Housing Has Higher Long-Term Returns Than Stocks?

housemoneyI finally got around to reading an academic paper that looked a bit dry but had a great title: The Rate of Return on Everything, 1870–2015 [pdf] by Jorda, Knoll, Kuvshinov, Schularick, and Taylor. I wonder which of the authors came up with that.

One of the major findings that was residential housing – when you add up the returns from both price change and imputed rent – had a higher overall average return than stocks (equities). Not only did housing have higher returns, but it also had lower volatility (standard deviation). Here’s a chart that compares housing and equities:

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When the paper was released, places like the Financial Times discussed the paper’s conclusions but none of them addressed my two immediate questions.

Did they account for the maintenance and management costs of rental real estate? If you own a rental property, you may still have to pay for lawn maintenance, replacing roofs, HVAC units, interior and exterior painting, replacing carpets, and various other issues. To be fairly compared with equities, you should also account for property management costs. Here’s are excerpts that deal with maintenance and repairs:

To the best of the authors’ knowledge, this study is the first to present long-run returns on residential real estate. We combine the long-run house price series presented by Knoll, Schularick, and Steger (2016) with a novel dataset on rents from Knoll (2016). For most countries, the rent series rely on the rent components of the cost of living of consumer price indices as constructed by national statistical offices and combines them with information from other sources to create long-run series reaching back to the late 19th century.

A number of additional issues have to be considered when constructing returns on housing. First, any homeowner incurs costs for maintenance and repairs which lower the rental yield and thus the effective return on housing. We deal with this issue by the choice of the benchmark rent-price ratios. Specifically, in the Investment Property Database (IPD) the rental yields reflect net income (i.e., net of property management costs, ground rent, and other irrecoverable expenditure) received for residential real estate as percentage of the capital employed.

Did they account for the annual property taxes required on residential real estate? In many US states, the annual property tax bill can exceed 1% of the value of the house. Some are closer to 2% annually, and these are owner-occupied numbers. Rental properties may be higher. That’s on top of any potential capital gains you’d owe upon sale of the house, and any taxes you’d owe on rent received. Here’s are excerpts that deal with taxes:

Although the extent of real estate taxation varies widely across countries, real estate is taxed nearly everywhere in the developed world. International comparisons of housing taxation levels are, however, difficult since tax laws, tax rates, assessment rules vary over time and within countries. Typically, real estate is subject to four different kinds of taxes. First, in most countries, transfer taxes or stamp duties are levied when real estate is purchased. Second, in some cases capital gains from property sales are taxed. Often, the tax rates depend on the holding period. Third, income taxes typically also apply to rental income. Fourth, owners’ of real estate may be subject to property taxes and/or wealth taxes where the tax is based upon the (assessed) value of the property.
This section briefly describes the current property tax regimes by country and provides estimates of the tax impact on real estate returns.

With few exceptions, the tax impact on real estate returns can be considered to be less than 1 percentage point per annum.

This is an interesting paper that tries to cover a huge amount of stuff. Estimating the return of all businesses from all countries for the last 150 years? Estimating the return of all residential real estate from all countries for the last 150 years? They mix together a bunch of different datasets, so it’s hard to know exactly the quality level of each and how well they accounted for things like taxes and maintenance.

I’m not sure why they prefer to use arithmetic averages instead of geometric averages, but even if you shave off 1% for additional property taxes and another 1% because you don’t think they account for maintenance costs adequately, housing returns are still at least comparable to equity returns.

Here is the most recent update of the Case/Shiller home price index from Multpl, which tracks US housing prices on an inflation-adjusted basis:

shiller1890

Some people use this to argue that housing returns only keep up with inflation, but home prices ignore the value of rent. The fact that most housing purchases involve a mortgage loan does complicate things a bit.

Bottom line. An interesting paper that compares the long-term returns (last 150 years!) of residential housing and equities. In the long run, some may be surprised that residential housing returns at least matched equity returns, and housing returns had lower volatility. This is a reminder that you can also build wealth via residential real estate, taking into account that rent makes up half of the total return. Stocks are not the only game in town. (Just like with stocks, can is not the same as will.) New services like AirBNB provide an alternate path to monetize residential real estate.

TD Ameritrade Commission-Free ETF List – Changes Effective November 2017

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Updated. As of October 2017, TD Ameritrade notified their clients of the following changes to their commission-free ETF trading program. Here are the highlights from the e-mail:

  • Here is the old ETF list [pdf]. Through 11/20/17, they trade commission-free. Starting 11/21/2017, they will trade at standard commission rates ($6.95 online trades).
  • Here is the new ETF list [pdf]. These 296 ETFs can be traded commission-free immediately (as of 10/17/17).
  • ETFs held less than 30 days will be charged a short-term trading fee of $13.90, down from $19.99. This new fee will go into effect on November 21, 2017.
  • All new ETFs on the commission-free list cannot be used as collateral for a margin loan, nor can they be included in margin equity for 30 days after purchase.

What ETFs are being removed? Initially started in 2010, the “old” list of 100 ETFs was based on advice from Morningstar as to which 100 ETFs that would be most useful for long-term investors to build a ETF portfolio. In other words, these were popular buy-and-old ETFs for “Average Joe/Jane” customers. These ETFs were from the biggest providers (Vanguard and iShares) and had the highest assets, highest trading volume, and lowest expense ratios.

There are now zero ETFs from Vanguard. The most widely-held iShares ETF are also missing. Here are some notable removals:

  • Vanguard Total Stock Market ETF (VTI)
  • Vanguard FTSE All-World ex-US ETF (VEU)
  • Vanguard MSCI Emerging Markets ETF (VWO)
  • Vanguard REIT Index ETF (VNQ)
  • Vanguard Total Bond Market ETF (BND)
  • iShares Core S&P 500 (IVV)
  • iShares Core US Aggregate Bond (AGG)
  • iShares TIPS Bond (TIP)
  • iShares 1-3 Year Treasury Bond (SHY)
  • iShares 20+ Year Treasury Bond Fund (TLT)

Note: TD Ameritrade will still provide free dividend reinvestment on your existing ETF positions.

