Instead of watching the entire 6-hour Berkshire Hathaway (BRK) annual shareholder’s meeting, I first read through the WSJ highlights and then watched selected parts of the Yahoo Finance replay which interested me.

One interesting topic was about Warren Buffett and Charlie Munger’s directions to their heirs. Buffett has famously directed his wife to put 90% of her assets into a Vanguard S&P 500 index fund and 10% into US Treasuries. In contrast, Munger has told his family “not be so dumb as to sell” their Berkshire stock. Why do they differ?

You can see this question at the 1:39:55 marker in the video. Here are my notes:

• Buffett initially tries to deflect this question by stating that 100% of his BRK stock will be given to charity. However, there would be nothing stopping her from buying BRK shares (or any other investment) at a later time, so that doesn’t really answer the question.
• Both Buffett and Munger have previously stated that they believe that Berkshire will likely perform better than the S&P 500 in the future.
• Buffett’s wife will have more money than she needs. Maximizing upside is not important. Downside protection is most important.
• In terms of investment performance, both are quite unlikely to suffer permanent loss, but the S&P 500 is still a little bit more reliable than BRK. There is still some chance that there could be a change in culture or executive leadership that might damage the company. Someone might succeed in breaking up Berkshire into parts.
• The 10% in short-term US Treasuries (essentially cash) goes even further, in case there is long severe depression or even if the stock exchange is closed, there will be cash on hand to handle things.
• In terms of human issues, it would be a news event if she had BRK shares and sold them. The media would care. Talking heads would offer alternatives. However, if she holds the S&P 500 index fund, that is so boring that it is quite likely nobody will ever bother her again. From all that I have read, never being bothered again sounds like something she would enjoy. (Most people don’t even know her name or what she looks like.)
• Munger concedes that the S&P 500 as well-constructed as a diversified portfolio of large companies. In terms of performance, it is “all but impossible for most people [to beat].” However, he’s still telling his family to stick with Berkshire.

Buffett and Munger are exceptionally rational as opposed to emotional. Therefore, both answers will most likely work out fine. Sometime in the next 50 years, the stock market will probably drop 50% again. The fact that Buffett thinks the S&P 500 is safer than even Berkshire is something to remember the next time there is a stock market crisis.

At the same time, Munger’s comments should make a current BRK shareholder feel more secure in holding shares for decades to come. Even with Buffett’s shares going to charity, there will still be a large chunk of shareholders with a long-term view.

A reader asked me to expand on the thought process behind my asset allocation choices. I don’t have a highly scientific answer, but here’s how I would explain it to a friend over drinks. Prepare yourself for some rambling…

I know that I could run simulations and backtest return data to figure out exactly which mix of assets have produced the best risk/return characteristics historically. I’ve also looked at various model portfolios based on such analyses. However, perfection can only be seen in retrospect and it is constantly changing. I just try to take away the big nuggets.

The overall goal is to hold asset classes that will provide long-term returns above inflation, distribute income via dividends and interest, and finally offer some historical tendencies to balance each other out.

Stocks Breakdown (Benchmark Ticker)

• 38% US Total Market (VTI)
• 7% US Small-Cap Value (VBR)
• 38% International Total Market (VXUS)
• 7% Emerging Markets (VWO)
• 10% US Real Estate (VNQ)

To put it briefly, I am taking the total markets and increasing the portion of one additional asset class which I think has the highest diversification benefits. For example, Small Value is a subset of Total US market, and Emerging Markets is a subset of the Total International market.

38% US Total Market. Instead of “stocks” or “equities”, I prefer to call it “owning businesses”. It’s not just a ticker blip going up and down. I am buying a diversified mix of real businesses that are a critical part of a huge economy. A single company or even a handful of big companies might go bankrupt, but as a whole they are not going anywhere.

The Vanguard Total Stock Market ETF (VTI) holds 3,600 stocks to represent the entire US publicly-listed market from Apple ($770,000 million) to Bridgford Foods Corp. ($100 million). It is market-cap weighted, which means that the amount of each stock held is directly proportional to the total market value of the company. See my VTI review for details.

