Archive for the 'Investing' Category
Online broker TradeKing.com has a new $50 sign-up bonus for new accounts as part of celebrating National Friendship Day. If you get a referral from an existing account holder, fund it with at least $1,000, and make a trade, both people will get $50. This is the best promotion from TradeKing in several months.
New qualifying account must be opened within the dates of 7-31-08 to 8-28-08. New referred client must fund their account with a minimum of $1,000 within 30 days of opening the new account. New referred client must also execute at least one trade in the new account within 180 days of the account opening. The minimum funds of $1,000 must remain in the account (minus any trading losses) for a minimum of 180 days or the credit may be surrendered.
I have an account, so if you’d like a referral just contact me, and I’ll be happy to send you one. I only need your e-mail address. For more information on TradeKing, please check out my TradeKing Review.
Posted in Deals & Offers, Investing | 3 Comments »
My mom has been asking me to look over her 401k plan, as she has been worried about its performance and suitability recently. In fact, she changed all the future contributions to 100% bonds a while back. As her 401(k) had somewhat limited choices (although they could definitely be worse), I had to make do with what was available. Usual disclaimer applies: I am not a financial professional.
1. Decide on an asset allocation.
This can be a complex topic, but I put most of my research in this series of posts on asset allocation. Given my mom’s age, years until retirement, other existing investments, and and risk preferences, I recommended an overall asset allocation of 60% stocks and 40% bonds. Currently, she is at 68%/32%. I would definitely like to have at least a broad US stock fund, a broad international stock fund, and a broad US bond fund. It might be nice to have Large-cap Value, Small-cap Value, Emerging Markets, Real Estate, or Inflation-protected Bond funds. The final ratios will be similar to the asset allocation breakdown here.
2. Make a list of fund options and characteristics
First up, you’ll want to gather a list of all your available investment options. Usually this includes about 5-30 mutual funds. If the fund details are not well organized, just ask for the ticker symbol and pull up their Morningstar.com snapshot. Put them in a spreadsheet, and include the each fund’s asset class, any front- or back-end loads, and annual expense ratio. Here are the 15 options in my mom’s 401(k) plan:
Now, I am completely ignoring Morningstar “star” ratings. They are based primarily on past recent performance, which have been shown to be a poor indicator of future long-term performance. You could buy a 5-star fund and have it end up a 1-star fund a few years later. Fund managers change all the time as well. I want to create a low maintenance portfolio that doesn’t involve chasing hot managers or performance.
3. Narrow down the options by cost and asset class.
If I don’t need the asset class, then I cross it out. If there are two similar funds, then pick the cheaper one with lower loads. In my “nice to have list”, if it is too expensive, then it becomes less useful as a diversifier and I cross it out as well. An example is the AIM Real Estate fund, with the 5.5% front load. The 6 bolded funds above are the ones that I am left with.
4. Decide if you are going to do a full asset allocation or cherry pick
It is often recommended that you implement your asset allocation across all your investment accounts (401ks, IRAs, brokerage) as one pie. For example, you might hold all your bond funds in tax-sheltered accounts for optimal tax efficiency. Or your 401k might only have one really good fund, and you can buy the other asset classes elsewhere. If this is the case, then you might want to cherry pick the funds you want for your 401k.
For other reasons, you might just want to implement your entire asset allocation as best you can within the 401k. I’m going to go ahead with this latter route for now.
5. Consider Target-date Funds or Pre-Set Model Portfolios
Many 401(k)s include an even simpler option, either all-in-one Target-dated funds or pre-set portfolio mixes. But all target-date funds are not made the same. Look at the prospectus and see what funds are included within them, and if they charge you an extra layer of management fees on top of the fees of the underlying funds. Many are crap, and you could do much better with your own custom mix. My mom’s 401k has no such option.
She does however, have a few options for pre-set model portfolios. These are basically a set ratio of selected funds (the pink and blue highlighted items above), which are are automatically rebalanced once a year. Shown above is the breakdown the “balanced model” option. However, I don’t like them because they include several expensive funds and exclude some of what I think are the best funds. Not including the large front-end loads of two of the funds, the average weighted expense ratio of the model portfolio was 0.59%.
6. Construct Your Custom Portfolio
In the end, I chose the 5 funds below. I decided to leave out Windsor II (Large Value fund) for the sake of simplicity. I calculated the averaged weighted expense ratio to be 0.48%.
7. Explain and Implement
Now, I have to explain to my mom why I picked these funds, and how they may perform in the future. If she wants, I may shift it to 50% stocks/50% bonds. I’ll check in on it again after a year to show her how to rebalance. This is not the perfect portfolio, but it will be better than her previous hodgepodge, and also be easier to manage.
Posted in Investing, Retirement | 15 Comments »
As outlined in this previous post about One Way To Track Your Progress Towards Financial Independence, you can say you’ve reached financial independence when your “passive” investment income equals your monthly expenses (”crossover point”):
The above chart was taken from the Your Money or Your Life, which also says the best way to generate income is by purchasing 30-year Treasury Bonds. But there are a variety of other ways that retirees generate income for retirement. Each one has their own pros and cons.
