Search Results for: Buying Stocks

TIPS Inflation Bonds Performance: Breakeven vs. Actual Inflation Rates

Posted on March 16, 2021 // 3 Comments

I own inflation-linked bonds as part of my investment portfolio. Specifically, Treasury Inflation-Protected Securities (TIPS) make up about 1/3rd of the bond portion, or 10% of my total portfolio. I go into more detail in my post Reasons To Own TIPS, but essentially they pay interest based on a fixed real yield plus ongoing inflation. To simplify: if the real yield is 1% and inflation is 3%, they pay 4%.

Traditional “nominal” Treasury bonds simply pay a flat interest rate that doesn’t change with inflation (i.e. 3%). The difference between the TIPS real yield and the nominal Treasury yield is at any given time is what inflation would have to be for them to pay out the exact same total yield, called the “breakeven inflation rate”. If the real yield on TIPS is 1% while the nominal rate is 3% at the same moment, then the breakeven rate is 2%. You could call it a market-based prediction of future inflation.

It turns out that 10-year TIPS bonds that matured over the last several years mostly underpeformed regular nominal Treasuries, as the actual inflation turned out to be less than the breakeven inflation rate. David Enna of TIPS Watch created the interesting chart below comparing the final performance of TIPS vs. nominal Treasury bonds maturing over the last several years, where green means that TIPS “won” and red means TIPS “lost” in terms of total return. I removed some columns and highlighted the initial breakeven rate (the market-based guess) and the actual inflation rate.

Enna states:

Still, the market-determined inflation breakeven rate measures sentiment and should not be viewed as an accurate prediction. In fact, the market often does a lousy job of predicting future inflation. The fact is, over the last decade, investors have been betting on higher inflation than actually resulted, and that has led to TIPS (in general) under-performing nominal Treasuries of the same term.

I have read some articles suggesting that you could adjust your TIPS holdings based on the real yield, but perhaps another way is to adjust your holdings based on inflation breakeven rate instead. You can track the 5-year and 10-year breakeven inflation rates at FRED. As of this writing in March 2021, the breakeven inflation rate has been rising very quickly since dropping quickly in early 2020.

The last time that the breakeven inflation rate dropped so drastically was in 2009. As with stocks, it can pay off to buy when everyone else is afraid. I was lucky to buy a chunk of long-term TIPS in 2009, but I didn’t buy much in 2020 since the real yields were still quite low.

I hold Treasuries, TIPS, and FDIC/NCUA-insured CDs because I like my “safe” assets to be of the highest quality, with no worries about getting both my principal and interest. In addition, TIPS also serves as a hedge against higher-than-expected inflation. However, that also means I might suffer if there is lower-than-expected inflation. My “insurance” didn’t pay out over the last 10 years, but that’s okay. I’m also fine if my don’t make a claim on my auto insurance, homeowners insurance, (and definitely life insurance!).

p.s. If you want to buy TIPS, these days you should consider buying Series I Savings Bonds first these days (up to the purchase limits). Their 0% real yield is better than the negative real yields on nearly all TIPS right now.

Filed Under: Banking, Investing //

How Robinhood Really Makes Money, and Why It No Longer Matters

Posted on January 26, 2021 // 11 Comments

While it seems that Robinhood and Gamestop are officially the new gambling version of a multiplayer online video game (CNBC, BI, Bloomberg), this story reminded me of this past Matt Levine article which is my favorite detailed-yet-understandable explanation of how Robinhood makes money. There have been many similar attempts to explain their business model, but this felt the most balanced. Even the footnotes are educational.

For example, he explains how the biggest brokers like TD Ameritrade used to handle payment for order flow, which you could equate to a discount on the stock price (“price improvement”):

“We’ll buy stock for you, you’ll pay us $5 to do it, we’ll get a discount on the stock and we’ll pass on 80% of the discount to you.”

Compare this with how Robinhood chose to do handle payment for order flow:

“We’ll buy stock for you, you won’t pay us to do it, we’ll get a discount on the stock and we’ll pass on 20% of the discount to you.”

Robinhood also happens to get paid more for their order flow than other brokerage firms. I’ve also explored this question back in 2018: Does Robinhood Brokerage Make Money in Shady or Questionable Ways? My basic conclusions were that:

  • Robinhood would be breaking the law if they broke the SEC rule of National Best Bid and Offer (NBBO) that requires brokers provide the best available bid and ask prices when buying and selling securities for customers. They wouldn’t do that, would they?
  • The order flow from Robinhood is probably more valuable because it is from small, retail investors (“dumb money”).