7% US Small-Cap Value. Historically, small-cap value stocks have produced a higher risk-adjusted return than the entire market. You could also argue that small companies a more representative of the private business market. Therefore, I choose to hold a little more of this asset class via the Vanguard Small-Cap Value ETF (VBR).

You probably haven’t heard of 99% of the stocks in the Small Value index, which is kind of the point. Someone who invests in individual small cap stocks must be wary of that company going bankrupt (or effectively bankrupt). But by owning 828 of these stocks at the same time, I don’t have to worry about VBR ever going to zero (although it can be relatively volatile). Will VBR outperform VTI by a huge margin? Maybe, maybe not, but it probably won’t lag the overall market greatly either.

VTI can be roughly broken down into 85% Large-Cap companies, 10% Mid-Cap companies, and 5% Small-Cap companies. My blend of 85% VTI and 15% VBR is still roughly 72% Large-Cap and 19% Small-Cap. I have “tilted” the amounts, but it’s still predominantly composed of huge businesses like ExxonMobil, Google, and Johnson & Johnson.

International Total Market. The United States is not the only place where businesses create value. Many brands that you deal with every day are listed in foreign countries – Nestle, Shell, Samsung, Toyota, GlaxoSmithKline, Anheuser-Busch InBev. (Bud Light is a foreign company!) The Vanguard Total International Stock ETF (VXUS) holds over 6,000 stocks from around the world according to market-cap weight. See my VXUS review for details.

I also keep to close to the world market-cap split with 50/50 US/non-US. If you want to go 70/30 or 60/40, that’s perfectly fine with me. Again it’s more important that you stick with it than any specific ratio.

Emerging Markets. Within the foreign markets, I choose to put extra money towards Emerging Markets – countries that currently include China, Taiwan, India, Brazil, South Africa, Mexico, Russia, Thailand, and Malaysia. Again, this asset class is more volatile but also has higher historical returns. The Vanguard FTSE Emerging Markets ETF (VWO) allows me to track this asset class in an efficient and low-cost manner. If there were better options for International Small Value stocks, I would have been open to that.

VXUS is 43% Developed Europe, 30% Developed Pacific, 19% Emerging Markets, and 7% Canada. My blend of 85% VXUS and 15% VWO is 37% Developed Europe, 26% Developed Asia, 31% Emerging Markets, and 6% Canada. Again, it’s not a huge tilt.

(Exit option: If something happened to me and my wife wanted to simultaneously simplify the portfolio, reduce the overall risk level, and generate cash, she could simply sell off my US Small Value and Emerging Markets positions that make up ~10% of the entire portfolio. The resulting portfolio would still be diversified.)

Real Estate. The Vanguard REIT ETF (VNQ) holds publicly-traded real estate investment trusts (REITs) which hold things like office buildings, hotels, apartment complexes, nursing homes, self-storage units, and shopping malls. I choose not to be active in residential real estate other than owning my own home, so I like the diversification and income that this asset class provides.

I am sticking with domestic REITs for both simplicity and lower costs. REITS only make up about 7% of my overall portfolio. I might include foreign REITS if it was a larger holding, but I’m going to bother splitting up 7%.

Bonds Breakdown

• 50% High-quality, Intermediate-Term Bonds
• 50% US Treasury Inflation-Protected Bonds

I keep roughly 30% of my portfolio in bonds. This is meant to be the stable ballast of my portfolio, but it should also generate some level of interest income. Bonds are debt, so I only lend money to the places that I think will pay me back most reliably:

• US government, which can both tax residents and print the world’s reserve currency. This includes US Treasuries, FDIC-insured bank accounts, and US Savings bonds. Treasury Inflation-Protected bonds also offer an interest rate that adjusts with inflation.
• Local municipalities, which can tax residents. If you don’t pay your property taxes, they take your house. “Muni bonds” currently offer the best tax-effective yield for my situation. I hold them through low-cost, actively-managed funds like Vanguard Intermediate-Term Tax-Exempt Fund Investor Shares (VWITX). See, I’m not only about index funds!

