The Only Two States of Your Portfolio: Happy All-Time High or Sad Drawdown

emoinvestQuick question – What was the highest value ever for your investment portfolio? Now, what was the value exactly a year before that? You probably know the answer to the first question, but not the second, even though both have little to do with your final portfolio value.

I am currently reading the e-book Global Asset Allocation by Meb Faber and he had a good observation that I don’t recall ever expressed in this specific manner (emphasis mine):

It is a sad fact that as an investor, you are either at an all-time high with your portfolio or in a drawdown – there is no middle ground – and the largest absolute drawdown will always be in your future as the number can only grow larger.

We tend to carry the highest value of our portfolio around in our heads because of the powerful cognitive bias of anchoring. Let’s say that 10 years ago you started with $20,000 and today with your contributions and investment growth your total is $100,000. If next year your portfolio experiences a drawdown to $80,000, you’ll probably identify your portfolio as being 20% down from $100,000, as opposed to a 400% increase from $20,000. $100,000 is “what you had” and you will forever be anchored to that number, even if for it only lasted just for a day.

That is, until you reach another all-time high (yes! $105,000) and that will be your new anchor. (This applies to individual holdings as well – I’ve found this especially pervasive when using brokerage smartphone apps that allow me to frequently check in with just a tap.)

If your portfolio is anything like mine, it has been repeatedly been hitting all-time highs for a year or two. The problem is, sooner or later, there is a 100% chance I’ll be stuck in a prolonged drawdown phase. I will think about my high-water value every time I check my statements (which is why perhaps it is better not to check your investment value much more than once a year). I will question my existing asset allocation and how to invest my new money.

Now add in loss aversion – the other finding from behavioral economics that people feel the pain of losses much more severely than the pleasure of gains (studies suggest we hate losses roughly twice as much as gains).

That means drawdowns are always lurking around the corner, and we hate them twice as much as any investment gain. It’s no wonder that investors are often their own worst enemies by not sticking to their investment plans.

The Affluent Investor by Phil DeMuth – Book for $100,000+ Club


This week I’ve been trying to catch up on my book reviews (you should see my “to read” shelf!), and after a good beginner book I thought I’d write about a good intermediate-to-advanced book. You’ve probably noticed there are a lot of starter books out there for novice investors but not as many with more advanced advice ($$$… the potential audience is a fraction of the size). Addressing this deficiency is the goal of The Affluent Investor by Phil DeMuth.

In terms of the title, the industry classifies you as “mass affluent” if you have investable assets between $100,000 and $999,999. From $1 million to $10 million you are “high net worth”. This definition excludes some possibly important stuff – your income, the value of your personal residence, pensions, etc. But in real world terms, I would say this book is for anyone who isn’t living from paycheck-to-paycheck. If you have a $10,000 portfolio and have a surplus each month, sooner or later you will reach $100,000. If instead you have a credit card balance and it just keeps inching up, then you need something closer to a Dave Ramsey book.

The overall tone of the book is that of a close friend who is smart and into finances. DeMuth is already a financial advisor to rich folks so the last part is expected. What I mean is that he will be blunt and isn’t afraid to make stereotypical assumptions in order to rattle off all his tips. At only 200 pages, most things are only touched upon in a concise manner. Here’s a rough outline of the topics covered:

  • Big picture rules. Get and stay married. Make sure you can afford your children. Avoid debt. Save early and invest it. Diversify. Plan ahead.
  • Financial advice based on life stage. He puts you in the basic “affluent” mold of 20-35s have a kid buy a house, 35-55 working hard at professional career making most of your money, 55-65 protect assets and prepare for retirement, and 65+ retire and spend down money.
  • Financial advice based on job. Has special advice for doctors, lawyers, small business owners, and corporate executives.
  • General investing advice and “Can you do better?” investing advice. General investing advice is keep costs low and buy index funds that closely approximate the global market portfolio. “Can you do better?” advice touches on things like value stocks, small-cap stocks, dividend stocks, momentum, low-beta, etc.
  • Asset protection. Being affluent means you have money, and other people will want it. Insurance, buying real estate with LLCs, homestead exemptions, and similar topics are are very complex but his take is condensed into less than a page each.
  • Tax minimization. IRAs, 401ks, Solo Pensions, 529 plans, Health Savings Accounts, etc.

Here are things you might expect from a “book for rich folks” but won’t find inside:

  • You won’t get in-depth, hand-holding walkthroughs of anything. Consider the book as a push in the right direction for researching ideas.
  • You won’t find his secret list of the best hedge fund managers.
  • You won’t find tips on how to get rich with real estate.
  • You won’t find advice on how to pick individual stocks like Warren Buffett.
  • You won’t find him selling his own personal advisory services.

A general problem with all books of this type is that the advice is pretty short and to the point, but it doesn’t provide very much supporting evidence. You’ll either have to do your own due diligence, or blindly decide to trust the author. I’ve read books where the author might sound convincing but their advice is horrible. In my opinion, I think for the most part the advice in this book is good. But I’m just another person on the internet, so again do your own research.

