When I think about the phrase “high-tech portfolio”, I don’t think tech stocks. Instead I think about using technology to build a smarter portfolio. Most actively-managed portfolios are constructed, in full or part, using 50-year-old “modern portfolio theory” methods. I’m working to change this by bringing superior portfolio technology to market.
So, while writing for this financial blog remains a passion of mine, I will likely be spending much more time refining software and building a financial software business. Much of that effort will be off-line at first. Occasionally, however, I will provide business and software updates on the Sigma1 Financial Software Blog.
Developing portfolio-optimization software combines two of my long-term passions: software development and finance.
Rest assured, that I will keep this blog up and going. I think it contains some hidden gems that are worth discovering. I will also continue to blog here when inspiration strikes.
I have been a rental property manager (landlord) for just over two years now. I’ve learned many things; two stand out:
- Residential real estate can be a great investment. Rental real estate can provide steady cash flow, excellent asset diversification, favorable tax treatment… all with modest capital gains potential.
- Rental real estate can be a real pain to manage at times. Both tenants and repairs cause headaches.
I currently own one rental property through my LLC. Because of item #2 above, I’ve recently turned over the property management to property management company. This choice will probably reduce net revenue about 10-12%, but will help take much of the stress out of finding and screening new tenants and dealing with repairs and tenant issues. If things work out well, I will consider purchasing a second rental property.
In my local real-estate market it is reasonable to expect about 5-6% net income on a fully-owned rental property. And over a 30-year period I conservatively estimate 1.5% appreciation. Further since real-estate prices are a large competent of cost-of-living and inflation, real estate makes a good hedge against real inflation. Finally, just as property values tend to go up, so do rental rates. Simply put, residential real estate is the best long-term inflation hedge I’ve found.
The flip side of rental property is the eventual likelihood of landlord/tenant issues ranging from breaking the lease, to late or unpaid rent, to property damage, to eviction — just to name a few. Vacancies without rent can really take a bite out of your cash flow. Properties can drop in value, and marketable rental rates can fall dramatically.
Somewhat of a wild card is the tax treatment of rental properties. In the “pro” side are depreciation of the structure which can be deducted, and the fact that “passive income” like other investment income is not subject to Social Security tax. On the “con” side is that fact that nothing can offset “passive income” except passive losses (and vise versa). Owner’s of rental real estate (or at least their accountants) will become very familiar with IRS Schedule E of their income taxes.
Rental real estate is not for every investor. Personally I wouldn’t recommend buying rental real estate until you have a minimum of $250,000 net worth. Managing a rental property can be time-consuming and challenging. Alternately, finding a good property management company is also a real challenge. And unlike infomercials and “Rich Dad Poor Dad” author Robert Kiyosaki suggest, real estate is not a financial panacea. However, for some higher net-worth individuals, rental residential real estate is worth considering as part of their investment portfolio.
There are many ways to diversify beyond Wall Street’s offerings:
- CDs (Certificates of Deposit)
- Bank at a Credit Union
- iBonds and/or Savings Bonds
- Residential Real Estate
- Commercial Real Estate
- Starting a Small Business
- Collectibles (gold, silver, platinum, art, vintage cars)
- DIY home improvement
Paying down debt is also an investment:
- Paying off (or paying down) credit cards
- Paying off auto loans
- Paying off student loans
- Paying down mortgage(s)
These debt-lowering options have the side benefit of improving your credit score and lead to a healthier credit report.
Additionally, there are “investments” that benefit your finances and offer other non-financial advantages.
- Education and training. Either self-taught or formal. (including reading this blog!) Increase your earning potential.
- Exercise, and healthy diet. The longer and healthier you live, the greater your potential to earn and prosper.
- Strengthen your social network. You will feel happier, more motivated, have more job networking opportunities.
Finally, there are methods to reduce and diversify your cost of living expenses:
- Learn to cook, grill, or otherwise eat at home more often. If you are persistent you may find you are eating better, healthier, and more economically.
- If you like coffee… brew your own. It may take time to learn what you like, but when you do you’ll love it. Whether it is is store-ground hazelnut drip, Vietnamese coffee with Chicory and sweetened, condensed milk, French Roast, or a plethora of other choices you will benefit.
