7/21/19

Investing is Easy


With disappearing pensions and the questionable status of Social Security, investing is pretty much necessary to secure a comfortable retirement for the average American. If you're just starting out, you may be wondering whether investing is easy or hard. As with many things in life, it depends on how easy or hard you want to make it.

Is investing hard? It doesn't have to be. Investing can be easy.

If your employer offers a 401k, put as much as you can into it and choose the lowest fee index funds available. And you're done. That's pretty easy.

If your employer doesn't offer a 401k, you don't like its offerings, or you've maxed out your 401k, investing can still be easy.

Capturing the returns that the market gives us is very easy and involves a few simple steps:

  1. Determine how much money you can afford to sock away and tie up for the long term.
  2. Choose your asset allocation.
  3. Choose a broker.
  4. Find the lowest fee index funds that track the assets in your allocation.
  5. Open an account with the broker, transfer your money, and buy the funds in accordance with your allocation.
  6. Whenever you have additional funds to invest (preferably every pay period), transfer the money to your brokerage account and buy additional shares of the index funds in accordance with your asset allocation.
  7. Rebalance periodically (once a year or every couple of years) so that your funds' percentage in your portfolio match your asset allocation.
  8. Leave your investments alone (apart from adding to them and rebalancing) until you are ready to sell and use them.

That's all there is to it. Investing doesn't have to be hard. If you follow the above steps to invest the easy way, you will do better than most professional money managers.

Determine how much money you can afford to sock away and tie up for the long term

The money you invest should not be needed for anything else. That means before you start investing you should have a fully funded emergency fund that is at least three to six months of your expenses. Few things sabotage investing more than having to sell your investments early to pay for an emergency or other expense. But once you have your emergency fund set up and your debts paid off, you should start investing any extra amount of money that you come by, no matter how small. The sooner you invest it, the sooner the money can work for you, and the more money you will have in the end. So this can be $10 a week, a $100 a month, etc--whatever you can spare and won't need until you retire.

Choose your asset allocation

An asset allocation is the mixture of stocks, bonds, and other assets that make up your investment portfolio. Your asset allocation is the biggest factor in the portfolio's returns over time, so it's important to make sure it's diversified with no one asset class or geographic region having too large a portion. Over your life time some asset classes and geographies will do well while others will experience catastrophic losses. There is no way to know in advance which asset class or which counties these will be, so the best and easiest approach is to own a bit of everything.

If you are a tinkerer, you can read up more on asset allocation to determine the one that is best for you. Another option is to consult a financial advisor or sign up for a robo advisor service like Betterment, Wealthfront, FidelityGo, Vanguard Personal Advisor Services, or Schwab Intelligent Portfolios. With the latter services you answer a few questions and you're set. A final option is to choose a one size fits all asset allocation designed by experts. You can find examples of these here.


Choose a Broker (or Robo Advisor)

Thanks to technological innovations and free market competition, there is an abundance of brokers to choose from. Which one is best for you largely depends upon what kind of investor you are. Most brokers offer similar products, so choose the one that has the best customer service, the lowest fees and trading commissions, and the lowest account minimums that are relevant to you.

For a regular broker account, you can't go wrong with Vanguard or Fidelity. Both offer no transaction fee index funds and great customer service. If you are starting with a small amount, Fidelity is better because there are no minimums to invest and you can transfer as little as $10 into your account at a time.

Choose Funds for Your Portfolio

You don't have to worry about this step if you are going the robo advisor route, as the robo advisor will pick the best funds for your asset allocation.

Once you have decided upon your asset allocation, the next step is figuring out how to buy the assets. The best way is by buying a mutual fund or ETF that owns a diversified basket representing the entire asset class and employs a passive investing strategy. In other words, buy your assets through the index funds whose holdings most closely match the asset.

For example, if one of the asset classes in your portfolio allocation is US Stocks, for that asset class pick the fund with the lowest expense ratio that tracks the broad US stock market. Don't pay attention to the fund's share price. That is irrelevant.

If you are picking a mutual fund, make sure it has no loads, no transaction fees, and has as low an expense ratio as possible. So, for example, if you choose Fidelity as your broker, for the US Stock part of your portfolio allocation you can invest in the Fidelity Zero Total Market Index Fund (FZROX), which tracks the entire US stock market and has no investment minimums and absolutely no fees.