Well, it turns out that:

If you don’t read Matt Levine’s entire explanation, here is the bottom line: Robinhood customers were essentially being charged an extra roughly 3 to 5 cents a share through poorer execution prices. If you only traded a few shares, then you still basically paid nothing. If you traded 100 shares, that might add up to $3 to $5 total. Roughly breakeven. If you traded 1,000 shares, that might add up to $30 to $50 total. For some people, Robinhood’s “free trades” were a better deal. For others, Robinhood’s “free trades” were a much worse deal.

Supposedly, Robinhood doesn’t do this anymore and satisfies NBBO again. But it still shows the general way in which Robinhood makes money today. High-frequency trading firms pay somewhat higher prices for the trading flows from Robinhood users, and Robinhood keeps as much of that money as possible while still barely satisfying NBBO. Perhaps a smaller number on the order of a half-penny a share. Other firms like Fidelity proudly boast of how they do better than NBBO (“price improvement” again), which is also a quiet dig at Robinhood.

[Fidelity’s] price improvement can save investors $18.53 on average for a 1,000-share equity order, compared to the industry average of $4.25.

All this no longer matters because Robinhood is no longer the sweet spot for newbie traders. People like to make fun of the Robinhood name because in a way they secretly stole from the “poor” average traders and sold their orders to the “rich”. However, they also forced everyone from Fidelity to Schwab to all offer commission-free trades. Robinhood did deliver something to us common folk!

The important difference is that firms like Fidelity and Schwab still have wealthy clients that demand phone numbers with helpful humans that answer after only a few rings. Meanwhile, Robinhood only provides an overwhelmed e-mail address than can take days or weeks to finally address your problems.

When Robinhood first came on the scene, they were the new sweet spot for cheap trades for small balances. However, now that free trades are everywhere, the sweet spot in my opinion has now shifted to something like a Fidelity or Schwab account. You get total commission costs either equal to or lower than Robinhood, plus better customer service from more knowledgable reps. If you still prefer a trendy new app over a stuffy old broker, check out my Big List of Free Stocks For New Commission-Free Brokerage Apps. Most of them have a phone number, and they’ll be less busy. (WeBull, M1 Finance, and Firstrade for sure have phone numbers.)

Filed Under: Deals & Offers, Investing //

What If You Invested $10,000 Every Year For the Last 10 Years? 2021 Edition

Posted on January 5, 2021 // 10 Comments

Instead of focusing only on what happened in 2020, how about stepping back and taking the longer view? How would a slow-and-steady investor have done over the last decade? Most successful savers invest money each year over a long period of time, these days often into a target-date fund (TDF). You may not find yourself buying Bugattis with Bitcoin, but we should not take for granted the ability for everyday folks to own a basket of successful businesses for tiny fees. Don’t pass up the opportunity right in front of you.

Target date funds. The Vanguard Target Retirement 2045 Fund is an all-in-one fund that is low-cost, highly diversified, and available both inside many employer retirement plans and to anyone that funds an IRA. During the early accumulation phase, this fund holds 90% stocks (both US and international) and 10% bonds (investment-grade domestic and international). It is a solid default choice in a world of mediocre, overpriced options. These “simple” funds have made substantial wealth for millions of investors.

The power of consistent, tax-advantaged investing. For the last decade, the maximum allowable annual contribution to a Traditional or Roth IRA has been roughly $5,000 per person. The maximum allowable annual contribution for a 401k, 403b, or TSP plan has been over $10,000 per person. If you have a household income of $67,000, then $10,000 is right at the 15% savings rate mark. Therefore, I’m going to use $10,000 as a benchmark amount. This round number also makes it easy to multiply the results as needed to match your own situation. Save $5,000 a year? Halve the result. Save $20,000 a year? Double the numbers, and so on.

The real-world payoff from a decade of saving $833 a month. What would have happened if you put $10,000 a year into the Vanguard Target Retirement 2045 Fund, every year, for the past 10 years? You’d have put in $100,000 over time, but in more manageable increments. With the interactive tools at Morningstar and a Google spreadsheet, we get this:

Investing $10,000 every year for the last decade would have resulted in a total balance of $184,000. That breaks down to $100k in contributions + $84k investment growth.

Extended edition: 15 years of real-world savings. What would have happened if you put $10,000 a year into the Vanguard Target Retirement 2045 Fund, every year, for the past 15 years instead? (Now $150,000 total.) Here are the extended return numbers:

Investing $10,000 every year for the last decade and a half would have resulted in a total balance of $324,000. That breaks down to $150k in contributions + $175k investment growth. Your gains are now officially more than what you initially invested.