- If you love high-quality craft beer, consider brewing your own. After the initial investment (~$200) you can brew your own for less than $4 per six-pack. Share it with friends, and grow your social network.
- Use those DIY skills to make your house more energy-efficient by installing low-E windows, LED light bulbs, and even update weather stripping and doors.
- Grow a garden.
I have employed all of these financial ideas except commercial real estate (not counting REITs), certificates of deposit, and gardening. My point is that it is possible to invest beyond Wall Street’s offerings. Wall Street now offers some great investments including ETFs, and excellent brokerage companies like Vanguard, Fidelity, and Interactive Brokers (for sophisticated investors). Finance and investing extends beyond stocks, bonds, ETFs, and Wall Street.
40 years old is still several years off for me, but I it is very likely I will be a millionaire by the time I reach 40. In fact, if you count my contributions to Social Security (including my employer’s half), the current value invested in my personal “Social Security Trust Fund” puts me there already. But I’m certainly not counting on Social Security.
So, I’ll be rich right? Wrong! First there’s inflation. Many economists say US inflation has been about 4% per year over the last century. There’s a handy rule of 72 that says, for example, 72/4 = 18. That means 4% inflation means that a million dollars today is only worth $500,000 in 18 years and $250,000 in 36 years.
Second, there’s taxes. Over $300,000 of my holdings are in tax-deferred accounts such as 401k accounts and IRA accounts. Sure this money is part of my net worth, but when it comes out at retirement I’ll likely be paying something like 30% tax on it. That’s about $90,000 to Uncle Sam. Poof! Gone!
Back to inflation. Inflation works like a stealth tax. According to government CPI figures, US inflation increased just 1.5% in 2010. That simply doesn’t jive with my experience. My HOA fees increased 7%, my electric and water bill increased 8%. Car insurance, home insurance, satellite TV, health-insurance premiums, internet, rooms at my favorite hotel, and meals at my favorite restaurant went up, by 4-10% last year. Even the local sales tax increased almost 1%, making everything that much more expensive on top of everything else. In Balhiser World 2010 inflation was about 4-5%, rather than the 1.5% according to the CPI. Thus I have some new ideas about what CPI stands for…
- Cagey Price Index (Price? What price? Prices are relative.)
- Calming Price Index (Nothing to see here. Relax. Inflation is under control.)
- Clairvoyant Price Index (Far away someone is substituting chuck steak for Filet Mignon. Meat is meat. And prices are low.)
- Creative Price Index (2+2=3 for sufficiently small values of 2)
- Cowardly Price Index (Please don’t be mad, prices aren’t that bad… see?)
Of course CPI officially stands for Consumer Price Index. Let just say that for the next 72 years the official CPI is 4%, but actually inflation is 5%. That handy rule of 72 says that at 4%, one million dollars today will be worth $62,500 of buying power. At 5% buying power is cut in half to $31, 250. Of a long enough time a 1 percent difference in inflation is a big deal.
So what? Well, the CPI is used for a lot of things such as government cost of living adjustments, tax bracket adjustments, Social Security benefit increases, and money paid on Treasury Inflation-Protected Securities, to name a few.
It’s bed time so I’ll cut to the chase.
- One million dollars is not what it used to be, and is certain to be worth much less in the future.
- To try to remain solvent (and avoid unpopular austerity measures) the US Government has a powerful incentive to under-report inflation.
- Many investors and economists are beginning to believe that the CPI significantly under-reports inflation. Examples: “CPI Controversy”, “Bill Gross says so”, “Forbes, pastries, and gold say so too”.
In my blog post Financial Toolkit: Indexing the World I discussed 5 ETF building blocks for diversified investment portfolio construction. In this financial blog post I’m going discuss a hypothetical investing situation:
Deborah is a 40-year-old woman with a $100,000 401K who just changed jobs. She transferred her 401K to an IRA, and has $100,000 now sitting in cash. Deborah’s new job pays $60K/year and she plans to contribute $10K/year to her new 401K. How might she invest her IRA funds?
As a proponent of diversified index investing, I suggest the following category questions… What percent 1) Domestic vs. foreign? 2) Stock versus bond?
I put forward the suggestion that Deborah’s choices in regard to these two questions will predict 80-90% of the performance of her chosen portfolio. (Don’t believe it, then read this asset allocation paper sometime when you are afflicted with insomnia.)