In conclusion, I think this book covers a lot of questions that are commonly asked by the intermediate individual investor. It’s not too long and not too short. Some of the advice won’t fit your own situation, but at this level if you just find one solid actionable idea that makes the entire $18 book worth it. I’m personally going to look into the solo defined-beneift plan idea again, although I may still be too young to take full advantage.

Vanguard High-Yield Corporate Bond Fund Review (VWEHX)

vanguardinvThe Vanguard High-Yield Corporate Bond Fund (VWEHX, VWEAX) is a low-cost, actively-managed bond fund that invests in medium- and lower-quality corporate bonds and is advised by Wellington Management Company. I don’t own any in my retirement portfolio, but while reading the book The Affluent Investor by Phil DeMuth, I was intrigued by this interesting tidbit:

If you have settled on buying them anyway, at least wait until the spread between treasury bonds and junk bonds of the same maturity is wide (say, 4 percentage points). The fund to own is Vanguard’s (ticker: VWEHX), which has a gimmick: it buys the highest rated junk bonds. Many institutional investors can only hold investment-grade bonds as a matter of policy, and they are forced to liquidate bonds that get downgraded even when it makes no sense to do so. Vanguard lies in wait to take advantage of their mistake. This is a hedge fund strategy in a bond fund wrapper.

(I should add that this is after the author warns you about the high-yield bond asset class in general, and how if you adjust the higher yields to account for higher defaults, the net advantage can be small or even zero. He also adds that high-yield “junk” bonds are also quite volatile and should be treated like equities.)

But going back to the quote, DeMuth is saying that this fund tries to take advantage of a specific market inefficiency. I’ve never seen this strategy mentioned in either any Vanguard materials or financial media coverage. I went back and took a closer look at their prospectuses and other investor documents.

I was aware that VWEHX tends to invest in the higher-quality portion of the junk spectrum. From the Product Summary on their website:

Created in 1978, this fund seeks to purchase what the advisor considers higher-rated junk bonds. This approach aims to capture consistent income and minimize defaults and principal loss.

From the Fund Prospectus (dated 5/28/14):

The Fund invests primarily in a diversified group of high-yielding, higher-risk corporate bonds—commonly known as “junk bonds”—with medium- and lower-range credit- quality ratings. The Fund invests at least 80% of its assets in corporate bonds that are rated below Baa by Moody’s […] The Fund may not invest more than 20% of its assets in any of the following, taken as a whole: bonds with credit ratings lower than B or the equivalent, convertible securities, preferred stocks, and fixed and floating rate loans of medium- to lower-range credit quality.

Digging further into the Prospectus, we find the following under the “Security Selection” heading:

Wellington Management Company, LLP (Wellington Management), advisor to the Fund, seeks to minimize the substantial investment risk posed by junk bonds, primarily through its use of solid credit research and broad diversification among issuers. […]

The Fund will only invest in bonds and loans that, at the time of initial investment, are rated Caa or higher by Moody‘s; have an equivalent rating by any other independent bond-rating agency; or, if unrated, are determined to be of comparable quality by the advisor. […]

Wellington Management selects bonds on a company-by-company basis, emphasizing fundamental research and a long-term investment horizon. The analysis focuses on the nature of a company’s business, its strategy, and the quality of its management. Based on this analysis, the advisor looks for companies whose prospects are stable or improving and whose bonds offer an attractive yield. Companies with improving prospects are normally more attractive because they offer better assurance of debt repayment and greater potential for capital appreciation. […]

To minimize credit risk, the Fund normally diversifies its holdings among debt of at least 100 separate issuers, representing many industries. As of January 31, 2014, the Fund held debt of 172 corporate issuers. This diversification should lessen the negative impact to the Fund of a particular issuer’s failure to pay either principal or interest.

Here’s a quick summary of the Moody’s Credit Rating hierarchy, per Wikipedia:

Investment Grade

  • Aaa – Highest quality and lowest credit risk.
  • Aa – High quality and very low credit risk.
  • A – Upper-medium grade and low credit risk.
  • Baa – Medium grade, with some speculative elements and moderate credit risk.

Below-Investment Grade (“Junk”)

  • Ba – Speculative elements and a significant credit risk.
  • B – Speculative and a high credit risk.
  • Caa -Poor quality and very high credit risk.
  • Ca – Highly speculative and with likelihood of being near or in default, but some possibility of recovering principal and interest.
  • C – Lowest quality, usually in default and low likelihood of recovering principal or interest.

From the Annual Report (dated 1/31/15):

This is the first time we are reporting the performance of the High-Yield Corporate Fund against its new benchmark composite index, which consists of 95% Barclays U.S. High-Yield Ba/B 2% Issuer Capped Index and 5% Barclays U.S. 1–5 Year Treasury Bond Index. As we mentioned when we made the change in November, we believe that the composite index is a better yardstick for the portfolio. It more closely reflects the portfolio’s longtime strategy of investing in higher-rated securities in the below-investment-grade category while maintaining some exposure to very liquid assets.

