Category Archives for Invest & Retire

Carnival of Financial Planning B – April 19th, 2013 – Thinking of Boston Edition

————————————————————————————————————————
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!
————————————————————————————————————————

Click here to enter my free $50.53 giveaway for a chance to win 5% of My Personal Finance Journey blog income and give another 5% to a charity of your choosing! Deadline to enter is April 30th, 2013.

Welcome to the April 19th, 2013 “B” Edition of the Carnival of Financial Planning! 

The Carnival of Financial Planning takes a long-term view of personal financial planning for individuals and families. The focus is on efficient and sustainable personal financial planning practices that can lead to lifetime financial security. 

If you’re wondering what the B edition means/stands for, what happened was that the carnival was getting so many submissions each week, that the organizer decided it would be more meaningful and easier to access if the submissions were split in to 2 groups, each being featured on a separate site each week. And this week, we’re hosting the second of the 2 groups!

By now, I’m sure everyone is well aware of the horrific events that have happened in Boston over the past week, starting with the bombs going off at the finish line at the Boston Marathon. This event hit home pretty hard for my fiance and I since we are both runners and have often attended large races such as this one. I have often been in the crowd near the finish line cheering runners coming in (such as when my fiance did the New York City Marathon in 2011), so it could have easily been me or someone that I know well that was hurt in an event like this. If you find yourself feeling down in light of this event, just watch a video of the finish line at any marathon across the country. You will be able to see true inspiration and human spirit. Our thoughts are with you Boston!  

Anyhow, enough of my rambling about recent events for now. Let’s get on with the Carnival. This edition is arranged by subject heading, so that you can browse efficiently.

Enjoy!

BUDGETING AND ECONOMICS

Brock Kernin @ Clever Dude writes What The XBox Taught My Son About Personal Finance – My son wanted to buy an Xbox, and ended up learning some important financial lessons and skills.

Philip @ PT Money writes 25 Insanely Easy Ways to Manage Your Money and Get Back on Top – These 25 ideas for managing your money are really simple and anyone could implement them. Doing just a few of these tasks could help you regain financial control.

Robert @ Kids Ain’t Cheap writes Coupon Tips and Tricks – Coupons are a godsend for financially strapped families. Whether you need to save on groceries, clothes, home decor or entertainment, there is a coupon to meet your needs.

JC @ Passive Income Pursuit writes 2013 Goals – 1st Quarter Update – Goal setting is great, but you must analyze them to see how you did. I take a look back at my several goals for this year to see how the 1st quarter of 2013 treated me. I’m very happy with several of the goals, but there’s still plenty to work on.

CAREER AND INCOME

Glen @ Monster Piggy Bank @ Monster Piggy Bank writes Time is Money – What are you Sacrificing for Money? – What are you sacrificing for money? Is it Time? Or perhaps physical or mental health? It is a question that I think many people don’t bother to ask themselves, as they don’t feel that they are sacrificing anything.

Daniel @ Sweating the Big Stuff writes The Average Age of First-Time Home Buyers – In 2009, the most recent available data, the average age of home buyers was 31 according to one study and 34 according to another. But what is normal?

Amanda L Grossman @ Frugal Confessions writes 5 Money Saving Tips for Savvy Shoppers – This is a guest post by Mike Collins, who is obsessed with building sustainable streams of income online and achieving financial freedom so he can live life… Read his 5 money saving tips!

Jon Haver @ Pay My Student Loans writes Government Pays Your Education – The US government is prepared to support the educational goals of veterans seeking higher education. A wide variety of programs offer partial-to-full financial aid for advanced degrees. You may find yourself eligible for more than one type of education benefit, allowing you to choose the one that suits you best.

DEBT AND CREDIT

John @ Fearless Men writes Be In the Know About Credit Cards Before They Own You – According to Forbes (March, 2012) the average credit card debt for indebted households was $14,517, and for all households was $6,772. That is a daunting statistic to have to face, and it’s a reality that many people live with every day. If you have a credit card it’s important that you take careful steps to avoid any of the pitfalls that can trap you in debt and keep you there almost indefinitely.

krantcents @ KrantCents writes How to Use Credit Cards Responsibly – Too many people have credit card debt! As of December, 2011, according to Capital One there was $801 billion total U.S. revolving debt. 98% is credit card debt! The total U.S. consumer debt is $2.5 trillion as of December 2011. The average credit card debt per household with credit card debt is $15,799.