Let’s say Deborah decides that a 80/20 domestic versus foreign allocation, and 60/40 stock versus bond allocation are right for her. Working out the math that’s $80,000 for US investments and $20,000 for foreign investments. Applying the second stock vs bond ratio to each yields the following: $64,000 for US equities, $16,000 for US bonds, $12,000 for foreign equities, and $8,000 for foreign bonds.
The US part is pretty easy to achieve. Plunk $64,000 in a low-cost, broad-market ETF (or mutual fund) like SCHB, and $16,000 into a total (aka aggregate) bond ETF like BND. The foreign stock component is easy too; but $12,000 into VXUS. Only the foreign bonds require two ETFs because there are no foreign total bond ETFs (to my knowledge); thus I suggest $4000 in a foreign government-bond ETF like IGOV and $4000 in a foreign corporate-bond ETF like IBND.
There you have it. A simple example of asset allocation.
My personal opinion is that an initial asset allocation process can be very simple and effective. Notice that I was able to avoid several secondary asset allocation measures such:
- Value vs Growth (stocks)
- Large-cap vs Small-cap (stocks)
- Sector allocation (stocks)
- Developed vs Emerging markets (stocks and bonds)
- Short-term vs Long-term (bonds)
- Average Maturity or Duration (bonds)
- Government vs Corporate (bonds)
- Investment-grade vs non-investment grade (bonds)
- Average credit rating (bonds)
All of these “secondary asset allocation factors” can be side-stepped by purchasing “total” stock and bond funds as outlined above. Such total (or aggregate) ETFs seek to own a slice of the total, investable, market-cap-weighted investing universe. Essentially, a total US stock fund seeks to own a piece of the whole US stock market. Similarly with a total US bond fund, etc.
In summary, if you have a diversified, low-cost investment portfolio, the two biggest ratios to know are domestic/foreign and stock/bond. [If you don't have a diversified, low-cost investment portfolio you might want to think about changing your strategy and your financial adviser!]
We all face occasional financial setbacks. One way to increase feeling of financial loss is to check your portfolio daily. Since I have a private fund that I manage, I feel obliged to stay on top of it daily. I’ve noticed that when the fund is up I feel modestly happy, but when it is down I feel doubly disappointed.
Sometimes various financial stresses come together at the same time. Recently minor financial setbacks have converged for me: modest potential issues with my rental business, and a few percentage points drop in my fund, and long hours at my day job. Navigating these financial stresses involves 1) avoiding impulsive decisions, and 2) carefully considering available options. For example part of me wants to sell the rental property in the next year or so, namely to avoid the occasional headaches of being a landlord and property manager. Another thought is to contract with a property management company, who charges a fee, but helps manage some of the day-to-day property management duties. Finally, I impulsively want to deleverage some of my investments.
I am approaching my latest bought of financial stress as I always do. With contemplation and composure. At least outwardly I am composed and seemingly unflappable. Internally, I am stressed and a bit anxious. This comes with the territory of managing a wide range of investments. This occasional stress is one of the few things I dislike about finance and wealth management. Of course it too shall pass.
I simply wanted to share the fact that, at times, maintaining a financial course can be emotionally challenging. I spend a lot of time talking about how successful investing can be easy… and in many ways it can be. Creating a financial plan can be fairly simple, but sticking to it at times can be stressful and nerve wracking. Financial discipline is worth it, and financial impulsiveness should be kept to a minimum. That is what I intend to do; even when it is not so easy.
I’ve been rather unmotivated to update this financial blog lately. The reason? Taxes! I generally like to keep the tone of this blog upbeat, and when taxes are on my mind my tone tends to be closer to beat up. Speaking of… my tax payment checks are going in the mail today. My property tax checks will be going out next month.
However, baseball season is now underway, and that is good. And my softball league will start up next month… one of the highlights of summer for me. I wonder how much complicated MLB player’s taxes are and how many states they have to file in? Also US military personnel. If I made the rules, US soldiers would not have to pay single cent of tax on their wages while in combat tours.
Whoops, I’ve done it again! Thinking about taxes and spoiling the prospect of a good mood. So on to the topic of gold. I can’t seem to go anywhere with out seeing or hearing either “We buy Gold!” or buy physical gold from us because someone thinks gold will go to $2000 per (troy) ounce.
