Richer by the Day

Passive Versus Active Portfolio Experiment, Month 2 Results

Mike — Wed, 24 Jun 2009 11:03:29 +0000

My results from the second month of my Passive Versus Active Portfolio Experiment are now in. They are as follows:

Month 2 Results

Passive: I had one transactions this month; a dividend reinvestment. My passive portfolio increased by a total of 10.32%. This gain includes the commission that would have been charged had I liquidated my position at the end of the month. My dividend reinvestment is not subject to a commission.

Active: I had five transactions this month; 3 purchases and 2 sales. My active portfolio increased by a total of 1.91%. This gain includes commissions, including the one I would have been charged had I liquidated my third position at the end of the month.

Benchmark: During the same time period, the S&P 500 increased by 1.97%. For the first time, one of my investment portfolios (active) failed to beat the benchmark for the month. My passive portfolio significantly outperformed the benchmark this past month.

Overall Results to Date

After two months, my passive investments have taken the lead in profitability. Both my passive and active investments have beaten the benchmark return of the S&P 500.

Passive Return to Date: 21.56%

Active Return to Date: 13.99%

Benchmark Return to Date: 10.69%

Cash for Clunkers, A Clunker of a Law

Mike — Mon, 22 Jun 2009 16:38:34 +0000

The Cash for Clunkers law is intended to jump start the auto industry by inspiring people to purchase new cars. Touted secondary benefits include aiding consumers in new car purchases and various environmental benefits. The program offers vouchers towards the purchase of a new car when an older, lower MPG car is traded-in. The restrictions of the law make the program much less effective than it could have been and most consumers may be better off skipping the program entirely.

The voucher you receive would start at $3,500. Your passenger car clunker must be at least 8 years old and have fuel efficiency at least 4 MPG worse than the new car. If it’s 10 MPG worse, then you could get the larger voucher, worth $4,500.

If your car is at least 8 years old, congratulations. Owning vehicles for a long time is a favorite technique of the frugally minded. Driving a more fuel-efficient car sounds like a money savings potential as well. So what’s the problem with the Cash for Clunkers program?

New Cars Only

The biggest one is that it can only be used to buy a new car; one of the fastest depreciating assets you can buy. A new car may lose more in value as you drive it off the lot than the voucher will hope to provide. Also, your 8+ year old car is probably paid off. Switching to a new car probably means adding a new car payment.

Trade-Ins Get Scrapped

The car you “trade-in” to get the credit isn’t really a trade in. If it’s worth more than the voucher, that’s still all you’ll get for it. Your old car will not be resold but scrapped. The environmental benefis of fuel efficient cars may easily be trumped by the discarding of a perfectly running, older less fuel efficient car.

Of those people who would benefit from the cash for clunkers program (those with older cars worth less that $3,500-$4,500) you have to imagine that most would generally fall into two categories: frugally minded people who would never buy a new car or people who cannot afford a new car. I fear the Cash for Clunkers program, which in my opinion is an auto manufacturer friendly law rather than a consumer friendly one, will actually hurt those consumers who use the program.

If you are thinking about using the Cash for Clunkers incentive, first consider if you need a new vehicle or if your current one is serving your needs. If you do decide that you need a new car, do what the financially savvy do and buy used. If the lure of the Cash for Clunkers program is too great and you do qualify, the most I can offer is to warn you that it’s probably going to end up costing you more.

Friends or Money - Which Would You Rather Have?

Mike — Fri, 19 Jun 2009 14:31:01 +0000

At different times in our lives we may be lacking in friends, money, or both. While money is certainly important, you may often find that a friend is much more valuable.

Friends can provide lasting support and help us to endure periods with less money. They may allow us to find happiness in life even though money can rarely do the same. A life flush with money without a friend to enjoy it with doesn’t seem all that desirable. To be rich and lonely seems like a pathetic existence.

What is a friendship worth? Consider the support a friend provides during a tough time. In that sense, you can put a price on the value of a friendship. What amount of money would it take to help you endure a situation alone, without the benefit of a comforting friend? Even in a desperate financial situation, such as a recent layoff, you’ll probably find that the value of a friend remains high. A $10,000 windfall may help you to get by for a few more months, but a friend could provide value for an entire lifetime.

You might conclude that the best situation would be to have friends and money. That certainly seems rational. Then you’d have the resources to do the things you’d like to do and people with which to do them. Unfortunately, that situation can be difficult to achieve. Assuming the alternative is to have one or the other, would you rather have close friends or lots of money?

