The Full Motley -- 4Q, 2018

It has been a highly active three months, even though the amount of my rebalance would perceive it as rather uneventful. Political uncertainty dragged the markets down significantly for several weeks last month leading into the mid-term elections, and then the market recovered sharply in the wake of the elections when the House and Senate were split. Overall, the spread of the fluctuations this past month were about 10% but it ended just about where it was three months ago.

Despite the activity, rebalancing now was insignificant. However, these shaky markets serve as a microcosm for the value that periodic rebalancing provides against longer market activity. Any temptation to move during the height of market uncertainty was neutralized because my next scheduled rebalance was known. If the market retreat continued, then my rebalance at that time would have been more impactful (potentially buying more shares of the equity funds when they were lower). As it turned out, the markets recovered so the dip in values meant nothing as they virtually recovered in the same amount of time. In short, it took the emotion out of the equation during the most emotional time to invest.

As I discussed in my last update, I recently modified my target 85/15 allocation (due to changes at Vanguard) with 30% to Total Stock Index Fund and PRIMECAP Fund, 15% to Total International Stock Index Fund, 11% to Total Bond Index Fund, and the remaining 4% to Total International Bond Index Fund. After all the market activity, only Total International Stock Index Fund was off by 1%, so my reallocation involved fractional percentages coming from the other four funds to make up that percentage point.

To reintroduce the graph for these numbers, which I have not used in five years (back when I started at my current position), here was the impact of this quarter's reallocation:

Vanguard Total Stock Market Fund   30.3% /  -0.3%  / 30%
Vanguard PRIMECAP Fund    30.4% / -0.4% / 30%
Vanguard Total Int'l Stock Fund    14.0% /  1.0%  / 15%
Vanguard Total Bond Market Fund   11.1% /  -0.1%  / 11%
Vanguard Total Int'l Bond Fund   4.2% /  -0.2%  / 4%

Smoke Screen or True FIRE

Even firefighters can get burned

Earlier this month, it occurred to me that all this chatter about early retirement lately reminds me of the late-90s, and it makes me think that a severe market correction is on its way.

Recently, the FIRE (financial independence, retire early) movement traded barbs with financial wisdom expert Suze Orman when she made disparaging remarks about early retirement. The ridicule coming back was fierce, and “escalated quickly” to align with Millennial nomenclature.

Unfortunately, what Orman’s critics do not understand – and what many FIRE proponents have not learned yet -- is that there are a lot of unforeseeable changes ahead. Orman is coming from the perspective of having lived through all the changes that she has, and she knows how unpredictable life gets. She knows that even the best laid plans often go awry. And she knows, but she graciously did not say it, that, in the case of a majority, FIRE is a fad.

As troublesome as instant gratification in everything is, delaying gratification in everything is fraught with its own pitfalls. As tragic as it is to say, witnessing the early deaths of fellow FIRE proponents or other friends will make many re-evaluate those priorities. And in terms of gratification, it is very rewarding to put $10,000 aside today and have it equal $15,000 within two years.

If their target is to retire between the ages of 35 through 40, then they are more likely than not earning a salary that reflects a full college education and equal work experience. That means that they started about 10 years ago, at most 15 years. Therefore, whatever little amount that they had invested in the markets were not devastated in 2008-09. They remind me of my peers who attempted early retirement based on the rising markets of the late-90s, most of whom refigured (or abandoned) their plans once the market retreated. While setting aside $10,000 and having it rise to $15,000 within two years reinforces that behavior, having that amount then equal $8,000 after five years will be a different story altogether. If the early deaths of peers do not make them reconsider their commitment, this financial loss could start a paradigm shift away from the lifestyle.

More to say than Twitter allows

I knew a girl whose face looked at least 10 years younger than she was. It was age-defying. But it was not natural luck or good genes. It was the result of a concentrate regimen. Her list of don’ts, won’ts and can’ts was extremely limiting. It is not that most people are unaware of the damage their skin suffers and how it ages them, but they have weighed the pros and cons and have decided that aging skin is worth the benefits of having fun in the sun once in a while. Many FIRE proponents are living their lives to a set of rules far more restricting than conventional wisdom, and all for the sake of forgoing the same conventional wisdom.

