Owning a McDonald’s Franchise: Purchase Cost vs. Annual Profit

Posted on October 19, 2015 // 20 Comments

mcfranchise_logoDespite their negative media attention, the McDonald’s franchise that I drive past every day is packed all the time. I rarely eat there (especially since my diet bet), but I used to think to myself that if I were going to buy a franchise, I’d buy a McDonald’s. My impression was always that McDonald’s were always pretty clean with consistent food (even if you consider it consistently unhealthy), while Burger King’s were often dirty with inconsistent food.

A common knock against purchasing a franchise is that you are “buying a job”. A recent Businessweek article broke down the gross sales, gross profits, and net profits of the average McDonald’s franchise in the US. I found the numbers very interesting:

mcfranchise_income

Average annual profit per franchise: $150,000 a year, roughly. Okay, but how much does this franchise cost? From the official McDonald’s franchise website:

Initial Costs
$45,000 Initial Fee paid to McDonald’s

Equipment and Pre-Opening Costs
Typically these costs range from $944,352 to $2,172,045. The size of the restaurant facility, area of the country, pre-opening expenses, inventory, selection of kitchen equipment, signage, and style of decor and landscaping will affect new restaurant costs. These costs are paid to suppliers.

Average cost of new franchise: At least $1 million roughly, with a minimum of $500,000 in cash and non-borrowed resources. Other sources state $750,000 minimum in liquid assets. You must be able to cover 40% of the costs of a new franchise location. You must be able to pay cash for at least 25% of the cost of an existing franchise, with the rest financed over at most 7 years.

Average hours of work per week as an owner/operator? I could not find reliable statistics, but here is an excerpt from a Reddit AMA from a businessperson from New Zealand who has owned a total of three McDonald’s franchises and recently sold the last one.

How much work was required of you per week on average? If my goal were to own one McDonalds and do the minimum amount of work possible, while also running it well, how low do you think I could get that weekly number of hours? And what would I be doing in that time?

I would work 9am – 5pm, 6 days a week. Mostly I’m at my office sorting problems remotely from there. I liked to pop down to my couple stores at least a couple times a day and check on them – make sure they’re clean, and to check on the Restaurant Manager about any issues. Typically I used to work hard for 4-6 hours a day, with the rest out in the stores just checking on them.

Exit / Selling price? One would imagine that if your franchise is doing well and churning out good numbers, someone else would readily buy it. If your business is struggling, then both your annual income and total business value will drop. The same Reddit user above reported selling for “just above” NZ $1.4 million, or US $916,000. I’m a bit confused by the purchase price, but it appears that he paid NZ $550,000 via business loan, 12 years ago.

In the end, owning a McDonald’s franchise is still a business which means you take on risk for potentially significant gains or losses. But if you spend 40 hours a week and only keep tabs on one location, it might really feel like you bought a job. These statistics help explain why most franchisees own multiple locations; Businessweek says the average is six.

Filed Under: Career, Entrepreneurial, Investing //

Ideal Diversification Between US and International Stocks?

Posted on October 13, 2015 // 9 Comments

earth_apolloOne of the decisions a DIY investor needs to make is how much international stock exposure to add to their portfolio. Recently, the US stock market has had much higher returns than non-US stocks overall, including Emerging Markets. But this Vanguard article reminds us of the diversification benefits of adding international stocks. Somewhere between 20% and 50% is the historical sweet spot:

vg_intl

Vanguard says 60/40 is best. Over the past year or so, Vanguard has shifted their “ideal” stock asset allocation to 60% US and 40% international. This is the breakdown used for their Target Retirement 20XX funds, their LifeStrategy funds, and also their 529 College Savings Age-Based portfolios. Part of their justification is that the expense ratios for their international funds has dropped as well.

World market cap weighting is at 52/48. What do the global capital markets have to say? The world market cap weighting has shifted to 52% US and 48% non-US, as tracked by the Vanguard Total World Stock ETF (VT). VT tracks the FTSE Global All Cap Index which is a free-float-adjusted, market-capitalization-weighted index.

I like simplicity and symmetry, so I am sticking with 50/50. I’m just one amateur, but I feel the trend is towards a market-cap weighting. 50/50 isn’t all that far from 60/40, especially because my overall asset allocation will soon by 60% stocks and 40% bonds. 50/50 is also really easy to rebalance and makes my portfolio looks nice and symmetrical.

