Archive for the 'Investing' Category
Wednesday, November 18th, 2009
Berkshire Hathaway’s (BRK) recent announcement that it was buying railroad Burlington Northern Santa Fe (BNI) also included a provision for a 50-for-1 stock split of B shares so that smaller shareholders of BNI would be able to be converted to Berkshire shares and avoid capital gains. Warren Buffett has been trying to avoid this for years, so after some random web surfing — I mean… research, I figured I’d share my findings.
At the end of trading yesterday 11/18, Berkshire’s A shares currently cost $103,100 apiece and B shares were $3,430. After a 50-to-1 split, a B share would cost about $69. Several news articles are talking about how this brings the share price down to the “common man”. For a $69 investment, you should able to attend the Berkshire Hathaway Annual Meeting in Omaha this May, although you could also buy tickets for $5 on eBay directly from BRK.
But wait, you may already own a piece of Berkshire… or you may soon.
S&P 500
Right now, Berkshire Hathaway is not part of the S&P 500. Many folks (including me in the past) thought the S&P 500 was simply the largest 500 companies in the US, but not quite. I’ve read that BRK is likely excluded due to inadequate trading volume of their high-priced shares. If the stock split occurs, it is possible that BRK will become part of the S&P 500 and thus be bought by every S&P 500 index fund out there. I’m sure Wall Street traders have already begun the speculating.
As of 1/18, the market cap of BRK was roughly $160 Billion. Looking at this chart of S&P 500 components sorted by size, BRK would actually be #9 on that list, as it is worth more than even Chevron or AT&T. If included, BRK would constitute about 1.65% of the index.
Total Stock Market
However, you may already own a piece of Berkshire if you own part of a mutual fund that tracks an index following the “total” US stock market. For example there’s the Vanguard Total Stock Market Index Fund (VTSMX), which is held within all of the Vanguard Target Retirement Funds. By my rough calculations, BRK is approximately 1.3% of the broad US market. So for every $10,000 of VTSMX or VTI you hold, you own $130 of BRK already.
Sharebuilder
Of course, for years now you could own $1 or $50 or $500 of BRKB by buying partial shares of BRKB through Sharebuilder ($25 bonus). You wouldn’t want to go too small as the $1 to $4 commission would take too big a bite, but it can be one way to gradually accumulate BRK shares. I think I have about $45 worth right now, myself, mainly due to an opening bonus.
Posted in Investing | 9 Comments »
Tuesday, November 17th, 2009
Speaking of LendingClub, I saw that they now offer a IRA with no opening fees and no annual maintenance fees. Previously, there was a $250 annual fee. However, it does now require an increased $15,000 minimum opening balance, which essentially restricts it to a 401k rollover or the transfer of existing IRA funds.
Since P2P loan interest is taxed at ordinary income rates like interest from savings accounts, the ability to place them in a tax-deferred account is attractive. But since person-to-person lending is such a new asset class, I would hesitate to make it larger than say 5% of my portfolio, which would require a total portfolio size of $300,000. So, I’m out.
It is interesting that the custodian EntrustCAMA allows a lot of options in their Self-Directed IRAs like holding physical precious metals, investing in private small businesses, and investing directly in real estate. I’m not sure if you can only hold LC notes in this free IRA.
Posted in Investing | No Comments »
Monday, November 16th, 2009
Over at Bogleheads there was an interesting thread which explored how finance professor Moshe Milevsky has been pushing the concept of human capital as an additional variable to the traditional ideas of net worth, portfolio construction, and asset allocation. These are explored in this this trade magazine article for financial advisors, this draft academic paper, and also in his book Are You a Stock or a Bond?.
Human Capital
There are some differing definitions, but below is a brief explanation (taken from the magazine article above) of what is meant by human capital here:
Human capital is a measure of the present value of your client’s future wages, income and salary (net of any future income taxes and expenses). For example, if she is a doctor, lawyer, engineer or even a professor, she has probably invested an enormous amount of time, effort and money to finance her education. That investment will hopefully pay off over many future years of productive labour income in the form of job dividends over the next 10, 20 or even 30 years. Sure, clients can’t really touch, feel or see human capital, but like an oil reserve deep under the sands of Alberta, it will eventually be extracted and so it’s definitely worth something now.
