There Is No 100% Safe Portfolio: The Future May Not Look Like The Past

Posted on August 19, 2019 // 8 Comments

Last week, the yield on the 30-year US Treasury bond dropped below 2% for the first time in history. Many other articles will try to explain why this happened, and what this means for the future. Not me. I have no clue what’s coming and don’t think anyone else does either. Here’s the historical yield chart via Financial Times:

Reader skg recently shared that the original 1992 edition of Your Money or Your Life by Vicki Robin and Joe Dominguez is now available online (partially to promote the new 2018 edition).

I rate this book a “must read” for those interested in a philosophical inspiration behind financial independence. However, the specific investing advice inside was to put all of your money into a ladder of 30-year US treasury bonds. Here an excerpt from the book on what they were looking for:

1. Your capital must produce income.
2. Your capital must be absolutely safe.
3. Your capital must be in a totally liquid investment. You must be able to convert it into cash at a moment’s notice, to handle emergencies.
4. Your capital must not be diminished at the time of investment by unnecessary commissions, “loads,” “promotional” or “distribution” expenses (often called “12b- 1 fees”), management fees or expense fees.
5. Your income must be absolutely safe.
6. Your income must not fluctuate. You must know exactly what your income will be next month, next year and twenty years from now.
7. Your income must be payable to you, in cash, at regular intervals; it must not be accrued, deferred, automatically reinvested, etc. You want complete control.
8. Your income must not be diminished by charges, management fees, redemption fees, etc.
9. The investment must produce this regular, fixed, known income without any further involvement or expense on your part. It must not require maintenance, management, geographic presence or attention due to “acts of God.”

That sounds pretty good, right? But then you have to remember that Joe retired about 1970 and this book was written about 1990. Look again at rates from 1970-1990 in the chart above. Another excerpt:

For most of this century, up until the late 1960s, interest rates were under 5 percent. Since their peak in 1981, long-term interest rates have been wending their way back down toward their historical norms. You did not need to catch the bond market at those abnormal highs in order to reach FI. Even at 5 or 6 percent, this program will work.

In 1969, when Joe reached FI, his capital was invested in bonds with interest averaging 6.85 percent and maturities extending into the 1990s. Through a few judicious bond swaps, and with no income other than the income from the bonds, his portfolio now has an average yield of 9.85 percent and maturities extending to the year 2007 on average.

Note that bolded quote “Even at 5 or 6 percent, this program will work”. Well, what about 2%? It probably wasn’t even on his radar as a possibility at that time. I’m sure something else will happen in the next 30 years that isn’t on my radar now.

Even buying the safest bonds in the world and locking them in for the longest period possible is not free from risk. Long-term bonds can still be one component of a diversified portfolio, assuming you understand when it will do well and when it won’t. However, it is important to realize that owning 100% long-term bonds at 2% leaves you very vulnerable to future inflation.

This is only a small part of the book, and there is additional discussion about being flexible in your own spending:

Your choices, attitudes, beliefs, habits, tastes, fears and desires have the ultimate effect on your bottom line.

Bottom line. Every time I see the line “for the first time in history”, I am reminded that no portfolio is 100% safe. We can look back at history as guide, but also accept its limitations. Even buying the safest bonds in the world and locking them in for the longest period possible is not free from risk. Preparing for retirement isn’t just about your investment portfolio, but also having adequte insurance coverage and your ability to be flexible in both spending and earning.

Filed Under: Investing, Retirement //

Maximizing Retirement Time: Being Flexible in Both Work Income and Spending

Posted on August 15, 2019 // 9 Comments

When it comes to Financial Independence Retire Early (FIRE), many people get turned off because they define retirement as “never, ever working again for money”. Financial independence fits better with my goal of spending the most of your limited time on Earth aligned with your values.

If the idea is to maximize your independent time, then you have to accept that luck matters. This chart from Michael Kitces explores equally likely scenarios from someone spending down a $1,000,000 portfolio of 60% stocks and 40% bonds.

Equally likely:

  • Ending up broke or feel alarmingly like you are headed towards broke.
  • Ending up with many, many times more money than you started with.

Is retiring as soon as you reach the 4% rule too risky because you might run out of money? Or is working longer for 3% too risky because you might have wasted years of your life working when you didn’t need to?

Let’s look again at some charts from Engaging Data. Here are sample results for the early retirement scenario at 4% withdrawal rate at age 40 ($40k from a $1m 65/35/5 portfolio, retirement horizon 50 years, female longevity table).

  • Red – Alive, but ran out of money.
  • Light green – Alive, with less money than you started with.
  • Green – Alive, with between 100% and 200% of what you started with.
  • Dark green – Alive, with over 200% of what you started with.
  • Grey – Dead.