From Wellington Management Advisor Letter (part of Annual Report, dated 1/31/15)

The decline in commodity prices sparked a significant widening of high-yield bond spreads, and although the problems now affecting high-yield energy credits are justifiable, they are relatively isolated
to that industry. We are looking to take advantage of recent dislocations created by the sell-off in non-energy companies, where wider spreads are attractive and the credits are well-supported by strong fundamentals.

The fund remains consistent in its investment objective and strategy and maintains a significant exposure to relatively higher-rated companies in the high-yield market. We believe that these issuers have more consistent businesses and more predictable cash flows than those at the lower end of the spectrum. We prefer higher-rated credits in order to minimize defaults and provide stable income. We continue to diversify the fund’s holdings by issuer and industry and to de-emphasize non-cash-paying securities, preferred stock, and equity- linked securities (such as convertibles) because of their potential for volatility.

Costs and Fees

The expense ratio of the High-Yield Corporate Fund Investor Shares at 0.23% and Admiral Shares at 0.13% are very low in comparison to the peer group average of 1.11% for High-Yield Funds (calculated by Lipper). The fact that Vanguard itself runs at-cost and the fund advisor Wellington agrees to only takes a fee of 0.03% are quite impressive:

Wellington Management Company LLP provides investment advisory services to the fund for a fee calculated at an annual percentage rate of average net assets. For the year ended January 31, 2015, the investment advisory fee represented an effective annual rate of 0.03% of the fund’s average net assets.

In comparison, sometimes the creator of an index (like the S&P 500) will want a few basis points just for allowing a fund to follow their computer-generated list of companies. Wellington is pruning through thousands of often-illiquid bonds.

Portfolio Credit Quality

Here is the breakdown of the Vanguard High-Yield Corporate Bond Fund portfolio by credit rating as of 1/31/15. Remember that Baa and above is investment grade, so the vast majority (87%) of their holdings are indeed the top two rungs of the non-investment-grade spectrum. I assume that the 5% allocation to US government bonds is in case of an increase in fund redemptions.


I am neither recommending nor discouraging investment in this fund. There are many types of risk involved: credit risk, interest rate risk, liquidity risk, poor security selection risk. I was just intrigued by a quote in a book and wanted to dig into it further.

I have read through the prospectus and annual reports and pointed out all of what I saw were pertinent mentions of their investment and bond selection criteria. I didn’t find anything particular in Vanguard’s materials about picking bonds that have recently fallen from investment-grade to just below investment-grade, but such a strategy would certainly align with their historical portfolio and stated goals of holding the “best of the junk”.

If this is indeed a significant market inefficiency, I wonder why it still exists. Perhaps you can only do it with a very low expense ratio? I don’t believe there is any other actively-managed bond fund consisting of high-yield bonds that has such a low expense ratio; 0.13-0.23% is nearly as low as many index funds.

The low costs alone create a relative performance advantage for this fund. I chose not to emphasize past performance as that can be fleeting, but this fund’s past performance numbers also beats their Lipper peer group average over the last 1, 5, and 10 years.

Now, I do own shares of the Vanguard High-Yield Tax-Exempt Fund, which has a different advisor; Vanguard Fixed Income Group. I wonder if they do a similar thing there?

The Elements of Investing – Book Review (Updated Edition)


There are two major types of investing books for beginner investors: “Instructional to-do list” books basically tell you what you should do. “Inspirational big-picture” focus more on the philosophical reasons why you should do those things. Both can be equally important and useful.

The Elements of Investing: Easy Lessons for Every Investor by Burton G. Malkiel and Charles D. Ellis falls more into the former “list” category. Malkiel is a noted academic and wrote the classic bestseller A Random Walk Down Wall Street. Ellis is a former director of Vanguard Group and wrote the classic bestseller Winning the Loser’s Game.

Basically, two pillars of the investment world got together and tried to whittle down their 80 years of experience into 200 pages and roughly 2-3 hours of reading time. The pages aren’t even big, as the hardcover version is only 7 inches tall. You could read the entire thing in an afternoon or in snippets before going to bed within a week.

In opinion, they did a pretty good job. Topics are covered in a brief, straighforward manner. If you’ve read your share of personal finance material, none of it will be new to you, but they remain critically important. The key takeaways are clearly laid out and repeated over and over to drill them into your head. Things like:

  • Save regularly and never take on credit card debt (most important).
  • Utilize any available tax-advantaged plans like IRAs, 401ks, 403bs.
  • Keep a safe, liquid emergency fund.
  • Diversification, rebalancing, dollar-cost averaging, and low-cost indexing are the keys to investing success.

There are also a lot of little nuggets of wisdom in the book. My two favorite quotes:

The real purpose of saving is to empower you to keep your priorities—not to make you sacrifice. Your goal in saving is not to “squeeze orange juice from a turnip” or to make you feel deprived. Not at all! Your goal is to enable you to feel better and better about your life and the way you are living it by making your own best-for-you choices. Savings can give you an opportunity to take advantage of attractive future opportunities that are important to you.