I exclude investment-grade corporate bonds because I don’t see enough benefit in taking on extra risk in this manner. I’d rather get 3% dividend yield through stock ownership (which includes unlimited upside potential) than get paid 3% interest (with no upside potential). Corporate bonds don’t have the company interests aligned with you – they want to appear stable and pay as little interest as possible. I’m not overly trusting of bond rating agencies in general.

I also exclude international bonds because what’s the point of diversifying to get a significantly lower interest rate? Vanguard US Total US Bond Market ETF (BND) has a current SEC yield of 2.43%. Vanguard Total International Bond ETF (BNDX) has a current SEC yield of 0.74%. Blech!

Recap. At a basic level, I own baskets of US businesses, international businesses, real estate, and high-quality debt. I plan to eventually spend the dividends from the businesses, rent from the real estate, and interest from the loans. I expect the stock dividends and rent to increase faster than inflation. I expect that the bond interest will at least keep up with inflation. This mix makes sense to me and I believe I can hold it through the ups and downs. It is not perfect but it is good enough.

I recently read (and re-read) a post at Philosophical Economics titled Diversification, Adaptation, and Stock Market Valuation, which serves both as an educational resource and an interesting argument for a new shift in stock investing. It’s rather lengthy and not written for novices, but it doesn’t require a finance or math degree either. I recommend reading it in full, but here are my notes.

#1 Diversification is good. Buying a single stock exposes you to the risk of your investment going to zero. Lots of companies have gone to zero. For a long-time, most people either bought individual stocks or bought funds that owned a limited number of individuals stocks. High risk leads to lower valuations and thus higher expected returns.

Buying a diversified basket of stocks provides good returns with greatly minimized risk of permanent capital loss. Here’s the dividend history of the S&P 500 from 1926-2016, adjusted for inflation:

#2 People are realizing that diversification is good. When Jack Bogle published Bogle on Mutual Funds in 1993, Vanguard was considered a big success after reaching $100 billion in assets. (I recently bought a first edition for my collection.) Today, Vanguard manages over $4 trillion in assets. Yes, 40 times as much.

In 2000, under 10% of asset were in index funds. Today, roughly 25% of the US stock market is now held in index funds with no signs of retreat. Nearly everyone has the ability to buy a basket of 500 to 3,000 stocks for just $5 a year per $10,000 invested.

#3 We are also seeing higher average equity valuations. Correlation or causation? If everyone starts to agree that low-cost index funds (and “closet” index funds) makes investing less risky, then shouldn’t lower expected risk lead to higher valuations, and thus lower future expected returns? It won’t be a straight line, but it could be a powerful overall trend.

A couple of excerpts:

My argument here is that the ability to broadly diversify equity exposure in a cost-effective manner reduces the excess return that equities need to offer in order to be competitive with safer asset classes. In markets where such diversification is a ready option–for example, through low-cost indexing–valuations deserve to go higher. But that doesn’t mean that they actually will go higher.

To summarize: over time, markets have developed an improved understanding of the nature of long-term equity returns. They’ve evolved increasingly efficient mechanisms and methodologies through which to manage the inherent risks in equities. These improvements provide a basis for average equity valuations to increase, which is something that has clearly been happening.

Definitely food for thought.

People always argue about how “efficient” the market truly is. Only academic, ivory-tower geeks believe in efficient markets right? My longstanding opinion is that no, markets are not 100% efficient, but it’s a tough, cutthroat world out there. Especially over the long run. Here’s yet another reminder to put in the anecdote folder.

This WJS article (paywall) talks about Jack Meyer, a superstar manager of the Harvard endowment that went on to run a high-profile hedge fund called Convexity Capital. Unfortunately, his hedge fund has lost over a billion dollars (!) of client money recently, in fact losing money every one of the last 5 straight years.