It is not that today’s FIRE kids cannot retire early. Suze Orman and I (and others) know that upwards of 90% simply will choose not to retire early.

To be clear, I am not rooting against the FIRE proponents. I am crediting that at least 10% of them will see the commitment through (and I hope it is more). Besides, plenty of FI/RE proponents will experience the markets tumbling below where they started investing, and immediately think “it’s a FIRE sale!” (Which, for the record, was my reaction in 2008 when it happened in relation to my own purchases in 2003 and thereafter.) But having a bit more experience and wisdom in life and in the markets, I am just a lot more skeptical and more reasonable to believe that most of the FIRE kids will see it through.

If Finances Get Too Heavy

A long while back, I noted that I might discuss financial gravity sometime. Let me get on that now!

I believe the concept of financial gravity first appeared on my radar in a post by Jim Wang, who is an amazing financial blogger and most of his posts are easily digestible and I have reprinted his material on my blog before. He discusses the concept using an airplane, but the concept might be more visually appealing when considering a hot air balloon.

Either way, the concept is that our expenses are our financial gravity. The goal is to be airborne or levitate, so financial gravity is an opposing force. If we had no financial gravity, then 100% of our income would be placed toward our financial goals. However, we all have financial gravity because it is expensive to be alive. Plus, our consumerism culture puts a premium on spending.

The theory of financial gravity is that our expenses equate to the weight that we are putting into our airplane or hot air balloon. Whether you visualize it as our baggage or our own body weight, the less weight, the less effort it will require to become airborne. The more weight we have, the more effort it will exhaust to get airborne -- as well as sustain that status.

While everyone has expenses, the makeup of our expenses is almost as unique as we are individually. Even if two people earn the same, they are not going to spend it in the same ways. Therein lies the first part of the solution of financial gravity, jettison the excess baggage. Cutting expenses is taught all the time, but financial gravity provides a different visual and approach to the tired subject. If you want that brand name latte every morning because the coffee in the office is not the same, then it will weigh down your financial goals. Simply stated, the daily lattes are part of your financial gravity. Cutting out daily lattes for coffee in the office would equate to upwards of $1300 annually, which could be placed into a Roth IRA instead, and it would be earning for you. It would become the fuel for your airplane or hot air for the balloon.

Doubling the benefit, cutting out daily lattes means you have one less expense to satisfy, so not only is an extra $1300 being spent toward gas to fund your financial goals, but you will need less money to stay airborne because you have lost that extra weight.

Perhaps going without specialty lattes is too much of a sacrifice. Changing a daily latte habit into a weekly treat would change those numbers slightly. You would only set aside $1050 per year, but you would get to have a latte every week. This might be an additional benefit in that the latte would become more of a treat and less of a chore.

If swapping out specialty lattes for coffee from the office is laughable, then other areas of delaying gratification could be found in comparable exchanges. Maybe it is the weekly movie nights, or the drinks before, after and/or during live games, or declining invitations to happy hour and other social gatherings (perhaps even weddings when the invitations get excessive). Wherever those minor expenses add up in excess of the personal rewards; that is, wherever the drama exceeds the fun. I have heard "coming of age" stories where the subject realized that going out clubbing both nights of every single weekend had lost its appeal.

Do not underestimate how much your social circles weigh into your financial gravity. Being responsible enough to prioritize your social calendar is a good trait. Playing a victim of requests for your presence is not a good trait. Presumably, few friends are so close that that their personal finances are taken into consideration when making social plans. The assumption becomes that the invitation will be declined if the event is not a priority. If your long-term financial goals are more important than weekly clubbing events, then that is a sign of maturing. If your friends do not follow suit, then you may just be maturing ahead of them.

Daily lattes, weekly movie nights, happy hours, tailgating, clubbing, etc. are all weighing down your financial goals by giving you less money to set aside and bloating your personal maintenance.