Joining an Investment Club

Mike — Wed, 17 Jun 2009 13:21:51 +0000

Traditionally, investment clubs were used as a way to learn about the seemingly complex and complicated world of investing. Though the internet and other educational resources have grown to fill this role, you may still find considerable value in joining an investment club.

Investment clubs are groups that meet regularly to discuss investment opportunities. Members contribute money to the club so that investments can be made. At each meeting, members may report on a company, review an investment book, host a guest speaker, or simply discuss different strategies. In the beginning, basic investment concepts may be covered as well. Particularly in the early stages, many investment clubs focus on member education. For more information on investment clubs and general investing events in your area, visit the National Association of Investors Corp. (NAIC).

Investment clubs do much more than simply improve your financial literacy. They allow you to bounce ideas off of other investors, pool your money to reduce the impact of commissions, research more companies than you could on your own, and bring together investors who have found success in many different niche markets. As with any club, investment clubs also provide a social outlet to meet new people and build friendships.

Depending on your investment knowledge, interest of friends, and availability or clubs seeking new members in your area, you may choose to join an existing club or start a new one of your own. A new club offers maximum flexibility while an existing one may have the structure and resources it would take years to generate on your own.

If you want some of the benefits of an investment club without as many formalities or putting any real money at risk, you could even form a club that doesn’t make actual investments. Without actual money in the game, the club might not be taken as seriously and you may have deep regrets when your hard work is not accompanied by actual monetary gains, but if your main goal is education, an investment club with a virtual portfolio could be a nice place to start.

Have you ever belonged to an investment club?

Passive Versus Active Portfolio Experiment

Mike — Mon, 15 Jun 2009 21:01:03 +0000

Look to nearly any personal finance blog or advice column and you’re likely to hear similar advice regarding investments. It generally goes something like this: “Very few investors (and probably zero novices) can successfully time the market to get better returns.” I myself have made the statement many times. The concluding advice is to invest passively in low cost index funds and be satisfied to match the market, since the probable alternative of active investing is to under-perform the market.

Though I genuinely believe this prevailing wisdom, I wanted to ensure that it’s the case not for the average investor, but for me as an investor. I’m not suggesting that I’m better or worse than average, but my performance is really the only one that matters to me and yours should be the only one that matters to you.

Setting Up The Experiment

I created and funded a new brokerage account for the sole purpose of comparing the two investment methods. I intended to use half of my money passively and the other half actively.

Background Info

My passive investment would be a diversified ETF that produces a monthly dividend that will be automatically reinvested. The active investments would be trades that I intended to generally hold for hours or days, or longer if so inclined. I’m intentionally not discussing the dollar amounts and actual investments because I’m more interested in conveying my process rather than my specific transactions. I will say that my investments are sufficiently large that commissions are largely negligible, representing less than one-quarter of a percent of the transactions. I could have run the experiment without risking actual money, but I don’t want my results to be biased. By putting actual money at risk, I’m more inclined to find as profitable investments as possible for each method. Without risking money, I might make better or worse active investments, hoping to prove that one method is better. Instead, I’m trying to have highly profitable passive and active investments whose results will speak for themselves.

Monthly Results

It is my intent to publish the gains and losses of my two methods on a monthly basis, for as long as I continue the experiment. Since I began in mid-April, my first month’s results are in and reported below. My second month is also nearly complete. Those results will be published in the next week or two.

Month 1 Results

Passive: I had two transactions this month; 1 purchase and 1 dividend reinvestment. My passive portfolio increased by a total of 10.19%. This gain includes commissions, including the one that would have been charged had I liquidated my position at the end of the month.

Active: I had ten transactions this month; 5 purchases and 5 sales. My active portfolio increased by a total of 11.85%. This gain includes commissions.

Benchmark: During the same time period, the S&P 500 increased by 8.54%.

Overall Results to Date

After one month, my active invesments have proven to be more profitable, though my passive investments also beat the benchmark return of the S&P500.

Free Lending Club Webinar This Thursday

Mike — Wed, 10 Jun 2009 20:23:03 +0000

For anyone who missed the announcement on their blog, Lending Club is hosting a free 30-minute online webinar this Thursday, June 11th.

The webinar is designed to show you

“How to Put Your Cash to Work with Lending Club. We’ll provide an overview of how Lending Club eliminates the high cost and complexity of traditional banks and offers investors the opportunity for returns that average over 9% annually.”

