If Retail Investors Are Dumb Money, Who Is Raking Up All The Alpha?

Posted on September 29, 2021 // 4 Comments

Here’s a follow-up to my post about the return gap of retail investors due to poor timing. For every seller of a stock share, there is a buyer. Therefore, if the timing of retail investors is reliably a little worse than average, we also know that someone else is on the other side of all those trades. Is there a group of non-retail investors that is reliably making money off the “dumb money” trades of retail investors?

Larry Swedroe digs into this question in his Advisor Perspectives article The Suckers at the Investment Table:

New research confirms that institutional investors, such as mutual funds, outperform the market before fees, and they do so at the expense of retail investors. That is bad news for retail investors and for investors in active mutual funds, who underperform after fees.

The research finds that the stocks and bonds individual investors buy go on to underperform and the ones they sell go on to outperform – demonstrating that retail investors are “dumb money.”

Unfortunately for fund investors, the same large body of evidence demonstrates that while mutual funds generate gross alpha, their total expenses exceed gross alpha, resulting in negative alphas for their investors.

If on average, an actively-managed mutual fund generates 0.7% of gross alpha, but after you subtract the expense ratio and trading costs which add up to nearly 1%, the net alpha is still negative. The active manager is the winner, taking all of the alpha for themselves in the form of relentless fees taken as a percentage of the entire asset base. The retail investor/customer still loses out. An fairer fee structure would be to take a larger percentage, but of the alpha only.

People will continue to argue about this, but I’m not surprised to see that these studies found alpha. It’s just much, much harder to do than most people think, and that’s exactly why you almost never see a fee structure based on alpha (thought they do exist). Even Charlie Munger, who is famous for his stock-picking skills and disagreement against the “hard” form of Efficient Market Theory, only says that the top 3% to 4% of professional investment managers will outperform (source):

I think it is roughly right that the market is efficient, which makes it very hard to beat merely by being an intelligent investor. But I don’t think it’s totally efficient at all. And the difference between being totally efficient and somewhat efficient leaves an enormous opportunity for people like us to get these unusual records. It’s efficient enough, so it’s hard to have a great investment record. But it’s by no means impossible. Nor is it something that only a very few people can do. The top three or four percent of the investment management world will do fine.

In the end, costs always matter. If you find a genius to pick stocks but they cost more than they help, then you still lose. The only actively-managed mutual funds that I have seriously considered buying are from Vanguard, which improves the odds with substantially lower expense ratios and a history of investor-friendly practices. As a DIY individual investor buying index funds, you can keep your head down and “grind out” reliably above-average returns over time due to the rock-bottom costs. (There, I fit in my own poker reference!) Even as a DIY individual stock investor, as at least I understand what I own and don’t have to pay a 1% management fee every year.

Filed Under: Investing, Retirement //

Mind The Gap: How Investor Timing Affects “Real-World” Returns

Posted on September 28, 2021 // 2 Comments

Morningstar has released the 2021 update to their annual Mind The Gap study, which measures the gap between reported investment returns (buy and hold throughout the entire period) and investor returns (actual returns experienced due the real-world timing of buy and sell transactions). How well does the average investor time their purchase and sell transactions?

For the 10-year period from 12/31/2010 to 12/31/2020, the average return gap was negative 1.7% annually, with negative gaps across the board:

Investors in US stock funds had a 10-year return gap of negative 1.2% annually. This gap has varied over past rolling 10-year periods, but has been consistently slightly negative:

Now, this is not completely due to performance chasing. Here’s a quick example of how steady dollar-cost averaging may also result in a return gap:

To use a simple example, let’s say an investor puts $1,000 into a fund at the beginning of each year. That fund earns a 10% return the first year, a 10% return the second year, and then suffers a 10% loss in the third year, for a 2.9% annual return over the full three-year period. But the investor’s dollar-weighted return is negative 0.4%, because there was less money in the fund during the first two years of positive returns and more money exposed to the loss during the third year. In this case, there was a 3.3-percentage-point per year gap between the investor’s return (negative 0.4%) and the fund’s (2.9%).

Morningstar ran some extra simulations and DCA does possibly account for some of the gap, but a perfectly-steady DCA investor still outperformed the real-world investor in 6 out of 7 fund categories. DCA can’t be helped if you are simply investing what you can, when you can, but there is still extra trading in and out that appears to only make things worse.

The most boring fund category that includes Target-Date funds has the smallest return gap. Target-date funds are included in the “Allocation” fund category as they include a managed mix of stocks, bonds, and other classes. These funds have the calmest trading activity, and we see that the return gap has been consistently smaller over time:

The fund categories with the most volatile cashflows in and out have the greatest return gaps. Alternative funds and sector equity funds did the worst.

Investing in a low-cost target-date fund (TDF) is easy to dismiss as “too simple” or for the “inexperienced newbies only”, but often the inaction of TDF investors work in their favor. Maybe we should give credit to the humble investors that knows they could do a lot worse by thinking they have skills that they don’t actually have. (Meanwhile, I’m also guilty of thinking that I can do better than a TDF.) From a Bloomberg article using Mind the Gap data from 2015:

But target-date funds have one big advantage over other kinds of mutual funds, the data show. The average mutual fund has a flaw, which is that the average investor hardly ever does as well as his or her funds. Investors tend to jump in and out of funds at the wrong time. They buy high, choosing funds only after they’ve done well. And they sell low, dumping underperforming funds just as they’re about to take off.

targetdategap

Filed Under: Behavioral Economics, Investing, Retirement //

Public REITs vs. Private Equity Real Estate Funds: A Performance Comparison

Posted on September 24, 2021 // Leave a Comment

There are many ways to access real estate as an asset class – publicly-traded REITs like Realty Income, diversified REIT ETFs, private funds that hold baskets of individual properties, and many new fintech varieties. This Institutional Investor article discusses a new research article comparing public REITs and closed-end private equity real estate (PERE) funds:

In a new study published in the Journal of Portfolio Management’s real estate issue, authors Thomas Arnold, David Ling, and Andy Naranjo found that, when compared side-by-side, real estate investment trusts outperformed U.S. closed-end private equity real estate, or PERE, funds by 165 basis points annually.

