It is very tempting to invest in an actively-managed mutual fund that has above-average returns. Why would you invest in the ones with below-average returns? However, there’s something behind the whole “past performance does not guarantee future results” fine print. While there will always be funds that outperform, it is exceedingly difficult to pick them out in advance.
[Read more…]
I’ve decided to invest $10,000 in Prosper and Lending Club to compare their performance as an investment. Putting $5,000 in each will allow me to invest in 200 loans at $25 a piece, so that each loan will only be 0.5% of each respective portfolio. The money has already been deposited:
Prosper Screenshot:
Lending Club Screenshot:
Prosper advertises returns of seasoned returns of 10.08%. Lending Club advertises rates of 5.81% to 9.43% depending on credit grade, but always with prime borrowers. I want to compare both absolute performance and the investing experience (ease of use, customer service, liquidity, etc.). However, I’m not sure exactly how I should run the experiment…
Background
[Read more…]
New 401(k) plan fee disclosure requirements from the US Department of Labor are coming soon. This includes defined benefit, 401(k), 403(b), profit sharing, and other retirement plans. I was getting confused myself, so I wanted to summarize some of the basic deadlines. First, there are three main parties involved:
First, there is a new requirement for fee disclosure by service providers to the fiduciaries (i.e. from Fidelity to the employer). These regulations become effective on July 1, 2012. The idea is to get fiduciaries to understand the services received from providers and to determine the reasonableness of the costs incurred. You’d think that your employer would already demand to know what they’ve been paying for all these years. Why don’t they? All too often, you, the employee are the one paying for it out of your investment balances and earnings!
Which brings up the next stage, the fee disclosure requirement from plan fiduciaries to participants (i.e. from employer to employee), which becomes effective August 30, 2012. Now, your employer is legally required to tell you what fees you’re paying, including both investment management fees and administrative fees for things like record keeping, accounting, and legal services. However, this is likely be wrapped up into just an overall percentage for each investment option, or worded as dollars charged per $1,000 invested.
The basic problem remains. Employers choose 401k plans with high fees often because they it doesn’t affect their bottom line – most are smaller companies with plans that shift the cost burden onto the employees. However, by simply shining a brighter light on these fees and allowing easy comparison between employer plans, it lets employees have more information to affect change. Indeed, it appears this forced transparency is working already, as the WSJ reports:
Employers “have been polishing up their plans in anticipation of fee disclosure, making sure the fees are appropriate,” says David Wray, president of the Plan Sponsor Council of America. He says nearly two-thirds of 401(k) plans changed their investment lineup last year, and 57% did so the year before, compared with a “normal number” of about 10%.
More reading: Department of Labor, NY Times, Employee Benefits Law Report
I’ve had an account with Scottrade for several years now, and here is an updated, in-depth review for 2012 (last one I did was in 2006!). I will focus on all the little things that make brokers different from each other, from completing your taxes to buying a stock on a moment’s notice. This review will be from the point of view of a casual private investor who does not trade daily but does mostly buy-and-hold ETF investing and also trades some individual stocks with a small portion of his portfolio (less than 5% of overall portfolio).
Unique Characteristics
Commissions and Fees
I was offered a review copy of a book called Gems from Warren Buffett which is basically selected snippets from Warren Buffett’s Letter to Shareholders of Berkshire Hathaway. I read it and it was entertaining, but there was no real original material other than the contribution of organizing the quoted portions into themes like “Managing With Style” or “Market Forces”. It was also short; the book was small with large print and still only ran a little more than 100 pages.
I suppose if the author was another notable investor the curation might be useful, but that wasn’t the case. I’m actually a little surprised that even Buffett granted permission for this book to be published, although he did stipulate a condition that 20% of print and eBook sales (not just profits!) will be donated to a charity that he supports (Glide.org).
In any case, I can’t say that I recommend buying the book. Instead, if you’re really serious about learning insights into Warren Buffett’s way of investing and business management, do what other serious investors do and read the full, unabridged letters. Buffett is known for spending a good deal of time carefully writing the letters to be both informative and understandable.
Updated. Shareholder letters from 1977 to 2014 are available free to all on the Berkshire Hathaway website. You can also now purchase all of the Shareholder letters from 1965 to 2013 for only $2.99 in Amazon Kindle format (~$22 paperback). That is a very reasonable price to have them all stored in electronic format; you used to be able to find them floating around on document sharing sites, but it looks like they have reclaimed copyright protection on them.
