Making a savings account with a bond fund

The 7 Best Bond Funds for Retirement Savers in 2019 | Kiplinger

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Last week I said that savings accounts were for suckers, and that instead you could use bonds to accomplish pretty much the same thing, but make a lot more in interest.  A couple readers asked how that worked in a little more detail.

“Hey thanks for the finance blog… What bond funds do you recommend (ETFs) and do you just hold them in a normal brokerage acct to be able to sell them?”  –JS

How liquid are Bonds? Say I need a quick 5K for a new HVAC unit or some other unforeseen expense. Should I keep any money in a traditional savings account?”  –CW

If we like the concept of using bonds instead of a savings account, let’s dive into how we would actually do it.

1. Open a brokerage account with Vanguard (or Fidelity—we have money at both, but more at Vanguard and have been with Vanguard longer.  Both are excellent.  I’ll write this for Vanguard but in parenthesis I’ll put the information for Fidelity).  You want to make sure it’s a regular brokerage account and not an IRA or something like that.

As a “savings account” you’ll want be able to pull out money when you need it.  A brokerage account allows you to do that, but an IRA account would not.

2. Link your Vanguard account to your checking account.  This is very secure and I have never had an issue with it.

Online you’ll put in your checking account routing number and account number.  A few days later you’ll see two little deposits (think something like $0.21 and $0.09).  This allows Vanguard to ensure that it’s your account.  When you see those amounts, you’ll go back to Vanguard’s website and enter them.

Once you’ve confirmed those, then you’re Vanguard account will be linked to your checking account, so you can transfer money between them very easily.  Sadly, there’s no free lunch and Vanguard will take those two little deposits back.

3. Pick your bond fund.  Vanguard has a ton of options (as does Fidelity).  I want to keep it simple so I pick an index fund to minimize fees.  Also, I want to go as broad as possible to maximize diversification.  Basically, you can go one of two ways—either buy a bond ETF like BND or buy a bond mutual fund like VBTLX (for Fidelity it’s FXNAX).

ETFs are a lot more flexible and I think we’re entering a world where mutual funds will slowly go extinct in favor of ETFs.

4. Buy your BND shares.  Take what ever was in your savings account and buy shares of BND.  It’s a pretty easy process.  Depending on how much money we’re talking about, you might want to break it up into a couple purchases, although statistics say you should just dive in with a single purchase.

5. When you go to buy the shares, it will ask you how you want to fund them.  You’ll pick your bank account that you just linked and it will all work.

When you need to take money out of your savings account (like when CW’s heater goes bad), you just do the opposite—sell the shares and when it asks where you want the money you select your checking account.  Generally it takes about two or so business days to complete the transaction, so just make sure you plan a little ahead.

These ETFs are extremely liquid so you can sell them whenever the market is open.  In fact, you can also sell or buy them when the market is closed.  It will just fill the transaction at the next possible price, when the markets open next.

Easy peasy, lemon squeezy. 

When a huge fall is no big deal

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There was a time when a 7% drop in the stock market in three days would have been a big deal.  Now . . . meh.

The stock market peeked last Wednesday and then over the next three trading days promptly fell 7% (and then yesterday recovered about 2%).  You’d think that should be notable, but it really doesn’t seem like that.

Why a 7% drop isn’t a big deal

First, this has been a crazy year anyway, so a drop like this just seems like par for the course.  In fact, I think that speaks to how crazy things have been that we’re now numb to it. 

A 7% drop is actually a pretty big deal.  Since 1940 (I didn’t want to include the Great Depression where there were a lot of crazy drops), there have been 28 three-day drops that bad or worse.  Is that a lot or not too much?

28 times in 70 years means it averages once every three years or so.  That doesn’t seem too crazy.  As it happens, we had two such periods in 2020, once in February and again in March.  That’s probably not very surprising giving the total stock market meltdown we experienced then.  Before that you have to go back to 2015 and before that 2011.  That seems to line up with our average; this happens every few years.

But the difference is when this happened before in 2015 and 2011, it seems like we made a big deal of it.  Everyone, Stocky included, talked about it a lot, tried to figure out what caused it, and predicted when things would turn around.

This time it just seemed like another couple days.  Personally, I think after surviving the Corona stock market, we just expect this now.  Down 4% in one day, whatever?!?!?  My, oh, my, how far we’ve come (or how far we’ve fallen).

The other thing that made this drop not so bad is it seemed like we were just giving back the gains we made over the previous couple weeks. We lost a lot, but it felt like we just gave back the house money we won a few weeks earlier.

 The fall erased the gains we experienced since mid-August.  That doesn’t seem like all that big of a deal.  Easy come, easy go.

Crazy stock moves is just how 2020 rolls

Nothing about 2020 can really surprise us any more, but how does 2020 stack up to other years.  So far, we’ve had major stock market moves (up or down at least 1%) 46% of the time.  Nearly half the days have seen the stock market move dramatically—think up or down about 280 points for the Dow Jones.

That happens every once in a while, but what really makes 2020 crazy is that 16% of the days have had CRAZY major stock moves (up or down at least 3%–about 800 points for the Dow Jones).  That’s the one that seems remarkable.  That means almost once a week, we’re seeing something crazy happen.  Wow that’s exhausting.