This recent bout of poor performance has altered Mr. Meyer’s worldview… of other managers (emphasis mine):

Mr. Meyer has often told smaller endowments and foundations that ask for advice to index 75% of their assets and use board connections to access world-class active managers for a sliver of their portfolios. He says he used to think 80% of active managers didn’t add value but now thinks it is closer to 95%.

Convexity is in that remaining 5%, he said.

Matt Levine of Bloomberg has a funny yet wise take on this:

I assert that 100 percent of active managers believe that only 5 percent of active managers add value, and that 100 percent of active managers believe that they are in that 5 percent, or at least say so in interviews. Otherwise why come to work every day? But that means that 95 percent of them are wrong. If you’re looking for the ones who are wrong, I guess one place to start would be among the ones who lose money five years in a row.

That 5% number reminded me of this quote from Charlie Munger of Berkshire Hathaway (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.

As Josh Brown puts it, edges are ephemeral. Okay, so somewhere around 4 out of 100 people *whose job it is to add value*… will actually add value. Sounds like a tough job, but something to consider when they come asking for your money.

Barron’s has released their 2017 annual broker rankings. Two major themes this year are (1) trade commissions dropping overall and (2) improved mobile app trading.

To analyze 2017’s top brokers, we took a hard look at the value they offer to clients, analyzing security, mobility, and social-media features as well as the depth of their investment tools and their trading capabilities. Our primary consideration in judging these 16 firms is how they work for our readers, who are high-net-worth active investors. Price-improvement statistics are built into our Trading Experience and Technology category.

Note that part about high-net-worth active investors, which may or may not describe you. Their overall winner this year was Fidelity Investments, which barely beat out last year’s winner Interactive Brokers. Thankfully, Barron’s also supplied separate rankings for novice investors, long-term investors, and those that value in-person service:

Top 5 Brokers for Novice Investors

1. TD Ameritrade. Performed well in customer service & education, portfolio analysis, research tools, and mobile offerings. Free real-time quotes across desktop and mobile.
2. Fidelity
3. Merrill Edge
4. E-Trade
5. Charles Schwab

Top 5 Brokers for Long-Term Investing

1. TD Ameritrade. The only broker to provide a wide range of commission-free ETFs from various providers based on popularity instead of in-house ETFs or paid placement).
2. Fidelity
3. Charles Schwab
4. Merrill Edge
5. E-Trade

Top 5 Brokers for In-Person Service

1. Merrill Edge. This is mostly about physical branches, and Merrill Edge is technically Bank of America.
2. Charles Schwab
3. Fidelity
4. TD Ameritrade
5. E-Trade

If you really want to get into the details, another handy feature is Barron’s huge comparison chart with data from all the brokers surveyed. As in past years, Vanguard declined to participate in the survey.

Quick commentary. I agree that TD Ameritrade is good for long-term investors who want to use an independent brokerage. They combine a full brokerage feature set with a list of 101 commission-free ETFs based on overall popularity (which means they are the ETFs you’d actually want to buy).

There was no mention of the Robinhood free trading app. Does the lack of any competing free trading apps indicate that this business model isn’t viable?

I keep most of my long-term assets directly at Vanguard, while my individual stock trades are done through Merrill Edge. I’m happy with them so far. If you have $50,000 in assets across Merrill Lynch, Merrill Edge, and Bank of America accounts, you get 30 free trades per month. That’s already more trades than I need, but $100k in combined assets gets you 100 free trades per month.

I’ve been putting some side money into crowdfunded real-estate investments – see here and here – and I have decided to test out the quarterly liquidity window of my Fundrise eREIT investment (review). An important difference between most of these private real estate investments and publicly-listed REIT is liquidity. On most any given weekday, I can sell my public REIT (i.e. VNQ) for a price that an open market deems fair and within few days I will have cash in hand.

