Archive for the 'Investing' Category
Wednesday, December 21st, 2011
My post yesterday about the varying performance of different asset classes reminded me about a Businessweek article called the IRA Monte Carlo. This is a tax-saving trick for those who wish to convert their Traditional IRAs or old 401ks to Roth IRAs. Here’s a snippet:
1. Let’s say an investor has one traditional IRA with a value of $4 million.
2. The traditional IRA is split up into four traditional IRAs, each worth $1 million.
3. The investor converts all four to Roth IRAs at the beginning of the year.
4. The IRS effectively allows taxpayers to undo the conversion for up to 21 months. So in 21 months the investor looks at the performance of the IRAs. Say two of them go up from $1 million to $2 million and two drop from $1 million to zero. Because the IRAs were split into four, the investor can change her mind on the two that went down and revert those back to traditional IRAs. Thus, she owes taxes on only the two contributions that went up in value, and nothing on the two that went down, cutting her tax bill in half. This lops 21 months of risk off the bet that paying taxes now will be paid off with tax-free appreciation later.
Did that make sense? It was a little confusing for me, so here’s my take on it. Right now, there is no income limit converting Traditional IRAs to Roth IRAs (and paying the taxes owed). Everyone can do it. Basically, in the conversion you pay taxes now on gains at your current tax rate, but then as a Roth IRA your future gains are tax-free. This works out to be a good idea if your future tax rates upon withdrawal end up higher than your tax rates right now.
It boils down to: Pay your taxes now? or pay taxes in the future?
Let’s say you agree your future tax rate will be higher, whether for personal reasons (you think future income will be higher or at least the same) or external reasons (you think Uncle Sam will raise tax rates). The loophole here is that you are allowed an “undo” by the IRS, which you can take advantage of by splitting your big traditional IRA into multiple, smaller, separate traditional IRAs. Then convert the smaller IRAs, and wait up to 21 months:
- If the value of the converted IRA goes down, then you can undo the conversion and then redo it later, saving you on taxes. For example, if you converted $100,000 in Emerging Markets stocks in the beginning of the year and it went down to $80,000 – would you rather pay taxes on $100k or $80k?
- If the value of the converted IRA went up – say from $100k to $115k if you invested in Treasury bonds throughout 2011 – then you’re happy because that $15k gain is all tax-free. You just sit back, sip your cocktail, and leave it alone.
There’s not many times in life you get to hit the “undo” button. As in the examples given, I would recommend putting different asset classes in your separate IRAs so that you can take advantage of any non-correlated performance. Don’t completely change your investment holdings just for this tax trick, though. Just putting stocks in one and bonds in the other can offer a potential benefit.
Posted in Investing, Taxes | 8 Comments »
Tuesday, December 20th, 2011
It’s time for a end-of-year checkup on the ole’ portfolio, as I’m afraid that I’ll forget about it between Christmas and New Year’s. There isn’t much change to my investment portfolio itself, the target asset allocation is the same, and the specific fund holdings are pretty much the same. I’m closer to 70% stocks and 30% bonds now. With only about 7 trading days left, I wanted to see how the various asset classes that I own performed in 2011.
My portfolio is similar to the David Swensen model portfolio, which uses low-cost index funds to gain exposure to specific asset classes. Here is an implementation of the portfolio using actual ETFs in a recommended 70% stocks / 30% bonds breakdown.
30% Domestic US Equity (VTI)
15% Foreign Developed Equity (VEA)
10% Emerging Markets (VWO)
15% Real Estate (VNQ)
15% U.S. Treasury Bonds (IEF)
15% Inflation-Protected Securities (TIP)
The chart below shows the growth of $1,000 invested this way (eMAC) at the start of 2001 until the end of November 2011, as compiled by the financial advisory group ETF Portfolio Management for benchmark purposes.
I have also taken the liberty of updating their annual returns table to including 2011 year-to-date total returns (see highlighted) using Morningstar data as of 12/19/2011.
The weighted year-to-date return of the overall model portfolio is 0.35%, essentially zero for 2011. But from the table, you see that each individual asset class may have moved a lot. European and Emerging Market stocks performed quite poorly (in case you don’t read the news), the S&P 500 looks like it will more or less go nowhere for the year, REITs (Real Estate) did okay, and Treasury bonds did very, very well considering this low-yield environment. Inflation-Protected bonds (TIPS) were the superstar in my portfolio, they saved my bacon.
