Many, perhaps most, investors agonize over their asset allocations without paying any attention to the location of those assets once an allocation is decided upon. This is unfortunate, because in many cases asset location is as important as asset allocation. So what types of mutual funds are best for your taxable accounts and which should you avoid at all costs? The rules are relatively simple.
Criteria For An Ideal Taxable Investment
Long-term returns come almost completely from price increases as opposed to short-term capital gains, dividends, or interest payments
Distributes little or nothing in the form of taxable interest or dividend payments
Very low turnover in order to minimize taxable gains
Equity-based…sure, municipal bond funds pay tax-free interest, but bonds in general should go in your tax-deferred accounts such as your 401k/IRA. You should only ever own bonds in a taxable account if you have absolutely no room anywhere else.
Three Best Mutual Funds For Your Taxable Account
As you probably know if you’ve been reading this blog for a while, I’m a huge Vanguard fan. As it turns out, index funds are some of the most tax-efficient funds around, so it’s no surprise they top the list here. The other top mutual fund companies also carry quality index funds, especially Fidelity. Any of those would do as well so long as the expense ratio is comparable.
Vanguard Total Stock Market Index Fund (VTSMX) - The grand-daddy of them all, this index fund owns almost every stock there is to own in America, leading to super-low turn-over and a very tax-efficient ride. Every investor should own this fund as a core taxable holding, in my opinion.
Vanguard Total World Stock Index (VTWSX) - This fund covers both domestic and foreign large-cap stocks in a single fund. It’s admittedly a bit low on the small-cap exposure, but for most investors wanting broad exposure to the entire equity universe in a tax-efficient package that won’t matter. Initially I had declared I wouldn’t be buying this fund in my taxable account, but the simplicity and tax-efficiency of it just might change my mind.
Vanguard Tax-Managed Capital Appreciation (VMCAX) - This fund is technically not an index fund, although it does adhere to many indexing principals. From the prospectus, it starts with the index and then removes some of the higher-yielding stocks in order to improve tax-efficiency. This may not be a strategy everybody agrees with, but in the past has yielded very nice results. One note: this fund focuses a bit more on mid- and small-caps than the above index funds so it may be more volatile over time.
In a creative gambit, the North American unit of South Korea-based Hyundai Motor Company is introducing a new incentive: Hyundai will take your car back if you are laid off or experience any other covered life-changing event. This coverage is actually an insurance policy taken out by Hyundai via a third-party insurer for every vehicle sold in America and is valid for one year from the date of purchase.
Conditions of Coverage
Only covered life-changing events are covered, including: involuntary unemployment, personal bankruptcy if self-employed, accidental death, overseas transfer
The buyer must have made at least two full payments before making a claim
Coverage Details
Hyundai will cover the difference between the vehicle’s value and remaining loan amount up to $7,500 for a covered event
Coverage is automatic at no additional charge regardless of heath or employment history
Is It Worth it?
Needless to say, I’m skeptical. Hyundai claims the coverage will come at no additional charge, but who’s to say dealers wouldn’t be willing to sell at a lower price without the added coverage? The odds are extremely low that any given Hyundai buyer will lose their job within a year, so I don’t think many people will benefit from this deal. Hyundai and the insurance company, however, both benefit from the publicity of the deal and extra cash flow it affords.
If I were in the market for a new car, I might consider Hyundai more than I otherwise would, but it probably wouldn’t tip the scales too much in their favor. However, if I was worried about losing my job, I wouldn’t be buying a new car in the first place. Thus, the plan strikes me as nothing more than a clever marketing deal. Still, if it sells cars…
The common 401k plan is universally praised by almost every financial journalist around, including most of the blogosphere (me included). The advantages are touted endlessly: tax deferral on gains, a current tax deduction, the company match, etc. A growing number of bloggers and journalists, however, have been questioning not only the wisdom of relying completely on your 401k for retirement (which I don’t recommend) but on the wisdom of investing in a 401k at all. According tothesebloggers, the downsides of investing in a 401k often far outweigh the upside. Here are some common arguments against investing in a 401k.