Here is another Nareit article about the study, where I noticed that the research was actually sponsored by Nareit. Here is a direct link to the study itself.

This other Institutional Investor article points out one of the “benefits” of private real estate funds – namely the fact that they don’t offer accurate daily pricing. You should also consider this a “benefit” of personal homeownership – when things are scary, houses simply don’t sell (instead of giving you a shockingly low price at that moment).

REITs, like any public security, are priced in real time. At the depth of the economic shutdown in March and early April, REIT investors imagined doomsday scenarios as commercial property and hotels sat empty and analysts forecasted that individuals would be unable to make rent payments for the foreseeable future. The price of REITs fell in line with that outlook.

In contrast, private real estate funds use other valuation methods, including appraisals — which depend on property transactions. Back in March and April, no real estate was changing hands to inform these valuations. As a result, the net asset values of private portfolios didn’t reflect the carnage.

Real estate continues to intrigue me, but I’ve always stopped short of directly investing in a rental property because I want to avoid any management responsibility (or even the responsibility hiring a good property manager). To me, rentals are best considered a potentially-lucrative part-time self-employed business opportunity, with the greater upside and downside involved. I also love that I can completely ignore my portfolio for months at a time, and the dividends and interest payments still keep coming in.

I’ve experimented with other options like PeerStreet, Fundrise and others, but the vast majority of my real estate investments are still in the low-cost index ETF VNQ (Vanguard Real Estate ETF). As long as you are good at ignoring the price drops during the scary times, it has been a solid long-term holding. Per Morningstar, here is the growth of $10,000 invested in VNQ since inception 25 years ago (with dividends reinvested!):

Filed Under: Investing, Real Estate //

Stash Review: Simplified Automated Investing, Improved $80 New Account Bonus, Stock Parties

Posted on September 21, 2021 // 4 Comments

Updated with MyPoints promo and Stash Stock Party info. MyPoints has a new Stash promo that has a total value higher than the $20 Stash referral offer. If you don’t already have a MyPoints account, you can first join via this $10 MyPoints referral link to grab an additional $10 upfront bonus. Then log into your MyPoints account and search for “Stash”. Right now, MyPoints is offering 11,000 points (worth $70 in gift cards including Amazon) if you open via their link and deposit at least $5. Stash will give you another $10 as well, for a total bonus of $80. This is a limited-time offer. Their fine print:

*Points will appear as Pending for 32 days.
Must enter valid sign-up information, including bank account information to earn Points.
Offer may only be redeemed once (1) per user.

Original post with full review:

Stash is an investing app targeted that people who want a simple way to build a long-term diversified portfolio, as opposed to day-trading meme stocks, crypto, or high-risk options. All you need is five bucks, a smartphone, and a bank account.

Fee structure and plan features. Stash charges a simple, flat monthly fee. The three plan options are $1/month, $3/month, and $9/month (screenshot below). You make purchases in dollar-based amounts (fractional shares) and there are zero commissions per trade. Each ETFs still has its own underlying expense ratio, as with all brokers.

$1 a month tier (Beginner)

  • Taxable brokerage account and your selected mix of individual stocks and/or ETFs.
  • Automated investing. You choose how much money to direct each month, and all of that money will automatically be fully invested via fractional shares.
  • Stock-Back rewards debit card. If you open an optional bank account (Green Dot Bank), they will issue you a debit card that earns rewards in the form of stock shares. Earn 0.125% stock on all of your everyday purchases, and up to 5% at certain merchants with bonuses.
  • Savings and budgeting tools to help decide the right amount to put aside each month.
  • $1,000 in life insurance.

$3 a month tier (Growth)

  • Everything in the Beginner tier above, plus…
  • Traditional and Roth IRAs are supported.
  • Smart Portfolio. At this higher tier, Stash will help you design a target mix of ETFs that fits your needs.
  • Automatic rebalancing. Stash will automatically monitor and rebalance your portfolio as needed, if it drifts away from your target portfolio.

$9 a month tier (Stash+)

  • Everything in the Beginner and Growth tiers above, plus…
  • Children’s Custodial accounts. Invest in separate UGMA /UTMA account for your children under 18.
  • Double Stock Back. Get special bonuses the Stock-Back® Card and double the rewards you would earn on the regular tier.
  • Automatic rebalancing. Stash will automatically monitor and rebalance your portfolio as needed, if it drifts away from your target portfolio.
  • $10,000 in life insurance.

Stock and ETF trades are executed during four trading windows each weekday. Dividend reinvestment is offered on taxable, IRA, and custodial accounts. Stash Investments LLC is an SEC registered Investment Advisor, which means they are licensed to provide you retirement and investing advice. For me, the relatively low rewards percentage on their Stock Back card is not high enough to make it stand out, especially when compared to the 1% to 2% cash back you can get from other rewards credit cards.

The main draw to this app is the ability to automatically build a portfolio using small, regular amounts. This feels like a descendent of dividend reinvestment plans (DRIPs) where you would send in a check for $25 or $100 and be invested in a company’s stock like ExxonMobil. My great-aunt still gets a check every quarter from ExxonMobil from a DRIP she started decades ago. These days, you can pick nearly any company or group of companies via index ETFs.