What ETFs are being added? The “new” list of 296 ETFs are mostly niche ETFs. Providers include AGFiQ QuantShares, First Trust Portfolios, iShares ETFs, J.P. Morgan Asset Management, PowerShares by Invesco, ProShares, State Street Global Advisors’ SPDR, and WisdomTree Investments. They cover a wide range of specific investment themes.

Unfortunately, this move also puts TD Ameritrade more firmly into the pack of brokerage with ETF/mutual fund “supermarkets” based on who will pay them for shelf placement:

TD Ameritrade receives remuneration from certain ETFs (exchange-traded funds) that participate in the commission-free ETF program for shareholder, administrative and/or other services, generally ranging from the equivalent of approximately 15% to 30% of the ETFs’ annual net operating expense ratio.

This is a common arrangement and you’ll see the same thing at Schwab and Fidelity, but in my opinion you end up a bigger list of less-attractive products. They also tend to have higher expense ratios. I’ve never even heard of these before:

  • First Trust Alternative Absolute Return Strategy ETF
  • iShares Fallen Angels USD Bond ETF
  • PowerShares Optimum Yield Diversified Commodity Strategy No K-1 Portfolio
  • QuantShares US Market Neutral Anti-Beta Fund

To be fair, there are still some iShares Core ETFs (though not the broadest ones) and some SPDR ETFs that cover broad indexes (though with lower asset size and trading volume). There are maybe 15-20 ETFs that I could see as part of a low-cost, long-term portfolio. A few examples:

  • SPDR Dow Jones Total Market (SPTM)
  • SPDR S&P World ex-US (SPDW)
  • SPDR Lehman Aggregate Bond (SPAB)
  • iShares 0-5 Year TIPS Bond ETF (STIP)
  • iShares Core International Aggregate Bond ETF (IAGG)
  • iShares Core U.S. REIT ETF (USRT)
  • iShares Global REIT ETF (REET)

Here are two ETFs on the list that I have bought myself in the past:

  • WisdomTree Emerging Markets SmallCap Dividend Fund (DGS)
  • WisdomTree U.S. SmallCap Dividend Fund (DES)

Mostly, I just don’t like the fact that they changed it after many years. You might have built up a position with $0 trades, and now it costs $6.95 to buy more. You can try and switch to the closest approximate ETF, but what about next time they shake up the list? TD Ameritrade won “#1 for Long-Term Investing” in the Barron’s magazine 2017 rankings. I don’t know if long-term investors like to switch holdings every 7 years. Maybe the niche ETFs are a better draw for TDA’s target audience.

If you want to construct a low-cost, broadly-indexed ETF portfolio, I would compare with the offerings from Schwab, Vanguard, and Fidelity. None of those are an independent brokerage like TD Ameritrade, but they do offer commission-free trades on low-cost, broad ETFs. You could also look into the free trade offers from Bank of America ($50k+ in relationship assets) and Robinhood (trades done via app only).

Current New Account Promotions. TD Ameritrade will let you trade commission-free for 60 days + get up to $600 if you open a new individual, joint, or IRA account. The specific bonus depends on how much money you move over. Note that unlike some other offers, this one includes IRAs and thus rollover IRAs from 401k plans.

Bottom line. TD Ameritrade has shifted the nature of their commission-free ETF program. Overall, the widely-held, broad ETFs from Vanguard and iShares have been removed. In their place, many niche/sector ETFs and smaller, newer ETFs have been added. If you like specialized ETFs, check to see if it is on their newly-expanded list of 296 ETFs.

Savings I Bonds November 2017 Update: 2.48% Variable Interest Rate

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Savings I Bonds are a unique, low-risk investment backed by the US Treasury that pay out a variable interest rate linked to inflation. You could own them as a replacement for cash reserves (they are liquid after 12 months) or bonds in your portfolio.

New inflation numbers were just announced at BLS.gov, which allows us to make an early prediction of the November 2017 savings bond rates a couple of weeks before the official announcement on the 1st. This also allows the opportunity to know exactly what a October 2017 savings bond purchase will yield over the next 12 months, instead of just 6 months.

New Inflation Rate Component
March 2017 CPI-U was 243.801. September 2017 CPI-U was 246.819, for a semi-annual increase of 1.24%. Using the official formula, the variable component of interest rate for the next 6 month cycle will be 2.48%. You add the fixed and variable rates to get the total interest rate. If you have an older savings bond, your fixed rate may be very different than one from recent years.

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

Buying in October 2017
If you buy before the end of October, the fixed rate portion of I-Bonds will be 0.0%. You will be guaranteed the current variable interest rate of 1.96% for the next 6 months, for a total 0.00 + 1.96 = 1.96%. For the 6 months after that, the total rate will be 0.00 + 2.48 = 2.48%.

Let’s say we hold for the minimum of one year and pay the 3-month interest penalty. If you theoretically buy on October 31st, 2017 and sell on October 1, 2018, you’ll earn a ~1.76% annualized return for an 11-month holding period, for which the interest is also exempt from state income taxes. If you held for three months longer, you’d be looking at a ~1.91% annualized return for a 14-month holding period (assuming my math is correct). Compare with the current best bank interest rates.

Buying in November 2017
If you buy in November, you will get 2.48% plus an unknown fixed rate for the first 6 months. The fixed rate is likely to be zero or 0.1%. (Current real yield of 5-year TIPS is ~0.20%.) Every six months, your rate will adjust to the fixed rate plus a variable rate based on inflation. If inflation picks up, you’ll get a hiked rate earlier than versus buying in October.

If haven’t bought your limit for 2017 yet, I don’t feel strongly one way or the other. If you like the idea of locking in a rate of return for the next 12 months that is a bit better than current CD rates, buy in October. If you think inflation will go up soon, buy in November. Your November fixed rate might be also be bumped up a tiny bit to 0.1%.

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

Over the years, I have accumulated a portfolio of I-Bonds with fixed rates varying from 0% to over 1%, and I consider it part of my inflation-linked bond allocation inside my long-term investment portfolio.

