My 529 Plan Asset Allocation, Part 2: Glide Path

This is a continuation of Part 1: Extension of Retirement or Standalone Portfolio?

If you’ve chosen a standalone portfolio for your 529 plan, every provider will offer you age-based portfolio that automatically adjusts based on the age if your child. In general, it starts out with mostly stocks and over time becomes mostly bonds and cash. This preset plan is called the glide path.

My biggest gripe about the glide path of most age-based default portfolios is their short holding periods for stocks. Nearly every one starts with a ton of stocks, and then quickly shifts to a ton of bonds. You’re basically hoping for big stock returns over a short window of time, which is more gambling than investing. Allow me to explain…

Here is the glide path for Moderate Age-Based Option of the Vanguard 529 plan, Nevada (click to enlarge):

vg529aa_2

You start at 75% stocks, and then at 6 years old you are down to 50% stocks, and then at age 11 you are down to 25% stocks. So 25% of your portfolio only holds stocks for at most for 6 years. (Imagine if you contributed money at age 5.) Another 25% is only held at most for 11 years.

If you contributed equal amounts of money every year to this Nevada 529 moderate age-based plan, your average hold time for half your portfolio (2/3rds of the stock portion) is around 4-5 years in stocks. If you did a lump-sum in the beginning, the average hold time for half your portfolio would be 8.5 years.

Here is the glide path for Moderate Age-Based Option of the UESP 529 plan (Utah):

utah529aa_1b

You start at 80% stocks, and then at 7 years old you are down to 60% stocks, and then after another 3 years (age 10) you are down to 40% stocks. At age 13, you are at 20% stocks. That means 20% of your portfolio only holds stocks for at most 7 years. Another 20% only holds stocks at most for 10 years. Another 20% holds stocks at most for 13 years.

If you contributed equal amounts of money every year to this Utah 529 moderate age-based plan, your average hold time for 60% your portfolio (75% of all your stock holdings) is around 5 years in stocks. If you did a 100% lump-sum in the beginning, your average hold time for 40% of your portfolio would be 8.5 years.

Hold time vs. Investment returns

Here is a customized chart from PortfolioCharts.com that shows how past returns varied by holding period for the US stock market. (More info on these charts here).

Note that within 5-year and 10-year periods, there are lots of white and red squares which indicate periods of zero or negative inflation-adjusted returns. The longest drawdown was 10 years. Wouldn’t you like to have ridden that out with a longer holding time?

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Side note: Some people have criticized the sharp step-downs in the glide path. Vanguard addressed this concern in their 529 whitepaper [pdf]. They ran back-tested simulations and found little difference between a smoothed and stepped glide path (click to enlarge).

vg529_stepped

They concluded asset allocation was more important, which I agree with, but I wasn’t satisfied with the amount of evidence supporting their short stock holding periods. Sure, on average things look good, but in any given 5-year period things could be quite bad.

My alternative plan is more slow-and-steady, just like my overall retirement portfolio. I will start out with a balanced allocation at roughly 60% stocks and 40% bonds, as opposed to 75%, 80% or 100% stocks. I will then stay that way as long as I can so the stock portion will have a long holding period. Probably 6 years out from college, I will convert 10% from stocks to bonds/cash. So 60/40 > 50/50 > 40/60 > 30/70, and so on until I am at 100% cash at age 18.

I will also front-load my contributions so that they are within the first few years. I know not everyone can do that. This means I will hold all of my stocks for a minimum period of 10 years, with the average holding time closer to 15 years. Look again at the green/red chart above with a 15-year holding period.

I haven’t quite decided on the exact fund mix, but I have settled on using the Utah 529 plan, as it allows full customization and scheduling of your own glide path with a pretty solid menu of low-cost and passive investment options. Last part of this series will have the full implementation.

My 529 Plan Asset Allocation, Part 1: Extension of Retirement or Standalone Portfolio?

529I’m finally getting around to setting up 529 college savings plans for my kids. It remains my opinion that you should make sure your retirement savings are on track before worrying about college savings. The government let me borrow over $50,000 in student loans for college, but they won’t let me do that again for retirement.

(Related: Top-ranked nationally-available 529 plans and state-specific tax benefits.)

Other than deciding how much money you’ll contribute, the big question is what do you invest it in? The most common default investment choice is an all-in-one fund that adjusts automatically based on the age of the beneficiary. Essentially, a tweaked target-date retirement fund. Under this model, each child of different age would then have their own standalone asset allocation.

