Some folks don’t like it when I write about investments that aren’t low-cost index funds. The thing is, when I find something intriguing, I like to dig deeper and then keep a record my findings. That way I can look back later and see how things turned out and compare with my opinions at the time. Just because I write about something doesn’t mean I recommend it, you have to read the entire post.

SolarCity is a company that installs and finances solar panels on commercial and residential properties. Back in October 2014, they started to allow individual investors to buy senior, unsecured corporate bonds directly from them online. You could invest as little as $1,000 in these SolarCity SolarBonds and pay no trade commissions or fees. The critical feature is that these “solar bonds” were backed only by the claims-paying abilities of the issuing company. If SolarCity fails, then you could lose your entire principal as well as any interest owed.

In general, the more confident you are that you’ll be paid back, the lower the interest rate the borrower has to pay. Other factors will come into play, such as the overall interest rate environment. With this in mind, check out the history of these bonds:

• In 2014, SolarCity was issuing 7-year bonds paying a 4% annual interest rate.
• In mid-2015, SolarCity was issuing 5-year bonds paying a 5% annual interest rate.
• Currently in August 2016, SolarCity is offering a 18-month bond paying 6.5% annual interest rate. Ends August 30, 2016.

Supposedly, SolarCity is passing on the savings of doing things in-house and not having to pay investment banker fees. I still declined to write about these SolarCity bonds in the past because the yield and term lengths were not good enough to grab my interest. But 6.5% in 18 months? Okay, you’ve at least gotten my attention.

Consider that as of 8/24/16, an 18-month Treasury bill yields approximately 0.70%. The highest 18-month FDIC-insured CD pays roughly 1.35%. Investment-grade (A) corporate bonds are averaging ~1.15% for a 2 year maturity. Even a junk bond ETF like JNK may have a 6.5% yield but an average maturity of over 6 years.

What’s happening? Well, SolarCity is struggling in several areas. It’s been losing money reliably, every year. Here’s the stock price chart:

Perhaps more importantly, it has some big bills that are coming due soon. According to this TheStreet article, SolarCity has $3.25 billion in debt, with $1.23 billion due by the end of 2017. Note that date. At the same time, Tesla has offered to buy SolarCity in an all-stock deal.

Obviously Elon Musk and his SolarCity co-founder cousins want it to happen, as it has been widely-reported that they bought a big chunk of these bonds on their own. See Fortune, WSJ, and MarketWatch.

Why would they buy these bonds? My wild-guess opinion is that it looks like SolarCity is trying to extend its debt long enough so that Tesla can safely buy the company and then refinance things on better terms. I would say that if the deal closes, then these 6.5% bonds will pay off. I believe that Tesla will still be around in 18 months. However, if the deal doesn’t close for some reason, then SolarCity might be in big trouble.

Are these 6.5% bonds worth the risk? Given that Elon Musk and his cousins are a big shareholder in both companies and just bought $100 million of these bonds, that would seem to place your interest in line with theirs at this point. I’d actually rather hold these bonds for 18 months than be a shareholder for 18 months. However, you are still faced with the chance that the deal will hit some unforeseen obstacle, so it all depends on your confidence level. For me, the reward just isn’t high enough to justify the risk of permanent principal loss (I’d rather have a house as collateral), so I am going to pass and wait to see how it turns out.

The following chart taken from this Bloomberg article by Eric Balchunas shows the drastic difference in expense ratios when Vanguard has an offering in an asset class or not.

Like Walmart arriving in a new town, the entry of Vanguard into a particular investment area causes a collective gnashing of teeth as other fund managers are forced to drop their prices to compete. That dynamic is borne out in the table below, which shows the cheapest ETF fees for products that do or do not have a Vanguard-provided equivalent.

This is the “Vanguard Effect”. Here’s my version of explaining how it works:

• When Vanguard competes in an area, the expense ratios across the board are much, much lower.
• Note that the cheapest expense ratios you see in those asset classes not necessarily from Vanguard itself. It is often from a competitor like Charles Schwab.
• When Vanguard doesn’t compete, the expense ratios are much higher.
• In those no-Vanguard asset classes, the competitor won’t lower prices just because they can. They’ll keep the profit margin as high as they can, as they are bound to serving the business owners as well as ETF share owners. The gap between what they can charge and what they must charge goes to business profits. They aren’t evil, they are just trying to serve their two masters.
• At Vanguard, the business owner is the ETF share owner. (Vanguard uses the term “client-owned”.) For them, the most efficient way to pass on potential profits is to keep expenses as low as possible.

This is why you see DIY investors always wish Vanguard would offer something like an International Small Value ETF or a US Micro Cap ETF. By simply entering the ring, even the expense ratios of the ETFs we already hold from other providers will go down.

Here’s an interesting series of charts that measure how many hours of work it has taken to buy various things like the S&P 500 index, an ounce of gold, or a barrel of crude oil. You could see it as an alternative to adjusting historical prices by CPI inflation. Found on Twitter, done by @TheChartmeister.

In July 2016, the average hourly earnings of a production worker according to the Bureau of Labor Statistics was $21.59 an hour. In January 1964, it was $2.50 an hour.

In July 2016, it would take roughly 100 hours of work to buy the S&P 500 index if it was in dollars. Back in 1964, it would have only taken roughly 30 hours of work.

Here are direct links to the tweets.