A helpful reader sent me a WSJ article with the provocative theme that all this investment advice about asset allocation doesn’t matter for most people. Why?
For the vast majority of savers, improved investment returns won’t materially extend how long retirement money lasts. That’s, in large part, because few investors have enough money in their retirement account to tilt the balance.
Far more important, says the paper from the Center for Retirement Research at Boston College, are three variables that don’t require a brokerage account: how long you work, controlling spending and tapping the value of your home.
Briefly, the study found that 47% of households would fall short of their income needs in retirement at age 67, when Social Security kicks in for those born after 1960. However, even if investors were able to theoretically earn a guaranteed 6.5% above inflation annually in a riskless investment, 44% would still be short.
How little are people saving? The WSJ article notes that having $500,000 in financial assets by retirement age would put in you in the top 10% of savers. The CRR working paper itself mentions that “the typical 401(k)/IRA balance of households approaching retirement is less than $100,000” but I didn’t see a source.
The Employee Benefit Research Institute (EBRI) found that in 2010 the average IRA individual balance (all accounts from the same person combined) was $91,864, while the median balance was $25,296. EBRI also found that at year-end 2010, the average 401(k) account balance was $60,329 and the median account balance was $17,686. But that’s for all folks, not just people of retirement age.
This shouldn’t be too surprising. Your savings rate is the most important factor in determining if you can retire comfortably. Working longer is the same as saving more and spending less (for a while). Getting used to spending less now would aallows you to need less in retirement. Doing a reverse mortgage is just another word for cashing in your savings, isn’t it?
Why asset allocation is still important. The paper concludes that financial advisors should focus more on savings rates and less about the complex ETF portfolio they just designed for you. Probably true. However, asset allocation has always been something that we did to help our situation without actually doing the hard work of having to save more. Imagine a pill that we could take to lose weight, while not actually eating less or exercising more.
I suppose we should view designing an asset allocation more as a potential “boost” to our nest egg than the driving force, and realize that earning an extra 1% or 2% a year won’t help if you’re just compounding a small chunk of your income. How much is enough? Studies have found that a savings rate of 16.62% would have worked out well historically.
Updated. I bought the original version with my own money, but then got offered a review copy of the newly released The Most Important Thing Illuminated which contains the same material but with additional commentary from respected investors Christopher Davis (David Funds), Joel Greenblatt (Gotham Capital), Paul Johnson (Nicusa Capital), and Seth Klarman (Baupost Group) as well as an extra chapter from Howard Marks. Most serious investors will recognize these names. The original is great, but if you’re willing to spend a bit more money (eBook is $9.99), this new version does have a little more meat to it. I’ve updated this review to include the new chapter.
If you wrote a book about investing and wanted some big-name endorsements, you couldn’t do much better than this – The Most Important Thing: Uncommon Sense for the Thoughtful Investor by Howard Marks has recommendations from Warren Buffett, Jeremy Grantham, Jack Bogle, Joel Greenblatt, and Seth Klarman.
Howard Marks is already famous around many investment circles for his Client Memos as the chairman and cofounder of Oaktree Capital Management, although not as well-known as Buffett’s shareholder letters. This book is basically a distillation of those memos into book form. Here are my personal notes.
Efficient Markets
Marks is an active investor, and this book is about successfully generate excess turns (alpha). Some people seem to think that “efficient markets” is black and white – either you believe in the Easter Bunny or you don’t. Market prices are completely perfect or investing is purely skill. This book helps you view market efficiency as a continuum. Beating the market by trading large-cap common stocks which are following by thousands of professionals is exceedingly hard. Oaktree Capital chooses to focus on what he perceives as less efficient markets – things like convertible securities and high-yield debt from distressed companies (“junk bonds”).
Developing your own investment philosophy
I enjoyed this quote:
Where does an investment philosophy come from? The one thing I’m sure of is that no one arrives on the doorstep of an investment career with his or her philosophy fully formed. A philosophy has to be the sum of many ideas accumulated over a long period of time from a variety of sources. One cannot develop an effective philosophy without having been exposed to life’s lessons
Quality vs. Price
The title of the book is a bit misleading, as there is no single “most important thing”. Basically each chapter is an expansion of one or more of his memos and it titled “The Most Important Thing is… XXX”. However, an overarching theme of the book is about risk control. I’ve already written about higher risk vs. higher investment return.