Another year, another reminder that predicting short-term market movements is way beyond me. 
I continue to be happy with owning various asset classes with long-term expected positive returns, but which tend not to move in sync and thus smooth out the ride.
Next year, I intend to learn more about an income-oriented portfolio as that may potentially work better – at least psychologically – for the early-retirement set. My secret crush, the Vanguard Wellesley Income Fund (VWINX) was up 7.91% in 2011 YTD. It’s a income-oriented actively-managed fund with about 35% in dividend stocks and 65% in corporate bonds – but with a tiny expense ratio of only 0.28% for investor shares, 0.21% for admiral shares.
Posted in Investing, Real Estate | 12 Comments »
Monday, December 5th, 2011
E-Trade has decided to join in on the commission-free ETF party, announcing a limited set of ETFs that you can trade with no commission fees effective 12/16/2011. However, to “discourage short-term trading, E*TRADE will charge a short-term trading fee on sales of participating ETFs held less than 30 days.” I tried but couldn’t find how much that fee was on the fees page. Thanks to reader Shraz for the tip.
The fund companies represented include WisdomTree, Global X, and db-X (Deutsche Bank). Many of the ETFs are definitely niche products, like a New Zealand Dollar ETF or a Aluminum ETF… meh. There are a few ETFs that may be somewhat interesting, if you like the idea of a dividend-weighted strategy:
WisdomTree Total Dividend ETF (DTD)
WisdomTree LargeCap Dividend ETF (DLN)
WisdomTree SmallCap Dividend ETF (DES)
WisdomTree Emerging Mkts SmallCap Dividend ETF (DGS)
WisdomTree International SmallCap Dividend ETF (DLS)
For context, here’s more information on other brokerage companies with their own specific ETF lists:
If you are the type of investor that wants to buy low-cost, index/passive ETFs with no commmission fees, I would say that Vanguard and TD Ameritrade are the best bets. You could build a low-cost and simple ETF portfolio from Total US (VTI), Total International (VEU), Total Bond (BND), and Inflation-Protected Bonds (TIP) for free at TD Ameritrade. You’d have to either go with a mutual fund version for TIPS or pay a commission for TIP from Vanguard.
Posted in Investing | 2 Comments »
Wednesday, November 30th, 2011
Jemstep is a new website that lets you track your investment portfolio along with providing advice on improving your mutual fund and ETFs holdings. In terms of existing products, you could call it a combination of the all-in-one view of of Mint.com plus the mutual fund ratings of Morningstar.com. However, the key difference from Morningstar is that their Jemscore ranking system is customized for your specific preferences. The weighting of different factors changes with your answers to the topics covered by their “goal preference” survey:
- Demographics: Age, time to retirement, etc.
- Risk tolerance: Common risk-questionnaire survey questions about return vs. volatility
- Fees, Taxes, & Income: Sensitivity to fees, taxes and gains, preference for income vs. total return
- Fund preferences: Active vs. passive, manager tenure, loads, etc.
- ETF preferences: Liquidity (volume) preferences, bid/ask spread sensitivity
Investment Account Aggregation
I haven’t entered all of my brokerage accounts, but so far the aggregation service works fine and all my different holdings including individual Treasury bonds shows up fine. Jemstep uses CashEdge for account aggregation, which is well-known and the backbone of several big banks. Although anything with a ticker symbol is tracked, Jemstep only provides rankings for mutual funds and ETFs and not individual stocks or bonds. There isn’t much in the way of asset allocation breakdowns or volatility measurements. (Update: There is an asset allocation chart available in the Portfolio summary page, although it may not pick up all your holdings.) It does track the historical performance of your accounts, which you can compare to a few basic benchmarks like the S&P 500.
Mutual Fund Rankings
I certainly like the idea of a customized ranking system. However, if anything, I don’t know if it goes far enough. The main weakness I see in their ranking system is the same as for Morningstar. Despite my survey answers, overwhelmingly what matters most is recent past performance. The rankings change each month, so if you always want to hold the “best fund” you’lll be left chasing one hot fund after the next. The top-ranked fund will rarely ever be an index fund.