However, I ran across an interesting discussion on the Bogleheads forum where some people used their 529 plans as an extension of their primary retirement portfolios. As the 529 offers tax-deferred growth and tax-free withdrawals for qualified educational purposes, you could treat it like an IRA and put some tax-inefficient assets inside. For example, I could squeeze in some riskier stuff like real estate (REITs), small value stocks, and/or emerging markets stocks for a couple of decades. Or safe stuff like TIPS. You wouldn’t have to adjust for beneficiary age, just rebalance things whenever you spend it down.

This gets a little tricky because even if you start early, you’re typically going to save up a bunch of money over 15-20 years and then spend it all within 4 years. Contrast this with retirement, where you typically save up over 30-45 years and spend it over another 20-35 years. Also, if you don’t spend the funds in a qualified manner, your withdrawals may be subject to both income tax and an additional 10% penalty.

In my opinion, an important factor to consider is your personal tuition assistance philosophy.

Are you going to cover a certain percentage of your child’s tuition, no matter what? Some parents will promise to cover 50%, 75%, or 100% of college expenses, regardless of actual 529 balance. In that case, the 529 plan is less of a savings bucket as it is just another way to gain some extra return via tax sheltering. Perhaps then it makes sense to consider your 529 as a piece of the bigger picture.

Let’s say you invest solely in 100% risky stocks for the entire 15 years, and there is a last-minute crash where you lose 50% of your value. If your final 529 balance is much less than expected, the rest of your portfolio probably did better and you can fulfill your commitment with other assets. (The same thing could happen if you invested solely in 100% safe bonds. The return might be so low that your final balance is quite disappointing.)

Are you treating the 529 plan as a piggy bank? “Here, I saved this much money for you. You handle the rest.” In this case, you are setting aside a fixed amount, labeling it “college funds”, and you’re done. It is separate in your mind. So why not invest it separately? You probably do want to make your investments diversified initially and also more conservative as your child gets close to college. Having the value drop in half at the very end could force your child to take on a significantly larger amount of debt.

After some thought, I am taking a hybrid approach. I am committed to covering at least a “good chunk” of my kids’ college expenses, without limiting it to a fixed amount. (I won’t guarantee 100% as I am wary as to how colleges use their huge sticker prices.) First, we have the financial means, even if it means working a little longer. Second, we feel an obligation to pay it forward because my parents covered a big portion of my own tuition and my wife’s parents covered all of her tuition. My goal is to have my kids feel free to take some career risk in their 20s, although I am not opposed to them having a little debt (“skin in the game”).

My plan is to make my 529 a miniature copy of my retirement portfolio. If my retirement portfolio asset allocation is 60% stocks and 40% bonds, then the 529 portfolio will also be 60% stocks and 40% bonds. So the 529 will be a standalone portfolio, but it will grow at the same rate as my retirement portfolio. Once the time comes, I will spend the 529 money and also withdraw from my retirement portfolio if needed (hopefully not). However, in the meantime, I won’t have to constantly rebalance across two additional smaller accounts.

My kids are 1 and 3 right now. I plan on keeping my cloned asset allocation setup for at least the next 10-12 years, and then taper down over the last 5 years so that it is 100% cash or short-term bonds by age 18. This differs from most age-based default options offered, as they taper steadily over the entire 18-year period. More details on why I like my way better in Part 2 tomorrow.

How To View Your Spouse’s Account Within Vanguard

vanguard_logoMy wife and I both hold IRAs at Vanguard.com, and we each have our own usernames and passwords. This used to work out fine – I would login to either one when I needed to update our portfolio-tracking spreadsheet. But after enabling two-factor authentication, it became a nuisance as the security code would be sent only to her cell phone and she’d then have to forward it back to me within 10 minutes.

I’m sure we are not the only household where one person wants to view their spouse or partner’s investment information. There are now two ways to deal with this situation.

Vanguard now allows you to add a secondary phone number for two-factor authentication. You can now add a second phone number and choose between receiving your security codes by voice message or text message. This way, both my wife and I will get a text when either of us logs into one of our accounts.

Vanguard lets you grant direct view-only access another Vanguard account holder. With this option, now my wife’s IRA holdings show up on my primary account view right next to my own IRAs. So convenient! As the family’s CIO, I now only have to log into the other account to make our annual IRA contribution. This is exactly what I’ve wanted for a while.