Want some support to own international stocks? If the recent poor performance of international stocks has you down, Research Affiliates recently updated their Expected Returns Chart (mentioned previously) and it shows Developed European, Developed Asian, and Emerging Market stocks having a much better outlook than US stocks:

vg_intl2

They use a mix of different historical valuation techniques to make these forecasts, so they aren’t just pulled out of thin air.

Want some support to NOT own international stocks?
While it is hard to argue against the historical diversification benefit of owning some international stocks, I don’t know if it is absolutely necessary. If you bought big chunk of the S&P 500, and a smaller chunk of US Treasuries, and ignored it for 30-40 years, you’d probably come out pretty happy. Some big names would agree:

One argument is that many US companies already make a huge chunk of their money from their international operations anyway.

So there you have it. I hope you are sufficiently confused. 🙂

Filed Under: Investing //

Simple Portfolio Rebalancing: Year-End vs. Random Day

Posted on October 7, 2015 // 8 Comments

I’m catching up on some reading. James Picerno of The Capital Spectator did some backtesting of simple portfolio rebalancing where once a year you go back to your target asset allocation. Does it matter if you rebalance at the end of every year, or just pick any random date once a year? His test portfolio was a globally diversified portfolio made up 60% stocks and 40% bonds (11 different funds).

Here’s a chart of his results:

rebalance1510

His comments:

The basic message: rebalancing is a valuable tool for generating superior risk-adjusted performance. But it seems that tapping into this value-added service doesn’t require a lot of intellectual firepower for a standard asset allocation strategy. Letting a monkey choose the rebalancing dates over a period of years works as well if not better than automatically rebalancing at the end of each year.

My version: Rebalancing helps you maintain your desired risk profile, and it may even improve your risk-adjusted returns (it did in the last decade). Get the benefit with minimal fuss by rebalancing once a year. It doesn’t really matter what day, just make sure to do it once a year. However, I find it easier to stick with the same one every year so you can put it on your calendar. (First business day after Christmas, July 1st, your birthday, etc.)

Filed Under: Investing //

Finametrica Risk Tolerance Assessment Review + Discounts

Posted on September 28, 2015 // 8 Comments

riskprofile0Spend any time researching investments, you’ll eventually run across the concept of “risk tolerance”. If you don’t hold an investment through both the ups and downs, then you won’t enjoy its average returns, either. So how can you predict your behavior ahead of time?

What the financial industry uses is a risk tolerance survey, or risk questionnaire. You are asked a series of multiple choice questions based on theoretical scenarios to find your risk tolerance. You or a hired professional can then use that information – along with other factors like risk required and risk capacity – to determine your portfolio. I’ve taken several of these online assessments, but can someone really know how they would react to a 50% drop in their net worth in an environment of mass panic, without actually experiencing it? It is the real-world behavior that matters.

If a risk survey is the best tool available, what is the best risk survey? Which one is most carefully-written, backed by academic research, and historically vetted? From what I can tell, that is the Finametrica Risk Profiling Survey. Normally the cost is $40 for an individual to take the test, but I ran across a discount in this CNN Money article:

You can get a more accurate gauge of your appetite for risk by completing a risk tolerance questionnaire. Vanguard has a good asset allocation tool that’s free, while FinaMetrica offers a more comprehensive version for $40 (although given recent market turbulence FinaMetrica is offering the test and the nine-page report that comes with it for $4 until the end of September). Both tests recommend an investment portfolio based on your answers.

Okay, four bucks, I can handle that. (The promo has been extended to October 31st, as well.) I paid, answered 25 multiple choice questions, and I was done in under 10 minutes. Of course, a few more minutes of poking around and I discovered the same test for free by clicking here. Pfft. What’s up with that?

(Update: Reader Jason points out that the free version doesn’t accept free e-mails like “gmail.com”. I would suggest trying various free e-mail forwarding services if you want a workaround. Just google “disposable e-mail”.)

Questions. I took screenshots of the entire survey but I won’t post the specific questions here. They do share these sample questions, which I can confirm are actual questions from the paid test.

1. Compared to others, how do you rate your willingness to take financial risks?
Extremely low risk taker.
Very low risk taker.
Low risk taker.
Average risk taker.
High risk taker.
Very high risk taker.
Extremely high risk taker.

2. How easily do you adapt when things go wrong financially?
Very uneasily.
Somewhat uneasily.
Somewhat easily.
Very easily.

3. When you think of the word “risk” in a financial context, which of the following words comes to mind first?
Danger.
Uncertainty.
Opportunity.
Thrill.

The general idea is that the questions poke and prod you from various directions, trying to avoid having one misunderstood question alter your overall results. The questions were all brief and multiple choice, except for the last one which asked you to predict your own risk tolerance score relative to the overall population.

