I’ve talked about the importance of savings rate, but remember that investing that savings prudently is also part of the process. Here’s a question – What percentage of your current net worth is saved income, and what is investment growth? This can be a tricky question, as most people invest their money gradually over time and only look at the total balance on their statements. However, as times go by your investment growth should be significant.

For example, I spent the first few years of working paying down my $30,000 in student loans. I finally started investing in 2004, which means I have been regularly saving for about 10 years now. As a rough proxy for my portfolio, I will use the Vanguard LifeStrategy Growth Fund (VASGX) which holds a static 80% stock and 20% bond portfolio consisting of diversified, low-cost index funds. It’s pretty darn close, especially considering all the options out there.

The 10-year historical return of VASGX is roughly 7.03%. Put another way, $100,000 invested back in 1/1/2004 would be $205,497 today. But I didn’t invest all my money at once, I had to wait for each paycheck or any side business profit to come in first.

A better simulation would be investing $10,000 each year from 2004 to 2013, for a total of $100,000 spread out over that decade. I don’t have any fancy software that will run the numbers for me, so I made a rough estimate using VASGX and Morningstar’s handy-dandy “Growth of $10k” charts. I calculate that:

$10,000 invested on 1/1/2004 would be $20,550 as of 7/5/2014.
$10,000 invested on 1/1/2005 would be $18,254 as of 7/5/2014.
$10,000 invested on 1/1/2006 would be $17,078 as of 7/5/2014.
$10,000 invested on 1/1/2007 would be $14,706 as of 7/5/2014.
$10,000 invested on 1/1/2008 would be $13,686 as of 7/5/2014.
$10,000 invested on 1/1/2009 would be $20,861 as of 7/5/2014.
$10,000 invested on 1/1/2010 would be $16,689 as of 7/5/2014.
$10,000 invested on 1/1/2011 would be $14,505 as of 7/5/2014.
$10,000 invested on 1/1/2012 would be $14,843 as of 7/5/2014.
$10,000 invested on 1/1/2013 would be $12,977 as of 7/5/2014.

As you can see, investment returns varied widely based on initial investment date. $10,000 invested in 2008 did only slightly better than $10,000 invested in 2013. However the total present value is now $164,149. So those ten investments of $10,000 would only be $100,000 if stuck under my mattress, but is now worth over $160,000. I calculated the internal rate of return as 8.1%.

My actual contributions were higher and not quite as constant, but it remains that roughly 60% of my portfolio size today is from saved income, and 40% is from investment growth.* This was not a product of honed skill, excellent timing, or high intelligence. It was just saving regularly, investing in low-cost diversified funds, and not panicking.

This reminds me of this Jack Bogle quote:

Own the stock market, own the bond market, as modified to meet your needs, and don’t peek. One of the greatest rules for investing ever made. […] Don’t even peek at your account; don’t open those 401(k) statements. If you don’t look at your 401(k) statement–this sounds outrageous, but it’s true–for 45 years … you start when you’re 20 and you don’t open a single statement for the next 45 years, when you open that statement the day you retire, you are going to go into a dead faint of amazement about how much money you’ve accumulated.

The hardest part of investing is not doing anything stupid.

To summarize, looking back on my last 10 years, I must say that both savings rate and investment return are important. If I didn’t save, I wouldn’t have anything to invest. But if I didn’t invest it prudently, I’d also have a lot less than I do now. Start as soon as possible, learn about investing basics, learn about managing risk and emotions, and the combination will be quite powerful over time.

* Side note: I ran the numbers the same way for Vanguard LifeStrategy Moderate Growth Fund (VSMGX) which is a static 60% stocks and 40% bonds, and the results were still very similar. My $100,000 spread out over the last 10 years would have grown to $156,000, working out to 36% of the final portfolio being investment gains.

Real estate investment trusts (REITs) offer the ability to invest in commercial real estate within the comfort of your brokerage account. ETFs in turn offer the ability to invest in a diversified basket of REITs. The Morningstar article This REIT ETF Remains Prettiest on the Block by Abby Woodham offers up reasons why the Vanguard REIT ETF (VNQ) is the optimal choice, including comparisons with similar products. Highlights:

• Low expense ratio. VNQ expense ratio is 0.10%.
• Low tracking error. VNQ’s historical performance only lags its benchmark index by 0.03%, a number even lower than its expense ratio.
• Large, mid, and small-cap exposure. VNQ’s holdings include smaller REITs that other ETFs often exclude.
• Exclusions. VNQ excludes mortgage REITs and non-real-estate specialty REITs (timber, prisons). This could be considered good or bad, as these will act differently than traditional REITs. I kind of like timber REITs, though.
• Schwab US REIT ETF (SCHH) is slightly cheaper (0.07% e.r.) but lacks small-cap exposure.
• iShares US Real Estate ETF (IYR) includes Mortgage and Specialty REITs but is more expensive (0.46% e.r.)

I agree with most of the points made; I use VNQ for my REIT exposure. It’s good to learn more about the competition as well. The same underlying holdings of VNQ are also available in mutual fund form:

• Vanguard REIT Index Fund Investor Shares (VGSIX) – $3,000 minimum
• Vanguard REIT Index Fund Admiral Shares (VGSLX) – $10,000 minimum

Bonds are supposed to provide both income and stability in your portfolio. International bonds, especially Emerging Markets bonds, are becoming more popular. But do you need them in your portfolio? Respected author/money manager William Bernstein doesn’t think so. From an ETF.com interview:

ETF.com: One thing that puzzled me is that among your recommendations, I don’t see an international bond fund as part of the allocation—even one that’s currency-hedged. Why?