Milevsky likes to talk about people as businesses and thus includes human capital on the balance sheet of “Me, Inc.”:
When you’re young, your human capital may very well dwarf your 401k balance. With this in mind, it may make you feel better about any short-term losses.
Your human capital can be viewed as a hedge against the losses in your financial capital. So, as a 50-, 40-, or especially 30-year old, you should be willing to take more chances with your total portfolio, perhaps even borrow to invest or leverage into the stock market, because you have the ability to mine more human capital if needed.
Am I a Stock or a Bond?
One characteristic of your human capital to think about is if it tends to act like a stock or a bond. As a tenured university professor, Milevsky offers himself up as a good example of a bond that offers a reliable and steady coupon (paycheck). However, an small business owner, investment banker, or even a car salesman would have an income that is much more correlated with current economic conditions - much like a stock would.
A common piece of advice that relates to this is when people are told not to hold too much of their employer’s company’s stock (often in 401k plans). Since your salary is already tied to that company, it would be wise to add some diversification so that all your eggs aren’t in one basket.
Along the same diversification argument, if you are a “bond” then you may be able to take more equity risk in your retirement portfolio. On the other hand, if you are a “stock” then you may want to reduce your exposure to stock market swings. “Your invested assets should zig when your salary zags… tilt your financial portfolio away from your human capital.”
Thoughts
Unfortunately, rarely are things so simple. Human capital is at best a guess of the future, and you could be really far off. And just because your income isn’t tied to the stock market, doesn’t necessarily mean you can stomach the swings of a highly risky portfolio. If you’re the type to panic and sell at the bottom, perhaps increasing stocks would only hurt your long-term investment returns.
I like to imagine a good financial couple as one that pairs up a stock and bond. Perhaps one person holds a steady government job with a pension and healthcare benefits into retirement, while the other is an entrepreneur that takes some risks and tries to strike it big.
Also, what if I don’t want take advantage of all my human capital? Sure I could work for another 35 years and consider a big chunk of human capital in my net worth, but I’d really rather not. 
What do you think of this concept?
Posted in Investing, Retirement | 11 Comments »
Monday, November 9th, 2009
Online broker TradeKing has extended their $50 sign-up bonus for new accounts another month, until November 30th. You must open with $2,500, fund within 30 days, and make a trade within 180 days of account opening.
4) To qualify for this offer, new accounts must be opened and funded with $2,500 or more. Account funding must occur within 30 days of account opening, and one trade must be executed within 180 days of account opening, for account to qualify. Offer is not transferable or valid in conjunction with any other offer. Open to US residents only. One offer per household. TradeKing can modify or discontinue this offer at anytime without notice. The minimum funds of $2,500 must remain in the account (minus any trading losses) for a minimum of 6 months or the credit may be surrendered. Other restriction may apply.
TradeKing offers $4.95 trades with no minimum balance requirement. I’ve been using them for a while, they are a good basic broker. For more information, please check out my TradeKing Review.
Posted in Deals & Offers, Investing | 7 Comments »
Monday, November 9th, 2009
Mentioned previously, the cash rebate promotion offered by Prosper person-to-person lending has been extended to December 31st.
Original promotion
- Invest $1,000 to $4,999 by November 15, and you will still receive your 1% cash bonus by December 4.
- Invest $5,000 or more by November 15, and you will still receive your 2% cash rebate into your Prosper account by December 4.
Extended promotion
- Invest $1,000 - $4,999 by December 31 and receive a 1% cash rebate into your Prosper account by January 22, 2010.
- If you invest $5000 or more, you will receive a 2% cash rebate into your Prosper account by January 22, 2010.