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

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

[Image: 1946 Savings Bond poster from US Treasury – source]

RealtyShares Update: My First Loan Default and Foreclosure Recovery (Ongoing)

realtyshareslogoHere’s an update on my debt investment at RealtyShares. The borrower stopped paying for unclear reasons, and as a result this is my first investment to go into foreclosure proceedings. I am still hopeful for a full recovery of my principal and accrued interested, but it will take a while to come to a resolution. I wanted to share some interim details for those interested.

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Initial investment details.

  • Property: 6-unit, 6,490 sf multifamily in Milwaukee, Wisconsin.
  • Interest rate: 9% APR.
  • Amount invested: $2,000.
  • Term: 12 months, with 6-month extension option.
  • Total loan amount is $168,000. Purchase price $220,000 (LTC 76%). Estimated after-repair value $260,000. Broker Opinion of Value $238,000.
  • Loan is secured by the property, in the first position. Personal guarantee from borrower.
  • Stated goal was to rehab, stabilize, and then either sell or refinance.

Subsequent summary of events.

  • January 2016. Funds committed. Loan closed.
  • July 2016 to May 2017. Sporadic payment history for over a year. They would be on-time for a while, then there’d be a late payment, then things would brought back current, etc.
  • May 2017. Borrower stated that the property was under contract for $225,000 with final walk-through completed and expected close within 30 days.
  • June 2017. Borrower stopped paying. I guess the sale fell through (or they lied). Foreclosure process initiated by RealtyShares.
  • September 2017. Judgment granted in Wisconsin court. By law, there will be 3-month redemption period where they borrower can still keep house if they pay foreclosure judgment plus interest, taxes, and costs. Expected scheduled sale date in December 2017.

Payment history. I invested $2,000 and have gotten paid $210.84 of interest before the payments completely stopped. That’s paid interest of 10.5% of principal with a rough estimate of 24 months elapsed from January 2016 to January 2018 (could be longer). My total return will depend on how much money the property will fetch upon sale.

What’s next? It was only a matter of time before I got a default. The question is how often that happens and the size of any losses. When it came to Prosper or LendingClub, the interest rates might be higher but when a loan was 60 days late you were pretty much done. As an unsecured loan, you had nothing to fall back on if the borrower broke their promise (besides hurting their credit score). Sending it to collections might get you pennies on the dollar.

However, this debt is backed by a hard asset, and RealtyShares has already started the foreclosure process. Within three months, either the borrower will have paid it off or the apartment complex will be put up for sale. I tried to research some recent comps in the area using the popular real estate websites like Zillow, but this is a somewhat unique property (6-plex). I don’t see any reason why it would sell for significantly less than the loan amount.

This is complete speculation, but I wonder if the borrower is still collecting rent from all these tenants even after they stopped making loan payments and even now during the foreclosure process. Just pocketing the rent… Is that allowed? Otherwise, the incoming rents should be higher than the mortgage payment, so why not keep paying on the loan? Curious.

Communications quality. I would grade the online updates from RealtyShares as acceptable/good. They are relatively detailed and consistent, providing me a look inside the foreclosure process. Here is a copy/paste of my most recent updates:

October 9, 2017 We have identified a real estate broker to sell the property. The broker spoke with the previous property manager who was at the property a couple of weeks ago and who may be available for property preservation. The broker is going to take a contractor to the property to try and get an accurate cost estimate to complete the renovation.

September 21, 2017 Judgment was granted at the hearing. We expect the filed judgment from the court in approximately one week and will process it upon receipt. We should be able to schedule the sale in late October and it will be held after the redemption period expires—sometime in December. As soon as we receive the filed judgment order from the court we will have the exact 3 month redemption date. Sale cannot be held until the redemption period has expired.

September 8, 2017 The partner has declined to go forward with the purchase of the property. On the foreclosure front, the judgement hearing is scheduled for September 18th. If the judgement is successful, there is a 6-month right of redemption period during which the property can not be sold. During this period we will identify a property preservation firm and a commercial broker to sell the property.

August 25, 2017 A minority partner has stepped forward and has asked for a week to visit the property with the idea of making a paydown in exchange for an extension. We have agreed to speak next week after his inspection.

August 22, 2017 Service has been completed on the foreclosure. The defendants were personally served with the summons and complaint on August 2, 2017. The statutory answering time will expire on August 22, 2017. The judgment hearing will be scheduled at that time.

June 29, 2017 Due to the borrower’s inability to stay current, we have decided to start the foreclosure process for payment default. The foreclosure will run parallel with the sales process, meaning if the sponsor can sell the property and pay us off before the foreclosure is complete we will stop the process, if not we will take over the property. Typically, foreclosures in Wisconsin take up to 12 months.

Bottom line. Well, I used to wonder what would happen in a foreclosure scenario, and now I get to find out. So far, I’m just waiting. There is no secondary market, so I can’t sell my share and invest it elsewhere. I must be patient, and hopefully I will earn an illiquidity premium as a result (i.e. higher returns). I will update again when there is more to report on the recovery process. If you are interested and are an accredited investor, you can sign-up for free and browse investments at RealtyShares before depositing any funds or making any investments.

I’ve also made investments in these other real-estate sites: PeerStreet, which offers $1,000 minimums and automated investing. Patch of Land, a debt investment backed by a single-family residential property in California. Fundrise eREIT, a basket of commercial property investments with an equity focus.

S&P 500 Total Return: Still Doubled From October 2007 to 2017

In early October 2007, the S&P 500 index hit just over 1,500 – an all-time high. You might have been concerned, or you might not have even noticed. Less than 2 years later, the financial crisis occurred and the S&P 500 dropped 50% down to 750 (March 2009). If you were a lump-sum investor, October 2007 would have been the worse month to invest in a rather long time. However, consider this chart via Bloomberg article:

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If you held on through the panic, you broke back even some time in mid-2012 if you include dividends (total return). Four years after hitting bottom, you were again hitting an all-time high. After that, basically all of 2013 was spent reaching new “all-time highs” over and over again. You might have gotten nervous again. Is it time for another drop?