As in so many human endeavors, the secrets to success are patience, persistence, and minimizing mistakes.

The updated 2013 edition of the book (original edition was 2009) includes some interesting (controversial?) suggestions for dealing with the current low-interest environment for bonds. Since the current yield for US Treasury bonds is so low, and thus the future expected return just as low, they offer up tax-exempt municipal bonds, emerging markets bonds, and even blue-chip dividend stocks.

It was sort of weird to be told “stay the course!” and then in the next chapter be told “here’s how to change course!”. I actually appreciate that they express their honest opinions, even if it appears to contradict passive-investing dogma. Jack Bogle himself does it from time to time. (I personally choose to hold muni bonds instead of US Treasuries as well.)

Bottom line: This investing primer would make a very good gift for a recent college graduate or young worker if they are ready to start getting serious about investing. If they aren’t, the book may be a bit dry. I will be adding it to my recommended books list, once I get around to updating it…

Beware of Mutual Funds That Artificially Juice Their Dividend Yield

juicingdividendsI like seeing my dividend income roll in each quarter, as do many other investors. But are mutual funds artificially “juicing” their reported dividend yields to attract investors? This is explored in a recent academic paper Juicing the Dividend Yield: Mutual Funds and the Demand for Dividends, which I found via Alpha Architect. Here is the abstract:

Some mutual funds purchase stocks before dividend payments to artificially increase their dividends, which we call “juicing.” Funds paid more than twice the dividends implied by their holdings in 7.4% of fund-years examined. Juicing is associated with larger inflows, and is more common among funds with unsophisticated investors. This behavior is consistent with an underlying investor demand for dividends, but is hard to explain by taxes or need for income, as funds can generate equivalent tax-free distributions by returning capital. Juicing is costly to investors through higher turnover and increased taxes of 0.57% to 1.52% of fund assets per year.

The problem with making extra trades to make your dividend yield look higher is that it is not tax-efficient. The increased turnover itself creates extra capital gains and trading costs. Also, when a funds buy a stock just before the ex-dividend date, then that dividend no longer qualifies for the lower dividend tax rate. I just ran across this problem last month when doing my taxes and looking at my qualified dividend income percentages. (I’m not saying that WisdomTree is not engaging in any “juicing” behaviors, it is very hard to actually calculate and there are other factors involved.)

Interestingly, the paper authors propose addressing that exact problem. Make it easier on investors and require funds to report their qualified dividend income percentages (emphasis mine):

One minimally intrusive regulatory change that could improve investor decision-making is to require funds to break out dividend income into qualified dividends (entitled to a reduced income tax rate, when the stock was held for 60 days or more) and non-qualified dividends (which pay the full income tax rate, for stocks held for less than 60 days) when reporting their distributions in filings such as annual reports. Such disclosure would not harm an investor that was already informed about juicing, but would ensure that investors had easy access to the information necessary to make an informed decision if they chose to do so.

Bottom line: Juicing exists and it hurts investors with higher turnover and higher tax bills, but it’s hard to know when by just looking at the usual mutual fund stats. Until then, be careful if you’re buying an actively-managed fund primarily due to their high dividend yield.

Benjamin Franklin and Compound Interest: “Money makes money. And the money that money makes, makes money”

bencompWe’ve all heard of the power of compound interest. We’ve all heard of Benjamin Franklin. But have you heard of the story where Ben Franklin let his money compound quietly for 200 years? Here’s an excerpt from the book The Elements of Investing:

Benjamin Franklin provides us with an actual rather than a hypothetical case. When Franklin died in 1790, he left a gift of $5,000 to each of his two favorite cities, Boston and Philadelphia. He stipulated that the money was to be invested and could be paid out at two specific dates, the first 100 years and the second 200 years after the date of the gift. After 100 years, each city was allowed to withdraw $500,000 for public works projects. After 200 years, in 1991, they received the balance—which had compounded to approximately $20 million for each city. Franklin’s example teaches all of us, in a dramatic way, the power of compounding. As Franklin himself liked to describe the benefits of compounding, “Money makes money. And the money that money makes, makes money”

Very neat. A bit of digging suggests it all started out as basically a dare. From a Philadelphia Inquirer article:

Benjamin Franklin, God love him, may have been the first Philadelphian with an addytood. How’s this for an in-your-face response?

In 1785 a French mathematician named Charles-Joseph Mathon de la Cour wrote a parody of Franklin’s Poor Richard called Fortunate Richard in which he mocked the unbearable spirit of American optimism represented by Franklin. The Frenchman wrote a piece about Fortunate Richard leaving a small sum of money in his will to be used only after it had collected interest for 500 years.

Fat chance someone would be dumb enough to try that. Ha. Ha.

Franklin, who was 79 years old at the time, wrote back to the Frenchman, thanking him for a great idea and telling him that he had decided to leave a bequest to his native Boston and his adopted Philadelphia of 1,000 pounds to each on the condition that it be placed in a fund that would gather interest over a period of 200 years.

