Portfolio Two Updated July, 2018

Portfolio two is almost 14 years old.  The beneficiary contributed $7000 and the trustee $14,200 for a total of $21,200.  The current balance is $39,012 for a gain of 84% or ~8% / year when adjusted for the timing of cash flows.  You can see the detail here or at the link on the bottom.

This portfolio is unique because it has moved to ETF’s and ~ 25% cash position.  The ETF’s have been doing well, with a large position in VTI (total US market) and a split between VEU (all world non US) and HEFA (all world non US hedged against the US dollar to get local market performance).  There also is a small biotech position (IBB) and gold ETF position (IAU).

When we moved to ETF’s from individual stocks in 2016, we also purchased a 2 year CD which paid 1.55% interest, because our money market fund was essentially offering “zero” interest on our money and we wanted to keep about $10,000 or so in cash and yet get some sort of return on the money.  This CD recently redeemed into cash in the account.  We could buy a new CD, but we are currently getting 1.85% return in our money market so we can just leave it there because the 2 and 3 year CD’s aren’t offering much more than that, and interest rates seem more likely to go up than down.  Thus we are planning (for now) to just leave cash in the money market instead of buying a CD because the incremental interest is negligible.

I want to have the beneficiary contribute now and have the trustee match, make our investments for summer 2018, have everything clear, then move the fund out of UTMA status and to the beneficiary (like we did with Portfolio One).  Then we can give the (technically former) trustee “agency” capabilities so that we can still take advantage of my free trades (which apply to the accounts that are under me or I have agency capabilities for).

 

Basic Investing Plan Updated June 2018

This is an update to my “basic investing plan” to take into account market shifts.  As always do your own research and make your own investing decisions.

This is a plan for a reasonably sophisticated investor; the goals include:

  • Diversity among investing classes
  • A few representative investment choices to allow for differing levels of risk
  • Aiming for very low costs
  • International options
  • Taking into account the impact of currency risk (rise and fall of the US dollar)

Fixed Income:

In my prior plan I recommended brokerage CD’s.  At the time (near zero interest rates), these were the only (almost) risk-less options to get a return above zero.  However, short term interest rates have shifted and it is now a viable option to leave money in money market accounts which should yield near 1.75%.  The current yield curve (as of June 2018) looks like this:

  • Base rate (no CD, leave in money market) – 1.75%
  • 1 year CD – 2.30%
  • 2 year CD – 2.80%
  • 3 year CD – 3.00%
  • 5 year CD – 3.30%
  • 10 year CD – 3.40%

ETF Options:

ETF’s are recommended due to their (generally) very low annual expenses and their tax efficiency (they do not generate gains unless you sell them).  The following ETF’s are good considerations for any portfolio:

Vanguard – Total US stock market (VTI)  – Provides exposure to all classes of US public stocks (over 3000 stocks).  They are “market weighted”, meaning that you are investing money based on the relative value of each stock.  This means that the top tech stocks (Apple, Microsoft, Alphabet (Google), Amazon and Facebook) comprise over 10% of the total investment (as of year end 2017).
VTI Top Ten

Vanguard – All-world except US stock market (VEU) – Provides exposure to all major non-US stock markets.  This index is also market weighted, and includes stocks from Europe, Asia (including China) and other major markets.

VEU_Top_Ten

iShares – Large and Mid-Capitalization Non-US stocks, Hedged vs. US Dollar (HEFA) – moves in the US dollar can significantly impact the return of foreign ETF’s like VEU, above.  For instance, if the dollar rises 20% against a basket of foreign currencies over a period of time (which has happened multiple times, along with reversals), this rise could completely wipe out the underlying return of these stocks.  Essentially the VEU international ETF above is maybe half a bet on the US dollar vs. a basket of foreign currencies, and a bet on the underlying performance of these foreign stocks.  If you want to get the “pure” return of these assets, HEFA should be seriously considered for your portfolio.  This ETF has slightly higher expenses than the other ETF’s listed above, but this is due to the added hedge costs, and is still a reasonably 0.7%.

iShares – Gold Trust (IAU) – tracks the short term price of gold.  Can be viewed as a hedge against market volatility and (potentially) likely to hold its value in a time of inflation or a debased US currency.  Does not offer a return in terms of dividends or stock returns.

Grayscale – Bitcoin Investment Trust (GBTC) – as of mid June 2018, this is the only ETF (like) way to participate in the crypto space directly.  It has a 2% annual expense ratio.  This product trades like an ETF and can be bought or sold easily on an exchange.  There are unique tax implications to owning this investment – here is the document that they provided with 2017 taxes.  Not recommended unless you want to deal with additional complexity.