High-Grade Bonds or Certificates
U.S. Treasury bonds are a very safe and reliable way to generate regular income, as it is guaranteed by the U.S. government and they are very liquid. A similar situation results you invest in bank CDs or other investment-grade corporate or municipal bonds. The primary drawbacks are lower returns, especially relative to inflation. The 30-year bond is currently yielding somewhere around 4.5%. The current real (above inflation) yield for a 20-year TIPS (inflation-indexed bond) is only about 2.20%.
This means that if you want both the highest safety and you wish to only live off the interest of your money without ever touching the principal, you can only withdraw about 2.2% each year. That’s only $183 per month for each $100,000.
60/40 Asset Allocation with 4% Safe Withdrawal Rate
Although there is still much ongoing debate, the “4% rule” is based on on research by William Bergen:
William Bengen, a U.S. researcher, has back-tested a 4% withdrawal rate with a balanced portfolio of U.S. stocks and government bonds earning overall market returns and found that you would have been able to safely withdraw 4% of your portfolio over any 30-year period since 1926. [source]
The general idea is that if you have a portfolio with an asset allocation of 60% stocks/40% bonds, you can withdraw 4% of the portfolio each year with only a small chance of running out of money somewhere down the line. A 4% withdrawal rate would be $333/month for each $100,000. However, your portfolio will experience wilder swings, and this rigid method is very sensitive to the returns in the first years of retirement. If you have a bad decade upfront, your chance of going broke rises quickly.
Income-Focused Mutual Funds
These are mutual funds who primary objective is not growth, but to create a stable income stream from a combination of stock dividends and bond interest. The secondary objective is some capital appreciation, which ideally will help the income stream to keep up with inflation.
A passive index fund example is the Vanguard Target Retirement Income Fund (VTINX), which is currently yielding 4.05%. A popular actively-managed example is the Vanguard Wellesley Income Fund (VWINX), which is currently yielding 4.71%. Both of these funds hold roughly 35% in stocks/65% in bonds. Wellesley has been around since 1929, and many retirees swear by the reliable income it produces.
Managed Payout Mutual Funds
A new breed of mutual funds actually adjusts to help you spend your money as fast as you like. You choose how fast you wish to withdraw your money (3%? 5%? 7%?), and the fund does it’s best to accommodate that without going broke. Vanguard has their Managed Payout Funds, and Fidelity has their Income Replacement Funds.
These funds help you create regular monthly payments like an annuity, but still include risk from the stock market. They are also very new and could be seen as unproven.
Individual Dividend Stocks
I know of several retirees who manage their own portfolios of individual stocks. These people accumulate shares in companies with a history of reliable stock dividends, like General Electric and Coca-Cola, and live off the dividends. An ETF of top dividend producers, DVY, currently yields 5.14%.
I would be wary though that the share value of these stocks can vary widely without the cushion of bonds. DVY has dropped by over 20% so far this year, which is indicative of many similar dividend stocks.
Income Annuity
With a simple version of an immediate annuity, you hand over a lump-sum upfront in return for fixed income payments for life. Of course, if you die early then you don’t get your lump sum back. However, you could live until 110. It’s almost like life insurance in reverse. A special risk here is that your insurance company must stay solvent the entire time, so you must check credit ratings.
I went to ImmediateAnnuities.com and looked into a Joint Annuity, where the income payments keep coming as long as one of us are alive. A rough quote for a 40-year old says that each $100,000 paid will get me about $450 a month. That is the same as saying I can earn 5.4% interest forever, but remember that I lose the principal. Of course, this value goes up with age. For a 60-year old couple, you can get 6.4% forever. At age 70, you can get 7.5% forever.
How much income will a million bucks get you?
Based on these numbers, with $1,000,000 one could get anywhere from $1,830 a month (very little risk, no principal loss) to $5,833 per month (fixed annuity at age 65, all principal is given up). I’d probably end up going with something in between, but it is food for thought.
Posted in Investing, Retirement | 28 Comments »
I believe in holding a diversified, low-cost, passive investment portfolio. However, at the same time there is so much financial hype out there that I understand the natural tendency of people (especially intelligent, hard-working, competitive people) to actively manage their investments. They may think they can pick the best growth stocks like AAPL or GOOG, they may be Buffett disciples and search for durable competitive advantages, or they may be stable dividend seekers. Or maybe they just want to pick the best fund managers instead.
But what if you suck at it? By investing in low-cost index funds, you are essentially guaranteeing yourself to be somewhat above average every year. Wander off-course, and you could do great, or more likely you could crash and burn.
Many people decide mitigate this risk by doing some form of Core and Explore investing, where you keep most of your money in passive funds and gamble a bit with the rest. Since I do this myself to a (very) small degree, I’ve been toying with an idea that takes this one step further.
1. Start Out Small
Let’s say you are young and aggressive, and want your portfolio 100% stocks. Let’s say you carve out 5% of that, throw it into a cheap discount broker, and start trying some ideas out.
