I received more that the usual number of questions and comments inside the blog, so unfortunately my responses will be even briefer than usual...
1. Reader Question
LTR, you have a great blog and provide a great service, so thank you for that. I have noticed in several recent posts that you have recommended VWLTX and VWLUX for the bond portion of a taxable account. I was wondering why you favor the long-term funds vs intermediate [VWITX / VWIUX]. It seems as if you would reap most of the potential upside, with considerably less potential downside. Your comments would be appreciated.
VWITX/VWIUX are a very reasonable option as well. The reason I usually recommend VWLUX is that despite the "long-term" in its name its actual average maturity is just a year longer than that of VWITX/VWIUX. For that extra year (and a truly tiny drop in credit quality), you get nearly 0.5% higher annualy yield out of VWLUX than out of VWITX which in my estimate is a superb tradeoff.
2. Reader Question
1. You should recommend some books (that is if there are any investing books you like)
2. I would be interested in hearing your take on the Colorado 529 Stable Value Plus plan (http://www.collegeinvest.org/collegeinvest-savings-plans/stable-value-plus-plan/). This stems from a recent Finance Buff article on the subject. Basically the fund returns 3% (net of fees) in a 529 account, the funds are backed by Metlife Insurance company. Putting aside the fact that this is a 529 and that the underlying value doesn't fluctuate with interest rates - what do you think is the risk equivalent of this type of investment? Investing in a pool of corporate bonds ? Investing in a single corporate bond? If MetLife fails I'm not sure there is any recourse? Would you see the writing on the wall before it fails and be able to get out (i.e. credit worthiness would be downgraded first). Other states offer similar plans, but none with a rate this high (again from the Finance Buff not my own research!).
My usual reading recommendations for passive investors are William Bernstein's books -- "Intelligent Asset Allocator" (a bit heavier read), "Four Pillars of Investing" or "The Investor's Manifesto" (the last two are similar and easier reads than the first), as well as "Bogleheads' Guide To Investing". If you are also interested at least learning about active investing, then Graham's "Security Analysis" (heavy) and "Intelligent Investor" (much lighter) are classics. Also for anyone interested in investing or economics (or even politics for that matter), Darrell Huff's "How to Lie with Statistics" is a great little book.
Stable value funds (SVF) are "pretty safe". Underlying them are typically diversified investment-grade bonds wrapped in interest rate contracts that prevent fluctuation in value. Those interest rate contracts ultimately reduce total returns by a bit but insulate investors from any volatility. The safety of SVFs comes down to (a) the safety of underlying investments of corporate bonds and interest rate contracts and (b) the safety of the backing institution.
It would probably take an unprecedented calamity to threaten (a). Even during the Great Depression investment-grade bonds generally held up well with less than 1% in default losses in most years. Their prices were undoubtedly very volatile but ultimately they came through and delivered the promised interest and return of principal. I don't think anybody can give a meaningful estimate of likelihood of worse-than-Great-Depression economic event. Just off top of my head, maybe there is a 25% chance in a lifetime or 3% chance any given decade? For all we know we may not have been far from it in 2008 but avoided it thanks to a mix of smart, if late, leadership and a whole lot of luck -- and who knows, we are not completely out of the woods yet. It seems likely that the first to go in such a scenario would the highly leveraged financial companies underwriting those interest rate contracts. But the collapse would be unlikely to stop there. Things would get very bad for almost everyone in almost every way. I am not sure there is a meaningful way to invest for such a scenario -- other than to have some physical gold and silver on you. If there is a bright side there, it's that the loss of your 529 investment would probably be somewhere on the third page of your immediate concerns.
As far as (b) -- safety of MetLife specifically separate from a greater economic calamity -- then chances are pretty good that the SVF investors would be made whole or nearly whole even if MetLife screwed up royally. Briefly skimming the prospectus for that SVF, its holdings will be commingled with MetLife's "general account" which is basically the giant pool of investments out of which most of MetLife's different policies are paid. Policyholders come before even bondholders on the who-gets-paid-first-in-a-bankruptcy totem pole. There is an argument to be made that a "separate account" structure would have been even safer, as CO 529 investors would have complete claim on their particular pool of investments instead of sharing in claims with other MetLife policyholders. But the "general account" should be quite safe too.
I am not certain of the exact numbers in case of most infamous insurance company failure, AIG, but I believe that even if it were not bailed out, policyholders could have been made whole or close to whole by making the bondholders take large haircuts (or wiping them out completely). I am not saying that to make a case against bailouts (which in retrospect look like brilliant, if unfair, decisions) but to demonstrate the substantial safety cushion policyholders, such as CO 529 SVF investors enjoy. The bankruptcy process might be protracted and messy but ultimately you would be very unlikely to lose much if anything in an event of MetLife's failure -- provided of course it's not happening against the background of general economic collapse of scenario (a).