For example, let’s look at my holding of the Vanguard Emerging Market Index ETF, VWO. Instead, it recommends as #1 the iShares MCSI Malaysia ETF (EWM). Okay, the Malaysian market has been doing quite well recently, but would it really be wise to hold a single small country ETF with a 0.53% expense ratio as opposed to one that holds all the emerging economies from China to Southeast Asia to Latin America, all at 0.22% expense ratio? Likewise, Morningstar has EWM at a 5-star rating and VWO at only a 4-star rating. Screenshot (click to enlarge):
Another #1 fund ranked for me was the Yacktman Fund (YACKX). I actually kind of like this actively-managed fund as a “fun money” holding, as the manager takes concentrated bets and isn’t afraid to be different than the crowd (right now, its portfolio is 11% Pepsi and 11% News Corp). But again, right now the past performance of Yacktman looks really great. But some quick research shows that back in 2000, recent performance was awful, and the fund’s assets were only $69 million which means very few people owned it. The fund’s own board of directors tried to oust him (see 2001 Kiplinger’s article). Would Jemstep (or Morningstar) have been recommending it then?
Posted in Investing | 11 Comments »
Monday, November 14th, 2011
(Update: Betterment has a new promo for a $100 bonus with $10,000 investment held for at least 60 days. This is a bigger bonus with bigger requirement than the previous $25 bonus for a $250 investment. In case you wanted to know, my $1,000 experimental Betterment portfolio has been fully converted to the new asset allocation already, and is currently worth $964.)
Betterment.com is an investment service that started up last year, where simplicity and ease of use is the focus. Back in May, I opened an account for myself and wrote a review of Betterment. Right now if you open an account with at least $250, you will get a $25 bonus.
My primary gripe at the time was their asset allocation for stocks. (I actually liked the simply bond allocation.) However, I recently received an e-mail that they are making some changes in September. Before:
- 20% Vanguard Total Stock Market ETF (VTI)
- 20% iShares S&P 500 Value Index ETF (IVE)
- 20% iShares S&P 1000 Value Index ETF (IWD)
- 15% iShares Russell 2000 Value Index ETF (IWN)
- 15% iShares Russell Midcap Value Index ETF (IWS)
- 10% SPDR Dow Jones Industrial Average ETF (DIA)
After:
- 25% Vanguard Total Stock Market (VTI)
- 25% iShares S&P 500 Value (IVE)
- 25% Vanguard Europe Pacific (VEA)
- 10% Vanguard Emerging Markets (VWO)
- 8% iShares Russell Midcap Value (IWS)
- 7% iShares Russell 2000 Value (IWN)
The major change is that they are adding international stock exposure, which is nice since about 55% of the world’s publicly traded market value is outside the US. They have landed on a conservative 35%/65% international/US split. You may also notice that they got rid of the Dow Jones ETF, which I complained about as well since the Dow Jones is simply not a very good index. The iShares S&P 1000 Value Index ETF is gone as well, most likely because it had so many overlapping holdings with the S&P 500 Value index.
How will the change occur? From the same e-mail:
Starting in September, your account will automatically begin transitioning to the new portfolio, and will be phased in over a period of two months to take advantage of average pricing over time.
Such a change to their portfolio and the subsequent buying/selling will unfortunately mean some extra tax bills for investors, but this is how it goes with internet startups. In the long-term, I feel the changes make Betterment a better product.
Posted in Investing | 12 Comments »
Wednesday, November 9th, 2011
Time for another update of my investment portfolio, including employer 401(k) plans, self-employed plans, IRAs, and taxable brokerage holdings.
Asset Allocation & Holdings
You can view my target asset allocation here, along with link to other model portfolios. Despite the headlines, I still like to buy, hold, and rebalance. Here is my current actual asset allocation:
Everything is within acceptable ranges, other than I need to buy more TIPS. This is just an overshoot since I have my 401k buying shares in a stable value fund automatically, and my TIPS are mostly stuck in IRAs. Actually, my TIPS holdings have been doing great, due to how low real yields are right now. Last I checked, even 10-year TIPS had negative real yields.
My current ratio is about 75% stocks and 25% bonds. I’ve been thinking about this balance. On one hand, I’m contributing a lot of money into the portfolio, and I hope that I can get my “early” retirement on within the next 10 years. At that point, I’m going to want something closer to a 60% stocks and 40% bonds setup, the classic balanced fund ratio. So I want to shift towards bonds, but bond yields don’t look very appetizing right now. For now, I’m just going to keep up the gradual shift.