If you are picking an ETF (exchange traded fund), make sure it has as low an expense ratio as possible and that it is liquid. By liquid I mean that it has a large number of shares traded every day and is thus easy to buy and sell. An analog to volume of shares traded is assets under management. If you are not sure whether an ETF is liquid, look for its assets under management. If it is in the billions of dollars, that fund is almost certainly liquid.

If you will be investing small amounts into ETFs periodically, pick those that the broker offers commission free. If the broker doesn't offer commission free ETFs, go with a no transaction fee index mutual fund instead. There's no reason to pay commissions.

Open a Brokerage or Robo Advisor Account

Open a traditional or Roth IRA at the broker or Robo Advisor you chose in the above steps. Link it to your bank and set up a funding transfer. Depending on the broker and your bank this can be instant or a couple of business days to set up.

Invest Regularly

Once your account is open, transfer additional funds whenever you can. Set up an automatic monthly transfer, or, better yet, a paycheck deduction. Even small amounts will add up over time.

Rebalance Every Once in a While

You don't have to worry about this step if you choose a robo advisor because the robo advisor will rebalance for you.

Rebalancing is a method of keeping your portfolio in line with the asset allocation you chose. As the market fluctuates, some assets will make up a larger portion of your portfolio (overweight) than you allocated while others will make up a smaller portion (underweight). If you are regularly contributing fresh funds for investment, buy more of the asset that is underweight.

For example, suppose in your asset allocation you chose US Stocks to be 35% and bonds to be 40% (with other asset classes making up the difference). As the market fluctuates, the portion of your portfolio that is in stocks might climb to 45% while bonds might drop to 30%. In this case, you would use your fresh money to buy bonds until they are back to their 40% allocation.

If you do not put fresh money in regularly, rebalancing involves selling a portion of the assets that are larger than their allocation and using the proceeds to buy the assets that are smaller than their allocation. So, in the example above you would sell some of your US stocks so that they're back to 35% of the portfolio and use the proceeds to buy additional bonds.

Bringing your portfolio back in line with your asset allocation by rebalancing helps you buy asset classes when they are relatively cheaper than others. In the case where you sell some of your overweighted assets to buy the underweighted ones, you are selling high and buying low.

If you are rebalancing by selling a portion of one asset to buy more of another, do this once a year or every couple of years. While rebalancing is beneficial, doing it too often can be counterproductive and  is just a waste of your time. Remember, investing should be easy.

Leave Your Investments Alone

Investors are their own worst enemies. Apart from adding fresh money to invest and rebalancing once every year or every other year, leave your investments alone.

Be aware that there will be many temptations to tinker.

You will hear about some investing "system" that's "proven" to beat the market and you'll want to change your investments to that strategy. Don't do it. The best system is passive index investing.

You'll see some economist or talking head on the news saying how stocks or bonds will crash and you'll be tempted to sell that portion of your portfolio. Don't. All these experts are at best right half the time. No one knows the future.

One or more asset classes will experience a terrible crash. Your allocation should insulate you from the worst of the damage and your overall portfolio may even increase in value. Still, people will be screaming doom and gloom and the news will tell you it's the end of the world. You will be tempted to sell the assets that fell the most. Don't listen to the news or your emotions. Stay the course. If you do anything, rebalance your portfolio with fresh cash or by selling the assets that are high to buy the ones that are low.

Do this consistently and over the long term and you'll be amazed at how your savings snowball into a fortune. It's that easy.

7/20/19

$50 Per Pay Check Dividend Portfolio Update 7/18/19


It's been a month since I began the $50 per pay check starter dividend stock portfolio with $200 for fun and profit.

This Thursday, 7/18/19, as on 7/3/19, I sent another $50 over to M1 Financial to buy additional fractional shares of the 100 mostly dividend growth stocks in the portfolio.

As of market close on 7/18/19, the portfolio value is $295.99 and the cash in the account is $3.11, for a total account value of $299.10. So far the account has earned $0.34 in dividends and lost $0.90 in total due to market fluctuations.

I'm still not sure why there is any cash in the account, but I suspect it hasn't been invested because M1's algorithms were unable to use that money and keep each stock at roughly 1% of the portfolio. I wonder how high this amount will reach before it is invested.