If I had some gold trinkets or coins sitting a drawer somewhere — gold items that didn’t have any sentimental value to me — I’d get some local cash quotes, pick the highest, and sell. But as for buying gold… nah… I’d rather buy index funds or black gold, in the form of ETFs XLE and/or VDE. In fact I currently own XLE, VDE, SPY, VTI, SCHB to name a few.
Well, I’ve got to cut off this financial/baseball/gold/taxes blog post early, as I’ve got to run the dog to advance canine training class. Best investing wishes, and may taxes not bite too deeply this year.
By most accounts I paid more federal income tax than GE for 2010. Personally, I paid more in regular federal income tax than I did for my brand new car. When you factor in social security tax, medicare tax, state tax, and property tax that is an additional $16,700 or so. I probably paid about another $4200 in sales tax, gas tax, liquor tax, fees, tariffs, assessments, regional assessments, urban renewal, licensing, and other government fees. I’d bet I paid more (federal income) tax than GE, and I’d bet almost everyone reading this blog did too, but I’m even more sure that GE paid it’s accountants more than I did. I wonder how many millions GE spent on accounting, preparing, and filling its 2010 return?
I don’t blame GE for taking advantage of the system… minimizing tax is one of the key responsibilities to its shareholders. But I am troubled by the corporate tax system. Why should GE pay 0.0% and IBM pay 24.8%? Shouldn’t large U.S. corporations play by the same rules? Shouldn’t the rules be more even across companies? Who wrote these crazy rules? Well, that last question is rhetorical, obviously!
I think a 35% base corporate income tax rate is way too high, but 0% (for GE) is way too low. My opinion is that a 15-25% corporate tax is much more internationally competitive. But even at 15%, GE’s 14.2 Billion USD profit should be taxed at a little bit more my than my way-way-way less than a million, barely-6-figure, USD income.
With only a few weeks remaining in 2010, now is a great time to make any tax-planning adjustments.
Step 1 is determining your general current capital gains and gross income situation. Do you have carry-forward tax losses? What are your current 2010 realized net short-term and long-term capital gains? What are your unrealized capital gains? What is your 2010 “ordinary income” situation looking like?
Answering these questions gives you a starting point for year-end tax planning.
For example, if you have big long-term capital gains because you sold a bunch of company stock to make a down-payment on a vacation property, you make ask yourself, “is paying 15% tax on these gains a good deal, or do I want to try to offset them with a few capital losses?”
Or, you may ask the inverse question… “I have a bunch of unrealized long-term capital gains; Should I sell now and realize them for the ‘bargain price’ of 15% tax?”
Some of these financial questions are tough to answer. That is why I pay my CPA $80/hour to help me answer them. [This is a bargain price; my previous CPA was $150/hour. Finding a good one for $80/hour was a godsend!] If your struggling to answer them, I’d encourage you to set up an appointment with your CPA, or if you don’t have one a local CPA. Bring your best answers or guesses, and you might be surprised how much they can enlighten you in one short hour.
A little year-end tax planning could save you $500, $1000, possibly several thousand dollars. If you have to pay $80, $100, or even $250, for this I’d say its money well spent.
Previously I started blogging about the very different approaches my parents took with respect to money and investing. In this blog post I continue that discussion with a story of how I became even more passionate about investing.
My parents divorced not long after I started attending college. Because of the way divorce law works, my Mom received the majority (perhaps two-thirds) of the family assets plus a fairly significant monthly alimony payment. Over the next ten years Dad rebuilt his financial life, benefiting from the remarkable 90′s bull market and intelligent investing. Over that same period, Mom’s financial fortunes floundered. I witnessed both financial journeys as a powerless spectator.
The sad irony is that Dad, the savvy investor, was willing to listen to my investing ideas, whereas Mom stubbornly refused almost all of my investing advice. I saw Mom make one bad investing decision after another. She put the house on the market but could not sell it because her asking price was about $100K too high. She loaned money to business partners without a written contract… money that was never paid back. Most upsetting to me: She let her investment adviser, Sam W., manage her IRA, losing money with highly under-diversified utilities stocks and funds in the midst of this tremendous bull market. The contempt and disappointment I feel towards Sam still lingers with me to this day. That Mom blindly trusted this man, who likely had little interest in her well-being, and shunned her son’s financial advise left me with stunned disbelief.
