Financial Planning Advice From Allan Roth’s 40 Years of Experience

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Allan Roth is one of the financial planners whose independent opinions I have come to respect, and he shares seven takeaways from 40 years of financial planning. Financial Planning is an industry trade magazine targeted at (obviously) professional financial planners, but many of the articles are quite useful for DIY investors as well.

Read the article first, but here are my personal interpretations of his lessons (not his words):

  • A solid income and frugality both matter, but either one is not enough. He’s advised a high-income doctor with a net worth smaller than an emergency fund, and a 10X millionaire who is still afraid to spend their money. Both needed help.
  • Many people overestimate their ability to handle real-world risk. He has seen firsthand how clients answer the theoretical, as compared to how they later react during a real-world market crisis. Same idea as how paper trading is not real trading.
  • Indexing and low fees = higher returns. Some things take time to work out, especially when billions are spent on marketing against it.
  • You can’t predict the future. Other people can’t predict the future. Market cap indexing means that you will own the winners, many of which will be companies that don’t even exist today. Own bonds for safety, and accept whatever yield there is. You can’t predict rates either. The problem is that someone will always get it right any given time, and they’ll be loud about it.
  • The CFP designation doesn’t mean much (good or bad). CFP wants to be the gold standard for a professional financial planners, but they don’t do enough to put the clients first. It just means they have a minimum level of education, 2 years of industry experience, and chose to pay the annual dues that year. You could be a great planner without being a CFP, or a bad planner with multiple complaints and still be a CFP.
  • Financial planners provide the greatest value in: “real planning, improving tax-efficiency, behavioral coaching, and insurance analysis.” That means this stuff is harder and often benefits from an outside perspective. Note that this list excludes stock-picking and market-timing.
My Money Blog has partnered with CardRatings and Credit-Land 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.

Emergency Funds Are The First Building Block For Retirement

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The Blackrock article Emergency Savings = Better Retirement? comes from Blackrock’s department that helps companies manage their retirement plans. They propose the idea of creating a separate “sidecar savings account” in order to prevent early withdrawals via 401k loans (and often defaults):

A “sidecar savings” account may help build short-term stability, giving participants the confidence to commit to long-term retirement goals. […] Plan sponsors could help participants meet short-term financial needs by taking steps to help reduce [401k loan] defaults.

In other words, they want to give employees an emergency fund! Not exactly a new idea, but it supports the idea that the highest priority should be a short-term emergency fund, even if the real goal is higher retirement savings balances.

At the recent BlackRock Retirement Summit, Rachel Schneider of the Aspen Institute Financial Security Program explained that if participants have confidence about near-term stability through access to emergency cash, it may improve long-term behavior. “If they have more security today,” she said, “It should translate into more long-term savings.”

Build up your financial fortress in stages:

  • Looking past the next payday. Going from paycheck-to-paycheck to having $1,500 in the bank lets many things become minor speed-bumps instead of derailing your life. Do whatever you can to create this fund. For example, I’d even deliver Uber Eats/Doordash/Instacart in my open hours.
  • Looking past your current job. Going from having a minimal emergency fund to ~$10,000 gives you the ability to take career risks and thus the opportunity to turbo-boost your income. You might deliver on Uber Eats to build up this fund, but Uber Eats won’t take to you financial freedom. You need to build up valuable skills and/or business equity.
  • Reaching the point of inevitable financial freedom. Finally, going from $10,000 to $100,000 is amazing because that’s when you realize that reaching financial independence is a matter of WHEN, not IF. It’s a sign that you’ve put in the dirty work and developed the habits and structure required. The only remaining component is time, so now you can make some more minor adjustments to make that time more enjoyable. Similar job with more flexible hours? Less hours? Less politics? Better boss? “The first $100,000 is a b****.”

I prefer the comfort of cash in the bank, but you just need something that you know will float you in the short-term, be it cash or a stock portfolio or whatever else you’re willing to sell. I’ve heard various things like “I can just use my credit cards” or “I can just take a home-equity loan”. Unfortunately, 2020 has shown us that long-term unemployment and long-term depressed wages can happen out of nowhere. Taking on debt when you don’t even have enough income to make the payments can quickly spiral out of control.

My Money Blog has partnered with CardRatings and Credit-Land 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.

My Money Blog Portfolio Income Update – November 2020

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While my investment portfolio is designed for total return, I also track the income produced. Stock dividends are the portion of profits that businesses have decided they don’t need to reinvest into their business. The dividends may suffer some short-term drops, but over the long run they have grown faster than inflation. Interest from bonds and bank deposits are steadier, but these days it’s a struggle to simply keep up with inflation.

I track the “TTM” or “12-Month Yield” from Morningstar, which is the sum of the trailing 12 months of 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 close approximation of my portfolio (2/3rd stocks and 1/3rd bonds).