Matt @ Living in Financial Excellence writes Strategic Planning for the Everyday Family – We started working on our strategic financial plan. We recognized that this should include more than just a few financial goals and targets. We wanted to take some time and plan our family’s future. Financial planning is just a small piece of the overall picture.

INVESTING AND SAVING

John S @ Frugal Rules writes Online Brokerages I Use: Scottrade Review – There are many outlets for your choosing if you want to invest in the stock market. They all have their features that set them apart. Find the one that fits your needs for overall investing as well as investing for your retirement needs.

Roger the Amateur Financier @ The Amateur Financier writes First Quarter 2013 Resolution Progress (and 4 Tips to Resolution Success) – It’s been more than three months since the start of the new year, more than a quarter of the way through 2013.

Darwin @ Darwin’s Money writes 5 Reasons Why Bitcoins are the Dumbest Investment Ever – Bitcoin is dominating the headlines, but consider these 5 reasons why it’s a horrible investment.

Mike @ Personal Finance Journey writes House swap vs couch surfing – a frugal vacation! – Simple out of the box ideas to having a frugal vacation and saving money with accommodation. How do you save money when traveling?

MR @ Money Reasons writes Investing Is Like A Skill Based Game – I describe how investing is like a game and that you should realize that losing is part of winning.

Mike @ The Financial Blogger writes Q2 Net Worth Update: The Plan is Finally Working! +2.20% – How are things working out with my finances?

Jester @ The Ultimate Juggle writes Will Our Kids Have Wealth Building Opportunities Like We Had? – Are there less wealth building opportunities for kids in the future? I think this is a possibility and explain why I think so.

Kyle @ The Penny Hoarder writes Get Paid to Eat Dog Food – The next time you’re feeding Fido or Fluffy, you might want to consider taking a taste of their food yourself. If the thought of doing so repulses you, you might not be a candidate for the next great pet food tester. However, if you’re feeling a bit more adventurous and are considering having that bite!

Michael @ Financial Ramblings writes Putting a Cap on Retirement Accounts? – The federal government is considering capping the balances in your tax-advantaged retirement accounts. This article provides more detail on exactly what they’re talking about.

Crystal @ Budgeting in the Fun Stuff writes We Finally Did Our Taxes – Sheesh! – We didn’t make as much in 2012, but we paid about the same amount in taxes anyway thanks to having to pay the self-employment taxes on everything. YUCK!

IMB @ Investing Money writes Should You Invest Money Now? – The right timing often plays a serious role in good investing. It’s important to ask yourself – is now the time to invest money? Read here for good tips.

Tushar @ Start Investing Money writes The Benefits of Locking Up Your Money for Longer – We all know how important it is to manage our money in the best possible way. Ideally this means building up an emergency fund to cover three months’ worth of outgoings in case we should need it, and then maximizing the rest of the available cash we have.

Lauren @ L Bee and the Money Tree writes When Money Is No Object…. – I re-watched the film -Pretty Woman- over the weekend, and was surprised- I had forgotten how awesome that movie is! Anyway, in the movie the Richard Gere character takes Julia Roberts shopping and he tells the clerk at the store that he’s going to spend -an obscene amount of money-!

Kevin @ 20smoney.com writes Last Minute Car Rentals-Your Questions Answered – You might have been told that booking your car hire in advance will guarantee you the best options and the best rate, and this is true.

William Cowie @ Bite the Bullet Investing writes Fear of Investing: Watcha Gonna Do? – Many people shy away from investing, because they’re afraid of losing money. Yet they already have the skill to avoid the fear of the unknown. This post shows how to unlock that.

RISK MANAGEMENT AND INSURANCE

Jason Hull @ Hull Financial Planning writes The Day After the Initial Diagnosis: MS and Financial Planning – After you receive the initial diagnosis of multiple sclerosis or another long-term degenerative disease, it’s tempting to throw in the towel and panic. Here’s a set of steps you need to take to prepare yourself for your new situation.