Results. Well, I guessed that my score would be 50 out of 100. My actual score was 54 out of 100, which they say is “slightly-higher-than-average” and actually in the 64th percentile. (So the score isn’t a percentile even though they are on a bell curve? I’m not good at statistics.)

riskprofile1

According to your risk, you are assigned one of 7 Risk Groups. You are then told the “typical attitudes and values” for people of your Risk Group, as well as if you differed significantly in any specific areas. Here’s how people in my Risk Group 4 would have picked their overall portfolio:

riskprofile3

So my risk tolerance peers would pick Portfolio 4, but in reality I am between a Portfolio 5 and 6.

Finally, you are provided a summary chart. Here’s mine:

riskprofile2

Final impressions.

  • Relatively good risk tolerance survey. I’ve already expressed my view that these surveys are only one limited piece of the puzzle. But as far as risk surveys go, this one did feel like it went more in-depth than others that I have tried. However, I would have enjoyed more interactivity and/or questions using charts and/or graphs.
  • Best as a tool to help communicate your personality to others, like spouse or financial advisor. I didn’t feel the report was very useful to me. I already know that I am a relatively conservative investor who also knows that I have to take some risks to beat inflation. The real value of this survey is that it would help describe my investment personality to my spouse, partner, kids, or financial planner. So if it’s just you, I don’t know if I can recommend it. If you want to educate a family member, then it may be worth the time and money. If you have an advisor, get them to pay for it. 🙂
  • $40 price point is high for individuals. As a DIY investor, I would not have paid $40 to answer 25 multiple choice questions about myself. I can definitely see an advisor paying that much on behalf of their client as part of their service (and many do). At the discounted $4 rate, I thought it was worth it. Of course, free would have been even better…
  • Don’t expect any specific portfolio recommendations. The CNN article promised a “recommended investment portfolio based on your answers”. I don’t think that is an accurate statement (see table above). I would say you just get a very high-level breakdown of what other people of a similar risk level “would prefer”. They don’t even use the words “stocks”, “bonds”, or “cash”.
Filed Under: Deals & Offers, Investing //

BullionDirect Bankruptcy: Buyer Beware With Gold Storage Companies

Posted on September 20, 2015 // 13 Comments

2015goldBullionDirect.com sold gold and silver bullion and even offered to store it in a vault for you for free. How nice of them. Unfortunately, they lied. From a Austin American-Statesman article with lots of customer interviews:

By the time auditors and lawyers got access to Bullion Direct’s 14th-floor offices six weeks ago, there were only a handful of gold and silver coins in an office safe. A second vault it had recently rented held only slightly more.

An estimated $30 million in cash, metal bullion and valuable coins, meanwhile, had vanished.

Here’s another snippet from a CoinWeek article (more detailed updates here):

Bullion Direct filed a declaration that stated that “when a customer placed an order, the precious metal was not actually purchased unless the customer agreed to take actual delivery of the product.” In other words, they never bought the metal customers purchased if it was to be stored.

This story is not about whether or not to buy gold. The lesson is that if you buy physical gold from a dealer and they either never deliver it to you or they say they’ll store it for you but the vault is really empty and say “oops we’re bankrupt!”… there is no government insurance mechanism that guarantees your assets. They can say they have “layers of insurance” and “regular, independent audits”, but they could also be lying to your face. If you have your gold stored somewhere, do you know the actual name of the insurance company they are using, and have you verified with that company about what exactly that policy covers?

From what I can tell, you could just replace “gold storage” with “pink teddy bear storage” to get an approximate idea of your level of protection. You can sue for your lost teddy bears, but if the company is broke and criminally stole your money, you may not get much if anything back even after liquidating any remaining assets.

This is very different from keeping assets under set limits at an FDIC-insured bank or holding regulated securities at an SIPC-insured brokerage firm. If you hold cash at a FDIC-insured bank and it fails, you’ll get your money back (subject to limits of $250k per account designation). If you hold Vanguard mutual funds in a TD Ameritrade account, those shares are also structured as to be protected if either Vanguard or TD Ameritrade has financial problems. (To be clear, your number of shares is protected up to limits, but the market value of those shares is not guaranteed.)

If I was to buy gold, so far my plan would be to buy 1 oz. American Eagle coins direct from a US Mint Authorized Purchaser, and then test them again myself with this Fisch gold coin tester. There is a premium over spot price for coins, but it would improve liquidity. Perhaps it is even worth paying the 3% markup for paying with credit card, especially if you can earn at least 2% in cash back or points, and then chalk up the net 1% markup as a form of purchase protection. Of course, storing it yourself has its own set of potential issues.