2. Track Your Performance Honestly
Thinking you’re doing well at stock-picking without knowing your relative performance is like running around the track alone with no stopwatch and saying “Gee, I’m fast!”. To gauge your self properly, you need to:
- Keep track of all investment inflows and outflows. This means keeping track of all your contributions, buys, sells, and fees/commissions paid.
- Account for uninvested cash. If you would have put $1,000 into an index fund, but instead bought $500 of GE, that means you also have $500 of idle cash earning 0-4%.
- Calculate your return properly, taking into account the information from the previous two steps. Here are two ways, one provides an estimate while the other gives more accurate numbers.
- Pick the appropriate passive benchmark portfolio. For example, the S&P 500 only works if you are investing in large, US-based companies.
3. Adjust Based On Your Relative Performance
You should run a comparison with your benchmark regularly. Each year that you beat your benchmark, you can increase the percentage of your portfolio which you actively manage. If you lag behind the benchmark, you must decrease the percentage of your portfolio which you actively manage. A really crude rule might be simply to increase or decrease the active amount by 2% each year based on performance.
If you are truly horrible, you’ll be out of stock-picking completely in a few years. For most people, you’ll probably be out of it within a decade or so, having learned a valuable lesson. If you are the proper mix of skillful and lucky, then soon you’ll be controlling the entire portfolio.
Sound reasonable?
Posted in Investing | 20 Comments »
Okay, so I view my last post on 401k loans as a failure. I tried to use as little math as possible in explaining why 401k loans are not a bad idea due to the incorrect concept of “double taxation”. Instead, I probably managed to confuse many of you all further. I have tried to come up with a better example with the math thrown back in, and think I have found one. Please give me another chance! 
The Method
If double-taxation really occurs in 401k loans, that would mean that taking out such a loan somehow negates the inherent tax-advantages of the 401(k) plan. Certainly, taking a loan and paying it back would be worse than just leaving the 401(k) completely alone, right? I am going to walk slowly through three scenarios that will show that this is simply not true. The three hypothetical scenarios:
- Elton contributes $10,000 to a 401(k) and does nothing. He does not take any loans of any type. He waits a year and pays for his $10,000 wedding in cash.
- Elton contributes $10,000 to a 401(k). He then takes out a 401(k) loan of $10,000 to pay for his wedding, and then repays the $10,000 a year later using after-tax money earned from his job.
- Elton contributes $10,000 to a 401(k). He then takes out a credit card loan of $10,000 to pay for his wedding, and then repays the $10,000 a year later using after-tax money earned from his job.
Very Simple Assumptions
Annual gross salary is $20,000. Income tax is 25% of gross income. There is no interest charged on any loans, as I’m just trying to isolate the issue of double-taxation. There is no growth in the funds, either. He doesn’t need to eat or sleep, so no other expenses. 
(And yes, 401(k) loans are usually capped at 50% of total balances.)
The Results
Scenario #1: No Loans
- In Year 1, Elton makes a total of $20k gross. He contributes $10k pre-tax to his 401k, and pays taxes on the remaining $10k.
- In Year 2, he again makes $20k gross and does not make any additional 401k contributions.
- He spends $10k on his wedding. The 401k stays at $10,000 the whole time.
Scenario #2: 401k Loan
- In Year 1, Elton makes a total of $20k gross. He contributes $10k pre-tax to his 401k, and pays taxes on the remaining $10k.
- He then takes a $10k 401k loan out, and puts the $10k in his bank.
- He spends $10k on his wedding, and his bank balance goes down accordingly.
- In Year 2, he again makes $20k gross and does not make any additional 401k contributions.
- Finally, he pays back the borrowed $10,000 back into his 401k using the money he earned in Year 2.
Scenario #3: Credit Card Loan
- In Year 1, Elton makes a total of $20k gross. He contributes $10k pre-tax to his 401k, and pays taxes on the remaining $10k.
- He then borrows $10k via his credit card.
- He spends $10k on his wedding.
- In Year 2, he again makes $20k gross and does not make any additional 401k contributions.
- Finally, he pays back the borrowed $10,000 back into his credit card using the money he earned in Year 2. The 401k stays at $10,000 the whole time.
Recap
In all three scenarios, the amount of taxes paid is the same, and the final result is the same. Total taxable income over two years is $30k in all 3 cases. Final taxes paid: 25% of $30k, or $7,500. You end up with a 401k with $10,000 of pre-tax money in all 3 cases. No additional taxes are paid by taking out a 401(k) loan.
It does not matter even if he spends the $10,000 borrowed and pays it back later with after-tax money! Thus, I still conclude that there is no “double-taxation” on 401k loan principal.
Posted in Investing, Retirement | 41 Comments »
Well, the United Rentals tender offer that I participated in went through successfully. As expected, the offer was oversubscribed (press release), which means that more shares were offered than they were looking to buy. Only an estimated 34% of shares tendered will be bought, which left many would-be arbitrageurs holding shares of URI they didn’t really want. The stock price dropped to $16.83 as of the end of Friday.