Asset Class / Fund % of Portfolio Trailing 12-Month Yield (Taken 12/24/19) Yield Contribution
US Total Stock
Vanguard Total Stock Market Fund (VTI, VTSAX)
25% 1.72% 0.43%
US Small Value
Vanguard Small-Cap Value ETF (VBR)
5% 2.22% 0.11%
International Total Stock
Vanguard Total International Stock Market Fund (VXUS, VTIAX)
25% 2.60% 0.65%
Emerging Markets
Vanguard Emerging Markets ETF (VWO)
5% 2.76% 0.14%
US Real Estate
Vanguard REIT Index Fund (VNQ, VGSLX)
6% 3.86% 0.23%
Intermediate-Term High Quality Bonds
Vanguard Intermediate-Term Treasury ETF (VGIT)
17% 1.72% 0.29%
Inflation-Linked Treasury Bonds
Vanguard Short-Term Inflation-Protected Securities ETF (VTIP)
17% 1.25% 0.21%
Totals 100% 2.06%

 

Trailing 12-month yield history. Here is a chart showing how this 12-month trailing income rate has varied since I started tracking it in 2014.

Reality check. 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 bear market. When stock prices go up, this percentage metric usually goes down, which keeps me from getting too euphoric during a bull market. I see it as a conservative, valuation-based indicator of how much I can withdraw perpetually, due to our very long retirement horizon of 40+ years. During 2020, the lower income rate suggests that while the value of my portfolio is up, the future returns also look lower due to high valuations and low interest rates.

Despite reading countless articles debating this topic, I still feel a 3% withdrawal rate remains a reasonable target for planning purposes if you want to retire young (before age 50) and a 4% withdrawal rate is a reasonable target if retiring at a more traditional age (closer to 65). If you are not close to retirement, your time is better spent focusing on earning potential via better career moves, investing in your skillset, and/or looking for entrepreneurial opportunities where you own equity in a business.

For the past few years, our portfolio has distributed about 2% to 2.5% in the form of dividends and interest. If we were to stop working, we would then take out another 0.5% to 1% by selling a few shares and then we’d have our 3%. Right now, we are both still generating some employment income (though significantly less in 2020) and withdraw less than this income number, so we don’t have to sell anything.

Practical and personal implications. I let all of our dividends and interest accumulate without automatic reinvestment. I treat this money as our “paycheck”. Then, as with a real paycheck, we can choose to either spend it or reinvest in more stocks and bonds.

Instead of trying to purely live off the income, we use it to enable us to have more flexible working hours as parents of three young kids. On a good day, we look forward to a day of work with adults (who can wipe their own butts) and then we look forward to the next day of spending all day with the kids (who can experience pure joy and wonder). If we’re being honest, I don’t think either of us truly wants to be a full-time stay-at-home parent while the other works for money full-time. Nor do we want to be the full-time worker while the other stays at home. There would likely be resentment issues both ways.

But the portfolio income is what makes it all possible. We are very thankful for this financial flexibility, which has been both a result of conscious preparation over 15+ years and good fortune. Others may use their portfolio income to pursue their passions, start a new business, travel around the world, sit on a beach, do charity or volunteer work, and so on. I may not be “retired”, but I am still glad we seriously pursued financial freedom before having kids.

My Money Blog has partnered with CardRatings and Credit-Land 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.

MMB Portfolio Asset Allocation Update, November 2020

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I support the idea of skin in the game, and I wish more “experts” would simply share what they actually own. Here’s my current portfolio update as of November 2020, including all of our 401k/403b/IRAs, taxable brokerage accounts, and savings bonds but excluding our house, cash reserves, and a few side investments. I use these updates to help determine where to invest new cash to rebalance back towards our target asset allocation.

Actual Asset Allocation and Holdings

I use both Personal Capital and a custom Google Spreadsheet to track my investment holdings. The Personal Capital financial tracking app (free, my review) automatically logs into my different accounts, adds up my various balances, tracks my performance, and calculates my overall asset allocation. I still use my manual Google Spreadsheet (free, instructions) because it helps me calculate how much I need in each asset class to rebalance back towards my target asset allocation.

Here are my YTD performance and current asset allocation visually, per the “Allocation” and “Holdings” tabs of my Personal Capital account, respectively:

Stock Holdings
Vanguard Total Stock Market (VTI, VTSAX)
Vanguard Total International Stock Market (VXUS, VTIAX)
Vanguard Small Value (VBR)
Vanguard Emerging Markets (VWO)
Vanguard REIT Index (VNQ, VGSLX)

Bond Holdings
Vanguard Limited-Term Tax-Exempt (VMLTX, VMLUX)
Vanguard Intermediate-Term Tax-Exempt (VWITX, VWIUX)
Vanguard Intermediate-Term Treasury (VFITX, VFIUX)
Vanguard Inflation-Protected Securities (VIPSX, VAIPX)
Fidelity Inflation-Protected Bond Index (FIPDX)
iShares Barclays TIPS Bond (TIP)
Individual TIPS securities
U.S. Savings Bonds (Series I)

Target Asset Allocation. I do not spend a lot of time backtesting various model portfolios, as I don’t think picking through the details of the recent past will necessarily create superior future returns. I mainly make sure that I own 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 make a small bet that US Small Value and Emerging Markets will have higher future long-term returns (along with some higher volatility) than the more large and broad indexes, although I could be wrong.

While you could argue for various other asset classes, I believe that it is important to imagine an asset class doing poorly for a long time, with bad news constantly surrounding it, and only hold the ones where you still think you can maintain faith through those fearful times. I simply don’t have strong faith in the long-term results of commodities, gold, or bitcoin.

