Puerto Rico Exposure in Vanguard Tax-Exempt Municipal Bond Funds

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Speaking of holding municipal bonds, I’ve been catching up on the troubles in Detroit and Puerto Rico. Last month, there was a flurry of articles warning about mutual funds with high exposure to Puerto Rico bonds, as they were yielding over 9% and trading at 60 cents on the dollar. Most junk corporate bonds don’t yield that much! Yet, they still clung to investment-grade status from the major ratings agencies because if they went any lower, the bonds would crash as many mutual funds would be then forced by their mandates to sell the bonds. Don’t you love ratings agencies?

From NY Times:

For example, the $34 billion Vanguard Intermediate Term Tax Exempt fund [VWITX], the biggest muni bond fund, lost more than 5 percent from May through August. And the largest exchange-traded tax-exempt fund, the $3 billion iShares National A.M.T.-Free Muni Bond fund [MUB], lost 8.3 percent in the same period. [...]

In late August, it was Puerto Rico’s turn to roil the market. A Barron’s article detailed the territory’s high debt load and an economy that wasn’t producing enough revenue to easily cover that debt. The S.& P. Puerto Rico municipal bond index fell 10 percent over the next two weeks before the bleeding stopped. Still, the index was down 16.4 percent in the first nine months of the year.

As of 11/19/2013, Morningstar reports the trailing YTD total return of MUB was -2.97% and VWITX was -1.43%. From Reuters:

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Reasons to Buy Actively-Managed Mutual Funds

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I would characterize my personal portfolio as 85% passive, 15% active, and 100% low-cost. Why is part of my portfolio managed by people trying to generate “alpha”? Aren’t I supposed to say that index funds are always better? Author and money manager Rick Ferri has a good post about When Active Funds Makes Sense, even he is a well-known index fund advocate.

Here are a few circumstances when I consider an actively managed fund over an index-tracking product:

  1. The absence of a diversified low-cost index fund or ETF that tracks the asset class.
  2. An active fund is lower in cost than an equally diversified index fund.
  3. An active fund has greater diversification than an index product, even if the fee is slightly more.
  4. The unique risk I am trying to capture is better suited to active management than in an index-tracking product.

He then discusses in detail a few categories that satisfy these conditions: municipal bonds, high-yield corporate bonds, and value stock strategies. I was particularly interested in the muni bonds part:

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$30,000 Beat-the-Benchmark Experiment – One Year Update, Prosper and LendingClub

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After posting Part 1 yesterday, here is Part 2 of my Beat-The-Market experiment one-year update. In order to test out P2P lending, I started with $10,000 split evenly between Prosper Lending and Lending Club, and went to work lending other people money and earning interest with an 8% target net return.

I tried to keep these portfolios comparable in terms of risk level, while still trying to maximize overall return net of defaults. I reinvested any new money from interest and early loan payoffs regularly for the first several months, but recently I stopped reinvesting my money as aggressively as I was thinking about selling everything (also LendingClub inventory was a little sparse at times). I ended up with $1,044 of idle cash at LendingClub and $862 at Prosper. More on that later.

$5,000 LendingClub Portfolio. As of November 1st, 2013, the LendingClub portfolio had 218 current and active loans, 28 loans that were paid off early, and none in funding. Two loans are between 1-30 days late. 6 loans ($126) are between 31-120 days late, which I will assume to be unrecoverable. Three loans have been charged off ($69, two A-rated and one C-rated). $1,044 in uninvested cash. Total adjusted for late loans is $5,304.


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$30,000 Beat-the-Benchmark Experiment – One Year Update, Part 1

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It’s finally been a full year since starting my Beat the Market Experiment, a series of three portfolios started on November 1st, 2012:

  1. $10,000 Passive Benchmark Portfolio that would serve as both a performance benchmark and an real-world, low-cost portfolio that would be easy to replicate and maintain for DIY investors.
  2. $10,000 Beat-the-Benchmark Speculative Portfolio that would simply represent the attempts of an “average guy” who is not a financial professional and gets his news from mainstream sources to get the best overall returns possible.
  3. $10,000 P2P Consumer Lending Speculative Portfolio – Split evenly between LendingClub and Prosper, this portfolio is designed to test out the alternative investment class of person-to-person loans. The goal is again to beat the benchmark by setting a target return of 8-10% net of defaults.