Sam @ Simplefinancialfreedom writes At What Age Should You Get Term Life Insurance? – When it comes to taking out life insurance, age should not make any difference in overall terms because life insurance is a way to protect yourself and your

REAL ESTATE AND PROPERTY

Mr. Frenzy @ Frenzied Finances writes Spring Cleaning: Getting Rid of Spending Habits – Everyone has bad habits that serve as personal weaknesses. Now that it’s Spring, read these five tips to learn how to get rid of your bad spending habits.

RETIREMENT AND TAXATION

Mr.CBB @ Canadian Budget Binder writes Life, Money and Retirement-Skype Doesn’t Reach Heaven – Sometimes we need to ask ourselves why we work so hard for all the money we make and whether we are spending our time wisely. Pouring your life into one basket risks leaving behind potential memories that you might not be able to go back and get. Take time to evaluate your life, your priorities and your future

Kevin @ Passiveincometoretire writes Hidden 401(k) Fees Eating Away At Your Retirement Savings – Read how 9 in 10 Americans vastly underestimate their average total 401(k) fees they are paying over the course of their lifetime.

Michael Kitces @ Nerd’s Eye View writes Strategies For Existing Variable Annuities With GLWB Or GMIB Riders – While today’s variable annuities continue to get more expensive, many existing contracts with retirement income riders actually represent a great value… as a result, even if you wouldn’t buy an annuity in today’s marketplace, it may be a poor decision to get rid of an existing one without proper due diligence first!

That concludes this edition. A big thanks to everyone for participating! Please submit your blog article to the next edition of Carnival of Financial Planning using our carnival submission form. Past posts and future hosts can be found by clicking here.

***Photo courtesy of https://upload.wikimedia.org/wikipedia/commons/b/be/Boston_marathon_mile_25_gatorade_volunteer_050418.jpg

Using The Internet To Save On Housing

The following is a post by our featured writer Gary Parkinson. Enjoy! 

The latest US housing news is that the market has turned a corner after years of struggling during and following the recession.  If you are a first time home-buyer or looking to refinance, today’s market offers plenty of opportunities for you to secure an affordable mortgage plan.

Unless you have $500,000 put away in a special savings account, you will require a mortgage to buy or refinance your home.  But for years, the mortgage application process was considered tedious at best, particularly as web development made it easy to acquire information within minutes.  As time went on, retailers started selling products online, which shoppers could browse and purchase from the comfort of their own home.

The online shopping concept worked well for retail products, and is now a process that you can use to acquire a mortgage as well.  You can compare low mortgage rates from some of the leading firms across the country, and select a plan that addresses your unique financial needs.

The online comparison experience revolutionizes the mortgage application process by making it more convenient for you as a home buyer.  The traditional application process required you to take time out of your day to visit a bank or a mortgage broker, and participate in a back and forth negotiation over the terms and rates.  But as time goes on and advancements are made in technology, traditions become outdated and largely forgotten.

In addition to saving time, you will in all likelihood save money because you have access to all viable mortgage providers in one convenient spot.  In some cases, banks or brokers dictate what they feel is a fair and affordable mortgage plan.  By shopping online, you put the control firmly in your hands, and can select the best option without pressure from another party.

The housing market went on quite a roller coaster ride over the last few years, but you can definitely put the current conditions to good use with some helpful tools.  The Internet is a powerful tool that helps make life more convenient – it’s about time that home buying is made more convenient too.

How about you all? If you have taken out a mortgage to purchase a home or investment property, how did you approach the process? Did you use a bank, a mortgage broker, or an online resource? 

Share your experiences by commenting below!

Jacob’s Thoughts – Listed below are my random thoughts as I was reading this article.

• Even if you end up utilizing a regular bank or mortgage broker to secure a mortgage, I think it is valuable to use online resources at the very least to do some comparison shopping to make sure your financial representative at the bank or brokerage is in fact giving you a competitive deal!

***Photo courtesy of http://pixabay.com/get/10c96fd7ac86cff867c2/1366488229/house-48815_1280.png

Should You Get a Safety Deposit Box?