The Fundrise Income eREITs are private REITs that take advantage of new crowdfunding regulations open to all investors (not just accredited investors). The intended time horizon of this investment at least 5 years, but they also advertise “quarterly liquidity” as a feature (see below). I was interested to see how this feature worked, as many of the other asset-backed loans in which I am invested could take a year or longer to get my money back. I decided to test out this “emergency hatch”.

The rules. You are allowed to make a redemption request once per quarter. For the full details on Fundrise quarterly redemption plans, please see the section of each eREIT Offering Circular titled, “Description of Our Common Shares—Quarterly Redemption Plan” at this link. It’s pretty dense, and I will only highlight this table which includes the “early withdrawal penalty” imposed if you redeem your shares within 5 years.

In other words, if I redeem now after one year, I will pay a 3% penalty on the current net asset value (NAV). The NAV itself is a complex calculation of the underlying assets that I believe is only updated to investors once a quarter.

Note that you are not guaranteed to have liquidity of all your shares. If too many shareholders request liquidity at the same time, that might force them to sell assets at large discounts and harm other shareholders. Here is an excerpt from the Offering Circular:

Q: Will there be any limits on my ability to redeem my shares?

A: Yes. While we designed our redemption plan to allow shareholders to request redemptions on a quarterly basis, we need to impose limitations on the total amount of net redemptions per calendar quarter in order to maintain sufficient sources of liquidity to satisfy redemption requests without impacting our ability to invest in commercial real estate assets and maximize investor returns.
In the event our Manager determines, in its sole discretion, that we do not have sufficient funds available to redeem all of the common shares for which redemption requests have been submitted in any given month or calendar quarter, as applicable, such pending requests will be honored on a pro rata basis. […]

Redemption Process. The process of requesting a quarterly redemption was straightforward. Here’s a step-by-step rundown:

• Contact Fundrise support and request a redemption (3/6 in my case). You need to make this request at least 15 days prior to the end of the applicable quarter.
• They asked the reason for my redemption, and I told them. You don’t need to supply a reason, they just wanted feedback.
• They sent over the official redemption form, which I was able to read and complete online. I received an e-mail confirmation of my redemption request.
• At the end of the quarter (3/31 in my case), I received another e-mail confirmation that my redemption request was processed.
• 12 days after the end of the quarter (4/12 in my case), I received another e-mail confirmation that the funds were being transferred to my bank account.

Complete Investment Timeline. Here’s a summary of cashflows from beginning to end.

• December 29, 2015. Invested $2,000 into Fundrise Income eREIT (200 shares x $10 a share).
• Held for 15 months. Received 5 quarterly income distributions on a timely basis in April, July, October 2016 and January, April 2017. Total of $234.79.
• Early March 2017. Requested redemption of all 200 shares as of the end of quarter 3/31/17.
• April 12, 2017. Received $1,908 in principal back. 100% of NAV would have been $1967.

Screenshot:

So I invested $2,000 and after 471 days I collected a total of $2,142.79 for a total gain of 7.14%. The annualized return works out to 5.49%. That’s not amazing but not bad considering that I am bailing out of a 5+ year investment after only a year. I’m confident that my returns would have been better if I waited out the full 5 years as real estate ownership investments take time to work out. (Traditional non-traded REITs are infamous for having huge penalties for early withdrawals where you get back less than 90 cents on the dollar.)

Hopefully this post answers some questions about the liquidity of Fundrise eREITs. I received my money, as requested, in about a month. If instant/daily liquidity is important to you, I would still stick with publicly-traded REITs.

Bottom line. The Fundrise Income eREITs are meant as long-term investments with time horizons of at least 5 years. However, they advertise the availability of limited quarterly liquidity. I tested out this liquidity feature and was able to cash out subject to a 3% discount from net asset value. It worked as promised, howewer I would not recommend using this option unless necessary as it will impair your overall return. Fundrise does warn you that in an extreme event with depressed prices, this liquidity window may be closed for the benefit of long-term investors. You can sign-up and learn about currently-available Fundrise eREITs here.

