Real Estate Agents vs Selling Your Home DIY – Which is Better Suited For You?

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 The following is a guest post by Alex Sebuliba. Enjoy! 

In an increasingly independent world, the general public has access to a vast amount of resources that decades ago would not have been imaginable. From cloud computing to remote working, we are also now able to undertake fairly large scale tasks on our own without professional help. The vast resource of information that is the internet has made sure that help is at hand wherever we turn.

This is also the case when you decide to move / buy a new home.

For years now, people have been able to search for their dream property online, but have always had to include real estate agents every step of the way.

This isn’t the case anymore, and it’s been proven that an increasing number of people are now turning to a DIY approach when it comes to buying and selling. However, does this really save you time and money? This blog post investigates…..

Example A – The DIY Home Seller

So, you’ve searched for your dream property and want to sell your existing home – which happens to be in Nottingham, for example.

There are a variety of sites you can use for this, but the first step is to contact a company which provides the tools and services required for selling your home as a personal project. For a fee, they’ll send you a ‘for sale’ sign and then advertise your property on major sites which dominate the market such as Rightmove and Zoopla. It does still cost money, but it’s estimated that depending on the property you’re trying to sell, you could save up to £6,000 doing it this way.

After researching house prices and resale values in Nottingham, you would then get to work obtaining certificates, documents and evidence for potential buyers. There’s one small problem however…

What if your property doesn’t sell?

The house has been on the market for a while, and so far, you’ve managed to save money by not letting any estate agents in Nottingham in to the selling process. But, you’ve only had a small amount of interest, and the time you have to take out of your day to work on the sale of the home is becoming prohibitive. Not only may this become a frustrating process, but you also have to bear in mind that if you have signed up for independent sale in relation to any advertising company, you will still be charged a fee around £500. OK so it’s still a lot cheaper than using agents, around about £5000 cheaper than using agents, but what if you can’t manage to sell and eventually revert to using an estate agent after time?

Not only does that defeat the initial purpose of independent selling but it also means that you would have paid your independent advertisement fee of £500 on top of the cost of using an estate agent as well as wasting the time investment.

What do the traditional agencies have going for them?

Firstly, the estate agents in Nottingham, or the estate agents in Leicester, Birmingham, Bristol, London or wherever they are, will have a deep understanding and knowledge of the local area. They’ll be well versed on the in’s and outs of the property market and will be able to give personal advice based on your specific needs.

Secondly, practice makes perfect when it comes to price negotiating. It’s a skill many people think they possess, but in reality, it’s better to leave it to the professionals who know how to drive a hard bargain and get a price that is deserved.

Thirdly, and finally, all estate agents in Nottingham or wherever they may be are part of the financial ombudsman scheme – which provides people with safety and confidence in the knowledge that financial compensation is available if things go awry.

In this article, we’ve looked at some of the points and issues surrounding the DIY vs. Estate Agents debate. There is no denying it has become increasingly popular to go down the route of doing it yourself, however, you must bear in mind that even in today’s world, real estate agents have the professionalism and expertise to provide a competitive edge to your sales process.

How about you all? Have you used real estate agents or the DIY approach in the past to sell or buy a house? Why did you choose one over the other?

Share your experiences by commenting below!

Photo – http://farm5.staticflickr.com/4008/4590480945_4050b966bf_z.jpg

How Do You Find The Right Professional Indemnity Insurance For Your Needs?

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Welcome to My Personal Finance Journey! If you are new here, please read the “About” or “First-Time Visitor” pages to find out more about us. If you would like to receive free updates on articles like this by email, then sign up here or you can subscribe to the RSS feed. Also, check us out on Twitter or Facebook. Thanks for visiting! Keep on learning!
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The following is a guest post. Enjoy! 

Setting up and running a business is a complex task that requires much planning and dedication. And precisely because so much effort is involved, it only makes sense that professionals and business people would want to protect the source of their livelihood. This is where professional indemnity insurance comes into play.

But, as it happens with other types of insurance, it is often difficult to make a decision when it comes to choosing a suitable insurance provider. In this post, we list the best tips to help professionals find the right professional indemnity insurance cover.

Professional indemnity insurance: who is it for?

Purchasing professional indemnity insurance should be considered by any professional who wants to be protected against compensation claims. Clients can sue a professional if they suffer injury or financial loss as a result of inaccurate advice, errors, omissions, and faulty goods or services. Therefore, it is common for solicitors, medical professionals, architects, accountants, consultants, freelancers, pharmacists, translators, therapists, and psychologists to be covered by professional indemnity insurance.