Stock Holdings
Vanguard Total Stock Market ETF (VTI)
Diversified S&P 500 Index Fund (DISFX)*
Fidelity Extended Market Index Fund (FSEMX)*
Vanguard Small-Cap Value Index Fund (VISVX)
Vanguard FTSE All-World ex-US ETF (VEU)
Vanguard MSCI Emerging Markets ETF (VWO)
Vanguard REIT Index Fund (VGSIX)
Bond Holdings
Vanguard Limited-Term Tax-Exempt Fund (VMLTX)
Stable Value Fund* (3% yield on past purchases, 1.8% on new)
iShares Barclays TIPS Bond ETF (TIP)
Individual TIPS securities
The overall expense ratio for this portfolio is in the neighborhood of .20% annually, or 20 basis points, which is much lower hurdle to overcome than the average mutual fund expense ratio of over 1% annually. This is all DIY, so I don’t pay portfolio management or financial advisor fees.
3% Safe Withdrawal Rate
I’ve also decided to use a 3% theoretical safe withdrawal rate instead of a 4% withdrawal rate. So instead of reaching 25 times our annual expected expenses, we will need to save 33 times. This is due to the fact that we will probably reach early retirement with 10 years, and thus our portfolio will have to last a lot longer than a conventional age 65 retirement. 3% is a more conservative number, and in reality I doubt that we will even go by the 3% number in strict terms. From reading other early retiree stories, we’ll stay flexible and adjust our withdrawals somewhat with market returns.
With portfolio increases and additional contributions, at a 3% withdrawal rate our current portfolio would now cover 43% of our expected expenses. If you recall, I plan to have the house paid off at retirement as well. It might be nice to have a portfolio that yields 3% where we could spend the dividends and interest payments, and I have been tossing around ideas for that as well. I still like the idea of 50% Target Retirement Income (or similar) and 50% Wellesley Income.
Posted in Goals, Investing, Retirement | 10 Comments »
Friday, November 4th, 2011
I’ve gotten a few questions about the Dogs of The Dow, which is a stock-picking strategy that involves buying equal amounts of the 10 highest-yielding stocks from 30 companies in the Dow Jones Industrial Average. At the beginning of each year, you adjust the portfolio to again to hold only the top 10 highest-yielding stocks from the previous year, selling the rest.
This strategy had its 15-minutes of fame in the 1990s, but somehow keeps popping up now and again. At the site DogsOfTheDow.com, you’ll see a rather biased presentation of this strategy. I mean, look at the very first sentence of the site, after all the ads (emphasis mine):
Looking for a simple way to select high dividend yield Dow stocks for your investment portfolio? Try Dogs of the Dow. Read on and you will discover a technique that would have given you a 17.7% average annual return since 1973! That’s not bad, especially considering that the Dow Jones Industrial Average overall return was 11.9% during that same period (As reported in U.S. News & World Report, July 8, 1996)
Umm… yes, in 1996 this strategy was found to have excellent results looking backwards (known as data mining). That was fifteen years ago! You’d think the stats would have been updated a bit since then. I wonder why it hasn’t? Perhaps it’s because the Dogs of the Dow strategy has since lagged the Dow itself over the last 15 years. Check out this MarketWatch article by Mark Hulbert:
The strategy took the investment world by storm in the early and mid-1990s, on the strength of both its simplicity and excellent long-term track record — at least when back-tested. A funny thing happened on the way to the bank, however: In real time since then, the strategy has failed to keep up with a simple index fund. For example, the strategy has beaten the Dow itself in just 5 of the last 15 calendar years. And those five winning years have not come close to making up for the losses incurred in the 10 losing years.
As with many such simplistic strategies, as soon as it is pointed out, the market adjusts and the outperformance disappears. So while I’m still intrigued by the idea of living off of dividend income, I see nothing special about the Dogs of the Dow.
Posted in Investing | 9 Comments »
Saturday, October 29th, 2011
Discount broker Zecco Trading has a refer-a-friend offer where a new account holder can get a $100 cash bonus if you are referred by a existing member and fund the account with $10,000 within 60 days of receiving the invitation. A minimum $10,000 balance must stay in the account for the subsequent 90 days. So that’s a guaranteed 1% ROI in 3 months, an annualized return of 4% on your cash. The referring person from the Zecco Friends Program also gets $100.