I’m splitting this summary up: Part 1 will focus on the Benchmark vs. Beat-the-Benchmark results. Part 2 will include the P2P lending performance. Values given are as of November 1, 2013.

$10,000 Benchmark Portfolio. I initially put $10,000 into index funds at TD Ameritrade due to their 100 commission-free ETF program that includes free trades on the most popular low-cost, index ETFs from Vanguard and iShares. With no minimum balance requirement, no maintenance fees, and no annual fees, I haven’t paid a single fee yet on this account. The portfolio used an asset allocation model based on a David Swensen model portfolio, which I bought and held through the entire yearlong period.

The total portfolio value after one year was $12,095, up 21%. Here’s how each separate asset class fared from November 1st, 2012 to November 1st, 2013 (excluding dividends):

  • Total US Stocks +$986 (+25%)
  • Total International Stocks +$588 (+15%)
  • US Small Cap Stocks +$150 (+30%)
  • Emerging Markets Stocks -$3 (-1%)
  • US REIT +$72 (+7%)

Screenshot of holdings below:

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Consistently Top-Rated 529 Plans: Morningstar Gold and Silver Ratings 2010-2013

Investment research firm Morningstar rates 529 plans in their annual “529 College Savings Plans Research Paper and Industry Survey”. They recently announced their top plans from the 2013 survey, although it appears the full study and state-specific analyst reports are only available in their paid Premium section. Below, I have listed all of the top-rated plans from each of the 2010-2013 survey years, including which plans were consistently top-rated all four years.

Morningstar now uses a Gold/Silver/Bronze rating scale for the top plans and Neutral/Negative for the rest. (In 2010 and 2011, they employed the same methodology but used Top, Above Average, Average, Below Average, and Bottom. Top is now broken up into Gold and Silver, and Above Average is now Bronze.) The criteria include five P’s:

  • People. Who’s behind the plans? Who are the investment consultants picking the underlying investments? Who are the mutual fund managers?
  • Process. Are the asset-allocation glide paths and funds chosen for the age-based options based on solid research? Whether active or passive, how is it implemented?
  • Parent. How is the quality of the program manager (often an asset-management company or board of trustees which has a main role in the investment choices and pricing)? Also refers to state officials and their policies.
  • Performance. Has the plan delivered strong risk-adjusted performance, both during the recent volatility and in the long-term? Is it judged likely to continue?
  • Price. Includes factors like asset-weighted expense ratios and in-state tax benefits.

Consistently Top-Rated Plans 2010-2013

  • T. Rowe Price College Savings Plan, Alaska
  • Maryland College Investment Plan
  • Vanguard 529 College Savings Plan, Nevada
  • CollegeAdvantage 529 Savings Plan, Ohio
  • CollegeAmerica Plan, Virginia (Advisor-sold)

Gold and Silver-Rated Plans 2013 (source)

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International Bonds Now Largest Asset Class in World Market

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This Vanguard article included an infographic (see below) that shows the growth of international bonds as an asset class. If you were to consider the world’s investable market as split between bonds and equities, internationally-issued bonds are now the largest piece of the pie at 35%. This includes both government and corporate bonds.

Vanguard believes that holding international bonds is an important way add diversification to your portfolio, and in mid-2013 added international bonds to their Target Date Retirement and LifeStrategy all-in-one mutual funds (currently 20% of the total bond allocation). The Vanguard Total International Bond Index Fund Investor Shares (VTIBX) has an 0.23% expense ratio. I’m still not convinced of their necessity and don’t own any foreign bonds. Back in 2000, international bonds were still 19% of the global market, yet they took up 0% (none) of their Target Retirement and LifeStrategy funds.