Here is retired at 40 with a lower 3% withdrawal rate ($30k from a $1m 65/35/5 portfolio, retirement horizon 50 years, female longevity table):

Notice at even with the riskier 4% withdrawal rate, you have roughly a 60% chance that your portfolio never goes below the starting balance for as long as you are alive. That means you just spend your 4% every year and it just replenishes itself over and over. Sure, the 3% chart looks safer as there is no red “failure” area. But is that chance of failure worth working maybe another 10 years to go from 25x expenses (4%) to 33x expenses (3%)?

If your portfolio value drops early in retirement, flexible withdrawals are one important tool to improve your portfolio survival odds. However, what about flexible income as well?

What if you retired earlier so that if things go well, you get more retirement years, but if things go bad, then you fall back on some part-time back-up work? Your main risk is of poor returns in the first 10 years of retirement or so. You would accept the chance that you might have to do a little work again to prop your portfolio up during that time. A good part-time job would have the following characteristics:

  • Scales up and down easily. Ideally, you could spend 10 hours a week, 20 hours a week, or 40 hours a week on it as necessary. This could mean hourly shift work or flexible self-employment.
  • Higher-paid skilled work that is at least partially satisfying. Unskilled work will be the easiest to obtain, but the pay will be low. Uber/Lyft driver, food delivery, home health aide, retail, warehouse, etc. You want something where your special skills are compensated accordingly.
  • Minimal maintenance. For some jobs, if you aren’t constantly putting in hours, you’ll become obsolete and won’t be able to start back up again. There may be professional licenses to maintain, etc.

Here’s a brief list of ideas:

  • Healthcare. Many positions in the healthcare field can be part-time and hourly, from doctor to nurses to technician positions.
  • Elder care. This may be related to healthcare, but the overall aging population is another trend to consider.
  • Accounting. An accountant or someone with similar skills can usually find work during tax season, assisting other accountants.
  • Tech. There is often consulting or project work available, if you keep your contacts and skills up-to-date.
  • Passion work. Turn your hobbies into work. You could be a travel guide, taking people on hikes, tours, kayaking, etc. Carpentry projects could turn into an Etsy store. If you like to fix things, become the neighborhood handyperson.
  • Real estate. I tend to break up residential real estate investing into two parts – the actual ownership and the property management. Property management is basically a part-time job which you can do yourself, and the effective wage can be quite high if you are skilled at managing tenants. (The catch is that you can also lose money if you are unskilled at it.)
  • Teaching and kid-related. People are having fewer kids, but spending more on each one. Sleep training consultant. Potty training consultant. Academic tutoring at any age. Sports coaching at any age. Chess coaching. Language coaching. Musical coaching. These all command premium hourly rates.

I am a conservative person at heart, and I know that I would worry about my family’s finances if my portfolio dropped significantly from my retirement date. Therefore, I am both using a conservative withdrawal method and maintaining a semi-retired work schedule for the time being. I don’t have the luxury of a full traditional retirement, but I like the balance so far.

Bottom line. Living off of an investment portfolio of stocks and bonds depends a lot on luck. One way to deal with this is to be flexible with your withdrawals. Good luck means spending more, bad luck means spending less. This flexibility may allow you to retire earlier with a smaller portfolio balance. However, you could also plan for a little work income to offset early bad luck with portfolio returns. If you instead have early good luck with market returns, then you’ve just won many more years of free time.

Filed Under: Career, Investing, Retirement //

Portfolio Charts Tool Tests Flexible Withdrawals in Retirement

Posted on August 14, 2019 // 3 Comments

You’ve probably heard of the “4% rule” when withdrawing income from a retirement portfolio. I think using such a rule is fine when you are early in the accumulation phase, although I like the “3% rule” better for early (long) retirements. But heck, reach 25x expenses first and then reassess. However, when it’s actually time to spend down that money, the execution can be tricky. If you start out taking 4% on a $1,000,000 portfolio ($40,000) and then the market drops 50%, will you really take $40,000 (8%) out of your sub-$500,000 portfolio the next year?

Being flexible in your withdrawals works better with both theoretical backtests and natural tendencies. If my portfolio drops 50%, I’m going to tighten the belt and spend less money the next year. Some people may not want to admit this, but I would consider taking on a part-time job again in a severe event. I collect part-time job ideas as part of this Plan B.

On the flip side, if you’ve used a lot of portfolio simulators like FIRECalc and Engaging Data, you’ll notice that your portfolio sometimes gets crazy huge. If your portfolio doubles in size, you might decide to live it up a bit and spend more than 4% of your original amount (inflation-adjusted).