Many other stock brokers offer commission-free trades, but the set-and-forget feature where it just sucks money from your bank account every month is very important. You can invest as little as $5 a month, automatically. Of course, this is a crowded field nowadays, and if you had the $1,000 minimum required for a Vanguard Target Retirement mutual fund at Vanguard.com, you could also make automatic additional investments of as little as $1 a month. I would also consider M1 Finance a close competitor.

Sign-up process.

  • Sign up via app or online. Now available on desktop, iOS, and Android.
  • Your personal information (name, address, SSN), same as with all SIPC-insured brokerage accounts.
  • Fill out a short risk questionnaire to help guide you towards an appropriate investment.
  • Pick your investment, which you can change later.
  • Fund with any bank account. Verification can be done via two small test deposits. For many banks, you can expedite the linking process by using your bank login credentials instead.

Stash Parties for free bits of stock. Every few days, the app will notify you of an upcoming “Stash Stock Party“:

By attending a Stash Stock Party, Stashers can get pieces of offered stock(s). The amount of stock depends on the amount of people that attend the Stock Party—the more people that show up, the bigger the split prize pot (and your share of it) ultimately grows. To join a party, just visit this page (party.stash.com) on the party day, log in, and tap Claim stock.

If you log in during their pre-announced short window of time, you can claim a tiny bit of free stock (might only be 10 cents or 30 cents of stock). This is definitely gimmicky, but I realized that it basically covers my a $1 monthly subscription fee, and now I get to watch how these tiny bits of stock can grow over time. They are like little free lottery tickets. If I am not busy, I pick up them up. If I’m busy, no big deal. I have no plans to sell them. Here are some screenshots showing just a portion of my little tiny stock positions:

$20 referral bonus. Right now, if you sign up via a Stash referral link, you can get $20 of free stock (or cash). The standard amount used to be only $5. That is my link, so thanks if you use it! You must open an account, link a bank account, and fund with at least a penny ($0.01) into your new Stash investment or bank account. You don’t need to make a stock purchase, although you certainly can. Screenshot with details:

Bottom line. Stash is a financial app that allows you to gradually and automatically build an investment portfolio using regular purchases of a mix of individual stocks and ETFs. They charge a flat monthly fee starting a $1 per month. Right now, new users can get $20 of free stock to start via referral link.

Also see: Big List of Free Stocks For New Commission-Free Brokerage Apps

Filed Under: Investing, Reviews //

Were Vanguard’s 10-Year Stock Market Return Forecasts Accurate? Or Really Wrong?

Posted on September 20, 2021 // 3 Comments

Periodically, Vanguard publishes asset class return forecasts for the next 10 years. Here is their most recent one for September 2021. To their credit, they have also published a recent follow-up post tracking both those forecasts alongside the actual returns in retrospect. This is a good lesson on the difficulty of any sort of short-term market prediction, even after allowing yourself 10 years and wide error bars.

Below is a chart tracking their forecasts for the future 10-year average annualized returns of US stocks. Eyeballing their chart, for 2010-2020 their range of confidence was somewhere between roughly 5% and 10% annually, for a median around 7.5%. This accounts for their model’s 25th percentile to 75th percentage range of possible outcomes. This is a pretty big range! $100,000 times 5% annualized returns after 10 years is $163,000. $100,000 times 10% annualized returns after 10 years is $259,000.

Even accounting for that wide range, their forecast for US stocks was off. While the curve looks vaguely similar, US stocks did significantly better than their forecast:

Again, even accounting for the huge range of guesses, their forecast for international stocks was also off. Global non-US stocks did significantly worse than their forecast:

Vanguard’s original chart focuses on their 60/40 portfolio, which happens to look a lot better. Why? Their 60/40 portfolio consists of 36% US equities, 24% global ex-US equities, 28% US bonds, and 12% ex-US bonds. For one, future bond returns are much more simple to predict than stock returns. Your current 10-year yield is going to be pretty close to your eventual 10-year return. In addition, their US equities forecast was really wrong in one direction (too low), while their international equity forecast was wrong in the other direction (too high), so they tended to offset each other. Is this diversification in action? Certainly, yes, but also luck in my opinion. Both could have also been wrong in the same direction.

Should we just ignore this stuff completely then? I keep thinking back to this illuminating chart comparing the contributions of earnings growth, dividends, and P/E ratio changes to the total return of the S&P 500. Earnings growth and dividends have been pretty consistent for over 70 years, but the overall swings in return have been mostly caused by P/E ratio expansion and contraction.

Consider the analogy that P/E ratio expansion and contraction behaves like a rubber band. It can stretch pretty far, much farther than you might expect, but as you keep stretching it, the stronger it will eventually want to come back. But you never really know how far it can stretch, or when it will snap back. Forecasts can be wrong for a long, long time. You have to balance knowing that the run will end eventually, but not knowing when. Someone will always be right in retrospect.

If only we could focus solely on the earnings growth and dividends. Those are what really matter in the long run. This is the behavioral benefit of remembering that dividends are a share of profits being distributed to you as a business owner. Even if prices on a screen are dropping, the businesses are still working hard, making profits, reinvesting some for more earnings growth, and sending some of it to you as cash.

Filed Under: Investing, Retirement //

Reader Question: Should I Buy Savings Bonds in September/October 2021 or November 2021?

Posted on September 19, 2021 // 23 Comments

sb_poster

Here’s a timely reader question about Series I Bonds. It’s a good question because I predict that Series I Bonds will be soon getting even more media attention soon due to an even higher inflation-linked rate.

Would it be best to wait till November 1st to purchase I bonds? You mentioned the fixed rate will probably confine at 0. but what about the semiannual inflation rate? Do u think it is likely to be more than 3.54%? I’m new to this please educate me.

