Chart: Stocks and Bond Returns Tend To Move In Opposite Directions

Inside this AllianceBernstein post about the more complex concepts of levering bonds and risk parity strategies, there was a reminder about simple portfolio construction. For a very long time now, holding both stocks and bonds has been considered a “balanced” portfolio. Why is this? Because stocks and bond returns tend to move in opposite directions.

This behavior can be summed up using the finance term Beta. The 5-year rolling average beta of the S&P 500 return to the 10-year US Treasury return has consistently ranged from negative 0.1 to negative 0.3 over the past decade. This means that when when stocks went up, bonds tended to go down (but not too far down). When stocks went down, bonds tended to go up (but not too far up).


Always good to have a reminder of the benefit of holding both stocks and bonds.

How to Win the Loser’s Game: Free Documentary recently released a free documentary about the fund management industry and the effect of their high fees on the returns of everyday citizens. “How to Win the Loser’s Game” includes interviews with Vanguard founder John Bogle, Nobel Prize-winning economists Eugene Fama and William Sharpe, author and wealth manager Larry Swedroe, amongst many others. While the publisher is UK-based, most of the concepts are widely applicable to all fund management. The film is broken down into 10 different parts, each about 8 minutes long.

If you are a visual learner and rather watch an educational video than read a book, this documentary is definitely for you. The brief episodes gradually cover the benefits of a low-cost, long-term, low-maintenance, diversified investment strategy. Here’s the trailer, which ends with links to all 10 episodes.

Top 1% of Income at Age 30 = $135,000 a Year

I’ve never been into the whole 1% politicized debate, but Derek Thompson at The Atlantic has put out another chart that just begs for a glance.

The richest percentile of Americans makes many hundreds of thousands of dollars a year. So how could a $135,000 salary make you a one-percenter? If you’re 31 or younger, that figure puts you ahead of 99 percent of your age group.

Here’s what salary it takes to be in the top 1% (red) and 0.1% (blue) of wage and salary income, separated by age bracket.


Okay, so some people I know apparently were in the top 1%e at age 30. But as the author points out, the really rich don’t make their money from earned income, they make it from investment income. In other words, their money is doing the working, not them. However, that all likely started with someone (perhaps them, but perhaps a father or grandmother) deciding not to spend their salary on consumer goods and instead putting it towards an income-producing asset.

Remember kids, it’s not what you make that matters, it’s what you save! ;)

REITs and Rising Interest Rates

risingqSince March 2009, the FTSE NAREIT All Equity index of US real estate stocks has has nearly quadrupled. When will the party end? Mathematically, we know that bond values will go down in general if interest rates rise. But how would rising interest rates affect future REIT performance?

Here are some articles that examine historical REIT performance relative to interest rates: A Wealth of Common Sense, AllianceBernstein Blog, and Altegris Whitepaper [pdf].

The TL;DR version is that based on historical data, an increase in interest rates will not necessarily hurt REIT prices. Sometimes it did, sometimes it didn’t. Out of the seven past periods of rising interest rates, REIT performance was positive in four of them and sometimes they kicked butt. The average statistical correlation between REITs and bonds is very low. On top of that, the actual correlation oscillates from positive to negative. Sometimes REITs and rates move in the same direction, and sometimes they move in opposite directions.

Using predictions of future interest rates to further make predictions of future REIT performance seems doubly silly.

REIT Primer: Should You Add REITs To Your Retirement Portfolio?

empireHere is a fairly balanced and informational Morningstar article about real estate investment trusts (REITs). Below are my notes and excerpts:

  • Equity REITs are publicly traded companies that own and manage income-generating real estate properties. REITs are required to distribute at least 90% of their income to investors, which allows them to avoid paying corporate taxes. The bad news is that most of their distributions are taxed as ordinary income.
  • In order to further improve diversification, investors can hold a portfolio of REITs through a low-cost fund, like the Vanguard REIT ETF (VNQ). (This is how I hold my REITs, via the mutual fund equivalent VGSIX and VGSLX.)
  • REITs represent about 3.6% of the CRSP US Total Market Index, which tracks the entire U.S. investable equity market on a market-weighted basis.
  • Much like homeowners with mortgages, REITs buy properties using debt financing. This leverage amplifies both gains and losses in real estate values and increases share price volatility. In other words, REIT values will be a lot bumpier than just estimated your home’s resale value whenever a neighbor sells their house.
  • From 1972 through September 2014, the FTSE NAREIT All Equity REITs Index generated a 12% annualized total return, while the S&P 500 posted 10.5%.
  • Nearly two-thirds of the REIT index’s return from 1972-2014 came from distributions, which are largely derived from rental income. Investors should have modest expectations for capital gains.
  • REITs have historically not been a good hedge against inflation in the short term. As noted, long-term returns are significantly above inflation.
  • Current REIT valuations as of November 2014 are considered relatively high by traditional metrics.

Random fact: Did you know you can buy partial ownership of the Empire State Building in New York City via the Empire State Realty Trust (ticker ESRT)? You’d be collecting rent from some big name tenants. ESRT currently makes up about 0.17% of the Vanguard REIT Fund, so if you own VNQ you also own a tiny piece.

Schwab Intelligent Portfolios: Free Automated ETF Portfolio Manager


(Update 10/28: Schwab has indeed announced their free robo-advisory platform called Schwab Intelligent Portfolios, although it won’t actually start opening new accounts until Q1 2015 and not much new was leaked besides confirming that they will not charge any advisory fees, trading fees, or account fees. You’ll need $5,000 minimum to open, $50k minimum for tax-loss harvesting. Media coverage at Reuters, NYT.)

Original post below:

Speaking of robo-advisors, Reuters reports that discount brokerage Schwab is “weeks away” from announcing their own automated online portfolio management service similar to what is provided by Betterment, Wealthfront, and FutureAdvisor. This is big news because:

  • Schwab is a well-recognized name brand in the financial industry and has their own army of affiliated financial advisors.
  • This service will reportedly be free with no advisory fees, just the cost of underlying ETFs.
  • Schwab has their own set of in-house index ETFs with very low fees. Their Core US Index ETF (SCHB) has an annual expense ratio of 0.04%. Their Core International Index ETF (SCHF) charges 0.08%. Their Core US Bond Index ETF (SCHZ) charges 0.06%, and US REIT Index ETF (SCHH) charges 0.07%. (full list)

Theoretically, this could mean you could get a managed ETF portfolio with automatic rebalancing for safely under 0.10% annually or 10 basis points, all-in. If that happens, that would certainly shake up the industry and perhaps light a fire under Vanguard to do something similar. Hopefully they don’t force you to own some of their more expensive niche ETFs. Vanguard Target Retirement Funds offer a diversified portfolio of index funds and internal rebalancing, but the average cost is 0.17% annually.

If the article is correct, it may be worth waiting to see what Schwab has to offer before opening a “robo-advisor” account elsewhere.

Sequence of Returns Risk During Retirement Illustration

Businessweek has an article discussing the difficulties when trying to make a retirement nest egg last for the rest of your life. Most people just worry about the average returns of their investments. But another important concern during the withdrawal phase is sequence of returns risk.

Two retirees can start with the same initial portfolio balance and experience the same average return, but if one experiences highly negative returns in the first few years of withdrawals they can end up with very different outcomes. Instead of explaining this concept with a list of numbers, here is a graphical version from the BW article. Both Jane and John start with $1 million, experience 7% average returns, and take out $50,000 a year with a 3% increase each year for inflation.


Jane ends up 20 years later with $700,00 more than she started, and John is flat broke. Although the sequence of returns shown is a bit extreme, they are simply mirrored and it is still entirely possible.

Some people take this to mean that you shouldn’t retire when the market has been on a good bull run, but I think the point is that you simply don’t know what order your future returns will be. The bull run could keep on going and create a bubble, and then pop many years later. Or something like a declaration of war could crush the market even further even if things have already been bad for a while.

Briefly, a couple of options that can help alleviate this sequence of returns risk are a dynamic withdrawal strategy that continually adjusts to actual returns (no set number every year), and also annuitizing part of your portfolio using a single-premium immediate annuity. Finally, don’t forget the traditional advice of holding a sizable chunk of quality bonds in your portfolio.