The trusts for Philadelphia ended up a lot smaller than the trust for Boston, which many people assume is a result of poor management, but perhaps the lower returns were an acceptable result of Philadelphia following Franklin’s original instructions for the money:

“Boston has always prided itself that it compounded the money wisely. Philadelphia has always had an inferiority complex because it didn’t,” said Bruce Yenawine, a Syracuse University Ph.D. candidate in history who has spent years researching the Franklin funds in both cities. “But Boston decided to minimize risks and maximize proceeds. Philadelphia, on the other hand, focused on the other side of Franklin’s instructions by loaning the money to individuals. I think that’s more in keeping with what Franklin wanted.”

Franklin stipulated that the 1,000 pounds (the equivalent of $4,444) be invested and used to provide low-interest loans to “married tradesmen under the age of 26″ to get them started in business. Over the 200-year life of the trust, money from the Philadelphia fund was loaned to hundreds of individuals, mostly for home mortgages during the last 50 years. Boston, meanwhile, invested the bulk of the money in a trust fund that Yenawine describes as “a savings company for the rich.”

This NY Times article suggests that the initial funds came from Franklin donating his own government salary:

The 2,000 [pounds sterling] Franklin set aside came from the salary he earned as Governor of Pennsylvania from 1785 to 1788. ”It was one of Franklin’s favorite notions, one he tried to get written into the Constitution, that public servants in a democracy should not be paid,” Mr. Bell said.

Relating this back to personal finance, here is another Elements of Investing excerpt relating a Ben Franklin quote and compound interest:

Think in terms of opportunity cost. Think of every dollar you spend as the amount it could grow into by the time you retire. Ben Franklin famously advised, “A penny saved is a penny earned.” He was right but not entirely right. The Rule of 72 shows why. If you save money and invest it at, say, a 7 percent average annual return, $1 saved today becomes $2 in about 10 years, $4 in 20 years, and $8 in 30 years, and so on and on, inevitably growing. So the dollar a young person spends on some nonessential today would mean that $10 or more will be given up in retirement.

Schwab Intelligent Portfolios: Sample Asset Allocations and ETF Holdings

schwablogoSchwab just sent me an e-mail with the subject “The wait is over. The future of investing is here.” That boast means their new automated portfolio advisory platform called Schwab Intelligent Portfolios (SIP) is now opening accounts, meeting their stated date of Q1 2015. Here are some highlights of this service:

  • Portfolio asset allocation will be decided using a 12-part questionnaire.
  • Portfolio will be constructed using ETFs, mostly from Schwab-managed market-weighted and fundamental-weighted index ETFs.
  • No advisory fees, no trading commissions, no account maintenance fees.
  • Accounts must maintain a minimum balance of $5,000 to be eligible for automatic rebalancing.
  • Tax loss harvesting is available on an opt-in basis for clients with invested assets of $50,000 or more.
  • Live support via phone or online chat, 24/7/365

You can do the questionnaire and see your proposed asset allocation without signing up for an account. Here’s a screenshot taken from the questionnaire tool (click to enlarge).


Here are some sample asset allocations that the website provided. I basically just made up two fictional people, so don’t assume these are the only options they give out. First up is “Conservative Cal”, who is 60 years old with plans to retire at 65 and can’t stomach too much volatility. The proposed breakdown for Conservative Cal was 37% stocks, 47% bonds, 2% commodities, and 14% cash. See screenshots below.



Next up is “Long-term Linda” who is 30 years old with a long time horizon and a healthy appetite for risk. The proposed breakdown for Long-term Linda was 77% stocks, 11% bonds, 5% commodities, and 7% cash. See screenshots below.



It doesn’t actually tell you the exact ETFs you will be investing in unless you continue and fill out an application, but you can bet that most of them will be Schwab market-cap ETFs and Schwab fundamental ETFs. Also keep in mind that there will be “alternate” ETFs for each asset class to be used for tax-loss harvesting.

For example, here’s the likely primary ETF line-up for the stock portion:

US Large = Schwab U.S. Large-Cap ETF (SCHX)
US Large Fundamental = Schwab Fundamental U.S. Large Company Index ETF (FNDX)
US Small = Schwab U.S. Small-Cap ETF (SCHA)
US Small Fundamental = Schwab Fundamental U.S. Small Company Index ETF (FNDA)
International Developed Large = Schwab International Equity ETF (SCHF)
International Developed Large Fundamental = Schwab Fundamental International Large Company Index ETF (FNDF)
International Developed Small = Schwab International Small-Cap Equity ETF (SCHC)
International Developed Small Fundamental = Schwab Fundamental International Small Company Index ETF (FNDC)
International Emerging Markets = Schwab Emerging Markets Equity ETF (SCHE)
International Emerging Markets Fundamental = Schwab Fundamental Emerging Markets Large Company Index ETF (FNDE)
International REITs = Vanguard Global ex-US Real Estate ETF (VNQI)

SIP is a direct competitor to Vanguard’s Personal Advisor Services (VPAS) which has a lower average overall expense ratio on their suggested portfolios, but also charges a 0.30% advisory fee. Schwab’s overall average expense ratios on their suggested portfolios are higher, but charges no advisory fee. Schwab then goes as far as to guarantee that the total amount paid to ETF OneSource affiliates and Schwab ETF management fees will not exceed a 0.30% fee.

