Mental Model For Expenses: Past, Present, and Future (With Animated GIFs!)

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The theory behind financial independence is simple. Spend less, save more, invest it into income-producing assets. The reality is complex, full of daily decisions about balancing income and spending. The Morningstar article (yes, M* is writing about early retirement too now) A Simple Plan for Financial Independence presents this simplified graphic of your “personal economy”.

Income can come from labor, capital, or land. Expenses can be put toward your past (debt), present, or future (investing in capital or land).

I’ve been thinking about this “past, present, and future” mental model for expenses, it meshes will with the simple rules that I want to teach my children: Avoid debt whenever possible, and seek out income-producing assets.

Present. There is countless advice to save money on current expenses. Call it prioritizing, call it frugality, call it whatever. These are important, but I’d rather focus on the added ideas of past and future.

Past. While debt is an important part of the economy, I hate that going into debt for non-essentials is so readily accepted in today’s society. Using home equity lines of credit for a kitchen remodels. Credit cards for vacations. The entire microloans trend where you buy a $100 pair of jeans for $10 a month times 12 months ($120) is a dangerous mind game. Debt is having compound interest work against you, and thus making someone else rich. Debt should not be normalized. Debt is an emergency!

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Future. If you look at people who have really achieved financial freedom, where they truly spend the day doing whatever they want and without money worries, they have all have collected a big pile of income-producing assets. It could be rental property, commercial real estate, a laundromat/car wash/business, dividend-paying stocks, municipal bonds, a pension, Social Security or even just bank CDs if you have enough. In most cases, they collected them with purpose. They didn’t just put the minimum into their 401(k) and call it a day. They would shovel whatever extra money they had into their favorite money-making machine. When I buy more stocks, I see a future income stream:

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When you buy one of these income-producing assets, it should get you excited!

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I’m still not sure exactly how to create this distaste for debt and this desire for money factories, but I’m working on it. If you have these two in place, that should help with everything else – earning more income with labor, spending less on the present.

Oh, and here’s a funny-but-sad representation of the paycheck-to-paycheck lifestyle.

via GIPHY

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Super Simple Portfolio Rebalancing: Check Once A Year, Rebalance Every 6 Years On Average!

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All this talk about portfolio rebalancing is to improve your risk-adjusted return, not to maximize absolute returns. You are trying to squeeze the most return out of a given degree of risk. Otherwise, if you do nothing eventually whatever has a higher return (historically always stocks) will outperform and take over the portfolio.

Here’s another take on the proper frequency of rebalancing your portfolio to your target asset allocation. Vanguard Research has a new paper called Getting back on track: A guide to smart rebalancing [pdf]. The chart below shows the results of various combinations of time and threshold rebalancing strategies on a traditional 60/40 portfolio from 1926-2018.

I added the yellow highlights, which focus on the two extremes:

  • If you rebalanced every single month for 93 years straight (1,116 times!), your result would have been a 8.20% annualized tax-adjusted return and 11.7% volatility. Sharpe ratio 0.50.
  • If you checked in your portfolio only once per year, and then only actually took actions if your target percentage was off by 10% of more (i.e. 50/50 or 70/30), you would have rebalanced only 14 times over 93 years. That an average of once every 6.6 years! Your result would have been a 8.20% tax-adjusted return and 11.6% volatility. Sharpe ratio 0.50.

My kids like to dance to a popular kids YouTube channel called Super Simple Songs. I think the last method should be called Super Simple Rebalancing. You just need to make sure you’re taking action on those rare trigger dates.

Historically, your risk-adjusted return was a bit better if you rebalanced at a 5% threshold with quarterly checkups (8.31% with 11.6% volatility), but there is no guarantee that this small edge will apply in the future. However, this does explain why Vanguard uses the 5%/quarterly method in their paid portfolio management program Vanguard Personal Advisor Services. Historically, this has worked out to rebalancing once every two years on average, which isn’t so bad either.

This last sentence in the paper is a good summary of tax-aware investing:

Investors may also be able to improve portfolio performance, without sacrificing risk control, by practicing tax-efficient rebalancing through the use of tax-advantaged accounts, rebalancing with portfolio income, incorporating tax- and cost-sensitivity awareness into their rebalancing decision, and gifting overweighted and highly appreciated securities.

Bottom line. You could have rebalanced 1,000+ times from 1926-2018, or you could have just done it 14 times and it really wouldn’t have made much difference. The key is to pick a simple, consistent rebalancing rule and stick with it!

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Savings I Bonds November 2019: 2.02% Inflation Rate Prediction

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sb_poster

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

New inflation numbers were just announced at BLS.gov, which allows us to make an early prediction of the November 2019 savings bond rates a couple of weeks before the official announcement on the 1st. This also allows the opportunity to predict what an October 2019 savings bond purchase will yield over the next 12 months, instead of just 6 months.

New inflation rate prediction. March 2019 CPI-U was 254.202. September 2019 CPI-U was 256.759, for a semi-annual increase of 1.01%. Using the official formula, the variable component of interest rate for the next 6 month cycle will be 2.02%. You add the fixed and variable rates to get the total interest rate. If you have an older savings bond, your fixed rate may be very different than one from recent years.