Posted in Investing | 1 Comment »
Wednesday, November 4th, 2009
Prosper.com was the first big name in the person-to-person lending space. Things have been quiet recently, as they took a while getting SEC approval for their investment notes. In addition, the problems with “old” Prosper included the fact that they let just about anyone apply for a loan in the beginning, including people with horrible credit who had been basically turned down everywhere else. Many lenders thought charging a 35% interest rate was enough - it wasn’t. But as this recent Washington Post article outlines, things are picking up in the P2P space.
The way I see it, LendingClub (review, $25 bonus, performance update) basically looked at all the problems that Prosper had and tried their best to fix them. So now, Prosper is back, and in turn looks a lot like LendingClub. For example, LC requires a 660 minimum credit score to qualify for their lowest grade loan (amongst other things), and now Prosper requires a new borrower to have at least a 640 credit score with their new ratings system. With both, you can have them automatically construct a portfolio for you based on your risk/return preference, and you can buy/sell notes before maturity on a open trading market.
Prosper still has their “reverse auction” eBay-style method of determining the interest rate, but lenders are now are restricted to a specific range of interest rates. (LendingClub simply sets the interest rates for you.)
In order to stimulate lending activity, they have a few incentives going on. If you sign up as a lender and bid on two loans (minimum total investment of $50), they will provide you a free $50 bonus. Click here and on the orange “Invest Now” button and you’ll see it. You must reinvest this $50 by the end of 2009. On top of that, Prosper is also offering a 1% or 2% “rebate” back if you invest at least $1,000 or $5,000, which would help juice your returns. Details:
Starting on October 12 if you invest $1,000 - $4,999 you will receive a 1% cash rebate into your Prosper account or, invest $5,000 or more and receive a 2% cash rebate into your Prosper account. Lenders must invest the funds during the promotional period of October 12 through November 15 by being a winning bidder on loan listings that result in funded loans. Notes purchased through the trading platform are excluded from the promotion. Once you have bid and invested on the loan listings your 1% or 2% cash rebate will be deposited into your Prosper account by December 4.
Posted in Deals & Offers, Investing | 13 Comments »
Tuesday, November 3rd, 2009
Here’s a timely offer, at least for me. New-ish online broker OptionsHouse is offering 100 free trades when you open a new account with at least $3,000 with the promo code FREE100. The 100 free trades work for both stock and options trades, and are good for 60 days after funding. On top of that, their regular price for stock trades is only $2.95, while their options trades cost a flat $9.95 with no additional contract fees. Finally, there are no monthly minimum balances and no maintenance fees. Not a bad price structure.
Quality-wise, they promote the fact that Barron’s rated them #1 in Trade Experience and in the top tier overall in their March 2009 broker review. Although not a big name yet, they do seem like they are ready for serious traders. Here’s a snippet of the review:
Pros: As its name suggests, Options House has a lot of great tools for the options trader. Backed by market maker Peak6, this broker lets its retail customers use quite a few professional-level tools. Building a spread is very intuitive on this system, as is rolling a call or put from one strike to another. The site’s motto is “Fast matters,” and that goes for everything from finding possible trades to populating an order ticket to executing the trade itself.
Portfolio-analysis tools are top-notch here, too. The Risk Viewer includes a what-if calculator showing what could happen based on various market scenarios.
Options House also offers the Maxit tax-management tool for free. Although this is a Web-based platform, it has the flexibility and power of many of the software platforms.
Cons: No mobile access yet. However, the company says it is coming later this year. Limited fixed-income and mutual-fund offerings.
As noted I am starting to invest in some ETFs, so I might give these guys a spin. After looking through their fee schedule I noticed that they all partial outgoing ACAT transfers for free, which means that it won’t cost very much for me to move my holdings out if I need to. (Just transfer the important holdings out, keep one unimportant holding, and then sell it later.) I hope their free tax-management tools does my Schedule D for me.
Update: I just applied - relatively straightforward application, at the end you need to fax/mail in a signature page and a copy of your driver’s license or utility bill. They allow ACH funding online.