Historically, 2008 had that many crazy big days (the Great Recession).  Before that you have to go all the way back to 1933 and the Great Depression.  That puts things in perspective.  What we’re going through is crazy, but it definitely feels that we’ve just accepted a heightened level of crazy as our new normal.  Sigh.

As always, I remain fully invested and optimistic about the market.  I guess I just need to keep some Pepto close at hand. 

Savings accounts are for suckers

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Probably one of the first things you learned about personal finance when you were a little kid was “Savings Accounts”.    

Yet, as an adult, savings accounts are a horrible place to put your money.  How can that be?  In fact, a savings account could easily be costing you thousands of dollars each year.  Yikes!!!

If you don’t have time to read the whole blog, here is your answer: a bond fund gives you 10x more interest with a minimal tradeoff in safety.  Okay, there you go.  If you interested in understanding my thinking more, here you go.

Crazy low interest rates

Savings accounts today give you an interest rate in the 0.1% range or so.  Maybe if you shop around you can get as high as 0.5%, but that’s probably about it.

Obviously, that’s extremely low.  We know that stocks historically have an 8-ish% return, but that of course exposes you to the risk that you might lose some of your savings when you need it (more on how big a risk this actually is in a second).  Suffice it to say, there are a lot of people who understandably don’t like the idea of having their savings account invested in volatile stocks.  Fair enough.

However, you could invest in bonds which are much less volatile than stocks and still get a much higher return that your savings account.  Going back to the mid 1980s (which is about as far back as I could easily get reliable data), you can see that bonds have an average return of about 6%.  Comparing that to what you could get from a savings account is no comparison.

Just to put some numbers to it, let’s say that you have a nice round number like $10,000 in savings account.  You get about 0.3% interest which comes to . . . wait for it . . . $30 per year.  Now compare that to a 6% bond; you’d get about $600 per year on average.  That’s a huge difference–$50 per month.  This decision just paid for your internet bill or your cell phone bill.  If you want to get extra nerdy (you never have to ask Stocky that twice), $50 each month for your 40 year investing career would come to about $100,000.

Risk of losing money

Okay.  We understand that savings accounts give horrible interest rates.  So why do people still use them?

My suspicion is two fold:

  1. They don’t appreciate that there is an alternative to savings accounts called bond funds.
  2. They have an “over-exaggerated” fear of losing some of their savings.

We just took care of #1, so we can’t claim ignorance anymore.  Now let’s look at #2.  This is a legitimate concern.

We know that stocks move around a bunch (March, anyone?), and historically lose value about one third of the time.  Bonds, however, are a much different story.  Bonds historically have gone down in value in a given 12-month period about 9% of the time.  And just for funsises, if you calculate the average amount bonds go down when they do go down, it’s about 1%.

How does that make you feel?  Everyone has different risk tolerances, but to me this is a slam dunk.  You can use a savings account and be guaranteed to make a very, very small amount of interest.  Or you could take a TINY step up the risk ladder.  There you have a 90% chance of doing better, and if you’re unlucky that 10% of the time you’re only losing 1% (about $100 if you have $10,000 in their savings account).

Bond returns (since 1987)1-year3-years5-years
Best18%13%12%
Median6%6%6%
Worst-4%1%1%
% of time losing money9%0%0%

And here’s the kicker.  That was just looking at one year.  We all know that crazy swings in stocks and bonds become tamer if we allow for more time.  At three years, the LOWEST return for bonds was 1% (not negative 1%, mind you, but you’re making 1%).  If you push your time horizon out to three years, which doesn’t seem all that unreasonable, at least based on historical performance for the past 35ish years, the worst you could do with bonds is the best you can do with a savings account.  The rest is upside.

Irrational fear of losing money

Going back to the questions before, with all this knowledge, why would people still pick a savings account.  I think this is a classic example of going with your heart instead of your head.  The math is pretty compelling, and making the right decision here becomes a major windfall.

But some people just have a visceral aversion to exposing themselves to the possibility of losing money.  I’ve racked my brain and I can’t really come up with serious scenarios where you have a really short time horizon for your savings (less than a year), and you have a really low tolerance for being short as little as 1%.

Maybe if you’re saving for a down-payment on a house you get close, but even then, that tends to be more than a year process and if you are unlucky and come up a bit short, you can just take an extra month or two.  Being silly, maybe if kidnappers took your spouse and gave you a year to come up with the ransom, you probably don’t want to risk being short.  But then you’re better off getting James Bond or Jason Bourne involved.

Seriously, it’s hard to imagine where the massive trade off in return from a savings account is worth the very small security of being 100% certain you won’t lose money.

Personally, I have not had a savings account since I was in college.  We have a checking account for our normal family expenses and then we use a bond fund for shorter-term stuff and then stock funds for long-term stuff.

Risk buys you reward

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Nothing ventured, nothing gained”—Benjamin Franklin

Ying_yang_sign

That Benjamin Franklin guy was pretty smart.  This is not the first time one of his quotes have landed on this blog.  When you enter the world of investing, you need to figure out how you balance the two fundamental, opposing forces of investing: risk and reward.  At its simplest, investments compensate investors who take on greater risk with higher returns.