Space is Limited so register now

Date and Time: Thursday, June 11, 2009 Noon PT/3:00pm ET

Location: Online

Early Retirement, New Calculations and Considerations

Mike — Tue, 09 Jun 2009 16:53:58 +0000

Before I begin, let me issue a little warning about this post. What follows is a stream of consciousness type account of some of the things I’ve been thinking about lately regarding calculations for early retirement. I hope that this post generates a discussion rather than provides any answers on its own merits. I make many assumptions below, but I hope to focus on the method of thinking rather than the merits of those assumptions themselves. Now that that’s out of the way, let’s proceed:

First, Some Background

A general rule of thumb is that you need 25X your yearly expenses saved/invested to be able to retire. I’ve discussed this previously in my post, Deciding Early When to Retire. That number comes from the fact that withdrawing 4% historically allows your investments to last indefinitely. Assuming the 25X number is correct, you might still be miscalculating your retirement needs. It’s in this area that my latest calculations come into play.

The two main factors of influence are my mortgage and the fact that retirement investment accounts can’t be accessed until much later in life then I hope to retire.

Assume a 32-1/2 year old with expenses of $6000 a month including a new 30 year mortgage that is $3500. Using the 25X calculation, you’d say that $1.8 Million is necessary for retirement. If the inflation-adjusted equivalent was finally achieved in a 401K by age 45, however, retirement still wouldn’t be possible, since that money couldn’t be touched without penalty for many more years.

The Solution

To solve this problem, I’ve been considering retirement in two stages: the first part is from early retirement until full retirement age (or penalty free withdrawal age for the particular investment type) and the second part is from full retirement age onward.

Part One

Assume the person described above wants to retire at age 45 and can’t touch their retirement accounts until age 62-1/2. Their non-retirement investments will have to cover their expenses for 17-1/2 years. $6000 x 12 mos x 17.5 years = $1.26 Million in non-retirement accounts. This number is in today’s dollars. In 12.5 years, when the person reaches age 45, that number will be $1.823 Million, assuming 3% inflation. Assuming 11% annual returns, that means they’d need $495K in investments today. If they have that much, no new investments are required. If not, then new contributions should be added. This calculation could be updated regularly to decide the necessary amounts of future investments. Another assumption here is that investments for part one don’t grow at all during early retirement (or only enough to cover inflation) and will be completely depleted by full retirement age.

Part Two

All other assumptions the same, expenses at full retirement age would be $2500 per month (in today’s dollars) since the mortgage will be paid off by then. Using the 25X rule, $750K is required. Adjusting for inflation, the number is $1.82 Million. But those investments will also be compounding over time, so only $80K is required today.

Other Considerations

Assuming future expenses will only grow with inflation is a general flaw of the 25X rule. An early retiree may have to find their own health insurance rather than rely on a company sponsored plan. They may have to pay for their children’s college expenses, weddings, etc, even though those costs aren’t reflected in today’s expenses. Obviously the other assumptions could also be wrong.

Conclusion

What this two part approach to calculations tells me is two-fold:

First, investing in non-retirement accounts is essential to cover the costs during early retirement.

Second, you may need much less in retirement accounts than you think because a large current expense (mortgage) may not be an expense in retirement and you have a lot of time for retirement account investments to grow before they are needed.

I am very interested to see what other people have to say about this line of thinking. Again, you may make different assumptions. The basic idea I’m looking for input on is breaking up retirement calculations into the times before and after retirement accounts will be used for funding and how some of today’s expenses (notably a mortgage) won’t be a factor after full retirement age.

What Playing Disc Golf Has Taught Me About Managing My Finances

Mike — Fri, 05 Jun 2009 10:56:00 +0000

It seems as though many in the personal finance blogging community enjoying playing disc golf, and I am no exception. I am blessed to live in one of the greatest small cities in the country for disc golfers, with many beautiful, free, and challenging courses. In fact, the disc golf courses here helped my wife to sell me on the idea of relocating.

As I was playing last week, it crossed my mind that many of the lessons I’ve learned playing disc golf are highly applicable to personal finance. Here are some that come to mind:

Until It’s in the Basket, The Hole Isn’t Done

It’s easy to lose focus on short putts, because they seem so easy. What happens as a result? Some easy birdies become pars and some sure pars become bogies.