Yet, if you continued to hold on until now (October 2017), even if you had the worst possible timing an pushed all your chips in on October 2007, you would have doubled your money. Over the last 10 years, even after both pushing your chips in at an all-time high and experiencing a 50% drop, you would still have earned over a 7% compounded return.

You could interpret this as pro-stocks, but my takeaway is instead that all-time highs don’t mean much. The price could drop by 50%. The price could go up 100%. We’ve seen that, and thus should be prepared for both. Instead of worrying, try considering either possibility and make a plan.

If stocks keep going up from here, I will ______. If stocks drop 50% from here, I will _______.

In my case, my portfolio could be described roughly as 67% stocks and 33% bonds. If all my stocks dropped 50% and my bonds held steady, then I would end up at 50% stocks and 50% bonds. After a 50% haircut, I would be shaken but hopefully remind myself that stock valuations would look a lot better as well. If I can get up the courage, then I will rebalance back to 67/33. If I turn out to be a scaredy-pants, simply staying at 50/50 should still keep me adequately exposed to any recovery.

Kelly Criterion and Your Fun Money Allocation

chipsDo you think you’re a below-average driver? I didn’t think so. In the same vein, Jason Zweig had a funny tweet the other day that hit home:

His linked article ends with this advice:

Put 90% of your money in low-cost index funds and lock yourself in by adding a fixed amount every month through an electronic transfer from your bank. […] Speculate with just the remaining 10%, and use a checklist of buying criteria to make sure you never buy a stock purely because it has been going up.

This coincided with me reading stuff about the Kelly Criterion, a mathematical formula used to determine the optimal size of a series of bets. Basically, the greater your “edge”, the greater your bet size should be. If you have zero edge, then you should bet nothing. If you have negative edge, you should theoretically bet against yourself (if only casinos allowed that).

Here’s an interesting example that involved a special coin where you have the advance knowledge that it has a 60% chance of heads and 40% chance of tails. In short, with this edge you should consistently bet 20% of your bankroll each time. That’s it! If the coin was 52.5% heads/47.5% tails, you should only bet 5% of your bankroll. Most people do not find this intuitive.

What’s your own edge? Consider that some folks think that only 5% of Active Investment Managers Will Add Value. This is where I insert a couple of Charlie Munger quotes:

I think it is roughly right that the market is efficient, which makes it very hard to beat merely by being an intelligent investor. But I don’t think it’s totally efficient at all. And the difference between being totally efficient and somewhat efficient leaves an enormous opportunity for people like us to get these unusual records. It’s efficient enough, so it’s hard to have a great investment record. But it’s by no means impossible. Nor is it something that only a very few people can do. The top three or four percent of the investment management world will do fine.

If you stop to think about it, civilized man has always had soothsayers, shamans, faith healers, and God knows what all. The stock picking industry is four or five percent super rational, disciplined people, and the rest of them are like faith healers or shamans. And that’s just the way it is, I’m afraid. It’s nice that they keep an image of being constructive, sensible people when they’re really would-be faith healers. It keeps their self respect up.

Bottom line. In stock market investing, most of us lack an edge and thus should stick with index funds. But we all like to think we have some edge, so maybe a 5% or 10% fun money allocation is acceptable. Anything higher would be claiming to have some crazy, unreasonable edge. I would say it also depends on how aggressively your fun money is managed. Berkshire Hathaway stock is relatively low risk. Mine is invested in short-term loans backed by real estate with conservative loan-to-value ratios and a target return of 7%. The latest cryptocurrency promoted by celebrities on social media? Not low risk.

PeerStreet Review: Real Estate Backed Loan Investments, My 14-Month Experience

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I’ve been investing in various real-estate crowdfunding platforms since early 2015 with minimum $1,000-$2,000 investments here and there. In August 2016, I put $10,000 into a new platform: automated real-estate loans from PeerStreet. I decided to wait a year and see how it worked out letting someone else pick your loans. For this type of lending, you have to be an accredited investor. Here’s my review after 14 months of being an investor.

The basic premise of PeerStreet is simple (and similar to other sites). Real estate equity investors want to take out short-term loans (6 to 24 months) and don’t fit the profile of a traditional mortgage borrower. They are professional investors with multiple properties, need bridge financing, or they are on a tight timeline. As a real-estate-backed loan investor, you lend them money at 6% to 12% and usually backed by a first lien on the property. The borrower stands to lose the equity in their property (I keep LTV under 70%), so they are highly incentivized to avoid default. In the worst case, you would foreclose and liquidate the property in order to get your money back. However, this is better than Prosper or LendingClub where it is an unsecured loan and your only recourse is to lower their credit score.

What are PeerStreet strengths? Here are the reasons that I decided to put more a higher amount of money into PeerStreet as compared to other worthwhile real estate marketplace sites:

  • Debt-only focus. Other real estate (RE) sites will offer both equity and debt (and some thing in between). PeerStreet only focuses on debt, and I also prefer the simplicity of debt. There is limited upside but also less downside. Traditionally, this might be called “hard money lending”.
  • Lower $1,000 investment minimum. Many RE investment sites have minimums of $10,000 or $25,000. A few will go down to $2,000 but there is not a steady supply. At PeerStreet, $25,000 will get me slices of loans from 25 real estate properties.
  • Greater availability of investments. Amongst all of the RE websites that I have joined, PeerStreet has the highest and most steady volume of loans that I’ve seen. I dislike having idle cash just sit there, waiting and not earning interest. They apparently have a unique process where they have a network of lenders that bring in loans for them. This steady volume allows the lower $1,000 minimums and more diversification, as well as easy reinvestment of matured loans.
  • Automated investing. The above two characteristics allow PeerStreet to run an automated investment program. You give them say $5,000 and they will invest it automatically amongst five $1,000 loans. You can set certain criteria (LTV ratio, term length, interest rate). When a loan matures, the software can automatically reinvest your available cash. I don’t even have to log in.
  • Consistent underwriting. You should perform your own due diligence in this area, as you can only feel comfortable with automated investing if you think every loan is more or less underwritten fairly. The riskier loans get higher interest rates. The less-risky loans get lower interest rates. The shady borrowers are turned away. Otherwise, you’d want to pick and choose. After doing this for a year, I stopped wanting to pick and choose. I want to just sit back and let the software choose for me. We’ll see if it works out.
  • Backed by Andreessen Horowitz and also Michael Burry. Andreessen Horowitz did the Series A funding. Michael Burry was an early seed investor, using $6.1 million of his own money according to TechCrunch. As profiled in The Big Short, Burry is known for being analytical to a fault, as opposed to being a good salesman.