A related idea is that people tend to think of investments only in terms of quality. Strong companies vs. struggling companies. Highly-rated bonds vs. Lower-rated bonds. Strong developed countries vs. Weaker emerging countries. But what’s important is the price. A high-quality company can be a high-risk or low-risk investment, depending on what price you pay for it. A junk bond can be a high-risk or low-risk investment, depending on what price you pay for it.
Cycles
Marks strongly believes in the recurrence of cycles. One side of the pendulum occurs when people seems think that there are minimal risks, either because of recent history or some new invention that eliminates risk (CDOs?). Often, the only worry remaining is that we’ll miss out on the opportunity for great returns. The other side of the pendulum is when uncertainty is everywhere. Here, people say things like “I’m staying out of the market until the dust settles.” This reminded me of a chart I pulled out a lot during the housing bubble:
If you’re going to pick a time to invest, it’s better when people are scared, because at least they are properly considering all the potential risks. It should be scary and uncomfortable. He reminds you, as Charlie Munger says, “It’s not supposed to be easy.” If you wait until the dust has settled, there won’t be great prices anymore.
Illuminated-only Bonus Chapter: Reasonable Expectations
This is good reminder about having a clear goal as to what you want to achieve with your portfolio, but also to keep that goal within reason:
The key questions are what your return goal is, how much risk you can tolerate, and how much liquidity you’re likely to require in the interim.
Extraordinary skill is rare. When someone else promises returns “too good to be true”, the next question to ask is “why me?” If they found a can’t miss investment opportunity, why are they sharing this with you? If some talking head on TV makes a bold prediction, why aren’t they busy betting their net worth on the outcome? With today’s complex derivatives and betting markets, they should be rich and sunning themselves on a yacht instead.
Recap
Even though I am primarily a low-cost, buy, hold, & rebalance type of investor, I felt this book still provided me with new information for my own evolving investing philosophy. Creating alpha is not easy, and most people who try to do so consistently fail, so you should be very careful and realistic when assessing your own skills. I’ll be sure to read his future memos. Thankfully, they can be found at the Oaktree Capital website, free and available to all.
I was following an interesting discussion about living off of dividend income from stocks over at the Bogleheads forum, and member Beagler posted a link to a excerpt on income investing from the book Bogle on Mutual Funds.
You may know that John Bogle is the founder of Vanguard, now one of the largest fund organizations in the world and a pioneer in low-cost index funds. But what I really like about his books is his focus on common sense as the foundation for his advice. An example of this is his Gotrocks parable [pdf] adapted from Buffett. But back to this excerpt. He first points out how stock dividends have been a good way to create an income stream over the long run that grows faster than inflation.
Of course, by investing in common stocks you assume the risk that dividends will decline during periods of recession or depression […] What is truly remarkable is that the record of dividend payments by U.S. corporations heavily favors rising dividends over declining dividends, almost irrespective of prevailing business conditions.
Here’s a chart of the historical S&P 500 annual dividend, inflation-adjusted. (Note this is absolute dividend, not dividend yield percentage.)
Now, the problem is that you can also pay too much for dividends. He shares an example of how if you were comparing the dividend income from a diversified stock portfolio yielding 3% and growing at 6% annually or a long-term bond yielding 7% each year, it would take 26 years for the dividend income to total the bond income payments.
Unfortunately, defining what constitutes too high a price for dividends is a fallible exercise, one that must take into account not only the average historical valuations for stocks but the current valuations for other investment alternatives as well. History suggests that stocks are relatively expensive when the price paid for $1 of dividends is above $30 (i.e., a yield of 3.3%) and relatively cheap when the price paid is less than $20 (a yield of 5%). However, stocks may well be attractive at a yield of, say, 3.5% if there are compelling reasons to assume that their dividends will increase rapidly or if yields on other classes of financial assets are relatively unattractive.
In the example shown in Figure 2-5, buying a portfolio of stocks at a 3% yield rather than a bond at a 7% yield might not be a sensible investment, especially considering the incremental risk incurred in holding stocks. When stocks yield 4.5% and bonds yield 6%, that may be quite another story.
What would Bogle say right now, when the S&P 500 yield is ~2% and 30-year Treasury bonds are ~3%? The relative difference between the stock yield and the bond yield is less than 1%. I would argue that his last sentence would suggest stocks are actually preferred over other classes at this point.