Most Larger Investors Didn’t Do So Well
This means that even if you bought more than 100 shares at the lowest price available after the tender offer was announced ($18.95), sold whatever you could at $22 and sold the rest for the best price available afterwards ($17), you wouldn’t have made any profit. In fact, you would have lost about 4%. While you can always hold onto the stock and hope for a rebound, that leaves you as a stock investor, not an arbitrageur.
In practice, trying to game one of these tender offers on a large scale is very difficult. Even if you have confidence the offer will not be revoked, there are too many smart people playing. If the offer price is close to the current share price, the expected profit would be so low that the risk wouldn’t be worth it. If the offer price is significantly above the share price, then everyone will rush will tender their shares, ironically resulting in nobody being able to sell their shares.
Better Opportunity For Smaller Investors
However, if you bought an odd lot of 99 shares, which are given priority in many cases including this one, you would have gotten all your shares cashed out. Buying perfectly at $18.95 and selling at $22 would be a 16.1% gain in about a month’s time. Of course, your actual profit before commissions and fees would have only been $301.95. $300 is the cost of a schmoozing business lunch with a few martinis on Wall Street. Therefore, this is a great chance for small-time investors to have an edge.
My timing wasn’t quite perfect - I bought at $19.81 per share, resulting in a profit after fees of $191.91 (9.8%) in less than a month. Annualized return is likely to be north of 100%. Even after taxes, that will be buy me over 25 meals from the lunch carts.
I’m pretty picky about which of these offers I decide to jump into, so we’ll have to see if any other interesting ones pop up.
Posted in Investing | 7 Comments »
Yesterday, I bought 99 shares of United Rentals (ticker URI) stock for $19.81 per share, in the hopes that the company will buy it back from me next week for $22. Huh?
Quick Background
Sometimes companies choose to buy back their own shares for a variety of reasons. Often this is done via a Dutch auction process where each shareholder will indicate at what price they wish to sell (”tender”) their shares. The company will then start buying back starting with the cheapest price and going up until they get enough shares. If you indicate a higher price, you balance getting more money with the risk of having them not be sold.
United Rentals Details
URI is the largest equipment rental company in the world. In early June, United Rentals told shareholders that they wanted to buy back 27 million shares using a Dutch auction with a range of $22 to $25 per share. The offer period ends on July 16th. At the time, the stock price was only $19.50. You can find more in their Letter to Shareholders, part of a larger SEC Filing.
Risks and Rewards
The price of URI stock has been wavering recently between $18 and $21. Given that the $22 minimum offer price is currently a ~10% premium over the current market price, one risk is that too many people will tender their shares for $22, which means URI will only buy a partial amount of your shares. Your remaining shares may then drop below the price at which you bought. This risk is alleviated if you buy an odd lot of 99 shares, because according to their stated buying process your shares will be bought first.
Another related risk is that this tender offer will be canceled or amended. The company might lower it’s offered price. So then it becomes a fuzzy skill to “read between the lines” and make an educated guess as to how the management will handle this.
I am not an expert at this process by any means and am not recommending that anyone else follow my example, but here is why I think it will still happen:
- The day before the tender offer came out, the share price was only $19.50. With less than a week to go, the stock price is around $20. The stock has not plummeted or anything, but has been moving up and down with the overall market a bit. The picture remains about the same, so there is no new reason for them to change their minds if they haven’t already.
- The company had the ability to back out on this offer on July 1st (and technically every other day so far) based on one out-clause, but declined to do so.
- The current P/E ratio of the stock is only 6. It is not an overpriced growth stock, although it does have some debt issues. Most examples of fundamental analysis that I found have reported this company to be at least somewhat fairly valued.
- The financing for this deal appears to be taken care of already. So they don’t need to find anyone to lend them the money for this.
Again, I am primarily a passive index fund investor; I am not an expert in this area (not even average) and I do not consider this stock part of my portfolio. This more of a calculated gamble with a short-term resolution (offer expires July 16th), with the added bonus of learning more about stock markets in the process. I am always interested in learning more, and have been waiting for a good opportunity to try another one of these. (Kaizen!) Besides, you tend pay more attention when you have some skin in the game.
Personal Details
I bought my shares yesterday for $19.81 with a limit order set at $20 before market open. Upside: If all goes well, I will gain $216.91 (minus $25 in fees) with an initial investment of $1961.19. Basically I’m trying to make $200 while putting up $2,000. That is a return of 10% over what should take a few months. Annualized that’s still over 30%. Downside: The tender offer is canceled, and I am left with 99 shares of URI. I can either keep them and hope for positive return down the road, or I can sell them. If I really want to minimize potential losses, I can set a sell stop order.
Although I have an account with Zecco Trading (review) for my other fun money plays that has free trades, I decided to buy these with my Scottrade (review) account because I have used them for similar arbitrage transactions in the past and I have a few free trades left over from their referral program. I will need to contact Scottrade today and let them know that I wish to participate in this tender offer. I will be subject to an additional $25 fee for “non-mandatory reorganizations”. In cases like this, I like having a local branch to talk to so I can make sure things are done in a timely manner.