Accordingly, I was impressed to see that Portfolio Charts updated their already-useful Retirement Spending Tool to account for flexible portfolio withdrawals. Everything has been elegantly simplified into four variables:

Withdrawal Rate: the percentage of the portfolio you withdraw every year to fund your retirement expenses

Change Limit: The maximum amount that a withdrawal can increase or decrease from year to year

Account Trigger: A simple rule for when you’re allowed to increase or decrease spending based on how the portfolio is doing relative to its original value

Withdrawal Limit: The minimum or maximum withdrawal you realistically need to pay the bills and live a happy life regardless of what a flexible spending strategy might recommend

Keep in mind that the spending is already inflation-adjusted, i.e. it increases each year with inflation even with no change. Here’s a screenshot:

Take some time to play around with the many combinations. You could see what happens if you let the withdrawals vary wildly. You could see what happens if you only allow the withdrawal amount vary within a tight range. How does your portfolio balance change? For example, I thought about starting with a relatively conservative number like 3% base withdrawal rate, but also be willing to drop it to 2.7% (10% less) if the portfolio drops by 10% in value. Meanwhile, I’d wait until the portfolio increases by 50% before I start paying cash to fly business class everywhere (#goals).

If I were to have a wish list for a new feature, I would like it to show me the minimum balance that the portfolio reached during any of the scenarios. This would let me know the maximum drawdown experienced using my set of variables, as the chart is a little hard to read.

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

Best Interest Rates on Cash – August 2019

Posted on August 4, 2019 // 16 Comments

Here’s my monthly roundup of the best interest rates on cash for August 2019, roughly sorted from shortest to longest maturities. The target for the Fed Funds Rate was just cut by 0.25% as of 8/1/19, so look out for small rate drops this month (probably right after I publish this post). Check out my Ultimate Rate-Chaser Calculator to get an idea of how much extra interest you’d earn if you are moving money between accounts. Rates listed are available to everyone nationwide. Rates checked as of 8/4/19.

High-yield savings accounts
While the huge megabanks like to get away with 0.01% APY, it’s easy to open a new “piggy-back” savings account and simply move some funds over from your existing checking account. The interest rates on savings accounts can drop at any time, so I prioritize banks with a history of competitive rates. Some banks will bait you and then lower the rates in the hopes that you are too lazy to leave.

  • Popular Direct is at 2.55% APY with $5,000 minimum. I don’t like this bank because they always create a “new” account instead of giving old customers the higher rate automatically, but it’s the top rate. Betterment Everyday Savings just dropped to 2.44% APY with a no minimum balance requirement ($10 min to open). There are several other established high-yield savings accounts at 2% APY and up, although some have had small drops recently too.

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 (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. Marcus Bank has a 13-month No Penalty CD at 2.35% APY with a $500 minimum deposit. Ally Bank has a 11-month No Penalty CD at 2.30% APY with a $25,000 minimum deposit. You may wish to open multiple CDs in smaller increments for more flexibility.
  • Quontic Bank has a 12-month CD at 2.70% APY and $1,000 minimum with an early withdrawal penalty of 12 months (!) of interest. Andrews Federal Credit Union has a 8-month special at 2.86% APY and $1,000 minimum – anyone can join via partner organization for a small fee.

Money market mutual funds + Ultra-short bond ETFs
If you like to keep cash in a brokerage account, beware that many brokers pay out very little interest on their default cash sweep funds (and keep the difference for themselves). The following money market and ultra-short bond funds are not FDIC-insured, but may be a good option if you have idle cash and cheap/free commissions.

  • Vanguard Prime Money Market Fund currently pays an 2.24% SEC yield. The default sweep option is the Vanguard Federal Money Market Fund, which has an SEC yield of 2.21%. You can manually move the money over to Prime if you meet the $3,000 minimum investment.
  • Vanguard Ultra-Short-Term Bond Fund currently pays 2.40% SEC yield ($3,000 min) and 2.50% SEC Yield ($50,000 min). The average duration is ~1 year, so there is more interest rate risk.
  • The PIMCO Enhanced Short Maturity Active Bond ETF (MINT) has a 2.52% SEC yield and the iShares Short Maturity Bond ETF (NEAR) has a 2.53% 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.

  • 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 8/1/19, a 4-week T-Bill had the equivalent of 2.11% annualized interest and a 52-week T-Bill had the equivalent of 1.89% annualized interest (!).
  • The Goldman Sachs Access Treasury 0-1 Year ETF (GBIL) has a 2.27% SEC yield and the SPDR Bloomberg Barclays 1-3 Month T-Bill ETF (BIL) has a 2.04% 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. There are annual purchase limits. If you redeem them within 5 years there is a penalty of the last 3 months of interest.

  • “I Bonds” bought between May 2019 and October 2019 will earn a 1.90% 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 2019, 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.

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 capped, and there are many fees that you must be careful to avoid (lest they eat up your interest). Some folks don’t mind the extra work and attention required, while others do. 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.

  • The only notable card left in this category is Mango Money at 6% APY on up to $2,500, but there are many hoops to jump through. 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, and if you make a mistake you won’t earn any interest for that month. Some folks don’t mind the extra work and attention required, while others do. Rates can also drop to near-zero quickly, leaving a “bait-and-switch” feeling. I don’t use any of these anymore, either.