It must also be noted that some professionals are required by law to have professional indemnity insurance before they can take on clients. In the United Kingdom, financial advisors, accountants, surveyors, architects, engineers, and IT consultants must be covered by professional indemnity insurance. In other professions, the relevant trade associations might require members to be insured.

To sum up, it is a good idea to have some level of professional indemnity cover, even in professions where this type of insurance is not mandatory. This can protect business owners and their companies and give them additional peace of mind.

Top tips to find the right professional indemnity insurance policy

Some of the things to keep in mind when comparing professional indemnity insurance providers include:

– Requirements made by professional bodies or by law

In some professions where professional indemnity insurance is mandatory, the relevant professional body has already set out exactly how much indemnity insurance members should have. This is the case of accountants, who are required to have a policy that is worth at least 2.5 times their gross income, based on the previous year’s figures.

– The level of cover

Companies may offer protection against loss of client data, damage or misplacement of documents, negligence, unintentional breach of intellectual property rights, and unintentional misuse of confidential information, libel, slander, and defamation. However, not all policies cover all of these instances, so it pays off to spend some time making sure that insurers offer the adequate level of protection for every business.

-The policy limitations

When it comes to insurance, limitations or exemptions are almost as important as the level of cover. For example, professionals working in fields like construction or environmental consultancy must remember that this type of insurance does not cover professionals against pollution or environmental claims. In many cases, work that has been carried out abroad or by sub-contractors is not covered either.

Another thing to look out for is whether legal expenses cover is included in the policy or not, and if so, to which level. We all know that legal services come at a high price, and more so in certain types of compensation claims.

– The policy type

Professional indemnity insurance policies come in two forms. In the event of a claim being made, each and every claim policies (also known as any one claim policies) will pay the agreed amount for every claim that is made. On the other hand, aggregate policies consider all claims being made during the period in which the policy is in force as one single claim. In this case, once the maximum amount agreed has been paid out, future claims will not be covered.

Last but not least, it is useful to look for a policy that is specific to each trade, rather than a “generic” one. This will ensure that professionals can carry out their job with complete peace of mind, knowing that their insurers are aware of the specific risks involved and able to cover them to satisfactory levels.

 How about you all? Do you carry business insurance for your ventures?

Share your experiences by commenting below! 

Photo credit – http://upload.wikimedia.org/wikipedia/commons/thumb/a/ae/Protect_earth.png/681px-Protect_earth.png

Father’s Day Gift Ideas for the Hard-to-Buy-For Dad in Your Life

This is a post by MPFJ staff writer, Jeff. Jeff writes about Sustainable living and finances at his website, Sustainable Life Blog. Jeff really enjoys traveling with his wife as much as he can, to wherever he can.

With Dad’s day just around the corner, it’s still not to late to pick out the perfect gift for him this year.

If your dad is like mine and just goes out and buys what he needs (or wants) when he needs it, it makes him difficult to shop for because he has everything that he wants! Even though he’s hard to shop for, I want to make sure my dad knows that I appreciate all he’s done for me, so I try and find a great gift every year.

Here are a few I’m looking at this year:

1. Tools. My dad always said growing up that to do the job right you needed the proper tools. The catch was that he never really had the proper tools, so he always just improvised. This year, I’m considering getting him a tool that he’s talked about needing/wanting for a while but for some reason hasn’t gotten for himself.
2. Wash his car. Dads love to have their cars cleaned, and mine is no exception. Make sure to either take it to a nice place, or if you’re tight on cash do it yourself in the front yard. Remember to vacuum the interior as well – dad will really appreciate it.
3. Movies. Send your dad (and mom) on a trip to the movies. Get them a gift card to your local theater for the cost of 2 movies and a popcorn and let them enjoy the afternoon. Nothing better than a relaxing fathers day at the movies.
4. BBQ. Invite your family over and some of dad’s friends and host a BBQ. Let dad relax and catch up with everyone while you take care of the grilling and the rest of the food. If you don’t think you can pull it off yourself, ask relatives to bring salads or side dishes.
5. Something to eat. Everyone enjoys goodies, and what better way to celebrate fathers day than with a box of your dads favorite candies?
6. A game of golf/box of personalized golf balls. If your dad is into golf at all, offer to take him out on fathers day and hit the links with him. If he’s unavailable, why not get him a set of personalized golf balls to use next time that he hits the links?
7. Something tech-related. There are awesome new tech innovations out there, and if your dad is really into tech stuff, consider finding one of them for him. Maybe a belkin wemo or a pebble watch for dad on fathers day.