From our Weekly Chart Blog https://t.co/JnpGxQu8Ci pic.twitter.com/4XncX4UqYc

— The Chart Store (@TheChartmeister) August 7, 2016

From our Weekly Chart Blog https://t.co/JnpGxQu8Ci pic.twitter.com/PxYxIYxdxR

— The Chart Store (@TheChartmeister) August 7, 2016

From our Weekly Chart Blog https://t.co/JnpGxQu8Ci pic.twitter.com/cx3vbOJaIt

— The Chart Store (@TheChartmeister) August 7, 2016

Here’s a reader question on international equities that reflects some of what I’ve been reading elsewhere and thinking about in my head:

I was doing my mid-year rebalance and noticed that international equity funds did terrible over the past 10 years, I have a fair amount of money in international equities, as do you. I’m considering lowering the % because they generally under perform US funds. Would love your thoughts.

First, let’s look back at some history (i.e. my old posts). Is it really true that US stocks historically perform better than International stocks? Also, the diversification benefit comes from the very fact that these asset classes don’t always move in sync (not perfectly correlated), allowing you to attain a higher risk-adjusted return by holding some of both as opposed to just one or the other.

From 1970-2006, foreign stocks outperformed US stocks, while the point of optimal risk-adjusted returns was a split of 76% US and 24% Foreign Developed (EAFE) (70% is a typo). The chart is taken from a past edition of A Random Walk Down Wall Street by Burton Malkiel.

From 1970-2013, the same chart shows that US stocks now outperformed foreign stocks on average, with the point of optimal risk-adjusted returns at 70% US and 30% Foreign Developed. From Rick Ferri:

From 1970 to 2015, the average annualized return of the S&P 500 has been 10.3%, while MSCI Europe has returned 10.0%. Sometimes US wins. Sometimes International wins. Here’s a chart from Ben Carlson of A Wealth of Common Sense showing the rolling 5 year over- and underperformance of U.S. stocks relative to European markets (MSCI Europe):

This is an example of why “staying the course” sounds easy but it isn’t in real life. On one hand, some of the recent doubt about Europe and Emerging Markets has to be about performance chasing. Look at the recent divergence in two major mutual funds that track Total US (VTSAX) and Total International (VTIAX) indexes, taken from Morningstar. This shows the growth of $10,000 invested 5 years ago:

On the other hand, there are real reasons behind the performance difference. The US economy has been more resilient and the future does look more bright. Europe and Emerging markets have more obvious problems without a visible solution. But that also means that US stocks are more richly valued, and International stocks are “cheaper”. Every model that uses historical data shows that International stocks have a higher future expected return. Here is Research Affiliates as one example:

Summary. The formal advice is that you should have a written “investment policy statement” (IPS) that states why you hold your current asset allocation in the first place. In other words, what where the reasons behind your current allocation? Have they changed? For me, nothing has really changed about why I bought both US and international stocks in the first place. Their long-term historical returns remain similar, and while the US may be slightly ahead at this moment, this could easily change again in the next decade.

It’s not fun to hold these international stocks right now, but I focus on the fact that European and Emerging Markets valuations are relatively cheaper and the dividend payout rates are relatively higher. By owning a globally-diversified passive portfolio, I choose to rely on the markets to work themselves out over time.

Vanguard has a new research paper about global asset allocation. One of their findings was that market-cap-weighted indexed portfolios provided higher returns and lower volatility than the average actively managed fund. Thus, they suggest that a good starting point for all investors is a portfolio that is weighted according to the world’s relative market values.

However, in every country that they examined, investors on average had a home-country bias, tending to own more equity from the country they live in than the market-cap weighting would suggest. The chart below is rather striking. Found via Reformed Broker and Abnormal Returns.

Americans on average hold roughly 80% in US stocks, while the US market makes up 50% of the global market. However, the average Canadian resident holds roughly 60% in Canadian stocks while only making up 3% of the global market. Australian residents hold roughly 66% in Australian stocks while only making up 2% of the global market. I find this very interesting.

This is where I should state proudly that my stock holdings are split 50% US and 50% International, with equal amounts of the Vanguard Total US ETF (VTI) and Vanguard Total International ETF (VXUS) or their mutual fund equivalents. However, I admit that I do worry about the political and economic environments of other countries, especially given current events. On the other hand, I worry that I am being influenced by recent past performance. I usually end up telling myself that I am buying the haystack and letting the markets work themselves out over the long run.

The Vanguard paper also offers a guide to weighing various factors in deciding the amount of your home bias. Here’s a summary chart:

If I was going for a clickbait title, I’d say “No one invests in taxable accounts anymore”. The Tax Policy Center has a new report by Rosenthal and Austin about how the share of U.S. stocks held by taxable accounts has dropped significantly over the last 50 years:

Here’s another view of how the share held by retirement plans has increased:

The current numbers:

• ~25% of US corporate stock is held in taxable accounts.
• ~37% of US corporate stock is held in IRAs, defined contribution (401k) plans, defined benefit (pension) plans.
• ~38% of US corporate stock is held by foreigners, non-profits, insurance companies, and other plans (governmental, 529 plans).

Between 1965-2015, the percentage held by taxable accounts dropped from ~85% to ~25%. The inverse finding is that the percentage held by tax-deferred retirement accounts and foreigners went from 15% to 75%.

That means that today, 75% of US stock owners may not care about the federal tax rates on dividend and capital gains, because it doesn’t affect them. Either they aren’t fully exposed to those taxes, or the taxes are deferred and withdrawals are tax at ordinary income rates. This trend could affect future tax policy.