More References
» Fat Pitch Financials Contributor’s Corner - An excellent resource for such arbitrage deals, but requires a paid subscription of $125/year (or $15/month). I recently bought a year’s subscription when it was still $100/year.
» Stable Boy Selections - His 7/8 post reminded me about this offer, which I had actually forgotten about.
» New York Times DealBook Blog - More discussion on the probabilities of this offer going through.
Posted in Investing | 35 Comments »
A co-worker of mine disclosed today that she moved her entire 401k to cash and bonds last week. She is older than me and has what must be a sizable balance because her reasoning was “I couldn’t stand it anymore, all my contributions for the last year have disappeared! Why did I bother?”
I thought that it was an interesting - albeit dangerous - way of measuring returns. I can see how it can be depressing if you start with $100,000 at the beginning of the year, keep putting away $1,000 every month for a year, and then at the end of year… you still have only $100,000 due to market drops. It can be easy to view it as simply throwing money away. I miss the safety of cash!
But this is dangerous because comparing absolute changes in your entire account to your current contributions would seem to greatly magnify any gains or losses in your account. For example, if you start with $100,000 put in $1,000/month for a year in a bull market, you might end up with $124,000 at the end of the year. You put in $12,000, but your balance grew by $24,000! Feels great, maybe I need more stocks! But in reality this is basically the above scenario in reverse, and nowhere near a 100% return.
This way of framing losses reminded me of the popular behavioral finance book Your Money & Your Brain. Are our brains just wired poorly to deal with the swings of investing?
On the other hand, perhaps this should also serve as a reminder to properly assess your appetite for risk. Going back and forth between lots of stocks and zero stocks is highly unlikely to return in better overall returns. Numerous academic studies have shown that even professional money managers don’t do market timing well at all. Simply picking something in the middle and sticking with it actually turns out better. We can try to use these gloomy times to try and find that balance where we won’t be tempted to go either way in both good times and bad.
Posted in Investing | 56 Comments »
Via Bogleheads, yesterday Vanguard started the trading of a new investment that attempts to track the entire global stock market in just one fund. Dubbed the Vanguard Total World Stock Index Fund, here are some details from an older press release:
The new fund will seek to track the performance of the FTSE All-World Index, a float-adjusted, market capitalization weighted index designed to measure the equity market performance of large- and mid-capitalization stocks worldwide. The fund will invest in a broadly diversified sampling of securities from the target benchmark, which comprises more than 2,800 large- and mid-cap stocks of companies in 48 countries.
The current balance is about 41% US and 59% International. The ETF version (VT) features an expense ratio of 0.25% but has to be bought in a brokerage account. The mutual fund version (VTWSX) can be bought and sold for free at Vanguard ($3k minimum) and has an expense ratio of 0.45%, along with a 0.25% purchase fee and a 2% redemption fee on shares redeemed within 2 months of purchase.
Although you could basically replicate this fund with the proper mix of the Total US Stock Market ETF (VTI) and FTSE All-World except-US ETF (VEU) funds at a lower expense ratio, you’d also be subject to double the commissions when buying and selling. Besides, I think it’s just cool that you can now passively invest in the entire world with one ETF. For example, if China eventually becomes 25% of the world’s stock market value, then 25% of this fund would be invested in China without you having to lift a finger. If somehow India or Russia explodes instead, then you’ll still hold their share.
How could this fit in to your investment plan? More posts about asset allocation information here.
Posted in Investing | 34 Comments »
I’m always flattered when anyone (online or offline) asks me for investing advice, but at the same time I’m very cautious about giving it out. And it’s not just the usual *I’m not a financial professional* legal concerns, but the fact that it’s hard to give useful advice in a few paragraphs or a 5 minute chat. Over time, I’ve been refining my “amateur, informal financial advice over coffee” speech. My goal is to give specific ideas but to keep it simple. Let me know what you think.
1. Put your money in a Vanguard Target Retirement Fund. These mutual funds are an all-in-one basket of different low-cost index funds. You get some US stocks, some international stocks, and some bonds. The mix is automatically adjusted for you. No, they might not be perfect, but they are pretty darn good and very simple to hold. I have specifically have told my own mother to open an account at Vanguard. I withhold any theory talk about passive investing because this is when most people’s eyes seem to glaze over.
Just buy the fund with the date closest to when you want to start making withdrawals. All lifecycle or dated funds are not made the same. The ones in my 401k stink, and I don’t even like the Fidelity Freedom 20XX funds.
The Vanguard funds do have a $3,000 minimum initial investment. Until you have $3,000, just stick your money in an savings account paying decent interest and with an automatic deposit system. I know it sounds nice to “start investing with $100″ (and here are some ways to do that), but honestly, if you don’t have $3,000, your focus should be more on saving money by spending less/earning rather than investing at this point. There is no need to rush.
2. Read a good investing book
Websites and blogs are great, but it is still very hard to replace a good book. They tend to be professionally edited, better organized, cover all the bases, and are easy to refer back to. I think the following books are great and are definitely worth the $10-$20 cost:
If you’re not convinced (perfectly understandable), first borrow it from the local library and then buy a copy if you like it. Read as much as you can!