So Schwab admits that there is some extra profit baked into the program due to their more expensive fundamentally-weighted ETFs and such, but it should still be cheaper than Vanguard after all is said and done. Very interesting.

This is not my full review, as I haven’t decided if I should open a test account (superfluous trades get annoying at tax time). Although I will likely have my criticisms, I am still glad to see it finally roll out because I think Vanguard and others need the competitive pressure to keep improving their own low-cost advised portfolio platforms. A lot of people out there don’t need a full-service human advisor, but could still benefit from having occasional investment guidance available to them at a minimal cost.

Barron’s Best Online Stock Brokerage Rankings 2015

barrons2015Weekly business newspaper Barron’s just released their 2015 annual broker survey rankings. Here’s a snippet that helps explain their perspective and readership (emphasis mine):

To pinpoint 2015’s top brokers, we analyzed not just their security, mobility, and social media features but the depth of their investment tools and their trading capabilities. Our primary consideration in judging these 18 firms is how they work for our readers, who are high-net-worth active investors. Customization, especially of reports, is a particular focus, as is the ability to move smoothly from idea generation to a trade ticket.

Their overall winner was again Interactive Brokers, a broker designed for more advanced traders with an extensive feature set, low commissions, and low margin rates. Note that they have a minimum opening balance of $10,000 ($3,000 if age 25 and younger) and a minimum monthly fee of $10 even if you don’t trade at all (waived at $100,000+ equity balance). If you rack up those trades every month, this is the place to be.

Barron’s defines an “occasional trader” as someone who averages 6 stock trades and 2 options trade per month. A “frequent trader” makes 100 stocks trades a month, 100 option trades a month, and carries $30,000 in margin debt. I am not active enough to even be called an “occasional trader”, but I still like having a clean user interface, relatively low commissions, no maintenance fees, and helpful customer service when I need it. Thankfully, Barron’s again ranked the brokers for these folks as well:

Top 5 Brokers for Novice Investors

  1. TD Ameritrade. Performed well in customer service & education, research tools, and mobile offerings. Improved desktop site and mobile apps integration. Free real-time quotes from NYSE, AMEX, and NASDAQ Level 1 and 2.
  2. Fidelity
  3. E-Trade
  4. Capital One Sharebuilder
  5. Merrill Edge

Top 5 Brokers for Long-Term Investing

  1. TD Ameritrade. The only broker to provide a wide range of commission-free ETFs from various providers based on popularity instead of in-house ETFs or paid placement).
  2. Fidelity
  3. Charles Schwab
  4. Merrill Edge
  5. E-Trade

Top 5 Brokers for In-Person Service

  1. Scottrade. Scottrade has over 500 physical branches across US, so that when you call you reach a human in that local branch. Free in-person educational seminars are offered as well.
  2. Merrill Edge
  3. Charles Schwab
  4. Fidelity
  5. TD Ameritrade

I would note that due to their active trader readership, most of Barron’s rankings don’t really consider the benefits of any commission-free ETFs that a broker like Fidelity or TD Ameritrade might offer. Perhaps their “long-term investing” ranking takes this factor into account. Vanguard’s brokerage arm is not included in the review. Also not included are automated brokers like Betterment or Wealthfront and other specialized brokers like Motif Investing.

Newcomer Robinhood and their free trades were mentioned in passing, but basically dismissed with skeptical quotes like “There’s no such thing as a free lunch […] They will make their money one way or another” and “A “free” trade could cost quite a bit if the broker is relying on payment for order flow rather than trying to create price improvement opportunities.” I still think Robinhood will eventually be bought out by one of these big brokers for their mobile-first design and young client base.

Vanguard Target Retirement Fund Changes 2015

vanguardinvI always keep track of the Vanguard Target Retirement 20XX Funds because:

  • They are a low-cost, broadly-diversified, “all-in-one” fund that I think are a good starting point for both beginning investors and those desiring simplicity.
  • I have recommended them to my own immediate family, and they hold them in their retirement portfolios.
  • I view them as an indicator of what the big wigs at Vanguard think is the “right” mix for most people.

So I was interested to see that Vanguard is again tweaking the asset allocation of their Vanguard Target Retirement Funds and Vanguard LifeStrategy® Funds. The claimed goal is “enhanced global diversification”. In practical terms:

  • International stocks as percentage of total stock allocation will be increased from 30% to 40%.
  • International bonds as percentage of total bond allocation will be increased from 20% to 30%.

Portfolio changes are expected to occur gradually and be completed by the end of 2015. Expense ratios are not expected to change.

