Financial IQ Score

There is one important (critical, even) element of your financial lifestyle that I have neglected to mention previously in this blog, and that is your Credit Score.  Not only have I failed to mention it in this blog, but honestly, and I should be ashamed to admit it, I have neglected my own credit score for the past 10 years, which was the age by which my mother required us to be financially self-sufficient.

In terms of finance, your credit score is a far better measure of intelligence than your IQ.  Sadly, I didn't even know what mine was.  All I knew is that it had to be decent because, when I bought my convertible in 2007, the salesman confided that, after his bosses saw my credit score, he wasn't allowed to let me leave without a sale.

Fortunately, this week I took that sizable step of getting my credit report from all three bureaus.  Honestly, I was planning to approach each of the three bureaus independently and find out the score myself instead of paying someone else to do it, but that's usually because the expense is $100+/yr from most of the companies offering the service.

However, the last time I was at my bank (Wells Fargo), I saw a whiteboard offering to provide your credit report for $1.  I didn't think much about it since the purpose of my visit was only to withdraw money to pay my mortgage at the bank across the street.  But a couple months passed since then, and as I went to the bank, I was ready to inquire about it.  Unfortunately, their whiteboard was now reading another advertisement, so when the teller asked if there was anything else they could do, I proactively inquired if the offer was still valid.  He said it was, and shortly thereafter, sat me down with a personal banker.

He printed the scores for me, which were very, very good thankfully, and then segued into offering a separate credit card through the bank.  He prefaced the fact that the card would have 0% interest for nine months, and unbeknownst to him, I am about six months away from starting a new career in law, so (ideally) I could use this card for the next six months and then start paying it down over the last three.  The card was ideal for my current situation (especially since I am having trouble paying off my current credit card each month).  I agreed, and we scheduled a follow-up meeting, and then I went across the street to the next bank to pay my mortgage.

At that bank, I was approached by a Personal Banker upon entering the door.  He asked why I was there (politely) and then offered to help me.  I don't know whether he knew the paperwork in my hands were my stellar credit report or not, but we paid my mortgage and then he went on a high pressure push for moving my assets over to the bank.

Now, the reason I pulled my accounts from this bank (where I had banked for over 13 years) last year was when I was quitting my job and going back to school, their checking account would have come with a monthly fee of $25.  Initially I opened up a new bank account with them where the balance to avoid the fee was significantly lower, but then Wells Fargo blew them out of the water with their checking account, so I closed that new bank account at a different branch through the same bank.  As it turned out, there was a $25 fee to close the new account and they had signed me up for the credit card that I declined when presented with the offer.

Cut back to current day, and their new sales pitch is that if I bring over one of my retirement accounts, then I would qualify for free banking across the board, and also (and this was the huge no-no of any aspiring salesmen) their retirement plans were superior to mine.  As we know through this blog, my account is self-managed.  While the comment was supposed to be directed at Vanguard, it was more of a personal attack on my own ability to manage my account.  Albeit, it was a blind attack since the blabbermouth clearly didn't know what he was saying would be interpreted so differently, but nonetheless, I left slightly insulted and very disgusted.

The entire conversation with Wells Fargo rep had nothing to do with my retirement accounts, even though my balances there are way higher and the interest rates at Wells Fargo are way higher.  Therefore, I have decided to move a larger amount of my savings account to Wells Fargo this month.  Not my investment accounts, mind you, but my savings account.  As we know from Vanguard's Investment Philosophy, saving is for the short-term, and investing is for the long-term.

Regardless, it was an eye-opening morning to see how competitive the financial corporations, especially for high balance account holders with high credit scores.

The Full Motley: 1Q, 2012 (supplement)

I have never done an entry like this one before, but I wanted to do it because I noticed today that my 401(k) balance has tripled since February 2009, and I haven't even contributed to it since last April.

Last week I made my first quarterly rebalance of 2012, and I noted that the benefit of anchoring your portfolio around your asset allocation and rebalacing to your target allocation at predetermined intervals is that it takes the guess work out of investing, and then, (A) you don't have to hire a professional, and (B) you won't react emotionally, and you'll make wiser moves in the long-run by focusing on the long term.