————————————————————————————————————————
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!
————————————————————————————————————————

Click here to enter my free $50.53 giveaway for a chance to win 5% of My Personal Finance Journey blog income and give another 5% to a charity of your choosing! Deadline to enter is April 30th, 2013.

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.

Everyone loves to have jewelry and valuables in their possession, even if only for the money they can bring in during times of a financial crisis. But, they can also be problematic if you own more than a handful. Keeping expensive jewelry at home is usually not a good idea as thieves, burglars, and even greedy visitors can steal them. You can also lose them in a fire, flood, and other natural disasters, and they could potentially not be covered by your insurance. The safest place to keep your jewelries and valuables is in a safety deposit box in a bank.

The safety deposit boxes in a bank are extremely strong; and they are vaulted and sealed for added security. They are safe from theft, burglary and robbery. They are also better protected from fire, flood, and other disasters than at home. However, they are not without faults; the chief being that they are not available to you 24/7.

But first, let’s look at the pros and then go on to examine the cons:

The Pros of having safety a deposit box:

• It is safe from thieves, burglars and robbers: Safety deposit boxes in banks are heavy, strong and sealed. They are kept inside well-guarded vaults deep inside the building. Thieves and burglars cannot get inside the vaults. Even armed robbers sometimes do not try to make their way into the vaults because they find the endeavor to be too risky.

• It is safe from fire, flood and disasters: Since safety deposit boxes are kept in heavily fortified vaults deep inside the bank, they are usually safe from fire, flood and other disasters, whether natural or man made. Of course, nothing is completely secure from a really big disaster, such as a devastating earthquake or nuclear attack, but that rarely happens.

• It is cost-effective: Banks usually charge between $15 and $25 per year for the smallest boxes and between $185 and $500 for the largest boxes. There are other sizes between these two sizes. Considering the value of your jewelries and how much you stand to lose if they are stolen, a safety deposit box is highly cost-effective.

• You can use the box to store anything of value: A safety deposit box is not only for jewelry and ornaments. It is also for other valuables such as important documents, photographs and letters. In fact, you can store any personal effects you like in it for safekeeping as long as they fit inside the box.

• Only you will have access to your box: No one except you or your agent or power-of-attorney will have access to it. In case of your death or disappearance, only your designated beneficiary will have access to it. This makes it safe from your own family and relatives. If you don’t trust your own family members, then it’s a good idea to keep your valuables in a safety deposit box.

The Cons of having a safety deposit box:

• You do not have 24/7 access to your belongings: Since your safety deposit box is kept inside the vault of the bank and the bank doesn’t open 24/7, you will not have access to your belongings at any odd hour you need them. If you need your jewelry often and at a short notice, then it is impractical to keep them in a safety deposit box.

• Your box can be frozen by the IRS: If you have been accused of any financial irregularities, the IRS may freeze your box until you have been cleared of the charges. The bank may also freeze your box if they suspect that you have gotten the contents in the box by unlawful means. They may also open it and examine its contents. During this period, you will not be able to access your box.

• You must keep the key in a safe location: If you lose the key to your safety deposit box, the bank may charge you a very high fee for a replacement. Therefore, you must keep your key in a safe location at all times. This can be problematic if you often forget where you place things. You can leave it at the bank for safekeeping, but you will have to pay an extra charge for that.

• The box has a limited size: You cannot store large items in the safety deposit box as it has a limited size. Generally, the box sizes range from 2″ x 5″ x 11″ (smallest) to 15″ x 22″ x 12″ (largest). Even the largest box is only large enough for jewelry and other small items. So they are not good for safekeeping large items.

How about you all? Do you have a safety deposit box, if you don’t mind sharing, what’s in yours? 

Share your experiences by commenting below!

***Photo courtesy of Stuart Conner

What International Equity Asset Allocation Level Should You Use in Your Portfolio?

————————————————————————————————————————
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!
————————————————————————————————————————

Click here to enter my free $50.53 giveaway for a chance to win 5% of My Personal Finance Journey blog income and give another 5% to a charity of your choosing! Deadline to enter is April 30th, 2013.

As you’ve probably noticed here lately, I have been doing a lot of analyses of my own personal finances and investing strategy. In the course of these analyses, I have been re-reviewing some of the books that helped me formulate my passive investing strategy several years ago.