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

Buying in October 2019. If you buy before the end of October, the fixed rate portion of I-Bonds will be 0.50%. You will be guaranteed a total interest rate of 1.90% for the next 6 months (0.50 + 1.40). For the 6 months after that, the total rate will be 0.50 + 2.02 = 2.52%.

Let’s look at a worst-case scenario, where you hold for the minimum of one year and pay the 3-month interest penalty. If you theoretically buy on October 31st, 2019 and sell on October 1, 2020, you’ll earn a ~1.72% annualized return for an 11-month holding period, for which the interest is also exempt from state income taxes. If you held for three months longer, you’d be looking at a ~1.89% annualized return for a 14-month holding period (assuming my math is correct). Compare with the best interest rates as of October 2019.

Buying in November 2019. If you buy in November 2019, you will get 2.02% plus a newly-set fixed rate for the first 6 months. The new fixed rate is unknown, but is loosely linked to the real yield of short-term TIPS. In the past 6 months, the 5-year TIPS yield has dropped to about 0.20% and has been close to zero. My best guess is that it will be 0.10%. Every six months, your rate will adjust to your fixed rate (set at purchase) plus a variable rate based on inflation.

If you have an existing I-Bond, the rates reset every 6 months depending on your purchase month. Your bond rate = your specific fixed rate (set at purchase) + variable rate (minimum floor of 0%).

Buy now or wait? In the short-term, these I bond rates will probably not beat a top CD. If you intend to be a long-term holder, a factor to consider is that the October fixed rate is 0.5% and that it will likely drop at least a little in November in my opinion. You may want to lock in that higher fixed rate now.

Unique features. I have a separate post on reasons to own Series I Savings Bonds, including inflation protection, tax deferral, exemption from state income taxes, and educational tax benefits.

Over the years, I have accumulated a nice pile of I-Bonds and now consider it part of the inflation-linked bond allocation inside my long-term investment portfolio.

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

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

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

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Best Brokerage and IRA Transfer Bonuses – October 2019

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Fidelity, Schwab, TD Ameritrade, E-Trade, Interactive Brokers, Ally Invest all now offer free stock trades. Vanguard offers free trades on all ETFs, not just their own. The new differentiators are things like user interface, customer service, and interest on cash sweep accounts. How about some cash in my pocket too?

The recent shake-up is a reminder brokers are transitioning to maximizing assets under management, as opposed to attracting traders that rack up those commissions. You can often get a cash bonus for switching teams, based on the size of assets that you move over. This usually involves an ACAT transfer of your securities, including tax cost basis history. Here’s a current list of the top brokerage transfer bonuses, along with some additional commentary on Fidelity and Vanguard.

Schwab

  • Link: Up to $2,500 bonus offer
  • $200 bonus for $50k, $300 for $100k, $600 for $250k, $1,200 for $500k, $2,500 for $1m+.
  • New or existing customers moving over new assets. Valid for retail brokerage accounts.
  • Make a qualifying net deposit of cash or securities within 45 days.
  • Maintain net deposit amount (less any market losses) for one year.

TD Ameritrade

  • Link: Up to $1,000 bonus offer
  • Note this matches or is better than their standard up to $600 offer.
  • $100 bonus for $25k, $200 for $50k, $500 for $100k, $1,000 for $250k+.
  • Valid for new taxable or IRA accounts.
  • Open by 1/30/20, funded with new funds or securities within 60 days.
  • Maintain net deposit amount (less any market losses) for 12 months.

Chase YouInvest + Sapphire Banking

  • Link: $1,000 Sapphire offer / Standard offer
  • Sapphire offer: New or existing customers. Brokerage and/or IRA. Must transfer a total of $75,000 or more in new money or securities into eligible Chase checking, savings and/or investment accounts. You must open a new Sapphire banking account by 11/19/2019, complete the $75k transfer within 45 days of opening, and maintain that balance for at least 90 days from the date of funding. Get $1,000 bonus.
  • Standard offer: $200 for $25k, $300 for $100k, $625 for $250k. Transfer within 45 days, maintain for 90 days.

Merrill Edge

  • Link: Up to $1,000 bonus offer / $900 Preferred Rewards offer / $600 Standard offer
  • $100 bonus for $20k, $250 for $50k, $500 for $100k, $1,000 for $200k+ in new assets to BofA/Merrill. If you have a lot more than $200k, you can call them at 888-637-3343 for a custom offer.
  • Expires October 17, 2019. This is a special link that is more than the standard offer. The page says “This limited time offer is valid only for MoneyShow attendees.” but reports of enforcement vary. If they do enforce, you may have to provide proof of attendance to San Francisco Money Show or accept the standard bonus amount.
  • Up to 100 free trades per month with Bank of America Preferred Rewards program.
  • Valid for new IRA or retail brokerage accounts (CMA).
  • Make a qualifying net deposit of cash or securities within 45 days.
  • Maintain net deposit amount (less any market losses) for 180 days.

