Wednesday, January 12, 2011

Formula 51

Random finance notes:

While I was in home-hunting mode, I stopped investing in my long-term stock funds. I wanted to hold on to as much cash as I could for maximum flexibility, plus I knew that being cash-heavy would make me more attractive to lenders.

(Note: "Cash" here means "Funds that I kept in an online savings account where it could be readily accessed." I didn't keep my down payment in 20 dollar bills.)

That proved to be a pretty good move, and because I ended up buying a condo for quite a bit less than my maximum, plus I'd been hoarding my savings, I wound up with a bit of a kitty to put back into the market. I decided this would be a great time to revisit my personal financial plan.

I'm lucky enough to be able to max out my tax-advantaged savings. I put the most that I can into my 401(k), and am doing some slightly slippery stuff this year to contribute to a Roth RIA. My 401(k) has good, not great, investment choices. There's a selection of about 20 funds. For general stock exposure, the best choice I have is a Vanguard S&P 500 index fund. I'd be much happier with a total stock market index that would give me more exposure to mid-cap and small-cap companies, but compared to the alternatives, I like this index fund. I put 80% towards that. 20% goes towards an international stock fund - not indexed, sadly, but with relatively low costs.

Since I have much more control over the Roth, I can pick the exact fund I want, which, oddly, is much simpler than the 401(k) - here I'm dumping everything into one of Vanguard's excellent Target Retirement funds, which holds an automatically-readjusting pool of stock and bond index funds.

So, since I have a little extra money to invest, I've been trying to think through what to do with it. Back before I suspended payments to save for the condo, I was dumping everything into a Vanguard Total Stock Market Index Fund. I love this fund - it gives full exposure to the entire US economy, has a super-low overhead, and negligible distributions for capital gains. Still, while it is diversified across companies, it still is hardly a diversified portfolio.

Relying mainly on the excellent advice I've gotten from Jane Bryant Quinn and other "less is more" gurus, I decided on the following ideal breakdown:
60% to the Total Stock Market
20% to the Total International Stock Index
20% to "bond funds" (more on this later)

(Side note: all of this is above and beyond my standing short-term emergency fund, which remains mainly at Ally Bank's online savings account, with a bit in my regular checking account.)

A good rule of thumb that I keep hearing is that the ideal amount of your portfolio to have in stocks is to take 110 and subtract your current age; the remainder is the percentage to hold with stocks. I hear conflicting advice about the amount to hold in international holdings. Traditionally the advice has been to keep about 20% there; international is good because it often moves differently from the US stock market and so provides balance and diversification, but it's also more sensitive to currency fluctuations, and foreign markets often are not as well-regulated and investor-friendly as the US stock market (and that's pretty frightening!). However, it seems clear that the next century will see a waning of US hegemony, and most growth will come from developing nations. 30% is now a much more common target, and I've seen people suggest as high as 50%. I decided, as a compromise of sorts, to stick to 20% of my TOTAL (not just stock) allocation into international; this works out to 25% of my stock section of my portfolio, a nice compromise between 20% and 30%.

I've been avoiding bonds for my whole life, and I still can't make myself buy them. I totally understand the safety that they bring to a portfolio, but I'm pretty terrified by the bond market right now... rates are as low as they can physically go, so there's no direction for them to move but up. Once they DO rise, then the value of all bonds sold now and for the last three years will plummet; and, if you hold them to maturity, you'll be missing out on much better rates. When Warren Buffet warns of a bond bubble, I pay attention.

Still, I don't know when bond prices will rise, and I don't want to keep all that cash sitting in my savings account. So, for now, I'm investing that 20% of my portfolio into online CDs. From an investor's perspective, CDs are exactly the same as corporate bonds, except that they're FDIC insured. The premium for bonds is so low now that it just doesn't seem worth giving up that extra insurance. I'm currently investing in CDs with a variety of maturities (1 year and 2 years). As those mature, I'll check and see whether the bond market has become any more normal. Once it does, I'll re-invest in bonds. Until then, I'll stick to CDs, thankyouverymuch.

So, that's all well and good, so far as a plan goes. How about execution? I was nervous of dumping my nest egg in all at once - with the markets as rocky as they've been, it would have felt really bad if they took a plunge the day after I bought in. Instead, I calculated how much I wanted to invest in each bucket to get to my desired 60-20-20 allocation, and then split that into thirds, with equal amounts going in on the middle of October, November, and December. As it turned out, the markets were relatively steady during this period, but it was great for my peace of mind.