Filed Under: Investing //

Charts: Municipal Bond to US Treasury Yield Ratio

Posted on September 16, 2015 // 5 Comments

I’ve been investing in tax-exempt municipal bonds for a few years now. I made the change due to a combination of reasons. For one thing, I started running out of room in my tax-deferred accounts for US Treasury bonds, TIPS bonds, and REITs. Second, I believe that buying muni bonds through a Vanguard actively-managed mutual fund gives me a diversified mix of high-quality bonds. Third, the effective after-tax yields on muni bonds can be very attractive when compared to US Treasury bond yields. In many time periods, muni yields have been as high as Treasury yields, even before any tax considerations. This was very rare pre-2008 financial crisis, with the historical average being a 80% ratio.

Here are a few charts that track the relationship between the yields on US Treasury and Investment-grade municipal bonds. Notice that the ratio of Muni-to-Treasury has kept close to 100% in the last few years. I’ve tried to dig up enough to cover a continuous timeline, but let me know if you have a better graph.

muni_timing3

Source: Wealthmanagement.com

muni_treasury_ratio

Source: Financial-Planning.com

muni_timing2

Source: ValueWalk.com

Although it can be tempting to use these charts as timing tools, I try to focus on the overall picture. Due to the tax-exempt advantage, I am happy as long as the muni rates are roughly the same as Treasury rates.

As of September 9, 2015, the SEC yield of Vanguard Intermediate-Term Tax-Exempt Investors Shares (VWITX) was 1.78% while the SEC yield of Vanguard Intermediate-Term Treasury Investor Shares (VFITX) was 1.43%. Both are hardly exciting and the muni fund is considered a little more risky (how much riskier is quite difficult to quantify), but for my own portfolio I think the higher yield is worth it especially considering the muni interest is exempt from federal income taxes.

Muni bonds are a somewhat different from other asset classes because they are owned mostly by individuals as opposed to institutions. Based on Morningstar investor returns, us individuals haven’t shown any superior skill at market timing their buys.

muni_timing

However, the performance gap is similar to that of the Vanguard Treasury fund of similar duration. So perhaps that gap is just due to the effect of natural cashflow timing (i.e. regular investments over time) rather than failed attempts at chasing performance.

Filed Under: Investing //

Do Financial Advisors Really Keep Portfolios and Clients Disciplined?

Posted on September 15, 2015 // 23 Comments

I written about Dimensional Fund Advisors (DFA), a mutual fund family that is powered by top academic research. Another things that makes DFA unique is that they are only sold through approved financial advisors. You can’t buy them with just any old brokerage account. (Exceptions are certain 401(k)-style retirement plans and 529 college savings plans.) Allan Roth has new article about DFA funds in Financial Planning magazine, which is a trade publication targeted to financial professionals.

Why not sell directly to Average Joe investor? Here is David Butler, head of DFA Global Financial Advisor Services:

DFA has no intention of bypassing the advisor channel and offering its funds directly to retail investors. “We think advisors help keep investors disciplined,” Butler says.

In my previous post The True Value of a Real, Human Financial Advisor, I wrote about this concept. A good client advisor will help you keep your cool when the next disaster comes. Vanguard says that the biggest “value add” from good advisors is their “behavioral coaching”. A good financial advisor keeps you from making the “Big Mistake” that derails your plans.

onepage_bigmistake

But later in the same Allan Roth article, the idea of advisors as disciplinarians is called into question.

But do investors get better returns? I tested Butler’s claim that DFA advisors help keep investors disciplined by asking Morningstar to compare the performance gap between the two fund families. The performance gap is the difference between investor returns (dollar weighted) and fund returns (geometric).

Over the 10 years ending Dec. 31, 2014, the DFA annualized performance gap stood at 1.28% versus only 0.22% for Vanguard. When I showed these figures to Butler, he responded, “It’s hard to make an argument about the discipline of advisors based on these figures.”

Here’s a primer on investor returns vs. fund returns. Investor returns are the actual returns earned by investors, based on the timing of their buying and selling activities.

The next step was to compare the investor returns of DFA’s largest fund, DFA Emerging Markets Value I Fund (DFEVX) with $14B in assets with the closest Vanguard competitor, Vanguard Emerging Markets Index Fund (VEMAX) with $54B in assets. I personally think a better comparison would be with their DFA Emerging Markets Core Equity I Fund (DFCEX), so I’m throwing that in as well.