3. Reader Question
Hello LTR I am new to investing and have stumble across your blog in my search for some solid no fuss advice. I am 42 and my husband is 40. We have 2 children. We came into some money about 3 years ago and have been paralyzed since. I have most still in cash at Chuck. I am stuck. We have about 200k to do something with and I just can't make a decision. Do we pay off out house which would take all our cash? Do we fund 1/2 our money to our kids college education? Where do we put this? We have other investments. A 401K with about 70K and a Roth with like 20K. I am looking at Wealthfront and Betterment. (Great review!) I am attracted to the no fuss service. I am a bit of an introvert as well so physically seeing a financial advisor is a bit overwhelming. The online investing looks attractive. I like your enthusiasm with Vanguard LifeStrategy Funds. I will check that out too. I can't believe I am reaching out like this for guidance but there is something about your blog, the way you write, that calms that inner fear as a ignorant investor. What's your advice?
Thank you for writing. I don't think a financial advisor is a necessity for most people. On top of that some advisors can be actually harmful to your financial well-being and all of them, good and bad, will cost a lot of money which may or may not be justified by the quality of their services. In place of an advisor -- and, really, even if you go with one -- you need to spend enough of your own time to learn about become comfortable with the basics of investing. It's not hard but it does require some time. Even more importantly, you have to adjust your total living expenses -- including those rare but inevitable big ticket items like new car purchases, house roof replacements, medical emergencies, and, of course, kids college -- to be well below your post-tax income. If you don't save then not even the best financial advisor in the world would be able to help you. To begin your education I recommend reading either of William Bernstein's lighter books or the Bogleheads book that I recommended in my reply immediately above this one. Hopefully my blog helps a bit too.
Good news is that with that $200K plus your $90K in 401k and Roth you are in pretty good financial shape -- certainly much better than most people your age. With another 20-25 years of working and good amount of new savings/investments combined with Social Security benefits you should be able to ensure a comfortable retirement for yourself even after you pay for your kids college. So don't rush into any decisions but take your time and educate yourself first -- start by reading those general investing books I mentioned.
Besides taking time to educate yourself, if you are quite averse to risk -- meaning you get nervous quickly when you see your 401k/Roth investments starting to slide in value -- then using some or most or even all of that $200K in cash to pay off your mortgage may be the simplest and least painful decision. This is especially true if your mortgage interest rate is, say, 4% or higher. Paying off a mortgage is more or less equivalent to guaranteed investment at the same interest rate. Since there aren't any guaranteed 4% investments to be had today, using cash to pay off a 4+% mortgage is certainly not a bad decision and may end up a great one. It's true that it may also end up being less optimal. Perhaps stocks will end up returning much more than 4% going forward, for example, and in retrospect you will wish you had put that money towards stocks instead. But nobody -- least of all I -- knows what the future holds. Those great returns from stocks may not materialize. Paying off a relatively high interest rate mortgage is a very sure thing. Once the mortgage is paid off you will have freed up a whole lot of your future earnings for new savings and investments. Just make sure you don't squander the opportunity by spending more once you pay off the mortgage. Use your new-found financial flexibility to save and invest more.
Aside from the possible mortgage payoff, I wouldn't rush to invest the $200K but instead take time to become comfortable with the basics of investing, understanding the differences between as well as upsides and downsides of stocks and bonds, and think about what kind of mix of the two (and it should almost certainly be a mix of both stocks and bonds) you would be comfortable holding while still having a good shot at having a comfortable retirement. It's not an easy decision, which is why you should take your time making it. Also, read my http://www.longtermreturns.com/2012/03/selecting-investment-strategy.html post. You can ignore the specific investment recommendations made there in favor of LifeStrategy or even Betterment or Wealthfront if you ultimately decide to go with those. But I tried to lay out the thinking process that should go into coming up with your investment strategy which should be the first step before making actual investments.
Hope that gives you an idea on how to proceed. Again, don't stress and do take your time to educate yourself on general investing, decide on a long-term investment strategy for yourself, and only then start looking into specific investments. The 529 is also a very good idea, but again take time to educate yourself on general investing first.
4. Reader Question
Parent's Portfolio (ages 64, 62)
Property: One home valued at about 375,000. Another home to be inherited
from my grandmother which is probably worth over 2 mil. Both where we
live in the Bay Area, California.
Income: about 5,000 a month from two social securities and my dad's
pension. They are going to save about 2k a month.