Real-world path to becoming a 401(k) millionaire. Not theoretical numbers from a calculator! Are you a dual-income household that can put away more? If you were a couple that both maxed out their 401k and IRAs at roughly $20k each or $40k total per year for 10 years, you would have a total balance of over $735,000. You would be 3/4 of the way to millionaire status after a decade. That breaks down to $400k in contributions + $335k investment growth.

If you did this for the last 15 years, you would be a 401(k) millionaire household. If you started when you were 30 years old, your account statement would show a balance just shy of $1,300,000 by the age of 45. (This doesn’t include the 401k company match, which is how many people reach millionaire status even faster.)

Timing still matters, but not as much as you might think due to the dollar-cost averaging and longer time horizon. Yes, the last decade has been a great run for US stock markets. But Vanguard Target funds also own a lot of international stocks, which haven’t been nearly as hot and have maintained lower valuations. More importantly, you can’t control that part. You have much more control over how much you save. Here are my previous “saving for a decade” posts:

Work on improving your career skills (or start your own business), save a big chunk of your income, and then invest it in productive assets. Keep calm and repeat. The only “secret” here is consistency. We have maxed out both IRA and the 401k salary deferral limits nearly every year since 2004. No inheritances, no special access to a hedge fund, no stock-picking skill. You can build serious wealth with something as accessible and boring as the Vanguard Target Retirement fund.

Filed Under: Inspirational, Investing, Retirement //

Major Asset Class Returns, 2020 Year-End Review

Posted on January 3, 2021 // 3 Comments

yearendreview

In terms of your retirement accounts, 2020 was definitely a year where it helped to simply ignore the constant market news and hold onto the assets that you believe have long-term promise. It was also a good year to own the entire haystack. Here are the annual returns for select asset classes as benchmarked by ETFs per Morningstar after market close 12/31/20.

Commentary. This NYT article explains Why Markets Boomed in a Year of Human Misery. A big part of that is the huge amount of money the US government and Federal Reserve will be spending around a trillion dollars on unemployment insurance benefits, stimulus checks, and forgivable PPP loans. The Federal Reserve also kept it easy for corporations to borrow money with liquidity and near-zero interest rates, but whether this keeps working for every future crisis is a big question.

The second major lesson is that we are bad at forecasting, so why listen to forecasts again at the beginning of 2020? Returns for 2021 could very well be much worse than 2020, even as we are soon able to see our family and friends in person again. I plan to focus on preparation instead of forecasting in all part of my life. In terms of investing, how can I make my portfolio and future income more resilient?

Investing at all-time highs might seem like a bad idea, but it actually hasn’t been historically. All asset classes were up at the end of 2019 as well. What I wrote last year applies again this year:

I won’t lie – I am pleasantly surprised at my brokerage statement this year, but I’m also wary about future returns. What keeps me owning a big chunk of stocks is that I am confident that the hundreds of business that I own through these ETFs and mutual funds will collectively make a profit, reinvest some of it to keep growing, and distribute some of it to me in the form of cash dividends. I am also confident that my US government bonds, municipal bonds, and FDIC/NCUA-insured bank certificates will keep the panic if a market drop does come.

The Vanguard Target Retirement 2045 fund (roughly 90% diversified stocks and 10% bonds) was up 16.3% in 2020. The benchmark for our personal portfolio, a more conservative mix of 70% stocks/30% bonds as we are closer to retirement, was up 11.5% in 2020.

Bitcoin. I didn’t list BTC because I don’t see it as a major asset class. The total value of all BTC in the world is now $600 billion (even at the current price of $32,000). The total market cap of gold is about $10 trillion. I have no well-researched predictions of about the long-term prospects of BTC. I’d only go as far as saying there is a case for a lottery-ticket-style investment of BTC, but I’d avoid nearly all the other random cryptocurrencies. (As in, I’d rather own BTC than spend what the average American does on lottery tickets, which adds up to over $250/year for every adult!) The appeal of BTC is that there is a finite amount (especially after the recent halving), and all these additional coins go against that. I own about 0.25 BTC via the Voyager app from a couple years back ($25 referral bonus).

Filed Under: Investing //

Skin in the Game: How Much Do You Have To Lose? (Book Notes)

Posted on September 27, 2020 // Leave a Comment

The central idea behind the book Skin in the Game: Hidden Asymmetries in Daily Life by Nassim Nicholas Taleb is simple. Never trust anyone without skin in the game. In the real world, behavior changes for the better when you have to pay a price for your mistakes. This is a very handy heuristic to apply in everyday life and applies in many areas. A good example of why we shouldn’t allow people to not have skin in the game is Bob Rubin:

The Bob Rubin trade? Robert Rubin, a former Secretary of the United States Treasury, one of those who sign their names on the banknote you just used to pay for coffee, collected more than $120 million in compensation from Citibank in the decade preceding the banking crash of 2008. When the bank, literally insolvent, was rescued by the taxpayer, he didn’t write any check—he invoked uncertainty as an excuse. Heads he wins, tails he shouts “Black Swan.”