Now, heading into the new year, I had another question to answer: how should I allocate my contributions going forward? It would be simple to just allocate each contribution up 60-20-20, but that wasn't nearly nerdy enough for me. After all, my goal isn't to INVEST 20% in international stocks, it's to HOLD 20% of my taxable investments in international stocks. Rather than rebalance every year or so, I'd rather my investments go to where they need to go in order to keep my overall allocation on track. When the US stock market goes on sale (or, as the pundits would call it, 'the market dives'), I want to buy more of it; when the market climbs, and that portion starts to swell past the 60% goal, I want to put my money elsewhere to help the other areas catch up.

Fortunately, this is just math. All I needed was data and a formula.

For data, I finally took the plunge and signed up with I'd been vaguely thinking of it for a while, but had put it off. Mint mainly advertises itself as a budgeting service, and I actually feel pretty good about my budgeting (or lack thereof). But, one day when I was trying to get a handle on my overall finances, I realized that I had logged on to three separate bank accounts and my Vanguard account, remembering the different passwords for each one, then switching between tabs, copy-and-pasting balances out, and punching them into the calculator. "That's dumb," I thought. "There's a site that does all this for me." So I signed up with Mint, and now life's much easier!

Mint can do a LOT, like send out warnings when bills are due, help with saving for particular goals, etc., but I mostly just use it as a dashboard to keep track of all my accounts at once. It groups accounts into separate categories: cash in one, investment accounts in another, and property (like real estate) in another. You can check each account's line item to see how much you hold there; for some, like brokerage accounts, you can drill down to check the value of each holding. What used to be a 10-minute trek now takes just about a minute.

With ready access to easy data, I brushed off another oldie: the Excel spreadsheet formula. I don't think I've done anything with Excel formulas since my high school physics class. Now that we're in the third millennium, I opted for a Google Docs spreadsheet instead, and was pleased to notice that I could do my equations with standard C-style math operators instead of the weird, terse Excel macro commands. I entered one column for my available funds (the sum of what's in my checking and savings accounts); one for the amount currently invested in the total stock market, another for amount currently invested in total international stock market; another for amount currently in "bonds" (i.e., CDs). I have a column with a fixed amount for what I plan to keep in short-term "emergency" savings - a largeish chunk for now as a buffer against unexpected expenses, with plans to lower to a smaller level after I pay this year's taxes.

To the right come my calculations. These turn out to be relatively simple. I figure out my total investable amount by summing every column and subtracting the emergency savings. From this, I multiply by the desired percentage for a given account, and subtract the amount currently in there. The result: by punching in the numbers from, I can immediately see exactly how much I should invest in each of my accounts in order to stay on my desired allocated track.

There are a few quirks. First of all, it's totally possible for a column to return a negative number. This can happen if an allocation gets seriously out of whack: basically, if one of the stock market indices shoots way up, then in order to bring it back into compliance, I'd actually need to sell shares and re-buy into others. If I was hard-core about rebalancing then I'd do this; instead, I'll just not contribute anything to that account in this cycle, and instead pay proportionally among the remaining fund(s).

For the next stage in this project, I'm playing around with the Form feature offered by Google. It's a very simple way to build a basic web form where the user can fill in a few fields, hit "Submit", and have their data show up in your spreadsheet. It looks good, but I still need to figure out how to properly apply the formulas to the newly submitted rows.

So, that's where that's at. I'm feeling pretty happy about the whole thing, and it's good to be moving back on track as far as long-term investing goes.

Incidentally: if I was super-serious about this whole thing, then I'd be taking my retirement accounts into consideration, and actually paying more attention about where I hold my funds. Since my stocks are all broad-based mutual index funds, they produce negligible taxable gains while I hold them; on the other hand, my CDs (and soon-to-be-bonds) generate regular income, which is taxed normally. It's a little backwards that I'm holding all of my CDs in my taxable accounts, and only keeping stock funds in my 401(k). That said, I do like the flexibility of having a variety of funds in my regular investment accounts; I don't plan to need this money any time soon, but if I do, it'll be good to have choices between my various accounts when making withdrawals, so I can protect the stocks if the market is down or harvest those gains if the market is up. In contrast, I love the set-it-and-forget-it nature of my Target Retirement fund, which I don't plan to ever touch prior to retirement.

Oh, and of course, standard disclaimers apply. I'm writing about this because I'm interested in it and thought I'd share my thought process and plans, but this is what works for me, not what will work for you. As my heroes at Marketplace Money say, "Talk with your own money person before making any big money decisions."

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