Instead of staying with my fixed 50/50 target, I am explicitly letting my US/international ratio float with the total world market cap breakdown. I think it’s okay to have a slight home bias (owning more US stocks than the overall world market cap), but I want to avoid having an international bias. I just want to maintain the balance of the total world market cap, which has become roughly 60% US and 40% international. This also means less need for rebalancing.

Stocks Breakdown

  • 46% US Total Market
  • 7% US Small-Cap Value
  • 30% International Total Market
  • 7% Emerging Markets
  • 10% US Real Estate (REIT)

Bonds Breakdown

  • 33% US Treasury Bonds, intermediate (or FDIC-insured CDs)
  • 33% High-Quality Municipal Bonds (taxable)
  • 33% US Treasury Inflation-Protected Bonds (tax-deferred)

I have settled into a long-term target ratio of 67% stocks and 33% bonds (2:1 ratio) within our investment strategy of buy, hold, and occasionally rebalance. I will use the dividends and interest to rebalance whenever possible in order to avoid taxable gains. I plan to only manually rebalance past that if the stock/bond ratio is still off by more than 5% (i.e. less than 62% stocks, greater than 72% stocks). With a self-managed, simple portfolio of low-cost funds, we minimize management fees, commissions, and taxes.

Holdings commentary. 2020 has been… well… you know. Many times I just have to keep reminding myself that I cannot predict the future, even there appears to be impending doom around the corner. There is no possible way I will know how the stock market will react in a week, a month, or a year. Some businesses will fail and new businesses will start. I just have to trust in capitalism, human ingenuity, human resilience, and our system of laws to allow capital to flow where it can work best over time.

When my equities had dropped significantly and my unrealized gains were low, I thought about moving towards simplicity and selling my positions in the US Small Value (VBR) and Emerging Markets (VWO) classes. However, I realized I actually liked having some extra moving pieces that didn’t move in concert with my relatively large VTI and VXUS positions. I did sell some tax lots of Wisdomtree ETF positions and swapped over to the closest Vanguard ETF equivalents.

I was not disappointed in my decision to hold only the highest-quality bonds and cash equivalents. US Treasuries, TIPS, investment-grade municipal bond funds, FDIC or NCUA-insured certificates of deposit, US savings bonds.

Performance numbers. According to Personal Capital, my portfolio went up about 3% so far in 2020, although the ride has not been nearly as boring as that sounds! I see that during the same period the S&P 500 has gone up +7%, Foreign Developed stocks down -3%, and the US Aggregate bond index was up about +6.6%. These numbers could change quite a bit in a week, so it’s not very useful information.

An alternative benchmark for my portfolio is 50% Vanguard LifeStrategy Growth Fund and 50% Vanguard LifeStrategy Moderate Growth Fund – one is 60/40 and the other is 80/20 so it also works out to 70% stocks and 30% bonds. That benchmark would have a total return of +3.8% for 2020 YTD as of 11/3/2020.

The goal of this portfolio is to create sustainable income that keeps up with inflation to cover our household expenses. I’ll share about more about the income aspect in a separate post.

My Money Blog has partnered with CardRatings and Credit-Land 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.

MYGAs: Fixed Annuities with Higher, Guaranteed Rates Like CDs

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I’ve been seeing a lot of articles about alternatives to traditional bonds and their ultra-low interest rates. The 5-year US Treasury rate is closer to zero than even 1%, an all-time low even considering the past decade (source):

Warnings about the dangers of chasing yield are for good reason. We need to be very skeptical. In a relatively quiet corner of the annuity world, you can get a “guaranteed” rate of 3% and above. This chart from Blueprint Income (via indexfundfan) shows the gap between the top 5-year MYGA rate and a 5-year Treasury, with a rate difference of 3.20% as of September 2020. The gap is slightly smaller as of this writing in late October 2020.

This is a huge gap if the level of safety is comparable. But is it? I actually bought a $10,000 MYGA contract back in 2015 as an educational investment, but never really wrote about it because it is relatively complex and I wasn’t sure it was worth the additional effort when the interest rate gap was much smaller. But given the growing gap, I think a DIY investor should consider at least learn about it as a potential part of their toolkit in 2020.

What are MYGAs? A “MYGA” is a form of fixed deferred annuity that offers a multi-year rate guarantee. For example, they may promise an annual interest rate of 3% for 5 years. This is similar to the rate guarantee from a bank certificate of deposit. However, there are several important differences between a MYGA and an FDIC-insured bank CD.

Annuities are bad though, right? Not all annuities are the same. I like the slogan of Stan “the Annuity Man” Haithcock: “Will do. Not Might do.” In others words, look for concrete promises with no wiggle room, not a “theoretical illustration based on historical returns”. A deferred annuity should state a fixed interest rate (ex. 3% for 5 years). A single-premium immediate annuity should promise you a fixed monthly income for the rest of your life (ex. $1,233 per month). Hard numbers, not a confusing formula based on the stock market (always quietly stripped of dividends).

Annuities also have a bad reputation because many have high commissions to encourage their sale. Often, the worse the annuity, the higher their commissions. However, MYGAs have relatively low commissions, often between 1% and 2.5% upfront (one-time) for the most competitively priced ones. On the flip side, many financial advisors won’t recommend an annuity because they don’t get paid an “assets under management” fee on them (which might be 1% every year, forever!).

