. $1 to open, no monthly minimums, no credit check, previous rate was 5.25% I believe. Anybody use this bank before?
As usual, check out my Ultimate Rate Chaser Calculator to see the potential profit from a move after accounting for transfer time. I hope they don’t pull what Umbrella Bank did - change their guaranteed date from 12/31 to 7/31 a day into the promotion. Thanks Steve for the tip.
Posted in Banking | 89 Comments »
If you look at the progress bars on the top right of this site, you’ll see our current progress towards our mid-term and long-term goals. I just wanted to spend a minute and discuss these goals, as I haven’t revisited them in a long time.
First of all, these were initially set over two years ago. Since then, I’ve quit a well-paying steady job, went back to school, and started doing a combination of mismatched jobs. Only recently am I about to get back on a stable income. My wife is doing incredibly well in her career, exceeding even our expectations. In other words, there’s no way we could have predicted how the last two years have turned out.
$1,000,000 Long-Term Goal… Sooner Than You Think
Many people point out that we’re going to need much more than $1,000,000 in order to retire. I totally agree - that’s why the deadline for this goal is actually set at age 45, after which we plan to keep working for another 10 years (and allow that million to keep compounding away). My goal remains to become “financially free” by age 55, meaning I don’t have to work, even though I’m sure I’ll need something to keep me occupied.
This gives me a goal that’s within 20 years from now, and a nice round number that I can wrap my head around. At the same time, we don’t want to be mercenaries - we both want meaningful jobs that won’t make the next 27 years miserable.
$100,000 Mid-term Goal… Almost Time!
Again, this goal was made based on me keeping my old job and income. Quitting put us behind (check out the dip in our net worth history chart), and it is unlikely we’ll catch up in time. Saving up $100,000 in non-retirement assets (mainly cash) for a house down payment is a lot harder than I thought. You don’t get the benefit of big stock returns, nor the time to compound them. It’s just cold reality - every dollar you spend is one less towards your goal.
Still, we try to maintain a good balance between saving and enjoying our lives, and with the housing market looking the way it is, we aren’t in a hurry to buy. If anything, our income by the end of 2007 will be higher than what we would have expected before, so it’s all good.
In the end, I’m still glad we made these goals, as it has definitely helped focus our energies. Hopefully my next post on this topic will be about the completion of this mid-term goal and the need for a new one!
Posted in Goals | 16 Comments »
Since I already wrung a few extra dollars from my cell phone bill with the Sprint SERO plan, I figured I’d try the same with another monthly expense - Cable TV and Broadband internet access with Comcast. Even though I know there are slightly cheaper options than Comcast in my area (satellite and DSL), I like being able to use my existing TiVo and the speed of Cable internet. To compensate, I try to get all the discounts possible.
In the past, I’ve already haggled $138 off my cable bill over six months. Then when I had to move, instead of moving my service, I canceled and signed up again in order to take advantage of their new customer promotions. This saved me another $250 including the free modem.
My discount expired a few months ago, and I’ve been paying full price without really thinking about it. But I just got notice of another rate hike yesterday, and my new bill is now barely under $100! Time for another call to Comcast. Here’s how the conversation went:
Comcast:How can I help you today?
Me: Hi, I’ve been a customer for a while now, and I’ve been seeing commercials for [competitor’s name] offering DSL for [price less than Comcast]. I’ve also noticed that you are offering new customers $19.99/month for High-speed internet. Is there any way you can offer that to me as well?
Comcast: Sure, let me check. [on hold] Yes, it shows you are eligible for a discount of $10 a month for 6 months. We can’t match [competitor’s name] because their DSL is slower than our service.
Me: Okay, great. What about TV? Am I eligible for any discounts there?
Comcast: Yes, you can get $15 off for 3 months. I have applied these to your account.
With a 10-minute phone call, I just saved another $105 ($60+$45) off of retail. And from the way she talked, it seemed like the computer has already pre-approved each customer for certain levels of discounts. If you’re paying full price, free money may be sitting there waiting for you to claim it! You don’t even need to employ any verbal ninja skills or Jedi mind-tricks.
I’m sure other cable providers have similar promotions. If you try, please share your experiences in the comments.
Posted in Frugal Living | 44 Comments »