If someone is giving you financial advice, don’t worry about what s/he “thinks”, ask them what they actually hold in their own portfolio. Sure, what is optimal for them may be different than what it optimal for your own situation, but at least put it out there and let the consumer decide. Predictions are cheap without real risk of loss/pain.

In case you are giving economic views: Don’t tell me what you “think,” just tell me what’s in your portfolio.

How much you truly “believe” in something can be manifested only through what you are willing to risk for it.

Conflicts of interest can be good, if it means skin in the game. Taleb argues that while many people think it is better for CNBC “experts” and/or journalists to not own the stocks or companies they talk about, it’s actually better that they do.

There are two types of “talking one’s book.” One consists of buying a stock because you like it, then commenting on it (and disclosing such ownership)—the most reliable advocate for a product is its user. Another is buying a stock so you can advertise the qualities of the company, then selling it, benefiting from the trumpeting—this is called market manipulation, and it is certainly a conflict of interest.

We removed the skin in the game of journalists in order to prevent market manipulation, thinking that it would be a net gain to society. The arguments in this book are that the former (market manipulation) and conflicts of interest are more benign than impunity for bad advice. The main reason, we will see, is that in the absence of skin in the game, journalists will imitate, to be safe, the opinion of other journalists, thus creating monoculture and collective mirages.

In general, skin in the game comes with conflict of interest. What I hope this book will do is show that the former is more important than the latter. There is no problem if people have a conflict of interest if it is congruous with downside risk for themselves.

Bureaucracy too often means NO skin in the game. We allow people elected for only a few years be allowed to bind all of us into agreements that last for decades. We should also look more closely at the former “civil servants” that conveniently land high-paying jobs soon after their terms are over.

Bureaucracy is a construction by which a person is conveniently separated from the consequences of his or her actions.

More critically, people with good lawyers can game regulations (or, as we will see, make it known that they hire former regulators, and overpay for them, which signals a prospective bribe to those currently in office). And of course regulations, once in, stay in, and even when they are proven absurd, politicians are afraid of repealing them, under pressure from those benefiting from them. Given that regulations are additive, we soon end up tangled in complicated rules that choke enterprise. They also choke life.

Employees have skin in the game, but perhaps not in a good way.

A company man is someone who feels that he has something huge to lose if he doesn’t behave as a company man—that is, he has skin in the game.

What matters isn’t what a person has or doesn’t have; it is what he or she is afraid of losing. […] The more you have to lose, the more fragile you are.

It is no secret that large corporations prefer people with families; those with downside risk are easier to own, particularly when they are choking under a large mortgage.

People whose survival depends on qualitative “job assessments” by someone of higher rank in an organization cannot be trusted for critical decisions.

How can you achieve true freedom?

Financial independence is another way to solve ethical dilemmas, but such independence is hard to ascertain: many seemingly independent people aren’t particularly so. While, in Aristotle’s days, a person of independent means was free to follow his conscience, this is no longer as common in modern days.

Intellectual and ethical freedom requires the absence of the skin of others in one’s game, which is why the free are so rare. I cannot possibly imagine the activist Ralph Nader, when he was the target of large motor companies, raising a family with 2.2 kids and a dog.

I have held for most of my (sort of) academic career no more than a quarter position. A quarter is enough to have somewhere to go, particularly when it rains in New York, without being emotionally socialized and losing intellectual independence for fear of missing a party or having to eat alone. But one (now “resigned”) department head one day came to me and emitted the warning: “Just as, when a businessman and author you are judged by other businessmen and authors, here as an academic you are judged by other academics. Life is about peer assessment.”

You can define a free person precisely as someone whose fate is not centrally or directly dependent on peer assessment.

Embrace taking some risk (those that don’t endanger your survival). Starting a business is one way.

Yes, take risk, and if you get rich (which is optional), spend your money generously on others. We need people to take (bounded) risks. The entire idea is to move the descendants of Homo sapiens away from the macro, away from abstract universal aims, away from the kind of social engineering that brings tail risks to society.

Doing business will always help (because it brings about economic activity without large-scale risky changes in the economy); institutions (like the aid industry) may help, but they are equally likely to harm (I am being optimistic; I am certain that except for a few most do end up harming). Courage (risk taking) is the highest virtue. We need entrepreneurs.

