Worry-Free Investing: Calculate Your Risk-Free Savings Rate For Retirement

Posted on December 17, 2008 // 11 Comments

Conventional advice has been that we should invest in some mix of stocks and bonds to reach our retirement goals. But as we’ve seen, rolling the dice on a varying return distribution every year can be quite stressful. What if we start our retirement planning based on buying a safe investment that guarantees a steady after-inflation return instead? This question is posed in the book Worry-Free Investing by Bodie and Clowes.

Treasury Inflation-Protected Securities (TIPS) are bonds that promise you a total return that adjusts with the CPI index for inflation. Very generally, it works like this: if the stated real yield is 2% and inflation ends up at 4%, your return would be 6%. TIPS are issued and backed by full faith of the U.S. government, so they are as safe as they get. As your investment the automatically adjust with inflation, you will never have to deal with the stomach-churning swings of stocks, and also you avoid the risk of underperforming inflation that traditional (nominal) bonds have.

How much would you have to save if you decided to take zero market risk and invest solely in TIPS? The book outlines the mathematical formulas to use, but also provides a free spreadsheet calculator to do the heavy lifting for us. I uploaded it to ZohoSheets:

I would recommend playing with the numbers a bit. To start, the book was written in 2003 when the real rates were relatively high at around 3%. Given the recent history of the 20-year TIPS yield (shown below), I would assume a maximum of a 2.5% real interest rate.

I would also change the replacement rate to something that more closely tracks your specific expected expenses. The book recommends the income required to maintain your “minimum acceptable living standard”. For the skeptical and/or early retirees, don’t put in anything for Social Security. Finally, don’t forget to input your current savings.

You now have your personal risk-free savings rate to reach your goals. (Warning: It might be really high! If so, try retiring at 65 and input something for Social Security.) But let’s say you need to save 10%, but you are able to save 15%. You could put the 10% in the ultra-safe TIPS, and put the other 5% in something riskier to boost your returns while still guaranteeing a minimum future income. I’ll share a possible solution from the book once I get access to a flatbed scanner.

Now, there are lots of potential glitches with this simulation. For one, there is reinvestment risk because the TIPS real interest rate will continue to vary, and could drop to much lower levels. The government could even conceivably stop selling new TIPS at any time. Some people are skeptical that the CPI properly tracks inflation. Finally, TIPS are taxed at ordinary income levels, so one should keep them in tax-advantaged accounts. However, most people’s 401ks don’t include TIPS as an option! Otherwise, taxes are going to hurt returns.

In the end, I think a portfolio of 100% TIPS is impractical for most people. However, I definitely like TIPS as a component, and see this thought process as a way to estimate a “target” savings rate that can let those so-inclined to take less risk and sleep better at night.

Filed Under: Investing, Retirement, Tools & Calculators //

Lending Club P2P: Review of New Post-SEC Changes

Posted on December 14, 2008 // 21 Comments

Now that LendingClub has finished their SEC filing and is one of the only P2P lenders currently operating (everyone else either shut down or is in an SEC quiet period), let’s take a look at some of the changes. You are now officially “investing” in notes offered by LendingClub, as opposed to directly “lending” to private individuals. The bad news is that this also means some new restrictions that have been added. The good news that now these notes can be traded on a secondary market, offering liquidity for loans that used to be a 3-year commitment.

Borrowers

I have always found borrowing from LendingClub to be very straightforward to borrowers. You get a 3-year, unsecured loan at a fixed rate. If you qualify (see below), you simply submit an free application and they tell you what rate you get. Then you can simply compare this rate with your other options – credit cards, home equity loans, whatever – before deciding if you want to attempt a listing. However, which the current credit conditions, remember that credit cards can only guarantee 6-12 months of a low rate, and home equity loans have gotten a lot more strict (and also put your house at risk).

Eligibility. However, be aware LC is only seeking “prime” borrowers. Borrowers must be a US citizen or permanent resident, and at least 18 years old with a valid bank account and a valid Social Security number. You can’t be from the following 8 States: Idaho, Indiana, Iowa, Maine, Nebraska, North Carolina, North Dakota, and Tennessee. You have to have good-to-excellent credit in addition to satisfying additional requirements. From their FAQ:

In order to qualify for listing a loan request, you will need a FICO score of at least 660 with a debt-to-income ratio (excluding mortgage) below 25%. In addition, your credit history must show that you are a responsible borrower:

* at least 1 year of credit history, showing no current delinquencies, recent bankruptcies (7 years), open tax liens, charge-offs or collections account in the past 12 months,
* no more than 10 inquiries on your credit report in the last 6 months,
* a revolving credit utilization of less than 100%, and
* more than 3 accounts in your credit report, of which more than 2 are currently open.