Series I Bond rates react every 6 months to delayed inflation reports from the Bureau of Labor Statistics. August CPI-U was already reported in mid-September, and September CPI-U will be reported in mid-October. 5 out of 6 months of data are already in the books, leaving only one month of data left. The 12-month trailing inflation rate as of that August CPI-U update was over 5%. Therefore, unless that data contains a significant amount of deflation, we already know that the next inflation rate on Series I Bonds is going to be higher than the 3.54% from May to October 2021. I roughly estimate the range that the next inflation rate will be between as 5% to 7%. That should be enough accuracy to make a purchase timing decision, earlier than my usual practice of waiting until mid-October.

  • If you buy in September or October 2021, you will receive a total rate of 3.54% for the first six months, then the “new” (estimated 5%-7%) rate for the next 6 months, and then new rates adjusted every six months for inflation onward.
  • If you buy in November 2021, you will receive the “new” (estimated 5%-7%) rate for the first 6 months, and then new rates adjusted every six months for inflation onward.

The takeaway is that either way, you will earn the “new” rate (estimated 5%-7%) eventually. If you buy in September/October, you’ll just have to wait a bit due to the staggered structure. Given that the current rate of 3.54% is still a higher interest rate than nearly any other savings account or CD is paying, I would personally just invest now if I had the cash ready and waiting. Also remember that Series I Bonds do not allow early withdrawals within the first 12 months after purchase date. As long as you complete your purchase by the end of September, it will count as purchased in September 2021 and you will be able to withdraw as of September 1st, 2022 (though subject to a penalty if held less than 5 years). It may take a little bit to set up your TreasuryDirect account, and it may take a couple business days for the withdrawal and purchase to process, so I wouldn’t wait until the last day.

Annual purchase limits. The annual purchase limit is now $10,000 in online I-bonds per Social Security Number. For a couple, that’s $20,000 per year. You can only buy online at TreasuryDirect.gov, after making sure you’re okay with their security protocols and user-friendliness. You can also buy an additional $5,000 in paper I bonds using your tax refund with IRS Form 8888. If you have children, you may be able to buy additional savings bonds by using a minor’s Social Security Number.

As noted in my previous savings bond posts, these Series I bonds are a unique investment opportunity in that they are only available to individuals and are subject to purchase limits. Even if the real yield (fixed rate) is set at zero, that is still significantly higher than that of TIPS that trade on the open market (well negative across the board!). If institutional investors like pension funds or endowments could buy I bonds like you and me, they would buying billions of them.

I plan to purchase up to my annual purchase limit for 2021 as part of my asset allocation to inflation-linked bonds, although you can start with as little as $25. I guarantee that there will be many more articles about Series I bonds in mainstream personal finance sites in November after the new rate is officially announced.

Filed Under: Banking, Deals & Offers, Investing, Savings Bonds //

John Paulson: Best Way For Average Person To Invest $100,000 Today?

Posted on September 9, 2021 // 17 Comments

Bloomberg has an interview transcript with investor John Paulson, and it has the catchy headline Billionaire Paulson Who Shorted Subprime Calls Crypto ‘Worthless’ Bubble. He does say that, but the interview also includes some insights on many other topics like asymmetrical trades, gold, the highly-limited supply of crypto leading to high volatility, interest rates, and controlling how you spend your time.

If you are having trouble getting around the paywall, let me include this quote:

If somebody came to you and asked how they should invest $100,000, what would you tell them?

I always say the best investment for an average individual is to buy their own home. So if you take that $100,000, put 10% down, get a $900,000 mortgage, you can buy a home for a $1 million. It was just reported that home prices were up 20% in the last month. So if you bought a home for a $1 million with $100,000 down and the home was up 20%, that’s $200,000 on a $100,000 investment. The longer you wait, the more the house is going to appreciate and the greater return you’ll have on your equity investment. So I think the single best investment for anyone with that type of money would be to buy their own house or apartment.

Basically, mortgages offer cheap leverage on an asset that he believe will keep going up for a while. A person can take $50,000 and control a $500,000 asset. If it goes up 10%, you just made another $50,000 and doubled your initial $50,000.

Yes, we learned that leverage works both ways in the 2008 Financial Crisis, meaning that if that $500,000 drops by 10%, you just lost your $50,000 downpayment. That’s what Paulson is most well-known for – making $20 billion betting against subprime mortgages during that crisis. In fact, I recall Paulson saying something very similar back in 2014 or so, that housing prices are going to keep going up. Here is the S&P/Case-Shiller U.S. National Home Price Index chart from Calculated Risk:

With this interview, I guess he doesn’t see this trend ending soon. I’m not saying I necessarily agree with this answer, but it is an interesting one when you consider all of the possible options.

Filed Under: Investing, Real Estate //

House Downpayments and Low Interest Rates: Keep Your Eye on the Prize

Posted on September 8, 2021 // 2 Comments

My neighbors put up their house for sale a couple weeks ago. A single open house, what felt like over 100 private showings, and in escrow within a week. So when I read this WSJ article Where to Stash Your Down Payment if You Didn’t Buy a House This Year, I felt their answer was too wishy-washy and complex. If you are looking for a house, as in – if the right one came up you would buy it – then keep your downpayment in 100% liquid and safe cash. Simple.

Keep your eye on the prize: The house + a 30-year fixed mortgage at 3%. Best quote from the WSJ article:

As Blair duQuesnay, a financial planner at Ritholtz Wealth Management, points out, there is another upside to waiting longer to buy: You can grow the original amount by ramping up your savings. “If they’re still earning, that could add to the down payment,” she said. “And the low interest rates we’re all complaining about? That’s how you’re going to get a low mortgage rate.”