DFA fund returns are often higher relative to index fund competitors. Here’s a Morningstar chart comparing the growth of $10,000 invested 10 years ago in each of the three funds. You can see the DFA funds do slightly better in terms of fund returns. Click to enlarge.

dfa_em_vg_10k

But what about investor returns? I took some screenshots of their respective Morningstar Investor Return pages.

dfa_em1b

dfa_em_vg

dfa_em3

We see that after accounting for the timing of actual cashflows, the average investor in the DFA fund actually lost money with an annualized return of -1.01% and -2.04%! Meanwhile, the average Vanguard investor earned over 6% annualized.

The three mutual funds don’t have the exact same investment objective, but they do both all pull from the overall Emerging Markets asset class. The DFA funds try to focus ways to earn greater long-term return by holding stocks with a higher “value” factor, but it also has a higher expense ratio. The Vanguard fund just tries to “buy the haystack” and passively track the entire index.

Let’s recap. The stated reason why DFA is only sold through advisors is that they offer more discipline. We are told that such behavioral coaching is where human advisors provide their greatest value. However, the evidence available suggests that DFA advisors are less good at trading discipline than when a similar fund is completely open to retail investors.

I found this rather surprising. I used to think that restricting my potential advisors to those were affiliated with DFA was one way of getting an “above-average” advisor. But after doing my own research, I found that even though DFA investments are generally lower-cost, the additional fees charged by individual advisors ranged widely from reasonable to quite expensive.

I am confident there are financial advisors that can provide the proper behavioral coaching that makes them well worth the cost. At the same time, clearly many are not providing the advertised guidance and discipline. The problem remains – how does Average Joe investor find the good ones? I still know of no clear-cut way.

Filed Under: Behavioral Economics, Investing, Retirement //

Lifetime Income vs. Lump Sum Payouts: You May Live Longer Than You Think

Posted on September 1, 2015 // 10 Comments

My parents are in the midst of planning their retirement payout structure. I don’t know about everyone else, but in my mind I tend to plan to live to pretty much exactly age 80. Early death is depressing to think about (even though I have term life insurance), but what about the other end? The Statistical Ideas blog had a timely post about longevity risks and lump-sum payouts which contained a “death table” (horrible name) for people born in 1950. I’m going to paraphrase the explanation in a way that makes more sense to me.

1950longevity

  • Out of every 100 people born in 1950, roughly 1/3rd are expected to die by age 65. (Blue)
  • If you are in the group alive at 65, your life expectancy is now age 79. That is, half of that group will die before 79. (Green)
  • But, that also means you have a 50% chance of living past 79. If so, you will live to somewhere between 80 to 110. In other words, possibly a really long time! (Red)

If you are a couple, then the odds of at least one of you living a really long time is even higher. Let’s take a couple, one male and one female, who are both age 65. According to this Vanguard longevity calculator, there is an 89% chance at least one will reach age 80, and a 45% chance at last one will reach age 90. If you are younger, your life expectancy is even longer; enter your age(s) into the calculator.

Here’s my mental shortcut. For an individual that is 65 today, there is roughly a 50/50 chance they will reach age 80. For a couple both at 65, roughly a 50/50 chance that at least one person will reach age 90. Putting it this makes make either scenario equally likely and would push me to plan accordingly. On one side of the coin flip, you have to enjoy life now! On the other side, you need to be prepared.

This longevity risk needs to be accounted for when you give up pensions or annuities that offer you a guaranteed income for life. A lump sum payout may sound attractive, but be very careful. Have any annuity and pension buyout offers analyzed and checked by an unbiased third-party. It is a big decision and may be worth paying an expert for their time.

Here’s a sad story of lowball buyout offers for lead-paint victims. Not to say all lump-sum offers are this bad, but it serves as a warning to make sure you understand what you are giving up.

Filed Under: Investing, Retirement //

Stock Investing: Taking Your Money Off The Table Until Things Calm Down?

Posted on August 27, 2015 // Leave a Comment

Updated 2020. How many e-mails have you gotten regarding “recent market volatility”? The advice is almost always the same, think long-term. Feeling some fear and uncertainty is normal. During extreme times, a phrase often heard will be “I’m just going to take some money off the table until things calm down. Why risk it?”

What happens when you play it safe? Here’s a 2015 chart from FiveThirtyEight.com comparing the results of a “cautious, play-it-safe” investor and the “do-nothing” investor:

538_markets

Imagine two people who each invested $1,000 in the S&P 500 at the beginning of 1980. The first one buys once and never sells. The second one is slightly more cautious: He sells any time the market loses 5 percent in a week, and buys back in once it rebounds 3 percent from wherever it bottoms out. At the end of last week, the first investor’s holdings would be worth $18,635. The second investor would have just $10,613.