Put together, these minimums are actually relatively strict. However, as a lender I would say that crafting a convincing loan listing showing your income, expenses, and exactly how you plan to pay off the loan is still very critical to get your loan funded.

Fees. Borrowers pay an upfront fee that is a percentage of the loan amount. The fee ranges from 0.75% to 3.50% based on the credit grade given.

Lenders

The interest rates charged by LendingClub currently vary from 7.37% to 20.11% (6.69 to 19.37% after fees) based on the credit grade assigned by LC after reviewing the borrower’s overall profile. There is no eBay-like bidding here. You see the rate, you read the listing and credit grade, and you decide either to fund it or not. Remember the minimum requirements above. The rates are higher than before, probably to counter potentially higher future defaults and to match increasing rates in the overall market.

Default Rates. You can see all the stats on existing LendingClub loans here. Up to this point, I have only investing in top-grade “A” loans. Out of 332 A loans, only 2 have been late since they started in June 2007. That’s a 0.6% late rate, with no defaults yet. Across all their loans, they have had a default rate of less than 3%. This includes a few loans that were of slightly lower quality than their current minimum requirements.

Looking at the overall late and default rates as compared to credit grades, it would appear the “sweet spot” is currently B and C grade loans. However, I personally still like minimal risk and plan on sticking mainly to A grade loans.

Finally, it is interesting to note that out of the $23 million of issued loans, there was also $199 million of “declined” loans. I’m not sure if this is due to rejection by LendingClub, or simply prospective lenders deciding that the loans were unsatisfactory. It also could be due to a lack of funds by lenders, so only the “best” loans were funded.

Eligibility. After the SEC filing, you must now meet certain minimum income and net worth requirements. You must also be a resident of on these 25 states (new states are added as they are approved):

California, Colorado, Connecticut, Delaware, Florida, Georgia, Hawaii, Idaho, Illinois, Louisiana, Minnesota, Mississippi, Montana, New Hampshire, Nevada, New York, Rhode Island, South Carolina, South Dakota, Utah, Virginia, Washington, Wisconsin, West Virginia, and Wyoming.

Liquidity. All loans you take on can now be sold on a secondary market at FOLIOfn, so if you need your money back it is possible. As an existing lender, I had to fill out some additional information, but my application was approved in a day and I can now view a listing of loans that people want to sell. FOLIOfn charges the seller a 1% trading fee.

Fees. Lenders pay a 1% service charge on all interest payments. Due to reasons that I haven’t worked out, this reduces the APR by less than 1%.

My Experience

In general, my use of LendingClub has been limited to some experimental investing. I like the idea and I like trying out new financial services, but as I mentioned, I’m also very risk-averse. My loans have to have an A-grade (I choose them myself and don’t use LendingMatch). Also, they have to outline a clear plan for repayment. My main problem so far is a lack of such high quality loans. I’ve only funded about 8 loans so far, but the volume seems to be picking up. I’ve been earning about 7% (8% minus fees) with no lates or defaults. The movement of money back and forth between my bank is smooth, just like with an online bank. I only wish there was an “instant funding” feature, as I don’t like to keep idle cash sitting there, but I like the ability to fund attractive loans quickly before they fill up.

In fact, although I usually don’t care about this sort of thing, yesterday I used their loan map mashup and actually found a loan by a local store that I have shopped at before. After reading it over, I am now moving some funds in to help fund that loan. Should be interesting.

How are your experiences with Lending Club?

Filed Under: Deals & Offers, Investing //

Madoff Hedge Fund = $50 Billion Ponzi Scheme

Posted on December 13, 2008 // 29 Comments

Ah, hedge funds, so sexy with their “rich people only” requirements and secretive investments. I have been catching up on a bunch of news articles about Bernard Madoff, who was recently arrested after admitting that his hedge fund was “all just one big lie” and a “giant Ponzi scheme”, estimated that his investors will lose about $50 billion. If true, this represents the one of the largest cases of investor fraud and definitely largest Ponzi schemes in history. The SEC said it appeared that virtually all of the assets of his hedge fund business were missing. Oops.