There are a few great ideas for fathers day gifts. I may just take my dad out for a nice steak lunch or dinner this year though.

How about you all? What do you typically do for your dad on Father’s Day? What was his favorite thing that you’ve done in the past?

Share your experiences by commenting below! 

***Photo courtesy of http://fc03.deviantart.net/fs71/i/2010/173/4/3/Happy_Fathers_Day_by_Nin10dohfanatic.jpg

I Have FINALLY Moved the Journey to WordPress Self Hosted!

Happy Thursday everyone!

As you can see, the layout of the site looks a little different today.

The reason?

I finally set aside all of my excuses and have moved My Personal Finance Journey from Blogger (where I’ve been for 3+ years) to WordPress Self Hosted. I’m using the Genesis Framework with the News Child Theme and very much like it so far!

Anyhow, this is just a quick post to humbly request that you bare with me for a few days while I get the kinks worked out on the new hosting platform. After that, I expect to be back in full force with a more reader-friendly platform that gives all of us better functionality.

How about you all? What blogging platform do you use?

If you’re on WordPress, what theme do you use?

Talk to you soon!

-Jacob

***Photo courtesy of wikimedia.org

Would You Consider Car Sharing?

The following post is by MPFJ staff writer, Shondell of Call Me What You Want, Even Cheap. She blogs about her recent car loan and mortgage pay off and a whole bunch more. Check out her blog right here.

Owning your own car is nice; it gives you the opportunity to go where ever you want whenever you want.

However, a car does cost money to buy and more money to keep. There is gas, insurance, servicing, and repairs, which over time, piles up to a huge amount money. If you just need a car to drive occasionally, there are several options. You can rent, borrow, buy, or you can consider car sharing.

What is car sharing?

Car sharing is a type of car renting where members rent cars for short periods of time, usually on an hourly rate. This arrangement is beneficial for people who use cars occasionally and also for those who like to change their cars quite often. The nature of the organization renting out the cars could be a private company, a cooperative, or an ad hoc grouping.

How long has it been around?

The idea of car sharing is not a new phenomenon; the concept has been around in one form or another since as early as the 1940s. It has become so widespread that there are now over a million members in cities around the world. The popularity of this model of car renting has forced even big name traditional car rental companies to start their own car sharing services to stay in business.

How does it differ from traditional car rental?

To some people, car sharing and traditional car renting sounds the same. But, car sharing should not be confused with traditional car renting. They are fundamentally different things.

• Car sharing is not limited to or by the office hours. You can rent a car at any time you like (day or night).
• You will not be provided with a chauffeur. From reservation to pickup to return, it’s self-service all the way.
• You will be able to rent a car by the minute, or by the hour or even by the day.
• You have to be pre-approved to rent the car, with background checks performed and a payment mechanism established.
• Vehicles are located at different locations throughout the service area, often in places accessible by public transit.
• Insurance is paid by the company. Every car has at least minimum liability insurance. Comprehensive and collision insurance are also common.
• Repair and maintenance are done by the company.

How does it work?

You have to make a reservation before you can use a car. You can reserve a car online, by phone, or by text message depending on the company’s reservation policy. Many companies accept all three methods. You will be required to provide the following information:

• The time you will need the car
• The duration you intend to use the car
• The type of car you want
• The place where you would like to pick up the car

After you have made the reservation, the car will be delivered to you at the time and place you have mentioned. A small card reader mounted on the windshield will keep the time. It will be your responsibility to clean and refuel the car. Some companies include the fuel costs in the rates so that the car is full when delivered to you.

What are the benefits?

Car sharing is growing in popularity because it has many benefits.

• Access to car: The first and foremost benefit of car sharing is that people who do not have a car, or can’t afford to buy a car or do not want to buy a car will get access to a car whenever they need it. In a way, it’s like owning your own car, but without the issues associated with ownership.
• Access to different cars: If you like to drive different cars every time you need one, then car sharing could be perfect for you because you can choose a different car every time you need one.
• Saves money: You can save a lot of money if you use the car only occasionally or only when you absolutely need it. You won’t have to buy insurance or pay for repairs and maintenance. This saves you a lot of money in the long run.

Car sharing can be a great way of life, especially for people who live down town and don’t need a vehicle 24/7. You will have access to a fleet of different types, brands and models of cars every time you need one without any of the hassles associated with ownership of a car. In some ways, it’s much better than owning a car.

I need a car for work so I have to own a car, but car sharing is very popular in my city.

How about you all? Would you or have you ever considered car sharing?

