Category Archives: Investing

Unicorns Hiding From Index Funds

We are going to change subjects a little bit today and discuss unicorns instead of financial independence. Now by unicorn I don’t mean the mythical horse-like creature with a horn on its head, I mean the startup companies, which are usually in the technology industry, and reach billion dollar valuations in just a few short years.

Back in 1997 a little company known as Amazon was looking for some capital and was ready to expand. So they did what every other company did when it got to this point, it tapped the public equity markets. It had an IPO (initial public offering) and raised $54 million, and after its IPO its valuation grew to $438 million. IPOs give a company capital through selling equity shares, which they use to invest back into the company, and also give shareholders of the company an easy way to “cash-out” and liquidate their investments, and at (hopefully) a decent price. When 99.99% of your net worth is tied up in a tech company you founded, it may be a good idea to sell at least a few shares to diversify a little, wouldn’t you think?

Let’s fast forward to December of 2015. Amazon now has a market cap of $315 billion (yes billion with a “b”). What this means is if you invested $10,000 in Amazon’s IPO in 1997, you would have approximately $4.4 million today (according to Business Insider). For the many index investors in this community, this type of unicorn is a great thing. By investing in total stock market index funds we unfortunately invest in some companies which go bankrupt (luckily the most you can lose is your investment), but at the same time we’re able to ride these unicorns which appreciate our original investment exponentially and in essence wipe out the losses of the companies which go belly up.

But something structurally has changed in the past few years in the way which companies seek to raise capital. Unicorns today don’t act like Amazon. A couple unicorns that come to mind are Uber which has a current valuation of over $50 billion and Airbnb which has a current valuation over $25 billion. Unlike Amazon, we have been unable to ride these unicorns since they didn’t seek our money as an investment through an IPO, but rather tapped the venture capital and private equity markets, which are extremely tough for people without seven plus figure net worths to invest in.

There are a few reasons why these technology companies have not IPO’d like similar companies have in the past, which I have outlined below:

  1. Today, companies are getting venture capital and private equity investments at some pretty high valuations, which back in the 90’s was much more possible through an IPO. These venture capital and private equity markets weren’t as lush as they are today.
  2. There is less regulation for non-public companies. No quarterly reporting requirements, less compliance, no SEC or PCAOB regulation, and less investors and analysts to answer to.
  3. There is less public scrutiny over your business when you aren’t public. Public companies get beat up pretty hard in the public eye. Miss one quarter’s earnings target and the media acts like you’re going under. When the only people seeing your financial results are a few investment firms, it becomes easier to manage expectations.

Now you’re probably asking – so what FF? What does this actually mean? That’s a good question. Could it mean smaller returns for equity index fund returns? Maybe. Could venture capital and private equity money dry up and growing companies start tapping the public equity markets again and find their way into our index funds? Maybe. Could it mean absolutely nothing? Maybe.

If Uber or Airbnb do IPO someday, they’ll be doing it with valuations over $25 billion and not $438 million like Amazon did in 1997. Therefore when our index funds buy these companies’ shares when they IPO, the potential ride higher has definitely been cut short due to how late in the game they are IPOing. I guess for the time being I’ll sulk a little knowing unicorns are hiding from my index funds, but at the same time I notice they may come back in the future.

Have you tried investing in venture capital or private equity? Does it even matter to an index fund investing strategy that companies like Uber or Airbnb are choosing to tap private equity / venture capital markets instead of IPOing?

HSA Investments

For those who follow Mad FIentist know that the Health Savings Account (“HSA”) is “The Ultimate Retirement Account.” I had an old HSA from a previous employer just sitting in an account for years. It would earn a few cents of interest per month and then I’d have to pay a $3 maintenance fee every month since I was no longer employed by the company.

Effective January 1st of this year I signed up for my current employer’s HSA. Luckily my employer covers the monthly maintenance fee and also contributes $500 annually to my account, spread over my 26 paychecks a year. The 2015 IRS limit on contributions to a single filer’s HSA is $3,350 and employer contributions count towards this limit. I decided to contribute $100 a paycheck or $2,600 a year which would get my total contribution to $3,100 during 2015, including the employer contribution. I guess I’m short changing myself $250 of tax-free income but I won’t lose sleep over it. Maybe I’ll contact HR and try to max this account out in December.