Finance Implications: You can’t half-heartedly track your finances and assume everything will be OK, stop managing your investment as retirement nears, or count your profits before you sell a stock. Losing focus before any of these tasks is fully complete could allow things to quickly get out of control. In that sense, as the end of an effort approaches, we should focus on it even more intensely.

When Conditions Change, So Too Must Your Approach

I’ve played the same hole a hundred different ways based on the time of year, wind, how I’m feeling that day, or simply due to the fact that my capabilities change as I age. A hole in one is so hard to repeat because even if we do everything the same internally, external forces are at work. Understanding those factors, and modifying your approach, is essential to finding continued success.

Finance Implications: Managing your money in a bubble doesn’t make sense either. You may choose to increase your emergency fund as unemployment rates fluctuate , invest more when market conditions are favorable, prepay your mortgage when alternative investments are less favorable, or reallocate your portfolio as you age. There may be times when you cut your budget to the bone and others when a little luxury spending will be allowed in. Learning to see that conditions have changed, and adapting your strategy for the new reality, will help to keep your finances on track.

Don’t use a Hydra on water holes

The Hydra is one of the few discs with the apparently desirable ability to float. This makes it the perfect disc for holes with large water hazards, right? Wrong! Using a disc that floats on a hole with a water hazard is planning for failure. Instead, I use my best, favorite, or most expensive disc. Why? That way I’ll be damn sure to clear the hazard!

Finance Implications: One area where we plan to fail is in buying more insurance than we need. Insurance is important and adequate coverage essential, but buying more than we need is misguided. Having so much life insurance that your spouse would get the equivalent of winning the lottery is not a smart move. When we use products for purposes other then they are designed, we often end up paying more. Life insurance is supposed to replace the income that you won’t be able to generate if you are dead. I recommend investing the money saved through lower premiums paid for adequate coverage versus paying more for excessive coverage.

Don’t use an expert disc if you are still a beginner

Using a disc that is beyond your skill level will leave you tired, frustrated, and typically short (and left) of your target. It takes time for your skills to be honed and your arm speed to increase. They make beginner and intermediate discs for a reason. Don’t be ashamed to play a skill-appropriate disc.

Finance Implications: So many of us would do best to stick to sound, time-tested savings and investing methods. But when we first start out, the promise of outsized gains lures us towards more exotic investments. Can money be made with currency trading, options, and other derivatives? Of Course. Is a new investor more likely to find more consistent long-term success investing in low cost index funds? I believe so.

One great shot makes the whole day worthwhile

It’s been said that a bad day golfing is better than a good day working and the same is certainly true for disc golf. It’s also amazing how a single great shot can leave you with a favorable memory of the day. Every round will have its ups and downs and keeping that in mind will allow you to tolerate your bad shots and celebrate your good ones.

Finance Implications: There are times when managing your finances can seem like a drag. This is especially true when you’re going through a rough patch, where income is dropping, debt is rising, or a combination of the two. Unlike your job, where you have limited control, managing your money gives you unlimited control. So go out there, celebrate your small victories, and above all have fun.

If you are interested in learning more about disc golf, or to find groups or courses in your area, check out The Professional Disc Golf Association.

What lessons has disc golf (or regular golf) taught you about money?

Credit Card Reform Has Negative Consequences For Responsible Card Holders

Guest — Thu, 04 Jun 2009 19:43:29 +0000

This is a guest post by Trisha Wagner, a freelance writer for DepositAccounts.com, where you can compare rates of checking accounts from dozens of banks in one place. Trisha writes regularly on the topics of personal finance and savings accounts.

If you have been paying attention to the news in recent weeks, you probably know that legislation to regulate the billing practices of credit card issuers is a hot topic. As more and more Americans struggle to keep afloat during the recession, this credit card reform at first seems like a win-win situation for everyone. Unfortunately that is not the case. In fact, the rules that are supposed to help consumers may inadvertently backfire making the situation worse for all credit card holders. Here are a few changes card holders can expect as a result of the credit card reform.

Someone has to pay

That someone will likely be card holders who have managed their accounts responsibly in the past. Consider the fact that in addition to limiting the ability of card issuers to charge whatever they please, banks are hemorrhaging money due to account holders defaulting on their payments. In an effort to recoup the money banks make on interest, fees and other penalties, it is likely they will turn their attention to people who are able to pay their balances.

It will be more difficult to get credit

Credit cards will no longer be handed out like candy at Halloween. Forget about fair or good credit, expect to see only those at the highest end of the credit score spectrum getting credit in the immediate future.