  • The best one right now is Orion FCU Premium Checking at 4.00% APY on balances up to $30,000 if you meet make $500+ in direct deposits and 8 debit card “signature” purchases each month. The APY goes down to 0.05% APY and they charge you a $5 monthly fee if you miss out on the requirements. There is also the TAB Bank 4% APY Checking, which I don’t like due its vague terms. Find a locally-restricted rewards checking account at DepositAccounts.
  • If you’re looking for a high-interest checking account without debit card transaction requirements then the rate won’t be as high, but take a look at MemoryBank at 1.60% APY.

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. Some CDs offer an “add-on” features that gives you the option of adding funds if rates drop. 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.

  • You could build a CD ladder at First National Bank of America at 2.90% APY for 5-year, 2.80% APY for 4-year, 2.75% APY for 3-year, 2.70% APY for 2-year, and 2.60% APY for 1-year.
  • 5-year CD rates have been dropping at many banks and credit unions, following the overall interest rate curve. A good rate is now about 3.00% APY, with Hiway Federal Credit Union offering 3.20% APY ($25,000 min) or 3.00% APY ($500 min) on a 5-year CD with an early withdrawal penalty of 12 months of interest. Anyone can join this credit union via partner organization Minnesota Recreation and Park Foundation ($10 fee).
  • Navy Federal Credit Union has a special 5-year CD at 3.50% APY ($1,000), but you must have a military affiliation to join (includes being a relative of a veteran). NavyFed also has an 18-month CD at 3.00% APY.
  • GTE Financial Credit Union has a promotional add-on CD that allows unlimited additional funds after CD opening. You can open a 5-year CD with $500 minimum at 3.04% APY.
  • 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 fixed early withdrawal penalties. Nothing special right now. As of this writing, Vanguard is showing a 2-year non-callable CD at 2.10% APY and a 5-year non-callable CD at 2.25% APY. Watch out for 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 fixed early withdrawal penalties. As of this writing, I am seeing no inventory on 7-year and 10-year CDs. Watch out for higher rates from callable CDs from Fidelity. Matching the overall yield curve, current CD rates do not rise much higher as you extend beyond a 5-year maturity.
  • 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 a sad 0.10% rate). I view this as a huge early withdrawal penalty. However, you could also view it as a hedge against deflation, but only if you can hold on for 20 years. As of 8/1/19, the 20-year Treasury Bond rate was 2.21%.

All rates were checked as of 8/4/19.



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

Vanguard Personal Advisor Services Portfolio Rebalancing Rules

Posted on July 26, 2019 // 2 Comments

vglogoIf you read about investing in stocks and bonds, there is a lot of discussion about rebalancing your portfolio. Should you rebalance? When? How often? How much? Carl Ozeck contributes his thoughts on the Vanguard Blog article Capital gains are a good thing. However, sometimes you just like to see what the professionals actually settle on.

In Vanguard Personal Advisor Services®, we use a “time-and-threshold” blend for our rebalancing strategy. We review the portfolio quarterly and rebalance if its asset allocation has deviated by 5 percentage points or more. Blending these triggers results in a more complex strategy, but it has merit. If we use this strategy on a 60% stock, 40% bond portfolio, the average portfolio turnover would be about 1.95%2 and average Sharpe ratio about 0.51. This shows that rebalancing can help you mitigate your risk while spreading out rebalancing events over time.

Vanguard Personal Advisor Services (my review) is an add-on service where they actually manage your portfolio and perform the trades on your behalf. The cost is 0.30% of assets annually. Their paid service performs a quarterly check-in, and rebalances if a 5% threshold band is exceeded. I think this is a good rule to save as a “default” and then adjust as needed for your own circumstances.

For our portfolio, I also perform quarterly check-ins and then rebalance with the free cash from dividends and interest. If possible, investments from work income are also directed in a manner to help rebalance. I only rebalance further if a 5% threshold has still been exceeded after all that for at least two quarterly check-ins.

Filed Under: Investing, Retirement //

Worthy Bonds Review: 5% Interest, Backed By Small Business Inventory Loans

Posted on July 24, 2019 // 9 Comments

Worthy Bonds are a fintech startup that offers you 5% interest by “supporting your fellow humans”. You can invest a little bit at a time, even doing “round-ups” of your purchases. However, whenever you see an interest rate well above FDIC-insured accounts, you have to dig deeper! The basic business model is that Worthy will pay you 5% interest and then take that money to loan out to small business owners (inventory-backed loans) at much higher interest rates, with Worthy keeping any difference as their profit. Here’s why I don’t like that structure.