Therefore, you never want to reassess your moves after one week since it just increases the temptation of reacting emotionally, but if you have the self-discipline to check your portfolio's performance frequently while holding true to your allocation & intervals, then there isn't much harm in checking in more often.

That was the case today when I heard that the markets were up, but I was curious how the recent string of increases had affected my portfolio.  Out of curiosity, I checked the price per share from last week when my reallocation took affect to the most recent price per share in the market.

• 24 = $79.16 < $81.03 (higher)
• 29 = $5.85 = 5.85 (even)
• 59 = $66.31 < $67.20 (higher)
• 84 = $11.03 > $11.02 (lower)
• 85 = $32.55 < $33.01 (higher)
• 113 = $28.72 < $29.20 (higher)

Four of my six funds have gone higher (including BOTH of the funds that I moved out of) and the total decline in the other two funds was only $.01.

There are two ways to analyze this information.  On the one hand, I could have been better off staying in the two funds highlighted in red for another week (which indicate the funds where I pulled money out yesterday).  On the other hand, the money I took from those funds has already been made back so the higher performing funds are already returning higher and the "profits" taken from there are holding stable or increasing in their own rights.

Obviously, making another change today would be foolish based on the small balance in my portfolio, but if you wanted to invest in an allocation that rebalanced frequently (such as daily), then the best fund for you is a "fund of funds" or a balanced fund which sets an allocation closely matching your preference.

Incidentally, the Target Retirement funds are a perfect example of that philosophy.  They have an allocation, and their investment managers seek to maintain that allocation daily, regardless of market performance.  While they miss out on having a large stake in the funds as asset classes that are rising, they also avoid giving their earnings back when those asset classes retreat.  As I've noted often in this blog, all investments fall much faster than they rise.

In my opinion, it is not worth the investment risk.  And, without question, it isn't worth the time investment to track your investments daily over the 30+ years.  If anyone had that much "spare" time, then I'd strongly recommend volunteering somewhere.  Life is about more than just money (although, understanding investments is invaluable knowledge).

The Full Motley: 1Q, 2012

It has been a long time since I have talked about my personal accounts on here, but the lack of updates does not reflect a lack of knowledge.  After erroneously rebalancing a month ahead of schedule on July 10, 2011, I furthered the "error" by rebalancing again on October 10, 2011 (a month ahead of schedule) since I felt the markets retracted more in September and it would be corrected by November.  That thinking is exactly what asset allocations are created to avoid.  Normally, the schedule should be what you do and speculation should be on what you are not doing.  Unfortunately, for my purposes, I cannot say that my early moves were a bad thing for my portfolio.  But I will say that they did not pay off much either.

This month I intentionally got back on schedule, and I was very pleased with how well my portfolio has performed since October 10th.  The funds that I discuss on these entries are in my 401(k) and in the past, I had been adding money into the funds at all times.  I left my job in April, so no money has gone into that account since then, and the balance is now higher than it was when I left, which is encouraging.  In my last entry, I noted that I expected the 2012 markets to raise higher than 10% as measured by the Dow, so I expect another summer slump, but I have another rebalance on May 10, 2012, which should be before the market retracts.

As for today's moves, here is my chart:

Fund # - Real / Current / Target
Fund 24 - 26% / +1% / 25%
Fund 29 - 5% / 0% / 5%
Fund 59 - 25% / 0% / 25%
Fund 84 - 9% / -1% / 10%
Fund 85 - 25% / 0% / 25%
Fund 113 - 10% / 0% / 10%

In the interest of full disclosure, although this blog should never be used as the primary tool for financial planning on any account except the one listed, there were additional moves made in which money was taken from two stronger-performing funds and placed into four lagging funds to preserve the target allocation, which is the point of rebalancing quarterly.

I only mention this caveat to note how pleased I was to see how well those two funds had performed since October.  The trickiest part about asset allocation is the actions in contrast to urges and expectations.  I mentioned how I failed twice last year by rebalancing a month ahead of schedule, but it is equally important to note that this move takes money out of stronger performing funds and put them in funds that are performing not as well.