I was interested in investing from the time I learned about compound interest at around the age of 9. I was fascinated by the math of computing compound interest monthly, daily, hourly, continuously. I was intrigued by the concept of companies, shareholders, stock exchanges, and business. But it was in watching and living the real-world consequences of my parent’s good and bad investing actions, that my lifelong passion for investing was forged.
These experiences are probably why I am so driven to help people avoid making big financial blunders. I’ve seen and felt the effects of load funds and self-serving financial advisers. I’ve seen the impact of poor diversification. I’ve seen the tears of losing a home, losing a business… due to poor financial choices.
I’m often looking for ways and words to become more persuasive. I’m looking for ways to help people build interest and confidence in shaping their own financial destinies. I’m working to develop tools to simply and explain the financial world. I’m working to create this financial education blog which will someday become part of a personal finance book.
Finance is my passion. This passion is often hard for people to understand. Perhaps this blog article will help people understand. Probably some of my readers share a passion for personal finance and investing. If you have a similar passion, I hope you will consider sharing your financial stories that shaped your financial lifestyle.
- What is the average weighted expense ratio for all my holdings?
- How much, if anything, did I pay in commissions in the last 12 months.
- What was my rate of return in the last 12 months? (post all fees and expenses)
- How does that compare to the to rate of return in the S&P 500 in the same time period. (inclusive of dividends)
- What is the 12-month standard deviation of my investment portfolio? (a measure of risk)
- What is my asset allocation between stocks, bonds, and other?
- Do any of my holdings have loads? If so why?
- How diversified are my holdings?
Bonus: Please update me on my portfolio’s tax efficiency and tax efficiency strategy.
Feel free to take good notes, and, if you like, send the answers to me. I’d be glad to give you my personal assessment/opinion.
Even though it is very unlikely that Balhiser LLC will do any hiring in 2010, it makes sense to lay out a rough sketch of expectations and policies. In many ways I’d like to follow the HP Way as outlined in David Packard’s excellent book. So here is a first pass.
Balhiser LLC is:
- A for-profit financial company seeking to produce long-term returns for its shareholders.
- A company where every employee is a shareholder.
- An innovative, conservatively-managed company that values bold ideas and prudent actions.
- As true of a meritocracy as humanly possible.
While I as president retain final say-so, salary and other financial information will be governed as follows (as permitted by law):
- Transparency. All employees and stockholders will have access to the company’s financial books. This includes salary, other compensation, and ownership information.
- Employees will play a key role in hiring their co-workers.
- Employees will, as much as possible, have say-so on who is on their project team.
- Friendly competition between project teams is encouraged.
- Competition between project team members is generally discouraged. Teamwork is strongly encouraged.
- Salary and compensation adjustments will be based on the following (in descending order of precedence):
- Company performance
- Project performance
- Individual performance
- Company performance is #1 because without reasonable performance the wants of the shareholders and employees simply cannot be met.
- Project performance is #2.
- Individual performance is #3 because:
- It is often difficult to measure objectively.
- Competition between individuals for salary, position, etc is frequently at odds with teamwork.
- Time spent on “getting credit” and “looking good” is time wasted. What matters is enjoying work, finding solutions, and making money.
- In the long term individual performance is still rewarded because:
- The teams with the strongest individual performers will tend to be more successful.
- The importance of project team success will result in high-performers being highly sought-after.
- Long-term low performance that is detrimental to the team is unlikely to be tolerated by the team.
As a final bit here is what currently constitutes Balhiser LLC:
- Invests company resources to make cash-flow and profit.
- Financial commentary and general (not-individualized) investment advice.
- Financing long-term investments and constructing a long-term financial portfolio with a strong balance sheet.
- An investment property (that is currently generating positive cash-flow).
- A business checking account.
- A handful of websites/domains.
- Over 75 articles on various financial topics.
- A computer, and other office equipment.
- A modest collection of accounts receivable.
Disclaimer: The Crazy Ivan Account (CIA) is not a Balhiser LLC asset. Commentary about the CIA is.