You are buying bonds issued by a single start-up. Worthy Bonds are really just 36-month bonds issued by Worthy Peer Capital, Inc. In other words, it’s a bond backed by a single corporation, in this case a very young startup that has never been profitable. The bonds are not rated and not traded publicly. Worthy is not a bank. Your funds are not FDIC-insured. They do promise to invest your money into “fellow humans”, which in reality are small business loans secured by the value of their inventory. Which brings me to…

Inventory-backed loans are NOT low-risk loans. Worthy makes a big deal about how they make “asset-backed loans” which are amongst the safest loans out there. Yes, these loans are less risky than unsecured loans like credit card debt, but if you perform some basic research about inventory financing, you’ll see that there are still many risks involved. From Investopedia:

Lenders may view inventory financing as a type of unsecured loan because if the business can’t sell its inventory, the bank may not be able to either. This reality may partially explain why, in the aftermath of the credit crisis of 2008, many businesses found it more difficult to obtain inventory financing.

The easiest way to confirm this is to ask the market. A bond backed by Microsoft might yield about 3.5% interest. Now pretend that you are a small business looking for an inventory loans. Online lenders quote rates varying from 10% APR to 100% APR. Now, which is really “low risk”? From Fundbox:

Yes, applying for an inventory loan is an easy and fast process; however, approval isn’t. Because the merchandise purchased will be considered as collateral, lenders will have to assess just how risky your business is. If they determine that you will have a challenging time selling your products, then that means they will have an equally hard time unloading the inventory in the event you can’t repay your loan, and they end up with it. […] Inventory financing typically comes with higher interest rates. Lenders feel they need extra security as there is no personal guarantee or collateral involved other than the inventory.

The loans they have taken out so far have 7.44% to 18% annual interest rates, plus collateral management fees of 6% to 12% annually. This is taken directly from their SEC filings:

As of December 31, 2018 we had entered in to three loan receivable agreements for an aggregate amount of $1,200,000, with small business borrowers. The loans pay interest at varying rates ranging from 0.62% per month to 1.5% per month and collateral management fees ranging from of 0.5% to 1% per month.

Limited upside, unlimited downside. I’m not saying inventory loans are a bad deal, if you are compensated properly for the risk. If Worthy was more of an “access” play, where they took a small cut (maybe 1%) of these risky business loans and gave you the rest, I would be more interested. However, this is more of a “we do fancy stuff in the background, and give you 5% and make you think that’s a good deal” play. Even if their loans work out and they get 10% or 20% or ???, you just get 5%. Meanwhile, if these loans go sour, and Worthy runs out of venture capital, then you may be stuck losing everything you put in. What happens when a company borrows money against their warehouse holding $10 million “value” of fidget spinners, but suddenly they are no longer trendy?

They advertise that you can take your money out at any time, but they don’t advertise as heavily that this is all unless they default. Everything can look great, until one day it doesn’t. There is no FDIC insurance coming to the rescue. Worthy is doubly-exposed in the event of a recession. Inventory loans will default at higher rates, and their venture capital backing may also dry up. At this time, they also don’t have a bankruptcy remote vehicle where the inventory loans are directly connected to your investments.

Bottom line. Worthy Bonds are one of the many fintech startups out there asking for your money. If you look past the 5% interest and slick app, the underlying investment is small business inventory loans, which carry a meaningful risk of loss and usually charge north of 10% annual interest to the borrowers. However, Worthy Bonds limit your upside to 5% interest, while the downside is unlimited.

If you want to invest in corporate bonds for about 5% interest, I would recommend Vanguard High-Yield Corporate Fund Investor Shares (VWEHX). The SEC yield is right about 5%, and you get a diversified portfolio of 500 different bonds from rated businesses after they charge a low .23% expense ratio (less if you buy Admiral Shares). That 0.23% is the only gap between the market returns of the underlying bonds and what you receive.

Filed Under: Investing //

Peerstreet Case Study #1: 90-Day Late Condo Near-Foreclosure Recovery

Posted on July 23, 2019 // 2 Comments

I’ve invested over $50,000 of my “alternative” money into PeerStreet real estate notes because of the ability to diversify into 50+ different high-interest loans backed by physical real estate. Here is a case study from one of my first loans where I was worried it was going to turn out badly, but it turned around. This was much different than my experiences with Prosper and LendingClub, where 90-days late almost always eventually results in a total loss. You can find additional case study links and the most recent update to my overall portfolio performance in my Peerstreet review.

Initial investment details.

  • Property: 2 bedroom, 1 bath, 975 sf condo in Salem, MA.
  • Net Investor Rate/Term: 8.50% APR.
  • Amount invested: $1,073.
  • Term: 24 months with extension option.
  • Total loan amount: $123,750 from Peerstreet and $13,250 from loan originator (10% “skin in the game”).
  • Appraised at $199,000 = 62% LTV.
  • Loan secured by the property in first position.
  • Stated goal is buy-to-rent.

Here is the Zillow listing. The buyer appeared to get a condo for a good price ($130k). The unit last sold for $155k in 2016.

Timeline.