Early withdrawal penalties. However, all annuities do have some complications to understand. Once you buy an annuity, you must keep it in an annuity and not withdraw until age 59.5, otherwise you will be subject to a 10% penalty on top of the taxes owed. It is a long-term commitment of funds, similar to an IRA contribution. However, after a 5-year MYGA contract expires, you can simply roll it over into another 5-year MYGA with the same or different provider. This is what I plan to do until I am past age 59.5. If you buy an MYGA with after-tax money, your interest gets to compound tax-deferred until you make a withdrawal. This can be helpful if you have already maxed out your IRA and 401k limits. (You could also convert to a single-premium immediate annuity with a guaranteed income stream.) Upon withdrawal, you will owe income tax on the gains (not principal).

Additional liquidity concerns. An early withdrawal before the end of your fixed term also will be subject to another large penalty, including a market-value adjustment and surrender charges. Some MYGA contracts allow small withdrawals, like 5% or 10% of the purchase amount per year. In general, this is not a good place for “emergency funds”.

“Guarantee”. This word is used frequently with insurance and annuity products. “Guaranteed income.” This only means it is “guaranteed” subject the claims-paying ability of the issuing insurance company. What happens if the insurance company can’t pay? This falls back onto the coverage limits of your state’s Life & Health Guaranty Association. From NOLHGA.com:

State guaranty associations provide coverage (up to the limits spelled out by state law) for resident policyholders of insurers licensed to do business in their state. NOLHGA assists its member associations in quickly and cost-effectively providing coverage to policyholders in the event of a multi-state life or health insurer insolvency.

When an insurer licensed in multiple states is declared insolvent, NOLHGA, on behalf of affected member state guaranty associations, assembles a task force of guaranty association officials. This task force analyzes the company’s commitments to policyholders; ensures that covered claims are paid; and, where appropriate, arranges for covered policies to be transferred to a healthy insurer.

The task force may also support the efforts of the receiver to dispose of the company’s assets in a way that maximizes their value. When there is a shortfall of estate assets needed to pay the claims of covered policyholders, guaranty associations assess the licensed insurers in their states a proportional share of the funds needed.

While the coverage limits vary from state to state, virtually all states offer at least $250,000 in coverage for the present value of an annuity contract. (Connecticut, New York, and Washington offer $500,000 in coverage. In California, the limit is only 80% not to exceed $250,000.) Look up your specific state’s limits here and here. Here is a reference chart (click to enlarge, source):

Unfortunately, this is not the same as being backed by the federal government, as with FDIC-insurance. It’s not even a state government backing, as only the member insurance companies have agreed to cover each other in cases of insolvency up to the policy limits. The guaranty system has not resulted in a loss to consumers within the limits since their inception in the 1980s, meaning it worked through the 2000 and 2008 market crashes. In order to be a licensed member of that association, you need to maintain a certain level of financial stability and under regular audits. Each individual insurer also rated by various agencies like AM Best, Moody’s, or Standard & Poors. In the end, there remains a possibility that an extremely large event could happen that would result in the inability of the stronger companies to help all the weaker ones. I recommend reading this paper about how the state guaranty system works in a failure.

It’s hard to put a number on the possibility of a partial loss even with this state guaranty system, but I’d definitely rather be covered with it than without. In this older 2013 post, I wrote about MYGAs and how to structure your accounts to stay within your state’s specific coverage limits.

Higher-rated insurers typically pay lower interest rates, and lower-rated insurers typically pay higher interest rates. There are different strategies on how to navigate this system. One is to decide on the lowest safety rating that you will accept, and then find the highest interest rate available with that minimum rating. Another is to simply trust in the state guaranty system and treat all the insurers as equal as long as you remain below the state-specific coverage limits. In that case, you simply buy the highest interest rate available from a licensed insurer.

If you are trying to understand what the ratings mean, first refer to the AM Best Ratings Guide [PDF], which states that “A Best’s Financial Strength Rating (FSR) is an opinion of an insurer’s ability to meet its obligations to policyholders.” followed by:

  • A++, A+. Assigned to insurance companies that have, in our opinion, a superior ability to meet their ongoing insurance obligations.
  • A, A-. Assigned to insurance companies that have, in our opinion, an excellent ability to meet their ongoing insurance obligations.
  • B++, B+. Assigned to insurance companies that have, in our opinion, a good ability to meet their ongoing insurance obligations.

I don’t know about you, but I would rate that as “Super Vague++”. Marginally more helpful is the fact that in the past, AM Best categorized the following as “Secure” : A++, A+ A, A- B++, B+. Anything below that fell to “Vulnerable”.

Here is another chart from AM Best that lists cumulative impairments over different time periods (via the Bogleheads forum):

It is important to note that an impairment does not necessarily mean that the insurer could not pay out the interest. It simply means that some sort of negative action was taken by a state regulatory agency. The insurer may be put under “administrative supervision” and may later exit while never missing any payments. Or, the insurer may be taken into conservatorship and the assets sold/transferred to a solvent insurer, again never missing any payments.

Again, I would spread out my MYGA contracts across multiple insurers and make sure the final size is well below your state’s contractual limits. For example, if the limit is $100k you put exactly $100k in a single contract at 3% interest for 5 years, at the end you’ll have over $115,000 and thus have $15k of your funds exposed.