Think of the least risky investment you could make—a savings account.  You could invest your money and know that your investment won’t lose money.  You could take out the money in a week, a month, or a year; and you would get your original money plus a very small amount of interest.  In the US, the risk of you losing money on this investment is 0%.  Unfortunately, because there’s no risk, the “reward”, the interest you make, is extremely low: less than 1% currently.

Let’s take a small step up the risk scale—short term government bonds.  The chances of you losing money investing in a 1-5 year treasury bond (let’s assume you invest in a short-term bond mutual fund like VSGBX), are extremely low, but it isn’t 0%.  There is a chance, albeit small, that changes in the market (interest rates) could decrease the value of your investment.  You’re taking on a little bit of risk (since 1988 there has never been a year where VSGBX has lost money), and to compensate for that risk these investments historically tend to return about 1-2%.  So you’re being paid a larger return than your savings account because you’re taking on more risk.

Take another step up the risk scale and you get to long-term government bonds and corporate debt (using a mutual fund like VBMFX).  These are riskier because there is some chance that you won’t get paid back; this is true for corporate, foreign, or municipal debt.  These are also riskier because like their less-risky cousins, the short-term bonds we just mentioned, long-term bonds can change in value due to changes in things like interest rates.  The difference with long-term bonds is that the effects are magnified; so if interest rates go up, that would cause the value of your short-term bonds to go down a little, but the prices on your long-term bonds would go down much more.  As you would expect, since long-term bonds are a little riskier (since 1988 VBMFX has lost money in 2 years), they tend to return a little more, historically in the 3-5% range.

Now, take a big leap up the risk curve and you get to stocks.  Stocks are extremely volatile, especially over the short-term.  Since 1930, there have been 24 years (about one-third of the time) where US stocks have decreased in value.  It’s definitely a rollercoaster ride.  Yet, by bearing the risk that in any given year your investment might go down in value, sometimes down a lot like in 2008 when stocks went down 37%, you get a significantly higher return.  Since 1930, stocks have returned on average about 8%.

graph

As you can clearly see in the chart, when you invest in assets with higher average returns (like stocks) you have a lot more volatility in those returns from one year to the next.  When you invest in assets with lower average returns (like bonds, especially short terms bonds or even cash), you enjoy much more stability in the value of your investments.

What’s your appetite for risk?

As an investor you need to determine what your appetite for risk is.  How will you balance the yin of high returns with the yang of higher risk?  At the end of the day, you need to have an investing strategy that allows you to sleep at night.  There’s no amount of money that’s worth freaking out every time the market takes a down turn, and it is certain that the market will take down turns.  Sometimes it will be a free fall like in 2008 when stocks cratered 37% or it might be a long-term grind like from 1973 to 1978 where stocks fell 23% over the course of 5 years.

That said, a long time horizon is your best friend when dealing with a volatile stock market.  While any given year might be crazy, over time there tends to be more good years than bad.  Take 2008: in 2008 stocks fell by 37%, and if you needed your money at the end of that year you were hurting.  On the other hand, if you had a longer-term investing horizon and were able to stay in the market, all your money would be made back by 2012.  In fact, while about 33% of the years have been down years for stocks since 1930, over that same period of there was only one decade, the 1930s, when stocks were down.

So how do you invest?  Well, you need to figure out your risk tolerance.  Here’s a good way to do that.  Imagine yourself as an investor at the end of 2008.  You’re in the depths of the financial crisis, stocks are down 37%, and pundits are saying we may be on the brink of financial collapse.  What do you do?

Some people like Warren Buffett and Stocky Fox (for important statements I revert to the third person) looked at that as an opportunity to continue to invest in stocks, just now we were buying them at a substantial discount compared to 2007’s prices.  In the end our faith was rewarded and we made a killing.  However, there were some times when the news just kept getting bad and Pepto-Bismol came in extremely handy.

Others felt burned by the 2008 investing bloodbath and pulled their money out of the stock market to put it in safer investments like bonds or cash.  They did so knowing their actions limited their potential for higher returns, but many were willing to accept that if it meant not having to risk their money continuing to disappear into the black hole of the financial crisis.

There’s no right or wrong answer.  You just need to figure out where you’re comfortable and invest accordingly.  If you’re willing to weather the storms then you should probably invest more in stocks.  If you’re more risk averse, then you should probably invest a larger portion of your portfolio in bonds.

Just remember, there’s no such thing as a free lunch.  With higher returns come higher risk.  If you want safer investments, you have to be willing to give up higher returns.

Making money in the Covid market

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It certainly looks like the stock market has recovered from the Covid pandemic.  Sure, some people may say it will crater again in the fall when flu season hits, but I don’t think it will.

The 2020 stock market seems like a movie.  Things started off great and then there was a huge disaster.  When things looked their bleakest, we saw things turn around, and in the end we had a happy ending where things were even better than before.  Star Wars, Harry Potter, Lord of the Rings, and now the 2020 stock market.

Buried in this roller coaster was a tremendous way to make a lot of money in the stock market.  I’m not talking about predicting the future where you had the perfect foresight to sell in February and then buy back on March 23 when things bottomed out.  That’s impossible.