CD’s and Money Market Funds As of June, 2018

For many years’ the USA (and much of the developed world) offered very low interest rates on accounts with low risk (guaranteed accounts).  The policy was known as “ZIRP” or “zero interest rate policy”.

As a result of ZIRP, this author started exploring CD’s purchased through a brokerage, which offered a couple of percentage points more in return (than zero) with the same, virtually zero risk.  These brokerage account CD’s typically offered higher returns than you can get from your local bank or savings accounts.

Over the last couple of years, however, the USA has begun to raise interest rates.  Today, the VMFXX money market from Vanguard offers a return of 1.74% (with an expense ratio of 0.11%).  There is also an expectation of continued increases in the future, although no one knows for certain what will occur.

Since the “base” rate is now effectively about 1.75% (more or less), the CD forward “curve” looks like this:

  • Base rate (no CD, leave in money market) – 1.75%
  • 1 year CD – 2.30%
  • 2 year CD – 2.80%
  • 3 year CD – 3.00%
  • 5 year CD – 3.30%
  • 10 year CD – 3.40%

When you buy a CD, you essentially “lock up” your money for that duration.  If you have a 2 year CD, for instance, you can always buy or sell off that CD, but if interest rates go up you won’t receive back 100% of your investment.  For example, if you have a 2 year CD at a rate of 2.80%, and short-term interest rates move from 1.75% to 2.00%, for example, and you needed to sell your 2 year CD, you might receive 99 or 98 cents on the dollar (it could seem higher because you’d also be getting back interest accrued prior to your next payout, for example if you had a semi-annual payout).  These are really minor “losses” in the grand scheme, especially if you are dealing in the thousands or even few hundreds of thousands.

The future of our interest rate policy is (as always), essentially unknown.  Interest rate policy is also closely tied with the value of our currency, although this takes the entire conversation off into a far more complex direction.

In a time of ZIRP for an extended period (we had it from 2008 to 2015), buying products like CD’s was essentially the only way to get any sort of risk free return on interest at all.  With short term interest rates at 1.75% and (likely?) heading upward, now there are more options on the table, including doing nothing and taking the short term rate or locking up funds for the near term or even medium term.

All of this income is taxable.  Thus the effective rate that you receive is lower, depending on your tax rate.  Tax rates did come down a bit with the 2017 tax changes, with most folks in the 12% / 22% / 24% range.  Thus if you get 2% your return is effectively around 1.5% – 1.6% after taxes.

This blog will also look into the current state of iBonds, another product that is essentially risk free that we reviewed in the past, in an upcoming post.

 

Buying CD’s Through a Brokerage Account

As part of my “basic investing plan“, this site describes how to buy CD’s through your brokerage account.

Buying CD’s through your brokerage is the same as buying them through your bank, except that you typically receive a much higher interest rate. When a bank sets up a CD or savings account and markets it to their existing customers, they typically pay their existing customers much lower than the highest rate available in the market.

Since CD’s are completely interchangeable, you can buy a CD from any bank. If the bank is taken over by the FDIC (Federal Deposit Insurance Corporation), you receive your money back plus accrued interest. During the last financial crisis many of my CD’s were redeemed by the FDIC in this manner.

You can select CD’s from the highest yielding bank. As long as the bank is insured by the FDIC and you are not past your insurance limit for that bank (typically $250k, although this can be higher if you look at joint minimums), you are completely insured by the Federal government and there is no risk of default as long as this program exists.

Here are the current yields for new issue CD’s. They will vary slightly but give a good idea of what you can receive over the next 5 years for no risk. New issues are bought at “par” or 100% of value.

CD yields

11/8/22 2.4% (5 years)

11/8/21 2.15% (4 years)

11/9/20 2% (3 years)

11/12/19 1.75% (2 years)

11/18 1.5% (1 year)

In these instances I am recommending “new issue” CD’s because if you buy an existing issue then it gets more complex. You will buy at some price other than 100% of par depending on interest rates and time outstanding and then you will potentially have gains or losses when or if you sell or hold to maturity. Since the differences are slight and the complexity is unneeded, I typically recommend buying new issues only.

If you need to sell the CD to raise cash for a purchase, you can sell them through the brokerage platform. You will receive a slightly higher or lower price depending on current interest rates vs. interest rates at the time you bought the CD. You will also receive a different amount based on accrued interest (because the purchaser will receive the payment, not you).