Share your experiences by commenting below!

***Photo courtesy of creativecommons.org

The Size of Your Emergency Fund Should Be In Inverse Proportion to the Stability of Your Income

There are all kinds of methods that are used to determine what the proper size of an emergency fund should be.

Perhaps in an attempt to simplify the process, the most common recommendations are for either a flat amount – say $1,000 – or a certain number of months living expenses, which typically ranges anywhere from one to six months.

In reality however, determining the right size for your emergency fund may not be all that simple. A flat amount or so many months living expenses will work only in the most general sense. Your method also needs to account for the variables of life. And one of the biggest variables is the stability of your income.

It isn’t possible to have the right-sized emergency fund unless you adequately adjust for qualitative factors, one of which is income stability. How should income stability affect the size of your emergency fund?

Types of income that should affect the size of your emergency fund

Evaluating the stability of income is mostly a matter of considering the source. A salaried position with full employee benefits would represent the most stable source of income. This will be especially true if the job is in a professional position, such as nursing, accounting or teaching. Government jobs tend to be even more stable, since layoffs from such positions are infrequent.

At the opposite end of the spectrum, are employment situations in which all – or at least a substantial amount – of your income is derived from non-salaried sources. Some examples might include:

• Self-employment
• Commission sales jobs (100%)
• Salaried jobs in which a substantial amount of compensation is derived from bonuses, commissions, or overtime
• Contract employment
• Hourly positions with variable schedules (includes most part-time positions)
• Seasonal jobs

Another type of employment with unstable income includes jobs with a high frequency of layoffs. An example of this would be many positions in the building trades. Since the construction industry in general tends to run with the boom and bust cycles of the real estate business, building tradesmen qualify as having less stable income sources.

Now that we’ve set some definitions for what constitutes income stability, and which income types they apply to, let’s get back to the question of how much to have in an emergency fund.

Greater income stability requires a smaller emergency fund

If you are on the high end of income stability – let’s say that you have a full-time, fully benefited job with the government, and you even have some tenure. If that is your situation, then you can be on the lower end of the emergency fund scale. Given that financial planners usually advise having something like 3 to 6 months of living expenses in your emergency fund, the stability of your income would allow you to keep your fund at the lower end of the range. You would likely be perfectly safe with just three months reserves, and you may even be able get away with a little bit less. For most people, the biggest emergency situation is the loss of a job or the potential for a serious reduction in earnings. But if your job and income situations are extremely stable, then that potential emergency will not be a reasonably likely scenario, and your emergency fund doesn‘t need to be as large.

Less income stability requires a larger emergency fund

It’s easy enough to see how a very stable income situation would require a smaller emergency fund. But the situation gets a bit more complicated when you’re talking about less stable income sources, such as the ones listed earlier.

If you are in a situation that is generally unstable income-wise – or at least has the reasonable potential to be so – you will want to be at the higher end of emergency fund recommendations, at the very least. In just about any of these income situations you should have at least six months of living expenses in your emergency fund.

If you’re income situation is at the high end of unstable – such as self-employment or 100% commission – you may want to increase your fund to cover as much is 12 months of living expenses. The larger emergency fund is necessary not only to compensate for potential loss of income, but just as important, to give you some peace of mind during periods of wide income fluctuation. If you have enough money saved to cover your living expenses for a year, you should be able to keep calm and to do whatever is necessary to turn your income situation around.

Still another benefit of the larger fund – from my own personal experience – is the tendency for other emergencies to develop when you’re dealing with an income crisis. Blindside disasters just seem to be more frequent when income is low. There’s nothing really scientific about how much money to have in your emergency fund. And there are different ways to calculate how much you’ll need. But whatever method you take, you should seriously consider your income stability as a major part of the criteria.

How about you all? What factors form the basis for the selected size of your emergency fund?  

Share your experiences by commenting below!

***Photo courtesy of http://www.flickr.com/photos/44313045@N08/6290270129/sizes/s/in/photostream/

What Asset Allocation Level Should You Use for Treasury Inflation-Protected Securities (TIPS)?

Over the past couple months, we’ve been discussing several interesting aspects of asset allocation and portfolio design. Thus far, we’ve explored how gold/precious metals, international equities, REITs, short-term bonds, and intermediate-term bonds perform as asset classes and if/how they should be weaved in to your asset allocation.

Continuing this investigation on portfolio construction, I wanted today to look in to the question of “what level, if any, of your portfolio should be allocated to Treasury Inflation-Protected Securities (more commonly referred to as TIPS)?”