E-Trade

  • Link: Up to $2,500 bonus offer
  • $200 bonus for $25k, $300 for $100k, $600 for $250k, $1,200 for $500k, $2,500 for $1m+.
  • New non-retirement brokerage accounts only.
  • Open by 12/31/19, funded with new funds or securities within 60 days.
  • Maintain net deposit amount (less any market losses) for 6 months.

Ally Invest

  • Link: Up to $3,500 bonus offer
  • $50 bonus for $10k, $200 for $25k, $300 for $100k, $600 for $250k, $1,200 for $500k, $2,500 for $1m, $3,500 for $2m+.
  • New non-retirement brokerage accounts only. (You must not have closed an account within the last 90 days.)
  • Open by 12/31/19, funded with new funds or securities within 60 days.
  • Maintain net deposit amount (less any market losses) for 300 days past bonus deposit (~370 days after opening).

Fidelity

  • Fidelity used to offer a variety of transfer bonuses, but they didn’t do a good job of curbing abuse and some folks got multiple bonuses without actually bringing in new money. Right now, I can’t find any transfer bonus links. Instead, here are a few reasons why you might want to move your money to Fidelity anyway (you can try out the other brokers above and take their money for doing so first).
  • Fidelity does not sell equity order flow to market makers and high-frequency traders.
  • Fidelity offers a relatively competitive default cash sweep option. As of 10/10/19, the Vanguard Federal Money Market fund pays 1.90% SEC yield, the Fidelity Government Money Market fund pays 1.58% SEC yield, Schwab pays 0.12%, TD Ameritrade pays 0.01%, and E-Trade pays 0.01%.
  • Fidelity has a variety of in-house stock and bond mutual fund options, which trade with no transaction fee at Fidelity and now have no minimum purchase amounts.
  • In my experience, Fidelity has had the most knowledgable customer service reps.

Vanguard

  • Vanguard has never offered a transfer bonus, to my knowledge. Instead, here are a few reasons why you might want to move your money to Vanguard anyway (you can try out the other brokers above and take their money for doing so first).
  • Vanguard has the most competitive default cash sweep option. As of 10/10/19, the Vanguard Federal Money Market fund pays 1.90% SEC yield, the Fidelity Government Money Market fund pays 1.58% SEC yield, Schwab pays 0.12%, TD Ameritrade pays 0.01%, and E-Trade pays 0.01%. This may or may not matter to you, depending on your idle cash balances.
  • Vanguard does not offer free trades on all stocks, but they do offer free trades on 1,700+ ETFs from any provider. Vanguard is not really built for heavy traders of individual stocks.
  • Vanguard has a variety of in-house stock and bond mutual fund options, which trade with no transaction fee at Vanguard.

Transfer notes.

  • Many brokers will charge an “Outgoing ACAT fee” of $50 to $150 when you leave them. I recommend contacting your destination broker and asking them to reimburse you for this fee. If you qualify for one of these bonuses, your account is probably big enough for them to consider it. You may have to send them a statement showing the fee.
  • Before moving, I would download all your old statements and tax cost basis information to make sure it transfers over correctly.
  • An ACAT transfer can take a week or so to complete, so you won’t be able to make any sell transactions during that time.
  • Consider performing a “partial” ACAT transfer where you only move over specifically designated shares (ex. only all 455 shares of BRKB) if you wish to keep some of your original brokerage account open. I would still transfer over all shares of any specific ticker, so that the tax cost basis carries over neatly.
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Robinhood’s New Savings Account is FDIC-Insured! 2.05% APY

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Robinhood brokerage has finally re-launched the high-interest cash sweep option after their failed (and illegal?) 2018 mash-up of checking accounts and SIPC-insurance. Robinhood Cash Management is basically what many other places like Betterment Savings have implemented, a FDIC-insured sweep account backed by a mix of different partner banks. The interest rate is variable and currently 2.05% APY as of 10/8/19. This is a pretty competitive rate when compared to other cash alternatives. Debit card has no fees on the Allpoint ATM network. Unfortunately, as is usual with Robinhood, you’ll have to join a long waitlist first.

This was an important move for Robinhood, as many of the established giants have joined the free stock trades party – Schwab, TD Ameritrade, E-Trade, Interactive Brokers, Ally Invest. However, not all of them offer competitive rates on idle cash. Schwab is notably bad in this regard. However, Schwab does offer well-trained humans and instant customer service via phone call. Robinhood has a slick app and user interface, but they don’t readily offer a phone number. Instead, you must wait around for a reply on their online messaging service. If I put a huge chunk of my net worth in a broker, I want a phone number.

So basically, there are free trades, high interest on idle cash, and good customer service. Which are the most important to you?

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S&P 500 Return Breakdown: Earnings, Valuations, Dividends (2015-2019)

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The financial news industry loves to provide constant updates of the S&P 500 along with endless guesses as to why it blipped up or down. I like reading about finance and it still drives me crazy! It just makes people focus on the short-term and think of the stock market like a roulette wheel. If you step back and take a longer-term view, here is a basic model for explaining the total return of the stock market:

Total Stock Returns = Earnings Growth + P/E Valuation Changes + Dividends

Here’s a quick common sense explanation:

Earnings growth. If your earnings stay the same, then all other things equal, one would expect the value of your company to stay the same as well. If earnings go up, again all other things equal, your company should be worth more, right?