Instructions. First, log into the account that you wish to share. Then, click on “My Accounts”, and then “Account maintenance” as shown below:

vgshare1

Next, scroll down a bit and click on “Account permissions”:

vgshare2

Since we were already joint owners on a taxable brokerage account, the process was quite streamlined and only took a few clicks. Otherwise, you may need to provide the full name, account number, and other personal information in order to identify the correct target account.

Here is a screenshot showing exactly what you can and can’t do with this authorization. Essentially, it is “view-only access” as opposed to be being able to alter account settings and initiate any buy or sell transactions. (Click to enlarge.)

vgshare3

Charlie Munger: The Complete Investor Book Review

mungercompleteI’ve just finished reading new book Charlie Munger: The Complete Investor by Tren Griffin. For the unaware, you can read the Wikipedia for Charles T. Munger, otherwise probably best know as the Vice Chairman of Berkshire Hathaway and partner of Warren Buffett. The book is meant to corral all the various sources of Munger teachings into a “unified theory” of investing. As is my practice, here are my favorite highlights of the book followed by a quick review. I will try to clearly separate what are Munger quotes and Griffin book excerpts.

First, some good sentences on why learning from reading is awesome (Griffin):

The point is not to treat anyone like a hero, but rather to consider whether Munger, like his idol Benjamin Franklin, may have qualities, attributes, systems, or approaches to life that we may want to emulate, even in part. This same process explains why Munger has read hundreds of biographies. Learning from the success and failure of others is the fastest way to get smarter and wiser without a lot of pain.

Munger on efficient markets:

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

The book also serves as a good introduction to value investing based on Benjamin Graham’s teachings. Griffin emphasizes the fact that it is about patience and waiting around a mispriced asset to appear. It is not about forecasting the future. Griffin:

Successful Graham value investors spend most of their time reading and thinking, waiting for significant folly to inevitably raise its head. Although Graham value investors are bullish about the market in the long term, they do not making investing decisions based on short-term predictions about stocks or markets.

What kind of qualities does any person owning stocks need (even index funds)? Here’s what Munger said when once asked about how much he worried about a big drop in the value of Berkshire:

Zero. This is the third time Warren and I have seen our holdings in Berkshire Hathaway go down, top tick to bottom tick, by 50%. I think it’s in the nature of long term shareholding of the normal vicissitudes, of worldly outcomes, of markets that the long-term holder has his quoted value of his stocks go down by say 50%. In fact you can argue that if you’re not willing to react with equanimity to a market price decline of 50% two or three times a century you’re not fit to be a common shareholder and you deserve the mediocre result you’re going to get compared to the people who do have the temperament, who can be more philosophical about these market fluctuations.

Why professional money managers don’t make big alpha (Munger):

For most professional money managers, if you’ve got four children to put through college and you’re earning $400,000 or $1 million or whatever, the last thing in the world you would want to be worried about is having gumption. You care about survival, and the way you survive is just not doing anything that might make you stand out.

Munger has been talking about the link between behavioral psychology and investing before it was popularized by books and mainstream media. There are many sources of misjudgments, but I like that he covers many of the more subtle ones that I put under “help me live a good life” more than “help me make more money”. Take envy and jealousy (Munger):

The idea of caring that someone is making money faster [than you] is one of the deadly sins. Envy is a really stupid sin because it’s the only one you could never possibly have any fun at. There’s a lot of pain and no fun. Why would you want to get on the trolley?

On drug and alcohol addiction, this is Griffin writing about Munger:

His timeless advice is to avoid situations with a massive downside and a small upside (negative optionality). Why play dice with something that can ruin your life forever?

Commentary. This book was a solid, short introduction to the world of Charlie Munger from an investing point of view. It has a ton of Munger quotes, but Griffin also does a solid job weaving in quotes from other famous investors like Warren Buffett and Seth Klarman. If you are a fan of Warren Buffett, you will like this book.

Of course, what makes Munger special to me is that he talks about stuff beyond investing, like ethics and morality. For example, I liked that he points out the lifetime benefits of simply “being reliable”. So many workers are just not reliable. Therefore, for a more complete picture, I recommend reading Poor Charlie’s Almanack, which includes transcripts of all his talks, lectures, and public commentary. Reasons for why it is not more popular include the length (really long) and the cost ($50+). After reading and digesting it all, I feel it was fifty bucks well spent. However, if you choose to skip the Almanack, I’d say you’d get $15 of value out of this book.