Exactly. Don’t complain about earning a low interest rate on your downpayment for perhaps 12 months. Be grateful that you’ll get a low fixed interest rate on your mortgage for the next three decades! A lot can happen in that timeframe, look at the past 50 years (via @lenkeifer):

Don’t forget that the American 30-year fixed mortgage with no prepayment penalty is an amazing product that would not exist if not for government intervention. It’s an awesome inflation hedge. If you don’t move (or even if you move but don’t sell), your mortgage payment is fixed for 30 years, no matter how high inflation gets. Mortgage rates are at historical lows, but even if rates do somehow go even lower, you simply refinance. You are covered either way!

According to this LendingTree study, the average downpayment across the nation’s 50 largest metros is is $46,283. The lowest is $28,000 in Oklahoma City, and the highest is $115,138 in San Jose. That’s roughly 10% of the average home prices in each area. FHA loans require a down payment of just 3.5%.

$50,000 is a lot of money (although many people drive around in cars worth more than that….) but your time horizon is very short when house shopping. Home buying is an emotional roller coaster in the best of times, and inventory is tight. There were over 30 offers on the house that we bought, and we couldn’t sleep until our offer was finally accepted. I’m not interested in the buy vs. rent debate, as there are too many personal and local variables for there to be a single answer. If I was in the market right now, I’d have all my ducks are in a row – mortgage pre-approval, downpayment documentation, income documentation, clean and orderly bank statements, and so on.

Long-term investments and short-term investments should be treated differently. For your house downpayment, don’t worry about the stock market going up another 10%. Don’t buy risky bonds chasing another 2%. Worry that messing around with your downpayment will somehow impair your ability to buy the home that you want. If earning zero interest bothers you, check out my best rates and earn 1% to 3% APY while keeping it 100% liquid and safe. Good luck!

Image credit: Imgflip

Filed Under: Banking, Investing, Real Estate //

Best Interest Rates on Cash – September 2021 Update

Posted on September 8, 2021 // 4 Comments

via GIPHY

Here’s my monthly roundup of the best interest rates on cash as of September 2021, roughly sorted from shortest to longest maturities. I look for lesser-known opportunities to earn 2% APY and higher while still keeping your principal FDIC-insured or equivalent. Check out my Ultimate Rate-Chaser Calculator to see how much extra interest you’d earn by moving money between accounts. Rates listed are available to everyone nationwide. Rates checked as of 9/7/2021.

Fintech accounts
Available only to individual investors, fintech companies often pay higher-than-market rates in order to achieve fast short-term growth (often using venture capital). I define “fintech” as a software layer on top of a different bank’s FDIC insurance. These do NOT require a certain number debit card purchases per month. Read about the types of due diligences you should do whenever opening a new bank account.

  • 3% APY on up to $100,000. The top rate is still 3% APY for July through September 2021 (actually up to 3.5% APY with their credit card), and they have not indicated any upcoming rate drop. HM Bradley requires a recurring direct deposit every month and a savings rate of at least 20%. Due to high demand, you must currently use a referral link to join. See my HM Bradley review.
  • 3% APY on 10% of direct deposits + 1% APY on $25,000. One Finance lets you earn 3% APY on “auto-save” deposits (up to 10% of your direct deposit, up to $1,000 per month). Separately, they also pay 1% APY on up to another $25,000 with direct deposit. New customer $50 bonus via referral. See my One Finance review.
  • 3% APY on up to $15,000. Porte requires a one-time direct deposit of $1,000+ to open a savings account. New customer $50 bonus via referral. See my Porte review.
  • 1.20% APY on up to $50,000. OnJuno recently updated their rate tiers, while keeping existing customers on the grandfathered 2.15% APY rate. If you don’t maintain a $500 direct deposit each month, you’ll still earn 1.20% on up to $5k. See my updated OnJuno review.

High-yield savings accounts
While the huge megabanks pay essentially no interest, I think every should have a separate, no-fee online savings account to accompany your existing checking account. The interest rates on savings accounts can drop at any time, so I list the top rates as well as competitive rates from banks with a history of competitive rates. Some banks will bait you with a temporary top rate and then lower the rates in the hopes that you are too lazy to leave.

  • T-Mobile Money is still at 1.00% APY with no minimum balance requirements. The main focus is on the 4% APY on your first $3,000 of balances as a qualifying T-mobile customer plus other hoops, but the lesser-known fact is that the 1% APY is available for everyone. Thanks to the readers who helped me understand this.
  • There are several other established high-yield savings accounts at closer to 0.50% APY. Marcus by Goldman Sachs is on that list, and if you open a new account with a Marcus referral link (that’s mine), they will give you and the referrer a 0.50% boost on top of the current interest rate for 3 months. You can then extend this by referring others to the same offer. Right now, Marcus is paying 0.50% APY, so with the offer you’d get 1.00% APY currently for your first 3 months.

Short-term guaranteed rates (1 year and under)
A common question is what to do with a big pile of cash that you’re waiting to deploy shortly (plan to buy a house soon, just sold your house, just sold your business, legal settlement, inheritance). My usual advice is to keep things simple and take your time. If not a savings account, then put it in a flexible short-term CD under the FDIC limits until you have a plan.

  • No Penalty CDs offer a fixed interest rate that can never go down, but you can still take out your money (once) without any fees if you want to use it elsewhere. CFG Bank has a 13-month No Penalty CD at 0.62% APY with a $500 minimum deposit. Ally Bank has a 11-month No Penalty CD at 0.50% APY for all balance tiers. Marcus has a 7-month No Penalty CD at 0.45% APY with a $500 minimum deposit. You may wish to open multiple CDs in smaller increments for more flexibility.
  • Lafayette Federal Credit Union has a 12-month CD at 0.80% APY ($500 min). Early withdrawal penalty is 6 months of interest. Anyone can join this credit union via partner organization ($10 one-time fee).