Where do I buy a MYGA? I am not a insurance professional and I’ve probably missed some details. But I also get no commission if you buy one of these things. As a consumer, you should know the MYGA commission is baked inside and the upfront price is the same no matter who you buy it from. Back when I bought my MYGA in 2015, I did my own research and chose to buy from “Stan the Annuity Man”. You can find the MYGA section of his site here with rates for your specific state. I had a positive experience and would recommend him, especially if you prefer to have a reliable person-to-person relationship with good communication. I am not affiliated with Stan, other than being a satisfied customer. In 2020, there are more “fintech” options including the Blueprint Income marketplace. Both of those websites are have an educational section with more information about MYGAs in general.

At the end of your MYGA contract, you will have short (30-day?) window where you can make a 1035 transfer to another annuity provider (or renew with the same provider at prevailing rate). I was given plenty of heads up by The Annuity Man team. Again, the price should be same no matter where you buy it, so I would pick the place you think you’ll get better customer service. It might even be a local broker.

Bottom line. This is a brief introduction to a unique annuity product called the MYGA (multi-year guaranteed annuity) that offers a fixed, tax-deferred yield that may be significantly higher than that of other investment-grade bonds like US Treasuries. There are many important factors to understand, including insurer stability ratings, state guaranty limits, liquidity rules, and surrender charges. I’ve probably overlooked something as well. MYGAs are best if you are a motivated DIY investor looking for higher-yielding fixed-income investments and have maxed out your other tax-deferred options like IRAs and 401(k) plans.

My Money Blog has partnered with CardRatings and Credit-Land 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.

What Really Matters In Your Personal Finances

My Money Blog has partnered with CardRatings and Credit-Land for selected credit cards and may receive a commission. All opinions expressed are the author’s alone, and has not been provided nor approved by any of the companies mentioned.

The best sentence about personal finance that I’ve read this week is from Beware of Financial Alchemy by Adam Collins of Movement Capital.

There are only a few things you can control that have a big impact on your finances:

If you’re young, how much you save
If you’re retired, how much you spend
How you behave when markets panic
Your allocation between stocks and bonds
How much you pay in fees

Everything else is a rounding error. The issue is we tend to focus on the rounding errors.

That’s exactly right. I write a lot about rounding errors because otherwise I’d just be saying the above sentence over and over again. Writing about personal finance often boils down to a game where you have to talk about the same 5-10 topics but manage to put a different spin on them so it feels fresh.

However, I try to focus on rounding errors that have a very high probability of helping you out without harming you. A little higher yield on an FDIC-insured bank account. A little more cash back on your existing credit card purchases. A little higher net return through lower cost index funds and no-commission-fee brokerage firms (or those that pay you to move over some assets). Piling on a few more data points on market drops to keep you in the long-term mindset. But don’t get scammed by someone promising what is simply too good to be true:

The truth about investing in 2020 is there isn’t an easy fix for high stock valuations and low bond yields. No strategy can magically transform today’s low return opportunity set into a high return future. So what can you do? Focus on what you can control and don’t get tempted by someone promising they can turn lead into gold.

My Money Blog has partnered with CardRatings and Credit-Land 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.

Savings I Bonds November 2020 Interest Rate: 1.68% Inflation Rate, 0% Fixed

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Update November 2020. The fixed rate will be 0% for I bonds issued from November 1, 2020 through April 30th, 2021. The variable inflation-indexed rate for this 6-month period will be 1.68% (as was predicted). If you buy a new bond in between November 2020 and April 2021, you’ll get 1.68% for the first 6 months. Don’t forget that the purchase limits are based on calendar year, if you wish to max out for 2020. See you again in mid-April for the next early prediction for May 2021.

Original post:

sb_posterSavings I Bonds are a unique, low-risk investment backed by the US Treasury that pay out a variable interest rate linked to inflation. With a holding period from 12 months to 30 years, 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 2020 savings bond rates a couple of weeks before the official announcement on the 1st. This also allows the opportunity to know exactly what a October 2020 savings bond purchase will yield over the next 12 months, instead of just 6 months. You can then compare this against a November 2020 purchase.

New inflation rate prediction. March 2020 CPI-U was 258.115. September 2020 CPI-U was 260.280, for a semi-annual increase of 0.84%. Using the official formula, the variable component of interest rate for the next 6 month cycle will be 1.68%. 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 simple “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 2020. If you buy before the end of October, the fixed rate portion of I-Bonds will be 0%. You will be guaranteed a total interest rate of 0.00 + 1.06 = 1.06% for the next 6 months. For the 6 months after that, the total rate will be 0.00 + 1.68 = 1.68%.

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, 2020 and sell on October 1, 2021, you’ll earn a ~1.04% annualized return for an 11-month holding period, for which the interest is also exempt from state income taxes. If you theoretically buy on October 31st, 2020 and sell on February 1, 2022, you’ll earn a ~1.10% annualized return for an 15-month holding period. Comparing with the best interest rates as of October 2020, you can see that this is slightly higher than a current top savings account rate or 12-month CD.

Buying in November 2020. If you buy in November 2020, you will get 1.68% 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 been consistently negative! My confident guess is that it will be zero (0%). 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 (total bond rate has a minimum floor of 0%).