  • May 2017. Loan originated. Maturity is set for June 2018.
  • May 2017 to June 2018. Interest-only payments made as agreed upon. (My portion was taken out July 2017.)
  • June 2018. Borrower requests extension.
  • August 2018. 6-month extension approved and extension fee paid.
  • November 2018. Borrower requests another extension. Additional 4-month extension granted.
  • April 2019. Payments stop coming in. Loan is late. Full balance of loan is due.
  • June 2019. Now 60+ days late. Still no payments. Demand letter sent. Foreclosure process initiated.
  • July 2019. At around 90 days late, the loan was suddenly brought current and paid off. All back interest (including default interest) and fees paid.

If you look at the MLS data, they tried to list it in March 2019 for $288,000 and then reduced to $249,000 in May 2019. The listed was removed, so I’m not sure who paid off the loan, perhaps the borrower or the loan originator somehow refinanced it elsewhere. The price wasn’t unreasonable, as the neighboring unit sold for $268,000 in May 2018 (2 bed/1 bath/1,000 sf). Notice that for this note, the loan originator put up 10% of the loan, so it had “skin in the game”. I don’t know if that made a difference.

Final numbers. I invested $1,073 in July 2019 and got paid $192.27 of interest and $1,073 of principal for a total of $1,265.27 as of July 2019. (This was an automated reinvestment which included whatever cash was in my account, thus the odd numbers.) This works out to a 17.92% total return over two years, which is 8.59% annualized return. The number was a little higher than the stated interest rate due the various penalty fees the borrower paid. These numbers are net of all PeerStreet fees.

I haven’t had a Peerstreet loan go through the entire process of foreclosure yet, but will write another update if/when that happens.

Bottom line. The vast majority of my Peerstreet loans have been paid back in full in a timely manner. Some of them end up with issues like late payments, sporadic payments, and/or repeated loan extensions, like this one. This one ended up as an example of an investment that looked like it was heading for foreclosure at nearly 90 days late with little communication, but bounced back and ended up being paid in full.

If you are interested, you can sign up and browse investments at PeerStreet for free before depositing any funds or making any investments. You must qualify as an accredited investor (either via income or net worth) to invest. If you already invest with them, they now sync with Mint.com.

Filed Under: Investing, Real Estate, Reviews //

Best Interest Rates on Cash – July 2019

Posted on July 2, 2019 // 8 Comments

Here’s my monthly roundup of the best interest rates on cash for July 2019, roughly sorted from shortest to longest maturities. Rates are dropping a bit, but it still pays to shop around. Check out my Ultimate Rate-Chaser Calculator to get an idea of how much extra interest you’d earn if you are moving money between accounts. Rates listed are available to everyone nationwide. Rates checked as of 7/2/19.

High-yield savings accounts
While the huge megabanks like to get away with 0.01% APY, it’s easy to open a new “piggy-back” savings account and simply move some funds over from your existing checking account. The interest rates on savings accounts can drop at any time, so I prioritize banks with a history of competitive rates. Some banks will bait you and then lower the rates in the hopes that you are too lazy to leave.

  • Wealthfront Cash is at 2.57% APY with no minimum balance. Note that while this account is FDIC-insured, there is no routing number since your money is split amongst four banks and thus you must initiate all transfers through Wealthfront. Northpointe Bank is at 2.55% APY with $25,000 minimum (but guaranteed for 3 months). CIT Bank Savings Builder dropped to 2.30% APY with a $100 monthly deposit (no minimum balance requirement). There are several other established high-yield savings accounts at 2% APY and up, although some have had small drops recently too.

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 (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. Marcus Bank has a 13-month No Penalty CD at 2.35% APY with a $500 minimum deposit. Ally Bank has a 11-month No Penalty CD at 2.30% APY with a $25,000 minimum deposit. You may wish to open multiple CDs in smaller increments for more flexibility.
  • MapleMark Bankt has a 12-month CD at 2.86% APY and $25,000 minimum with an early withdrawal penalty of 6 months of interest. Andrews Federal Credit Union has a 8-month special at 2.86% APY and $1,000 minimum – anyone can join via partner organization for a small fee.

Money market mutual funds + Ultra-short bond ETFs
If you like to keep cash in a brokerage account, beware that many brokers pay out very little interest on their default cash sweep funds (and keep the difference for themselves). The following money market and ultra-short bond funds are not FDIC-insured, but may be a good option if you have idle cash and cheap/free commissions.

  • Vanguard Prime Money Market Fund currently pays an 2.34% SEC yield. The default sweep option is the Vanguard Federal Money Market Fund, which has an SEC yield of 2.30%. You can manually move the money over to Prime if you meet the $3,000 minimum investment.
  • Vanguard Ultra-Short-Term Bond Fund currently pays 2.44% SEC yield ($3,000 min) and 2.54% SEC Yield ($50,000 min). The average duration is ~1 year, so there is more interest rate risk.
  • The PIMCO Enhanced Short Maturity Active Bond ETF (MINT) has a 2.63% SEC yield and the iShares Short Maturity Bond ETF (NEAR) has a 2.60% 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.