Let’s get started!

WHY BOTHER CONSIDERING THE ADDITION OF TIPS AT ALL?

To begin, the first question that I suppose we should address is why it’s even worth considering adding TIPS to your portfolio in the first place.

As is the case with many elements of Modern Portfolio Theory and portfolio construction in general, TIPS theoretically should provide a favorable diversification benefit when incorporated with other components of your portfolio.

More specifically, this diversification benefit comes from the fact that the average return statistics of TIPS are not perfectly correlated with other commonly-included asset classes of a portfolio. In mathematical terminology, we can say that the diversification benefit is obtained because the correlation coefficients of TIPS with the other asset classes are not 1.

To demonstrate this in tabular form, I ran a correlation coefficient analysis of the annual returns of the Total US Stock Market, TIPS, and Short-Term Treasuries between the ~40 year period between 1972-2011 (using data from the Bogleheads.org Simba backtesting spreadsheet).

The correlation coefficient results can be seen in the table below. As you can see (green highlighted cells), the correlation coefficients between TIPS and the Total US Stock Market / Short-Term Treasuries are quite favorable at 0.20 and 0.03, respectively. What this means in English is that the returns of TIPS move in sync with the stock market in general only 1/5 of the time and with Short-Term Treasuries almost none of the time.

According to Modern Portfolio Theory principles, adding a poorly correlated asset class in to a portfolio can often decrease volatility while possibly, increasing returns. Thus, this is the motivation for looking at including TIPS in a portfolio/asset allocation.

In addition to a potential diversification benefit, TIPS provide a “pure hedge” against US inflation. In other words, unlike some other indirect hedges against inflation that may or may not be guaranteed, TIPS offer investors a guaranteed real rate of return, no matter what happens to inflation in the future. This also indicates that the real returns of TIPS have less variance than that of nominal bonds. Lastly, being Treasury securities, they have 0 default risk.

WHAT DO THE EXPERTS SAY ABOUT ADDING TIPS TO YOUR PORTFOLIO?

Before getting too far in to my own asset allocation analysis, I generally like to quickly review and summarize the thoughts that people much more qualified than I am have on a subject.

As such, listed below is a summary of what has been recommended in the books of several well-respected asset allocation authors regarding the incorporation of TIPS in to a portfolio:

• Larry Swedroe (probably my favorite investing author I have found to date)
  • In Larry’s two books, The Only Guide to a Winning Investment Strategy You’ll Ever Need and The Only Guide to Alternative Investments You’ll Ever Need, Swedroe provides the most complete, definitive position that I could find in the literature of what allocation investors should consider giving to TIPS.
  • Essentially, he states that numerous academic studies have been conducted, and all come to the similar conclusion that TIPS should “dominate” the fixed income allocation for investors, especially in tax-sheltered accounts.
  • For example, he shared the results from 3 studies that concluded the optimal portfolio position based on risk-adjusted returns for the overall portfolio was between 50-100% of the fixed income allocation.
• Burton Malkiel
  • In his famous and amazing book (2003 edition), A Random Walk Down Wall Street, Malkiel provides example asset allocations with 5% of the total portfolio allocated to TIPS (~25% of the fixed income allocation).
  • Unfortunately, it is never explained exactly how this 5% level is derived. The book only mentions that TIPS are a wise component to add to a portfolio.
• William Bernstein (my 2nd favorite investing author I have found to date)
  • In his 2002 book, The Four Pillars of Investing, Bernstein displays sample portfolios/asset allocations with TIPS representing 4-20% of the total portfolio, depending on the investment horizon. 10% seemed to be a common allocation used within this range.
  • Generally, this equated to ~1/3 of the fixed income allocation. 
  • As was the case with Malkiel’s book, Bernstein doesn’t really get in to exactly how the allocation to TIPS was derived, but simply mentions that it is beneficial to have some exposure to the asset class.
• Alexander Green
  • In his book, The Gone Fishin’ Portfolio, Green recommends a 10% allocation to TIPS (equates to 33% of the fixed income allocation).
• Although not a book (but simply a group of people with a lot of collective knowledge), on the Bogleheads Forum, the most popular fixed income allocation is a 50/50 split between nominal and TIPS bonds.

Conclusion from Literature – So, after looking through all of the books that have helped me build my portfolio over the years, there doesn’t seem to be a clear consensus among the various authors. On one hand, we have several that recommend committing about 1/3 of fixed income assets to TIPS, while on the other hand, Swedroe is recommending anywhere from 50-100% fixed income allocation to TIPS. Of course, this number will change as your life cycle allocation adjusts during different life stages.