Buy now or wait? The fixed rate is most likely going to be zero for October and November purchases, and so I would personally wait until November and get the 1.68% inflation and unknown inflation rate after that, betting that it will be higher than 1.06%. Either way, it seems worthwhile to use up the purchase limit for 2020 as the rates will at least be slightly higher than other cash equivalents.

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 I 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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Three Pillars of Self-Determination: Autonomy, Competence, and Community

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After reading the book Sapiens about how the history of our species affects our everyday experience, I found the related book Tribe: On Homecoming and Belonging by Sebastian Junger. Again, our genetic material hasn’t had enough time to change much from a human living 10,000 years ago, when all humans roamed together in nomadic bands of around 30-50 people. Humans today still retain a strong instinct to belong to such small, social groups that work together toward a common purpose – “tribes.”

What happens we can’t live in tribes anymore? Why does living in our modern, affluent society actually lead to higher rates of depression and suicide?

First agriculture, and then industry, changed two fundamental things about the human experience. The accumulation of personal property allowed people to make more and more individualistic choices about their lives, and those choices unavoidably diminished group efforts toward a common good. And as society modernized, people found themselves able to live independently from any communal group. A person living in a modern city or a suburb can, for the first time in history, go through an entire day—or an entire life—mostly encountering complete strangers. They can be surrounded by others and yet feel deeply, dangerously alone.

In contrast, when a large-scale catastrophe occurs, rates of depression and suicide actually drop for a while, perhaps because we again feel united and connected with others.

[Researcher Fritz] was unable to find a single instance where communities that had been hit by catastrophic events lapsed into sustained panic, much less anything approaching anarchy. If anything, he found that social bonds were reinforced during disasters, and that people overwhelmingly devoted their energies toward the good of the community rather than just themselves.

The book includes many examples of how this need for true community is behind many societal problems. This also fits in with self-determination theory:

The findings are in keeping with something called self-determination theory, which holds that human beings need three basic things in order to be content: they need to feel competent at what they do; they need to feel authentic in their lives; and they need to feel connected to others. These values are considered “intrinsic” to human happiness and far outweigh “extrinsic” values such as beauty, money, and status.

Here how Wikipedia describes these three pillars:

  • Autonomy – Desire to be causal agents of one’s own life and act in harmony with one’s integrated self. (This does not mean you want to be alone.)
  • Competence – Seek to control the outcome and experience mastery.
  • Relatedness (Community) – Will to interact with, be connected to, and experience caring for others.

We want to help others. We are perfectly willing to sacrifice to do so. But we also want to be in a trusted group that would also risk themselves to help us. These smaller groups that extend past your nuclear family are a common element of Blue Zones.

What would you risk dying for—and for whom—is perhaps the most profound question a person can ask themselves.

A lighter version might be, how many people do you know that would be willing to commit real, significant sacrifice to help each other?

In the big picture, our country is struggling because we don’t feel united as one team. In the small picture, this is a critical part of “retirement planning”. Many people derive both competence and community from their work, and you will have to replace that to create a happy post-work life. (Similarly, if you hate your work, you probably don’t find community and competence there.)

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Schwab Plan Review: Free DIY Financial Planning Software

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Schwab has rolled out a new digital financial planning tool called Schwab Plan. They claim it to be a simplified version of the same financial planning software used by many human financial advisors. From their press release:

Schwab Plan is a digital self-guided financial plan available through Schwab.com that helps investors build a personalized plan that includes a range of factors such as desired retirement age, retirement goals, social security expectations, portfolio risk profile and asset allocation, and various income sources.

[…] they are able to generate a retirement plan that shows retirement goals and probability of funding those goals, a comparison of an individual’s current asset allocation to a recommended allocation based on plan inputs, and suggested next steps to get and stay on track.

Access to this tool is free to anyone with any type of Schwab account. (Eventually, this should include TD Ameritrade clients as well.) There is no minimum asset requirement and you don’t need to sign up for a new service. For example, I was able to access it with only a Schwab PCRA brokerage window account. Here are a few initial impressions and screenshots after testing it out.

First, you enter some basic personal information like current age, gender, retirement age, and life expectancy:

Next, you estimate your income needs in retirement. They offer additional assistance in estimated your health insurance costs in retirement. You then enter your assets and income sources. Your Schwab accounts are automatically imported, and you can manually add the raw balances of additional external accounts (no account aggregation). They use your information to estimate your Social Security income, and also ask about stock options and restricted stock units.

(They don’t ask about children, college savings, term life insurance, disability insurance, or any of those smaller details that a full-service advisor would ask about. There is also very little customization available in terms of recognizing your external asset allocations.)

Once everything is entered, they run a Monte Carlo simulation to estimate your probability of success.

You can then adjust the variables, such your retirement age and future spending, in order to see how it affects your success rate. I found the analysis to be reasonably consistent with my other research, and I liked that the results changed significantly for an early retirement (45 year period) as opposed to a traditional retirement (30 year period). They use a “confidence zone” system:

(The Monte Carlo simulations above does not equate to an 86% confidence level. This was after making some tweaks to improve the results.)

Bottom line. Schwab has added a free financial planning tool for all of their customers (no minimum asset requirement). After testing it out, it is not quite “professional-grade”, but I did find it to be slightly more advanced than most other free options. I would recommend trying it out if you have any type of Schwab account. Of course, it also provides a pathway to upgrade to their other portfolio management services, and I still have concerns about their Intelligent Portfolios product.