Arguments Against 401ks
Tax Rates Will Rise - A tax break today doesn’t seem like such a good deal anymore if you end up having to pay a much higher rate upon withdrawal. With a $10 trillion national debt, continuing budget deficits, and staggeringly large entitlement obligations for Social Security and Medicare, many if not most observers predict the U.S. government will have no choice but to raise taxes significantly in the future. After all, we can only live off borrowed money for so long. If taxes are raised significantly in the future, the scales tip more in favor of paying taxes now rather than later. A Roth IRA would be the most obvious alternative.
You Owe Income Tax On All Gains - In a 401k, there is no such thing as a capital gain: it is all considered regular income by the IRS and thus taxed at the highest possible rates. For some asset classes that throw off a lot of taxable income such as corporate bonds or REITs, this is fine since relatively little of their long-term return comes from capital gains. For low-cost index funds, growth stock mutual funds, and other low-turnover, equity-based investment strategies, however, this is a significant disadvantage. Since practically all of an index fund’s return comes in the form of long-term capital gains, the value of the tax deferral is minimized: these funds would be very tax-efficient anyway. “But you still start with more money in the beginning because you save on taxes,” you might say. This is true, but that isn’t necessarily enough to overcome the twin disadvantages of high-cost, low-quality investment choices prevalent in most 401k plans. Lazy Man And Money does the math here.
401ks Have Expensive, Sub-par Investment Options - On average, I have found this to be true. Sure, some larger companies administer their 401k plans through Vanguard or one of the other top mutual fund companies and offer low-cost, high-quality investment options to their employees but in my experience, this is rare. I have never in my life had a decent 401k plan, in fact. Many contend it’s better to forgo the tax deferral in favor of superior investment options, and this is certainly sometimes the case.
What’s The Alternative?
The three points above are all valid reasons to skip the 401k, depending on your individual circumstances. You should do your own homework to determine if a 401k is right for you. If it’s not, what’s the alternative?
Pay Down Debt - Paying down all your high-interest debt is an excellent alternative to investing in a 401k.
Invest In A Roth IRA - If you qualify, a Roth IRA is a great destination for your investment dollars. You can open an account anywhere you like and withdrawals are completely tax-free.
Invest In A Taxable Account - No tax advantages, but at least you have full control over your investment options and can withdraw your money at any time for any reason
Real Estate - If you know what you’re doing, an investment in real estate can pay huge dividends even in today’s market.
This week’s round-up will be short since I was in Memphis all weekend for the Liberty Bowl and have a homework assignment to complete for a job interview I had last week (yeah, they give homework sometimes). Enjoy!
The Finance Blog Network
Curt from Penny Jobs shares his goals for 2009. Good luck!
Passive Family Income shares his goal of generating $1,000 per month in passive income by the end of the year. Quite an ambitious goal but totally doable.
Her Every Cent Counts wonders if she should hire a CPA to do her taxes this year. I’ve been wondering the same thing, since my taxes are probably going to be pretty complex this year. But $500 complex? We’ll see.
Broke in the City relates the curious notion that some people feel guilty for prospering during difficult economic times. In my view, if it makes you feel guilty to spend money on non-essential luxuries, don’t do it. It’s not worth the guilt.
Happy New Year everybody! I think 2008 was a horrible year for many people and I must admit, I’ve had better. In 2008 I was laid off, suffered large losses in my portfolio (but then, who didn’t?) and to cap it off, my beloved Yellow Jackets were slaughtered last night in the Chick-fil-a Bowl. Here’s hoping 2009 is a bit better. Many of my goals are ambitious to say the least, but I figure you might as well aim high. At the end of the year, I’ll review my goals to see how well I did.
Personal Finance Goals
I’m not one of those bloggers who reveals intimate details of their finances online, so the following goals will be expressed as percentages and not absolute numbers.
Increase my net worth by 50% - This is actually a bit less ambitious than it sounds for a number of reasons. One, my portfolio is currently in an extremely depressed state. A modest market rebound combined with continued savings should get me close to this goal without any personal finance heroics. Still, meeting this goal will require me to watch my spending, get a new job within the next month, and increase my blogging income significantly over the next year.