Here’s a screenshot of the automated investing customizer tool:

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(Tip: Even if you plan on investing only in $1,000 loans, once you are fully invested you might change later to a higher minimum like $1,250 in order to more quickly reinvest your idle cash. For example, if you have $78 in interest and then a $1,000 loan is paid off, then you could invest $1,078 automatically into your next loan.)

What is a potential PeerStreet drawback? In my opinion, slightly lower yields. This is just my limited understanding and I may be wrong, but PeerStreet has a network of lenders bringing in these deals and so the net yield to the investor feels lower than other sites. This “con” is also their secret sauce that brings in the high loan volume (and ideally the ability to be more selective), and so I am willing to earn lower interest rates for the added diversification and convenience of automated investing.

Here’s the 1-minute video pitch from PeerStreet:

How does PeerStreet make money? As with other real estate marketplace lenders, they charge a servicing fee. PeerStreet charges between 0.25% and 1%, taken out from the interest payments. This way, PeerStreet only gets paid when you get paid. When you invest, you see the fee and net interest rate that you’ll earn. In exchange, they help source the investments, set up all the required legal structures, service the loans, and coordinate the foreclosure process in case of default. In some cases, the originating lenders retains a partial interest in the loan (“skin in the game”). Here’s a partial screenshot:

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What if PeerStreet goes bankrupt? This is the same question posed to LendingClub and Prosper, and their solution is also the same. The loans are held in a bankruptcy-remote entity and will continue to be serviced by a third-party even in a bankruptcy event. From their FAQ:

PeerStreet also holds loans in a bankruptcy-remote entity that is separate from our primary corporate entity. In the event PeerStreet no longer remains in business, a third-party “special member” will step in to manage loan investments and ensure that investors continue to receive interest and principal payments. Additionally, investor funds are held in an Investors Trust Account with City National Bank and FDIC insured up to $250,000.

Tax forms? In general, unless you use a self-directed IRA, the interest earned will be taxed as ordinary income (like bank account interest). For tax year 2016, I received a simple 1099-INT and filing it with my income taxes was easy. Here’s what PeerStreet says:

PeerStreet investors will be issued a consolidated Form 1099 for the income distributed from their investment positions. Investors may receive one or more of the following types of 1099 form:

1099-OID for notes with terms longer than one year (at the time of issue)
1099-INT for notes with terms less than one year (at the time of issue)
1099-MISC for incentives, late fees or other income, if more than $600.

My investment performance. I starting investing with $10,000 in August 2016. I’ve already had over $10,000 in loan value paid back already, but I chose to reinvest immediately. As of this writing in 10/1/2017, my total account value is $10,863.46 invested across 10 different loans after reinvestment. My interest to date is $863.46, which works out to 7.7% annualized return net of all fees and taking into account the short periods where my cash was idle. Here are screenshots of my paid-off loans and a chart of cumulative interest earned.

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Now, I don’t know what the default rate is overall, but sooner or later I will probably experience one. This will require patience as it will take a while for the foreclosure process to play out. In my experience, this is a critical difference with private real estate loans. You can’t make a few clicks and get your money back at the current market price. I might have to wait months or even more than a year. The good news that with a hard asset as collateral, eventually I have a solid chance of getting my money back with interest. I am willing to accept this illiquidity and hopefully earn higher returns in exchange.

Update: As of October 2017, PeerStreet has stated they have originated $500 million of loans with zero investor losses.

Bottom line. PeerStreet offers high-yield, short-term loans backed by private real estate. Instead of traditional “hard money lending”, accredited investors can diversify with only $1,000 minimum in properties nationwide with automatic investments, without having to do any physical legwork. The number of new, available investments is better than competitors in my experience. Will it provide superior risk-adjusted returns as compared to other high-yield bonds? I don’t know, but my experience so far after 14 months has been positive.

If you are interested and are an accredited investor, you can sign-up for free and browse investments at PeerStreet before depositing any funds or making any investments.

See also my previous investments: Patch of Land (accredited only), a debt investment backed by a single-family residential property in California. Fundrise eREIT (open to public), a basket of commercial property investments with an equity focus. RealtyShares, a debt investment backed by a 6-unit apartment complex.

Vanguard Thoughts: Pros and Cons from a 15-Year Client-Owner

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Vanguard has been sucking up assets like a vacuum, with total assets now exceeding $4 trillion. Their hybrid robo-advisor Vanguard Personal Advisor Services has over $65 billion in assets under management. Are they unbeatable? People tend to love building things up, then love tearing it down.

Vanguard holds the majority of my net worth, grown over 15 years in Vanguard brokerage accounts and Vanguard mutual funds/ETFs. You could therefore call me a fanboy, but also a concerned “client-owner” (I prefer the term “investor-owner”). As they keep hounding me to vote on their proxy, here’s what I like the most and least about Vanguard:

Pros

  • Historical track record. Vanguard has a long history of providing investments at a low cost. When they arrive to an asset class, costs tend to drop like a rock. This the Vanguard Effect.
  • Skill and experience. They are good at what they do – run low-cost index funds and low-cost actively-managed funds. They understand things like reducing index tracking error and utilizing securities lending to boost fund returns.
  • Ownership structure. Vanguard does have a unique ownership structure conducive to continuing to maintaining low costs. There are no outside shareholders or activist hedge funds working to squeeze out every last drop of profit.
  • Profitable. Vanguard has their current expense ratios and is actually making money (or technically breaking even) on every single fund and ETF. The others are losing money on their “cheap” products while they try to make money elsewhere.
  • Less company risk. All the above adds up to my opinion that Vanguard has the best chance of future, ongoing lower costs. A potential cost beyond expense ratios that should be considered is the cost of switching to a different fund in a taxable account. If I sell now to buy something else, I will have to pay taxes on a significant amount of capital gains. I want to minimize the chance of having to do that.