After my new HSA was all set up, I rolled over my HSA monies from my old account to consolidate the two and eliminate the old maintenance fee.

I was on my Personal Capital account last week and noticed my HSA account was over $3,000, yippee! I had read other bloggers mention you can invest a portion of the balance in most HSA plans, so I logged onto my HSA account to explore my options. Right on the home page there was a button for “HSA Investments.” After some clicking around I noticed I could invest any excess monies over a limit I set, into the offered mutual funds. Basically they asked me how much cash I want to maintain in my HSA account and they would invest the rest into a mutual fund of my choosing with no transaction costs. My three options of amounts to leave in cash were $1,000, $2,000, or $3,000. It auto-filled $2,000 as my choice, so I thought that would be fine for now. I may adjust to $1,000 in the future, but my deductible is in the $2,000 to $3,000 range so I figured $2,000 would be a nice safety net if I ever needed the cash. I also have an emergency fund that could cover unexpected health costs, so I probably will eventually set the cash amount to $1,000.

After I selected to leave $2,000 in cash, I clicked continue to peruse my mutual fund options. I’ve been pretty spoiled with my employer’s great Vanguard 401k plan, so I was very disappointed at my options for my HSA. I thought I’d just invest 100% in a target 2050 fund since I like to keep things simple and it would be a majority equities which I want, but low and behold the expense ratio was approximately 0.72%! What’s up with that crap!?!? I’ve been spoiled with extremely low Vanguard expense ratios I suppose. Recently I got a notice from HR that my Vanguard Total Stock Market mutual fund’s expense ratio was reduced from 0.04% to 0.02% in my 401k plan. That’s only 2 basis points a year in expenses!

So I proposed a question on Twitter to see what other personal finance bloggers had their HSA monies invested in. Lifestyle Accountant came to the rescue and noted an S&P 500 fund with a 0.25% expense ratio which my HSA plan offered. It’s a far cry from my 0.02% expense ratio mentioned above, but I guess I have to take it.

I reached out to the HSA custodian and they told me what is offered is what is offered, and no other funds can be invested in. So then I sent a message to my HR, and they elevated my request to the “appropriate expert” but I haven’t heard anything back yet.

Vanguard also weighed in on the subject:

asd

Does your employer offer an HSA? Do you invest part of your balance? If so, are your mutual fund options somewhat decent?

Asset Allocation – Part One

I’ve been thinking a lot lately about asset allocation. I know… I’m a wild and crazy guy. This financial independence community agrees on many things including cutting expenses, increasing income, reduction of taxes, and usually on some type of method for accessing capital (i.e. safe withdrawal rate). One thing I’ve noticed is the disparity in the community among the proper asset allocation.

There are many blogs focusing on different methods to achieve financial independence. One size definitely does not fit all. There are paths to financial independence through real estate investing, dividend investing, low cost index funds, etc.

One of the crowd favorites Mr. Money Mustache utilizes real estate and diversified low cost index funds. Dividend Mantra goes the individual dividend growth stock route and recently published a book. Go Curry Cracker and jlcollinsnh keep it simple with low cost index funds.

There are many ways to get to the goal, but no one has the answer of the best way to get there. This is because there is no best way. I have debated with myself over and over again the best way to achieve my goal of achieving financial independence. Do I buy a bunch of diversified dividend growth stocks? Do I buy rental real estate? Do I buy low cost index funds? I won’t lie, those questions played on repeat for a while.

In the past year, I have definitely settled on the low cost index fund method of getting there. The more I keep it simple, the less I have to stress about which is important to me emotionally. I still have some individual stocks that I have picked up over the years. I check my brokerage account daily, sometimes multiple times to see how my little portfolio is doing. If I stress about it that much now, who knows how bad I’d be in 10 years when I’d have a significant chunk of change in individual stocks in my brokerage account. Like I described in my last post, people like Mr. Money Mustache, jlcollinsnh, Rick Ferri, Jack Bogle, etc. have shown me that low cost index funds are definitely the way to go for me personally.