Posted in Deals & Offers, Investing | 7 Comments »
Monday, November 2nd, 2009
Schwab just sent me a press release announcing their new series of exchange-traded funds (ETFs) that have low operating expense ratios and passively track indexes.
The most commonly-noted drawback of ETFs is that you must buy them like a stock and thus pay trade commissions. However, if you buy these within a Schwab brokerage account, there are no commissions charged. Here is a chart comparing the new Schwab ETFs and their corresponding competitor from Vanguard. The ETFs don’t necessarily track the exact same index, but they are pretty similar.
This is definitely worth a second look. A possible criticism is that Schwab may increase expenses and reinstate trading fees in the future, which may lead to tax hits if you wish to switch back to other ETFs. Meanwhile, Vanguard has a long track record of rock-bottom expense ratios. However, it may also be that increased competition in this area by others like Fidelity and E-Trade will prevent this from happening.
Posted in Investing | 10 Comments »
Monday, November 2nd, 2009
Credit Card Debt
In the past, I have taken money from credit cards at 0% APR and placed it into online savings accounts, bank CDs, or savings bonds that earn 4-5% interest (much less recently), and keeping the difference as profit. I even put together a series of step-by-step posts on how to make money off of credit cards in this way.
However, given the current lack of great no fee 0% APR balance transfer offers, I am no longer playing this “game” and have just paid off my last 0% offer for now. This makes the net worth chart a bit funny, but it should clear up next month.
Retirement and Brokerage accounts
Our total investment portfolio increased by a few thousand dollars since last month. DW’s 401k was already maxed out at $16,500. I made another $1,000 contribution to my Solo 401k, for a total of $16,500 contributed in 2009 as well. (I forgot the limit was $16,500 and not $15,500 last month…) This makes us done with our goal of maxing out both our 401k salary contributions for 2009.
I am starting to build up too much cash, and have started investing for retirement in a taxable brokerage account as well. In the interest of tax efficiency, I’ll have to move around some investments in order to keep bonds in the tax-advantaged IRAs/401k and the “extra” stocks in taxable. I expect to finish investing $20,000 this week.
Taking that additional 20k into account, our total retirement portfolio is now $211,095, or on an estimated after-tax basis, $170,047. At a 4% withdrawal rate, this would provide $567 per month in tax-free retirement income, which brings me to 23% of my long-term goal of $2,500 per month.
Cash Savings and Emergency Funds
We keep a year’s worth of expenses in our emergency fund. Another $10,000 is earmarked for upcoming home improvement projects that I keep putting off (minor roof repair and solar water heating).
Home Value
I am no longer using any internet home valuation tools to track home value. Some people have suggested using my tax assessed value, but I also think that is too high. I simply picked what I felt is a conservative number based on recent comparables, $480,000, and keep it for at least 6 months if not a year. (Currently on month 2 out of 6.) For the most part I am concerned about mortgage payoff, which I still plan to accomplish in 20 years at most.
You can view previous net worth updates here.
Posted in Goals, Investing, Real Estate, Retirement | 17 Comments »
Thursday, October 29th, 2009
Here’s another good reader question about crappy 401k plans. Reader Robert saves enough to max out his 401k each year if he wanted to, in addition to maxing out his Roth IRA every year which he already does. However, his 401k plan is filled with expensive actively-managed mutual funds. He has no company match. Should he contribute to his 401k anyway, or invest outside in a taxable account?
Factor #1: How Long Will You Keep Your Job?
Even if you have a bad 401k plan, remember that as soon as you leave that company, you can roll over those tax-advantaged funds into a Rollover IRA at the company of your choice! You may or may not have a good idea of how long you’ll stay there, but the fact is most of my friends have not worked at any company longer than 5 years or so.
(A few plans offer what is called in-service withdrawals, where you can roll over your 401k fund into a IRA without leaving your employer. These are rare, but it’s worth asking about.)
Factor #2: Can You Help Your HR Department Make A Change?