HOW HAVE TIPS PERFORMED IN THE PAST COMPARED TO OTHER PORTFOLIO COMPONENTS?

In this case especially, the literature seemed to be rather inconclusive about what is exactly the correct amount an investor should allocate to TIPS.

The first thing that is interesting to examine when seeing how TIPS have performed compared to other common asset classes is to see how an investment made a long time ago (~40 years in this case) would have grown.

As such, shown below is the hypothetical growth of a $10k starting investment in Short-Term Treasures (red line), the Total US Stock Market (blue line), and TIPS (green line) between the years of 1972-2011.

As you can see, the investment in TIPS provided approximately (at least from the graph) the same return as that of Short-Term Treasuries. As would be expected, the equity asset class returned much higher than the fixed income investments.

The actual return data that produced the graph above is shown in the table below. First, as we would expect given that TIPS have a MUCH LONGER average maturity (~9 years) than the Short-Term Treasuries (~2 years), TIPS have higher volatility than the Short-Term Treasuries.

However, it is somewhat surprising to me that investors were not really compensated that much more at all for shouldering the increased risk of TIPS. For example, an investor only obtains an ~10% increase in average returns for TIPS in exchange for taking on an ~50% increase in volatility (standard deviation).

Essentially, what this data shows is that with TIPS, even though they have some attractive potential benefits, they don’t seem to have been very efficient compared to Short-Term Treasuries over the past 40 years.

TIPS ALLOCATIONS IN A 3-COMPONENT PORTFOLIO DESIGN

More important to us as portfolio design “engineers” is how an asset class will behave and/or benefit us when incorporated in a realistic portfolio/asset allocation.

To assess this for the TIPS asset class, I re-ran the portfolio analysis during the 1972-2011 period using a portfolio consisting 30% of fixed income (split between varying levels of Short-Term Treasuries and TIPS) and then a 70% allocation to the Total US Stock Market.

Shown below is the average annual return vs. risk graph that resulted from the analysis. Going from left to right, each plot point on the curve represents increasing allocations to TIPS, as described on the below table.

And, shown below is the exact data that was used to construct the return / risk curve above.

If we examine this data a little more closely, we see that numerically, the most efficient allocation to TIPS in terms of the highest return/risk ratio occurs at 1% TIPS, so very little at all (3% of fixed income allocation). However, in the grand scheme of things, the return numbers don’t change all that much as TIPS are incorporated, meaning there is not that significant of an effect.

Intriguingly, if a 60/40 equity/fixed income asset allocation split is used as opposed to the 70/30 employed above, the optimal level of TIPS becomes ~5% (12.5% of fixed income allocation). Furthermore, if a 50/50 split is used, the optimal TIPS level is found to be 8% (16% of fixed income allocation).

Overall, my 3-component TIPS analysis leaves me with the following question –

Why does my analysis predict much lower optimal levels of TIPS (3-16% of fixed income allocation) when the books I reviewed above recommended 25-100% of fixed income allocation?

I can think of several possible causes for the discrepancy. First, the data I’m using could be wrong (hopefully not). Second (and more likely), is the possibility that I am not comparing apples to apples, which in this case, means inflation-adjusted returns to inflation-adjusted returns.

To investigate the disparity in findings, I obtained the inflation data for the years being analyzed, subtracted it from the annual returns of the various asset classes, and generated the table below showing the summary of my findings.

When adjusting the returns for inflation (4.39% annual average inflation during the time period analyzed), the case for incorporating TIPS in to a portfolio becomes more significant, with the most efficient level being at a 7.4% TIPS allocation (of the total portfolio, or ~25% of the fixed income allocation) for the 70/30 equity/fixed income portfolio. If we use a 60/40 or 50/50 equity/fixed income overall asset allocation, the optimal allocation to TIPS becomes ~23% of the fixed income allocation.

You can view the complete set of numbers/calculations for my analysis by accessing the Google Docs Spreadsheet here.

CONCLUSIONS ABOUT TIPS ASSET ALLOCATION AND MY PERSONAL PATH FORWARD

So, after sifting through all this analysis, what’s the overall verdict on what asset allocation should be committed to the TIPS asset class?