Realty Mogul Review: Fractional Investment Property Ownership, Hard Money Lending

rmlogo

Added bonus for new sign-ups. I’ve been a registered member of RealtyMogul for a while, and they recently emailed me that if I referred a friend, we’d both get a $150 Amazon gift card just for completing the registration process (i.e. zero investment required). Here is a screenshot. The restriction is that you must be an accredited investor, which means either a single income of $200,000, joint income of $300,000, or net worth of $1 million excluding primary residence. I’ve registered at a few of these sites, and you may need to send in a scanned W-2 (was allowed to remove SSN) or brokerage statements for verification.

This is a nice carrot if you are already interested in hard money lending or fractional real estate ownership. You must either use this special sign-up link or use the promo code JONATHANP7 during registration. Offer expires 12/31/15.

*The referrer and the referred will each receive a $150 gift card (redeemable at Amazon.com) upon successful completion of the investor registration process at RealtyMogul.com by the referred party. Gift cards will be mailed within 30 business days to the address on file. This promotion is limited to 6 referrals per referral code and is only valid until December 31, 2015.

Original post from mid-2013 below:

Realty Mogul is a new “crowdfunding” start-up that lets you invest in residential investment property for as little as $5,000. You either take a partial ownership position in a property, or you become a lender to (experienced) house flippers. The new thing here is that you can do it completely online with a few mouse clicks (no mortgage brokers, real estate agents, or tenants) and again that low minimum $5,000 investment. (Thanks to reader Johnson for the tip.)

Taking an equity ownership position means that you own a little slice of a single-family home or multi-unit complex while a professional does the buying, fixing up, renting out, and eventual selling. Realty Mogul only has done one deal like this so far (fully funded) and the intended timeframe is 5-7 years. You earn rent while the house hopefully appreciates in value, and cash out when the house sells.

Being a lender looks very similar to the age-old practice of hard money lending, just with smaller chunks. You lend the money to a house flipper who needs a short-term loan (3 months to a year) and doesn’t want to deal with traditional mortgage lenders and their closing costs and long underwriting delays. The loan is backed by a personal guarantee (not too special, you can try to sue and/or hurt their credit score) and more importantly you usually have a first position lien on the property (if they don’t pay, the lender gets the title to the house). Most of the previously funded loans have an annualized interest rate of 8%.

rmshot

Realty Mogul states that they differentiate themselves from other similar startups like FundRise and Prodigy Network by (1) outsourcing the real estate expertise to vetted professionals and (2) keeping a focus on cashflow, either via rent or interest payments. Right now they’ve only had about 7 investments, but they seem to open a new one up after the last one fully funds.

Currently, the SEC limits this type of investment to accredited investors, which means either a single income of $200,000, joint income of $300,000, or net worth of $1 million excluding primary residence. When I tried the application, the only screening process was to check a few boxes and state that you qualify. Supposedly, the recently passed JOBS Act will allow them to drop this requirement later this year.

If given the option, should I drop $5,000 into this to try it out just like with person-to-person lending? $5,000 is still a lot of money to put into an investment where you are not able to do much due diligence. Getting good returns on a single investment project is all about the skill of that particular rehab team. Will the teams that sign up for capital via Realty Mogul always be the good ones, or those that are having a hard time getting funding from elsewhere? I thought that hard money lending rates were more in the 10%+ range; I don’t know if I’d be happy with 8% but maybe that’s the going rate now. Even if you have collateral, recouping your principal in case of a bad loan can get complicated and time-consuming. At least with P2P lending I can spread $5k over 200 different loans such that even though I am certain to get some defaults, it is unlikely I will get a negative return overall.

More: TechCrunch, LendAcademy, BizJournals, The Verge

High-Quality Bonds Still Best Antidote to Stock Price Drops

antidoteThere is a constant search for the elusive “new” asset class that offers high returns but with low correlation to stocks. In Skating Where the Puck Was: The Correlation Game in a Flat World, William Bernstein points out that soon after one is “discovered”, the future returns and correlations will quickly change as to be useless. Past examples have included commodities futures and international REITs.

But this Vanguard Blog post reminds us that of the original stock diversifier: bonds. Here a chart of monthly asset returns during times of severe stock market drops:

vg_bonds_danger

See a trend? Investment-grade government-backed, corporate, and municipal bonds. While their long-term returns aren’t going to be as high as stocks, high-quality bonds remain the best asset class for diversifying against stock market price drops. You can compare these results to Bernstein’s guide to picking bonds.