Cons

  • Lack of transparency on marketing costs. Vanguard runs a lot more advertising than they used to. I might argue too much, but nobody knows how much they are spending because they don’t disclose this even to their “investor-owners”. Vanguard is not a non-profit, but I have seen even non-profits suffer from internal bloat and having quality suffer in the pursuit of growth.
  • Lack of transparency on executive compensation. Vanguard may not have outside shareholders, but we also don’t know how much money the CEO or other executives make. If Vanguard were a publicly-traded company like Schwab, they would have to disclose these numbers. As “investor-owners”, I don’t get told anything. As this Bloomberg article states, “Vanguard is an important shareholder voice on executive pay, but it isn’t transparent on its own compensation.”
  • Mediocre customer service. Vanguard has struggled with the quality and responsiveness of their customer service as they have grown in size. My interactions with Fidelity and Schwab have consistently produced faster response times and more accurate levels of service. Vanguard themselves have admitted that they have had struggles in this area.
  • Not necessarily the cheapest at any given moment. If you look at any specific ETF benchmark at any specific moment in time these days, the cheapest offering might come from Vanguard, but it just as likely might come from Schwab, iShares, or Fidelity.

Financial author Jonathan Clements argues in his Protection Money article that he is willing to a little bit more for Vanguard ETFs in order to avoid potentially having to pay significant capital gains if the loss-leader pricing trend stops. I think that is a very valid argument.

Now, you could also buy Vanguard ETFs inside another brokerage account. However, you may have to contend with trade commissions. A few exceptions on ETFs: Merrill Edge and Bank of America will give you 30 free trades a month if you have $50,000 in combined assets at BofA and Merrill (plus better credit card rewards). The Robinhood app lets anyone invest with free commissions (although I’d expect even less than Vanguard in terms of customer service). You can transfer Vanguard ETFs to another custodian for a flat fee if you wish to avoid realized capital gains.

Big picture. Vanguard changed the investment world, but now the gap is much narrower. I started out with Vanguard and think they still have the best long-term structure, so I own Vanguard mutual funds and ETFs. However, Schwab and iShares Core ETFs held somewhere with low trading costs and good customer service are also very good choices for someone starting out. This group of “nearly as good” alternatives to Vanguard continues to grow. Meanwhile, there is still another large group of “definitely worse” alternatives. Debating between 0.01% is rather useless when there are still people paying 1% or more for index funds.

Robinhood: Free Share of Stock for New Users – Estimated Value

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Robinhood is a sleek smartphone app that’s a brokerage account with unlimited $0 trades with no minimum balance requirement. They’ve been around for a few years now and I’ve been impressed that they’ve kept up the free trade business model, partially by recently rolling out premium paid features. I enjoy the minimalist and intuitive interface.

Right now, if you a referred by an existing user you get a free share of stock. The existing user also gets a free share, so thanks if you use it! As I write this, that share is randomly selected from a pool of “widely-held companies”, which includes Apple ($158), Facebook ($172), or Microsoft ($75). Too bad they don’t offer Berkshire Hathaway Class A shares ($274,000). Okay, but there are also shares of companies that are worth $1 or less.

What share value should I expect? Here are screenshots from my phone showing some odds:

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For some reason they try to use the World’s Smallest Fine Print™, but here are selected details from their FAQ:

The stock bonus is one share selected randomly, when the bonus criteria are met, from Robinhood’s inventory of settled shares held for this program. When shares are purchased into this inventory, Robinhood purchases shares from the three to four companies representing the highest market capitalization in various ranges of share prices between approximately $3 and $175, limited to those companies that are widely held among Robinhood accounts. There is an approximately 98% chance of the stock bonus having a value of $2.50-$10, an approximately 1% chance of the stock bonus having a value of $10-$50, and an approximately 1% chance of the stock bonus having a value of $50-$200, based on the price of shares at the time of purchase. The Robinhood platform displays approximate odds of receiving shares from particular companies at the time the screen is generated. These odds do not necessarily reflect the odds of receiving stock in those companies at the time the stock bonus is awarded.

So… basically 98% chance of getting something $10 or less, and 2% chance of something higher. This means the weighted average share price can’t be more than ten bucks.

By the way, you can cash out your bonus by selling after 2 days and withdrawing your balance after 30 days:

Limit one offer per qualified referral with a maximum of one account per referred client. Stock bonus will be credited to the enrolled account within approximately one week after the bonus is claimed. Stock bonuses that are not claimed within 60 days may expire. Shares from stock bonuses cannot be sold until 2 trading days after the bonus is granted. The cash value of the stock bonus may not be withdrawn for 30 days after the bonus is claimed.

Bottom line. The Robinhood “Get Free Stock” promotion is clever and it certainly appeals to the hopeful gambler within us with a $200 potential value, but most people are likely going get a share of stock valued at $10 or less. (Don’t sell it and wait 30 years – see what happens!) I would just treat as a fun game if you otherwise want to be able to trade stocks for free on your smartphone. Robinhood is a good value on its own, see my full Robinhood review.

Sign up for Robinhood and get your free share here, and I’ll report back on any shares that I win.

Robinhood App Review: $0 Stock Trades, Easy-to-Use Interface

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Updated. The Robinhood app wants to “democratize the financial markets” by creating brokerage account in your pocket that offers unlimited free trades with no minimum balance requirement. That is a pretty bold move, and I was skeptical as I’ve been an long-time early adopter of free trading platforms (read: cheapskate investor).

I started out as a beta user in mid-2014 with their beautiful but manually-installed iPhone app. In August 2015, they rolled out both iOS and Android app and reported processing over 2 million free trades. As of 2017, they have over a million users and processed $30 billion in trades. According to Bloomberg, they recently raised money at a $1.3 billion valuation.

Application process. You must provide your personal information including Social Security number, net worth, income, investing experience, etc. This is the same as any other brokerage firm, but this may also be the first such account for many users. Everything was done online; there were no paper documents that required mailing or faxing.

