Friday, April 1, 2016

After a Brief Hiatus, I'm Back

The old saying goes that "life is what happens while you're busy making other plans." So here I write this post, nearly 5 years removed from my last. As you may imagine, a lot has certainly happened since then. My last post was made on October 4, 2011 when I had just graduated from college and began my first job. Since then, I have gotten married to the love of my life, been a member of the workforce for 4 1/2 years, and went to business school at nights while working full-time in order to earn an MBA. The cliche that time flies couldn't be more accurate.

What those 5 years have given me is valuable perspective (life experience, anyone?) that accompany entering adulthood. It's one thing to write about financial management and investing for those just entering the real world, but it's another to actually live it on a daily basis. I'm happy to note that the very investing ideas that I was discussing nearly 5 years ago are the same ones that I implement in my life now. My 401(k) asset allocation is balanced yearly between 3 funds and it's a basic allocation that should work for most young investors:

55% - broad, total stock market index fund
35% - total international index fund
10% - bond index fund of choice

The last option - the bond fund - is not a necessity for most investors under 30, and it may very well be your preference to remain 100% invested in equities. After all, as interest rates rise, the price of bonds go down in an inverse relationship. Since the Federal Reserve raised its target fed funds rate (i.e. 'raised interest rates') in December 2015 for the first time since 2008, many economists expect a pattern of tightening may continue over the next year or so depending upon economic conditions. As the Fed continues to raise rates, bond prices are likely to fall which may hurt bond investor's returns. This doesn't matter much to the long-term Generation WI$E investor, but it's important to note. However, having some exposure to bonds gives you the added benefit of extra income and diversification. If you own the bond fund in your 401(k), you will receive tax-deferred monthly income from the bond fund that can be reinvested to buy more shares in order to leverage the benefits of compounding.

There will certainly be much more to discuss over the coming weeks and months as both the world and financial information flow has changed dramatically in the 5 years since I last posted. I'm looking forward to sharing more of my real world financial journey with you as I continue my goal to make us all members of Generation WI$E.

Tuesday, October 4, 2011

It's Time for Some Inaction!

Like most people, I'm finding it very hard to distance myself from the grim news that has dominated the financial headlines over the past few months. Everyday seems to bring another story of a European bank or country on the brink of failure, the U.S federal government's fiscal issues leading the country to the verge of financial meltdown and more and more bad news on the economic front. It's safe to say that all of this is leading to heartburn for many investors, particularly those who are most exposed to equity markets and have thus received the brunt of the market's move to the downside. 

We will thus hear the requisite talking heads on CNBC and other financial news networks extolling the virtues of "buying aggressively" or from the opposite end of the spectrum "moving assets into cash, Treasuries, precious metals and other safe havens". My advice to you is relatively simple and may seem to go against the grain but it's battle tested and makes sense: simply stay the course, continue with your investment plan and let the market work its issues out. 

As soon as we become reactionary and allow market movements severely dictate how we invest in the here and now, we have let our emotions get the best of us. This is not to say that we shouldn't put some more funds to work since stock prices are low - in that case, it may make sense to buy some more shares of your index funds to better dollar cost average - but avoid any actions that run contrary to what your investment plan is. If, for example, you contribute 10% of your pre-tax pay to your 401(k), it may make sense to up that percentage to 15% or so if you can afford to do that. However, slashing that rate to 0 or upping it to 30% simply doesn't make much sense. Believe me, that type of reaction to current market gyrations occurs a lot more frequently than you realize! As the legendary John Bogle noted, "Don't do something. Just stand there."

Wednesday, September 28, 2011

Wall Street's Flavor of the Week

It seems like it was just yesterday that John Paulson was the darling of the investment community, earning billions of dollars in personal profit and causing fellow institutional investors to hang on his every word and action. How times have changed! A headline on today states, "Rivals Scout Paulson Assets" - if that doesn't sound dire, I don't know what does! I've brought this subject up before but it bears repeating because it shows how fickle investors are - you can be the "can't miss" investment manager one day and a goat the next. 

On Wall Street, you're only as good as your last trade. This goes for all types of investors and helps make the case for passive management much easier. After all, a handful of institutional investors - from hedge fund managers to mutual fund managers - are wildly outperforming their benchmarks at any given moment. The question then becomes how much staying power do those managers have; in Paulson's case, it appears, only a couple of years worth. In the case of the actively managed mutual fund manager, the same is true. It was only a few years ago that Bill Miller, the manager of Legg Mason's Value Trust had his 15-year streak broken of beating the returns of the S&P 500. From 1991-2005, Miller's fund posted returns that were greater than those of the index and was lauded in the press as an investment titan. There is no doubt that Miller is a great finance mind but even he admits that much of his streak was due to luck: "As for the so-called streak, that's an accident of the calendar. If the year ended on different months it wouldn't be there and at some point the mathematics will hit us. We've been lucky. Well, maybe it's not 100% luck—maybe 95% luck."       

The problem for investors like you and I comes when we're tasked with picking the managers who can consistently outperform year in and year out. Here's some food for thought: What's amazing about Miller's success is that consistent outperformance is so rare (1 in 2.3 million, according to Michael Mauboussin), yet the ultimate goal of most individual investors is to invest in mutual funds that can post that type of outperformance...which never comes. If that's the case, why are we throwing good money after bad?