Sure, interest rates will rise eventually. But we don’t know how much they will go up (could be very little), how fast (could be very slowly), or if they will stay higher (could drop down again). As long as you have high-quality and short/intermediate maturity lengths, bonds will keep on doing their job as the ballast in your portfolio. Check out the wiggly lines in this StockCharts.com interactive chart comparing the historical performance of ETFs tracking US stocks (VTI), international stocks (VXUS), and high-quality bonds (BND). Adjust the bottom time bar to adjust the lookback period.

vg_bonds_stockcharts

People will vary in how much bonds to have in their portfolios, but I like the idea of always having at least a little “slow and steady” stuff in my portfolio.

Charlie Munger: The First $100,000 Is The Most Difficult

There used to be a series of ING commercials where people would carry around their “Number”, which was usually over a million dollars. I think such large numbers actually discourage most savers, so what if we had an alternative goal that was both more achievable yet realistic?

I’m currently reading a new book called Charlie Munger: The Complete Investor by Tren Griffin because, well, I like to read anything about Charlie Munger. There is a lot of good stuff related to investing inside, but it didn’t mention one of my favorite personal finance quotes from Mr. Munger. I can’t seem to find an exact reference anymore, so here are two paraphrased sources…

First, here is an excerpt from the 2003 book Damn Right!: Behind the Scenes with Berkshire Hathaway Billionaire Charlie Munger by Janet Lowe (my review):

Munger has said that accumulating the first $100,000 from a standing start, with no seed money, is the most difficult part of building wealth. Making the first million was the next big hurdle. To do that a person must consistently underspend his income. Getting wealthy, he explains, is like rolling a snowball. It helps to start on top of a long hill—start early and try to roll that snowball for a very long time. It helps to live a long life.

Second, here is another version of the quote credit to Munger, per Conservative Income Investor:

“The first $100,000 is a bitch, but you gotta do it. I don’t care what you have to do—if it means walking everywhere and not eating anything that wasn’t purchased with a coupon, find a way to get your hands on $100,000. After that, you can ease off the gas a little bit.”

$100,000 is certainly a nice, round number. But is it a worthy goal? Consider these points:

Most people will never achieve $100k in portfolio assets. Forget a million bucks. Consider this chart from the Quartz article America is full of high-earning poor people. On average, even a person earning close to six figures will struggle to reach $100k in financial assets by age 55.

The figure below plots financial assets held by the upper middle class (household income from $50,000 to $75,000, and $75,000 to $100,000) aged 40 to 55. Financial assets are any assets a household owns that isn’t a house, car, or business, which means it includes all retirement funds.

networth100k

If you reach $100k quickly, that means you have high earning power. Let’s say you start a successful small business or are in a well-paid professional field. Well, you have the saving potential to reach the millionaire level, you just have to keep it by not increasing your spending accordingly.

If you reach $100k gradually, that means you have built up a strong habit of spending less than you earn. Let’s say it takes you a decade of steady saving to reach $100k. That’s okay, as you’ve shown that have both consistent earning power and spending restraint. You’ll be able to save another $100k over the next decade for sure, meanwhile your first $100k is going to keep on growing.

At the $100,000 level, compound interest become significant. At 5% return, your $100,000 will grow by $5,000 in just one year. That’s $5,000 for doing nothing but waiting around for a year. The year after that, you won’t just have another $5,000. You’ll have $5,250 due to compound interest. At the end of five years, that $100k is already $127,628.

Add in the additional money from your continuing habit of saving, and things start to improve quickly. Your snowball is growing. I no longer automatically reinvest my dividends from my taxable mutual fund and ETF holdings because I love seeing the money show up in my cash account. A few clicks and I’ll reinvest them, but I like the feeling of “cashing my dividend checks” and knowing that one day I’ll be waiting for them to arrive instead of my paycheck.

Now, I still think savings rate is a better measuring stick than portfolio size, because someone who can earn $60k and spend $30k every year is going to be able to retire much sooner than someone who earns $180k and is stuck in a lifestyle spending $150k. But if you are in the phase of your life where you love watching your account balances grow every day, even by a few dollars (been there, done that), $100k is the biggest goal you need.