I also would love to add real estate to my assets (physical real estate, not REITs) but my current situation does not lend itself to being the right time to get involved in this investment arena. I’m quite handy and wouldn’t mind having one or two investment properties churning some passive income my way in the future, but not right now.

Are you planning on achieving financial independence through real estate, index funds, or dividend stock investing? How did you decide on your method? Does emotions play a part, in addition to the numbers?

Savings Waterfall

I always joke around with my friends that although I’m 27, on the inside I’m much older. I’ve been hearing about this reddit thing for a while now. One of my previous roommates would always peruse it and giggle to himself, so I thought it was just funny posts and memes. The other day I followed a link on Twitter to reddit. It was a story about a 22 year old who was making $100k a year and couldn’t figure out why he was in debt and living paycheck to paycheck. Of course there were some pretty harsh comments, but for the most part everyone was giving him sound financial advice such as use Mint to track your expenses, trim the fat, pay down the debt, etc. I was quite impressed with the help these complete strangers were giving this guy who bared all to get his financial house in order.

After reading this feed of strangers helping a individual get his financial life in order, I decided to poke around reddit some more… and then I was hooked. My favorite subreddits are obviously r/personalfinance and r/financialindepedence. I highly recommend taking a spin through both of them. While doing so I found that Justin at Root of Good and Mr. Frugalwoods are avid commenters.

What I found great about reddit is that the posts and comments get voted up and down by other users, so by natural selection the “better” posts and comments float to the top of the page.

One of the great takeaways I got from binge reading reddit was this great savings waterfall. I think it is great and an easy introduction to those new to personal finance.
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So I decided to walk through the waterfall and see how I tracked against the recommendation.

  1. Emergency fund – I currently have 3 to 6 months of expenses in a liquid online savings account yielding 0.99% APY. Check!
  2. Contribute to 401k up to company match – My contribution percentage will ensure I max out my 401k in 2015, therefore I definitely get the full employer match. Check again!
  3. Pay down high interest debt – The only debt I currently have is student loan debt at 3%. I’ve paid off all my student loans that were 4% and higher, so I consider this a win as well since I am choosing to milk this lower interest rate and pad my investments.
  4. Max out IRA – I will max out my Roth IRA this year. I kind of broke the path of the waterfall since I contributed to my 401k more than required to get the match before opening an IRA. I did this for two reasons, first my 401k plan through work only charges a $40 annual administrator fee whether you have $1 in it of $1 million, and second the plan is with Vanguard. Most people like to open an IRA before maxing out their 401k for more investment options and cheaper fees, but it was a wash for me.
  5. Max out 401k – Check! This will be the first year I do it though… better late than never!
  6. After-tax savings/investments – I definitely broke this rule of the waterfall. When I turned 18 I started a brokerage account and would buy some individual stocks from time to time up until recently. Now that I have become a self proclaimed Boglehead* I don’t plan on contributing to this account anymore. I will contribute any monies left after maxing out my retirement accounts to my Vanguard account and stick to low fee Vanguard index funds. If jlcollinsnh didn’t convince me before, reddit, Bogleheads, and a podcast interview with Rick Ferri** did. I don’t know if I’ll divest from all my individual stocks, but no new capital will be deployed to them going forward.

Do you enjoy the personal finance and financial independence community on reddit? What do you think of the savings waterfall? Do you follow the steps?

* – A Boglehead is a term intended to honor Vanguard founder and investor advocate John Bogle, and are investing enthusiasts who participate in the Bogleheads Forum.
** – Here is the Masters in Business podcast episode where Barry Ritholtz interviews Boglehead Rick Ferri. I highly recommend it.

My Millionaire To-Do List!

J. Money over at Budgets are Sexy has a Millionaire Dollar Club that currently has 153 pledges. Well I plan on being number 154! The only requirements to be in the club are that I create a millionaire to-do list that is realistic and that I check back every so often on it to make sure I’m on track. I’ve broadly discussed my savings goals in other posts, but it will be nice to get them here as I continue my journey to the double comma club! Here are my goals that I plan on achieving every year:

1. Max out my pre-tax 401k – This one is a no-brainer in the personal finance community. My current biweekly payroll 401k contribution rate should get this done during the month of November this year.