Price-to-earnings ratio shows how much people are willing to pay as a multiple of earnings. When people are optimistic, the P/E ratio is high. When people are pessimistic, the P/E ratio is low. However, the overall ratio has some natural resistance points. A P/E of 10 means a 10% earning yield (ex. $100 share price and $10 of earnings per share). A P/E of 25 means a 4% earnings yield (ex. $100 share price and $4 of earnings per share).

Dividends. Cash money! In the long run, dividends tend to grow roughly at the same rate as earnings.

The WSJ Daily Shot used Bloomberg data to break down the performance of the S&P 500 total return by these components:

You can see that the dividend contribution has been pretty consistent at about 2% a year. Earnings have been going up the last 5 years, which is good news. Finally, we see that the P/E ratio has been a big part of the swings back and worth.

In The Little Book of Common Sense Investing, Jack Bogle called the changes in P/E ratio the “speculative return”, as opposed to something based on fundamentals. He made the following prediction about the future 10-year average return that book (originally published March 2007).

This was not meant to be an exact prediction. The main point was a warning that the future long-term returns were going to be lower than the historical returns of the last 25 years due to a lower dividend yield and somewhat elevated valuations. The annual return of Vanguard Total US Stock Market ETF (VTI) from March 2007 to March 2017 turned out to be 5.7%. According to the most recent quote (10/4/19), the average annual returns over the last 18 years has been 7%, last 15 years has been 9%, and the last 10 years has been 13%.

Bottom line. It can be educational to see the stock market return broken down into its parts: earnings growth, valuation change, and dividends. Much of the roller coaster performance we see every year is just the P/E ratio swinging back and forth. If you take a step back, you might find it easier to ignore the short-term volatility and focus on the long-term drivers of returns.

My Money Blog has partnered with CardRatings for selected credit cards, and may receive a commission from card issuers. All opinions expressed are the author’s alone, and has not been provided nor approved by any of the companies mentioned. MyMoneyBlog.com is also a member of the Amazon Associate Program, and if you click through to Amazon and make a purchase, I may earn a small commission. Thank you for your support.

Best Interest Rates on Cash – October 2019

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Here’s my monthly roundup of the best interest rates on cash for October 2019, roughly sorted from shortest to longest maturities. Rates are lower across the board due to the recent Fed rate cut. I track these rates because I keep a full 12 months of expenses as a cash cushion and also invest in longer-term CDs (often at lesser-known credit unions) when they yield more than bonds. Check out my Ultimate Rate-Chaser Calculator to get an idea of how much extra interest you’d earn if you are moving money between accounts. Rates listed are available to everyone nationwide. Rates checked as of 10/2/19.

High-yield savings accounts
While the huge megabanks like to get away with 0.01% APY, it’s easy to open a new “piggy-back” savings account and simply move some funds over from your existing checking account. The interest rates on savings accounts can drop at any time, so I prioritize banks with a history of competitive rates. Some banks will bait you and then lower the rates in the hopes that you are too lazy to leave.

Short-term guaranteed rates (1 year and under)
A common question is what to do with a big pile of cash that you’re waiting to deploy shortly (just sold your house, just sold your business, legal settlement, inheritance). My usual advice is to keep things simple and take your time. If not a savings account, then put it in a flexible short-term CD under the FDIC limits until you have a plan.

  • No Penalty CDs offer a fixed interest rate that can never go down, but you can still take out your money (once) without any fees if you want to use it elsewhere. Marcus Bank has a 7-month No Penalty CD at 2.10% APY with a $500 minimum deposit. CIT Bank has a 11-month No Penalty CD at 2.05% APY with a $1,000 minimum deposit. You may wish to open multiple CDs in smaller increments for more flexibility.
  • Total Direct Bank has a 12-month CD at 2.50% APY ($25,000 minimum) with an early withdrawal penalty of 3 months of interest. Navy Federal Credit Union has a special 9-month CD at 2.25% APY ($1,000 minimum), but you must have a military affiliation to join (includes being a relative of a veteran). Customers Bank has 2.25% APY ($25,000 minimum) on their liquid Ascent Money Market with a rate guarantee until 6/30/2020 (almost 10 months from today).

Money market mutual funds + Ultra-short bond ETFs
If you like to keep cash in a brokerage account, beware that many brokers pay out very little interest on their default cash sweep funds (and keep the difference for themselves). The following money market and ultra-short bond funds are not FDIC-insured, but may be a good option if you have idle cash and cheap/free commissions.

  • Vanguard Prime Money Market Fund currently pays an 2.00% SEC yield. The default sweep option is the Vanguard Federal Money Market Fund, which has an SEC yield of 1.94%. You can manually move the money over to Prime if you meet the $3,000 minimum investment.
  • Vanguard Ultra-Short-Term Bond Fund currently pays 2.16% SEC yield ($3,000 min) and 2.26% SEC Yield ($50,000 min). The average duration is ~1 year, so there is more interest rate risk.
  • The PIMCO Enhanced Short Maturity Active Bond ETF (MINT) has a 2.32% SEC yield and the iShares Short Maturity Bond ETF (NEAR) has a 2.36% SEC yield while holding a portfolio of investment-grade bonds with an average duration of ~6 months.