Save 30% of my gross income - This is difficult when you’re unemployed, but hopefully that will be rectified soon. At my last job, I was able to save a little in excess of 30% per month. Fortunately, most of my current prospects pay more than I was making before, so I should be able to meet or beat this savings goal. Of this savings, half will go towards retirement and half towards taxable investment endeavors.
Buy a rental property by the end of the year - More likely to happen is me buying a new personal residence and turning my current condo into a rental. This also depends on finding a job relatively soon and generating enough monthly cash-flow from alternative sources (blogging, etc) to give myself a sufficient financial cushion.
Career
Get A New Job - Preferably one that pays more than the last. Pretty much all my other goals this year depend on it.
Blogging
I now run two blogs, this one and Learn Spanish On Your Own. I’ll break down my goals for each of them separately.
Amateur Asset Allocator
Increase blog traffic by 20% per month - Of late, I’ve been clocking in at near 30% per month. I expect this pace to be fairly easy to keep up for the next 5 or 6 months but after that, it will be a challenge to keep the growth rate up as I near this blog’s saturation point (best estimate is about 60,000 uniques per month). This is an ambitious goal.
Bring search traffic down to 50% of overall traffic - At the moment, search traffic constitutes about 70% of this blog’s traffic with Google accounting for the great majority of that. I don’t like being so dependent on Google, so I plan to do something about it.
Average 30 posts per month - This will require some weekend posting, which is fine.
Write at least one article per week for article marketing - I’ve had a decent amount of success ranking for certain high-traffic keywords with article marketing in the past and plan to continue doing it. One quality article per week should be enough to get me 20-30 extra direct visitors and between 5-10 high-quality back links and perhaps dozens more low-quality back links. Over time, this will have a significant positive effect on my blog’s ability to attract search traffic.
Generate $2000 per month by year end - This goal should be easily obtainable if I manage to meet my traffic goals.
Learn Spanish On Your Own
Increase blog traffic by 20% per month - Like above, this should be easy to maintain over the next 6 months or so but will become increasingly difficult in the second half of the year. The overall market for Spanish learning blogs is much, much smaller than that for finance. That said, there is far less competition in this niche. In fact, I’ve yet to find a single major competitor. There are a few smaller blogs, but no 800 lbs gorilla. I plan on becoming that 800 lbs gorilla.
Average 20 posts per month - I plan on posting slightly less for the Spanish blog than this one, mostly because there are fewer readers overall and fewer opportunities for “link love”-type posts. However, 5 days per week is still a fairly significant posting volume on top of what I’ll be doing for this blog. It will be a busy year.
Write at least 2 articles per week for article marketing - Link-building is a bit more difficult in the Spanish niche since there just aren’t as many other blogs to link to you. For now, article marketing is my primary link-building strategy. Two articles per week should net me 10-20 high-quality back links, which I think is a good weekly clip.
Generate $1500 per month - While the traffic potential for the Spanish blog is much lower than for this one, I believe the profit potential per 1000 visitors (eCPM) is actually significantly higher. I’ve already had great luck selling certain learning programs that cost several hundred dollars each through Amazon (which translates into a high per-unit commission). My conversion rates are quite good, I’m just not driving enough traffic to those particular pages. This is my top monetization strategy for that blog.
For several years now, the peer-to-peer lending has been gaining traction as a valid way to borrow money without going through a bank via social lending sides like Lending Club(aff) and Prosper. It’s been a great boon for borrowers and has received wide mainstream media coverage, as related in the following video.
Some bloggers have begun including social lending in their alternative income reports and for every borrower, there has to be at least one (if not many) lenders, so obviously the lending interest is there. But is it worth it? After all, there may well be a reason banks are refusing to loan to many of these people.