According to this NY Times article, lucky investors included J. Ezra Merkin, the chairman of GMAC; Fred Wilpon, the principal owner of the New York Mets; and Norman Braman, who owned the Philadelphia Eagles. Unfortunately, there was also substantial money from several charities and endowments. Finally, throw in a few other hedge funds which did zero original thinking and instead simply invested their money in Madoff’s hedge fund as well.

Mr. Merkin, a prominent philanthropist and the founder of several hedge funds, including one called Ascot Partners, jolted his clients on Thursday with a letter announcing that “substantially all” of that fund’s $1.8 billion in assets were invested with Mr. Madoff.

“These investors were never aware that all of their money was invested with Madoff,” Mr. Susman said. “They are obviously shocked.”

Surprise! I also love the marketing techniques:

Mr. Madoff emphasized secrecy, lending his investment accounts a mysterious allure and sense of exclusivity. The initial marketing often was in the hands of what one source described as “a macher” (the Yiddish term for a big shot). At the country club or another exclusive rendezvous, the macher would brag, “I’ve got my money invested with Madoff and he’s doing really well.” When his listener expressed interest, the macher would reply, “You can’t get in unless you’re invited…but I can probably get you in.” [WSJ]

Sometimes it seems that human nature just dooms us to want to believe in impossibly easy money. If you aren’t familiar, check out this previous post on 12DailyPro (another Ponzi which suckered in a much less wealthy crowd) and a book about life of the original 1920s Charles Ponzi.

Filed Under: Investing //

Historical Distribution of Annual US Market Returns From 1825-Present: How Bad Was 2008?

Posted on December 11, 2008 // 19 Comments

Here is a chart that plots out the distribution of annual returns of the US stock market as measured by the S&P Market Index*. Guess where 2008 is so far?

This chart does a great job to fix the assumption that some have that the 8% or 10% annual returns we hear about come every year. Nope, those are just historical averages. Sometimes we lose 40% or more, and sometimes we gain 40% or more – in just one year! So you can’t say today that it will take X years at 8% per year to get back to what you had before. It could take longer, or it could take a lot less.

* The source for this data is a bit vague since both the S&P company and the S&P 500 index did not exist in 1825. Most sources quote Value Square Asset Management, Yale University. I found it via Daily Kos through Bogleheads and Get Rich Slowly. Here is another similar graph. It is not clear if the chart is based on total annual return, or simply a percentage change in price each year, but it looks like the latter. This paper (also from Yale) with data from 1815 to 1925 might be related.

Filed Under: Investing //

Saving More May Allow You To Take Less Stock Market Risk

Posted on December 11, 2008 // 14 Comments

Vanguard has a new article titled The importance of saving more, which tries to address evidence that investors may believe that “choosing investments that offer the possibility for relatively higher returns—and accepting the accompanying greater degree of risk—is a more viable alternative than saving more.”

In addition, the last few months probably have many of us re-examining the amount of risk we are comfortable with in our portfolios. I know I have. So what can we do?

Taken from the article, the figure below shows hypothetical outcomes for different portfolios based upon the following scenario: A 35 year-old individual begins saving 4% (grey bars) of his gross annual salary ($50,000, adjusted annually for inflation) each year for 30 years. In the red bars, the same individuals instead saves 6% of his salary. I highlighted two of the more interesting situations with the green arrows:

Here you see that based on historical data, the combination of a 50% stock/50% bond allocation and a 6% contribution rate leads to a similar range of outcomes as a 100% stock allocation and a 4% contribution rate. In fact, the former has a slightly better median outcome with much smaller swings over the years.

For example, a 50/50 asset allocation this year would have been down only around about 20%, instead of the stomach-churning 40% drop of a 100% stock portfolio. Wouldn’t that have been nice?

Higher savings provides a higher probability of success by shifting some of the responsibility for accumulation from the less-certain return stream of risky assets to a more-certain savings stream. In the end, if an investor is trying to maximize future wealth, a marginally higher savings rate rather than a substantially higher risk portfolio is the most likely path to retirement success.