Zecco has $4.95 stock trades, and no minimum balance requirement or inactivity fees. If you would like a referral, please contact me and I’ll send you one within 24 hours. All I need is an e-mail, but you must use that specific e-mail to open your new account, as well as click on the special application link (“Get Started Now”) in the referral e-mail that you receive. Thanks!
Posted in Deals & Offers, Investing | 4 Comments »
Thursday, October 27th, 2011
Daniel Kahneman, behavioral economics guru and Nobel Prize winner, has a new book out called Thinking, Fast and Slow. This one is definitely on my to-read list. You may remember him from his TED Talk about Happiness = Earning $60,000 A Year?
He wrote an article for the NY Times called Don’t Blink! The Hazards of Confidence (a little jab at Gladwell?), which covers one of the cognitive fallacies discussed in the book caused by overconfidence amongst professional stock-pickers and money managers. First, he covers what some of you may already know about the performance of actively-managed mutual funds:
Mutual funds are run by highly experienced and hard-working professionals who buy and sell stocks to achieve the best possible results for their clients. Nevertheless, the evidence from more than 50 years of research is conclusive: for a large majority of fund managers, the selection of stocks is more like rolling dice than like playing poker. At least two out of every three mutual funds underperform the overall market in any given year.
More important, the year-to-year correlation among the outcomes of mutual funds is very small, barely different from zero. The funds that were successful in any given year were mostly lucky; they had a good roll of the dice. There is general agreement among researchers that this is true for nearly all stock pickers, whether they know it or not — and most do not. The subjective experience of traders is that they are making sensible, educated guesses in a situation of great uncertainty. In highly efficient markets, however, educated guesses are not more accurate than blind guesses.
The second story was more personal, and had to do with a small group of financial advisors.
I asked for some data to prepare my presentation and was granted a small treasure: a spreadsheet summarizing the investment outcomes of some 25 anonymous wealth advisers, for eight consecutive years. The advisers’ scores for each year were the main determinant of their year-end bonuses. It was a simple matter to rank the advisers by their performance and to answer a question: Did the same advisers consistently achieve better returns for their clients year after year? Did some advisers consistently display more skill than others?
To find the answer, I computed the correlations between the rankings of advisers in different years, comparing Year 1 with Year 2, Year 1 with Year 3 and so on up through Year 7 with Year 8. That yielded 28 correlations, one for each pair of years. While I was prepared to find little year-to-year consistency, I was still surprised to find that the average of the 28 correlations was .01. In other words, zero. The stability that would indicate differences in skill was not to be found. The results resembled what you would expect from a dice-rolling contest, not a game of skill.
My, that must have been an uncomfortable presentation! Investing is an area where it is very hard to discern skill from luck, so be careful when asked to pay a nice chunk of money for it, be it through mutual fund expense ratios or portfolio management fees.
Posted in Investing | 5 Comments »
Tuesday, October 25th, 2011
Vanguard’s research division published a new report [pdf] that found that a portfolio split 50/50 between stocks and bonds had very similar inflation-adjusted returns regardless of whether the U.S. economy was growing or in recession. Here are the numbers from 1926-2009 taken from the report summary:
Given that timing recessions and expansions has been shown to be very difficult, this would suggest that making big asset allocation moves (bets, really) to 100% stocks or 100% bonds in anticipation is not worth the effort.
It also reminds me that as a portfolio asset allocation gets closer to 50/50, the swings in return each year are less wild. After 2008 and 2009, I think many people have a new appreciation for lower volatility. Maybe it would be better for many investors that don’t have full “faith” in the stock market to move their asset allocation to 60% stocks/40% bonds or similar, instead of the 80 or 90% stocks that some calculators or target-date retirement funds would suggest.
Along those same lines, Morningstar has found that most “tactical asset allocation” funds have had a hard time beating the simple-and-cheap Vanguard Balanced Index Fund (VBINX), which is basically just two index funds in a fixed 60% stock/40% bond ratio. The 10-year returns are in the top quartile of similar funds, with a below-average standard deviation.