Now, I’m not turning in a stock bull, and I still have about 70% stocks and 30% bonds in my portfolio, but this line of thinking makes me happier with my 70% in stocks. I’ve also been looking more at living off of dividend income in “early retirement”.
SmartMoney magazine has released the results of their Annual Broker Survey in its June 2012 issue. Check out the attached article for additional commentary and insight into rankings and methodology. You’ll find my own commentary on their findings below.
Scottrade doesn’t have a rock-bottem per-trade commission at $7 a trade, but it’s lower than average and they still win overall due to lower fees elsewhere – such as annual fees, inactivity fees, fees to use a phone, or close out an account.
One important factor here was speed of reply in addition to accuracy, and per the article all of the brokers surveyed now offer Live Chat online except for WellsTrade. I think TradeKing was the first to offer this feature?
SmartMoney mentions the the Merrill Edge BofA deal, where you can get 30 free trades a month if you hold a combined $25,000 as cash in your *deposit* accounts only at Bank of America. However, they don’t mention the WellsTrade deal which offers 100 free trades a year if you hold a combined $25k across acounts including your brokerage balance, but instead requires a PMA checking account that you have to keep active with “in-person” activity like writing a physical check at least once a year.
WellsTrade and Zecco enter the top 10 this year, but Vanguard and OptionsXpress were bumped out. Vanguard was #7 in their 2011 rankings. There was no mention of what happened… I’d like to know if they were notably worse in some area or were simply excluded? OptionsXpress was bought by Schwab last year, but still runs an independent site.
Finally, there was no mention of the quantity and quality of the commission-free ETF lists offered by the majority of these brokers. If anything, I thought that was more important to mention than smartphone apps that scan product barcodes at the grocery store.
Don’t forget to compare these results with the Consumer Reports 2012 Rankings and the Barron’s 2012 Rankings. The key is to drill down to see which broker satisfies your personal set of needs the best, as there is a lot of fluff in there. This is why I’d rather look at specific sub-rankings more closely than the big headline “Top 10” rankings.
Take the “Banking” category, which included as a criteria but some brokers just don’t offer banking services and I don’t think they should be penalized for it. Another area I don’t care about is “Research” tools. I’ve ever used a broker for research. Morningstar offers me everything that I need, otherwise I just look at Google/Yahoo quotes and look for related news and blog articles. I don’t see how a discount broker would have the time or resources for unique analysis. Just give me cheap trades with good fills, solid customer service when I need it, and track my capital gains and tax lots accurately.
…because it looks like I’m getting another one. After seeing repeated news articles titled “Mortgage rate set record lows”, I’m now looking at refinancing to a 15-year fixed mortgage for 3% with all lender closing costs covered. I’ve seen multiple quotes for under 3% and getting under or close to zero in net fees.
Here’s a chart of the historical mortgage rate averages, courtesy of HSH.com. It includes the 30-year fixed, 15-year fixed, and the 5/1 30-year adjustable. Since I bought my home less than 5 years ago, 30-year fixed mortgage rates have ranged from a high of 7% to just above 4% today.
Even though I stopped trying to predict mortgage rates a while ago, I still find it hard to believe that I started with an interest rate of over 6% and now could be paying under 3% with a no-cost refi.
Alternative investments
If I successfully close on this loan, I don’t know if I’ll be aggressively paying it down as much as before. It’s important to note that the risk levels are not the same for the options below, but the interest rate environment is finally tipping to the point that I’d consider investing instead of paying off 3% debt.
I’m going through a local mortgage broker, but you can find similar rates over at Amerisave. If the “all lender fees and points” is negative, that means the credit they give you is more than all closing costs including appraisals and title insurance. (Anyone use them before?) Compare that with rate quotes from and Quicken Loans.
“Sell in May and go away” is a rhyming market-timing slogan that may never… go away. Here’s a graphic that seems to support the idea that stocks have historically performed much worse between May and October than the rest of the year. Credit to Reuters/Scott Barber via Abnormal Returns. Data set is the MSCI World Index from 1971-2011.
Meanwhile, The Big Picture shares a bunch of graphs from TheChartStore that don’t make it look so clear-cut. Looking at this one, why shouldn’t just bail out every September? Data set is the S&P 500 from 1928-2011.
Larry Swedroe tests the theory out using 30-day Treasury bonds as the alternative investment in this CBS Moneywatch article:
He looked at returns through 2007 from six start dates since 1950. “Sell in May” beat “buy and hold” if you started investing in 1960, 1970 and 2000, but not if you started in 1950, 1980 or 1990. “It’s pure randomness,” Swedroe says. “How would you ever know when to start?”