Value Foundations

This week, I successfully passed the CFA Institute Investment Foundations program exam. There were 20 chapters, ranging from Microeconomics and Macroeconomics to Performance Evaluation, among other topics. Despite a 15-year career and several degrees and certifications in business, I found myself learning more detail about the specific functions of finance from overlooked-or-underappreciated simple concepts up into the complex worlds of international trade and of business production. While I will not delve into the complex topics here, I also found certain recurring themes throughout the investment world that seemed to represent the core definition of "value."

When bond investors are willing to pay above par value for an existing bond, they are said to be buying the bond at a premium. A premium is effectively a surcharge on the additional benefits on investments (or other items) that make them more desirable, e.g. "premium seating." All other things equal, investments will be more expensive if they offer one of these three drivers: higher returns, lower risk, or flexibility.

Usually they balance each other out, such as investments that offer either high (potential) returns or low risk. Differences in motivation lead investors to decide between investing in stocks or putting money into a savings account. Consistently, one of those three identified factors could determine which investment was more expensive, and therefore, more desirable. If the risk-to-return ratio were equal between two options, then flexibility often determined which option would be more valuable to investors.

While the concept of time is not readily apparent among these factors, it is embedded within risk factors. The shorter of a time frame in which to invest (known as a "time horizon"), then the lower the risk tolerance. As defined by the CFA Institute, risk tolerance is comprised of an investor's ability and willingness to take risk. Of course, there are subtle differences between the two elements. An ability to take risk can be limited by time horizon or quantity of assets. If the assets will need to be used sooner than later, then investors should not take risks with those assets. Likewise, if an investor only has a few assets, then they should not take significant risks with those assets, even if it limits an investors ability to pursue a higher return.

Conversely, investors who have a long time horizon have the ability to pursue higher risks. However, an individual investor may not be so willing to take such risks. If this risk-adverse investor has limited investing experience or knowledge, then the ability to take risk may be stunted by the willingness to take risks. I can identify with this scenario. I was very risk adverse, regardless of the juxtaposition between returns and risks. I did not fully understand stocks. Admittedly, I related better to the horror stories than the enrichment tales, even if the latter were more likely than the former.

Index investing is the act of attempting to match the returns of a specific market index. Conversely, active investing is the act of attempting to outperform that market. Of the two, there is higher risk in active investing, which psychologically explains why people assess a premium to active investing (even when numbers favor index investing by large, and also despite the fact that investors generally dislike losses more than gains of the same value).

Furthermore, I remember working as a financial adviser for Simmers Capital Management in mid-2000, and being told that a successful argument for clients is that there is more pride in selecting your own stocks or investments than benefiting from the equal gains through a third party, such as a portfolio manager (or an investment adviser, but obviously, we would not feed them that information). This phenomenon supports the third and final factor of flexibility. Investors place premium on flexibility in part for this reason. Additionally, flexibility reflects an investors ability to select terms of an agreement or customize an investment to match their needs. By paying a premium for flexibility, investors immediately reduced their ultimate return; however, they (typically) have also lowered their risk involved.

I started studying for this exam in February and I took it this week, so there was a breadth of knowledge imparted to me. Unfortunately, I did not capture the full scope of the information (in fact, I would wager that I have studied some of the new information in the past for prior exams, such as the Series 6 registration exam or others) but I have the textbook downloaded to my computer to reference again in the future. The concepts of micro-/macroeconomics will be areas where I pursue additional understanding, as well as international trade, especially as our current affairs as a nation center around those concepts.

The Full Motley -- 3Q, 2018

I worked at Vanguard for 8 1/2 years. I have described their managerial style as "driving you insane, and then calling you crazy." Despite being away for over 7 years and counting, they still find ways to continue that methodology.

Last month, Vanguard made a decision for its 401(k) plan participants that baffled me greatly. It eliminated numerous funds from its line-up, including my Vanguard Explorer Fund and Vanguard High-Yield Bond Fund. Inexplicably, it moved the balance of those closed funds into their target retirement funds. I like target retirement funds. For my friends who do not care about investing or markets or rebalancing or any of this jazz, the target retirement funds are great! These funds handle that part for those people. They work great, *IF* that is the only fund in the account!