Treasury Bills and Ultra-short Treasury ETFs
Another option is to buy individual Treasury bills which come in a variety of maturities from 4-weeks to 52-weeks. You can also invest in ETFs that hold a rotating basket of short-term Treasury Bills for you, while charging a small management fee for doing so. T-bill interest is exempt from state and local income taxes.

  • You can build your own T-Bill ladder at TreasuryDirect.gov or via a brokerage account with a bond desk like Vanguard and Fidelity. Here are the current Treasury Bill rates. As of 10/1/19, a 4-week T-Bill had the equivalent of 1.79% annualized interest and a 52-week T-Bill had the equivalent of 1.74% annualized interest (!).
  • The Goldman Sachs Access Treasury 0-1 Year ETF (GBIL) has a 1.99% SEC yield and the SPDR Bloomberg Barclays 1-3 Month T-Bill ETF (BIL) has a 1.85% SEC yield. GBIL appears to have a slightly longer average maturity than BIL.

US Savings Bonds
Series I Savings Bonds offer rates that are linked to inflation and backed by the US government. You must hold them for at least a year. There are annual purchase limits. If you redeem them within 5 years there is a penalty of the last 3 months of interest.

  • “I Bonds” bought between May 2019 and October 2019 will earn a 1.90% rate for the first six months. The rate of the subsequent 6-month period will be based on inflation again. More info here.
  • In mid-October 2019, the CPI will be announced and you will have a short period where you will have a very close estimate of the rate for the next 12 months. I will have another post up at that time.

Prepaid Cards with Attached Savings Accounts
A small subset of prepaid debit cards have an “attached” FDIC-insured savings account with exceptionally high interest rates. The negatives are that balances are capped, and there are many fees that you must be careful to avoid (lest they eat up your interest). Some folks don’t mind the extra work and attention required, while others do. There is a long list of previous offers that have already disappeared with little notice. I don’t personally recommend nor use any of these anymore.

  • The only notable card left in this category is Mango Money at 6% APY on up to $2,500, but there are many hoops to jump through. Requirements include $1,500+ in “signature” purchases and a minimum balance of $25.00 at the end of the month.

Rewards checking accounts
These unique checking accounts pay above-average interest rates, but with unique risks. You have to jump through certain hoops, and if you make a mistake you won’t earn any interest for that month. Some folks don’t mind the extra work and attention required, while others do. Rates can also drop to near-zero quickly, leaving a “bait-and-switch” feeling. I don’t use any of these anymore, but the Orion offer is worth consideration.

  • Orion FCU Premium Checking has 4.00% APY on balances up to $30,000 if you meet make $500+ in direct deposits and 8 debit card “signature” purchases each month. Consumers Credit Union Free Rewards Checking has up to 5.09% APY on balances up to $10,000 if you meet make $500+ in ACH deposits, 12 debit card “signature” purchases, and spend $1,000 on their credit card each month. Find a locally-restricted rewards checking account at DepositAccounts.
  • If you’re looking for a high-interest checking account without debit card transaction requirements then the rate won’t be as high, but take a look at MemoryBank at 1.15% APY.

Certificates of deposit (greater than 1 year)
CDs offer higher rates, but come with an early withdrawal penalty. By finding a bank CD with a reasonable early withdrawal penalty, you can enjoy higher rates but maintain access in a true emergency. Alternatively, consider building a CD ladder of different maturity lengths (ex. 1/2/3/4/5-years) such that you have access to part of the ladder each year, but your blended interest rate is higher than a savings account. When one CD matures, use that money to buy another 5-year CD to keep the ladder going. Some CDs also offer “add-ons” where you can deposit more funds if rates drop.

  • You could build a CD ladder at First National Bank of America at 2.70% APY for 5-year, 2.60% APY for 4-year, 2.55% APY for 3-year, 2.50% APY for 2-year, and 2.45% APY for 1-year.
  • 5-year CD rates have been dropping at many banks and credit unions, following the overall interest rate curve. A good rate is now about 3% APY, with Hiway Federal Credit Union offering 3.00% APY ($25,000 min) or 2.80% APY ($500 min) on a 5-year CD with an early withdrawal penalty of 12 months of interest. Anyone can join this credit union via partner organization Minnesota Recreation and Park Foundation ($10 fee).
  • Navy Federal Credit Union has a special 18-month cert at 2.60% APY ($1,000 minimum) and a 5-year cert at 3.00% APY, but you must have a military affiliation to join (includes being a relative of a veteran).
  • You can buy certificates of deposit via the bond desks of Vanguard and Fidelity. You may need an account to see the rates. These “brokered CDs” offer FDIC insurance and easy laddering, but they don’t come with predictable early withdrawal penalties. The rates are not competitive right now. Watch out for higher rates from callable CDs listed by Fidelity.

Longer-term Instruments
I’d use these with caution due to increased interest rate risk, but I still track them to see the rest of the current yield curve.