Money market mutual funds + Ultra-short bond ETFs
Many brokerage firms that pay out very little interest on their default cash sweep funds (and keep the difference for themselves). Unfortunately, money market fund rates are very low across the board right now. Ultra-short bond funds are another possible alternative, but they are NOT FDIC-insured and may experience short-term losses at times. These numbers are just for reference, not a recommendation.

  • The default sweep option is the Vanguard Federal Money Market Fund which has an SEC yield of 0.01%. Vanguard Cash Reserves Federal Money Market Fund (formerly Prime Money Market) currently pays 0.01% SEC yield.
  • Vanguard Ultra-Short-Term Bond Fund currently pays 0.28% SEC yield ($3,000 min) and 0.38% SEC Yield ($50,000 min). The average duration is ~1 year, so your principal may vary a little bit.
  • The PIMCO Enhanced Short Maturity Active Bond ETF (MINT) has a 0.23% SEC yield and the iShares Short Maturity Bond ETF (NEAR) has a 0.36% SEC yield while holding a portfolio of investment-grade bonds with an average duration of ~6 months.

Treasury Bills and Ultra-short Treasury ETFs
Another option is to buy individual Treasury bills which come in a variety of maturities from 4-weeks to 52-weeks. You can also invest in ETFs that hold a rotating basket of short-term Treasury Bills for you, while charging a small management fee for doing so. T-bill interest is exempt from state and local income taxes. Right now, this section isn’t very interesting as T-Bills are yielding close to zero!

  • You can build your own T-Bill ladder at TreasuryDirect.gov or via a brokerage account with a bond desk like Vanguard and Fidelity. Here are the current Treasury Bill rates. As of 9/7/2021, a new 4-week T-Bill had the equivalent of 0.04% annualized interest and a 52-week T-Bill had the equivalent of 0.08% annualized interest.
  • The Goldman Sachs Access Treasury 0-1 Year ETF (GBIL) has a -0.07% SEC yield and the SPDR Bloomberg Barclays 1-3 Month T-Bill ETF (BIL) has a -0.09% (!) SEC yield. GBIL appears to have a slightly longer average maturity than BIL.

US Savings Bonds
Series I Savings Bonds offer rates that are linked to inflation and backed by the US government. You must hold them for at least a year. If you redeem them within 5 years there is a penalty of the last 3 months of interest. The annual purchase limit is $10,000 per Social Security Number, available online at TreasuryDirect.gov. You can also buy an additional $5,000 in paper I bonds using your tax refund with IRS Form 8888.

  • “I Bonds” bought between May 2021 and October 2021 will earn a 3.54% rate for the first six months. The rate of the subsequent 6-month period will be based on inflation again. More info here.
  • In mid-October 2021, the CPI will be announced and you will have a short period where you will have a very close estimate of the rate for the next 12 months. I will have another post up at that time.
  • See below about EE Bonds as a potential long-term bond alternative.

Prepaid Cards with Attached Savings Accounts
A small subset of prepaid debit cards have an “attached” FDIC-insured savings account with exceptionally high interest rates. The negatives are that balances are severely capped, and there are many fees that you must be careful to avoid (lest they eat up your interest). There is a long list of previous offers that have already disappeared with little notice. I don’t personally recommend nor use any of these anymore, as I feel the work required and risk of messing up exceeds any small potential benefit.

  • Mango Money pays 6% APY on up to $2,500, if you manage to jump through several hoops. Requirements include $1,500+ in “signature” purchases and a minimum balance of $25.00 at the end of the month.

Rewards checking accounts
These unique checking accounts pay above-average interest rates, but with unique risks. You have to jump through certain hoops which usually involve 10+ debit card purchases each cycle, a certain number of ACH/direct deposits, and/or a certain number of logins per month. If you make a mistake (or they judge that you did) you risk earning zero interest for that month. Some folks don’t mind the extra work and attention required, while others would rather not bother. Rates can also drop suddenly, leaving a “bait-and-switch” feeling.

  • The Bank of Denver pays 2.00% APY on up to $25,000 if you make 12 debit card purchases of $5+ each, receive only online statements, and make at least 1 ACH credit or debit transaction per statement cycle. The rate recently dropped. If you meet those qualifications, you can also link a Kasasa savings account that pays 1.00% APY on up to $50k. Thanks to reader Bill for the updated info.
  • I removed Devon bank this month because it is now restricted only to Illinois residents (previously available nationwide).
  • Presidential Bank pays 2.25% APY on balances up to $25,000, if you maintain a $500+ direct deposit and at least 7 electronic withdrawals per month (ATM, POS, ACH and Billpay counts).
  • Evansville Teachers Federal Credit Union pays 3.30% APY on up to $20,000. You’ll need at least 15 debit transactions and other requirements every month.
  • Lake Michigan Credit Union pays 3.00% APY on up to $15,000. You’ll need at least 10 debit transactions and other requirements every month.
  • Find a locally-restricted rewards checking account at DepositAccounts.

Certificates of deposit (greater than 1 year)
CDs offer higher rates, but come with an early withdrawal penalty. By finding a bank CD with a reasonable early withdrawal penalty, you can enjoy higher rates but maintain access in a true emergency. Alternatively, consider building a CD ladder of different maturity lengths (ex. 1/2/3/4/5-years) such that you have access to part of the ladder each year, but your blended interest rate is higher than a savings account. When one CD matures, use that money to buy another 5-year CD to keep the ladder going. Some CDs also offer “add-ons” where you can deposit more funds if rates drop.