  • 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 7/2/19, a 4-week T-Bill had the equivalent of 2.22% annualized interest and a 52-week T-Bill had the equivalent of 1.92% annualized interest (!).
  • The Goldman Sachs Access Treasury 0-1 Year ETF (GBIL) has a 2.27% SEC yield and the SPDR Bloomberg Barclays 1-3 Month T-Bill ETF (BIL) has a 2.19% 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. There are annual purchase limits. If you redeem them within 5 years there is a penalty of the last 3 months of interest.

  • “I Bonds” bought between May 2019 and October 2019 will earn a 1.90% 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 2019, 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.

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 capped, and there are many fees that you must be careful to avoid (lest they eat up your interest). Some folks don’t mind the extra work and attention required, while others do. There is a long list of previous offers that have already disappeared with little notice. I don’t personally recommend or use any of these anymore.

  • The only notable card left in this category is Mango Money at 6% APY on up to $2,500, but there are many hoops to jump through. 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, and if you make a mistake you won’t earn any interest for that month. Some folks don’t mind the extra work and attention required, while others do. Rates can also drop to near-zero quickly, leaving a “bait-and-switch” feeling. I don’t use any of these anymore, either.

  • The best one right now is Orion FCU Premium Checking at 4.00% APY on balances up to $30,000 if you meet make $500+ in direct deposits and 8 debit card “signature” purchases each month. The APY goes down to 0.05% APY and they charge you a $5 monthly fee if you miss out on the requirements. There is also the TAB Bank 4% APY Checking, which I don’t like due its vague terms. Find a local rewards checking account at DepositAccounts.
  • If you’re looking for a high-interest checking account without debit card transaction requirements then the rate won’t be as high, but take a look at MemoryBank at 1.60% APY.

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.

  • You could build a CD ladder at First National Bank of America at 3.15% APY for 5-year, 3.05% APY for 4-year, 2.95% APY for 3-year, 2.85% APY for 2-year, and 2.75% APY for 1-year.
  • 5-year CD rates have been dropping at many banks and credit unions, following the overall interest rate curve. A good rate is now about 3.00% APY, with Citizens State Bank offering 3.20% APY ($1,000 minimum) on a 5-year CD with an early withdrawal penalty of 12 months of interest.
  • 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 fixed early withdrawal penalties. Nothing special right now. As of this writing, Vanguard is showing a 2-year non-callable CD at 2.15% APY and a 5-year non-callable CD at 2.30% APY. Watch out for 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 fixed early withdrawal penalties. As of this writing, Vanguard is offering 2.60% APY on a 10-year CD. Watch out for higher rates from callable CDs from Fidelity. Matching the overall yield curve, current CD rates do not rise much higher as you extend beyond a 5-year maturity.
  • 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 a sad 0.10% rate). I view this as a huge early withdrawal penalty. You could also view it as long-term bond and thus a hedge against deflation, but only if you can hold on for 20 years. As of 7/2/19, the 20-year Treasury Bond rate was 2.29%.

All rates were checked as of 7/2/19.



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

Is Your Stock Broker Quietly Charging As Much As a Robo-Advisor?

Posted on July 1, 2019 // 13 Comments

Here’s an educational post on How Discount Brokerages Make Money by Patrick McKenzie. It seems reasonable that a DIY investor understand these sources of revenue at a basic level: net interest, commissions, asset management fees, wealth management fees, securities lending, and payment for order flow.

For me, the biggest takeaway is that brokers make a lot more money quietly shorting you on cash interest than upfront from the big-banner-ad commission fees. Did you know that only 7% of Schwab’s revenue comes from commission? Meanwhile, a whopping 57% of Schwab’s revenue comes from net interest, which is the spread between what they earn on cash and what they pay you. E-Trade, 67%. TD Ameritrade, 51%. See you Are You Quietly Losing Money via Your Brokerage Cash Sweep Account?

I’ve mentioned this before, most recently in my Schwab Intelligent Portfolios review. Schwab makes a ton of money on your idle cash, and it is NOT an accident that they force you to own cash in their automated portfolios.

Right now, Schwab only pays you a sad 0.26% APY on your cash sweep. Both you and Schwab can earn much more than that elsewhere with essentially no risk, which leads to an interesting observation from the article:

Brokerage customers keep ~10% of their assets in cash. The 200 basis point spread between cash in brokerage accounts and money market funds or insured bank accounts, all of which are functionally riskless, is equivalent to a 20 bps asset management fee across the portfolio.