However, I am talking about a tried and true method of investing that we talk about all the time-dollar cost averaging.

Dollar cost averaging during Corona

If you need a quick reminder, dollar cost averaging is taking the money you want to put in the market, and investing equal amounts each week or paycheck or whatever.

For example, let’s assume that you invest $1000 per month ($250 per week).  If you were able to do that and could keep your discipline, you would have made about $1200.  In fact, because of the Corona market crash, you would have made about $900 more than if 2020 had been smooth sailing.  Let me explain:

The S&P 500 started the year 2020 at about 3200, and now it’s at about 3500, a bit less than a 10% increase.  If we lived in a pretend world where the stock market smoothly and steadily increased from 3200 to 3500 over these past eight months, you would have invested $250 each week and would now have about $9300.  That first week you would have gotten so many shares for your $250, and then each subsequent week the stock market would increase, so your overall portfolio would rise in value but the number of additional shares you bought each week would decrease.  But hey, you’re up, so that’s good.

However, what really happened, although much crazier and more stressful ended up being better for you at the end of the day.  We know that that 2020 stock market wasn’t smooth—it increased early on then had a massive, once in a century crash, after which it had about as steep a V-shaped recovery as we’ve ever seen.

If you were investing that same $250 each week, things would have seemed pretty normal the first two months.  However, once March hit the stock market cratered.  The value of your investments plummeted which was bad, but the silver lining was that each month you were buying additional stocks at a much lower price.  That meant you were getting more shares for each $250 you put into the market.

At the depths of the crisis, if you were able to keep your investing discipline, you were buying stock at about 30% off.  Think of it like getting stock from Kolh’s instead of Macy’s; exact same stuff just on sale.  Even after the market started its recovery, you were still able to get stocks at cheaper than you would have in that fantasy, smoothed-out scenario.

If you do all the math, it actually adds up to some pretty decent cheddar.  Through those eight months, at $250 each week, you would have invested a total of $9,000 (36 weeks).  That’s probably not too far off from what you may normally invest in your 401k.

In the smoothed scenario, you would have grown that $9,000 to $9,342, a profit of $342.  That seems pretty good given everything we have gone through so far in 2020.

 Real life CoronaPretend smoothed
Amount invested each week$250$250
Weeks3636
Total amount invested$9000$9000
Investment value at end of August$10,233$9,342
Investment gains$1,233$342

However, in real-life, thanks to dollar cost averaging, you would have grown your $9,000 to $10,233, a profit of $1,233.  Obviously, that’s quite a bit more and it speaks to the power of investing discipline.

When things were their worst, in late March, it was hard, really hard, to keep the faith and continue to put money into the market.  However, like every other time in the modern history of the stock market, if you were able to follow Rudyard’s advice and keep your head, things came around.

Obviously there’s a moral to this story which is Investing is a long term game.  The Corona stock market came and went over the course of a couple months.  Things looked terrible but then they improved.  If you can stay disciplined, the stock market will give you its riches.

The way to save the most black lives

If we as a society truly think Black Lives Matter, then we need to find actionable ways to save the most black lives possible.  Deaths of black people by police number about 200-300 annually.  Even if you assume all of those deaths were preventable, that is only a minute fraction of the lives that could be saved by black men living with their children and the mothers of those children.

SINGLE-PARENT HOUSEHOLDS (SPH) BY RACE

Nationally, about 35% of US households are headed by a single parent.  However, that varies drastically by race.  65% of black households are single-parent, the highest level for any ethnic group.  The group with the lowest percentage of single-parent families is Asian and Pacific Islander.  Whites are at 24%, American Indians are at 53%, and Hispanics are at 41%.

At a very high level, there is a remarkable correlation between single-parent households and other factors like reflect societal success like income, net worth, crime/incarceration, education.

RaceSingle parent households (SPH)% with high school diplomasAverage incomeAverage net worthIncarceration per capita (per 100k)
Asian/PI15%92%$87,194$210,100115
White24%89%$63,179$114,700450
Hispanic41%81%$51,450$21,420831
Native American53%74%Not listedNot listed1,291
Black65%79%$41,361$12,9202,306

The data show an obvious trend—Asians are the best ranked along every dimension, followed by whites, then Hispanics, and finally blacks.

Correlation does not equal causation.  To reach such conclusions would take enormous, expensive surveys.  Even then it might not be possible to tease out all the other important factors and isolate “single parent households”.  The rest of the analysis assumes there is a causation.  You are free to disagree.

INCREASED DEATHS WITH SINGLE-PARENT HOUSEHOLDS

Intuitively it makes sense that the people associated with single-parent households—both the kids, the parent living with the children, and the parent living without the children—are at increased risk.  The biggest culprit is wealth, or lack thereof; single-parent households tend to be poorer and with that comes a myriad of detriments: less healthcare, less nutrition, living in higher crime areas, and many more.

Beyond just the financial component, there are other reasons to think single-parent households increase mortality.  For the kids, there’s obvious value in having two parents.  Kids are less likely to have accidents if two set of eyes are watching instead of one.  Life-skills, especially those taught by a regularly present father may lead to less participation in drugs, crime, and gangs.  Depression and suicidal thoughts would seem easier to address with two parental resources rather than just one.