As opposed to many rules of thumb, not everyone at the same age has to have the same asset allocation. Savers may get to take less risk and sleep better at night. 🙂 Something to think about…

Filed Under: Investing, Retirement //

December 2008 Investment Portfolio Update

Posted on December 9, 2008 // 23 Comments

I’ve been trying to re-balance my portfolio using my recent 401k contributions, but I ran into some speed bumps, so here is a brief interim update.

9/08 Portfolio Breakdown
 
Retirement Portfolio Actual Target
Asset Class / Fund % %
Broad US Stock Market 27.7% 34%
VTSMX – Vanguard Total Stock Market Index Fund
DISFX – Diversified Stock Index Institutional Fund*
FSEMX – Fidelity Spartan Extended Market Index Fund*
US Small-Cap Value 9% 8.9%
VISVX – Vanguard Small Cap Value Index Fund
Real Estate (REITs) 8.5% 8.5%
VGSIX – Vanguard REIT Index Fund
Broad International Developed 25.8% 25.5%
FSIIX – Fidelity Spartan International Index Fund*
International Emerging Markets 7.1% 8.5%
VEIEX – Vanguard Emerging Markets Stock Index Fund
Bonds – Short-Term 4.6% 3.8%
VFISX – Vanguard Short-Term Treasury Fund
Bonds – Inflation-Indexed 12.7% 11.3%
VIPSX – Vanguard Inflation-Protected Securities Fund
Cash 4.7% 0%
FDRXX – Fidelity Cash Reserves
Total Portfolio Value $95,678
 

* denotes 401(k) holding given limited investment options

Contribution Details
For 2008, we have finally both contributed the annual maximum of $15,500 each towards our respective 401ks. We have not made any 2008 IRA contributions, but we did make 2007 contributions in April 2008. We will likely do our 2008 contributions in April 2009 deadline.

YTD Performance
The 2008 year-to-date time-weighted performance of our personal portfolio is now -42.5% as of 12/8/08.

For reference, the Vanguard S&P 500 Fund has returned -36.69% YTD, their FTSE All World Ex-US fund has returned –47.98% YTD, and their Total Bond Index fund is +2.20% YTD as of 12/8/08. The Vanguard Target 2045 Fund has returned -35.79 YTD, primarily due to a small international allocation.

Investment Changes
In my wife’s 401k plan, a few new investment options were added, including the Fidelity Extended Market fund (FSEMX). This is a nice complement to their in-house S&P 500 index fund. If you take 75% S&P 500 and 25% Wilshire 4500 Completion Index, you pretty much get the Total US Market, so we have moved our investments to that and sold off the bit that we had in the actively-managed Dodge & Cox fund. Nothing else in that 401k is terribly appetizing.

We have used our new contributions to bring us back towards our asset allocation target, with a 85% stocks/15% bonds split. This means I have been buying more International, REIT, and Small Cap. I have also been swapping funds around to make things “fit” better, due to the limitations of spreading money across different accounts.

You’ll notice that I am really below-target in my US allocation, and have $4,500 in cash. This is because the fund minimum for the Fidelity Spartan Total US index fund is $10,000 (in my 401k). In early 2009, I hope to add enough money to reach the minimum. I could buy ETFs instead or another more expensive Fidelity fund as a tracker, but not sure if I want to pay the roundtrip commissions given that it will be less than a month. Currently on the fence.

You can view all my previous portfolio snapshots here.

Filed Under: Investing, Retirement //

December 2008 Financial Status / Net Worth Update

Posted on December 4, 2008 // 24 Comments
Net Worth Chart 2008

Credit Card Debt
I have no actual consumer debt. In the past, I have been taking money from credit cards at 0% APR and immediately placing it into high-yield savings accounts or similar safe investments that earn 3-5% interest or more, and keeping the difference as profit. I even put together a series of step-by-step posts on how I make money off of credit cards this way. However, given the current lack of good low fee 0% APR credit card offers, I don’t think I’ll be doing anymore in the near future.

Retirement and Brokerage accounts
Ignoring new contributions, my retirement accounts have lost about ~$8,500 over the last month. I will perform another portfolio update soon to find more accurate year-to-date return numbers.