Prosper vs. LendingClub Investor Experiment: 2 Year Update

lcvspr_clipoIn November 2012, I invested $10,000 into person-to-person loans split evenly between Prosper Lending and Lending Club, looking for high returns from a new asset class. After diligently reinvesting my earned interest into new loans, I stopped my after one year (see previous updates here) and started just collecting the interest and waiting see how my final numbers would turn out at the end of the 3-year terms.

It is now about a week shy of the two year anniversary of this experiment, so here’s another quick update.

$5,000 LendingClub Portfolio. As of October 20, 2014, the LendingClub portfolio has 157 current and active loans. 71 loans were paid off early and 21 have been charged-off ($314 in principal). 3 loans are between 1-30 days late. 5 loans are between 31-120 days late, which I will assume to be unrecoverable. $3,515 in uninvested cash from early payments and interest. Total adjusted balance is $5,392. LendingClub reports my adjusted net annualized return as 5.27%. Here is a screenshot of my account.


$5,000 Prosper Portfolio. My Prosper portfolio now has 142 current and active loans, 85 loans paid off early, 31 charged-off. 6 loans are between 1-30 days late. 6 are over 30 days late, which to be conservative I am also going to write off completely (~$66). $3,024 in uninvested cash (early payments and interest). Total adjusted balance is $5,334. Prosper reports my net annualized return as 5.56%. Here is a screenshot of my account.


Recap and Thoughts

  • P2P lending is legit. LendingClub is preparing for an IPO on the NYSE. Institutional investors are buying a significant portion of LendingClub and Prosper loans. This WSJ article says 66% of Prosper loans in 2014 have been sold to institutional investors. What started out as the Wild West of unsecured loans is now accepted by Wall Street. This would suggest that reliable positive returns for investors are more likely, but also that chances for outsized returns will be diminished.
  • If you continually reinvest your interest, the return numbers you see will be higher than your actual long-term returns. Due to how they are calculated, your reported return will deteriorate as your loans age and more borrowers default. After two years, Prosper reports my annualized return as 5.56%. 4 months ago, it was 5.76%. 8 months ago, it was 7.55%. LendingClub reports my annualized return after 2 years as 5.27%. 4 months ago, it was 5.94%. This doesn’t mean you shouldn’t invest and your returns may better than mine, but be aware of this pattern if most of your loans are new.
  • If I were to invest all over again… First, I would do it within an IRA to avoid tax headaches. I would also buy at least 100 loans x $25, which also happens to be the $2,500 minimum for free automated investments at LendingClub (no minimum at Prosper). Picking loans can be fun for some but I got bored after a while.
  • LendingClub vs. Prosper relative performance. I tried my best to invest at both websites with the same criteria and overall risk preference. Right now, LendingClub is ahead by a bit. I wouldn’t put too much importance on the absolute numbers as I stopped reinvesting into new loans (at both sites) after the first year. Here’s an updated chart tracking the LendingClub and Prosper adjusted balances separately over these past two years:

Early Retirement Portfolio Income Update – October 2014

When investing, should you focus on income, or total return? I like the idea of living off dividend and interest income, but I also think it is easy for people to reach too far for yield and hurt their overall returns. But what is too far? That’s the hard part. Certainly there are many bad investments lurking out there for desperate retirees looking for maximum income. If possible, I’d like to invest for total return and then live off the income.

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

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

Asset Class / Fund % of Portfolio Trailing 12-Month Yield (10/18/14) Yield Contribution
US Total Stock
Vanguard Total Stock Market Fund (VTI, VTSAX)
24% 1.78% 0.43%
US Small Value
WisdomTree SmallCap Dividend ETF (DES)
3% 2.81% 0.08%
International Total Stock
Vanguard Total International Stock Market Fund (VXUS, VTIAX)
24% 3.35% 0.80%
Emerging Markets Small Value
WisdomTree Emerging Markets SmallCap Dividend ETF (DGS)
3% 2.97% 0.09%
US Real Estate
Vanguard REIT Index Fund (VNQ, VGSLX)
6% 3.51% 0.21%
Intermediate-Term High Quality Bonds
Vanguard Limited-Term Tax-Exempt Fund (VMLUX)
20% 1.70% 0.34%
Inflation-Linked Treasury Bonds
Vanguard Inflation-Protected Securities Fund (VAIPX)
20% 1.78% 0.36%
Totals 100% 2.31%