This is interesting, because they let you (sort of) pick the temporary bottom. But as you can see, you miss the huge gains. Perhaps the key is that you waited to sell until the market dropped first. If you wait until that sharp drop, then it’s probably already too late.

Remember, the only two possibilities for the stock market are all-time high or a drawdown. The highs you don’t really feel. The drawdowns are quite painful. Here’s a continuously updated chart from Doug Short illustrating the drawdowns since 2009. Lots of painful drawdowns, but during that time the market is up over 200%.

This is also why financial advisors tell you to create an investment policy statement. That’s where you write down ahead of time “If [this] happens to my portfolio, I will do [action or lack of action] because [reason].” Then when the drop actually happens, you break out that piece of paper to remind yourself what the calm, rational version of yourself would have done.

I would also add that this is why I don’t support the “100% in stocks” argument that I hear 10X more often after a long bull market. With time and pain, I have come to appreciate the warm fuzzies that come from owning a nice chunk of safe, liquid bonds.

Filed Under: Investing //

Playing “Fill-In-The-Blank” Mad Libs with Financial Buzzwords

Posted on August 18, 2015 // 2 Comments

madlibscoverAfter you spend enough time consuming financial media week after week, you start seeing patterns in the noise. I understand why of course, as creating content to feed the beast can get quite exhausting. But hopefully, by pointing out these out, you as an individual investor can realize that there may or may not be any substance behind the marketing buzzwords and short-term forecasts. Entertaining? Yes. Useful and actionable? Much less likely.

A good analogy would be with the classic word game Mad Libs, where “one player prompts others for a list of words to substitute for blanks in a story, before reading the – often comical or nonsensical – story aloud.”

Here’s how the usual “Profile of successful mutual fund manager” article usually goes. I am paraphrasing myself in 2006.

[Name of recently successful mutual fund manager] may not look the part, but at the helm of [formidable sounding firm], his [mutual fund name] has outperformed its benchmark by [big number]% annually over the past 5 years. The key is to [something skill-based like “on-the-ground” human research or complex computer algorithms] and also [something classic like “long-term perspective” or “focus on the fundamentals”]. As a result, the manager says that people should [something vague and simple for the Average Joe investor].

There are also the marketing materials coming directly from the firms themselves. Here’s an actual quote taken from a 2008 fund brochure. I’ve bolded the buzzwords for your convenience:

The OIM Core Plus Fixed Income strategy is rooted in the idea that individual security selection produces the best opportunity for risk-adjusted excess returns over time. Through an extensive, bottom-up research process, our portfolio management team focuses on optimal bond selection of investment grade corporate bonds, mortgage-backed securities, US Government Treasuries and taxable municipal bonds. The team employs a tightly controlled duration discipline and closely manages all portfolio risk factors. The portfolio management team’s objective is to produce predictable, consistent excess returns net of fees over the Barclay’s Capital Aggregate Bond Index.

The Oppenheimer Core Plus fund was supposed to be very conservative and was marketed to those with children within 5 years of college. What happened next? It proceeded to lose 38% of its value in 2008, while the fund’s benchmark actually rose 5.24%.

Barry Ritholz probably digests more financial media than 99.9% of folks out there, and in a recent WaPo article he pretty much nails the average CNBC guest who gets the question “Where’s the Dow going to be in a year?”:

“Our view is that the economy in the U.S. continues to _______, and we foresee _______ problems overseas ______. China is _______, and that has ramifications for the Pacific Rim’s ______. Greece is ______ in Europe. The commodity complex is causing _____ for emerging markets. But many sectors of the U.S. economy remain _______, and some sectors overseas are still _______. The valuation issue continues to be _____, and that means _____ for investors. That has ramifications for corporate profits that will be ______. We think the economy is going to do ______, and you know that means inflation will be _____, which will force interest rates to ______. Under these conditions, the sectors most likely to benefit from this are ______, ______ and ______. The companies best positioned to take advantage of this are ____, ____ and ____. Based on all that, we especially recommend an overweight allocation to ____, ____ and ____. Thus, we believe the Dow will be at ______ next year.”

There are good mutual fund managers, good financial reporters, and good hedge fund managers out there trying to do the right thing. But the problem is that when you see such meaningless words and phrases, you just can’t tell if they are good or bad. Next time you watch CNBC, Fox Business, or Bloomberg TV, see if you can match up the blanks and buzzwords. Thanks to reader CJ for the Ritholz article tip.