Fidelity 529 College Savings Plan Index Portfolios & Fee Reducton

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Fidelity Investments recently made a 40% reduction on the management fees for their direct-sold 529 Index Portfolios, with total expense ratios now ranging from 0.19-0.29%, down from 0.25-0.35%. Fidelity runs 529 plans based in New Hampshire, Massachusetts, Delaware, and Arizona. From the press release:

The index portfolio fee reduction applies to all Fidelity-managed direct-sold plans including The UNIQUE College Investing Plan, Fidelity’s nationally distributed plan, offered by the State of New Hampshire; the Massachusetts’ U.Fund® College Investing Plan; the Delaware College Investment Plan; and the Fidelity Arizona College Savings Plan. Total fees for the 529 Index Portfolios, including underlying mutual fund expenses, now range from 0.19 percent to 0.29 percent of assets, down from 0.25 percent to 0.35 percent. Unlike several competitor plans, all Fidelity direct-sold 529 college savings plans continue to have no annual account fees, low-balance fees, or fees to receive paper statements.

This should also serve as a reminder that Fidelity does offer low-cost index options in addition to their (inferior in my opinion) higher-cost actively-managed portfolios. The choices can be confusing – for example their “Portfolio 2030 (Fidelity Funds)” has a total expense ratio of 1.01%, whereas their “Portfolio 2030 (Fidelity Index)” has a total expense ratio of just 0.25%. You can change your investment option by sending in a form, usually limited to once a year unless you change beneficiaries.

Here is a screenshot of all the Index portfolio options and fee breakdown.

I think people are getting more aware of the impact of fees on performance, and this move makes Fidelity’s plans more competitive with other top 529 plans. See rankings by Morningstar and SavingforCollege.com.

There are also Fidelity-branded credit cards that credit 1.5% cash back (Visa) and 2% cash back (American Express) towards any Fidelity account. I choose to have mine directed to a 529 account, specifically their New Hampshire UNIQUE plan which they advertise as their national plan (you can live in any state, but your state’s plan may have better tax perks). I have also opened plans from Utah (lowest costs, flexible options) and Ohio (inflation-protected bonds as investment option) for my new kiddo and deposited her birthday gifts there.

$30,000 Beat-the-Benchmark Experiment Update – October 2013

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Here’s the October 2013 update for my Beat the Market Experiment, a series of three portfolios started on November 1st, 2012:

  1. $10,000 Passive Benchmark Portfolio that would serve as both a performance benchmark and an real-world, low-cost portfolio that would be easy to replicate and maintain for DIY investors.
  2. $10,000 Beat-the-Benchmark Speculative Portfolio that would simply represent the attempts of an “average guy” who is not a financial professional and gets his news from mainstream sources to get the best overall returns possible.
  3. $10,000 P2P Consumer Lending Speculative Portfolio – Split evenly between LendingClub and Prosper, this portfolio is designed to test out the alternative investment class of person-to-person loans. The goal is again to beat the benchmark by setting a target return of 8-10% net of defaults.

As requested, I updated the scale to zoom in on the comparison chart.

Summary. 11 months into this experiment, the Benchmark and Speculative portfolios are both up between 15-20%. The Speculative portfolio is actually winning now ($12,071 vs. $11,723). I sold all my AAPL shares in September. Both P2P portfolios continue to earn interest and are still on pace for an 8%+ annual return, but the growth rate has slowed lately as late loans have been taking a toll. Values given are after market close October 1, 2013.