Mixing target retirement funds into an existing allocation would be incredibly complicated for tracking, and more importantly, generally unnecessary. Instead of investing in the target retirement fund, add the funds that make up the target retirement fund into your existing allocation. Which was how I handled this predicament here. The fact that Vanguard found it prudent to talk out of both sides of its proverbial mouth concerns me though, and I suspect that it may be only a matter of time before this behavior extends beyond its staff and begins to drive its customers crazy.

The target retirement fund consists of the Total Stock Market Index Fund (got it), Total International Stock Index Fund (got it), Total Bond Market Index Fund (got it), and Total International Bond Index Fund (need it). Therefore, I will introduce the Total International Bond Index Fund into my account and set its allocation based on the fact that it is both a bond fund and an international fund. For numerous years, I quietly held the Vanguard GNMA Fund, although its performance has not warranted special treatment. Now that I have been forced to rejigger my entire allocation, I will throw that fund out of the mix. It has been considered for years, alongside rising my international exposure.

Missing from this line-up is my precious PRIMECAP Fund, which I feel grateful that fund was retained in a small roster of so-called "supplemental investments." Their description of these alternative funds would be how most active investors would achieve their target allocation. In particular, my exposure to the Explorer Fund skewed my risk profile higher, and I was comfortable with that increased risk because I had a higher exposure to the bond markets simultaneously.

Therefore, I felt my prior allocation was more robust than the target retirement fund. Simple workaround though, I could take the existing target retirement fund's allocation and apply it to my account since there is enough carry over. However, I do not like its 60/40 split between domestic and international stocks. I would sooner have a 80/20 split, but I will split the difference and make mine a 70/30 split in both stocks and bonds (Vanguard has a 60/40 split in stocks but a 70/30 split in bonds).

My new allocation will have 30% allocated to both the Total Stock Market Index Fund and PRIMECAP Fund, 25% allocated to the Total International Stock Index Fund, 11% allocated to the Total Bond Market Index Fund, and the remaining 4% allocated to the new Total International Bond Index Fund (although I might later adjust the bond split to 10.5% and 4.5%, respectively to reflect a 70/30 split).

For the sake of interest, the other supplemental investments were Vanguard FTSE Social Index Fund, Vanguard International Growth Fund (any domestic growth/value counterparts are conspicuously absent), Vanguard Long-Term Investment-Grade Fund, Vanguard Retirement Savings Trust (in addition to Vanguard Prime Money Market Fund), Vanguard Short-Term Investment-Grade Fund, and three other balanced funds: Vanguard Wellesley Income Fund, Vanguard Wellington Fund, and Vanguard Windsor Fund. No mid- or small-cap funds, which concerns me slightly and perplexes me greatly.

I am not sure what Vanguard was thinking in this decision, especially considering its most loved fund (Vanguard Index 500 Fund) was completely excluded. Based on the number of lawsuits on 401(k) providers for having poor selection choices, making this move now could be inviting a lawsuit. I am certainly disappointed with Vanguard, but having worked there before, it is a familiar feeling.

The Full Motley -- 2Q, 2018

Happy Independence Day!! Time for a quarterly update, as delayed as it may be. Although we just moved into the third quarter, I rebalanced on my usual May 10th date (but it has been a busy year on other projects, so I did not draft a correlated blog entry timely). Considering financial independence is the ultimate goal of personal investing, an update falling on Independence Day feels somewhat fitting!

During the past week, I heard a discussion on 1510 Money Radio about leaving money with a former-employer's 401(k) plan or moving it, and I tried to think of a single benefit for leaving it. There is far more control and flexibility in an IRA than in an employer's 401(k) plan, so by large, the benefits were to move the assets or, at least, it was a neutral impact to leave the money alone. The only scenario I could say was a benefit to leaving assets in a former-employer's plan (and the reason I had left my assets inside mine) was if the expense ratios were significantly less inside the employer's plan than in an individual investment. Strength in numbers.