  • Willing to lock up your money for 10+ years? You can buy long-term certificates of deposit via the bond desks of Vanguard and Fidelity. These “brokered CDs” offer FDIC insurance, but they don’t come with predictable early withdrawal penalties. As of this writing, I am seeing no inventory on 7-year and 10-year CDs. Watch out for higher rates from callable CDs from Fidelity.
  • How about two decades? Series EE Savings Bonds are not indexed to inflation, but they have a unique guarantee that the value will double in value in 20 years, which equals a guaranteed return of 3.5% a year. However, if you don’t hold for that long, you’ll be stuck with the normal rate which is quite low (currently a sad 0.10% rate). I view this as a huge early withdrawal penalty. You could also view it as a hedge against prolonged deflation, but only if you can hold on for 20 years. As of 10/2/19, the 20-year Treasury Bond rate was 1.90%.

All rates were checked as of 10/2/19.

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Fidelity, Schwab, TD Ameritrade, E-Trade, and Interactive Brokers Now All With $0 Stock, ETF, and Options Trades

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Update: Fidelity, Schwab, TD Ameritrade, E-Trade, Interactive Brokers, Ally Invest all now offer free stock trades. The new differentiators are things like user interface, customer service, and interest on cash sweep accounts.

Original post:

Schwab just announced the elimination of online commissions for stocks, ETFs and options listed on U.S. or Canadian exchanges as of 10/7/19 (press release). TD Ameritrade responded later the same day by matching that pricing as of 10/3/19. This will affect retail customers and also the many folks who have their portfolio run by financial advisors that use Schwab and TD Ameritrade as custodians. This could also be hard news for the feisty little guys who went there first like Robinhood, Webull, and Firstrade.

Commissions have dropped gradually for a long time, but it was still bringing in hundreds of millions of dollars to these publicly-traded corporations. That said, commissions only made up about 4% of Schwab’s net revenue. TD Ameritrade’s move was more surprising since commissions make up about 16% of their net revenue (they historically have a bigger focus on heavy traders).

I would note that TD Ameritrade and Schwab will likely keep making millions of dollars by accepting payment for order flow. This fact was always brought up with the startups that offered free trades first, but I have yet to see any hard evidence that individual investors are significantly harmed by this practice. The payments work out to about 1/10th of a cent per share traded.

I would worry more about them making money off the interest on your cash sweep. Schwab’s FDIC-insured cash sweep pays a sad 0.12% APY on all balances under $1,000,000 as of 10/1/19. TD Ameritrade’s FDIC-insured cash sweep pays a sad 0.01% APY on all balances under $25,000 as of 10/1/19.

The bigger picture here is the move away from trading and towards portfolio management and financial advice. More and more individual investors are saving in their 401ks and IRAs and such towards a million-dollar portfolio instead of traditional pensions (that were also worth a million or more, you just didn’t notice because it gave you $3,000 a month forever instead). The result is a huge fight over the trillions of dollars up for grabs, and it looks like free trades and low-cost ETF portfolio management are becoming standard equipment.

If everyone joins them at zero, the focus will move from pricing to things like customer service, convenience/user experience, and the cost to “upgrade” to more advanced components of financial advice. I actually look forward to that service-oriented competition more than this pricing war (I don’t trade much anyway). Brokers might also start expanding into new areas to replace those old stock trade profits.

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Breaking Down the Components of Financial Advice

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Vanguard has been relatively quiet after an SEC filing revealed their plans for a new digital-only advisory service called Vanguard Digital Advisor Services (VDAS). They have yet to send out any press releases or direct announcement about their new service. However, Vanguard is definitely working hard in the background on their advisory practices.

Earlier this month, they released a whitepaper called Assessing the Value of Advice based on their Vanguard Personal Advisor Services, which includes human advisors. They introduced a framework for measuring value via three components: portfolio, financial, and emotional.

Vanguard also published this short article Behind our passion for advice: Better outcomes for everyone that shows they want to impact the advice industry in the same way they forever changed the mutual fund industry.

Now more than ever, we see investors’ long-term success tied not only to the funds they use but also to the advice they receive. For more than 40 years, we’ve been champions in the mutual fund industry for accessibility, affordability, and alignment with clients’ interests. This has enabled investors to keep more of what they earn and to more easily reach their financial goals. We aim to do the same for financial advice.

This chart explores what a digital-only financial advisor can provide as compared to a human advisor:

With technology as our tailwind, opportunities abound to improve the ease of use, quality, and affordability of advice. Activities that once required time and effort from investors can now be automated and simplified. Rebalancing a portfolio, executing a tax-efficient spending strategy, or determining an optimal cash position can be done using algorithms and artificial intelligence. Technology has automated the common portfolio management tasks (the blue and the orange in the chart below). These core advice building blocks are more accurately and easily implemented than ever before, and technology allows us to provide them for less than 20 basis points. Even the most experienced and disciplined investor can benefit from advisory services at that price.

It certainly sounds like a description of Vanguard Digital Advisor Services (VDAS). I also hope they will more clearly define the added benefits of their Personal Advisor Services.