By definition, what works cannot be irrational; about every single person I know who has chronically failed in business shares that mental block, the failure to realize that if something stupid works (and makes money), it cannot be stupid.

A final summarizing quote:

Recall that skin in the game means that you do not pay attention to what people say, only to what they do, and to how much of their necks they are putting on the line. Let survival work its wonders.

Filed Under: Behavioral Economics, Book Reviews, Entrepreneurial, Investing //

Stupidity, Humility, and Stock Picking

Posted on February 20, 2020 // 5 Comments

XCKD’s latest comic is about stock picking and the efficient market hypothesis:

The hidden hover text goes on – On the news a few days later: “Buzz is building around the so-called ‘camping Roomba’ after a big investment. Preorders have spiked, and…”

XKCD is finding humor in the idea that stupidity can be made profitable. But highly efficient markets really do take away the effects of stupidity, because the prices are already adjusted accordingly. You can’t be convinced to buy Apple at $500 a share when it’s trading at $320. On the other hand, if you find success in picking stocks, it’s really hard to separate luck and skill. Humility is in order.

I would also extend the idea of humility to also include skepticism. The promise of easy money solutions anywhere should always ring alarms. It really hurts to read about people being told that buying another new car is the solution to not being able to afford their current car. We have doctors convincing other doctors within Facebook groups to lose millions in a cryptocurrency hedge fund where instead of brokerage statements, they accepted phone screenshots.

Edges are rare. Why does your edge exist? What is your evidence that it exists? Why has nobody else thought of it? How much will it cost to make the bet? If it does exist today, how long will it last? Why is it durable?

In addition, remember the Kelly Criterion and adjust your bet size with the size/confidence level of your edge. Even if you knew with 100% certainty that a coin was biased 60% heads and 40% tails, you could still go bankrupt if you bet improperly! I make some “Fun Money” bets, but they are very small portion of my net worth.

What I like about my retirement portfolio is that I could not touch it for 50 or 100 years, and I wouldn’t worry too much. I can be a little stupid; I don’t need to watch it like a hawk or be a hedge fund genius. My bets are relatively humble.

Filed Under: Investing //

How Your Portfolio Accumulation and Withdrawal Years Are Different

Posted on January 21, 2020 // 15 Comments

The last 10 years of stock market returns have been pretty remarkable. If you invested $100,000 in the S&P 500 in the year 2000 and held it though the dot-com crash and financial crisis, you would be closing in on $300,000 today. However, if you retired in 2000 with a portfolio invested in the S&P 500 and used a 4% withdrawal rate (increasing each year by 3% for inflation), your nest egg would less than $50,000 and on a path to zero!

This stark difference between accumulation and withdrawal modes is illustrated by the chart above, taken from the Blackrock Blog post How to avoid “dollar cost ravaging” in retirement. “Dollar-cost ravaging” is also known as “sequence of return risk”, as explained in the this quote:

Investors have probably heard the term “dollar-cost-averaging,” where you make regularly timed investments to smooth out the risk of “buying high.” Retirees tend to do the opposite. Instead of putting money into their portfolio, they take it out with a regular cadence in the form of income. “Dollar-cost-ravaging” occurs when the market loses value while you’re taking withdrawals, especially in the early years of retirement. Because money is coming out rather than going in, it’s harder for the retiree to recover their losses when markets rebound. We even saw this during one of the most successful bull markets in our history over the past decade. The sequence of returns matters, and the biggest challenge is a bear market early in your retirement.

Unfortunately, there is no easy solution to this problem. This is what the article offers: “Striking the right balance to limit your losses in a declining market is just as important as capturing growth when the market is strong.” In other words, don’t hold too much in stocks, but also not too little. You can more easily weather a recession when you are still working and saving then when you are spending it down. I think more important advice is that you should be ready to withdraw less money out of your portfolio if the market tanks early on in your retirement withdrawal phase. Don’t follow a rigid withdrawal rule from some academic study into oblivion!

Filed Under: Investing, Retirement //

Jack Bogle on Mailbox Money

Posted on June 24, 2019 // 4 Comments

While poking around the Bogleheads investing forum, I came across a thread discussing a 2015 ETF.com interview with the late Jack Bogle that touches on the topic of mailbox money in retirement. First, a nice dose of Bogle common sense:

If anybody were to give you a blueprint, I would say put your hand over your wallet. There are no blueprints. There is common sense, and the obvious principle here is to be more conservative and more protective when you’re older than when you’re younger. When you’re young, you have a small amount of capital, you can take more risk, you’ve got years to recoup, and you don’t care about income. When you’re older you want to protect what you have; if you’re wrong, you don’t have a lot of time to recoup, and on balance you want more income.