Portfolio Two Updated August 2017

Portfolio Two is our second longest lived portfolio.  This portfolio has been converted to ETF’s and a CD.  Beneficiary investment is $6500, trustee investment is $13,000 for a total of $19,500.  Current value is $34,290 for a gain of $14,790 or 76%, which is 7.8% over the life of the fund annualized.  Go here or to the link on the right for the portfolio detail.

This portfolio is different from the others in that there is a 1.55% CD for $10,000 and the rest are ETF’s.  The largest ETF is VTI (US total index) with VEU (all world ex US) and HEFA (non US, hedged).  We also have a small position in IBB for biotech.  All seem to be doing well.

It is a symptom of ZIRP that our CD returns less than the US or European stock funds, which are around 2.5% / year.

Portfolio 2 Updated April 2017

Portfolio Two is 12 1/2 years old.  The beneficiary contributed $6500 and the trustee $13,000 for a total of $19,500.  The current value is $33,334 for a gain of $13,834 which is 71% or 7.4% / year when adjusted for the timing of cash flows.  You can see the portfolio detail here or go to the links on the right.

This portfolio is different than the other portfolios because it has shifted to ETF’s and CD’s.  The ETF’s are broadly tied to the US and non-US stock indexes.  There is also a CD that returns 1.55% / year for $10,000 in the portfolio.

Since markets have gone up over the last year, this portfolio has done well (it tracks the market).  All of the ETF’s are near 100% of their 52 week high, which means that they are at or near their highs and the indexes have been rising continually over this time period.

Unlike the other portfolios, which are invested in individual stocks, these ETF’s do have annual expenses.  You can’t “see” the expenses because you receive the returns “net” of expenses, but this is disclosed.  Over the 1 1/2 years that we’ve had this portfolio the low cost ETF’s cost $86, which is very low for a portfolio of over $30k.  If you go back ten or fifteen years ago mutual funds would routinely cost 2% or more each year which would be $600 / year on a portfolio of this size.  It is a testament to the efficiency of ETF’s (which drove competition in the mutual fund markets, mutual fund expenses have been driven down proportionally, as well) that these sorts of rock bottom expenses are now commonplace if you know where to look.

In a technical note, the CD does fluctuate in value (a bit), but I record it at cost ($10,000) since we intend to hold it to maturity.  The cost fluctuations thus do not matter.

Finally, in another note, when I moved this portfolio over to Google Sheets, I noticed that I had been overstating the contributions in the “cash flows” calculation since 2012.  Thus the recorded return since inception now looks higher.  The value of the fund was always correct it was just the calculation of total gains to date that was incorrect.

 

Portfolio Two Updated January 2017 – Tax Time

Portfolio 2 is our second longest lived fund, at over 14 years.  This fund has transitioned from individual stocks to an ETF and CD mix.  The beneficiary contributed $7000 and the trustee $14,000 for a total of $21,000.  The current value is $32,151 for a gain of $11,151 at 53% or about 5.5% / year when adjusted for the timing of cash flows.  You can see the spreadsheet supporting this at the link on the right or download it here.

The fund contains 4 ETF’s and one CD.  The $10,000 CD earns 1.55% and will redeem in July, 2018.  This investment is essentially risk free (if the issuer goes under the FDIC will pay out the accrued interest and return the principal).

The largest ETF is VTI, which covers the US stock market on a capital weighted basis (that is to say that the largest market capitalization stocks comprise a larger portion of the index).  Since we have had a rally in Technology (prior to the election) and financials and commodities (mostly since the election), this ETF has done well.

There are two non-US ETF’s, the VEU (all world non-US, unhedged) and HEFA (major non-US markets, hedged against the dollar).  Surprisingly, these two funds mostly performed alike in terms of returns, even though the dollar rose during this period.  This is something I will investigate further in the future when I have some more time.

The fourth ETF is IBB, a NASDAQ bi0technology ETF.  This one was kind of a bet on future growth since it had been pummeled in the period before we purchased it.

In general, these ETF’s are low expense and overall the portfolio has a decent yield at 1.9% comprised of dividends and interest on the 1.55% CD.  This is a nice cash addition in an era of zero yields on short term cash and when even some large issuances have negative yields over a ten year span (in Europe).

I noted that the ETF HEFA (the hedged fund) had a small capital gain.  This is rare for ETF’s (they are common for mutual funds).  Since it is immaterial it is listed as a dividend on the report.

Due to the fact that these trust funds are “subsidiaries” of my account, typically they don’t pay any fees on transactions for individual stocks (essentially zero expenses every year).  Since ETF’s do have expenses, this portfolio will incur implicit expenses (they come out of the returns of the ETF’s so you don’t see them directly).  About $70 in implicit expenses hit the portfolio during 2016 (the CD is free of all expenses).