One fascinating topic of analysis that I wanted to take a look at in today’s post is an answer to the following question – “What is the best international equity allocation level one should use in their portfolio?” Well – let’s investigate this further!

Why Bother Adding International Equity / Stocks to Your Portfolio in the First Place?

In my opinion, adding the international equity asset class is the 3rd most important decision one makes in putting together their investment portfolio (right after #1 – choosing passive investing over the loser’s game of active management and #2 – deciding your overall equity/fixed income asset allocation based on your personal risk tolerance and investing horizon).

So, why is the addition of international equity such an important step to constructing a portfolio?

Essentially, it all comes down to correlation and diversification. Since international equity, US domestic equity, and fixed income portfolio components all move up and down in different ways/magnitudes, you get a diversification benefit by including them in your portfolio.

In simpler terms, this means that by adding international stocks, you get a higher overall portfolio return at a lower volatility/risk level (sometimes called efficient frontier). This is perhaps the most exciting and interesting thing to me regarding portfolio construction!

WHAT DO THE BOOKS SAY? – Optimal International Equity allocation

Conclusion from the literature – From the books written by the three authors above (some of the best on asset allocation I have found to date), it seems that the optimal allocation for international equities is between 30-40% of total equity holdings, with 40% likely being the “most efficient” single point.

International Equity AS A 1-COMPONENT PORTFOLIO

Having taken a look at the advice given in the literature about the best levels in which to hold international equities in one’s asset allocation, I then wanted to do some of my own analysis and number crunching to see how things looked for myself over a time scale I could control.

To do this, I went to Yahoo Finance (the site where I always get my historical pricing data) and downloaded the historical price information for the 4 Vanguard mutual funds shown below:

• Vanguard Total US Stock Market Index Fund, Ticker Symbol VTSMX.
• Vanguard Total International Stock Index Fund, Ticker Symbol VGTSX.
• Vanguard Short-Term Bond Index Fund, Ticker Symbol VBISX.
• Vanguard Emerging Markets Index Fund, Ticker Symbol VEIEX.

Whenever I do these types of back-test analyses, I generally like to pick the longest time period I can get access to. In this case, the historical pricing data only went by 16.75 years, to 1996. Therefore, the time period I chose for the analysis was 1996-2013 (present).

First, I wanted to analyze the pure fluctuations/growth of the individual mutual funds (1-component portfolios) over the time period. To do this, I simulated the growth of a $10,000 initial investment in 1996 in each of these funds.

The graph below shows the overall results, where the blue line = Vanguard Total US Stock Market Index Fund, the red line = Vanguard Short-Term Bond Index Fund, the green line = Vanguard Total International Index Fund, and the light blue line = Vanguard Emerging Markets Index Fund.

To add some definite numbers to the performance of the 1-component portfolios shown in the chart above, I generated the table below, displaying year-to-year, month-to-month, and total return data for the 1996-2013 holding period.

The chart and table above shows us some interesting findings.

• As we would definitely expect, all 3 of the stock funds are MUCH MUCH MUCH more volatile than the short-term bond index fund.
• The total international equity fund performed pretty terribly during this 17 year time period, with the final portfolio position only equally that of the short-term bond fund. I’m sure this will greatly affect our analysis of the correct international equity to hold, likely introducing some severe recency bias for us to watch out for!
• It appears that the most volatile portfolio was the emerging markets one, as we might expect.
• It is also rather significant to see that the portfolio direction changes of the 3 stock portfolios are not always the same, thus giving us some likely diversification benefit by using a combination of international equity in our portfolio.

International equity IN A 3-COMPONENT PORTFOLIO — 1996-2013 (17 Years)

While examining the “personality” of an asset class in the isolation of a 1-component portfolio is interesting, an even more important thing to look at is how the fund will perform when mixed in as part of an investor’s real life asset allocation.

To investigate this activity, I simulated the growth of the same $10,000 initial investment from 1996-2013 (present) using a 70% equity / 30% fixed income overall asset allocation portfolio. The 30% fixed income portion consisted solely of the Vanguard Short-Term Bond Index Fund mentioned previously, while the 70% equity allocation was split up employing varying levels of international equity (Vanguard Total International Stock Index Fund) holdings, from 0-60% of total equity position, along with using the Vanguard Total US Stock Market Index Fund for the domestic equity allocation..