The SPY ETF (tracking the S&P 500) closed at $298.83 on 7/18/19. Investing $50 into it at this price would have bought an additional 0.16732 shares, bringing the total shares to 1.015763 in our SPY benchmark. The benchmark investment value would thus be $303.54 as of 7/18/19.

The pretty much random stock dividend portfolio is now trailing the S&P 500 by 1.463%, showing exactly how easy it is to underperform the market.

Date
Additional Investment
Running Total Investment
Dividend Portfolio Account Value
Additional Benchmark SPY Shares
Running Total Benchmark SPY Shares
SPY Closing Share Price
Benchmark SPY Value
Dividend Portfolio VS Benchmark
6/24/19
$200.00
$200.00
$200.00
0.681107
0.681107
$293.64
$200.00
0.000%
7/3/19
$50.00
$250.00
$252.22
0.167336
0.848443
$298.80
$253.51
-0.511%
7/18/19
$50.00
$300.00
$299.10
0.167320
1.015763
$298.83
$303.54
-1.463%


The Excuses

Part of the portfolio's underperformance can be attributed to some ex-dividend dates that happened amount the 100 stocks in the dividend portfolio where the dividends haven't been paid out yet, and the accumulation of dividends in the S&P 500 ETF (the next ex-dividend date is in around two months). This difference should even out and swing into the portfolio's favor as its dividend yield is 3.681%, compared to SPY's 1.83%, as time progresses.

Another difference is that the S&P is market cap weighted. The performance of the largest companies among its constituents affects its performance to a larger extent than the dividend portfolio's, which is equal weighted. Also, the dividend portfolio doesn't hold many of the largest S&P stocks either because they don't pay a dividend or their dividend yield was too low at the time the portfolio was constructed. So, for example, the dividend portfolio doesn't have the top five stocks in the S&P: Microsoft, Apple, Amazon, Facebook, Berkshire Hathaway. It also has smaller stocks as well as international stocks, both of which aren't in the S&P 500.

Below is a collage of screenshots of the dividend portfolio holdings as of market close 7/19/19 (screenshots done on Saturday 7/20/19). It appears that M1 doesn't have an export feature yet (or I can't find it).



Don't Fall for the Pay with Points Trick at Amazon and Other Online Retailers


If you shop at Amazon and pay with an Amazon Rewards Card from Chase or a Discover Card you are offered to pay with your rewards points at checkout. Other online retailers have similar offers.



Never pay with your rewards points!*

The reason is simple: you save more money if you pay for the entire checkout amount with your credit card and redeem the points as a statement credit or cashback. (This assumes that you do not carry a balance on your credit card.)

Here's a simple example. Suppose you have $100 in redeemable points and are going to buy something that costs $100 (taxes and shipping included). At checkout you're offered the ability to pay with your points, which ends up making the purchase free.

If you pay with the points, they're deducted from your account and your item is shipped. Great.

But, what if instead of using your points, you pay for the full amount with your rewards credit card?

In this case, the $100 purchase will count towards new rewards. At Amazon that would be an extra $3 earned with the regular rewards Visa, $5 earned with the Prime Visa, or $1 earned with a Discover Card (for the last few years Discover has offered 5% rewards at Amazon in the last quarter of the year--October through December, so that would be $5).

Next, you log in to your credit card account and redeem the points you didn't use to buy the $100 item for a statement credit or cashback into your checking or savings account. The upshot is that you still got the item for free, but you earned additional rewards points for the purchase that you can use in the future.

*Things get complicated if you are carrying a balance on the credit card instead of paying off the entire amount when you get the statement. In this case, focus on buying less stuff you don't need and paying down the balance!

7/13/19

The Darker Side of Personal Finance (Part 2) Tony Robbins and Theodore Johnson


There are a lot of personal finance gurus out there that give sensible advice, that if followed, leads to a better life. Every once in a while they say something that on its face is very motivating, but after you think about it, it is hard to believe. When you look into it, you see that it's disingenuous, and this detracts from the personal finance guru's credibility. Last time we looked at Dave Ramsey and his 12% returns. In part two, we look at Tony Robbins and the story of Theodore Johnson.