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How To Lose Your Money Investing

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Sometimes the best solution to a problem comes by approaching it backwards. Charlie Munger often spoke about the principle of inversion. Instead of looking for things that you should do to achieve a goal, make a list of things you would do to make sure you never reach that goal. Then do whatever you can to avoid those things.

Safal Niveshak offers us this related graphic in his post 5 Ways to Destroy Your Wealth. I’m always a sucker for a clever Venn diagram…

Definitely a good list. However, I would say this graphic is more focused on “How To Destroy Wealth Investing“, as I can think of plenty of other ways to destroy wealth…

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Vanguard Digital Advisor Services (VDAS) Initial Review: 0.15% Fee Robo-Advisor

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The big news in financial advice world last week was that many details of Vanguard’s new portfolio management service were revealed when InvestmentNews reported this Vanguard SEC filing. Here are a few key differences between the new Vanguard Digital Advisor Services (VDAS) and their existing hybrid VPAS offering:

  • Vanguard Personal Advisor Services (VPAS) – Both human and online communications. $50,000 minimum. 0.30% annual advisory fee.
  • Vanguard Digital Advisor Services (VDAS). Online-only communication. $5,000 minimum for retail accounts ($5 minimum for 401k). 0.15% annual advisory fee.

The 0.15% fee would make it cheaper than the digital-only offerings of the first-mover robo-advisors Wealthfront and Betterment. After reading through the entire SEC filing brochure, I noted some important similarities and differences between their services and even Vanguard Target Retirement funds.

VDAS will conduct your trades for you across all your enrolled accounts. (Eligible account types include: individual, joint accounts with rights of survivorship, traditional IRA, Roth IRA, 401(k), and Roth 401(k) accounts authorized by plan sponsors). If you have a Vanguard-managed 401k, you could then move your taxable and IRA balances over to Vanguard and have them manage everything together. Betterment and Wealthfront have a relatively tiny footprint in the 401k space. I suppose you could also just buy the same Target Retirement fund across all your accounts.

VDAS takes advantage of tax-efficient asset location, prioritizing tax-inefficient assets into IRAs and 401k plans. Wealthfront and Betterment will also do tax-efficient asset location, but again they are unlikely to manage your 401k so you’ll still have to do some work yourself. With an all-in-one Target Retirement fund, it’s the same everywhere and you can’t separate the stocks from the bonds.

VDAS will provide online financial planning tools where you enter your personal details to create a personalized, goal-based financial plan. Wealthfront, Betterment, and every other robo-advisor will do the same thing (using their own algorithms of course). However, a Target Retirement fund won’t do that, for example telling you if you’re picking an inappropriate target fund based on your unique financial situation.

VDAS will build your portfolio using only these four Vanguard ETFs: Vanguard Total Stock Market ETF, Vanguard Total International Stock Market ETF, Vanguard Total Bond Market Index ETF, and Vanguard Total International Bond Index ETF. (401k accounts will be more flexible, working within the available investment options.) Retail accounts will not include recommendations to purchase individual securities or bonds, CDs, options, derivatives, annuities, third-party mutual funds, closed-end funds, unit investment trusts, partnerships, or other non-Vanguard securities. When cash is recommended as part of the strategic asset allocation target (usually only for those close or in retirement), the Vanguard Prime Money Market Fund will be used.

That makes the basic ingredients of a VDAS portfolio the same as a Vanguard Target Retirement 20XX fund. It’s even possible that the asset allocation will be identical. However, it’s important to note for expense reasons (see below) that VDAS holds the cheapest ETF versions while the Target fund holds the most expensive Investor Shares.

VDAS is only about 0.05% more expensive than the equivalent Vanguard Retirement Fund. That amounts to $5 a year on $10,000 invested, or $50 a year on $100,000 invested. Why? DAS uses Vanguard’s cheaper ETF versions which results in an all-in fee (advisory + underlying expense ratios) of 0.20%. The all-in fee for the Vanguard Target Retirement fund currently varies from 0.15% to 0.12% because it holds the more expense Investor Shares of mutual funds. Vanguard has noted elsewhere that mutual funds are more expensive to maintain on their side, and so they charge more.

VDAS and VPAS both perform portfolio rebalancing within 5% bands. According to a previous article, VPAS checks your portfolio quarterly and then rebalances if a 5% threshold band is exceeded. According to this brochure, VDAS also rebalances only when an asset class (stocks, bonds, or cash) is off the target asset allocation by more than 5%. However, VDAS will check daily instead of quarterly. This isn’t a big deal to me, but an interesting difference to note. Rebalancing will be done in a tax-sensitive manner.

The Vanguard Target Retirement funds handle the rebalancing internally, and every other robo-advisor will have a similar rebalancing feature. Automated rebalancing is an important and sometime under-appreciated benefit of a managed portfolio over a DIY portfolio. Us DIY folks all think we’ll rebalance the same way without emotion, but sometimes… in times of stress… we don’t.

VDAS will only buy Vanguard ETFs, which means they won’t be doing any ETF tax-loss harvesting with similar pair of ETFs. (The legality of that practice has yet to be tested in court if its use becomes widespread.)