3. Hey, no skipping ahead. Please do #2.
My friends ask me for advice. I say to read a book. Months later, most of them (not all) haven’t read any books but still want advice. Yes, I know, this involves effort. (Gasp!) Please, spend a weekend doing something that will dramatically increase your net worth in the future. If you don’t, then at least if you did #1, you’ll be ahead of most investors who pay too much money chasing hot stock tips or pay other people to chase hot stock tips for them.
4. Pay someone to do it for you
If it’s been years and you still haven’t read a darn book and don’t plan to, go to NAPFA.org and find yourself a fee-only financial advisor that you click with. Pay that person to keep you on track. If they are fee-only they are less apt to be biased on what investments they recommend. But remember, the person who will care most about your money is still you.
Posted in Investing | 30 Comments »
Kaizen is a a Japanese philosophy that focuses on continuous, gradual improvements in all areas of life. A popular example is that of Toyota Motors, where any worker can stop the entire factory line if they see an abnormality and worker suggestions are welcomed and regularly implemented. The role of kaizen in Toyota’s success is discussed in detail within this New Yorker article “Open Secret of Success“:
…Toyota’s approach: defining innovation as an incremental process, in which the goal is not to make huge, sudden leaps but, rather, to make things better on a daily basis. […] Most of these ideas are small—making parts on a shelf easier to reach, say—and not all of them work. But cumulatively, every day, Toyota knows a little more, and does things a little better, than it did the day before.
The parallels to personal finance are relatively obvious but I think it is still easy to underestimate the power of such small, continuous, improvements.
Starting a New Business
Many of us may have ideas about starting up a new business (side or full-time), or even consider a career change. But the task can be daunting, so we put it off. But taking small steps towards such a goal are relatively easy. Spend a little time regularly making contacts, read and learn new skills while sitting at a cafe, or simply making your fuzzy daydreams a little sharper. It doesn’t even have to be daily.
Changing Your Spending Habits
Habits are by definition almost subconscious behaviors, and very hard to break. This New York Times article “Can You Become a Creature of New Habits?” explores why using kaizen instead may be better suited to changing our habits as opposed to other more aggressive methods:
“Whenever we initiate change, even a positive one, we activate fear in our emotional brain,” Ms. Ryan notes in her book. “If the fear is big enough, the fight-or-flight response will go off and we’ll run from what we’re trying to do. The small steps in kaizen don’t set off fight or flight, but rather keep us in the thinking brain, where we have access to our creativity and playfulness.”
If you want to start a budget, why not tracking your spending in just one category, like dining out?
Taking it another step further, instead of just saying “I need to eat out less”, why not ask why you order out so much. For us, often times it is simply because we are tired and there is nothing easy to cook in the fridge. So I have started to keep a better stocked pantry and also make a regular schedule where I buy a small amount of “standard” fresh vegetables which are easy to incorporate. Each time I find a good recipe that uses only what is in my pantry, I write it down, so I slowly accumulate our own custom lazy-proof cookbook.
Kaizen Is All About You
These are just a few examples, and is kind of how I like to think of this blog. There are so many complex topics that are impossible to learn all at once, from investing to insurance to taxes. Every day I read and skim a lot of information, in the hopes of gleaming something a little useful that can help me get a little closer to leaving the rat race. It may just seem like little nothings, but when you add it all up together I know it has made a huge difference in our financial lives. But what may strike a chord in me might not apply to others, so it’s all about taking what works for you and applying it.
So remember, as long as you learn or implement something a little new each day, you should be happy!
Posted in Budgeting, General, Investing | 21 Comments »
I instantly dismiss any article that purports to share with me “764 stocks that Warren Buffet would buy”, because I don’t care if some writer thinks he would buy something. I’d only care if Buffett really bought it for Berkshire Hathaway and at what price. This Fortune article “Buffett’s big bet” explores another side of what Buffett believes.
In one corner, you have the Vanguard’s 500 Index fund, ticker VFIAX (admiral shares), which tracks the S&P 500 Index with a lean 0.07% annual expense ratio. (The regular investor shares are VFINX.) It passively invests in small pieces of huge publicly-traded US companies.
In the other corner, you have a group of five hedge funds hand-picked by a big name Wall Street money management firm called Protege (funds of funds, actually). They have worked with folks like David Swensen, and George Soros. Hedge funds are usually only available to individuals with more than $1 million net worth or $200,000 annual income, and they can invest in just about anything. Tiny companies, entire companies, foreign companies, pork belly futures, whatever. However, in exchange you pay big fees: 1% annually for the fund of funds layer, 1.5% annually for the hedge funds themselves, and then 20% of any gains on top of that.
Past performance stats: From its inception in July 2002 through the end of 2007, the Protégé fund gained 95% (after all fees), soundly beating the Vanguard S&P 500 index fund’s 64%.
Now you have to choose which one will have the best returns after all fees over the next 10 years. Which one would you choose? Well, Warren Buffett bet on the index fund, and put up the equivalent of $500,000 at the end of the bet, which would give $1,000,000 to the charity of the winner. He believe that those fees are simply too high to overcome, even with their ability to invest anywhere in the world. But more important of course are either the shame or bragging rights to those hedge fund managers!