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Fidelity Spire Saving App, Fidelity Go Roboadvisor Pricing Changes

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Fidelity is gradually moving into the areas previously catered to by startups like Betterment and Wealthfront. Younger customers, more mobile features, lower fees, etc. It was only a matter of time, but now we will have to see which big brokerage firm can pull it off the best. Schwab? Fidelity? Vanguard?

Fidelity Spire is their new mobile app, which doesn’t require any Fidelity account at all (but of course will work with them and/or be a perfect place to open a new account). As with many other apps, you can link your external accounts, track balances, and set financial goals. Fidelity acquired fintech startup eMoney in 2015, and is using that technology for account aggregation. Spire is not the same as the official Fidelity app, and you can’t made trades yet. After downloading and poking around a bit, it feels a like many other goal calculators within fintech apps like Stash and Acorns.

They are offering a rather dinky little $5 if you download the app, sign-in, set up a goal, and link it to a Fidelity Cash Management Account (FCMA). You can open the FCMA in the app, and it has no minimums and no account fees (and horrible 0.01% APY interest). This may be some low-hanging fruit for existing Fidelity customers, but not really much of an enticement otherwise. You can refer your friends for $5 each for up to another $25 (up to 5 friends).

Fidelity Go, their robo-advisor service, is also changing their fee structure. There is still no minimum to open an account (they’ll start buying stuff with $10) and here are the new advisory fees:

  • $10,000 or less: No advisory fee
  • $10,000 to $49,999: Flat $3 a month
  • $50,000 or more: 0.35% annually

At $10,000 in assets, $36 dollars a year = 0.36% annually. At $49,999 in assets, $36 dollars a year = 0.07% annually. Basically, everything under $50,000 in assets is now cheaper than before (and simply priced so you can think of it as even cheaper than Netflix.)

In addition, they also state that there are “no commissions, trading fees, or underlying fund fees that you pay.” Fidelity actually created a new line of mutual funds especially for their fee-based portfolios. They are called Fidelity Flex Funds and are similar to their other passive and actively-managed mutual funds but with zero expense ratios. For example, there is a Fidelity Flex 500 Fund and a Fidelity Flex International Index fund. I take this to mean that your entire portfolio will now be created using this proprietary line-up of funds. Previously, I remember seeing iShares ETFs and such.

As with other roboadvisors, the portfolio they choose will be based on you filling out a relatively short online questionnaire. If you aren’t sure about the resulting asset allocation, I recommend going back and change your answers to see the effects. With Fidelity Go, you do not gain access to financial advice from a human advisor. However, you will still gain access to their phone/live chat customer service, which has traditionally been rated highly.

One factor that I think is often overlooked in these “starter” services – What happens if/when you want to move your money elsewhere? Will they force you to sell all your proprietary Flex funds? If so, that could be a huge tax hit on a taxable account and a form of “lock-in”. This question doesn’t just apply to Fidelity, but all robo-advisors.

This is why I prefer to DIY and construct a portfolio using “high-quality interchangeable parts” that I can keep forever, like the Vanguard Total US Market ETF (VTI). Fidelity itself promotes the iShares Core Total US Market ETF (ITOT). You could do this using any broker, or you can use something like M1 Finance if you wanted more automation while maintaining the ability to port out your investments at any time.

My Money Blog has partnered with CardRatings and Credit-Land 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.

Rational Expectations: Advanced, Specific, Practical Portfolio Advice

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The fourth and final book in the “Investing for Adults” series by William Bernstein is Rational Expectations: Asset Allocation for Investing Adults. In Book 1: The Ages of the Investor, I learned to take advantage of a lucky streak in stocks and stop when I’ve won the game. In Book 2: Skating Where the Puck Was, I learned why it’s so hard to find any “new and improved” asset classes. In Book 3: Deep Risk, I learned about the scenarios that have led to permanent capital loss.

This final book includes the most specific advice about constructing your retirement portfolio. The entire series is great (and honestly not very long even read back-to-back), but this final book is especially dense with additional practical ideas for those that are already comfortable with investing basics. This isn’t at all scientific, but upon counting my Kindle highlights, Book 4 had 75 highlighted passages vs. 33, 25, and 36 respectively for Books 1-3. I’m only going to touch on the few that directly impacted my own portfolio construction.

Stocks. Here is an excerpt regarding how much of your portfolio should be allocated to international stocks.

Deployment among stock asset classes is relatively easier. The obvious place to start is with the total world stock market, as mirrored reasonably well by the FTSE Global All Cap Index, which in early 2014 was split 48/52 between U.S. and foreign equities. From there, we make three adjustments to the foreign allocation, two down and one up. First, the downs: if you’re like most people, your retirement liabilities will be in dollars, so a 52% foreign allocation is inappropriately high. Second, foreign stocks not only are slightly more difficult and expensive to trade but also are subject to foreign tax withholding. This presents no problem in taxable accounts, since those taxes will offset your liability to the IRS, but you lose that deduction if you hold foreign stocks in a sheltered account.

The up adjustment is a temporary one, since foreign stocks, as was discussed in chapter 1, currently have higher expected returns. So at the time of this writing, a foreign stock allocation somewhere in the 30% to 45% region seems reasonable.