I am not gaining much, necessarily, by leaving it with my old employer, but like I said, moving it into a rollover IRA would not have much more flexibility or control, so I strategically opted to leave it where it was.

Unfortunately, I have learned that Vanguard just limited its investment options allowed in its 401(k) plan, nixing two of the five funds into which I have been directing my assets for the past 10 years. Therefore, it may be time to roll my assets into an IRA to continue my current asset allocation. The flexibility is now better in a rollover IRA.

In the wake of numerous legal cases against employers offering limited selections and providing self-serving options in its employer-sponsored plans, this was a peculiar timing by Vanguard. They have conditioned their investors to utilize asset allocations and rebalancing for the past 40 years, so it is counter-intuitive that they would remove numerous sector funds that complete an independent allocation. For those 12 funds, the money was directed into their target retirement suite.

While these all-in-one funds are superb investments for novice investors who want to put all their assets into a single fund throughout their investing lifetime, target retirement funds should not be held in a robust portfolio with other investments, except as an intentional, strategic play (and even then, I would expect active investors to buy the index funds that the target retirement funds use directly). At best, the timing is peculiar. At worst, it was ill-fated. I would not be surprised to see this power-play backfire on Vanguard, which has had a handful of lawsuits in recent years (with very mixed results). Considering the benefits are two-fold for Vanguard: first, it forcibly increases the AUM in their target retirement suite, which is a highly competitive field in the industry right now, and secondly, and more damning, the expense ratio in the target retirement funds are higher than in at least some of the options that they have ceased offering. This move would cost investors more money in the long run, which is a legitimate basis for a legal complaint.

The Full Motley -- 1Q, 2018

I have been looking forward to this update for quite some time for two major reasons!  First, today is the ninth anniversary of my blog.  Back in 2009, I doubled the percent of my income going into my 401(k) because the market had fallen so low and I wanted to put more money in when the market was downtrodden.  My expectations, best as I recall, was that it would take years for the market to turn around, so I wanted to track my mentality as I expected the recovery would test my mental mettle as I put money into an account, only to see it fall further and further.  As luck would have it, this decision was made exactly one month before the end of the bear market and it was an abnormally long upward trend since that time.  Of course, that stretch may be nearing an end -- but I will address that later.

The other reason I have been looking forward to this post is that I have now been at my current job for about half of the time that I was employed at Vanguard.  Based on common sense alone, my balance at Vanguard should be twice as large as that at my current employer.  In that regard, it is no surprise that the balance is double.  Based on everything we know compounding interest, it should be no surprise that the balance is in fact more than twice as large as my current balance.  The fact that my balance is more than triple the balance of my active 401(k) balance provides minimal shock.

However, the part that astounds me are the following factors:

• When I doubled my payroll deductions, I went from putting just enough to maximize my employer match to double that percentage (this amount only lasted for two years).
• When I started at my new job, I started at more than 20% higher than my highest income at Vanguard (it is currently 45% now).
• At my new employer, I have been withholding the same amount that I had been withholding, which was still double the employer match.

By all accounts, the amount that I have put into my active 401(k) is considerably higher than the amount of my own money that went into my Vanguard account.  The fact that my Vanguard balance is more than triple than the balance in my active 401(k) supports the power of compound interest.  Even if I divided my present Vanguard balance in half, then that amount is still another 60% higher than my active 401(k) balance.

All these numbers and calculations support the simple belief that "time is money," and between the two, time is far more valuable.  Unfortunately, both are non-renewable resources.  While money can be used to generate more money, time cannot find you more time.  Therefore, time is the most valuable resource we have.  Likewise, everyone is given the same 24 hours in a day.  In that regard, time is the most just resource.

Unfortunately, "timing" the market is not the best route to go.  Perhaps if someone knew exactly what direction the markets were headed at any given time, then it would be a different story.  But because there is no way to know for certainty what today's market will do tomorrow, much less a year or two from now.  But if you were to predict whether the market would be higher or lower in the next decade, the good money bet has always been on higher.  That is the basis behind investing, as well as indexing and all the other concepts that I have discussed for the past decade on this blog myself.