Filed Under: Investing, Simple Living //

Acorns App Review: Auto-Invest Your Spare Change, Now Free For Students

Posted on August 13, 2015 // 75 Comments

acorns_screen

Updated review. New Android and web versions. Added details about “students invest for free” feature (anyone 24 and under). When I wrote about WiseBanyan, I remarked that now people could start investing a portfolio of ETFs with as little as 100 bucks. Well, what about investing just 57 cents at time?

Acorns is a new smartphone app that lets you invest your “spare change” into a diversified ETF portfolio of stocks and bonds. For example, if you bought something for $10.43, the Acorns app will “round up” your purchase to $11 and invest $0.57 into a brokerage account. The idea is that these small investments will make it simple and easy for folks to start saving and investing. Thanks to reader Steven for the tip.

How does it work? You’ll need to provide them:

  • Your personal information (name, address, SSN) because this is still a real SIPC-insured brokerage account underneath.
  • Your debit or credit card login information (so they can track your transactions and calculate round ups)
  • Your bank account and routing number (so they can pull money into your investment account)

The app scans your transactions, calculates the round-ups, pulls that money from your checking account, and automatically invests it for you. You can also make one-time deposits or schedule recurring deposits on a daily, weekly, or monthly basis. The app also tries to identify “found money” like rebates and rewards which it encourages you to also invest with a quick tap. Here’s a YouTube video demo:

Fees. You do not get charged any trading commissions for your investments, which can be a big factor in traditional brokerage accounts.

As of January 1st, 2015, Acorns has changed their fees to be either $1 a month (balances under $5,000) or 0.25% of assets per year (balances above $5,000). So on a $10,000 balance that would be $25 a year. No fee on $0 balances.

As of July 8, 2015, the management fees above will be waived for all students – defined as anyone under the age of 24 or you register under a .edu e-mail address and list your employment as “student”.

Withdrawals are free, but you may incur capital gains at income tax filing time. I don’t know if they will support asset transfers via ACAT.

Portfolio details. You can choose one of five target portfolios, ranging in risk level from conservative to aggressive. Mostly the popular Modern Portfolio Theory stuff that most other automated advisors offer… not surprising as their “Nobel Prize-winning economist advisor” is Harry Markowitz, who is a paid consultant.

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All portfolios are constructed using the following six index ETFs:

  • Vanguard S&P 500 ETF (VOO)
  • Vanguard Small-Cap ETF (VB)
  • Vanguard FTSE Emerging Markets ETF (VWO)
  • Vanguard REIT ETF (VNQ)
  • PIMCO Investment Grade Corporate Bond ETF (CORP)
  • iShares 1-3 Year Treasury Bond ETF (SHY)

Fractional shares are used. Dividends are reinvested. Rebalancing happens automatically. Their asset allocation has much in common with most other automated portfolios, although it is probably one of the more different ones that I’ve seen in that you have no exposure to any stocks from Developed European and Asian countries like the UK, Japan, or Australia.

I’m a little concerned about all the tax lots created when buying stocks in such small amounts. Dealing with taxes when you sell might be a headache if they don’t import directly to TurboTax or similar tax software.

Availability. You can now use Acorns in either iOS/iPhone/iPad, Android, or online web-based application. The apps are also compatible with Apple Watch and Android Gear, for those so inclined.

My thoughts. My first reaction was… that it was a great idea that I wished I thought of first. I used to participate in Bank of America’s Keep The Change program, which is similar in that it also rounds up your BofA debit card transactions to the nearest dollar but instead moves the money into a BofA savings account paying essentially zero interest. Acorns takes it further by letting you use any bank and any debit or credit card, and also lets you invest it for potentially higher returns.

In addition, I agree that Acorns will lower the psychological barrier to investing because you don’t even have to commit to $25 a week or $500 a month. You know if you can afford a gizmo or meal at $15.66, you can afford it at $16, so why not invest that spare change? The hurdle can’t get much lower than that.

At the same time, we have to be realistic. With this model how much you save depends entirely on how many purchases you make, with a theoretical average of 50 cents saved per transaction. Even buying five things a day times 50 cents is $2.50 a day or $75 a month. It’s good as a kickstart, but not nearly enough to fund a retirement.

If you want to look at it purely mathematically, a monthly fee of $1 taken out of a $75 investment ends up being like a front-end load of 1.3%. Or given the target demographic of active smartphone users, you could just look at a buck a month as something you’d otherwise blow on some Candy Crush Saga app. I do think it is smart to let anyone 24 and under or a student use it for free.