Simplifying all that, as of early 2014, the middle recommendation would be roughly 60/40 US/international while the world market cap weighting was roughly 50/50. A little home bias is recommended for US investors.

As of mid-2020, the world market cap weighting is 57% US and 43% International (source), which you might round to 60/40. The adjustments are mostly the same, except that foreign stocks probably have even slightly higher future expected returns as the US stocks keep climbing. If you want to maintain a slight home bias, I would speculate this might change the recommended range closer to 65/35 or 70/30?

Bonds. The recommended list includes short-term US Treasuries/TIPS, bank CDs, and investment-grade municipal bonds. Bernstein is not a fan of corporate bonds.

Sooner or later, we’re going to have an inflationary crisis, and in such an environment, long duration will be a killer. Stick to short Treasuries, CDs, and munis.

Own municipal bonds via a low-cost Vanguard open-ended mutual fund for the diversification. Own Treasury bonds and TIPS directly, as there is no need for mutual funds or ETFs since they all have the same level of risk. Own bank CDs and credit union certificates under the FDIC and NCUA insurance deposit limits.

Asset location. I found this advice about spreading your holdings across Traditional IRAs, Roth IRAs, and taxable accounts to be very useful and practical. Importantly, this may be somewhat different that what you have read elsewhere. I don’t want to summarize incorrectly, so I will just use the excerpts:

To the extent that you wish to rebalance the asset classes in your portfolio, all sales should be done within a sheltered account. If possible, you should house enough of each stock asset class in a sheltered account so that sales may be accomplished free from capital gains taxes. Next, all of the REIT allocation certainly belongs in the sheltered portfolio, since the lion’s share of their long-term returns come from nonqualified dividends.

The real difference made by location occurs at the level of overall account returns. In terms of tax liability, Traditional IRA/Defined Contribution > Taxable > Roth IRA. This means that, optimally, you’d like to arrange the expected returns of each account accordingly, with the highest returns (i.e., highest equity allocation) optimally occurring in the Roth, and the lowest returns (i.e., lowest stock allocation) in your Traditional IRA/Defined Contribution pool. To the extent that this is true, it conforms with the stocks-in-the-taxable-side argument. That said, for optimal tax-free rebalancing, unless your Roth IRA is much bigger than your traditional IRA, you’re still going to want some stock assets in the latter.

It is definitely nice to be able to rebalance and not have to worry about picking stock lots, making sure you have the right cost basis at tax time, and paying capital gains taxes.

My Money Blog has partnered with CardRatings and Credit-Land 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.

Protecting Your Portfolio From Hyperinflation, Deflation, Confiscation, and Devastation

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The third book in the “Investing for Adults” series by William Bernstein is Deep Risk: How History Informs Portfolio Design. As before, I’m just trying to pull out a few practical takeaways rather than summarize the entire book. In Book 1: The Ages of the Investor, I learned to take advantage of a lucky streak in stocks and stop when I’ve won the game. In Book 2: Skating Where the Puck Was, I learned why it’s so hard to find any “new and improved” asset classes.

The main problem addressed in this book is “deep risk”, the permanent loss of real (inflation-adjusted) capital. This contrasts with “shallow risk”, in which the value of something usually rebounds within 5-7 years or less.

Here are some deep risks that you can offset by purchasing insurance (and be happy if you never have to use it!).

  • Death of income earner.
  • Long-term health disability.
  • Legal risk – lawsuit with large judgment.
  • Select types of asset loss (i.e. theft, building fire).

Unfortunately, there are other deep risks against which you can’t buy insurance.

  • Hyperinflation, prolonged and severe.
  • Deflation, prolonged and severe.
  • Confiscation by government.
  • Devastation (war).

Over an extended period of time, history has shown us that “safe” bonds are often more sensitive to deep risk than stocks. Many countries saw 100% losses for their bondholders, while partial ownership in a business survived wars and regime changes. An example given was in Germany after World War II. Bonds are also at risk for inflation, while a 30-year fixed-rate mortgage (a negative bond) can be a great inflation hedge.

A portfolio of internationally-diversified stocks is the most practical way to protect yourself from both inflation and deflation. Historically, inflation is much more likely than deflation. You might have an event in one country, but it would be very rare to have a large majority of nations experience severe inflation and low stock returns all at the same time. In such a case you’d be looking at global devastation.

As for local confiscation and local devastation, you would be looking at foreign-held assets, foreign property, perhaps the right passports, and a plan to escape in a timely manner. This sounds like something that a billionaire might pay someone else to set up, but not so sure how practical it would be for most people.

Bernstein offers his own summary:

This booklet’s primary advice regarding risky assets is loud and clear: your best long-term defense against deep risk is a globally value-tilted diversified equity portfolio, perhaps spiced up with a small amount of precious metals equity and natural resource producers, TIPS, and, if to your taste, bullion and foreign real estate.

I admit that I am somewhat fascinated by worst-case scenarios, and I recommend reading the entire book for the full discussion. But in the end, my primary takeaway is that if you have a globally-diversified stock portfolio, you’ve done most of what you can in terms of deep risk. The rest is the same advice as before: consider TIPS if you have enough money, maximize Social Security, and keep some nice safe bonds and bank CDs for short-term needs (shallow risk).

My Money Blog has partnered with CardRatings and Credit-Land 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.