Bernstein: Well, first, there is absolutely no way any rational investor would want an unhedged international bond fund in their portfolio for a very simple reason: Your bonds are your “safe” assets. They are what you are defeasing your retirement with; they are what enables you to sleep at night; they are your liquidity for when you lose your job or for when you want to buy cheap equities or the corner lot from your neighbor who got caught in a liquidity squeeze.

And the unhedged currency exposure with unhedged international bonds is very risky. All you have to do is look to what happened to the euro and the yen in the last crisis—they cratered. That’s a risk you simply don’t want to take.

Now, when you have hedged currency risk as opposed to unhedged currency risk in a bond fund, you’ve got a smaller problem, but it’s still a problem. And that’s when you take foreign sovereign bonds and hedge them back to the dollar—you’ve basically got U.S. bonds.

Maybe you get a tiny bit of extra diversification, but it’s a trivial amount—plus you’re paying higher expenses and higher transactional costs to deal with foreign bonds.

On the other hand, the Vanguard Group apparently does believe that holding international bonds is a worthwhile way to add diversification to your portfolio, as in 2013 they added international bonds to their Target Date Retirement and LifeStrategy all-in-one mutual funds (currently 20% of the total bond allocation). The Vanguard Total International Bond ETF (BNDX) has an expense ratio of 0.20%, while the domestic Vanguard Total Bond Market ETF (BND) has an expense ratio of 0.08%.

As Bernstein puts it, “owning a currency-hedged bond international fund is just basically getting into slightly more expensive U.S. bond exposure.”

Personally, I’m also not convinced that international bonds offers something necessary. Maybe someday that will change. Whenever I’m not convinced, I choose simplicity. Thus, I have never and currently do not own any foreign bonds.

An important tenet of portfolio construction is rebalancing your portfolio to maintain your desired risk profile and also provide the best risk-adjusted returns. The next question is usually – Okay, so how often do I rebalance? Well, this Vanguard article targeted at financial advisors answers that question (found via Abnormal Returns).

Longer answer:

Our 2010 study looked at the performance of portfolios that used rebalancing strategies based on various time intervals, allocation thresholds, and combinations of both. The time-based portfolios were rebalanced monthly, quarterly, or annually, while the threshold categories were rebalanced when allocations deviated by a predetermined minimum (in this case 1%, 5%, or 10%) from their target allocations. The “time-and-threshold” strategy combined periodic monitoring with predetermined minimum rebalancing thresholds. […] We found that no one approach produced significantly superior results over another. However, all strategies resulted in more favorable risk-adjusted portfolio returns when compared with returns for portfolios that were never rebalanced.

Short answer: It doesn’t matter, as long as you do it regularly and without emotion. Rebalancing every month was no better than rebalancing just once a year.

Personally, I try to rebalance whenever I make my monthly share purchases by buying underweight asset classes, but I will only sell and create a taxable event once a year if things are really out of whack. The more common problem is that you are afraid to rebalance because that usually means buying whatever has been getting crushed and selling what has been rising. If you haven’t done it recently, that probably involves selling some stocks and buying some bonds. Like the shoe company says, just do it!

Being a peer-to-peer lender been a bumpy ride. Prosper Marketplace was first, but if you were an early investor/lender you’d have been lucky to have gotten back what you put in as most people had negative returns. Then came LendingClub with stricter credit standards and preset interest rates. Both companies operate with similar structures now and appear to have created a viable business model. In fact, LendingClub is planning an IPO with their last funding valuation at $3.8 billion. That’s pretty rosy considering they made just $7 million of profit in 2013, their first year of profitability in 7 years.

I’m not a big lender but I have invested over $15,000 of my own money into P2P loans. In the beginning, I would read every single loan listing as it usually included a story about what the borrower was going to do with the money (pay down debt, start a new business, buy a 200 sf tiny house). After a while, I started using automated software to match with loans, but it still felt like individuals lending money to other individuals. Today, a significant portion of loans are sold to institutional investors like hedge funds, pension funds, and even banks according to the New York Times article “Loans That Avoid Banks? Maybe Not“:

At Prosper, which has been courting institutional lenders over the past year, more than 80 percent of the loans issued in March went to those firms. More than a dozen investment funds have been formed with the sole purpose of investing in peer-to-peer loans. […] Santander Consumer USA, the United States arm of the Spanish bank, has an agreement to buy up to 25 percent of Lending Club’s loans.

I spoke to a LendingClub representative, and they stated that their investor base is currently “about 1/3 direct retail investors, 1/3 high-net-worth investors, and 1/3 institutional investors.”

Here’s a thought experiment: If somebody like Chase Bank goes to a P2P lender and buys a bunch of unsecured loans made to individuals, is that really much different than that same person just carrying a balance on a Chase credit card?

It used to be individuals who took the risk of lending and reaped any rewards of higher interest. The P2P company just cares about volume as it takes a fee from every loan. But if that volume comes from big financial firms that want first dibs, does that mean the individual investors will only get left with the scraps?

The loans not taken by these sophisticated investors go back to a fractional lending pool that is open to both individual investors and institutions. That doesn’t sit well with some. “The institutional investors are snapping up all the worthwhile loans,” one investor wrote on Prosper’s blog, echoing many comments. […] “By cherry-picking, almost by definition what they leave behind is not as good,” says Giles Andrews, founder and chief executive of Zopa, a British peer-to-peer lender that so far has dealt only with individual lenders.

Perhaps the best sign that P2P lending sites have become a legitimately good investment is that Wall Street and other professional investors are now crowding us out?