This is an important perspective. It’s one thing to pay a robo-advisor like Wealthfront or Betterment 0.25% annually and get some value out of it, and it’s another to effectively pay 0.20% for absolutely nothing. Add in your stock commissions, and you might even be paying more than a robo-advisor. If you keep a big balance in a bad cash sweep, you should really zap it into a top-yielding cash equivalent or buy a short-term Treasury Bill within that brokerage account. These days it’s all just a matter of clicks.

If that’s too much trouble every month, consider automatic dividend reinvestment or a one-time move to a broker with better cash sweep. My idle cash at Vanguard is in the Vanguard Federal Money Market Fund earning 2.29% with zero effort. At the very minimum, you should be aware of this hidden cost and acknowledge that it’s part of what you’re paying every month.

(A second takeaway is that the author believes that Robinhood gets more money for payment flow than other major brokers because they have a higher percentage of options trades than other brokers, and options order flow is more valuable than regular equity trades.)

Filed Under: Investing //

Stocks and Bonds Asset Class Correlations 2009-2019

Posted on June 25, 2019 // 2 Comments

Morningstar has an educational series on How and Why to Invest in Bonds, and one of the included articles What Role Do Bonds Play in a Portfolio? had an interesting chart of the correlations between several major asset classes for the past decade up to mid-2019:

You can see above that US and international stocks are closely (but not perfectly) correlated, which means that they tend to move in the same direction. However, junk bonds also tend to move very closely with US stocks.

The least correlated asset against US stocks was intermediate government bonds. In fact, they actually tended to go up a little when stocks go down. This is one of the reasons why I own short and intermediate Treasury bonds as part of my bond portfolio, while at the same time avoiding high-yield or investment-grade corporates.

There is also another correlation chart of the Great Financial Crisis of October 2007 to February 2009, which had similar overall results. The least correlated assets were again short-term and intermediate-term government bonds.

You can also explain this diversification intuitively without numbers. I love my shares of businesses (stocks), and much of them time they are going to chug along nicely. However, we know that there will be periods when they are in big trouble and the outlook is bleak. Weak companies will be going bankrupt, while many others teeter dangerously close to the edge. Do you want to own debt backed by those same companies at the same time? It’s a double-whammy when both your stock and bond holdings are going down at the same time.

I am also concerned by recent reports of record amounts of “barely” investment-grade debt. There is a thin line between being rated investment-grade and
“junk”. Do the ratings tend to land on the investment-grade side of that line because the ratings agencies themselves are being paid by those same companies? (Again, remember those mortgage-backed securities of the financial crisis.) I’d rather not to have to worry about that possibility. I like the simplicity and the “sleep better at night” safety of owning bonds backed by the US government instead. I do also own municipal bonds in my taxable accounts, which for some reason were not included in this chart.

Related past posts:

Filed Under: Investing //

Jack Bogle on Mailbox Money

Posted on June 24, 2019 // 4 Comments

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

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

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

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

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

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

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

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

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

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

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

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

Filed Under: Investing, Retirement //

Immediate Annuity Payout Rates vs. Long-Term Bond Interest Rates

Posted on June 20, 2019 // 13 Comments

I’m still learning about immediate annuities as a potential future income stream, and came across this ImmediateAnnuities.com article about the relationship between immediate annuity payout rates and interest rates. (Note: I am not talking about indexed or variable annuities. Those I avoid completely.) The chart below shows the close relationship between the payout rate for a common type of immediate annuity (single life, 10-year guaranteed payout) and the interest rate on high-quality long-term corporate bonds.

At the same time, there is much less correlation between the payout rates and short-term interest rates. The “Fed Funds Rate” that you hear about all the time in the financial media is a short-term rate set by the Federal Reserve.

Even though annuities like to tout themselves as “guaranteed”, nominal annuities with a fixed payout are still exposed to inflation risk. For example, your contract might state a fixed payout of $1,000 a month for the rest of your life, but if inflation spikes, that $1,000 won’t go nearly as far. With 3% average inflation, your effective paycheck shrinks to only $640 of equivalent buying power after 15 years. With 4% inflation, it shrinks to $550 of buying power.

Right now, long-term interest rates are near historical low and thus so are payouts. You could argue that your downside potential is much greater than the upside as historically there are many more examples of extended periods of high inflation than extended periods of deflation. I don’t want to buy a 20-year bond paying the current market rate of 3.5%, but I really don’t want to locked in what is essentially a lifetime bond paying 4%.

Now, if you are definitely going to buy an annuity, the article does make a valid point that if you wait a year for rates to increase, that’s one less year of income you earn from a lifetime annuity. You may also opt to hedge your inflation risk elsewhere.

I’m still decades away from the age when I would like to buy an annuity, but I do think now is a very tough time for current retirees trying to create guaranteed income. The income available from “safe” investments are so low, and you do even worse after taxes. However, I simply don’t buy into the theory that inflation has gone away forever, and I personally would have a hard time buying an annuity at current rates.

Filed Under: Annuities, Investing //
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