Every financial analyst knows the reason for that move would be to "buy low, sell high," but the problem outside of rebalancing is, when you sell, you have to put the money somewhere.  If a fund earns 25% over a quarter, and you want to "sell high," where is it going to go?  If you need it, then that's an option but it does not allow for further growth.  If you sell for the sake of selling high, then you probably know it is going to a stable value fund or a lesser performing fund.  But if you analyze the move, then there is a strong likelihood you will decide to hold the excess where it is.

This quarter reminds me how much rebalancing simplifies this struggle.  It is like cleaning house in a way.  Each fund has its set place, and if one fund gets moved over to one side or another, then you just move it back where it belongs without thinking about it as taking money from a "winning" fund and putting it into one that lags.  When those choices start getting the better of your mind, then reconsider the allocation.  But, as I've noted previously, when you adjust your allocation, then the new allocation should be decided upon about six months before the first action is made on the account.

I'm sure future entries will discuss this concept further, even though I am very comfortable with my current target asset allocation.

CNNFN: Dow at 4-year high, Nasdaq hits 11-year high

NEW YORK (CNNMoney) -- U.S. stocks rallied Friday, as investors cheered a much stronger-than-expected jobs report.

The Dow Jones industrial average gained 157 points, or 1.2%, the S&P 500 added 19 points, or 1.5%, and the Nasdaq composite increased 46 points, or 1.6%.

The rally pushed pushed the Dow, up more than 5% in 2012, to its highest level since May 2008. The Nasdaq, up more than 11% for the year, climbed to its highest level since December 2000. The S&P 500 has gained almost 7% this year, and finished at a six-month high.

The rally was sparked by the Labor Department's monthly jobs report, which showed that the U.S. economy added 243,000 jobs in January, far exceeding expectations. The unemployment rate dropped to 8.3%, the lowest since February 2009.

Economists surveyed by CNNMoney had expected the government to report an increase of just 130,000 jobs in January. The unemployment rate was expected to rise to 8.6%.

Economists had expected a slowdown in post-holiday hiring, considering that about 40,000 temporary couriers were hired for the holidays alone.

"The jobs data blew away market expectations," noted Marc Chandler, global head of currency strategy at Brown Brothers Harriman, calling it a "monster" jobs report. "This coupled with other recent reports for January, show the year has begun off on a firm note," he added.

Meanwhile, investors were also on the lookout for an official agreement on a debt-reduction plan and a second bailout for Greece. The deal is expected to be near, but negotiations are likely to continue thorough the weekend.

U.S. stocks ended mixed Thursday as investors digested a cautious economic outlook from the chairman of the Federal Reserve.

The Full Motley: 2012 Preview

On December 31, 2011, the market closed the year at 12,217.56, which was approximately 6% up for the year (opening at 11,577.51).  This news made me happy because all year, I had said that the 2011 markets would be up <10%.  Believe me, there were times when I thought I would be off.  More often than not, I expected that the markets would close higher than 10% but a surprisingly slow fourth quarter dashed those higher expectation.  Interestingly, the second and third quarters had most analysts forecasting a down year but, as often the case when taking current news and projecting it too far into the future, their predictions were short-sighted.  The best success is when projecting far into the future, at least a year.  That said, those expectations will not always prove to be true, but they remove emotion from investing, which is often the most common pitfall to trip up investors.

Case in point, my predictions last year were that the stock market would be up less than 10% (as measured by the Dow) and that bonds and gold would suffer great falls.  Additionally, I added an actively managed fund to my portfolio to hedge against the perceived lag of indexing.  As already noted, I was right about the markets going up between 0-10%, but my other expectations were incorrect.

The 12-month return in the Vanguard Total Stock Market Index (Investor Shares) was 0.96% whereas the returns for the PRIMECAP Fund retreated by -1.84%.  This is a testament to the strength of indexing since PRIMECAP is one of the most highly regarded actively managed funds Vanguard has to offer.  Additionally, the Vanguard Total Bond Market Index (Investor Shares) returned 7.56% in the year that I expected bonds to fall significantly.