The reason why expensive 401k plans exist is because they tend to be cheap for the employer. Essentially, the administrative costs for running the plan are shifted to the employees. Big companies tend to have better plans because they offer enough assets for companies like Vanguard to jump in.
Still, you might be able to enact some change. Print out some material about how high plan expenses can really hurt performance and thus people’s retirements. Talk to your co-workers, and make it an worker attraction/retention issue. You may not need to switch providers, but perhaps they’ll at least offer a better option or two. I’ve even read about Congress considering a law requiring all 401k plan administrators offering at least one index fund option.
Factor #3: How Expensive Is It?
Unfortunately for Robert, he shared his available investment options along with their annual expense ratios, and they are the worst I’ve seen yet:
Blackrock Fundamental Growth C MCFGX 1.94%
Blackrock Global Allocation C MCLOX 1.88%
Blackrock Government Income Portfolio C1 BGIEX 1.53%
Blackrock International Value C MCIVX 2.60%
Blackrock Large Cap Core C MCLRX 1.97%
Blackrock Large Cap Value C MCLVX 2.00%
Blackrock Value Opportunities C MCSPX 2.34%
Davis New York Venture C NYVCX 1.71%
Evergreen Core Bond C ESBCX 1.45%
J P Morgan Dynamic Small Cap Growth C VSCCX 2.12%
Mfs Total Return C MTRCX 1.52%
It may be tempting to think “well, no matter how bad the plan is, it will still be better than a taxable account, right?” Wrong. Actually, given current tax rates, it can be better to keep your money in a taxable brokerage account than in a 401(k) plan if the options are expensive enough. Here are some quick and dirty examples.
Let’s say you put in $10,000 in a taxable account. You invest in an index fund with 0.20% expense ratio. The broad US stock market earns 8% per year. Since you get the gains minus expenses, you get 7.8% per year. You get a 15% tax hit at the end for long-term capital gains. Your final after-tax balance after 30 years is $80,906. (Yes, I’m ignoring the annual taxation of dividends for now.)
10,000 x 1.078^30 x 0.85 = $80,906
Let’s say you put in $10,000 of after-tax money in a Roth 401(k). You buy a Blackrock fund with 2% expense ratio. Again, on average, all mutual funds that invest in the broad US stock market will earn the market returns (8%) minus expenses (2%), giving you a 6% return per year. However, you have no tax hit at the end since it is a Roth. (You’d get the same result with pre-tax money in a Traditional 401k.) Your final after-tax balance is only $57,434.
10,000 x 1.06^30 = $57,434
The above is a very simplified comparison, but the point is that the gradual annual hit of a high expense ratio can overcome the tax break advantage. Usually this takes an expense ratio above 1% and a long time horizon.
Recap / WWMMBD
If you think that your current plan options will continue to be this bad for the next 10 years or more, and you don’t think you’ll leave your company before then, then it may indeed be better to just invest outside a 401k plan. (Keep up the IRA contributions!) However, I think that soon 401k plans will be more tightly regulated, and the trend is for plans to at least offer a few low-cost options. I know my plan seems to get a little better every year. If it were me, I’d probably suck it up and still tuck money away in the 401k in the hopes of a brighter future.
Posted in Investing, Retirement | 36 Comments »
Monday, October 26th, 2009
In the book Paradox of Choice by Barry Schwartz, he talks about how there are two types of people, maximizers and satisficers (think satisfy + suffice). I will simply quote the excellent summary from the book’s Wikipedia page:
A maximizer is like a perfectionist, someone who needs to be assured that their every purchase or decision was the best that could be made. The way a maximizer knows for certain is to consider all the alternatives they can imagine. This creates a psychologically daunting task, which can become even more daunting as the number of options increases. The alternative to maximizing is to be a satisficer. A satisficer has criteria and standards, but a satisficer is not worried about the possibility that there might be something better. Ultimately, Schwartz agrees with Simon’s conclusion, that satisficing is, in fact, the maximizing strategy.