2. Max out my Roth IRA – I’ve already maxed out my 2014 Roth IRA during 2015 (since you have until April 15th of the following year) and it only took me three months. So now I’m onto my 2015 Roth IRA which I plan to max out as well.

3. Max out my HSA – My current biweekly payroll HSA contribution should get me close. Luckily my employer also contributes $500 to my HSA (which counts towards the employee contribution limit).

4. Pay off my student loans – I have less than $9k left, and the interest rate is only at 3%. I’m going to concentrate on funding my retirement accounts first, and worry about these later.

5. Never finance a car again – I currently do not even own a car, as I live in NYC. So I count that as a win for me! But I do know I won’t live in the city forever, so there will come a point in time where I will need to purchase a car again. And it will be a used car with cold hard cash!

6. Save at least 75% of every raise and bonus – I make quite a bit more now than I did fresh out of college, but I have tried not to let my spending increase as well. I do not subscribe to lifestyle inflation, and that has helped me funnel most of my raises and bonuses into retirement savings and the pay down of debt.

7. Once all tax advantaged accounts are maxed out for the year, begin funneling all savings into my after-tax brokerage account – I hope I run into this problem A LOT. I have an internal debate brewing right now about whether I should go the dividend producing portfolio route such as Dividend Mantra or go the more conservative, commonly accepted method of just dumping this money into Vanguard Total Stock Market index fund (but this debate is for another time).

Well there is my short, very attainable to-do list to become a millionaire. I’ve run the numbers and I should be able to get there by 40 if I stay in the same industry and career trajectory. This is a conservative estimate and if I can reach it any earlier, then SHABOOM!

Are you part of the Millionaire Club? If so, what are some of your more important goals to get there?

From WWII Vet and Janitor to Millionaire

I wasn’t planning on posting today, but I stumbled across this article on CNN* and had to share: Vermont man known for frugal ways donates millions.

Ronald Read of Vermont was a World War II veteran, gas station attendant, and janitor known for his frugal ways. He passed away last summer at the age of 92 and left his local library $1.2m, the hospital $4.8m, and friends and family the rest of his approximately $8m fortune.

Of course we don’t know everything about Mr. Read, but one can assume he did very well for himself over his 92 years, although it appears he never had a “high income” profession. According to the article he was extremely frugal and loved investing, specifically in dividend producing stocks.

I did some simple math and it appears he was born in 1922. Even if he began investing at age 30 in 1952, the S&P 500’s average return including dividends was 12.41% through 2014. That means Mr. Read’s money using the Rule of 72 would have doubled every 5.7 years for a total of over 10 times during his 62 years of investing!

If this doesn’t light a fire under your frugal, investing butts, I don’t know what does!

-FF

* I also referenced this article: Janitor bequeaths millions to library, hospital

Buffett vs. Hedge Funds

Years ago I had heard about a bet Warren Buffett made in 2007, and then on Tuesday Fortune wrote a follow-up article Warren Buffett adds to his lead in $1 million hedge-fund bet.

In 2007, Buffett made a wager with Ted Seides*, Co-founder, Co-CIO, and President of Protégé Partners, LLC, that the S&P 500 would outperform a collective group of five funds of hedge funds picked by Seides over a 10 year period.

The specific S&P 500 index fund Buffett picked was the Vanguard 500 Index Fund Admiral Shares (VFIAX). The names of the funds of hedge funds picked by Seides have not been published, most likely to conceal the fund managers’ embarrassment as VFIAX has gained 63.5% for the seven years since the initial wager compared to the collective 19.6% return (estimate as 2014 final figures were not available when the article was published) of Seides funds he selected.

The wager is now invested in Berkshire Hathaway B-shares worth $1.7 million dollars. Buffett is just doing what Buffett does best, winning. And if he does win, Girls Inc. of Omaha will be the lucky recipient of the wager.

I know that it is only seven years into a 10 year bet, but the selected funds have A LOT of ground to make up. Also, for those who think they can beat the market, here is another reason you will probably lose that battle.

Chalk one up for the the passive index investors!