  • Abound Credit Union has a special 13-month Share Certificate at 0.80% APY ($500 min), a special 47-month Share Certificate at 1.40% APY ($500 min), and a 59-month Share Certificate at 1.35% APY ($500 min). Early withdrawal penalty is 1 year of interest (and only with the consent of the credit union, so be aware). Anyone can join this credit union via partner organization ($10 one-time fee).
  • USALLIANCE Financial Credit Union has a special 18-month CD at 1.00% APY ($500 minimum new money) with an early withdrawal penalty of 6 months interest. You must join the credit union first, but anyone can join via American Consumer Council (ACC).
  • Lafayette Federal Credit Union has a 5-year CD at 1.26% APY ($500 min). Early withdrawal penalty is 6 months of interest. Anyone can join this credit union via partner organization ($10 one-time fee).
  • You can buy certificates of deposit via the bond desks of Vanguard and Fidelity. You may need an account to see the rates. These “brokered CDs” offer FDIC insurance and easy laddering, but they don’t come with predictable early withdrawal penalties. Right now, I see a 5-year CD at 1.05% APY. Be wary of higher rates from callable CDs listed by Fidelity.

Longer-term Instruments
I’d use these with caution due to increased interest rate risk, but I still track them to see the rest of the current yield curve.

  • Willing to lock up your money for 10 years? You can buy long-term certificates of deposit via the bond desks of Vanguard and Fidelity. These “brokered CDs” offer FDIC insurance, but they don’t come with predictable early withdrawal penalties. You might find something that pays more than your other brokerage cash and Treasury options. Right now, I see a 10-year CD at 1.70% APY vs. 1.37% for a 10-year Treasury. Watch out for higher rates from callable CDs from Fidelity.
  • How about two decades? Series EE Savings Bonds are not indexed to inflation, but they have a unique guarantee that the value will double in value in 20 years, which equals a guaranteed return of 3.5% a year. However, if you don’t hold for that long, you’ll be stuck with the normal rate which is quite low (currently 0.10%). I view this as a huge early withdrawal penalty. But if holding for 20 years isn’t an issue, it can also serve as a hedge against prolonged deflation during that time. Purchase limit is $10,000 each calendar year for each Social Security Number. As of 9/7/2021, the 20-year Treasury Bond rate was 1.91%.

All rates were checked as of 9/7/2021.

Filed Under: Banking, Deals & Offers, Investing //

45 Years of the Vanguard S&P 500 Index Fund: The Power of Low Costs

Posted on September 3, 2021 // Leave a Comment

Just over 45 years ago on August 31st, 1976, the late Jack Bogle started the first index mutual fund at Vanguard. It nearly didn’t get off the ground, garnering only 7% of the initial funding goal – it wasn’t even enough to buy shares of all the stocks in the S&P 500! Read Bogle’s own take from exactly 10 years ago at this 9/3/2011 WSJ article to better appreciate it took determination and stubbornness to make this happen.

Industry leaders mocked “Bogle’s folly”, wondering aloud why anyone would voluntarily agree to be “just average”. Well, Bogle had common sense and simple math on his side. He knew that over time, his fund was guaranteed to be above average due to it’s low costs. Some active mutual funds would outperform for a while, sure, but would there be reliable persistence in those superior returns? It turns out, very little. These days, people worry more about too much index fund investment.

Over time, more and more investors have realized the power of low costs. They are running away from high-cost funds. Morningstar just released it 2020 U.S. Fund Fee Study (free with registration). From the Executive Summary:

The average expense ratio paid by fund investors is half of what it was two decades ago. Between 2000 and 2020, the asset-weighted average fee fell to 0.41% from 0.93%. Investors have saved billions as a result.

(Thank you, Mr. Bogle.)

This chart shows the new investments flows into the cheapest 20% of funds (blue) against the remaining 80% (red) over the last 20 years:

Morningstar research has demonstrated that fees are a reliable predictor of future returns. Low-cost funds generally have greater odds of surviving and outperforming their more-expensive peers. […] Since 2000, net flows into funds charging fees that rank within the cheapest 20% of their Morningstar Category group have trended higher. Flows for the remaining 80% of funds have been negative in nine of the past 10 years.

Vanguard and it’s dirt-cheap index clones are winning. If you look closer, it’s the really low-cost funds that are gathering the most new investment. These are mostly the big names that have started competing directly with Vanguard on cost – iShares, Schwab, Fidelity, SPDR.

Of the $445 billion that flowed into the cheapest 20% of funds and share classes in 2020, nearly all of it went into the cheapest of the cheap, as 93% of net new money flowed into the least costly 5% of all funds.

Investors voted with their money. Follow this trend and continue to effect change with your investment choices. Look for a low-cost fund option in your 401k, and ask why if you don’t see it.

Filed Under: Investing, Retirement //

Crazy Rich IRAs: From Peter Thiel to Ted Weschler

Posted on August 31, 2021 // 6 Comments

Propublica recently reported that venture captialist Peter Thiel has a $5 billion Roth IRA. Essentially, he bought some lottery tickets using his IRA wrapper, and they paid off. The controversial part is that these lottery tickets weren’t available to everyone. They were dirt-cheap private shares of a startup that were only available to founders and a handful of early investors. At such an early stage, you can pretty much value your private company shares at whatever you wish. Here’s the Propublica version:

Open a Roth with $2,000 or less. Get a sweetheart deal to buy a stake in a startup that has a good chance of one day exploding in value. Pay just fractions of a penny per share, a price low enough to buy huge numbers of shares. Watch as all the gains on that stock — no matter how giant — are shielded from taxes forever, as long as the IRA remains untouched until age 59 and a half. Then use the proceeds, still inside the Roth, to make other investments.