Bogle on the idea of Social Security and stock dividends as mailbox money:

But you ought to think about all sources of your retirement income. Having said that, when you own an equity portfolio, don’t get into it for market reasons, get into it for income reasons. Oversimplifying, what you want to do when you retire is walk out to the mailbox on Social Security day and on dividend payment day for the funds—assuming they’re the same day—and make sure you have two envelopes out there. One is your fund dividend and the other is your Social Security check. The Social Security will keep up with inflation year after year, and dividends are likely to increase year after year. They have been going up. Every once in a while there is an interruption, such as the Great Depression of the early 1930s. And many bank stocks eliminated their dividends in 2008, so there was obviously a drop. But it has long since recovered, and then some.

Bet on the dividends, and not on the market price. You’ve got those two envelopes and that’s your retirement. If you have a pension plan (one that is not likely to go bankrupt—and a lot of them are likely to) that is a third envelope. You want to be concerned about whether you have enough income to pay utility bills, pay for your food, pay your rent or your mortgage, whatever it might be, every month. You want income to help you pay those bills. And in the retirement stage, that’s what investing should be about—regular checks from dividends and/or from Social Security and/or from a pension account.

The problem is that the yield on the Vanguard Total US Stock Market (VTSAX) or S&P 500 Index fund is only about 2%. That’s a lot less income than most people would like out of their portfolio. Here’s Bogle on a high-dividend stock strategy:

If you really need the dividend income, I see nothing wrong with overweighting high-dividend stocks, knowing you’re taking a small risk of falling significantly behind the total market. But you can own blue chip stocks, and you’re going to get a higher dividend, a situation I think would be attractive to an awful lot of investors. But once you depart from the market portfolio, you’re taking on extra risk. Any strategy may have done very well in the past, but in this business, the past is not prologue.

The draw here is that the low-cost Vanguard High Dividend Yield Index Fund (VHYAX) sends out bigger income “checks”, currently an SEC yield of 3.37% as of 5/31/19. However, roughly speaking, the dividend payout from high-dividend stocks is going to be more likely to drop with poor market conditions.

Alternative #1: Low-cost Value funds. While not from this interview, Bogle has said elsewhere that he thinks that Large-Cap Growth and Large-Cap Value stocks will have roughly the same average returns over the long run. The difference is that in Value you’ll get a slightly bigger share of returns in the form of dividends and a little less in share price appreciation. Growth is the opposite – less dividends and more price appreciation. Therefore, if you wanted to create a little more “mailbox money” than the S&P 500, you may consider buying the Vanguard Value Index Fund (VVIAX) or Vanguard Value ETF (VTV) with a current SEC yield of about 2.8%.

Alternative #2: Low-cost Dividend Appreciation fund. I can’t find any Bogle commentary on this strategy, but you could also buy into the Vanguard Dividend Appreciation ETF (VIG), which invests in companies with at least ten consecutive years of increasing dividends. This fund also has a ~2% yield similar to the S&P 500, but historically they offer a more stable and steadily growing income stream without sacrificing too much in total return.

In the end, treating your dividend checks as retirement income is not all that different than taking out about conservative 3% a year from your portfolio. If you really wanted to make your income checks equal 3%, you can do some tweaks like going with the Vanguard Value Index fund and the Vanguard Total Bond fund and get very close without “reaching for yield” with junk bonds or niche investments. My portfolio is different and yet the income still gets close to 3% when I track the dividends and interest every 3 months.

Bogle would also remind you to make sure you are investing in low-cost, passive funds so you aren’t giving away 1% off the top to a fund manager. If you have a DIY mindset, you also avoid paying a financial advisor taking out another 1%. Paying both of those and you’ll be missing 2/3rds of your potential mailbox money.

Filed Under: Investing, Retirement //

My Money Blog Portfolio Income and Withdrawal Rate – June 2019 (Q2)

Posted on June 13, 2019 // 3 Comments

dividendmono225One of the biggest problems in retirement planning is making sure a pile of money lasts through your retirement. I have read hundreds of articles about this topic, and still haven’t a perfect solution to this problem. Most recently, I looked into the idea of buying a ETF that tracks stocks with 10+ year histories of growing dividends.

The imperfect (!) solution I chose is to first build a portfolio designed for total return and enough downside protection such that I can hold through an extended downturn. As you will see below, the total income is a little under 3% of the portfolio annually. I could easily crank out a portfolio with a 4% income rate, or even 5% income. But you have to take some additional risks to get there.

Starting with a more traditional portfolio, only then do I try to only spend the dividends and interest. 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. With this method, I am more confident that the income cover our expenses for the rest of our lives.