If you can’t tell already after 10 seconds of reading this site, I am a hardcore maximizer. I love collecting data, poring over alternatives, finding out secret exceptions, all so I can choose the “best” choice. I prefer the term “good enough-er” to satisficer. For some people, the second it reaches the “good enough” stage, they are done and move on.
A Pathetic Maximizer Story
This happened just last week. A friend of mine comes over, and brings some McDonald’s with him. After he leaves, I go to throw out the garbage but notice an unpeeled Monopoly game piece. I peel it out of curiosity, but I get no instant-win and two random streets (St. James Place and Atlantic Avenue). But wait… I vaguely know that one of the rules of the game is that if you collect all the streets of a neighborhood (same color), you win a cash prize. However, some streets are given out all the time, while others are very rare. What if I had one of the rare pieces?
Of course, I then had to fire up the computer and search for the rare pieces. Lo and behold, Wikipedia also has a list of all the rare pieces. For example, Ventnor Avenue is also yellow like Atlantic, but is always the “missing” piece and thus essentially worth $25,000 by itself. My pieces were of course worthless. But I still had to know.
Maximizing and Investing
I began to think about how this relates to personal finance. In investing, you’d obviously like to maximize your returns. However, it is very difficult to know in advance which stock or mutual fund will outperform the rest. You could read books, financial statements, interview executives, or watch CNBC all day. You could listen to Warren Buffett’s every bowel movement and dissect all his annual shareholder letters for hints and tips.
Or if you’re like me, you may decide that even though the market isn’t perfectly efficient, it is still very efficient especially when costs like mutual fund fees, trade commissions, and tax considerations are taken into account. I now invest passively, and agree to be “satisficed” with the returns of the world markets minus costs. But even here, I am trying to maximize my returns by minimizing costs by buying Vanguard index funds or similar ETFs so that my portfolio costs less than 0.20% of assets annually.
Better to Satisfice?
The things I could maximize financially go on and on. From bank interest rates to cell phone plans, credit card reward structures to auto insurance premiums. Would I be happier if I just picked something “good enough” and moved on? Perhaps it is you readers that are the smartest, letting us slightly kooky bloggers do all the research for you, and then just picking what is good enough for you! 
Where maximizing hurts most is when it stops you from taking action. It doesn’t matter if your interest rate is 1.8% vs. 1.85% when your money is still stuck in a 0% checking account at some megabank. It doesn’t matter if you get the optimal 401k asset allocation if you’re not even contributing the most you can to the plan. For me, I have been putting off fixing up my house and adding solar hot water for several months because I want to find the “best” contractor. Meanwhile, I’m still using too much electricity and the tax breaks may expire.
Are there some things where you maximize, and others where you satisfice?
Posted in Frugal Living, Investing, Time Management | 15 Comments »
Thursday, October 22nd, 2009
For a long time, the my knowledge of bonds could be summed up in one sentence: Bonds are an IOU where you lend money to someone and they pay you interest plus your principal back eventually. There are many risks with bonds, and just two of them are credit risk and interest rate risk. Credit risk is the possibility that you won’t be paid back. Interest rate risk is the fact that once you’ve bought a bond, the value of that bond varies with prevailing interest rates.
Why Bond Values Change With Interest Rates
Let’s say you bought a bond from the US Treasury for $1,000 at pays 4% annual interest once a year ($40). What if the next day, market conditions change and now the US Treasury offers $1,000 bonds paying 5% interest ($50). Nobody would buy your bond for $1,000 anymore, they’d only pay $800 for it, since $40 is 5% of $800. This is why you may have read that bond prices tend to move in the opposite direction of interest rates.
So what’s the next level of understanding? I think this recent Vanguard Blog article on bonds expands on things nicely. The primary point is that the impact of rising or falling rates on bond returns varies depending on time horizons and the duration of your bonds.