Vanguard recently decided to kill off it’s own market timing fund, the Vanguard Asset Allocation Fund, formerly actively managed by Mellon Capital. Even a low expense ratio of 0.27% couldn’t save this one.
Posted in Investing | 12 Comments »
Monday, October 17th, 2011
If you wrote a book about investing and wanted some big-name endorsements, you couldn’t do much better than this – The Most Important Thing: Uncommon Sense for the Thoughtful Investor by Howard Marks has blurbs from Warren Buffett, Jeremy Grantham, Jack Bogle, Joel Greenblatt, and Seth Klarman.
Howard Marks is already famous around many investment circles for his Client Memos as the chairman and cofounder of Oaktree Capital Management, although not as well-known as Buffett’s shareholder letters. This book is basically a distillation of those memos into book form. Here are my personal notes.
Efficient Markets
Marks is an active investor, and this book is about successfully generate excess turns (alpha). Some people seem to think that “efficient markets” is black and white – either you believe in the Easter Bunny or you don’t. Market prices are completely perfect or investing is purely skill. This book helps you view market efficiency as a continuum. Oaktree Capital chooses to focus on what he perceives as less efficient markets – things like convertible securities and high-yield debt from distressed companies (“junk bonds”).
Developing your own investment philosophy
I enjoyed this quote:
Where does an investment philosophy come from? The one thing I’m sure of is that no one arrives on the doorstep of an investment career with his or her philosophy fully formed. A philosophy has to be the sum of many ideas accumulated over a long period of time from a variety of sources. One cannot develop an effective philosophy without having been exposed to life’s lessons
Quality vs. Price
The title of the book is a bit misleading, as there is no single “most important thing”. Basically each chapter is an expansion of one or more of his memos and it titled “The Most Important Thing is… XXX”. However, an overarching theme of the book is about risk control. I’ve already written about higher risk vs. higher investment return.
A related idea is that people tend to think of investments only in terms of quality. Strong companies vs. struggling companies. Highly-rated bonds vs. Lower-rated bonds. Strong developed countries vs. Weaker emerging countries. But what’s important is the price. A high-quality company can be a high-risk or low-risk investment, depending on what price you pay for it. A junk bond can be a high-risk or low-risk investment, depending on what price you pay for it.
Cycles
Marks strongly believes in the recurrence of cycles. One side of the pendulum occurs when people seems think that there are minimal risks, either because of recent history or some new invention that eliminates risk (CDOs?). Often, the only worry remaining is that we’ll miss out on the opportunity for great returns. The other side of the pendulum is when uncertainty is everywhere. Here, people say things like “I’m staying out of the market until the dust settles.” This reminded me of a chart I pulled out a lot during the housing bubble:
If you’re going to pick a time to invest, it’s better when people are scared, because at least they are properly considering all the potential risks. It should be scary and uncomfortable. He reminds you, as Charlie Munger says, “It’s not supposed to be easy.” If you wait until the dust has settled, there won’t be great prices anymore.
Even though I am primarily a low-cost, buy, hold, & rebalance type of investor, I felt this book still provided me with new information for my own evolving investing philosophy. I’ll be sure to read his future memos. Thankfully, they can be found at the Oaktree Capital website, free and available to all.
Posted in Book Reviews, Investing | 1 Comment »
Wednesday, October 5th, 2011
I’m currently reading the book The Most Important Thing: Uncommon Sense for the Thoughtful Investor by Howard Marks. Inside, he talks a lot about risk. Most people seems to grasp the idea that riskier investments offer the prospect of higher returns. Stocks are expected to offer higher returns than cash or bonds. Bonds are considered less risky, and thus return less. However, Marks states that too many people have a simplistic risk/return relationship in their heads:
Source: Table 5.1, The Most Important ThingHowever, there is no requirement that riskier investments will actually provide those higher returns. It’s only the average expected returns that are higher, but since the uncertainty is also higher. Put another way, the distribution of potential returns is wider. To be more precise, he shares this risk/expected return chart instead:
Source: Table 5.2, The Most Important ThingWhen I started investing several years ago, I remember reading several personal finance articles that responded to questions from older investors that had some catching up to do with their nest eggs. The solution was simple – own more stocks! You’ll need the extra return, they reasoned. That’s exactly the wrong way to think. There is no easy shortcut to saving more.
Posted in Investing | 7 Comments »