The return of annual fees

When credit cards were first introduced they didn’t have the same perks that most of us have become accustomed to in recent years. Consumers who do qualify for credit may be surprised to see more offers that include annual fees.

Grace periods may be eliminated

Credit card holders who pay their balance in full each month may no longer avoid interest charges. Some banks are considering charging interest from the date of purchase which would have a big impact on consumers who use their cards to pay for all expenses and then pay off the balance at the end of the month.

Reward programs may not be as rewarding

In the past, card holders who managed their account responsibly were able to take advantage of a number of rewards programs. In an effort to trim their costs and make up for lost revenue, banks may decide the programs are not worth the cost.

In conclusion when all the dust settles, all card holders will be effected by the changes in the credit card industry. We have little control over what banks or even government officials decide to do, however we do have control over our own personal finances. Consumers struggling with high levels of debt as a result of irresponsible spending or an unexpected financial hardship must focus on a strategy that will get them out of debt once and for all. People who have managed their finances responsibly in the past must continue to do so in the future to ensure their financial stability. We should consider this a reminder that living below our means and saving money for unexpected expenses is the first step toward financial security.

Researching Potential Houses

Mike — Wed, 27 May 2009 11:00:21 +0000

When looking at potential houses to buy, there’s a lot you can do to learn about the property without ever setting foot inside the door. Whether it’s to save the time wasted on problem properties or gain negotiation leverage when making an offer, here are some of the steps you can take:

Visit the Realtor’s Website

You’ll probably use Realtor.com, or a similar site to start your real estate search. One of the first things you should do after finding a house that looks promising is visit the listing agent’s website. The agent site will often have a thorough description and many more pictures than what’s available on Realtor.com. I’ve found virtual tours and learned a ton by visiting realtor’s sites, even when Realtor.com had only sketchy details and one, or no, pictures. You’ll also find information about upcoming open houses.

Do a Drive-By

Another benefit of visiting the realtor’s site is that you can often get an address for the property. This info isn’t always provided at the larger real estate search sites. With the address in hand, you can do a drive-by of the house before deciding whether to schedule a showing. Why is a drive-by so important? Well, pictures of houses are usually taken from the best possible angle and don’t always tell the whole picture.

Here’s an uncropped version of the photo from above:

Still interested?

For a virtual drive-by, use Google Street View. Speaking of Google, that leads us into the next tool, satellite imagery.

Satellite Imagery

A drive-by will let you check out neighbors, but you might miss out on other issues in the area. By looking at satellite imagery of the home, you get a broader perspective. You might spot a garbage dump through the woods, even though you never would have noticed this by driving by. I’m usually a Google-snob, preferring most of their products. Google Maps and Earth are really great, but I actually prefer the Bird’s-Eye feature at Microsoft’s Live Search Maps. Bird’s Eye imagry is taken from lower altitude and gives a lot more detail. Using both Google Maps and The Live Search Maps Bird’s Eye view gives the most complete picture.

Assessor’s Website

Going to the town or county (depending on state) website that the property is located in can give a lot more information as well. At the very least, you can probably find the assessment record for the property. This will tell you the assessed value and may even have some alternative pictures, a floor plan and more. Often, plat maps, showing the property boundaries are also available. If you’re really lucky, you may even be able to pull up the property records for the house. This can tell you the name of the current owner, the price they paid for the house, and even the outstanding balance on their mortgage(s). This information is extremely useful in price negotiations. If you’re planning a low offer, you can make it just high enough that it will allow them to pay off their existing mortgage.

Finding Problem Neighbors

As nice as a house might be, a bad neighbor could prove problematic. Don’t expect the sellers to clue you in on who to avoid. I like to check sites like Rotten Neighbor, which lets you see ratings for people in your neighborhood. If you have kids, than doing a Registered Sex Offender Search is an absolute must as well!

One Last Google

Googling the names of the owners, or the address, is a useful final step. You might learn about a divorce, lawsuit, lien, etc in the process. If you feel that this, or any of the other steps, is too invasive, then simply skip it. If not, you may learn something that will help in the negotiations.

Another nice feature of these tips is that they can mostly be done from the comfort of your home. This is particularly useful if you are searching for properties far from your current address. Being the most informed buyer possible will ensure that you choose the best possible home available. Doing some up front work will save you the heartbreak of falling in love with a house and then learning about its problems or paying more than necessary on account of your ignorance. Happy House Hunting!