The return data for the growth of the $10,000 initial investment from 1996-2013 utilizing various levels of international equity can be seen in the table below:

Lastly, if we look at the far right column of the table above (the inverse of the return/risk curve slope), we see that the largest numbers occur between 10-30% international equity levels. What this means in plain English is that we get the largest decrease in volatility per unit decrease in return between 0-30% international equity. This is definitely the area where we would want to have been during this period. Having more international equity would have given us more decrease in return than decrease in risk.

Conclusion from 3-Component Portfolio, 1996-2013 Holding Period – From this specific analysis, we saw that the most efficient international equity allocation was a meager 10% of your total equity position, much less than the 40% being touted by the literature as being the most efficient point. However, we also saw that having any amount of international equity decreased volatility at the same time as decreasing return, with 10-30% international allocation featuring the greatest decrease in risk (being in this range wouldn’t be the most terrible thing ever!).

INTERNATIONAL EQUITY IN A 3-COMPONENT PORTFOLIO — 1972-2011 (~40 years)

Truthfully, I was a little shocked at the results above. 

After all, a 10% international equity maximum efficiency is quite a bit than the 40% point that was found by the literature! This got me thinking that either a) the 17 year time period I used was not long enough to capture history in a representative way or b) my calculations are off.

In order to investigate the situation further, I decided to expand the years of my analysis to the time period of 1972-2011, since these were the years covered by Simba’s return data spreadsheet from the Bogleheads forum.

I then modeled the average annual returns during this ~40 year time period of the same 70/30 equity-fixed income allocation portfolio mentioned above at varying levels of international equity exposure (0-60%, as a % of the total equity position). In order to meld the analysis to the data available in the spreadsheet, the 3-components held in the portfolio were the Total US Stock Market (domestic equity position), Total International Market (international equity position), and the Short-Term Treasury Fund (fixed income position). 

Shown below is a graph plotting the annual return (y-axis) vs. the risk/volatility/standard deviation (x-axis) at varying levels of international equity exposure, from 0-60% of the total equity holding position. Also pasted below is the table with the data that the graph was constructed from.

In my humble opinion, the graph and data shown above would fall in to what I would call the “beautiful” category. What I mean by this is that it is a textbook example of the magic of diversification and portfolio construction / asset allocation.

Let’s walk through it. Start off at the bottom of the curve, which corresponds to a portfolio having an equity position consisting of 0% international stocks. As we increase the international equity to 10-30% (each point/plot on the graph represents 10% more international equity), we see something amazing – volatility decreases, but average return increases! Pretty sweet, right?!  

In fact, the standard deviation of the portfolio does not start increasing back to what it was when we just had US domestic equity until an international equity allocation of 40%! In terms of the maximum return/risk ratio, this data indicates that the most efficient point is when international stocks = 30% of total equity holdings. However, it is also significant to note that if you can tolerate more risk, you would have obtained a higher return with an even greater (40-50%) international allocation level.

If you’re interested in looking through all of the details/numbers of this analysis, you can access the Google Docs spreadsheet by clicking here.

Conclusion from 3-Component Portfolio, 1972-2011 Holding Period – 30% international equity as a percentage of total equity holdings was found to be the most efficient in terms of highest return with lowest risk.

CONCLUSIONS, MY CURRENT International ALLOCATION, AND PATH FORWARD

So, after going through all of this investigation comparing varying levels of international equity, what’s the overall verdict? Well, I think it can be summed up in a couple of key-points:

• The literature suggests that an “optimal” amount of international equity holdings is 30-40% of your portfolio’s total equity position. 40% is most often quoted as the most efficient single point.
• My analysis of the 17 year, 1996-2013 holding period was confounded by international equities having returns of approximately 1/2 of US domestic equity. While all international equity allocations decreased both risk and return, an allocation between 10-30% international preserved return while decreasing risk the most efficiently.
• Extending the analysis to the 40 year period from 1972-2011 revealed that 30% international equity as a percentage of total equity holdings was found to be the most efficient in terms of highest return with lowest risk.