$10,000 Benchmark Portfolio. I put $10,000 into index funds at TD Ameritrade due to their 100 commission-free ETF program that includes free trades on the most popular low-cost, index ETFs from Vanguard and iShares. With no minimum balance requirement, no maintenance fees, and no annual fees, I haven’t paid a single fee yet on this account. The portfolio was based loosely on a David Swensen model portfolio with a buy-hold-rebalance philosophy. Portfolio value is $11,723. Screenshot of holdings below:

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Vanguard STAR Fund vs. Vanguard Balanced Index Fund

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I previously wrote about how the Vanguard Balanced Index Fund was a good example of the benefits of holding both stocks and bonds in your portfolio. Now, I’d like to extend this and compare the Vanguard Balanced Index Fund (VBINX) with another veteran balanced fund, the Vanguard STAR Fund (VGSTX). They are similar yet different:

Vanguard STAR Fund
(VGSTX)
Vanguard Balanced Index Fund
(VBINX)
Overall Asset Allocation 60% Stocks
40% Bonds
60% Stocks
40% Bonds
Expense Ratio 0.34% 0.24%
(0.10% Admiral shares)
Geographic Exposure Both US and international stocks, US bonds only US stocks only
US bonds only
Investment Style Actively-managed,
11 underlying funds
Passively-managed,
cap-weighted index
10-year annualized returns (as of 6/30/2013) 7.22% 6.86%
(6.98% Admiral shares)

Here’s a chart of how $10,000 invested 10 years ago would have done. With the Vanguard STAR fund, you’d have $20,653 today. With the Vanguard Balanced Index fund, you’d have $19,749. (This is with Investor shares, which have a lower minimum investment than Admiral shares. The minimum used to a lot higher, but now it is $10,000 for Admiral shares.)


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My observations:

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Morningstar Target Date Retirement Fund Comparisons & Trends 2013

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Target date funds (TDFs) get their name because they adjust their portfolio holdings automatically over time based on a given target retirement date. In general, this means shifting from mostly stocks to less stocks over time (known as the “glide path”). TDFs continue to grow in popularity, especially within employer-based plans like 401k’s and 403b’s.

Morningstar Fund Research recently released its 2013 industry survey, Target-Date Series Research Paper [pdf]. While it feels targeted at financial professionals, there are some good nuggets for us individual investors looking to decide where to invest. For example, we have to be careful as look how widely the glide path can very between different brands of target funds:


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While the most popular TDF providers have much more similar glide paths, they still differ in important ways (especially after retirement age).


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Other highlights from the paper:

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OptionsHouse Raising Commission Rate From $3.95

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Online stock broker OptionsHouse sent me the following e-mail today:

On October 1, 2013, OptionsHouse is changing our stock commissions rate. However, we wanted to notify you that this change will not affect any of your current accounts with us. In addition, if you choose to open and fund any additional accounts in the future, you will continue to receive your current stock commission rate. For full details related to changes to our stock commissions, please visit our rules page.

Basically, their commission on stock trades is going up from $3.95 to $4.75 for new customers only. Existing customers will stay at $3.95. They’ve done this before, as I’m actually grandfathered in at $2.95 a trade (opened back in 2010), which I think is a good way to treat existing customers. Options pricing remains the same, starting at $5 for up to 5 contracts. Under $5 a trade with no minimum balance requirements is still very competitive.

There is still a small window if you want to get yourself grandfathered in at $3.95 a trade. You must complete your application prior to 10/1/2013 and fund your account prior to 1/1/2014. There are a variety of promotions available for new customers. You can only get one of these, so pick carefully:

Betterment.com Review: Application Process, Updated Asset Allocation

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betterment screenshot

Updated with new asset allocations 2013. Betterment.com is an online investment tool that rolls portfolio management, trading commissions, and rebalancing into one website. I opened an account when it started with $1,000 to look under the hood. Since then, they’ve actually made several changes in response to feedback and constructive criticism.

The main attraction of Betterment is simplicity. It boils everything down to a single slider (see above) to indicate your risk preference, and takes care of everything else in the background. ETF buying, ETF selling, rebalancing, and so on. On the surface, it’s as easy as having a bank account, besides the critical fact that you can lose money!

Application Process

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