Buffett himself assesses his chances of winning at only 60%, which he grants is less of an edge than he usually likes to have. Protégé figures its own probabilities of winning at a heady 85%. Some people will say, of course, that just by making this bet, Protégé has acquired some priceless publicity.
The last part is probably true. No matter what, Protege will make a ton of money in fees at the end of 10 years. If they win the bet, they’ll be on magazine covers and end up even more insanely rich. If they lose, they simply change their hedge fund name and try again.
[CNN / Forbes via Reader Ethan]
Posted in Investing | 10 Comments »
Have you ever considered becoming a professional financial advisor? You can read about one man’s story in this article Evolution of an Investor from Conde Nast Portfolio. Blaine Lourd started out as a stockbroker, and found out he was really good churning accounts for his own profit:
“It was amazing, the gullibility of the investor,” he says. “When you got a new customer, all you needed to do was get three trades out of him. Because one of them is going to work. But you have to get the second one done before the first one goes bad.” […]
It wasn’t exactly the career he’d hoped for. Once, he confessed to his boss his misgivings about the performance of his customers’ portfolios. His boss told him point-blank, “Blaine, you’re confused about your job.” A fellow broker added, “Your job is to turn your clients’ net worth into your own.” Blaine wrote that down in his journal.
Although he kept at it and became rich and successful, Lourd eventually got tired of picking investments for his clients based on whether it made him richer and not them. When he tried to change his investment recommendations in a manner that followed his conscience, the large brokerage firm he worked for fired him. (A.G. Edwards, now Wachovia Securities) Now, he is a fee-only financial planner who makes less money advocating passive investing, but sleeps better at night. (I doubt he’s eating Top Ramen, however.)
His job, as he now defines it, is to tell investors that the smartest thing they can do is nothing. He acts as a brake on, rather than an accelerator for, their emotions. For that, he takes between one-half of a percent and 1 percent annually, which is more than they’d pay if they simply bought index funds on their own. “I tell them, ‘Look, if you can control your own emotions and you want to go to Vanguard, you should do it.’ And every now and then, someone asks the question, ‘Why do I need you, Blaine? What are you doing?’ And I say, ‘Howard, be careful or I’m going to send you back to Smith Barney.’ And they laugh. But they know exactly what I mean.”
The comments on the article seems to focus primarily on the whole active vs. passive investing debate, which is valid but I think misses the bigger point mentioned above that one way happened to make him a lot more money. Even if you believed in active investing, you could still avoid things like promoting high-cost, in-house mutual funds, trading in and out excessively to generate commissions, and selling unnecessary insurance products.
I also enjoyed this article because it reminded me of my idle fantasies of becoming a financial planner. Wouldn’t it be cool to help people manage their money better on a 1-on-1 basis? Unfortunately the reality seems to be that most people starting in this field have to put in at least a few years in a commission-based brokerage firm making cold calls and aggressively pushing whatever products they say to push. Otherwise, with no experience and no big recognizable company name behind you, it will be impossible to get any clients.
My own idea was to join some firm with low entry requirements like Ameriprise or Edward Jones, but only sell products that I felt were appropriate like index funds or term life insurance. I wonder what would happen? I suppose that I would be fired quickly for not meeting quotas. Even Mr. Lourd, who was still making lots of money for his old company even while advocating index funds, got fired for not following the company line. Still, it would be fun to try.
Posted in Investing | 24 Comments »
Everybody’s talking about gas prices… they’ve reached another high, everybody wants a hybrid… so why not explore how an individual can try to limit their exposure to gas prices?
How much more are you really paying?
Yes, $50 for a fill-up hits some sort of mental trigger, but sometimes I wonder if people really have calculated exactly how much more they are paying. According to AAA, the current national average is $3.70/gal, while a year ago it was $3.05. If your car gets 20 miles per gallon, you drive 12,000 miles per year, paying 65 cents more per gallon equates to an extra $390 per year. (If you got a stimulus check, this means a lot of it might have already been spent…)
Now, for many families who are walking a financial tightrope, such a hard-to-avoid increase is just a another step closer to the edge. But for the Wii-playing, Starbucks-drinking crowd, is an extra $32/month really worth making a fuss over? I mean, some of these folks are the same ones whose eyes glaze over when I describe some of the extra things I do for money outside of a regular workday.
Hedging Against Future Increases
Now, someone could always play with oil futures contracts like the airlines do, but that’s a bit complicated for the average person. However, if we are afraid that gas prices will rise even further but are comfortable paying the current price, it would make sense to try and buy a bunch of gas at today’s prices and lock-in that rate. A while ago there was a company called the FuelBank that tried to make this a reality, but it appears to have gone nowhere.
Buying the Oil ETF USO
Another way that you can effectively buy at today’s prices is to buy shares of the United States Oil ETF, symbol USO, from your favorite online stock broker. This idea was initially explored in this SeekingAlpha article back when it debuted in 2006. Unlike other commodities ETFs or investing in an energy company like Chevron or Exxon, the objective of this ETF is specifically to keep it’s net asset value (NAV) at the price of crude oil. (Specifically, the spot price of West Texas Intermediate light, sweet crude oil delivered to Cushing, Okla., minus expenses.)