Listed below are my key takeaways from this investigation:

• TIPS provide the potential for a very significant diversification benefit due to their low correlation with both equities and nominal bonds.
• In addition, since TIPS provide a solid hedge against inflation (something which is almost guaranteed to happen) by providing “real returns,” they are truly a hard asset class to ignore.
• The literature recommends that between 25-100% of an individual’s fixed income allocation be committed to TIPS because of these benefits. It is often stated that TIPS should be the dominant holding in one’s fixed income allocation (meaning >50%).
• In my own analysis of the ~40 year period between 1972-2011 using a 3-component portfolio of US equity, Short-Term Treasuries, and TIPS, I found that:
  • The return values HAVE to be adjusted for inflation in order for TIPS to have a significant case to be included in the portfolio.
  • After adjusting returns for inflation, the most efficient level for TIPS in a portfolio is ~25% of the fixed income position. 
  • I hypothesize that the TIPS allocation for maximal portfolio efficiency would have been higher if I used intermediate or long-term maturity bonds in my portfolio construction. However, since I like to use short-term bonds (which provide an indirect hedge against inflation since short-term rates are able to adjust fairly quickly as inflation changes), dominant levels of TIPS were not required to increase efficiency.

My Personal Path Forward – I want to lastly share how this analysis affects me personally. I currently use a 70/30 equity-fixed income asset allocation. 5% of my total portfolio (or ~17% of my fixed income position) is allocated to TIPS. Thus, I’m a little bit below both the optimal level found in my own analysis above and also what is suggested by most authors in the literature/Bogleheads.org. Because inflation is almost a certainty to occur in the future and the fact that TIPS provide a guaranteed real rate of return, I think it is prudent for me to increase my TIPS allocation.

Regarding the question of WHAT TIPS allocation I will use going forward, I believe I will stick to the lower end of the recommended spectrum, shooting for a ~25% fixed income allocation to TIPS, or 8% of my total portfolio. I don’t necessarily want to increase much higher than that due to the longer maturity that the Vanguard TIPS mutual fund I will use has (9 years). To keep my overall fixed income / equity allocation levels the same, I’ll exchange my short-term bond index fund allocation over to TIPS to make the required change.

A good question going forward perhaps is whether it is better to use the new Short-Term TIPS Fund or the regular TIPS Fund that Vanguard offers. I’ll put that on my list of things to analyze soon!

How about you all? Do you have any exposure to TIPS (or another inflation hedge) in your investing portfolio?

If so, what % of your portfolio does it constitute?

Share your experiences by commenting below!

Are You Making These Rookie Couponing Mistakes?

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Emergency Fund Considerations – Where Should the Account Be Located and What Should It Be Invested In?

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By now, you all probably have read about the importance of having an emergency fund (with enough money to live off of if the need arises) invested in a very stable account. In fact, in my account hierarchy / financial prioritization order, this type of cash account ranks right near the top.

However, several aspects of emergency funds that there exist substantial differences in opinions include 1) where this money should be held and 2) what the money should be invested in. As such, today’s post will be dedicated to seeking position on these two considerations around emergency funds.

Let’s get started!

Emergency Fund Location – Where Should the Money Be Invested?

When it comes to the location of your emergency fund savings, the key is access. 

We need to have access to this money within 1-2 days or so at the most if something unexpected pops up. More specifically, we need to have this easy, quick access to our money also without incurring any penalties, fees, or additional debt (like a credit card – which is the whole reason why credit cards are NOT emergency funds).

If we limit our selection to account locations with this criteria, nearly all traditional retirement accounts are eliminated, and we are left with the options below:

• Contributions (but NOT earnings) to a Roth IRA.
• Normal, taxable accounts.

While both of these account types are viable options for an emergency fund, analyzing your personal finances can provide some insight in to which is likely the better emergency fund location option for you.

Let’s start out by stating the obvious – if your income is high enough that you are not allowed to contribute to a Roth IRA, then your only option is to use a taxable account for your emergency fund. If this is the case for you, you can likely skip the next few paragraphs.

For the remaining people who ARE ELIGIBLE to make Roth IRA contributions each year, they likely to fall in to one of two categories:

• Category 1 – Folks who are fully funding their Roth IRA each year, and
• Category 2 – Folks who are NOT fully funding (or not funding at all) their Roth IRA each year.

However, as you’re likely well aware, we cannot simply fund a Roth IRA with however much we want each year. There is a set yearly (and vis-a-vis, lifetime) limit that the IRS imposes each year ($5.5k in 2013, for example). Because of these limits, it is in your best interest to begin funding a Roth IRA as soon as possible (i.e. not waiting until you build up an emergency fund in a regular taxable account to start your Roth IRA contributions). 