VDAS will not buy fractional shares of ETFs. A minor note, but an increasing number of brokers offer fractional shares, like M1 Finance. This can be helpful if you invest in smaller amounts, for example via dollar-cost-averaging with each paycheck.

Fee comparisons. The VDAS 0.15% advisory fee is very competitive. It’s cheaper than the base offerings of Betterment and Wealthfront of 0.25%. Schwab’s Intelligent Portfolios says it is “free” but from a cash drag perspective the effective fee is an estimated 0.12% (others estimate 0.20%). Betterment and Wealthfront have the head start in terms of technology and a modern design interface, but can Vanguard close the gap?

I was a bit surprised at how little VDAS costs more than a Vanguard Target Retirement fund. I have been a fan of Vanguard Target Retirement funds because they are basically a robo-advisor rolled into a simple mutual fund. However, in my opinion they should be cheaper. Is it possible for Vanguard to make them any cheaper by using ETFs or Admiral Shares? Do they want to? It seems that the answer to at least one of those questions is no.

As DIY person, I would remind folks that you can always buy the “Big Four” ETFs yourself at any low-cost broker: Vanguard Total Stock Market ETF, Vanguard Total International Stock Market ETF, Vanguard Total Bond Market Index ETF, and Vanguard Total International Bond Index ETF. It’s really not that hard if you are so inclined. A new broker M1 Finance offers free commissions, free rebalancing, and fractional shares. Now you have the same portfolio at an all-in cost of 0.05%.

Bottom line. Vanguard Digital Advisor Services is definitely going to make a dent in the robo-advisor field. The competition is far from over.

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My Money Blog Portfolio Income and Withdrawal Rate – September 2019 (Q3)

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dividendmono225One of the biggest problems in retirement planning is making sure a pile of money lasts throughout your retirement. I have read hundreds of articles about this topic, and there is no single solution. My imperfect (!) solution is to first build a portfolio designed for total return using assets that have enough faith in to hold through an extended downturn. I do not look for the highest income – no specialized ETFs, no high-dividend-only stocks, no high-yield bonds.

Then, only after that do I check out how much it distributes in dividends and interest. Dividends are the portion of profits that businesses have decided they don’t need to reinvest into their business. The analogy I fall back on is owning a rental property. If you are reliably getting rent checks that increase with inflation, you can sit back calmly and ignore what the house might sell for on the open market.

I track the “TTM Yield” or “12-Month Yield” from Morningstar, which 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. I prefer this measure because it is based on historical distributions and not a forecast. Below is a very close approximation of my investment portfolio (2/3rd stocks and 1/3rd bonds).

Asset Class / Fund % of Portfolio Trailing 12-Month Yield (Taken 9/17/19) Yield Contribution
US Total Stock
Vanguard Total Stock Market Fund (VTI, VTSAX)
25% 1.85% 0.46%
US Small Value
Vanguard Small-Cap Value ETF (VBR)
5% 2.35% 0.12%
International Total Stock
Vanguard Total International Stock Market Fund (VXUS, VTIAX)
25% 3.05% 0.76%
Emerging Markets
Vanguard Emerging Markets ETF (VWO)
5% 2.71% 0.14%
US Real Estate
Vanguard REIT Index Fund (VNQ, VGSLX)
6% 3.29% 0.20%
Intermediate-Term High Quality Bonds
Vanguard Intermediate-Term Treasury ETF (VGIT)
17% 2.20% 0.37%
Inflation-Linked Treasury Bonds
Vanguard Short-Term Inflation-Protected Securities ETF (VTIP)
17% 2.12% 0.36%
Totals 100% 2.41%

 

Here is a chart showing how this 12-month trailing income rate has varied over the last five years.

One of the things I like about using this number is that when stock prices drop, this percentage metric usually goes up – which makes me feel better in a gloomy market. When stock prices go up, this percentage metric usually goes down, which keeps me from getting too euphoric. I see it as a very conservative, valuation-based withdrawal rate metric due to our very long retirement horizon of 40+ years.

In practical terms, I let all of my dividends and interest accumulate without automatic reinvestment. I treat this money as my “paycheck”. Then, as with my real paycheck, I can choose to either spend it or reinvest in more stocks and bonds. This number does not dictate how much we actually spend every year, but it gives me an idea of how comfortable I am with our withdrawal rate.

I am a proponent of aggressively saving, and then using the potential income that brings to improve your daily lifestyle. Instead of sitting on a beach, we used our nest egg to allow us to work less hours in a more flexible manner as parents of young children. Others may use it to start a new business, travel around the world, do charity or volunteer work, and so on. The income from our portfolio lets us “work less and live more” now as I now fear running out of time more than running out of money.

(If you’re still in the accumulation phase, you don’t really need to worry about this number. I believe a 3% withdrawal rate remains a reasonable target for something retiring young (before age 50) and a 4% withdrawal rate is a reasonable target for one retiring at a more traditional age (closer to 65). If you are young, instead focus on your earning potential via better career moves, investing in your skill set, and/or look for entrepreneurial opportunities where you own equity in a business.)

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