The total weighted yield was 2.31%, as opposed to 2.49% calculated last quarter. This means that if I had a $1,000,000 portfolio balance today, it would have generated $23,100 in interest and dividends over the last 12 months. Now, 2.31% is significantly lower than the 4% withdrawal rate often recommended for 65-year-old retirees with 30-year spending horizons, and is also lower than the 3% withdrawal that I prefer as a rough benchmark for early retirement. Hurray for zero interest rates!

So how am I doing? Using my 3% benchmark, the combination of ongoing savings and recent market gains have us at 90% of the way to matching our annual household spending target. Using the 2.31% number, I am only 69% of the way there. That’s a big difference, and something I’ll have to reconcile. Consider that if all your portfolio did was keep up with inflation each year (0% real returns), you could still spend 2% a year for 50 years. From that perspective, a 2% spending rate seems extremely cautious.

Early Retirement Portfolio Asset Allocation Update – October 2014

Here’s an update on my investment portfolio holdings for Q3 2014. This includes tax-deferred accounts like 401(k)s and taxable brokerage holdings, but excludes things like physical property and cash reserves (emergency fund). The purpose of this portfolio is to create enough income to cover all of our household expenses.

Target Asset Allocation


I try to pick asset classes that will provide long-term returns above inflation, regular income via dividends and interest, and finally offer some historical tendencies to balance each other out. I don’t hold commodities futures or gold as they don’t provide any income and I don’t believe they’ll outpace inflation significantly. In addition, I am not confident in them enough to know that I will hold them through an extended period of underperformance (don’t buy what you don’t understand).

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

Actual Asset Allocation and Holdings


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

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

Notable Changes

Last quarter, I had sold my PIMCO Total Return fund holdings. Well, that was lucky on my part with all the recent Bill Gross drama. I decided to sell my stable value fund holdings too as I needed rebalance into more TIPS bonds and I was now able to buy TIPS inside my employee retirement plan using the Schwab PCRA brokerage window. All of our tax-deferred space is now taken up with TIPS and REITs, so the rest of my bonds are tax-exempt munis and savings bonds.

Otherwise, not much new, I rebalanced with new money and reinvested dividends. By this, I mean I don’t automatically reinvest dividends into the same mutual fund or ETF that generated them. Instead, they accumulate for bit and then I reinvest them in whatever asset class has been lagging recently. This also makes fewer tax lots for my taxable accounts.

That’s it for portfolio holdings. In a separate update post, I will update the amount of income that I am deriving from this portfolio.

Comparing Three Major Levers You Can Pull On Your Retirement Portfolio

One of the most popular posts on the Vanguard blog is My one piece of investing advice by Andy Clarke. Let’s start with the following baseline scenario:

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

Now, imagine there are three “levers” that you could pull in order to try and increase your final savings balance at retirement – asset allocation, savings rate, or time horizon. In each case, everything else in the scenario stays the same.


Which single option do you think has the most impact? Taken from the blog post, the results below are based the median balance found after running Monte Carlo computer simulations based on historical returns.


I would look past the absolute values and instead focus on the relative effect of each option. In case you haven’t figured it out, the one piece of investing advice is “save more”. The easiest lever to pull is a more aggressive asset allocation because it doesn’t require the pain of spending less and saving more (though you get more stomach-churning bumps and less reliable results). But here we see that saving just 3% more was equally powerful. If you pulled all three levers, your final balance would have more than doubled!

Investment Robo-Advisor Comparison Chart

Automated portfolio management is the new hotness. In the coming years, I see a continued expansion of players followed by a lot of mergers and acquisitions. analyst Elisabeth Kashner has finished her series on robo-advisors with a final comparison of the current field – The Best Robo Advisor … For You . The entire series is interesting for those that care about such things, but here is the final summary chart:


You may (or may not) be surprised by what she actually picks for her son’s starter portfolio.