Specifically, this applies to the location of emergency fund savings in the following way:

• Category 1 – Folks who are fully funding their Roth IRA each year. 
• If you’re already maxing out your Roth IRA each year, then you’re better off having your emergency in a regular, taxable account, so you can save your “tax-free” Leg of the Three-Legged Stool for retirement, when you need it more, and have more growth.
• Category 2 – Folks who are NOT fully funding (or not funding at all) their Roth IRA each year.
• If you’re not funding (or not fully funding) a Roth IRA each year, then you’re better off opening up a Roth IRA as soon as possible and beginning to use your contributions as an emergency fund.
• This will get you started accumulating capital to take advantage of the set lifetime limits imposed by the IRS on Roth IRA contributions.

If you’re interested in reading more about this decision process, I’d recommend the two great articles below:

• MyDollarPlan.com – Roth IRA Emergency Fund Explained
• BogleHeads Case Study – When Using a Roth IRA As An Emergency Fund Makes Sense

Emergency Fund Vehicle – What Should the Money Be Invested In?

In other words, we want to invest in some vehicle that has close to 0% chance of decreasing in value, that does not lock up our money for a set period of time and incur fees/penalties for early withdrawals (like a CD), and gives us a competitive yield based on the stability profile.

If we impose these criteria, we are left with the following obvious options:

• Money Market Mutual Funds and Money Market Savings Accounts.
• This is what I currently utilize for my emergency fund savings.
• Bank Savings Accounts (not available in a normal brokerage Roth IRA, but may be available through Bank IRAs, like ING Direct/CapitalOne360).
• Bank Interesting-Bearing Checking Accounts (probably not available in a Roth IRA).

However, here recently in reading Oblivious Investor and some of the BogleHeads Forums, I’ve discovered that folks are using (in whole or in part) Short-Term Bonds/Short-Term Bond Mutual Funds as vehicles for their emergency fund savings.

Most likely, the reason for this is because they are trying to obtain more competitive interest rates on their savings, given the abysmally-low rates offered by money market accounts these days. For example, as of this writing, the CapitalOne 360 money market savings account is offering 0.75% APY, while the Vanguard Short-Term Bond Mutual Fund has delivered a return of 1.5% over the past year, so about 2x what the money markets are getting.

Having established that Short-Term Bonds meet the competitive yield criteria, we then need to determine if they are liquid and very stable. As far as liquidity goes, if you use one of Vanguard’s Short-Term Bond funds, they are likely to have $6-30 billion or more in total assets, meaning that you drawing out even $20,000 in emergency fund money in one day will likely not be a problem at all. So, I think Short-Term Bond Funds are fine from a liquidity perspective. 

Thus, the only thing left to analyze is the stability of Short-Term Bond Funds. In a post I wrote in April 2013, I analyzed the ~20 year performance data of 5 of Vanguard’s Short-Term Bond Mutual Funds. The results are shown in the table below:

As you can see in the table above, all of these short-term bond funds are VERY stable.

• In fact, during the period from 1996-2013 (even with experiencing two financial crises in 2000-2001 and 2008-2009), the minimum return over a year-long period was close to +1%. 
• Furthermore, the worst loss experienced in any one month period was only -2.46%. 

Thus, I would conclude that Short-Term Bonds are indeed a suitable place for a part of your emergency fund, and maybe even ALL of your emergency fund if your total assets are fairly large.

For me personally, since my total assets are not extremely large yet, I like the idea of holding my emergency fund in a very secure, FDIC-insured, money market savings account that cannot decrease in value. This makes me feel better about taking risks in other places in the equity portion of my portfolio. However, I wouldn’t be opposed to shifting my emergency fund to short-term bonds in the future as my asset base grows.

How about you all? Do you hold your emergency fund in a Roth IRA or in a normal, taxable account?

What do you invest in with your emergency fund savings to keep it secure?

Share your experiences by commenting below!

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Teach Your Children This One Skill to Help Them Financially for the Rest of Their Lives

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Welcome to My Personal Finance Journey! If you are new here, please read the “About” or “First-Time Visitor” pages to find out more about us. If you would like to receive free updates on articles like this by email, then sign up here or you can subscribe to the RSS feed. Also, check us out on Twitter or Facebook. Thanks for visiting! Keep on learning!
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The following post is by MPFJ staff writer, Melissa Batai. Melissa is a freelance writer who covers topics ranging from personal finance to business to organics to food. She blogs at Mom’s Plans where she shares her family’s journey to healthier living and paying down debt.

Share your experiences by commenting below!

***Photo courtesy of http://www.flickr.com/photos/11921146@N03/4004900258/sizes/l/in/photolist-76Uajs-76UWkw-7ge