Core features.

  • Yes, the app really gives me $0 commission trades with no minimum balance requirement. That means you could open account, put in five bucks, and buy a single share of Zynga (ZNGA) if you wanted to (maybe two on a bad day…).
  • Robinhood now supports market orders, limit orders, stop limit orders, and stop orders. Certain orders may be entered as good for the day or good till canceled (GTC).
  • You can open an individual cash or margin account.
  • Customer service is encouraged to go through their e-mail “support@robinhood.com”, but they have added a phone number now during market hours (9:30am – 4:00pm EST) at (650) 940-2700.

Along with all the other legit brokerage firms, Robinhood Financial is a member of the SIPC which protects the securities in your account up to $500,000. Data is encrypted with SSL. Apex is their clearing firm.

Funds transfers. You can manually link any bank account with your routing number and account number, but you can also directly use your username and password at these banks: Chase, Bank of America, Citibank, Wells Fargo, U.S. Bank, Charles Schwab, PNC, Silicon Vally Bank, and USAA. ACH transfers are free and take approximately 3 business days (same as other brokerages).

Robinhood recently added an automatic deposits feature where you can schedule ACH transfers on a weekly, biweekly, monthly, or quarterly basis.

ACAT account transfers. Robinhood now accepts incoming stock transfers from outside brokerage accounts. To do this, go your app account menu, select “Banking”, then select “Stock Transfer” and follow the on-screen instructions. Incoming transfers are free. Outgoing transfers will incur a $75 fee.

Robinhood Instant. Robinhood Instant is a free upgrade that gets you a “limited margin account” that has the following features:

  • Immediate access to funds from selling stock. That means you can reinvest those funds without waiting two days for settlement. (All brokerage margin accounts offer this.)
  • Limited instant deposits. Use up to $1,000 of your pending bank deposits right away. No waiting 2-3 days for a bank transfer to complete.

What’s missing? Getting free trades is great, but I think it’s also important to know what you won’t get, at least right now:

  • You must access your account via a mobile Apple iOS or Android device (iPhone, iPad, iPod Touch, Android phone, Android tablet). There is no official web interface. There are unofficial ones available, but I would be wary of sharing your login credentials with a 3rd-party.
  • Broker-assisted phone trades are $10 each, according to their fee schedule.
  • Electronic statements are the default. I don’t even see an option to enable paper statements in the app, but according to their fee schedule paper statements cost $5 a pop.
  • Options trading is not available at this time.

How do they make money? First, Robinhood will make some money the same way other brokers do: collect interest on your idle cash, charge you interest for margin loans, and sell order flow. The most innovative prospect is to the plan to sell API access to other financial apps.

The fact that Robinhood sells order flow may leave you with a slightly worse execution price as compared to other brokers with more complex order routing. If you are making large value trades, then this small percentage difference may add up to something significant that matters more than commission price. With my tiny order volume, I am fine with them selling my order flow if they are giving me commission-free trades.

Robinhood Gold is their premium service tier that gives you extending trading hours and interest-free margin for $10 a Month. My Robinhood Gold review.

User interface. Over the last 10 years, I’ve opened an account at the majority of the “discount” brokerage firms. I’ve had $0 trades before, along with $2 trades, $2.50 trades, $4.95 trades and so on. What makes Robinhood special is their modern, app-centric approach. I agree with this quote from Wired:

But the app’s simplicity is meant to be about more than style. Ease of access and understanding is meant to make Robinhood compulsively engaging for a new generation of investors that don’t find the stock market very accessible from the mobile screens at the center of their lives.

Screenshots.

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Recap. Robinhood delivers on their $0 stock trades promise with no minimum balance. The app-only user interface is clean and intuitive. Customer service is on the lean side, but my requests were responded to within a day or so. They continue to make incremental improvements. They’ve been open to the public since March 2015, which is honestly longer than I expected.

Sign up for Robinhood with my referral link and get a free share of stock, and I’ll get one too. Details on this promotion here.

University of Berkshire Hathaway: Notes From Annual Shareholders Meeting (Book Review)

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If you are a Buffett & Munger follower, you should be intrigued by University of Berkshire Hathaway: 30 Years of Lessons Learned from Warren Buffett & Charlie Munger at the Annual Shareholders Meeting by Daniel Pecaut and Corey Wrenn. Anyone can buy all the old BRK shareholder letters, but there are very few transcripts from the live shareholder meetings in Omaha, Nebraska (1986–2015). There is definitely overlap, but these live interactions sometimes provide a peek into their less-publicized opinions (especially Munger’s). Here’s how the authors describe the book:

This book isn’t for the first-time investor. It’s for the informed investor who sees the value of being able to get deep into the mindsets of Warren Buffett and Charlie Munger. If you want to walk around in their shoes for the past three decades, absorb what works, and then apply it to your own investments, then this book is for you.

The current price is only $0.99 in Kindle format. At that price, it should be an easy decision on whether to own the entire book forever, but here are my personal notes and highlights to give you an idea of the contents:

How Berkshire Hathaway differs from other actively-managed stock mutual funds:

The public has long viewed Berkshire as a sort of mutual fund with large stock holdings. This view underestimates or ignores 1) Berkshire’s insurance companies’ impressive generation of low-cost float, 2) Berkshire’s impressive and growing stable of cash-generating operating businesses, and 3) Berkshire’s ability to orchestrate value-enhancing deals.

Classic quote on stock market prices:

Buffett noted that many investors illogically become euphoric when stock prices rise and are downcast when they fall. This makes no more sense than if you bought some hamburger one day, returned the next day to buy more but at a higher price, and then felt euphoric because you had bought some cheaper the day before. If you are going to be a lifelong buyer of food, you welcome falling prices and deplore price increases. So should it be with investments.