Also, don’t call it a “piggy bank”. A piggy bank means you put in a quarter, and you can take out a quarter later on. A piggy bank is a bank savings account. Acorns on the other hand is a long-term investment account that you have to be ready not to touch for at least a decade. Sure the “expected” return is 4-9% but you have a good chance of a permanent loss of money if you withdraw within the next few years. If you start using this app, please remember this.

Bottom line: Neat idea, very nicely-designed app. Free for students or anyone age 24 and under. The Acorns app may not fund your entire retirement, but it can help those that need a nudge to invest. Automation helps you keep on track. I think there should an option for an FDIC-insured high-yield savings account.

Filed Under: Investing, Reviews //

Motif Investing Review – Be Your Own Fund Portfolio Manager, Even Get Paid By Others

Posted on August 13, 2015 // 34 Comments

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Updated. Ever wanted to manage your own mutual or ETF? A new brokerage company called Motif Investing will let you do just that. One of their pitches is that you can invest in a group of up to 30 individual stocks that fit into a motif or theme like “Housing Recovery” or “Lots of Likes” (companies that have the most Likes on Facebook). You can buy the entire basket of stocks with just one $9.95 commission, with no ongoing management fees. The minimum motif investment amount is $250.

My initial impression was that it felt a bit too trendy and gimmicky to recommend as a long-term investment. Indeed, I don’t really care how many Facebook Likes a company has, and I doubt I would buy stocks based on my love of pets or my political views. It’s just not my style.

Since they let you customize the basket, anyone could essentially make their own ETF or mutual fund with ZERO expense ratio. You can’t track a broad index like the S&P 500, but if you do have a basket of stocks that you buy regularly, this would be a very cost-efficient way of doing it. You can add or remove stocks, and adjust the relative weighting of each stock in the motif. Here’s a screenshot (click to enlarge):

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Horizon Motifs are preset “target date” motifs which are commision-free and with zero management fee. There are 9 different Horizon Motifs – you pick one of three time horizons (1 year, 5 year, or 15 year) and one of three risk levels (conservative, moderate, or aggressive). Kind of like a Target Date 20XX mutual fund, kind of like a roboadvisor. If you buy these specific portfolios, they waive their $9.95 commission. More information at this post: Horizon Motif Review: Commission-Free, No Advisory Fee, Index ETF Portfolios.

You can even make money when others use your Motif Portfolio with the Creator Royalty Program. Every time a client makes a $9.95 trade using your Motif, you’ll get a $1 royalty fee. For example, after reading an article about the Voya Corporate Leaders Trust Fund which bought 30 stocks in 1935 and then never sold them (but still charges a 0.52% management fee every year), I created the Depression Survivors Motif which does basically the same thing except it has zero management fees.

So far, I’ve made one entire dollar! 🙂 Recent performance has been abysmal due to recent oil price drops, as Chevron and ExxonMobil are significant holdings.

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My plan is to someday create a custom basket of dividend-oriented stocks that hopefully will provide a long-term stream of growing income. For example, look at the SPDR S&P Dividend ETF (SDY) that holds 60 highest-yielding stocks of the S&P 1500 that have raised their dividends every year for the past 25 years. It’s a nice idea, but it leaves out some good companies and the 0.35% expense ratio eats up 10% of the original yield of the underlying companies. Why not hold most of these directly, remove some of the ones you don’t like, and keep the 0.35% as extra return for yourself?

Motif also uses dollar-based trades, which means every penny is invested, while they keep track of any fractional shares for you. No maintenance fees, no inactivity fees. In many ways, this is similar to the unlimited plan at Folio Investing, but Motif Investing has the potential to be a lot cheaper ($10 per motif trade with no minimum trade requirement vs. $29 every month for Folio) and is closer to a ETF in that they do real-time market trades. You can still do regular real-time trades of individual stocks for $4.95 per trade. Currently there is no automatic dividend reinvestment, the dividends go to cash and you reinvest yourself as desired.

Update: As of 8/13/15, Motif is adding the following features:

  • Dollar-based, real-time purchases of single stocks and ETFs (in addition to whole shares).
  • Stop loss orders by whole or fractional shares.
  • Create your own stock or ETF watch list.

New customer bonus. Right now, Motif Investing is offering new customers up to a $150 cash bonus when you open with $2,000+ and make 5 trades. If you make 1 trade, you’ll get $50. 3 trades will get $75.

Filed Under: Deals & Offers, Investing //
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