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.

Portfolio Two Updated February 2018, and It’s Tax Time

Portfolio Two is our second longest lived portfolio, at 13 1/2 years.  This portfolio is unique because the individual stocks have been sold off and replaced with ETF’s and a CD.  See the details here or at the link on the right.

The beneficiary has invested $7000 and the trustee $14,200 for a total of $21,200.  The current value is $38,428 for a gain of $17,228 or 81%, which is 7.7% a year when adjusted for the time value of cash flows.

Walking through the detailed transactions often helps you to find items you’ve overlook – we noted that the biotech ETF IBB had a stock split (3-1) in December 2017 so I have been understating the value of this portfolio by almost $2000 since that time on my consolidated view.

There were no stock sales last year so the only tax impacted item is dividends which were approximately $632 during 2017.

The portfolio is doing well.  It is interesting to see that the VEO ETF has returned 33% including dividends since we’ve owned it but the HEFA ETF has returned 19% including dividends… the difference is due to the 10% or so fall in the US dollar vs a basket of other world wide currencies.  HEFA is hedged so you get returns in original currencies while VEO also includes the net effect of the dollar on returns (which magnified returns in this case).

 

The Impact of the Dollars’ Fall on Portfolios

A few years’ back the dollar fell significantly against other currencies around the world.  US citizens who don’t travel overseas may not have seen the impact, but the impact was real in terms of investors in that anyone holding overseas assets (Europe, Canada, Australia) saw a “double return” in that the investments themselves rose and the return after the currency surge was an even bigger boost.

Then the dollar rose against most other currencies, and there were discussions that the Dollar / Euro ratio would move towards 1/1.  In general, if anyone has a prediction about FX, treat it with more than a grain of salt, because the consensus is often very wrong.

ETF’s took notice of investors wanting to get the underlying return of foreign stocks without the impact of the US dollar vs their currency, and ETF’s like HEFA were created.  HEFA takes a non-US portfolio of large capitalization stocks from major markets around the world and hedges them against fluctuations in the US dollar.  While it isn’t a perfect mix (because the underlying weighting of stocks comprising each index are different), HEFA under-performed the Vanguard non-US stock  ETF VEU by a bit less than 10%.  This is what you’d expect because the dollar fell by about 10% when compared to a basket of major market currencies during the last 12 months.

In this case, buying HEFA hurt returns because the dollar fell against foreign currencies.  When the dollar falls, you are better off in foreign assets.  On the other hand, HEFA would have been a superior investment to VEU during all the times when the US dollar was strengthening.