Related: Munger: Work For Yourself An Hour Each Day and Munger on Parenting and Childhood.

iShares Core ETFs Expense Ratio Changes 2015

logo_isharesBlackrock announced changes to its iShares Core ETFs, which are targeted towards buy-and-hold investors. 7 ETFs now have lower expense ratios (see chart below). Both iShares Core S&P Total U.S. Stock Market ETF (ITOT) and the BlackRock Total Stock Market Index Fund (BKTSX) now have expense ratios of 0.03%. For comparison, the Vanguard Total Stock Market ETF (VTI) currently has an expense ratio of 0.05%. The Schwab U.S. Large-Cap ETF currently has an expense ratio of 0.04%, but they also announced plans to match the 0.03%. Price war!

                         
Category     Fund     Ticker     Previous     New
expense ratio expense
                  (%)     ratio (%)
U.S. Equity     iShares Core S&P Total U.S. Stock Market     ITOT     0.07     0.03
      iShares Core U.S. Growth     IUSG     0.09     0.07
      iShares Core U.S. Value     IUSV     0.09     0.07
International Equity     iShares Core MSCI Emerging Markets     IEMG     0.18     0.16
      iShares Core MSCI Europe     IEUR     0.14     0.12
      iShares Core MSCI Pacific     IPAC     0.14     0.12
Fixed Income     iShares Core Total USD Bond Market     IUSB     0.15     0.12
 

Let’s also take a look at what’s inside. Effective 12/18/2015, ITOT will also shift indexes from the S&P Composite 1500 Index to S&P Total Market Index (TMI). It’s about time for something that called itself a “total” fund, as the previous index only tracked roughly the biggest 1,500 stocks. The new index tracks nearly 4,000 stocks.

In comparison, the Vanguard Total Stock ETF (VTI) tracks the CRSP US Total Index, which means it already holds nearly 4,000 individuals stocks. The Schwab US Large-Cap ETF tracks the and Dow Jones U.S. Large-Cap Total Stock Market Index and only holds 765 stocks. So while Schwab wants to hold on to the “cheapest” title, it’s ETF sausage has different ingredients.

Finally, there is also a new international bond ETF, the iShares Core International Aggregate Bond ETF (IAGG).

15 out of the 24 iShares Core ETFs can be traded commission-free in a Fidelity brokerage account. Out the the 7 listed above, all but IPAC and IUSB are included in their commission-free list. The free trade list offers pretty good selection overall, considering the Core MSCI Total International Stock (IXUS) and Core Total U.S. Bond Market (AGG) are much more popular anyway and are on the commission-free list.

Recap. This is another direct result of consumer demand for low-cost, well-run, index ETFs. Advisors want to keep their clients happy, and thus pressure the providers. The competition between iShares/Fidelity, Vanguard, and Schwab should continue to lead to better products at lower prices for consumers. I’m still sticking with Vanguard, but new DIY investors can now open an account at any of these three and build their own diversified, low-cost portfolio with no trade commissions.

Early Retirement Portfolio Income Update, November 2015

monopoly_divI like the idea of living off dividend and interest income. Who doesn’t? The problem is that you can’t just buy stocks with the highest dividend yields and junk bonds with the highest interest rates without giving up something in return. There are many bad investments lurking out there for desperate retirees looking only at income. My goal is to generate reliable portfolio income by not reaching too far for yield.

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

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

Asset Class / Fund % of Portfolio Trailing 12-Month Yield (Taken 11/5/15) Yield Contribution
US Total Stock
Vanguard Total Stock Market Fund (VTI, VTSAX)
24% 1.92% 0.46%
US Small Value
WisdomTree SmallCap Dividend ETF (DES)
3% 2.98% 0.09%
International Total Stock
Vanguard Total International Stock Market Fund (VXUS, VTIAX)
24% 2.83% 0.66%
Emerging Markets Small Value
WisdomTree Emerging Markets SmallCap Dividend ETF (DGS)
3% 3.44% 0.10%
US Real Estate
Vanguard REIT Index Fund (VNQ, VGSLX)
6% 3.92% 0.24%
Intermediate-Term High Quality Bonds
Vanguard Intermediate-Term Tax-Exempt Fund (VWIUX)
20% 2.99% 0.60%
Inflation-Linked Treasury Bonds
Vanguard Inflation-Protected Securities Fund (VAIPX)
20% 1.31% 0.26%
Totals 100% 2.41%

 

The total weighted 12-month yield was 2.41%. This means that if I had a $1,000,000 portfolio balance today, it would have generated $24,100 in interest and dividends over the last 12 months. Now, that is significantly lower than the 4% withdrawal rate often quoted for 65-year-old retirees with 30-year spending horizons, and is even lower than the 3% withdrawal rate that I have previously used as a rough benchmark. I’ll note that the muni bond interest in my portfolio is exempt from federal income taxes.