When I think about it, I am impressed with how different 2017 feels compared to when I started seriously learning about investing in 2003. Instead of only reading about it in few books mostly read by finance nerds, nowadays nearly every robo-advisor out there uses a globally-diversified mix of low-cost ETFs to build their portfolios. What used to be a relatively quiet alternative to buying 4-star active funds is now becoming the default choice.

We’ve seen from the Callan Investment Returns Table that the best-performing asset classes constantly change from year to year. In a industry magazine called Investments & Wealth Monitor, there was an article titled Why Global Asset Allocation Still Makes Sense by Anthony Davidow. (Found via AllAboutAlpha.)

Here’s an illustration of how a globally-diversified portfolio has outperformed. Below is a graphic from the article comparing a 100% S&P 500 portfolio, and 60/40 S&P 500/US Agg Bond portfolio, and a “globally diversified portfolio” using historical data from January 1, 2001 to December 31, 2016. Index values are used directly as opposed to actual ETFs or funds. The portfolio are rebalanced annually back to target asset allocation.

Their “diversified portfolio” had a rather finely-diced list of asset class ingredients:

• 18% S&P 500 (US Large-Cap)
• 10% Russell 2000 (US Small-Cap)
• 3% S&P US REIT
• 12% MSCI EAFE (International Developed)
• 8% MSCI EAFE Small Cap
• 8% MSCI Emerging Markets
• 2% S&P Global Ex US REIT
• 1% Barclays US Treasury
• 1% Barclays Agency
• 6% Barclays Securitized
• 2% Barclays US Credit
• 4% Barclays Global Agg EX USD
• 9% Barclays VLI High Yield
• 6% Barclays EM
• 2% S&P GSCI Precious Metals
• 1% S&P GSCI Energy
• 1% S&P GSCI Industrial Metals
• 1% S&P GSCI Agricultural
• 5% Barclays US Treasury 3–7 Year

I do wish this portfolio was a bit more simple and easy to replicate. However, if you take a step back, you could simplify this asset allocation into the following:

• 56% Global Stocks (50% US/50% Non-US)
• 5% Global REIT (60% US/40% Non-US)
• 34% Global Bonds (70% US/30% Non-US)
• 5% Commodities

Now, we can’t necessarily expect a global portfolio to always outperform. One thing is usually doing better than another thing you own. Most recently, US stocks have outperformed International stocks quite significantly. Here’s an explanation from the article about the “free lunch” of diversification:

Diversification strategies do not guarantee capture of profits or protection against losses in any market environment, but they have been shown over time to provide a smoother ride. Rather than bearing the brunt of the 2000 Tech Wreck and the 2008 Great Recession, the diversified portfolio provided cushioning under the large market drop and was able recoup losses and grow over time.

We’ve all been told that past performance is no guarantee of future returns, but it’s still hard to buy an investment that has been performing poorly. We need to remember the historical power of diversification and that even though something may look horrible now, good news may be just around the corner.

Callan Associates updates a “periodic table” annually with the relative performance of 8 major asset classes over the last 20 years. You can find the most recent one at their website Callan.com, with access to previous versions requiring free registration.

Every calendar year, the best performing asset class is listed at the top, and it sorts downward until you have the worst performing asset. Here is the most recent snapshot of 1997-2016:

The Callan Periodic Table of Investment Returns conveys the strong case for diversification across asset classes (stocks vs. bonds), investment styles (growth vs. value), capitalizations (large vs. small), and equity markets (U.S. vs. non-U.S.). The Table highlights the uncertainty inherent in all capital markets. Rankings change every year. Also noteworthy is the difference between absolute and relative performance, as returns for the top-performing asset class span a wide range over the past 20 years.

I find it easiest to focus on a specific color (asset class) and then visually noting how its relative performance bounces around. This year, I note that Emerging Markets (Orange) tends to either run really hot or cold. For the past 4 years, Emerging Markets has been near the bottom. MSCI EAFE (Developed Foreign Stocks, Light Grey) have also been doing relatively poorly. I still hold them as they will one day bounce back to the top.