For some perspective, here is a history of the major tweaks to Vanguard Target Retirement funds:

  • 2003: Target Retirement 20XX Funds are first introduced.
  • 2006: Overall total stock exposure is increased slightly for various Target dates. Emerging markets stocks are added to certain Target dates with longer time horizons.
  • 2010: International stocks as percentage of total stock allocation is increased from 20% to 30%. Three of the underlying funds (European Stock Index, Pacific Stock Index, and Emerging Markets Stock Index) were replaced by a single fund, Vanguard Total International Stock Index Fund.
  • 2013: International bonds are added as 20% of the total bond allocation. Vanguard Short-Term Inflation-Protected Securities Index Fund replaced the Vanguard Inflation-Protected Securities Fund for certain Target dates with shorter time horizons.
  • 2015: International stocks as percentage of total stock allocation will be increased from 30% to 40%. International bonds as percentage of total bond allocation will be increased from 20% to 30%.

I’m not exactly sure how I feel about all this. On one hand, I think Vanguard tweaks their formula too often. Their asset allocation today looks rather different from 10 years ago. Has the historical investment data really changed that much? What is going to happen over the next 10 years? I would argue that none of the recent changes are absolutely necessary. On the other hand, taken individually each change is a relatively small tweak and can be supported by historical data. The funds remain low-cost and broadly-diversified, and that is probably the most important thing to consider. I would still recommend them to my family (who primarily invest in tax-deferred accounts).

(Also see: Do You Need International Bonds In Your Portfolio?)

My personal portfolio still looks pretty similar as a Target fund with big holdings in Vanguard Total US and Total International. But as a self-directed investor that prefers having control of the ship, unexpected changes like this remind me why I not longer hold these auto-pilot funds.

Berkshire Hathaway 2014 Buffett Letter: Buy Businesses, Not Currency

brklettersBerkshire Hathaway has released their 2014 Letter to Shareholders [pdf]. To commemorate the 50th anniversary of Warren Buffett taking over the company (1965-2015), both Warren Buffett and Charlie Munger wrote separate letters discussing both the past 50 years and looking forward to the next 50 years. This is in addition to normal discussion of 2014 activities and performance.

As always, the letter is written in a straightforward and approachable fashion. Even if you aren’t interested in BRK stock at all, reading the letter is very educational for investors and business owners of any experience level. Highly recommend reading the entire thing.

In terms of investing advice for the individual investor, he talks about the difference between buying shares of businesses and buying “dollars”.

The unconventional, but inescapable, conclusion to be drawn from the past fifty years is that it has been far safer to invest in a diversified collection of American businesses than to invest in securities – Treasuries, for example – whose values have been tied to American currency. That was also true in the preceding half-century, a period including the Great Depression and two world wars. Investors should heed this history. To one degree or another it is almost certain to be repeated during the next century.

Stock prices will always be far more volatile than cash-equivalent holdings. Over the long term, however, currency-denominated instruments are riskier investments – far riskier investments – than widely-diversified stock portfolios that are bought over time and that are owned in a manner invoking only token fees and commissions. That lesson has not customarily been taught in business schools, where volatility is almost universally used as a proxy for risk. Though this pedagogic assumption makes for easy teaching, it is dead wrong: Volatility is far from synonymous with risk. Popular formulas that equate the two terms lead students, investors and CEOs astray.

It is true, of course, that owning equities for a day or a week or a year is far riskier (in both nominal and purchasing-power terms) than leaving funds in cash-equivalents. […] For the great majority of investors, however, who can – and should – invest with a multi-decade horizon, quotational declines are unimportant. Their focus should remain fixed on attaining significant gains in purchasing power over their investing lifetime. For them, a diversified equity portfolio, bought over time, will prove far less risky than dollar-based securities.

One other tidbit that will surely be dissected by the media is that Charlie Munger hinted who would be the successor as CEO if/when Buffett were to step down. The two people named were Greb Abel, CEO of Berkshire Hathaway Energy, and Ajit Jain, who heads Berkshire’s reinsurance business. From Munger’s letter:

Provided that most of the Berkshire system remains in place, the combined momentum and opportunity now present is so great that Berkshire would almost surely remain a better-than-normal company for a very long time even if (1) Buffett left tomorrow, (2) his successors were persons of only moderate ability, and (3) Berkshire never again purchased a large business.

But, under this Buffett-soon-leaves assumption, his successors would not be “of only moderate ability.” For instance, Ajit Jain and Greg Abel are proven performers who would probably be under-described as “world-class.” “World-leading” would be the description I would choose. In some important ways, each is a better business executive than Buffett.

I would also point out this part from Buffett’s letter:

Our directors believe that our future CEOs should come from internal candidates whom the Berkshire board has grown to know well. Our directors also believe that an incoming CEO should be relatively young, so that he or she can have a long run in the job. Berkshire will operate best if its CEOs average well over ten years at the helm. (It’s hard to teach a new dog old tricks.) And they are not likely to retire at 65 either (or have you noticed?).