Maturity vs. Duration
When you look at the stats for a bond mutual fund, you’ll see both average maturity and average duration. While a bond’s maturity is how long before your principal is repaid, the fact that most bonds pay out regular interest payments (coupons) changes the actual sensitivity to interest rates. This is where average duration comes in - it takes into account the relative discounted cash flows to accurately measure price sensitivity with respect to interest rate. Short version: Look at duration, not just maturity.
Time Horizons
The table taken from the article shows how the impact of interest rates changes with time horizon. In this scenario, you have a bond fund with a duration of 5.8 years and an initial yield to maturity of 4%. Then we see what happens if rates either stay the same, rise to 6%, or drop to 2%. (Rates are assumed to change evenly over two years). As with most bond funds, the interest income is continuously reinvested into new bonds.
If your time horizon is a lot shorter than your duration, then we see that the major risk is rising interest rates. Rising rates can crush your returns, while falling rates can boost them. However, if your time horizon is a lot longer than your duration, then the larger risk is lower interest rates, because as you re-invest your interest payments into new bonds (with lower interest rates), those lower rates will hurt your return in the long run.
Another interest thing to notice is that if you held for the exact length of the duration, 5.8 years in this case, then your annualized return would be very close to your initial yield of 4%, regardless of whether rates rose or fell.
In general, if you’re saving for a short-term goal, it may be wise to pick a duration that is also short enough so that interest rate swings won’t wipe you out. If your time horizon is for a retirement that is decades away, then picking a duration for a bond fund is more about other factors than just predicting upcoming interest rates. Remember, future higher interest rates can actually help your long-term returns. For example, consider the balance between the increased volatility of long-term bonds with their higher long-term historical returns.
Posted in Investing | 11 Comments »
Monday, October 19th, 2009
Over the weekend, I finally got around to reading this Time magazine article about Why It’s Time to Retire the 401(k) which has been getting some buzz. The author promotes bringing back what I call “portable pensions” to replace the employee-controlled 401(k) plan, which would guarantee say 50% of your last year’s salary for the rest of your life. Sounds nice, but how will it work, and who’ll pay for it?
Take the Mr. Shively in the article, who is still working at 68. About 25 years ago, his employer dropped the pension and replaced it with a 401(k). Over those two and a half decades, he has managed to save $70,000 in a 401(k). Yet it is suggested that if only his company kept the pension, he would be getting $1,308 per month, or $15,700 a year. Such a lifetime of cashflow from age 65 would cost at least $200,000 according to ImmediateAnnuities.com ($250,000 if joint, covering a spouse also age 65). Where did the $130,000-$180,000 difference come from?
Pensions are more expensive to run than 401(k) plans. Let’s say you have average employees making $50,000 a year and you match 100% up to 5%. That costs $2,500 a year - bang, you’re done, and you don’t have to worry about investing the money to meet future liabilities. Where does the savings go? Either Shively got paid more (through higher salary or matching contributions) and didn’t save it, or his employer pocketed the savings, or likely a little of both.
This brings us to the other problems of the 401(k) system are, which were explored in this 2001 Barron’s article by William Bernstein after the last stock market crash. “The 401(k) is likely to turn out to be a defined-chaos
retirement plan.”
Employees are not saving enough. Will this be fixed by a portable pension? Only if employers are willing to pay higher total compensation, which is unlikely. Otherwise, will people really be okay with forced savings like an additional mandatory 5-10% contribution? Folks tend to see that as a tax, like Social Security.
Investors are depending on future market returns which will likely not be as high as in the past. The idea of gaining 8% per year, 5% after inflation, sounds nice but may not happen in the future. Current P/E ratios are still above average current. This means people will need to save even more than they thought. Again, where will this money come from?
401(k) expenses are too high, which reduces returns even further. Having a guaranteed income for life requires insurance companies. Which means instead of mutual fund expenses, you’ll have hidden insurance fees and guaranteed returns that will have to be significantly less that market returns. If more transparency and direct competition existed, perhaps the costs could be minimized.