Much of this would apply for the adults as well.  The reduced stress of having to be “everything” for the parent with the kids would be reduced.  For the parent not with the kids, most often the father, being with his family likely has a positive impact.  He has something more to live for and a loving family to come home to—perhaps he takes better care of himself with diet and exercise, engages in less criminal activity, seeks to improve his professional prospects to support the children he sees every day.  This is all conjecture and would of course need to be supported by data, but it certainly passes the stink test.

Sadly, the research in this area is sparse and not comprehensive.  Also, it is riddled with correlation/causation and other statistical issues.  However, the research that has been done statistically significantly concludes that single-parent households lead to premature deaths . . .  for all involved.  Mortality for children increase by about 40% to 100%, for the parent who lives with the children (typically the mother) by about 50%, and even for the parent not living with the children (typically the father) by about 200%.

Both boys and girls of single-parent families have increased mortality, but this increased mortality is doubled for boys compared to girls.  Suicide is about twice as common for single-parent children, with a greater impact on girls than boys.  Death due to household accidents is about 40% more common for girls and 270% more common for boys.  Death due to addiction is about 400% more common. All really, really sad stuff.

The data also show that the risk among single-parent children, already much higher, is especially deadly for young kids.  Infants and toddlers in single-parent households have about a 100% mortality increase while the older kids have a 30% increase.

Reasonable people can debate the precise statistical impact, but the data seems to clearly show these broad trends:

  • Kids of single-parent households have increased mortality, and it is worse for younger kids and for boys.
  • Both parents associated with single-parent households have increased mortality, and that worse for the fathers/parents not in the household.

ACTUAL LIVES LOST

We can estimate the annual deaths caused by single parent households.  The data is incomplete so we have to make a few assumptions on population size, but those probably don’t have a large impact on the final calculations, and certainly not on the conclusions that single-parent households are leads to thousands of black deaths.  The rest is just math that we learned in 4th grade.

In the United StatesPopulation (millions)Annual death rate (all population)Incremental death rate due to SPHIncremental deaths associated with SPHIncremental deaths reduced by SPH rate for blacks going to US average
Black kids (4 and younger) in SPH2.00.12%0.12%2,4001,292
Black kids (5 and older) in SPH6.30.10%0.03%1,8901,018
Black mothers (age 19-50) associated with SPH6.10.13%0.06%3,6601,970
Black fathers (age 19-50) associated with SPH6.10.23%0.46%28,06015,109
TOTAL   36,01019,390

Applying those increased death rates to the populations of kids, mothers, and fathers associated with single-parent households, we get about 36,000 deaths of black people each year due to single-parent households.  Assuming that black single-parent household rate fell to the US average, (being reduced from 65% to 35%), that still is over 19,000 incremental black deaths.

Most sobering are the kids.  Over 2,300 black kids are dying each year because of greater single-parent households (more than 6 every day).  And this is mostly focused on babies and toddlers.

We all want a better world.  We all want fewer black people dying.  Reforming law enforcement will likely lead to a few reduced black deaths.  Increasing two-parent households will save orders of magnitude more black lives, especially the most precious black lives, the black kids.

Top 5: Silver lining benefits of coronavirus

Just like you, the Fox family has had to hunker down as we go through this crazy time.  I haven’t been able to write a post lately because of a little thing called . . . homeschooling.

Since we’re fully invested, we’ve lost about one third of our net worth, in line with the overall market decline.  In addition to homeschooling we’ve been on pretty much full lockdown in North Carolina.  A bit more trivially, I am missing out on the NCAA tournament which I had tickets to and I’m totally bummed that the NBA season is done since I love watching basketball.

With all that negativity, it’s important that we do try to stay positive and embrace the upsides that might come from all this craziness.  Here are my top 5 investing/financial benefits that could come from the coronavirus experience.

5.  The internet:  Everyone knows the internet is bigger than ginormous, but it has really shined.  With homeschooling I’ve made a lot of lessons by using the limitless free resources other parents and schools have made available online.  The cubs and I do science and geography lessons everyday and youtube is an amazing resource for that.

Foxy Lady and I have been watching shows on Amazon Prime.  Given how much we order off Amazon, Prime would be a given anyway, but with the shows we’re basically getting Netflix-lite for free.  As it is, Prime comes out to about $8 a month which seems a screaming bargain.

Pretty much every public library in the country offers access to download an enormous collection of books for free.  I haven’t bought an actual book in probably 10 years, and I haven’t read a physical book in over a year; I just get any book I want for free on my tablet through my library.

Of course, we knew all this, but I think the pandemic has really highlighted how much is out there and how much is for free.  It’s truly astonishing.  INFLATION KILLER.

4. Online grocery shopping:  When we moved down to Charlotte we were near a Walmart that allowed for online grocery shopping and then you would pick up your order at the store.  It’s not home delivery (I think they were just going to start this before the pandemic hit), but it’s still pretty sweet. 