It’s not clear how they found this data, but they also included the owners of other large IRAs:

Ted Weschler, a deputy of Warren Buffett at Berkshire Hathaway, had $264.4 million in his Roth account at the end of 2018. Hedge fund manager Randall Smith, whose Alden Global Capital has gutted newspapers around the country, had $252.6 million in his. Buffett, one of the richest men in the world and a vocal supporter of higher taxes on the rich, also is making use of a Roth. At the end of 2018, Buffett had $20.2 million in it. Former Renaissance Technologies hedge fund manager Robert Mercer had $31.5 million in his Roth, the records show.

Ted Weschler, along with Todd Combs, are the heirs to the “stock picking” part of Warren Buffett’s job at Berkshire Hathaway. Greg Abel will be the future CEO and help handle all the wholly-owned subsidiary companies within Berkshire, and Ajit Jain will run the large insurance operation.

As a public figure, Weschler submitted this personal statement defending and explaining his IRA, and it reveals some interesting details. He opened his first “IRA” in 1984 as a 22-year-old Junior Financial Analyst making $22,000 a year. He seems to be mixing up the terms for 401k and IRAs in his letter (confirmed in WaPo story below). His timing was lucky, as 401k plans had just been born with the earliest ones starting around 1980. Here is a 1982 WSJ newspaper scan about these newfangled “salary reduction plans”, which were what 401k plans were initially called.

Anyhow, his 401k/IRA balance had grown to $70,385 by the end of 1989, when he rolled it over into a self-directed IRA at Charles Schwab. Fast forward 23 years, and by the end of 2012, his IRA was worth $131,000,000! Thanks to the new Roth IRA conversion option when he promptly rolled it over into a Roth IRA even though he had to pay $29 million in taxes. By 2018, the balance was at $264 million.

Also significant:

I invested the account in only publicly-traded securities i.e., all investments in this account were investments that were available to the general public.

[…] In closing, although I have been an enormous beneficiary of the IRA mechanism, I personally do not feel the tax shield afforded me by my IRA is necessarily good tax policy. To this end, I am openly supportive of modifying the benefit afforded to retirement accounts once they exceed a certain threshold.

This WaPo article is a follow-up with Ted Weschler about his amazing IRA skills.

I also realized that Weschler wanted to encourage young people to do what he did to accumulate his nine-digit net worth: save and invest, early and often, and take advantage of any retirement account benefits offered by their employer. “In a perfect world, nobody would know about this account,” he said. “But now that the number is out there, I’m hopeful that some good can come of it by serving as a motivation for new workforce entrants to start saving and investing early.”

My takeaways:

  • You may not agree with all the tax rules, but there is a reason why standard personal finance advice includes maximizing your Roth IRA contribution each year AND taking full advantage of your 401k plan with any employer contribution.
  • If you believe that your future tax rate after age 60 will be higher than your current tax rate, then you should consider converting any pre-tax “Traditional” IRA balances into Roth IRAs, even if it requires a big lump sum payment today.
  • If your income is too high to qualify for a regular Roth IRA, check if you are eligible to contribute to a “backdoor” Roth IRA, essentially making a non-deductible Traditional IRA contribution and quickly performing a Roth IRA conversion. If you are high-income and a big saver, look up the “mega backdoor” Roth IRA, which involves making a non-deductible contribution to your 401k plan (if allowed by employer plan document).
  • Roth IRAs have differences from Traditional IRAs beyond just the timing of the tax being upfront or at withdrawal. If you want to leave an inheritance (as these rich people most likely do), realize that Roth IRAs don’t have the required minimum distribution (RMD) rules that apply to traditional IRAs. Bottom line: More compounding + more tax shelter = bigger estate.
  • Consider putting your riskiest investments with the highest potential upside inside your Roth IRA. My Roth IRA holds REITs: low tax-efficiency and higher risk/return profile. No sleepy bonds!
  • As a BRK shareholder, if you were to think of a contest to win “The Next Warren Buffett”, finding the person who built the biggest IRA in the world using publicly-available investments would be a pretty smart filter! Maybe Berkshire Hathaway’s investment side will be alright after Buffett and Munger are gone.
Filed Under: Investing, Taxes //

S&P 500 Returns by Components 1900-2020: Earnings Growth + Dividends + P/E Changes

Posted on August 29, 2021 // Leave a Comment

In the previous post How Much of Historical Stock Returns Is Due To P/E Ratio Expansion?, we saw how the S&P 500 historical average total return could be broken down into separate components of earnings growth, dividends, P/E multiple changes, and inflation. Here’s how it broke down from the period of January 1976 to March 2021:

I wondered: Is this a common breakdown? What about other periods of time? You may have seen charts showing the rolling historical 10-year total returns of the S&P 500. For example, 1980-1990, 1981-1991, 1982-1992, and so on. Here is such a chart:

Crestmont Research has generously shared the same total returns, but broken down into the separate components of earnings-per-share (EPS) growth, dividends, and P/E multiple changes. As they put it:

There are only three components (excluding transaction costs and expenses) to the total return from the stock market: dividend yield, earnings growth, and change in the level of valuation (P/E ratio). To assess the potential returns from stocks for the next decade, this analysis presents the total return and its components for every ten-year period since 1900.

Observations. Despite my discovery that it didn’t take 25 years to recover from the 1929 crash, notice that the Great Depression was the only period where corporate earnings consistently dropped for an extended period. We do see the dividends still being paid out, but experiencing your business make less and less earnings for years must have been very difficult.

Since approximately the time of World War II, the overall profits of the S&P 500 companies have risen in every single 10-year period. Meanwhile, the dividend yield was also positive, although it has experienced a gradual decrease over time. If you just look at those two components added together, that is quite impressive.

Finally, we see that the component with the wildest swings by far is the Price/Earnings ratio. From this visualization, it looks like huge “waves of optimism” and “waves of pessimism” that are end up causing most of the overall volatility in total return. Right now, we appear to be still riding one the waves of optimism.

Filed Under: Investing //
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