I have sent in another $5,000 late last month and $5,000 this month in order to max out my pre-tax 401k contributions for this year. My asset allocation is way off target so I need to sit down and try to rebalance using these funds today. It might be tricky to due to the $10,000 minimums for index funds at Fidelity, and I might actually buy ETFs and pay the trade commission.

Cash Savings and Emergency Funds
Why am I not panicking (yet)? Well, I think a big part is my fat cash pile that serves as my emergency fund. In my mind, having a separate short-term reserve keeps me from worrying about my long-term “can’t touch” portfolio.

I have about $49,000 net in sitting in different forms of safe cash earning from 3 to 6% interest, while now my entire retirement portfolio is worth about $93,000. I will keep accumulating cash until I reach a full year’s worth of expenses, which is about $60,000. I think this is prudent given the high unemployment rate right now.

Home Equity
This is the second month of testing out my new way of estimating our house’s value. Again, I take the average estimates provided by Zillow, Cyberhomes, Coldwell Banker, and Bank of America. Then, I shave off 5% to be conservative and subtract 6% for expected real estate agent commissions (11% total). I use this final number as my estimate for home value. Looks like my home value has dropped by another 1% or so.

Overall, another tough month. However, I am very thankful we both still have jobs – knock on virtual wood!

You can see our previous net worth updates here.

Filed Under: Goals, Investing, Real Estate, Retirement //

S&P 500 at 750: Thoughts From A Market Timer

Posted on November 21, 2008 // 35 Comments

I knew I shouldn’t have turned on CNN in the hotel. I go away for a week and it’s 1997 again!

I don’t feel like posting any more articles from the “buy-and-holders“, although I remain one. So how about some commentary from John Hussman, whose fund HSGFX is actually even for the year down “only” 15% YTD. I don’t own this fund and am not saying he’s always right, but I think he does a good job of laying out the reasons for his conclusions.

His November 17th weekly commentary is long, but worth the read. Some excerpts:

Our activity as investors is not to try to identify tops and bottoms – it is to constantly align our exposure to risk in proportion to the return that we can expect from that risk, given prevailing evidence.

As for extreme and less likely benchmarks, the 780 level on the S&P 500 would represent a 50% loss from the market’s peak, and would put the market in the lowest 20% of all historical valuations. I would expect heavy demand from value-conscious investors about that level if the market were to decline further, and a decline below that level could be expected to reverse back toward 780 fairly quickly. Further down, but very unlikely at this point from my perspective, the 700 level on the S&P 500 would represent the lowest 10% of historical valuations, 625 would put the market in the lowest 5% of valuations, and anywhere at 600 or below would put the market in the lowest 1% of historical valuations. I don’t expect to see such a level, but there it is. Note that these estimates are unaffected by how low earnings might go next quarter or next year. Stocks are not a claim on next quarter’s or next year’s earnings – they are a claim on an indefinite stream of future cash flows.

As a side note, do your best to filter out comments like “investors are moving out of stocks and into …” or “investors are selling into this decline” or “investors are buying into this rally.” On balance, investors do not sell shares, and they don’t buy shares. Every share purchased is a share sold. The only question is what price movement is required to prompt a buyer and a seller to trade with each other. No money will come off the sidelines into stocks. No money will come out of stocks and onto the sidelines. All such talk is non-equilibrium idiocy. Keep in mind that the “market” consists of different traders with a variety of time-horizons, risk-tolerances, and analytical methods (e.g. technical, report-driven, value-conscious). It is helpful to think in terms of which group of individuals is likely to do what, and when. It is equally important to know which group of investors you belong to. As the old saying goes, if you’re at a poker table and you don’t know who the patsy is, you’re the patsy.

Here’s my attempt at a quick summary: While the present looks bleak, the potential for future returns is looking brighter and brighter for long-term investors. The opposite was true a few years ago. If you’re young and still putting money away, this is a good thing! (Although adequate emergency funds should be your first goal.)

Filed Under: Investing //

Vanguard’s New Self-Employed 401(k) Plan – Roth Option Included

Posted on November 16, 2008 // 22 Comments

Vanguard has recently announced the details of their Individual 401(k) plan – otherwise known as Solo 401k or Self-Employed 401k. Although you can’t apply yet it seems, many of us passive investors have been waiting for Vanguard to offer this for a long time.