I love this way of shopping, and Walmart loves it too.  Our grocery bill has actually gone down because we don’t have impulse buys and we don’t buy things we already have (I am terrible with that when it comes to cucumbers for some reason).  Walmart loves it because it cuts down on people they need in the store, theft, damage to merchandise, and a lot more.  Everyone wins.

With all the social distancing, I’d like to see this promoted more.  Think of all the infected people who come shop, touch different stuff, and get others sick.  A grocery store is the most necessary of stores right now so we can’t shut them down, but they are also one that is infecting people the most.  Why can’t states say if you buy online and pick up without going into the store your order won’t be charged sales tax?  That would be a helluva bargain compared to shutting down entire swaths of the economy.

Long-term if more and more people do that, grocery stores can turn into distribution centers that run much leaner—less space, less people needed.  They save money and pass that on to us.

3.  Euthanizing zombie retail:  The pandemic will bankrupt a lot of companies.  Broadly, that’s a sad thing, since some of those are going to be good companies that just got swept up in this tsunami.

But there are a lot of companies that will go under that should go under.  They are crappy companies with crappy business models selling something that customers don’t want.  Go to a local mall and you’ll see a ton of them.  Right now they’re dying a slow death and the chances of them making it are zero.

This business cycle will “put them down” and free up that space, those workers, that capital to be used on businesses that do make sense and can work. 

2. Changing teaching:  Schools closings have forced us to use a completely new paradigm for teaching our students.  Actually, the approach to teaching has largely been unchanged for a couple thousand years—students go to a school, listen to a teacher who stands in the front of the room, and there you go.

Sure, in my lifetime, technology has made some inroads, but compared to other industries the impact has been pretty muted.  Look at the role technology plays in your kid’s classroom (pre-virus) compared to the role it played when we were kids.  Now look at how technology has totally transformed other industries—purchasing airline tickets, watching movies at home, consuming breaking news, listening to music, trading stocks, looking up any possible bit of information you’d ever want to know, and on and on.

I’m not saying schools in their current form should be abolished, but there is absolutely a compelling case to make major change.  Should there be more home learning?  Better distance interaction (see #1)?  I don’t know the exact answer, but I do know that this experience will show that there is a ton of opportunity for improvement—better educational outcomes costing less money.  Like always, those that drive that improvement will make tons (the US spends about $700 billion on education).

1. Video-conferencing:  As I mentioned here, I think there is a ton of potential for video-conferencing to really transform the world in a positive way.  Most of corporate America has been told to stay home and telecommute.  We still have meetings, still need to interact with people, and still need to get business done.  Now we just need to do it remotely instead of face to face.

This is the major opportunity for video conferencing.  Right now the technology is kludgy.  It’s no where close to what is necessary to make it a seamless substitute for those in-person meetings.  A few of my nerd friends and I got together for some Dungeons and Dragons action, and it was not ideal (I’d give it a C-).

However, once the technology comes in the demand seems unlimited.  It will create so much value (think about not having to take a two hour, $500 flight for a 60-minute meeting).  It will also make collaboration SO MUCH more productive.  I said this could be a trillion dollar opportunity, and now in the teeth of coronavirus, I think I might have underestimated it by 2-3x.

So there you have it.  It sucks what we’re all going through, but we will get through it as a society, no question.  More specifically, as investors we’ll come out of this stronger than before; I absolutely believe that.  

How much stock should you have in the company you work for?

Retirement-Planning2

A common question investors have is “How much of my investments should be in my company’s stock?”  Many of us work for publicly traded companies (Stocky worked for Medtronic and Foxy Lady used to work for VF).  Many of those companies include stock as a significant part of their employees’ compensation.  So what is an omnivore to do?  The short answer is: Don’t invest a lot in your employer.

It adds up

The general thinking among companies is that it’s good for their employees to own company stock.  It motivates them to work hard, so then the company does better, which then raises the stock, and that finally makes the employee richer.  See everyone wins.

My sense is that before 2000 compensation in the form of stock was much more prevalent.  I can speak to my experience at Medtronic:  The default for your 401k investments was Medtronic stock.  When they did the 401k match, the match was in Medtronic stock.  They also have a program where you can buy Medtronic stock at a 15% discount compared to the market price.  You had the option to take your bonus in cash or get a larger bonus in Medtronic stock options.  Long-term incentives are given in stock and options.  High performers can get awards of stock or options.

What difference can you really make?

The company wants you to do it because collectively if a lot of their employees own stock, they are probably motivated to do better.  But as an individual, what difference can you really make?  I know that sounds anathema, like when people say they don’t vote because one vote doesn’t make a difference (I do vote in every election, but the way).

Let’s think about that for a minute.  Stocky worked at Medtronic, a company which has about 50,000 employees and earns $20 billion each year.  Actually, I think I did really good work, and let’s imagine that because I worked my furry little tail off, I was able to develop programs that led to an extra $2 million in sales.  That’s a lot actually (I think I might have been underpaid), but compared to the bigger picture, that such a tiny drop in the bucket that it wouldn’t affect Medtronic stock in any possible way.

On the other hand, if I bust my tail and work hard, my bosses will see that and I’ll get a raise and a promotion.  That’s where the real upside for me is.  Not in the impact on the stock.  I’m sorry to say that, but it’s true.  The payoff in owning stock (compared to owning a diversified mutual fund) just isn’t there.  But the downside is very real if things don’t go well (more on this in a second).