Now, USO hasn’t done the best job of tracking crude oil prices exactly on a day-to-day basis, but it seems to get the general trend right if you hold an extended period of time. From 5/7/07 to 5/6/08, crude oil went from $61.48 to $121.82 a barrel, an increase of 98%. (source) For the same date range, USO went from $48.06 to $93.38 a share, up 94%. (source)
In order to counteract the theoretical $390 from the example above back, you could have bought 9 shares of USO for a total upfront cost of $390 a year ago, which would be worth $408 more today. So in theory, the average driver could put aside something like $1,000 and buy 10 shares of USO to hedge against rising gas prices. Even just one share would dampen the effects somewhat.
The Catches
Unleaded gas prices only went up 21% in the same time period that crude oil went up nearly 100%. So the ratio between crude oil price and unleaded gasoline doesn’t seem to be a constant. Also, if gas prices fall then your savings at the pump will likely also be negated by a drop in USO’s share price. Also, you could account for the lost potential of any money put aside for this if you had invested it elsewhere.
I don’t personally plan on doing this, but it is an idea that could work if you were really sensitive to higher gas prices and/or buy a lot of gas. Another alternative is a site like HedgeStreet, though I haven’t looked too deeply into it.
Posted in Frugal Living, Investing | 25 Comments »
529 plans have become a very popular tool for saving for college for those that choose to help out their kids (or simply funding some continuing education for yourself). Most states have their own 529 plans, sometimes even multiple choices within those plans. They are very flexible - anybody can invest in any state’s 529 plan, and that money can pay for college expenses in any other state. Beneficiaries are also easily changed between relatives.
Conventional Advice
The standard advice for picking a plan is to first check if your state has a good tax deduction for using your state’s plan. Something like 32 states offer some sort of benefit. If so, then consider going with that plan. If not, then go with the “best” out of state plan since many state plans have poor investment choices and higher fees. If somehow you have a really horrendous state plan with high fees, then you might even forgo the tax deduction and go with an out-of-state plan.
But… Why not do both?
Most 529 plans allow both partial and complete rollovers into another state’s 529 plan. So, why not first take any tax breaks available to you by contributing to the in-state 529, and then see if you are able to quickly roll over those funds into a better out-of-state plan. Keep the in-state plan open if you intend to make future contributions. I checked out a sampling of various state plans and they all offered partial rollovers.
This way, you get both the upfront tax benefit, and the long-term low-fee benefit. Seems plausible, no?
Some states might have a tax-deduction recapture rule. In that case, I might consider contributing only up to the tax deduction and then opening up another better 529 for additional contributions. You can have multiple 529s.
My Experience - Oregon, New Hampshire, and California 529s
You may be wondering why I have a 529 plan listed in my net worth, even though I don’t even have any kids. In fact, I have opened 529 plans from three different states! About five years ago, the California 529 was giving away $50-$100 gift cards for opening a plan and depositing $100. I figured, why not, that’s a pretty nice return on investment. We might use it, and if not you can always withdraw principal without penalty. So I opened up an account for me and one for my wife, with us as the beneficiaries.
Then, while in Oregon, they offered a state tax deduction on $2,000 of contributions each year (now $4,000 for a married couple). So I contributed to that. Finally, there was a Fidelity College Rewards 529 credit card that paid 2% back into a Fidelity 529 plan (it now only pays 1.5% back to new applicants). 2% back on everything was great, so I opened up a 529 from New Hampshire that Fidelity ran.
Long story short, I have since rolled everything into the New Hampshire 529 plan with no fees from anyone. The paperwork was easy, although you do want to track your contributions in case you make a non-qualified withdrawal. The New Hampshire plan is not bad, with a 0.50% expense ratio for their index fund portfolios including all management fees, and no maintenance fee, and only a $50 minimum to start.
Best Out-of-State Plans To Consider
I haven’t done exhaustive research on this topic, but if you believe in low-cost index funds then one of the best plans is definitely the Ohio CollegeAdvantage 529 plan. The have Vanguard mutual funds with a 0.18-0.23% management fee on top of fund expenses. The total annual asset-based fees can be as low as 0.21%, but the age-based portfolios are about 0.30%-0.35%. No maintenance fees.
If you believe there is a performance benefit to investing in several asset classes, there is also the more-expensive West Virginia SMART529 Select plan which offers mutual funds from Dimensional Fund Advisors (DFA). Total asset-based fees are 0.65% - 0.88%, plus a possible $25 maintenance fee for non-WV residents.
Since I still have my credit card relationship and my balances are low, I don’t bother moving away myself. I don’t actively contribute anything except my credit card rebates, so saving 0.15% in fees on my $3,000 would be less than $5 a year. But for folks with larger balances and held over longer periods of time, the performance advantage of lower fees can definitely be significant.
Posted in Investing | 10 Comments »