The Vanguard® Individual 401(k) plan is a retirement plan for self-employed individuals. This plan is available only to sole proprietors or partners in business who have no common-law employees. The only other participant allowed in this plan would be a spouse of the business owner if he or she works for the business. Business owners should not establish this plan if they have common-law employees, including their children.

There is some confusion as to whether this includes the sole owners of an S-Corporation, but I’m betting it does as it is a passthrough entity and we are essentially self-employed. Here are some more Vanguard-specific details, along with some comparison with the Fidelity Self-Employed 401(k) which I currently have:

  • Seems like you can buy any Vanguard fund with no commissions, and there is “no minimum initial investment required to open most funds” (emphasis mine). It doesn’t seem like you have the option to buy ETFs through their brokerage service. At Fidelity, the Fidelity funds are also free, but I am subject to minimum initial investments. However, I do have the ability to buy any ETF with a $12-$20 commission, as well as buy individual bonds.
  • The Vanguard Individual 401(k) will accept three types of employer and employee contribution sources: individual employee salary deferral contributions (pre-tax money), traditional employer contributions (pre-tax money), and Roth salary deferral contributions (post-tax money). Roth is available! Fidelity does not have this.
  • Employees can move money between different Vanguard funds by phone or in writing only. This is kind of a pain. I can manage my Fidelity Self-Employed 401(k) online like a regular brokerage account, with limit trades and everything.
  • There are no set-up fees charged to the employer for a Vanguard Individual 401(k) plan. Vanguard charges employees a $20 annual account service fee for each mutual fund held in an account within the Vanguard Individual 401(k). If you like to own multipole funds, that can add up quickly! (Note: If at least one participant in a Vanguard Individual 401(k) plan qualifies for Flagship™, Voyager Select™, or Voyager™ Services, the account service fee will be waived for all participants in the plan.) Fidelity has no setup fees, and no annual account fees at all.
  • Rollovers are permitted out of the Vanguard Individual 401(k), but not into it. Not sure why this is the case.

This is only a superficial review, but so far I’m not planning to try and open one. It turns out that I am quite happy with my Fidelity Solo 401k, as it provides a lot of flexibility, great customer service, and reasonable costs. Vanguard has a wider array of index funds, but I can also buy the equivalent Vanguard ETFs at Fidelity. If I buy in large enough chunks, the commission is balanced out by the lower annual expense ratios. Besides, if you are at not at least Voyager ($50k in assets), the $20 fee per fund from Vanguard costs as much as two trades anyway.

The main thing going for Vanguard is the Roth option, which I must admit should be very attractive for most people. But for us, our current tax bracket is high enough that I prefer pre-tax contributions.

Via Guzzo the Contrarian and Bogleheads.

Filed Under: Investing, Retirement //

CA Residents: $50 Gift Card For ScholarShare 529 Plan

Posted on November 15, 2008 // 8 Comments

Here is another 529 account bonus, but only open to California residents. If you open a California ScholarShare 529 College Savings Plan today and sign up for automatic investing of at least $50 per month on the account, and you’ll receive a $50 Target GiftCard.

From the fine print:

To receive a $50.00 Target GiftCard (a “Gift Card”), eligible individuals must (a) open a new account under the ScholarShare Plan (a “ScholarShare Account”) within 30 days of registering for the Gift Card offer between August 15, 2008 and December 31, 2008 and (b) establish an automatic investment plan for the ScholarShare Account of at least $50 per month, with the initial $50 automatic investment contributed and invested within 90 days after the ScholarShare Account is opened. Limit: two (2) Gift Cards per person. Each ScholarShare Account must have a different designated beneficiary and be individually owned (no trust, custodial or other ownership arrangements).

Filed Under: Deals & Offers, Investing //

$25 Referral Bonus: Ohio CollegeAdvantage 529 Plan

Posted on November 14, 2008 // 14 Comments

The Ohio CollegeAdvantage 529 Savings Plan is currently offering a $25 refer-a-friend bonus if you open an account and deposit at least $25 by December 15, 2008. You can be a resident of any state, and there are no application or annual fees.

Is This Ohio Plan Any Good?
After doing some research on the best 529 plan for those without an in-state tax break, my opinion was that the two best overall 529s were the Ohio CollegeAdvantage and the Illinios BrightStart plans. Illinois uses Vanguard, has a decent variety of low-cost index options (average ~0.20% total annual expense ratio), and has one of the lowest fee structures around. Ohio is similar – they use Vanguard, are a bit more expensive (average ~0.30% total annual expense ratio), but have a few more investment options like inflation-protected bonds. So yes, it is a solid plan.