As it turns out, peer-to-peer lending has yielded decent returns so long as you don’t get greedy. Jonathan at My Money Blog was diligent enough to put together some aggregate return numbers for Prosper lenders in a previous post. The data may be a year or two old, but should still be more or less representative. Keep in mind that with the credit crisis, default numbers are probably a bit higher across the board, but especially among borrowers with lower credit scores. Here are some important points to note:
Loans made to borrowers with at least a 600+ credit score returned in the 9-10% range on an average annual basis. Not bad.
Loans made to borrowers with less than a 600 credit score lost a significant amount of money.
Defaults peaked at 10.03% for borrowers with a 600+ credit score while defaults for those with poorer credit reached an astonishing 31.34%
What Does This Tell Us?
It tells us sub-prime lender executives weren’t alone in their stupidity: the average Joe fared no better. In fact, most of them fared far, far worse. Sure, they may have charged in excess of 30% for loans to uncreditworthy borrowers, but it turns out that wasn’t nearly high enough.
Lending to prime borrowers, however, turned out to be a prudent move. A 9-10% return from prime borrowers with good credit is probably a risk worth taking since as an asset class, peer to peer lending is likely to be uncorrelated with other asset classes. Based on these numbers, I would suggest lending only to prime borrowers.
Of the two major social lending sites, I favor Lending Club(aff) over Prosper mainly due to the fact that Lending Club only accepts prime borrowers whereas Prosper will accept almost anybody, it seems. Of course, you could choose to lend only to prime borrowers on Prosper but the temptation of those 35% sub-prime loans may be too great, at least for me. I intend to start lending on Lending Club in the near future once I settle into a new job and my finances stabilize. As credit because harder and harder to obtain even for borrowers with sterling credit, I think an opportunity for significant gains is opening up for risk-tolerant peer-to-peer lenders with excess cash to invest. After all, many of these borrowers will have nowhere else to go.
“The purpose of a job interview is to secure an offer”
This might seem an obvious statement, but many interviewers go in without securing an offer as their top priority. In fact, many recruiters will tell you that’s the primary problem a lot of job searchers have. Let me explain.
Avoid “Turning Off” During An Interview
Many candidates go into the interview with the attitude that the company has as much to prove as they do. While this is true, I believe it’s the wrong attitude and likely to negatively affect your job prospects. Always do your best whether or not you think the job is actually right for you or not. Here’s why.
For example, if an interviewer says something about the job requiring significant travel or unusual hours, many job searchers will decide then and there the job isn’t for them and “turn off,” so to speak. Unwilling to travel, a mental switch is thrown where the job candidate writes off the job as “undesirable” and stops trying. Whether you realize it or not, your lack of enthusiasm is clearly evident to the interviewer, severely diminishing your chances of getting an offer.
Why should you care if you don’t get an offer for a job you don’t think is perfect for you? The answer is that nothing is set in stone. Most objections you may have from benefits to travel requirements to hours worked can be negotiated into a successful compromise, turning it into a job that could potentially be a perfect fit for you. If you write it off mid-way through the interview, however, you’ll never know the position’s true potential. Always do your best, even if you aren’t sure you are the best fit. You never know.
Back in October as part of a group writing project, I made a series of year end predictions about where the economy would be at the end of 2008. Let’s just say it’s a good thing I’m not a professional economic forecaster. Here is a list of predictions I made and how they fared:
Who Will Win The Presidential Election?
My Answer: Obama
Result: It turns out I was correct on that one but by that point in the election season, Obama was commanding a significant lead in all the major polls. I wasn’t exactly going out on a limb on that one.
How Will The Dow Fare?
My Answer: Just above 11,000
Result: I couldn’t have possibly been more wrong. At the time, I suspected we had reached capitulation or close to it. It seemed as though the market was regularly shrugging off bad news, which is sometimes a sign of a market bottom. Well, it wasn’t. As of right now, the Dow stands at 8,391. I know the year isn’t quite over yet, but I would bet good money we won’t see 11,000 by Wednesday. Anybody willing to take that bet?
What About The Unemployment Rate?
My Answer: No Change from October
Result: As it turns out, November was one of the worst months for job losses on record, with over 533,000 non-farm eliminated in that month alone. December was a better than November, but that’s not saying much. Still, I’m optimistic a recovery is near. I have already seen signs of one locally.