Given the volatility of stock returns, the associated sequence of returns risk, and current high valuations, I still like the income yield measuring stick. I feel that the income yield number does a rough job of compensating for stock market valuations (valuations go up, probably dividend yield go down) as well as interest rates (low interest rates now, probably low bond returns in future). With 60% stocks, I am hoping that the dividends will at least keep up with inflation, and that I will never have to “touch the principal”. Over the last 15 years or so, the annual growth rate of the S&P 500 dividend averaged about 5%.

As noted previously, a simple benchmark for this portfolio is Vanguard LifeStrategy Moderate Growth Fund (VSMGX) which is an all-in-one fund that is also 60% stocks and 40% bonds. That fund has a trailing 12-month yield of 2.07%. Taken 11/9/2015.

So how am I doing? Staying invested throughout the last 10 years has been good to me. Using the 2.24% income yield, the combination of ongoing savings and recent market gains have us at 84% of the way to matching our annual household spending target. Consider that if all your portfolio did was keep up with inflation each year (0% real returns), you could still spend 2% a year for 50 years. From that perspective, a 2% spending rate seems like a very conservative number. As such, we are currently redirecting a chunk of our monthly savings into a college savings account. We are doing well and we want to help pay for our children’s higher education, so might as well get that tax-deferral started now.

Early Retirement Portfolio Asset Allocation Update, November 2015

Here’s a (late) Q3 2015 update on my investment portfolio holdings for 2015. This includes tax-deferred accounts like 401(k)s and taxable brokerage holdings, but excludes things like real estate and cash reserves (emergency fund). The purpose of this portfolio is to create enough income to cover household expenses.

Target Asset Allocation

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I try to pick asset classes that will provide long-term returns above inflation, distribute income via dividends and interest, and finally offer some historical tendencies to balance each other out. I don’t hold commodities futures or gold as they don’t provide any income and I don’t believe they’ll outpace inflation significantly. In addition, I have doubt that I would hold them through an extended period of underperformance (i.e. don’t buy what you don’t can’t stick with).

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

Actual Asset Allocation and Holdings

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

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

What’s New? Commentary
Things are still sticking pretty close to my target asset allocation. Before the year ends, I would like to relocate my “spice it up” holdings of WisdomTree SmallCap Dividend ETF (DES) and WisdomTree Emerging Markets SmallCap Dividend ETF (DGS). Mostly because a big chunk of their dividends are unqualified and thus subject to higher income rates. I can also do a bit of tax loss harvesting. But where to move them? I could squeeze them in my Fidelity Solo 401k plan that lets me buy ETFs (displacing either TIPS or REITs), buy similar mutual funds in my Schwab 401k brokerage window (displacing TIPS), or even buy some similar DFA funds in a Utah 529 account and consider it part of my portfolio (smart?). Or I could just liquidate them and just stick with total stocks funds (boring).

As for bonds, I’m still underweight in TIPS mostly due to lack of tax-deferred space as I really don’t want to hold them in a taxable account. My taxable bonds are split roughly evenly between the three Vanguard muni funds. The average duration across all of them is roughly 4-5 years.

A simple benchmark for my portfolio is 50% Vanguard LifeStrategy Growth Fund (VASGX) and Vanguard LifeStrategy Moderate Growth Fund (VSMGX), one is 60/40 and one is 80/20 so it also works out to 70% stocks and 30% bonds. That benchmark would have returned about 1.47% YTD for 2015 (as of 11/4/15). I haven’t bothered to calculate my exact portfolio return, but it should be close to this number.

I like tracking my dividend and interest income more than overall market movements. In a separate post, I will update the amount of income that I am deriving from this portfolio along with how that compares to my expenses.

myRA Starter Retirement Account Launches Nationwide

myra_logoThe U.S. Department of the Treasury announced the national launch of myRA (my Retirement Account), a new starter option for those who don’t have access to a retirement savings plan at work. There have been some improvements and tweaks since their initial pilot launch in late 2014.

No monthly or annual fees. No minimum contribution requirement. No minimum balance requirement. Contribute as little as a dollar every paycheck if you like.

Fund via automatic paycheck deduction, automatic bank transfers, or federal tax refund. Automatic paycheck deductions work through your employer’s direct deposit system.