Investors have poor investing knowledge. This is kind of an unsaid reason of why 401(k)s are bad, because there will always be those invested poorly. My concern is related to this recency bias. 401ks got traction initially because markets were hot at the time. Talk of pensions increase now because the recent performance was awful. What happens when the markets get hot again? Will people be happy with their 6% steady increases when others are gaining 30% in year?
I’d like to see what happens with this “portable pension” idea, but the practical realities concern me.
Posted in Investing, Retirement | 19 Comments »
Monday, October 12th, 2009
If you haven’t noticed already through your portfolio statements - the stock markets are doing well in 2009. The broad US stock market and the broad developed international markets are up 22% and 29%, respectively. Some funds are doing especially well, such as the Vanguard Emerging Markets Stock Index Fund (VEIEX) which is up +62.6% year-to-date.
Vanguard recently sent me a newsletter with a link to an article titled Strong 2009 performance warrants yellow flag, which states in part:
While it may be gratifying to see these robust gains lift the balances of your funds, the markets have “come a long way in a hurry,” as the saying goes. At this point, it may be wise to ensure that your asset allocation is in line with your long-term goals.
A discussion thread on this article at Bogleheads had member Robert T pointing out the following comparisons in 2008 and 2009 YTD performance data:
Many of the asset classes that got hit the worst in 2008, have made the largest comebacks. Of course, we can’t know for sure if this surge will continue or if we’re headed back down again. But I think Vanguard’s advice is sound, to make sure our asset allocations are on target. If you had the guts to rebalance at the end of 2008, then buying more stocks “low” would have paid off nicely. Right now, you’ll want to make sure you’re not overweight in stocks.
I have been using my ongoing investments to balance out my asset allocation through the year, but as my latest portfolio snapshot shows, I am still overweight in Emerging Markets and underweight in bonds.
Is your asset allocation where you want it to be?
Posted in Investing, Retirement | 20 Comments »
Saturday, October 10th, 2009
Here’s an update for my person-to-person (P2P) lending activity at LendingClub, which are unsecured loans between U.S. residents. It could be to help people pay off credit card debt, home improvements, business financing, or even buying a house. You can think of it as taking out the bank middleman, which pays tiny interest on checking account balances and then charges much higher rates to borrowers.
LendingClub Portfolio
I now have made 62 active loans with $1,680.08 in outstanding principal. Most are A grade, with a decent spattering of Bs. Keep in mind that a borrower has to have a 660 credit score as well as other additional requirements just to make their lowest G grade. (Only about 10% of loan applications are accepted.) Although they do have an automated service to pick for you, I tend to pick my own loans to try and find both a combination of good risk profile and also a person who I want to help out. It’s kind of a hobby of mine. Here is a screenshot from my account page:
Performance & Commentary
The good news is that out of my two previous late loans, one of them is now current again and the other one is on a “payment plan”. I am not sure if that means they lowered the amount due, or that they are just allowing a slower payback temporarily, but it is again showing regular payments (and contact) from the borrower. Much better than reading “left voicemail. left voicemail. we haven’t heard from them in 4 months…”. I have no defaults to date.
According to LC, my “Net Annualized Return on Investment” based on my interest payments received so far is 9.14%. As an investor, I would not expect this rate to be my actual rate to maturity, but so far so good. While my goal is to get a substantially higher yield than from a online savings account, it also comes with a healthy dose of risk. Don’t put your emergency fund here!
$25 New Lender Bonus
If you are interested trying P2P lending with no risk, you can still use this special $25 lender sign-up link to get a free $25 to try it out with no future obligation. There is no credit check and you don’t even have to deposit anything. After you are approved, the $25 will show up in your account balance, and you can lend it out immediately.
If you’re looking to borrow at LendingClub, it’s relatively straightforward. Send in your information, and see what interest rate they offer you. Compare it with your credit card or other financing options. If you like it, fill out your application carefully (verify income if possible) and go for it. If you don’t like the rate or the full amount is not funded, you can either accept partial funding or walk away with no obligation.
Posted in Investing | 18 Comments »