Sunday, September 18, 2011

It's Much Easier to Spend What's Not Yet There

Much of what there is to be learned about managing your finances properly comes when we tame our emotions and focus on the psychological aspects of financial decisions. A mistake that many people make when they get paid is that they have much of their cash on the way out as soon as it comes in. This typically happens when an individual has credit card bills and other debts to pay. The easiest way to avoid this type of occurrence is to make sure you only charge to your credit card(s) that which you know you can easily pay back when you have income come in. Secondly, even if you find yourself stuck with some bills, be sure to keep contributing to your 401(k) for the tax and compounding benefits and save a set percentage of every paycheck for an emergency fund. Ultimately, the 401(k) and emergency fund contributions are two cash "outflows" that shouldn't make you feel bad because by making them, you're only helping yourself. 

By not "segmenting" (outside of the 401(k) and emergency fund contributions) your money before your actual paycheck is deposited, you will immediately begin to see substantial savings. After all, it's much harder to spend money when you can actually see your account balances declining with each purchase, rather than simply thinking about it and accounting for it later at which point you'll likely realize that most of your paycheck is gone before it's even arrived!

Monday, September 12, 2011

The Benefits of the High-Yield Index Fund

Many people are often faced with the seemingly difficult situation of trying to maximize their income due to lack of sufficient cash flow. This becomes even more of a problem as economic growth slows and employers lay off workers and cut salaries in order to help manage their cost structures during a downturn. Luckily, there are some investments that offer regular distributions that can help add a few extra dollars to your household balance sheet every month.

One such investment is a high yield bond index fund. High yield bonds - also known as "junk bonds" - are the debt of corporations and other entities that may be experiencing financial distress. As a result, investors receive a higher interest rate as compensation for the greater risk to their invested cash. As Rob Williams, director of Income Planning at Schwab notes, "Defaults on investment-grade bonds have historically been low, though the frequency increases as credit quality declines."   

Better still, the diversification of a high yield bond index fund ensures that if one issuer were to default, the likelihood of a significant impact on the rest of the portfolio is minimum. How do such funds help maximize current income? The funds pay out their distributions monthly and in the case of the Vanguard High-Yield Corporate Investor Shares (VWEHX), currently yields 6.91%. Thus, even though the numbers might appear small in the beginning - only $30 or so extra a month on a $5,000 investment - you have the choice of taking that cash every month to maximize current income or reinvesting it to help your stake compound which will lead to even higher passive income amounts in the future. 

Overall, high-yield bond funds are a much better avenue for investing in high yield securities due to their overall lower risk profile, low fees and impressive long-run returns

Monday, September 5, 2011

Helping Kids Understand Credit

A recent WSJ article regarding kids and credit cards piqued my interest and led me to think more about the role that parents play in shaping their child's view of money and finances. The old saying goes "the apple doesn't fall far from the tree" and in the world of financial learning, that is indeed correct. Much of what children learn about spending in their formative years comes via observation. If they observe their parents engaging in profligate spending, they are more apt to believe that is OK behavior because they have little understanding of cause and effect. After all, if they are still living in a comfortable home with nice clothes, food on the table and toys to enjoy, they will likely take that as a confirmation that their parents' spendthrift ways are rational behavior. Similarly, if a family carefully watches its budget while still providing the same nice clothes, food and toys in a household, a child will take this as confirmation that their parents' budget consciousness is important. 

Children are very impressionable. If they see you reaching for a credit card every time you go out to shop, they will begin to think that credit cards are an instant source of money (they are) but it's up to you to set the example and teach them that when the time comes for them to get a credit card, its balance should be paid off in full every month. 

This is a problem that confronts Gen Y parents in particular because we are gradually moving away from a monetary system based on physical dollar bills. Instead, the majority of consumers are more likely to use electronic payment methods such as a debit or credit card to pay for a store purchase. This has its pros and cons but there is one key thing I would recommend all parents do: before exploring credit cards with children, teach them about saving and spending the old fashioned way - with cash. There is much greater regret among children when the $10 bill they were given is spent than if it were simply accounted for via swiping a card. It may be old fashioned, but it certainly worked for me when I was a child!

Tuesday, August 30, 2011

Debunking Financial Myths

I came across an interesting and informative article the other day - "10 Financial Myths Debunked". An especially relevant myth is assuming long-term average stock market rates of return of 8 percent as are certain rules of thumb when planning for retirement. 

Point 4 is relevant because most people are way too optimistic when it comes to calculating potential rates of return during retirement planning. From a young age, it pays to err on the side of caution and assume anywhere from a 5-7% long-term rate of return on your portfolio. If you have the time, use a financial calculator to plug in your current investments, time horizon and potential rates of return from 5-7% and see where you end up during the year you plan to retire. By assuming a smaller potential return, you will be able to set up the best possible plan to reach your goals and ensure that your investments don't overpromise and underdeliver.

It's also worth noting that "rules of thumb" in the investment world are rarely worth the paper they're printed on because each person is different and the world is not static. Since the world we live in today will be drastically different than the world we will live in 40 years from now, it's not worth prescribing to certain rules that simply can't change with the times. For example, it's impossible to tell what type of health we will be in, what our family situation will be like and how the world will really be so far into the future. Thus, we should plan our investments out based on our own goals and risk tolerances, while avoiding "catch all" rules of thumb that don't accomplish much.