Principle: 115,000. Split evenly as per Permanent Portfolio and housed
in two pensions. One will be rolled into a Vanguard IRA at the end of
I had them open a Roth IRA with Vanguard and make monthly deposits to
hopefully build up around 10k of an emergency fund. It will be in the
GNMA fund (for added diversity).
My Portfolio (age 26)
Property: None. Currently renting, soon to be traveling.
Income: Enough to live on without any debt until I leave to travel. I
already paid off my college loans and keep my credit in excellent order.
Principle: $40,000; only 30k of it is for retirement.
10,000 in Vanguard Extended Market Index VEXMX. Compliments my parent's
S&P Index so we have complete domestic equity exposure.
10,000 in Vanguard Emerging Market Index VEIEX. I opted for EM over
Total International as they are highly correlated and I have the long
time frame to take on the extra risk.
10,000 in Vanguard Intermediate Investment-Grade Index VFICX. With my
parents Treasury exposure and their EF in the GNMA fund, all that's left
is corporates. I'll probably bump this up to Long-Term Corporates if I
feel the price isn't so inflated as it is at the moment.
7,000 in Schwab's Intermediate CA Muni Fund SWCAX . This is money I am
going to use for a long trip across the US and into Europe. I will draw
on this over the next year and consider it cash.
3,000 as an Emergency Fund. I currently have this in a Schwab Dividend
ETF SCHD as I won't be needing it anytime soon (what with the 7k in
cash) and would like it to grow on it's own.
Location: I contribute the maximum to my tax-shelters each year.
VFICX and part of VEXMX in my Vanguard Roth IRA.
The rest of VEXMX in my HSA (HSA Bank).
VEIEX in taxable at Vanguard.
SWCAX and the EF are in taxable, but not with Vanguard - instead with
Schwab (best bank for traveling).
1) How do you think this overall portfolio looks? I will be the sole
inheritor of my parents estate and they are open with me about all this.
2) Re: my bond exposure. Long-term over Intermediate-Term?
3) Re: my emergency fund. I think it's alright to assume the risk given
that I have all the extra cash to burn through first. Do you?
4) The only scenario where my portfolio will not perform well is in
periods of extremely high inflation. Do you think I should start adding
I-Bonds as a hedge against this possibility or should I opt for better
returning investments and ride out such a scenario?
5) My overall goal was to diversify as much as possible. As it stands,
the only assets we don't have are International Bonds and Developed
International Equity. Should Vanguard finally offer International Bond
Indexes, I will probably split my fixed-income allocation between one
and my current corporate. Does this seem wise?
1) For your parents' portfolio since their living expenses are actually less than their income, the Permanent Portfolio is a very reasonable, very conservative choice. I would not expect it to have anywhere close to its substantial returns of the past 30+ years, but it should remain a very safe, if unspectacular way to invest. Their eventual inheritance of your grandmother's house will ensure a very comfortable retirement for them, even if the living expenses start to exceed their pension + SS benefits. However, unless I misunderstood, it sounds like your parents have no earned income. If that's the case they are not eligible to contribute to an IRA and will have to invest their savings in taxable accounts instead.
For your portfolio, since you view it as extension and compliment to your parent's portfolio, your choices are reasonable as well. I would go with VGTSX over VEIEX but it's not a major decision in the big picture.
2) VFICX is a reasonable holding. There is really no absolutely way to say that it is better than VWESX (long-term corporates) or vice versa. You are young enough that you could certainly ride out the extra volatility of VWESX if you chose to, but it does not mean that you should choose it.
3) I definitely would not view SCHD as any kind of emergency fund money. Even SWCAX is a stretch on the definition of "emergency fund". SCHD, can and will nosedive in the next crisis, whenever that comes. SWCAX can drop quite a bit too if California's recent financial progress reverses or general interest rates rise. If it's money that absolutely have to be available on moment's notice I would reconsider these investment choices in favor of something a lot less risky.
4) I-Bonds are a very good (relatively speaking) investment today, even if we never see particularly high inflation. After a year they also double as a very reasonable emergency fund. I would strong consider them over SWCAX and SCHD since you have that money pegged as "emergency fund". I would even prefer them to VFICX today.
5) The way things stand, I probably wouldn't invest in an international bond index fund even if one were available. Interest rates are fairly depressed all over the world. The extra cost and currency risk of international bond investing may outweigh whatever diversification or yield benefits it might carry. Choices available to individual US investors -- I-Bonds, CDs, investment-grade corporate and muni bonds, maybe even EE-Bonds are likely as good or better than can be had internationally at the same relative level of risk. This may change in the future depending on how interest rates change, but I would not rush into international bond investing today. I would instead take my international diversification on the equity side, especially in European and Japanese equities which have had a rough going and are relatively cheap -- which is why I would recommend VGTSX over VEIEX.