How about you all? What % of your portfolio’s total equity position is invested in international stocks/funds?

Have the movements in the international markets ever caused you to be alarmed/change your strategy, or did you not have that much trouble keeping a long term focus?

Share your experiences by commenting below!

Which Short-Term Bond Mutual Fund Should You Use For Your Fixed Income Asset Allocation in Taxable and Tax-Sheltered Accounts?

————————————————————————————————————————
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!
————————————————————————————————————————

Click here to enter my free $50.53 giveaway for a chance to win 5% of My Personal Finance Journey blog income and give another 5% to a charity of your choosing! Deadline to enter is April 30th, 2013.

As I discussed in a post last week where I analyzed intermediate- and long- vs. short-term bonds, I determined that the stability that short-term bond offered made them better suited for my personal investment needs. This was my conclusion in spite of the significant finding that intermediate-term bonds are in fact more efficient in terms of the risk-adjusted return provided.

Having determined that short-term bond funds are best suited for my needs, the question then becomes, “What is the best specific type of short-term bond fund for my needs?”

Seeking out an answer to this question will be the topic of today’s post. Let’s get started!

What Short-Term Bond Mutual Fund Options are Available?

Since my experience has shown that no one is able to consistently beat Vanguard when it comes to low-cost investing, I will focus my screening to the funds that Vanguard offers.

A quick search through the Vanguard database reveals the following short-term maturity bond mutual funds on offer (all credit qualities shown):

• Limited-Term Tax-Exempt, Ticker Symbol VMLTX
• Short-Term Tax-Exempt, Ticker Symbol VWSTX
• Short-Term Bond Index, Ticker Symbol VBISX
• Short-Term Federal, Ticker Symbol VSGBX
• Short-Term Investment-Grade, Ticker Symbol VFSTX
• Short-Term Treasury, Ticker Symbol VFISX

Since the purpose of my fixed income asset allocation is STABILITY, I am not interested in holding anything but the highest credit quality bonds. This restriction removes the Short-Term Investment Grade fund from the list of eligible options, leaving the 5 options shown below:

• Limited-Term Tax-Exempt, Ticker Symbol VMLTX
• Short-Term Tax-Exempt, Ticker Symbol VWSTX
• Short-Term Bond Index, Ticker Symbol VBISX
• Short-Term Federal, Ticker Symbol VSGBX
• Short-Term Treasury, Ticker Symbol VFISX

A Look Inside the Short-Term Bond Fund Options

In my experience, a highly valuable, yet often overlooked type of analysis is to simply read IN DETAIL about what a mutual fund actually holds. It’s so simple because this information is freely available from the fund provider’s website and/or fund prospectus, yet often, I’ve found investors (I am even guilty of this I admit) don’t take the time to really understand a mutual fund before investing in it.

As such, listed below is a look inside each of the short-term bond fund options:

• Limited-Term Tax-Exempt, Ticker Symbol VMLTX
• Invests in short-term, high-credit quality (AA and AAA) municipal bonds with a maturity around 2+ years.
• 90% municipal bonds
• 8% cash
• Average bond holdings maturity = 2.6 years. 
• Short-Term Tax-Exempt, Ticker Symbol VWSTX
• Invests in very short-term, high-credit quality (AA and AAA) municipal bonds with a maturity between 1-2 years.
• 85% municipal bonds
• 15% cash
• Average bond holdings maturity = 1.3 years. 
• Short-Term Bond Index, Ticker Symbol VBISX
• Passively managed index fund that holds representative bonds in such a way that it tracks the Barclays US 1-5 year government/corporate bond index (short-term investment grade US bond market).
• Average bond holdings maturity = 2.8 years. 
• Invests in short-maturity U.S. Treasury, agency, and investment-grade corporate securities. Listed below are the major category percentages.
• 62% Treasury
• 8% US agency
• 21% corporate bonds
• 2% cash
• 0.2% mortgage backed securities
• 7% other government securities
• Short-Term Federal, Ticker Symbol VSGBX
• Fund that holds short-term bonds issued either directly by the government in the form of Treasury bills or by federal agencies. Listed below are the major category percentages.
• 7.5% Treasury
• 72% US agency
• 10% mortgage backed securities
• 11% cash
• Average bond holdings maturity = 2.3 years.
• Short-Term Treasury, Ticker Symbol VFISX
• Fund that invests in almost exclusively (99.99%) short-term maturity Treasury Bills issued by the US government.
• Average bond holdings maturity = 2.3 years. 
• Has essentially zero credit risk since T-Bills are backed by full faith and credit of the US government.