Luck and the Ovarian lottery:

Buffett launched into an intriguing thought problem he called “the ovarian lottery.” You are to be born in 24 hours. You are also to write all the rules that will govern the society in which you will live. However, you do not know if you will be born bright or retarded, black or white, male or female, rich or poor, able or disabled. How would you write the rules? Buffett said how one comes out in this lottery is far more important than anything else to one’s future. He and Munger were huge winners having been born American (“in Afghanistan, we wouldn’t be worth a damn”), male (at a time when many women could only be nurses and teachers), white (when opportunities for minorities were slim) and good at valuing businesses (in a system that pays for that like crazy). Buffett noted it is important to take care of the non-winners of the ovarian lottery. Therefore, some sort of taxation is in order. Given that few people with money and talent are turned away from free enterprise under the current system, the 28% capital gains tax is probably okay.

Investing in yourself:

Buffett asserted that the very best investment you can make is in yourself. Buffett shared that, when he talks to students, one of the things he tells them is what a valuable asset they have in themselves. Buffett would pay any bright student probably $50,000 for 10% of their future earnings for the rest of his life. So each student is a $500,000 asset just standing there. What you do with that $500,000 asset should be developing your mind and talent.

State-sponsored legal gambling:

Buffett asserted that to a large extent, gambling is a tax on ignorance. You put it in, and it ends up taxing many that are least able to pay while relieving taxes on those who don’t gamble. He finds it socially revolting when a government preys on its citizens rather than serving them. A government shouldn’t make it easy for people to take their Social Security checks and waste them by pulling a handle. In addition, other negative social things can flow from gambling over time.

Read, read, read:

Buffett agreed that he is big on reading everything in sight and recommended good investors should read everything they can. In his case, he said that by the age of 10, he’d read every book in the Omaha public library on investing, some twice! Fill your mind with competing ideas, and see what makes sense to you.

Investing with real money:

Then you have to jump in the water—take a small amount of money, and do it yourself. He joked that investing on paper is like reading a romance novel versus doing something else. Munger shared that Berkshire Director Sandy Gottesman, who runs a large, successful investment firm (First Manhattan), asks interviewees, “What do you own, and why do you own it?” If you’re not interested enough to own something, then he’d tell you to find something else to do.

Book recommendations, including The Richest Man in Babylon:

We have often recommended to our friends and clients George Clason’s classic, The Richest Man in Babylon, so we were delighted to hear Charlie speak of it. He said that he read the book when he was young and that the book taught him to under-spend his income and invest the difference. Lo and behold, he did this, and it worked.

Munger also suggested that it is very important to learn how to avoid being manipulated by lenders and vendors. He strongly recommended Robert Cialdini’s book, Influence, for the task. He also recommended Cialdini’s newest book, Yes, noting that Cialdini is the rare social psychologist who can connect the world of theory and daily life.

Note: This a dated quote, and Robert Cialdini’s newest book is actually Pre-Suasion: A Revolutionary Way to Influence and Persuade, published in 2016.

Work for yourself an hour each day:

He got the idea to add a mental compound interest as well. So he decided he would sell himself the best hour of the day to improving his own mind, and the world could buy the rest of his time. He said it may sound selfish, but it worked. He also noted that if you become very reliable and stay that way, it will be very hard to fail in doing anything you want.

Simple career advice:

“Do what you enjoy the most. Work for people you admire. You can’t miss if you do that.”

Investing in stocks (equity) vs. bonds (debt):

Buffett noted that the analytical hurdle for buying a bond requires answering the question, “Will the company go out of business?” while buying an equity requires answering the more difficult question, “Will the company prosper?” This is why Berkshire bought the 15% notes of Harley Davidson rather than the stock. He had no question the company would stay in business, quipping, “You have to like a business where the customers tattoo your name on their chests!” But gauging Harley’s long-term prosperity was much more difficult, especially during the throes of the crisis.

Also see my earlier posts on appreciating your absolute standard of living and why you should maintain some optimism.

Bottom line. If you’re a Buffett & Munger enthusiast, this is a nice addition to your collection. Lots of familiar wisdom but also includes some additional perspective. If you’re not a Buffett & Munger enthusiast, I might start elsewhere, for example with Warren Buffett’s Ground Rules if you’re not ready for the original shareholder letters. Here’s to hoping the authors will do a similar book on the Wesco Financial meetings with Charlie Munger.

How Much International Stocks In Your Portfolio? 2017 Outlook

globeHere are some updated thoughts on holding stocks based outside the US in your portfolio.

There is no “ideal” amount of international stocks that experts agree upon. You have numbers ranging from 0% (US only) to 50% (market-cap weighting). For a good summary of this situation, check out these two recent articles from Christine Benz and John Rekenthaler of Morningstar.

The world continues to change, and the market weights will change with it. Here’s an interesting infographic by Jeff Desjardins at VisualCapitalist about world GDP breakdown for the last 2,000 years. The time axis is kind of wonky from 1-1900, so I’d focus on just 1900-now. GDP is not the same as market value, but the point is that the world will not look the same in 30 years.

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Right now, in terms of valuation, US stocks are relatively expensive and International stocks are relatively cheap. Via this ETFTrends article by Chris Konstantinos at RiverFront Investment Group, via TRB:

Looking a 12-month forward P/E ratio at the MSCI All-Country World Ex-US index, we are currently at the largest valuation gap between US and non-US markets in the 15+ years of data to which we have access.

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My take: Pick a split and stick with it. I don’t feel too strongly about this topic. If a Belgian company buys Budweiser, does that change how the business works fundamentally? If you go with 100% US stock and wait 30 years, you’ll probably be just fine. If you go with 50% US and 50% International and wait 30 years, you’ll probably be just fine. One choice will do better than the other, but nobody knows which one. These days I’ll be happy if we manage to avoid nuclear war.

I personally like buying a bigger haystack with all the needles and thus I like 50/50. If you want to hedge somewhere in between, consider that Vanguard Target and Lifecycle All-In-One funds are 60/40 now but they used to be 80/20 and then 70/30. It’s more important that you pick something and stick with it, as opposed to bailing out when one does a lot better than the other.

In terms of psychology, you can always twist the situation as needed. If you are 100% US, you could be happy with US outperformance over the last decade. If you are 50/50, you can take solace in the valuation gap and that any mean reversion from this point onwards will lead to future international outperformance.