I track the “TTM Yield” or “12 Mo. 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. (Index funds have low turnover and thus little in capital gains.) I like 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 6/13/19) Yield Contribution
US Total Stock
Vanguard Total Stock Market Fund (VTI, VTSAX)		 25% 1.99% 0.50%
US Small Value
Vanguard Small-Cap Value ETF (VBR) 		5% 2.20% 0.11%
International Total Stock
Vanguard Total International Stock Market Fund (VXUS, VTIAX) 		25% 3.00% 0.75%
Emerging Markets
Vanguard Emerging Markets ETF (VWO) 		5% 2.69% 0.13%
US Real Estate
Vanguard REIT Index Fund (VNQ, VGSLX) 		6% 3.96% 0.24%
Intermediate-Term High Quality Bonds
Vanguard Intermediate-Term Tax-Exempt Fund (VWIUX) 		17% 2.79% 0.47%
Inflation-Linked Treasury Bonds
Vanguard Inflation-Protected Securities Fund (VAIPX) 		17% 2.66% 0.45%
Totals 100% 2.65%

 

Over the last 12 months, my portfolio has distributed 2.65% of its current value as income. 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 happy. This also applies to the relative performance of US and International stocks. In this way, this serves as a rough form of a valuation-based dynamic withdrawal rate.

In practical terms, I let all of my dividends and interest accumulate without automatic reinvestment. I like to look at this money as my “paycheck” arriving on a regular basis. Then, as with my real paycheck, I can choose to either spend it or reinvest in more stocks and bonds. This gets me used the feeling of living off my portfolio and learning to ignore the price swings.

We are a real 40-year-old couple with three young kids, and this money has to last us a lifetime (without stomach ulcers). 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. We spend less than this amount now, but I like to plan for the worst while hoping for the best. For now, we are quite fortunate to be able to do work that is meaningful to us, in an amount where we still enjoy it and don’t feel burned out.

Life is not a Monte Carlo simulation, and you need a plan to ride out the rough times. Even if you run a bunch of numbers looking back to 1920 and it tells you some number is “safe”, that’s still trying to use 100 years of history to forecast 50 years into the future. Michael Pollan says that you can sum up his eating advice as “Eat food, not too much, mostly plants.” You can sum up my thoughts on portfolio income as “Spend mostly dividends and interest. Don’t eat too much principal.” At the same time, live your life. Enjoy your time with family and friends. You may be more likely to run out of time than run out of money.

In the end, I do think using a 3% withdrawal rate is 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’re still in the accumulation phase, you don’t really need a more accurate number than that. Focus on your earning potential via better career moves, investing in your skillset, and/or look for entrepreneurial opportunities where you own equity in a business.

Filed Under: Goals, Investing, Retirement //

Callan Periodic Table of Investment Returns 2019

Posted on May 13, 2019 // Leave a Comment

dilbert_divers

One of the harder things about investing is buying an investment that has been performing poorly. How many people are getting media attention for pushing the idea of diversification in international stocks right now? None. I mean, some folks are talking about it, but nobody is getting any media attention. It’s not “trending” because nobody’s interested. US stocks have been smoking European and Japanese stocks for a while.

Even if something is a good long-term investment, the short-term ride can be very bumpy. Callan Associates updates a “periodic table” annually with the relative performance of 8 major asset classes over the last 20 years. You can find the most recent one at their website Callan.com. The best performing asset class is listed at the top, and it sorts downward until you have the worst performing asset. Here is the most recent snapshot of 1999-2018:

The Callan Periodic Table of Investment Returns conveys the strong case for diversification across asset classes (stocks vs. bonds), investment styles (growth vs. value), capitalizations (large vs. small), and equity markets (U.S. vs. non-U.S.). The Table highlights the uncertainty inherent in all capital markets. Rankings change every year. Also noteworthy is the difference between absolute and relative performance, as returns for the top-performing asset class span a wide range over the past 20 years.

I find it easiest to focus on a specific Asset Class (Color) and then visually noting how its relative performance bounces around. In last year’s update, I noted that Emerging Markets (Orange) and MSCI World ex-US (Light Grey) had bounced back to the top. Of course, by the time 2018 ended, they were right back to the bottom again.

(Dilbert comic source)

Filed Under: Investing //

The Personal Finance Index Card: Book Version Differences

Posted on April 22, 2019 // 7 Comments

After rediscovering the young adult versions of fitting personal finance advice on an index card, I decided to go back and read the book The Index Card: Why Personal Finance Doesn’t Have to Be Complicated by Helaine Olen and Harold Pollack. (I was able to find it via library eBook.)