There's an oft repeated quote, supposedly uttered by Albert Einstein, that compound interest is the 8th wonder of the world. Whether Einstein said it or not, it is true that it's the compounding of gains over time that can produce large amounts of wealth. And conversely, borrowing from and paying compounding amounts of interest to someone else is a sure recipe for financial disaster.

In his books MONEY Master the Game: 7 Simple Steps to Financial Freedom and Unshakeable: Your Financial Freedom Playbook Tony Robbins and the experts he interviews offer a lot of great financial advice, including the benefits of compounded returns over time.

One of Robbins's examples of the power of compounding in the books is the story of Theodore Johnson. Robbins has recounted this story many times since the books' publication in interviews and other media.

The Magic of Compounding and Theodore Johnson

The story goes something like this. Theodore Johnson worked for UPS and never earned more than $14,000 per year. He was persuaded to save and invest 20% of his salary. With some effort he managed to do this. As a result, his investments grew to $70 million, $36 million of which he donated to education.

Talk about the power of compounding! Johnson never earned more than $14k per year, but thanks to compounding he was able to donate $36 million and still have $34 million left over as spending money.

The moral of the story is that you should invest as much as you can, as soon as you can, and as often as you can. If you do, you too can be rich. Even if the amounts are small. Just look at Ted Johnson, who never earned more than $14,000 per year.

But if you think about it, even just a little, it doesn't make much sense. The story leads one to believe that Theodore Johnson had a low income. $14k a year is pretty much nothing. Did he even graduate from high school? Forget about being able to invest, how was he able to eat? Something about the story smells fishy. Maybe this was a few decades ago and adjusted for inflation the salary wasn't that low. Maybe he was a UPS delivery man or worked in one of their warehouses.

Not Quite as Exciting

Actually, Johnson retired as Vice President of Industrial Relations. $14k a year for a vice president position at UPS? What year was this? 1952. $14,000 in 1952 dollars is roughly equivalent to $135,000 in 2019 dollars.

The story isn't as exciting now. "Theodore Johnson never made more than $135,000 a year, but he amassed a fortune of $70 million." This doesn't sound as good. It's not turning a measly $14k salary into a fortune.

The other wrinkle in the story is that Johnson invested heavily in a single stock, UPS.

Put that together and you get, "a corporate executive earning $135k a year puts all his money in the company stock and ends up with $70 million when he's 90." Johnson retired in 1952. His fortune grew to $70 million by 1991, when he was 90 years old.

That's hardly motivating and you might wonder what else Robbins says that leaves out salient facts.

(Still, even with a salary of $135k and getting lucky with a spectacular stock, it seems kind of hard to end up with $70 million.

By the time he retired, Johnson owned $700,000 worth of UPS. From 1952 to 1991, a 39 year period, this amount grew to $70,000,000. That's a compound growth rate of 12.53%. Johnson's return from when he started buying the stock to 1952 had to be a lot higher for him to end up with $700k when he retired.)

The moral from the Theodore Johnson story is a good one, but I wish it weren't as sensationalized and was more nuanced. Invest as much as you can as early as you can. However, buying a single stock, no matter how much you know about the company, is not investing. It is gambling. We never know what the future holds. This is why Ashvin Chhabra says one's own business, or significant amounts of your employer's stock, belongs in the "aspirational" risk bucket, the same place where speculative investments should be allocated. It's where the potential rewards are great but the risks may be greater. Imagine working for Radio Shack and putting all your savings into its stock. Your story would never make the personal finance press because you'd end up with nothing.

Tony Robbins does not deserve all the blame. Here is how the NY Times tells it: "Theodore R. Johnson never made more than $14,000 a year, but he invested wisely -- so wisely that he made $70 million. Now he is donating $36 million of his fortune for education." I get that newspaper articles are meant to sell papers and personal finance stories are meant to motivate, but when you leave out certain facts that, intentionally or otherwise, cause the audience to get the wrong impression, you risk your credibility when the audience discovers the facts you left out and their interpretation of the story changes from one of "anyone can do this" to one of "that guy was already making a lot of money and then he got lucky."