Since Medtronic is a really huge company, maybe an individual can’t make much of a difference.  But wouldn’t an individual employee be able to have a bigger impact on the company’s stock if they were at a smaller company?  Maybe it makes sense for people in smaller companies to own more of their company stock for that reason.

The logic is sound—certainly if you work at a smaller company your individual contributions will have an outsized impact.  But the negative is that your risk goes up as well.  Larger companies tend to have greater margins for error when things go bad.  If you’re in a smaller company, the risk of bankruptcy or some other catastrophic event with the stock is so much higher.  And remember, as an investor you’re looking to lower risk not raise it.  So with all this I don’t the think argument for an individual to be a shareowner so they can drive the stock upwards holds a lot of weight, especially when you compare it to the downside.

What happened to loyalty?

If you own a lot of your employer’s stock, you’re violating the first rule of diversification.  The whole point of diversification is to make sure that one company or one sector or one “something” can’t hurt you too much if everything goes to hell.  Think about that with your own company.  The single most valuable “financial asset” you have is probably your career and the future earnings that go with that.

Now imagine that something goes terribly wrong with your company (a product recall, losing a lawsuit, missing the boat on a market trend, etc.).  If you’re an employee that sucks because you’ll probably get smaller bonuses and raises; at the extreme you might get let go.  If you’re a shareholder that sucks because the value of your stock will go down.  If you’re an employee and a stockholder you get the double whammy.  That is what diversification is trying to save you from.

But wait a minute.  I can hear some people say stuff about loyalty and having faith in your company and putting your money where your mouth is.  To that I say “hooey”.  If you’re working hard every day to help your company succeed, isn’t that loyalty and faith?

Remember that your portfolio is ultimately meant to support you in your life’s goals.  For most of us that probably means securing a comfortable retirement.

Just to put things in perspective, every year a few stocks that get removed from the S&P 500 because of “insufficient market capitalization”.  That is French for “the stock went down so much the company wasn’t considered S&P 500 material any more.”  7 stocks out of 500 doesn’t seem like a lot but that’s about 1.5% of the entire index.  And remember that the S&P 500 as a whole was up 29%!!!  That was an awesome year for the entire index, yet still 7 companies couldn’t make the cut.  Imagine what would happen in an average year or even a bad year.

Let’s think about the fate of the employees at those companies for a second.  Being kicked off the S&P 500 is a bit of a slap in the face so you know things at the company aren’t good.  There’s probably a lot of things happening like stores closing, people being laid off, salaries being frozen, moratoriums of new hiring so the existing employees have to work more.  Just a bunch of bad stuff, right?  So if you’re working there life probably isn’t awesome, and the idea of polishing up your resume is probably pretty top-of-mind.

Now imagine all that is happening while a big portion of your portfolio is taking a dive (remember, these companies got booted off the S&P 500 because their stocks went too low).  Ouch.  That is definitely rubbing salt in the wound.  In the investing world managing risk, and minimizing it where you can without impacting your return, is super-duper important.  When you own a lot of stock in your company, you’re just taking on unnecessary risk.

So there we are.  There’s definitely some romantic notion of owning stock in the company you work for.  It seems like the right thing to do.  But you’re just taking on risk needlessly.  My advice is that you should really keep that to the absolute minimum.  In the Fox household, we sell the Medtronic stock when we can.  It’s not that we don’t think it’s a great company (it is) or we don’t have faith in its future prospects (we do).  It’s just we don’t want to bear the risk that something really bad could go down, leading to me possibly losing my job just as your portfolio is doing a belly flop.

How much of your portfolio is of your company stock?

Should you invest in gold?

Long before there were ever stocks or bonds, the original investment was gold.  Heck, even before there was paper currency or even coins, gold was the original “money”. 

That begs the question, What role should gold have in your portfolio?  If you don’t want to read to the end, my quick answer is “None”.  However, if you want to have a bit of a better answer, let’s dig in.

Gold as an investment

Just like stocks and bonds, gold is an investment.  The idea is to buy it and have it increase in value.  Makes sense.  And historically, it seems to have been a good one—back in 1950 an ounce of gold was worth about $375 and today it’s worth about $1300.  Not bad (or is it???).

However, there is a major difference between gold (and broadly commodities) as an investment compared to stocks and bonds.  Gold is a store of value.  If you buy gold it doesn’t “do” anything.  It just sits in a vault collecting dust until you sell it to someone else.

That’s very different from stocks and bonds.  When you buy a stock that money “does” something.  It builds a factory that produces stuff or it buys a car that delivers goods or on and on.  What ever it is, it’s creating something of value, making the pie bigger.  That is a huge difference compared to gold, and it’s a huge advantage that stocks and bonds have over gold.  You actually see that play out by looking at the long-term investment performance of gold versus stocks.

Golden diversification

Statistically speaking, gold gives an investor more diversification than probably any other asset.  We all know that diversification is a good thing, so this means that gold is a great investment, right?