Throw in the tax implications of all that buying and selling, and I agree. Do you really want to base your investing strategy on a data-mining result that has no logical explanation behind it? Sounds too much like driving a car using only your rearview mirror.
However, Tadas Viskanta of Abnormal Returns has what I think is a reasonable compromise – what if you just decided to rebalance your portfolio at the very end of April and the very end of October? You should rebalance your portfolio regularly anyway, so why not do it twice a year, six months apart. If your target asset allocation is 70% stocks/30% bonds and now you’re at 80/20 due to the recent run-up, why not go back to 70/30. If things end up at 60/40 in November, then again, go back to 70/30.
You could call it “Remember to Rebalance in May and November”. It even rhymes! If “sell in may” really works, you’ll get some benefit from this mean reversion wackiness. If it’s just noise, you portfolio shouldn’t theoretically be hurt any more than picking other months.
I am often reminded when talking with friends and coworkers that most people don’t understand the important of low fees when it comes to investing. The Vanguard blog had a recent post exploring why a 1% expense ratio is much more significant than it appears. The problem is that expense ratios aren’t charged to you directly as a line item like an overdraft fee or a monthly bill – it is quietly taken away in tiny pieces from your returns which makes it easy to ignore.
For another, fees are expressed as a fraction of assets. A 1% equity management fee seems small and reasonable. “One percent” just sounds tiny – as in “there’s a 1% chance of rain tomorrow.” But suppose you reframe fees in other terms. Suppose you expect a stock fund to earn 8% over the long run. Assuming inflation of 3% and a tax rate of 25%, you’re in effect paying one out of every three dollars of future expected return in costs.* A fee of “one third of all of the money you make” sounds like a lot, especially when many money managers could do worse than the market averages.
Basically, if you are expecting to earn 3% a year above inflation after taxes, paying 1% to a manager is like paying 1/3rd of all your earnings. As you can see below, I could own the S&P 500 for as little as 0.05%. Things get even worse when looking at bond funds and their tiny yields.
Research has shown repeatedly that costs matter more than star ratings and past performance. The lower the expenses, the less headwind year in and year out.
With that knowledge, Vanguard has announced another round of fee cuts! Vanguard says the price drops are a result of them being client-owned and passing on any savings resulting from increased assets. Others speculate that it’s a reaction to competition from other low-cost ETF providers like Schwab. Either way, investors win. The drops are pretty small, but to me it’s like getting a little guaranteed boost in returns that will compound every year. A selected sample of funds with fee drops below:
| Funds In My Personal Portfolio | Old expense ratio | New expense ratio |
|---|---|---|
| Vanguard 500 Index Fund (Admiral/ETF Shares) | 0.06% | 0.05% |
| Vanguard Total Stock Market (Admiral/ETF) | 0.07% | 0.06% |
| Vanguard Small-Cap Value Index Fund (ETF) | 0.23% | 0.21% |
| Vanguard Small-Cap Value Index Fund (Investor) | 0.37% | 0.35% |
| Vanguard Total Bond Market Index Fund (Admiral/ETF) | 0.11% | 0.10% |
| Vanguard Inflation-Protected Securities Fund (Investor) | 0.22% | 0.20% |
Admiral shares are now open in most index funds with a $10,000 investment, and you can always start like I did with the Investor shares at $3,000 and convert to Admiral when the balances grow. ETFs usually offer the same low expense ratios as Admiral shares, but you should also keep in mind the cost of trade commissions. Buying Vanguard ETFs and mutual funds directly with an account with Vanguard is free. TD Ameritrade also offers commission-free trades on a wide variety of Vanguard ETFs (along with other providers).
Over the last year or so, Vanguard has made several moves that lowered my portfolio costs. They added Admiral shares, removed purchase fees on their Emerging Markets fund, and dropped expense ratios again.
The Best Credit Card Bonus Offers – 2025
Big List of Free Stocks from Brokerage Apps
Best Interest Rates on Cash - 2025
Free Credit Scores x 3 + Free Credit Monitoring
Best No Fee 0% APR Balance Transfer Offers
Little-Known Cellular Data Plans That Can Save Big Money
How To Haggle Your Cable or Direct TV Bill
Big List of Free Consumer Data Reports (Credit, Rent, Work)