I noticed that the book version of the “index card” was slightly different. The original card had 9 items, but two of them were merged away into each other (401k/IRAs) and (Pay Attention to Fees/Buy Index Funds). I bolded the new additions below. (You can see all chapters on the Amazon page.)

  1. Strive to Save 10 to 20 Percent of Your Income
  2. Pay Your Credit Card Balance in Full Every Month
  3. Max Out Your 401(k) and Other Tax-Advantaged Savings Accounts
  4. Never Buy or Sell Individual Stocks
  5. Buy Inexpensive, Well-Diversified Indexed Mutual Funds and ETFs
  6. Make Your Financial Advisor Commit To a Fiduciary Standard
  7. Buy a Home When You Are Financially Ready
  8. Insurance – Make Sure You’re Protected
  9. Do What You Can To Support the Social Safety Net
  10. Remember The Index Card

Here again is the original:

Here are my notes on the newly-addressed topics of home-buying and insurance.

Home-buying. This will always be a hard topic because it mixes in emotion, personal history, peer pressure, and all that fuzzy stuff. If you want to own a home, you need to make sure the purchase won’t blow up your overall financial picture. Nothing really surprising, but still good advice.

  • Get your debt under control first.
  • Save up as close to a 20% down payment as you can.
  • Stick with a 15 or 30 year fixed-rate mortgage.
  • Prioritize what you really want and need in a home. Stay within your budget.
  • Location, location, location.

Insurance. There are low-probability events that can destroy decades of hard work, and that’s why humans invented insurance to spread the risk. Here are their cut-to-the-chase bullet points:

  • Emergency fund – Maintain one!
  • Life insurance – If you’re young(ish), just buy 30-year level term insurance.
  • Property insurance – Raise your deductible as high as you can handle.
  • Health insurance – Always sure you stay in-network.
  • Liability insurance – Coverage for at least twice your net worth.

I’m glad that this book still retained its “quick-and-dirty” nature. No single rule will cover every scenario, but it’s good to have a clear and concise collection of the big points along with just enough explanation that you understand the basic reasoning behind it.

Filed Under: Book Reviews, Budgeting, Credit Cards, Insurance, Investing, Real Estate, Retirement //

Bonds For The Long Run? Long-Term Bonds vs. Stock Returns (1823-2013)

Posted on November 14, 2018 // 4 Comments

When it comes to news, the headline “man bites dog” will get people’s attention, not “dog bites man”. Similarly, a new research paper that questions the idea of “Stocks for the Long Run” will create headlines like the WSJ article Sometimes, It’s Bonds For the Long Run (paywall?) by Jason Zweig.

Prof. McQuarrie has compiled a new database of US bond prices dating all the way back to 1823, including longer-term federal, municipal, and corporate bonds. During this early period, he found that bond returns were much closer to stock returns than from 1900 onward. The WSJ included this chart of rolling 30-year average returns:

Assuming the data is accurate, the returns between US stocks and US bonds from 1823-1900 do look very similar, even somewhat correlated. I don’t know what it was like in the 1800s to buy a share of a company vs. buying a debt instrument. I imagine the environment was very different and that very few average households participated.

However, I also noticed how the 30-year average returns for stocks rarely dipped much below 4% real return over the past 200 years. If you’re telling me to look back at history, that’s also a crazy finding in my opinion. In contrast, holding onto bonds that averaged a negative real return over 30 years? Yikes.

The WSJ article also points out that 30-year Treasury bonds outperformed stocks as recently as from 1981 to 2011. But then I looked up this chart of historical 30-year Treasury yields:

The 30-year Treasury had a yield of about 14% back in 1981. Check out this 1981 NY Times article 30-YEAR U.S. BONDS HIT 15%. The decades-long bull run for bonds fueled by continuously dropping rates doesn’t have much room to go lower. The 30-year Treasury today is 3.35%.

Now, look at the first chart again and notice where the bond returns were negative from 1950 to 1980. The 30-year Treasury didn’t exist in 1950, but the 10-year Treasury equivalent yield in 1950 was about 2%. In 1950, corporate bonds yielded about 3%. Sound familiar? That’s about the same rates as today, so it’s hard to get too excited about long-term bond returns at this point.

It’s an interesting paper to read, but I don’t see anything that would change my portfolio outlook overall. I hold 2/3rd stocks and 1/3rd bonds, which is probably a lot more bonds than is usually recommended for someone my age, but I am also much closer to living off of my portfolio than most people my age. Bonds and cash are important components and everyone should probably own some. Still, if you made me pick, I’d bet on “Stocks for the Long Run”.

Filed Under: Investing //
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