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No risk of loss. Your money is backed by the US government, just like US Treasury bonds and FDIC-insured bank accounts. You earn the same interest rate as the Government Securities fund available to Federal employees, known as the G Fund. The good news is that it earns the higher interest of longer-maturity bonds while maintaining zero principal risk like a bank account. Interest is compounded daily.

The G Fund 1-year historical return for 2014 was 2.31%. Taken from TSPFolio, here is the interest rate history. The current annualized rate for November 2015 is 2.125%.

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What does “starter account” mean? There are no stocks or other riskier options here. You can roll over your myRA into a private-sector Roth IRA once you’ve either reached the max balance of $15,000 or the max time period of 30 years.

What do you mean it’s a Roth IRA? I mean just that; it is a Roth IRA. The same rules apply:

  • Tax-fee and penalty-free withdrawal of contributions at any time, if needed.
  • If you make a qualified withdrawal, you’ll pay no taxes on both contributions and earnings.
  • For 2015, the contribution limit per person is $5,500 a year, or $6,500 if you are at least 50 years old by the end of the year.
  • The income limit is based on modified adjusted gross income (MAGI). The 2015 phase-out range for singles is $116,000 to $131,000. For married filing jointly is $183,000 to $193,000.

Although you may not be the target audience, you can still use myRA if you have a 401k or previous IRAs. Again, myRA is a Roth IRA so you’d have to direct part or all of your annual contribution to this Roth IRA instead. The G Fund is something that I would invest in if it was an option for me, but it is somewhat inconvenient to open another account just for one investment option. For example, if you are 90% stocks and 10% bonds, a $5,000 total contribution would only direct $500 towards a myRA.

Commentary. As I noted when it first came out, myRA is kind of a Frankenstein cobbled together from the parts bin. Existing Roth IRA vehicle. Existing Thrift Savings Plan G Fund. Comerica Bank quietly manages the backend (they’ve done previous work for the Treasury). It’s a bit clunky as you have to tell your employer to direct deposit some of your paycheck into your myRA, which a is basically a Comerica bank savings account and routing number (111925074). If you employer can’t handle split direct deposits, you must contribute via bank transfer or tax refund.

Will this combo convince someone who’s not saving today, to start? My guess is that the popularity will be relatively low. While I personally wouldn’t mind having the G Fund as an investment option, but I don’t know that someone who’s not saving now will be enticed by a 2% interest rate. (Maybe if rates rise.) But hopefully I’m wrong and the opportunity to have a “retirement plan of your own” is enough.

To me, what’s missing is super-easy auto-enrollment (auto opt-in, voluntary opt-out). So the best case scenario is if small businesses without 401(k) plans actively encourage their employees to sign up for myRA, as we’ve seen that automatic deductions are a good trick to save more for retirement. For more information, visit the myRA.gov employer FAQ.

Morningstar Top 529 College Savings Plan Rankings 2015

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Investment research firm Morningstar has released their annual 529 College Savings Plans Research Paper and Industry Survey. While the full survey appears restricted to paid premium members, they did release their top-rated plans for 2015. Remember to first consider your state-specific tax benefits that may outweigh other factors. If you don’t have anything compelling available, you can open a 529 plan from any state.

Here are the Gold-rated plans for 2015 (no particular order). Morningstar uses a Gold, Silver, or Bronze rating scale for the top plans and Neutral or Negative for the rest.

Here are the consistently top-rated plans from 2010-2015. This means they were rated either Gold or Silver (or equivalent) for every year the rankings were done from 2010 through 2015.

  • 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)

The trend here is consistency. There was no change in either of the lists above as compared to last year. Utah only missed on out the consistent list because they weren’t top-ranked in 2010.

The “Five P” criteria.

  • 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.

A broad recommendation is to simply stick with one of the plans listed above unless your in-state plan is offering significant tax breaks. Many other state plans may have specific investments that will work just fine as well. Here are my personal favorites, and why:

  • The Nevada 529 Plan for its low costs, variety of Vanguard investment options, and long-term commitment to consistently lowering costs as their assets grow. The Vanguard co-branding is also a sign of positive stewardship.
  • The Utah 529 plan has low costs, includes a nice selection of Vanguard and DFA funds, and is highly customizable for DIY investors. Over the last few years, the Utah plan has also shown a history of passing on future cost savings to clients.

I feel that a trend of consumer-first practices is important as the quality of all 529 plans can change with time. Sure, you can roll over your funds elsewhere, but wouldn’t you rather have your current plan just keep getting better and better?