The following are the 2011 returns for funds in which I am invested or in which I have been invested in the past five years listed from highest (bonds) to lowest return (international):

• GNMA Fund Inv 7.69%
• Total Bond Mkt Index Inv 7.56% (Adm 7.69%)
• High-Yield Corp Fund Inv 7.13
• 500 Index Fund Inv 1.97
• Total Stock Mkt Idx Inv 0.96% (Adm 1.08%)
• STAR Fund 0.77%
• Prime Money Mkt Fund 0.05%
• PRIMECAP Fund Inv -1.84%
• Explorer Fund Inv -1.89%
• Total Intl Stock Ix Inv -14.56%

At this point in the year is when I like to set my strategy for the coming year.  While the Presidential Election adds a great degree of uncertainty to American investors, I recently read that the market is usually positive during election years.  As a result, I am not going to make any changes to my current allocation and maintain my current investment strategy.

As for the market itself, I expect that the Dow will be up over 10% and close above 13,439.32 in 2012.

Experimental Fund

One of my favorite films (easily, Top 5) is "American Beauty."  The tagline for the film was "Look closer."  It rings as a periodic reminder each time I am asked for my thoughts on a specific investment.  Whenever someone asks my thoughts, my first question is never "how much are you putting in it?"  Amounts are always relative.  My first question is "will the amount you're putting in the investment be more than 5% of your overall balance?"  If the answer is no, then I often encourage the investment with a mindful eye.

One term I learned from listening to Mo Ansari over the years is "exit strategy."  When I left my last job, I formulated my exit strategy for almost 15 months before my actual departure.  However, a job is not an investment (at least, not in these terms) and formulating an exit strategy at that point would have been heavily delayed.  The best exit strategy is formed before you invest.  And it is written.  In case you haven't noticed, a lot of this blog has been written for my own use to remember what I was thinking at the time I made specific moves.

If you invest in a fund, you should know your tolerance for its success and its failure.  "If the fund raises above 20%, immediately remove the gains."  "If the fund falls 20%, immediately sell the position."  Those are examples of flawed exit strategies.  They lack a relative basis.  The last time I added a new position to my portfolio, my exit strategy was to sell out if the fund under-performed the relative index fund for two consecutive years.  The markets could gain or lose 20% in a given year, and it is not a reflection on the investment.  Every investment has an opportunity cost, and that is the true measure for its success or failure.

For example, invest 2% of your bond index fund into a GNMA fund.  The opportunity cost is measured by the performance of that bond index fund, because this money would be doing better or worse if you had left it in that investment.  The true performance for your GNMA Fund would based on that bond index fund.

This complex mentality will block you from making three critical errors.  First, you will never move your stock funds to a bond.  The basis for comparison will be impossible to track (or more effort than it's worth).  Second, the fund will have an established second home.  If your fund is under-performing against your original expectations, then your exit strategy innately moves it to its base.  Whether you invest in another experimental fund immediately thereafter is another story, but at least you will not stay on the fence with that experiment's conclusion.  There is no agonizing over the conflicting thoughts of "it could move back up (yes, it could) but it could keep falling (also true)."  Finally, your expectations will not fluctuate like your emotions.  If you consider today what you think the market will do in 2012, but you do not write it down, then chances are your memory of today's expectations will be significantly different than what they will be when you recite them in December 2012.  This is because emotions affect our expectations.

(to be continued... ??)

We Believes

During my time at Vanguard, I worked in our institutional processing department for six years.  We had minimal interaction with investors, and as a result, many people in our department were not aware of the specifics of investing.  Fortunately, I worked in the retail customer service department for several years beforehand, so I came into the department with sufficient exposure.

After the markets crashed in late-2008, a friend from the retail side and I were eating lunch and he mentioned the bore of reciting Vanguard's investment philosophy to every caller.  The irony was that I had not thought about it since I left that division, and the more thought I gave it, the more I felt people in my new department should be aware of our company's investment beliefs.  Therefore, I created a Powerpoint to present the concept to them in an abbreviated fashion.