7/7/19

The Darker Side of Personal Finance (Part 1) Dave Ramsey's 12% and the Difference Between Average and Compound Average


There are a lot of personal finance gurus out there that give sensible advice, that if followed, leads to a better life. But every once in a while they say something incredible and disingenuously false that ruins their credibility. One of those is Dave Ramsey and is 12% returns. You too can retire a millionaire. Just invest $100 per month in a good growth stock mutual fund that I recommend.

Dave Ramsey's 12% Returns

If you follow all of Dave Ramsey's advice to the letter you will be much better off financially, and probably as a person, than if you don't do any of the things he recommends. But one thing that he says that makes him less credible is that with "a good growth stock mutual fund" you will earn around 12% annually. Investing $100 a month into the fund for 40 years, say from the time you're 25 until the time you're 65, you will retire a millionaire.

Here is the claim on his website, where the data is from 1923 to 2016. The range may change by the time you read this as Ramsey's website is updated.

Putting aside the issue of the fees associated with the funds that Ramsey recommends and presumably gets a commission from, this is kind of disingenuous if you think about it.

Depending on the time frame that you pick, the S&P 500 has averaged around 12% annually. For example, from 1923 to 2016, a 93 year period, the S&P 500 has averaged an annual return of 12.5%. The key word here, however, is "averaged."

An average annual return is different from a compounded annual return.

Here's a simple example. Suppose a $10,0000 investment goes up 50% the first year and down 40% the next, and this pattern repeats every year. So, the investment grows to $15,000, then falls to $9,000, and so on:

Actual Investment

Year
Starting Value
Rate of Return
Ending Value
0
      10,000.00
50%
  15,000.00
1
      15,000.00
-40%
    9,000.00
2
         9,000.00
50%
  13,500.00
3
      13,500.00
-40%
    8,100.00
4
         8,100.00
50%
  12,150.00
5
      12,150.00
-40%
    7,290.00
6
         7,290.00
50%
  10,935.00
7
      10,935.00
-40%
    6,561.00
8
         6,561.00
50%
    9,841.50
9
         9,841.50
-40%
    5,904.90
10
         5,904.90
50%
    8,857.35


In the last year, the investment is valued at $8,857.35, for a total loss of $1,142.65 or 11.43%. The average annual return for this investment over the 11 years, however, is a positive 9%!

Let's say I'm trying to sell you this investment and I say, on average it returns 9% per year. That's true! But here's the disingenuous part. I say next, so if you put in $10,000, and you average 9% per year, your investment will be worth $23,673.64 in ten years:

Investment as Marketed

Year
Starting Value
Rate of Return
Ending Value
0
      10,000.00
9%
    10,900.00
1
      10,900.00
9%
    11,881.00
2
      11,881.00
9%
    12,950.29
3
      12,950.29
9%
    14,115.82
4
      14,115.82
9%
    15,386.24
5
      15,386.24
9%
    16,771.00
6
      16,771.00
9%
    18,280.39
7
      18,280.39
9%
    19,925.63
8
      19,925.63
9%
    21,718.93
9
      21,718.93
9%
    23,673.64

That's not true. Why? Because average and compound average returns are being conflated. But as you can see above, there's a big difference.

I'm not sure if Ramsey does it on purpose or not, but he makes the same conflation. He uses the historical average return of the market to forecast a compounded annual return. This makes his advice look much better than it is, and if you realize this you might start to question everything else he says.

So what are the real numbers?

From 1923 to 2016, the S&P 500 has averaged 12.25% per year. Investing $100 per month for 40 years would have produced a portfolio valued at $996,927.31 if the 12.25% were compounded.



The actual compound annual growth rate of the S&P 500 during this same period was 10.34%. That is seemingly not such a big difference from 12.25%, but it is huge (and is also why fees matter so much!).

Investing $100 per month for 40 years and having that compound at 10.34% would have yielded a portfolio of $587,779.81, which is a $409.147.50 difference from the advertised amount! And this doesn't factor in inflation or fees.



The saddest part for me is that this might reasonably lead one to conclude that Dave Ramsey is full of crap and that everything he recommends doing is worthless. I don't understand why he doesn't use the actual compound returns, they are even provided in the MoneyChimp calculator link on his website) and increase the monthly investment amount to compensate. A hundred dollars a month sounds a lot easier than three or four hundred, I guess.