Will The Bailout Package Be Effective?
My Answer: No
Result: It’s hard to tell these things for certain because the true effectiveness of the bailout plans will only become clear in hindsight. I think it’s reasonable to say at this point they haven’t been as effective as hoped. They may have helped prop up the financial system temporarily, but I think history will show there was relatively little long-term benefit.
What Will Happen To The Dollar?
My Answer: The Dollar will stabilize against major currencies.
Result: I actually wasn’t too far off on this one. There was a mini-dollar rally (and subsequent mini-bear market) as foreigners fled to the perceived safety of U.S. Treasuries and dollar-denominated assets. It’s probably unfair to say the dollar has “stabilized” but it’s currently faring a bit better than it was just a few months ago. We’ll have to wait this one out. The longer-term trend is still down, I’m afraid.
This past week was a busy one for most bloggers. Most took at least a few days off to celebrate the holidays with their families. Still, there were some good posts this week.
Finance Blog Network
Curt from Pennyjobs gives us 10 things to avoid at your family Christmas party. Managing family relationships is both a positive and a negative part of the holiday season. Raise your hand if this post strikes a chord. Yeah, I thought so.
Passive Family Income tells us how to control home heating costs. This is especially important when money is tight.
Rich Credit Debt Loan reveals a few signs your teen needs money management help. I would go so far as saying a little self-examination by most adults would reveal a few of these signs as well.
Carnival of Personal Finance
This week’s Carnival of Personal Finance was hosted by The Finance Blog Network’s own Andy over at Saving To Invest, and it was a monster. Thanks to Andy for including my post of 8 Job Interview Tips. I’ve never actually hosted a carnival on this blog but think I should. Any feedback on whether or not it’s worth the work involved from a traffic/subscriber/networking perspective?
Budgets Are Sexy gives us 3 Rules For Cash Gifts. Cash is by far the mots common gift I receive. This year unfortunately, I’ll be spending most of my gift money on bills and such but usually, these rules are spot on: spend the money on something you’ve always wanted but are too frugal to buy yourself. There’s nothing wrong with indulging a bit.
Brip Brap asks, What If Saving Was Stupid? He raises a good point: Soviet citizens thought “nothing that bad could ever happen here” too.
Master Your Card gives us 42 ways he’s going to make 2009 awesome. I suppose my resolution is to relearn a musical instrument: I haven’t practiced my guitar nearly as much as I should have the past few years and it shows. By next Christmas, I plan to be Jimi Hendrix reincarnated. His suggestion to learn a new language is also an excellent one in this rapidly-globalizing world. <Transparent Self-Promotion>Might I suggest Spanish?</Transparent Self-Promotion>
To many, time horizon and risk tolerance are the only two factors to take into consideration when determining your asset allocation, but I prefer a more holistic approach. In reality, there are many other factors that can and should affect your asset allocation, not the least of which being how much money you already have and last but not least, your investing goals.
What Are Your Goals?
I feel your individual goals should be the main determinant in your asset allocation. For example, say you already have a $500,000 portfolio and your goal is a $1,000,000 portfolio in 15 years (whether or not that’s a wise goal I’ll leave as an exercise to the reader). In this situation, you only need an annual compounded return of 4.73% to reach your goal. You could probably achieve this sort of return by allocating the vast majority of your portfolio to government bonds. You probably don’t need to take any equity risk at all.
How Much Risk To Reach Your Goals?
This is an example of the interplay between risk tolerance and risk avoidance. While your risk tolerance may allow for a much, much higher exposure to equities, your goals don’t require it. So long as your goal remains the same, there is no reason to invest in equities. That said, it might also be wise to take a hard look at your goal and decide whether or not it is too conservative, but that’s a debate for another day. The point is, asset allocation decisions cannot be made in isolation from your personal goals and current financial situation. Your current net worth should affect your asset allocation strategy since it determines how much risk you’ll need to take to reach your goals. Don’t be afraid to devise an asset allocation strategy that differs drastically from what everybody else says it should be. After all, nobody’s situation is exactly like yours.