Collecting 529 Bonuses
We don’t have kids (yet), and yet I’ve opened a bunch of different 529 plans in different states for their bonuses or in-state resident tax advantages. The nice thing is that you can usually roll them over into another 529 plan, although some states do a tax recapture. (Oregon didn’t.) So open an account, get the bonus, and just see if you like it. If you don’t have kids yet, simply list yourself, your spouse, or even your parents as the beneficiary. You can always change it later.

For the curious, I am currently in a New Hampshire plan run with 0.50% expense ratio by Fidelity because I have a grandfathered-in 2% cash back card that deposits into the 529. Given how good the Ohio account is, one day I might be rolling everything over there.

Referral Bonus Instructions
Both the referred and referree get $25, and I’d love for you to help fund my future kid’s college. 😉 Here are the easy instructions:

  1. You can enroll online or via mail. The online process was quick and easy, and I didn’t have to mail in anything.
  2. The first step is to input your personal info and choose a login/password. Next, you’ll verify your e-mail and complete the application.
  3. After that, you’ll choose your funding amount and select an investment fund. Your initial deposit must be a least $25, and is funded using the account/routing numbers of your bank account. At the bottom, you will need to enter a referral code to get the bonus. Enter 2465786.
  4. In 1-3 days, your initial deposit will be sucked out, and in 5-7 business days you will get your $25 bonus. The $25 will be deposited directly into the 529 account, and will be invested in the same thing as your initial deposit.

I opened the account last week and got my $25 bonus successfully and as promised:

Filed Under: Deals & Offers, Investing //

Should I Invest In My 401(k)’s Stable Value Fund?

Posted on November 6, 2008 // 28 Comments

While investigating the bond options in my wife’s 401(k), I noticed that the only “safe” option in her account was a Stable Value fund. I have noticed this label before, but never really paid them much notice. What is a stable value fund?

The pitch: “Cash with better interest”. You get the safety and stability of principal found in a money market fund, but with the higher returns of an intermediate bond fund. Here is a graph from 1990-2006 via the Stable Value Investment Association website (yellow is money market, blue is stable value, and red is bond fund):

How? In essence, stable value funds invest in intermediate-term bonds and similar investments, but the usual day-to-day fluctuations are smoothed out by the guarantee of an insurance company. For example, the insurance company guarantees that a certain amount of interest will be paid. If the actual return from investments fall short, the insurance company makes up the difference. If the actual investments outperform, then the insurance company keeps the difference.

This insurance guarantee also keeps the per-share price (NAV) at $1, much like a money market fund, even though the assets being held are riskier. Because they are limited to qualified retirement plans like a 401(k) or 403(b), they are allowed to use “book value accounting” instead of the more strict daily “market value accounting” required of most retail mutual funds.

What are the risks? In most cases, even if investments perform poorly, the insurance company will eat the loss rather than face the bad publicity. This is similar to money market funds. However, the danger is when things go so bad that the insurance company goes bankrupt. An example is the Trust Advisors Stable Value Plus fund which failed, as outlined by this NY Times article. Although technically the investors eventually recovered all their principal, it took over a year for everything to settle. There have been other isolated instances where investors have lost a portion of their principal.

To invest or not? Stable value funds are pretty popular, and found in 2/3rds of all 401(k) plans. Who wouldn’t want a fund with hardly any volatility that pays high interest? The fund in my wife’s 401(k) is “guaranteed” to earn 4.55% for all of 2008. Be careful though, because they are not all made the same. According to this study by JP Morgan Chase, returns from good/bad stable value funds can differ by up to 2% per year.

As for safety, I would treat it like a money market fund in that you should only buy if you trust the insurer and learn about the actual holdings. Otherwise, buy a bond fund somewhere else if you smell something fishy. Unfortunately, if you really want a “safe” holding place inside your 401(k), many times you don’t have much choice. Finally, I would also point out that in the end they are still bonds, and are subject to the risk of having their modest returns eaten up by inflation. If you are a young investor, stocks still provide the best long-term growth prospects.

Filed Under: Investing //
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