-FF

* For those thinking “who is this Ted Seides character?” He is a graduate of Yale and Harvard, has his CFA, and co-founded Protégé Partners in 2002. I wonder if some of his investors ever wished they had just bought an index fund?

Rich Uncle Pennybags

I received my favorite gift ever for Christmas when I was 8 years old, when my uncle gave me the board game Monopoly. I had always known from a young age that money was important, as I noticed to buy and have “things” you needed money. I asked lots of questions when I was young so even at this point I understood why people needed to work, and that the house, food, cars, etc., cost money. Monopoly is a great learning tool for children as it teaches the concept of owning vs. renting, banks, money, trading, commerce, bankruptcy, and simple addition and multiplication. There were no credit cards in Monopoly, so I understood if you didn’t have the money for it you couldn’t buy anything (a concept which unfortunately many adults struggle with). I was mesmerized from the start and it helped paint a picture for me of finance and money at a young age, that probably would have been hard to do otherwise.

Until 5th grade, Monopoly was my only view into business, finance, and money, other than things I would learn from my family (of which have no business or finance education). But then in 5th grade we played a stock market game that in all honesty had a huge impact on me. I was hooked from the start. The fact you could buy shares in a business for sometimes a few dollars blew my mind. I could actually own a piece of McDonald’s!

But then there was a huge void in the education about anything related to personal finance and money. I took classes like economics and statistics in high school, and they offered accounting classes which I did not take, but they taught the basic accounting of debits and credits. But if I actually wanted to learn anything about investing or what a CD was, then I had to look it up online and teach myself. I declared as a Finance major before I even got to college as all of this was still very interesting to me, plus I felt there was so much for me to still learn (plus the stereotype that finance guys made the big bucks!). Luckily a professor who took interest in my college career persuaded me to go the accounting route, as I graduated when jobs were scarce and many of the finance majors couldn’t land jobs right out of school, I at least had a job even if it wasn’t in something I was all that passionate about.

So there I was, 21 years old in the work force, with a Bachelor’s degree from a business school and still had NO idea about money and personal finance. I thought I was doing great! I had a brokerage account where I traded stocks (traded not invested), had a car payment, was saving for retirement, all while chipping away at my student loans. But looking back now I just thought I was doing great, when in actuality I was far from it (at least the “me” five years later thinks so).

What scares me is that for someone who had always been interested in investing and personal finance, and had a degree from a business school, I really didn’t understand money and personal finance. Therefore I worry for other people who go through life and don’t take the time to educate themselves about personal finance. Many people think that everyone else has a car loan, a mortgage, and some student loans that they’ll be paying for most of their lives so it must be “right.” Or Bob who sits in the cube next to me contributes 5% of his pay to his 401k, and I contribute 6% so I must be GOLDEN and right on pace to retire at 55!

That’s exactly the problem with personal finance education, no one is ever taught it! Most people learn from family, friends, or coworkers who are most likely even more clueless than they are! I understand everyone’s situations are different, and people have different wants and needs, but even the basics would help. Sex-ed is was taught (awkwardly of course) in 6th grade, and again in more detail in 9th grade. Why isn’t Intro to Personal Finance taught at the high school level as a mandatory education requirement? And I’m just talking the basics such as what is a credit card, mortgage, 401k, CD, etc. Usually kids are first subjected to credit cards when they arrive on a college campus (if they go to college) and are approached by bank and credit card company reps with free t-shirts.

Yes I still have one (from said reps) and it is pink and says "COLLEGE" across the chest.

Yes I still have one (from said reps) and it is pink and says “COLLEGE” across the chest. Luckily I did NOT rack up credit card debt as a result.

So you’re saying if I buy something now, you’ll bill me in a month, and I don’t even have to pay the full balance!?!?

As you can see by my enthusiasm on the topic, this is a subject that really frustrates me as I see people squandering their hard earned money away due to ignorance on the subject. People are raised thinking money is a taboo subject and you’re supposed to learn as you go. I think this needs to be challenged and changed, and personal finance needs to be taught at a young age. Luckily my parents were very open about their finances growing up so I at least at something to base my understanding off of. But unfortunately not everyone is as lucky, or willing to put in the time to ask questions, research, and take responsibility for their own personal finances.

-FF