Well, not really.  Stick with me on this one.  Gold is negatively correlated with stocks (for you fellow statistics nerds, the correlation is about -0.12).  Basically, that means when stocks go up gold tends to go down, and when stocks go down gold tends to go up. 

Over the short term, that’s probably a pretty good thing, especially if you want to make sure that your investments don’t tank.  In fact, that’s one of the reasons gold is sometimes called “portfolio insurance”.  It helps protect the value of your portfolio if stocks start falling, since gold tends to go up when stocks go down.

However, over the long-term, that’s super counter-productive.  We all know that over longer periods of time, stocks have a very strong upward trend.  If gold is negatively correlated with stocks, and if over the long-term stocks nearly always go up, then that means that over the long-term gold nearly always goes (wait for it) . . . down.

That doesn’t seem right, but the data is solid.  Look back to 1950: an ounce of gold cost $375.  About 70 years later, in 2019, it’s about $1300.  That’s an increase of about 250% which might seem pretty good, but over 70 years that’s actually pretty bad, about 1.8% per year.

Contrast that with stocks.  Back in 1950 the S&P 500 started at 17, and today it’s at about 2900.  That’s an increase of about 17,000%, or about 7.7% per year.  WOW!!!

Just to add salt in the wound, inflation (it pains me to say since I think the data is suspect) was about 3.5% since 1950.  Put all that together, and gold has actually lost purchasing power since 1950.  Yikes!!!

A matter of faith

Fundamentally, if you have faith that the world will continue to operate with some sense of order, then gold isn’t a very good investment.  So long as people accept those green pieces of paper you call dollars in exchange for goods and services and our laws continue to work, gold is just a shiny yellow metal.

However, if society unravels, then gold becomes the universal currency.  The 1930s (Great Depression), the 1970s (OPEC shock), and 2008 (Great Recession) were all periods where gold experienced huge price increases.  Those are also when the viability of the financial world order were in question.  Each time, people were actively questioning if capitalism and banks and the general financial ecosystem worked. 

People got all worked up and thought we were on the brink of oblivion.  Gold became a “safe haven”. People knew no matter what happened, that shiny yellow metal would be worth something.  They didn’t necessarily believe that about pieces of paper called dollars, euros, and yuans.

Yet, the world order hasn’t crumbled.  Fiat currencies are still worth something.  Laws still work, so that stock you own means that 1/1,000,000 of that factory and all it’s input belongs to you.  Hence, gold remains just a shiny, yellow metal.  

The bottom line is that stocks have been a great long-term investment, and gold hasn’t.  And that’s directly tied to the world maintaining a sense of order.  So long as you think that world order is durable and we’re not going to descend into anarchy Walking-Dead style, then gold isn’t going to be a good investment.

So the survey says: “Stay away from gold as an investment in your portfolio.”

Putting a bow on December 2018

The new year is a great time to take account of things in life.  We look at the year just ended, reflect on our successes and failures, decide how this year will be better, make our resolutions, and take on the new year.

I was all prepared to write a few posts on all that, but then the tidal wave that was December 2018 hit.  I posted last week right at its depths, but even the craziness of the last few days of the year require, neh demand, its own post.  So let’s put a bow on that crazy month.

As bad as it was . . .

I posted last Monday, Christmas Eve, that with a bit over a week to go, December 2018 had already become the 4th worst month in the 69-year history of the S&P 500.  Going into that trading day, we were down 12% for the month, and then in an act worthy of Old Testament God, the market plunged that day another 3%.  Just in time for the holiday.  Thanks a lot.

It was bad and we were in the teeth of an all-time bad stock market plunge.  If you think of it as the 4th worst (or 3rd worst after that Monday) month in almost 70 years, you’d expect something like this once every 25 years or so.  That’s a generational storm.  Batten down the hatches.

. . . and how it ended

But there’s a reason that December ends after the 31st day and not the 24th day.  The day after Christmas (obviously markets were closed for Christmas), the markets increased 5% which is a crazy high amount.

Before we look at the larger picture, let’s just reflect on December 26 for a second.  It was the largest point gain day for both the S&P 500 and the Dow Jones Industrial Average.  Also, it was the 18th largest percentage increase for the S&P—top 18 out of over 17,000 trading days since 1950.  Not bad.

Back to the story, so Wednesday there was a big recovery but we were still down a lot.  But the market kept chugging along each day, and it ended the month up 7% for the lows on Christmas Eve.  Let’s not fool ourselves.  It was still down 9% for the month, but compared to where we were as Santa was loading up the sleigh, that’s not that bad.

In fact, while there’s no doubt that December 2018 was a bad month, it didn’t even rank in the Top 10 worst months of all time (it was at 11).  Not that that should make you feel good, but we were thinking we were being hit with a generational storm, and it ended up being an every 5 or 6-year storm.  Those things happen.

The stock market is a very complex human experiment, but in a lot of ways it’s very simple.  I think the crazy roller coaster ride in the month of December (and more broadly all of 2018) really illustrates this.  Things are never as bad as they seem, and the best strategy is usually to just sit tight and let the craziness work its way out of the system.

I hope everyone has a wonderful Christmas and New Year.  Next up you’ll see how the Fox family did on their investments including the wins and losses, so makes sure you have a box of tissues.