Vanguard is a solid investment company, anchored by these sound strategies and beliefs.  Some are how to succeed and some are how to not fail, but each of them is worth considering (and in the case of his entry, sharing) and I always appreciated the fact that it was never referred to as their "creed."

We Believe:

• Investing is for meeting long-term goals; saving is better for short-term goals: Money that investors may need in the short-term (two years or less) should be kept in short-term investments which protect capital. These include money market funds (a fund that invests in short-term financial instruments such as cash), bank accounts, or government bonds (Gilts). Clients should only consider investments in the stock market or corporate bonds when they have money to put away to help meet a longer-term objective.
• Broad diversification, with exposure to all parts of the stock and bond markets, reduces risk: If an investment portfolio does not fairly reflect the overall investment market in terms of balanced asset allocation (the process of dividing investments amongst different asset classes such as stocks, bonds and cash) and investment style (such as growth or value), we believe clients are taking additional risk. We judge that this is unlikely to pay off over the long term.
• An investor's most important decision is selecting the mix of assets to be held in a portfolio, not selecting the individual investments themselves: Deciding on the mix and proportion of stocks, bonds, and cash in a portfolio is critically important - much more so than deciding on individual assets or funds. To work out the asset allocation that's best for each individual, investors need to consider factors such as their financial needs, their tolerance of risk and the length of time they want to invest.
• Consistently outperforming the financial markets is extremely difficult: Economic uncertainties, random market movements, and the rise and fall of individual companies mean it is extremely difficult for anyone - including professional investors - to beat the market in the long term. An active manager buys or sells shares (or bonds) in order to meet a particular investment objective. Therefore, typically actively managed funds have higher operating and transaction costs which can eat into returns. So we believe it makes sense to begin by considering funds that follow an index.
• Minimizing cost is vital for long-term investment success: Costs matter a great deal because investment returns are reduced pound for pound by the fees, commissions, transaction expenses and any taxes incurred. Investors as a group earn somewhat less than the market return after subtracting all those costs. Therefore, by minimizing costs, investors improve their odds of meeting their investment objectives.
• Investors should know how each investment fits into their plans, and why they own that particular asset: Investors need to be clear why they own each particular investment. Knowing the characteristics of each investment and the role it plays in a diversified portfolio increases investors' chances of selecting suitable investments that can be held for the long term.
  Risk has many dimensions and investors should weigh 'shortfall risk' - the possibility that a portfolio will fail to meet longer-term financial goals - against 'market risk', or the chance that returns will fluctuate.
  In the long run, what matters most is whether your investments enable you to meet your objectives. Earning enough to meet objectives is much more important than whether investments suffer interim declines or trail a market benchmark. But many investors react only to market risk. They may bulk up on stocks when markets are doing well, taking on more market risk than they realize. Conversely, they're tempted to reduce allocations to stocks in response to market downturns. In truth, to achieve long range goals, most investors need to accept some level of risk from equities.
• Market-timing and performance-chasing are losing strategies: Market-timers who buy and sell frequently, hoping to 'catch the wave' as securities rise and fall, need to be very sure that their timing is right. Otherwise, they stand to lose money from market movements while also paying significant transaction costs. As many investors say: it's time in the markets that counts, not timing the markets. Also, market fashions change - often very suddenly. There is no guarantee that a performance-chasing strategy, asset class (a type of investment such as stocks, bonds or cash), or fund that has performed well will continue to perform well next year, next month - or even tomorrow.
• An investor should not expect future long-term returns to be significantly higher or lower than long-term historical returns for various asset classes and sub-classes: The major asset classes (equities, bonds, cash investments) have long histories and well established risk/reward characteristics. When estimating future returns for asset classes or sub-asset classes, long-term historical returns are a good place to start. Vanguard expects that returns from various sub-classes of the stock market will be similar to each other over long periods. Also, Vanguard expects that the long-term return for equities will be higher than that for bonds, and that bond returns will, in turn, exceed returns on cash investments over long periods.

Investors should always remember that no method for predicting market returns is perfect. Past performance is not indicative of future results.  Contrariwise, "you have to stand for something or else you'll fall for anything."  That is especially true when it comes to a fool and his money.

A lot of this article was reprinted from Vanguard.com