Greb Abel is 52 and Ajit Jain is 63. So my prediction would be Abel, the younger person. But really, the more important part of the letter is how they explain the structure and the culture of Berkshire will endure.

(I was surprised that Buffett also recommended AirBNB for booking a room for their annual meeting in Omaha.)

Shareholder letters from 1977 to 2014 are available free to all on the Berkshire Hathaway website. You can also now purchase all of the Shareholder letters from 1965 to 2013 for only $2.99 in Amazon Kindle format (~$22 paperback). Three bucks is a very reasonable price to have an approved copy forever stored in electronic format; you used to be able to find PDFs floating around on document-sharing sites, but it looks like they have reclaimed copyright protection on them.

If you missed it, last year’s letter discussed Buffett’s Simple Investment Advice to Wife After His Death.

Voya Corporate Leaders Trust Fund: Replicating a Buy & Hold Fund From 1935

est1935Imagine that it is 1935, and the US has just survived the Great Depression. You think to yourself – if a company can survive this, it’s got to be pretty solid. So you buy equal amounts of stock from 30 of the largest US companies, and hold them… forever! If a company splits, you just keep the two new companies. If a company gets sold, you just keep the new shares of the purchasing company. If they go bankrupt, you let them. 80 years later, you would have the Voya Corporate Leaders Trust Fund (LEXCX), which has beaten 98% of other Large Value fund peers over the last 5 and 10 years. It’s also beaten the S&P 500 over the last 40 years:


I found about the fund via this Reuters article, which outlines its interesting history and helps explain some of its holdings. Standard Oil is now ExxonMobil and Chevron. Santa Fe Railway is Berkshire Hathaway. The remnants of retailer Woolworth eventually became Foot Locker.

Let’s be clear, I am not saying people should run out and invest in this fund. I just want to point out that this is a very early predecessor to the first index fund – it is passive, low-turnover, transparent, and (relatively) low-cost. I have no idea how the future performance will hold up, but I view it is another example of the power of less stock-picking and more patience. Even Jack Bogle seems to approve:

Its unique nature has often drawn attention including from Vanguard Group Inc founder Jack Bogle, who said he remembers the fund from his days as an undergraduate around 1950. “It’s not a bad idea at all,” he said.

The expense ratio today is 0.52%, which is lower than average for all funds but somewhat expensive given that the managers don’t seem to do much beyond administrative duties. Given the simplicity of this method, can’t we avoid the middleman costs and do even better?

I’ve written about Motif Investing (review) before, which allows you to essentially create your own ETF (“motif”) of up to 30 stocks with zero management fee. Well, only 21 stocks are left in the Voya fund, so that’s perfect. Motif is a registered brokerage firm that will let you trade all 21 stocks at once for $9.95 a trade. I couldn’t find anything similar in their existing catalog, so for kicks I created my own Community Motif using the LEXCX holdings as of 12/31/2014. I called it Depression Survivors – Blue Chip Stocks Since 1935. Here’s the widget they made for it:


If you create a custom motif, they have a Creator Royalty program which gets you $1 royalty if someone invests using it. If I get even a dollar I’ll be highly amused. You can build your own motif by tweaking things or adding your own dividend stocks or whatever. Motif Investing still offers a $150 sign-up bonus if you open with $2,000 and make 5 trades.

Fidelity IRA Match: Switch and They’ll Match Your Contributions Up to 10%

Fidelity has released an infographic [pdf] about the power of saving 1% more of your income:


To coincide with this, Fidelity started a related promotion to entice folks to move over their IRA assets to them. The Fidelity IRA Match is designed to mimic the 401(k) contribution matching that many employers offer, where Fidelity will match between 1% and 10% of your future contribution for 3 years if you roll over $10,000+ to them. Valid for both new and existing Fidelity customers, but only for IRAs and not other account types. Here’s the breakdown:

Qualifying transfer* Match rate Estimated max benefit* (age 50+)
$10,000 1% $165 ($195)
$50,000 1.5% $247.50 ($292.50)
$100,000 2.5% $412.50 ($487.50)
$250,000 5% $825 ($975)
$500,000 10% $1,650 ($1,950)


* Qualifying transfers must be rollovers or transfers from non-Fidelity IRAs (Traditional or Roth). Rollovers from workplace savings plans are not eligible for this offer. Estimated max benefit is based on $5,500 annual contribution for three years ($6,500 for age 50+). Max benefit is set at $1,950.

It’s an interesting proposal. Keep in mind that many IRA custodians will ding you with an outgoing transfer fee if you move your money out. Also, Fidelity has other deposit promotions going on that offer a little less than the max payout here, but they are more straightforward bonuses.

To participate, you must register at If you do participate, I would like to point out the availability of their Fidelity Spartan Index funds, their Fidelity Freedom Index 20XX target-date funds which you can now purchase in an IRA, and their commission-free iShares ETFs. Fido has some good, low-cost products on their menu, but you may have to look for them.

Selected fine print:

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