Just by reading through this information, there are a couple potential red flags (highlighted in red text above) in the structure of the Short-Term Federal and Short-Term Tax Exempt Funds that could make these unattractive to me.

• With the Short-Term Tax Exempt Fund: 
• The average maturity is only 1.3 years, which is a little shorter than I would like for someone with a long term investing focus like I have. 
• In addition, the fund holds a fairly large position in cash (15%). This often can be a sign that the fund has to keep a lot of cash on hand to handle redemptions of investors pulling their money out. 

• With the Short-Term Federal Fund:
• The most significant issue, in my opinion, is the lack of exposure to US Treasury securities (only 7.5%). 
• Instead, the fund is overweighted in US agency and mortgage-backed securities, which can cause an unnecessary increase in exposure to risk. 

What Do the Experts Say About the Type of Short-Term Bonds to Use?

Short-Term Bond Fund Options as a 1-Component Portfolio

Having taken a look at the advice given in the literature about which type of short-term bonds to hold in one’s fixed income allocation, I then wanted to do some of my own analysis and number crunching to see how things looked for myself over a time scale I could control.

To do this, I went to Yahoo Finance (the site where I always get my historical pricing data) and downloaded the historical price information for the five Vanguard bond mutual funds investigated above.

Whenever I do these types of back-test analyses, I generally like to pick the longest time period I can get access to. In this case, the historical pricing data only went by 16.75 years, to 1996. Therefore, the time period I chose for the analysis was 1996-2013 (present).

First, I wanted to analyze the pure fluctuations/growth of the individual mutual funds (1-component portfolios) over the time period. To do this, I simulated the growth of a $10,000 initial investment in 1996 in each of these funds.

The graph below shows the overall results, where the dark blue line = Vanguard Short-Term Treasury Fund, the red line = Vanguard Short-Term Bond Index Fund, the green line = Vanguard Short-Term Federal Fund, the purple line = Vanguard Short-Term Tax Exempt Fund, and the light blue line = Vanguard Limited-Term Tax Exempt Fund.

Just by inspecting the graph above, there are a couple interesting observations that can be seen:

• As expected, the tax-exempt municipal bond funds featured a lower return over the ~17 year holding period, since the returns are tax-free.
• It is interesting to note that the performance of the Short-Term Treasury, Bond Index, and Federal Funds only really started to diverge in the past 5 years or so since the market downturn in 2008-2009. 

Short-Term Bond Fund Options in a 2-Component Portfolio

While examining the “personality” of an asset class in the isolation of a 1-component portfolio is interesting, an even more important thing to look at is how the fund will perform when mixed in as part of an investor’s real life asset allocation.

To investigate this activity, I simulated the growth of the same $10,000 initial investment from 1996-2013 (present) using a 70% Vanguard S&P500 Index Fund equity allocation and 30% fixed income allocation utilizing either of the 5 Vanguard Short-Term Bond Funds mentioned above.

The growth of the $10,000 initial investment in the various 70/30 2-component equity/fixed income portfolios can be seen in the graph below, where the dark blue line = using the Vanguard Short-Term Treasury Fund, the red line = using the Vanguard Short-Term Bond Index Fund, the green line = using the Vanguard Short-Term Federal Fund, the purple line = using the Vanguard Short-Term Tax Exempt Fund, and the light blue line = using the Vanguard Limited-Term Tax Exempt Fund. For reference, I have also included the growth that would have occurred if the Vanguard S&P500 Index Fund was used by itself (100% equity, no fixed income – orange line).

Although this graph is somewhat “pretty” to look at, I’m afraid it doesn’t tell us all that much, with the exception that incorporating the Vanguard Short-Term Treasury, Bond Index, and Federal Fund essentially results in the same performance over the time period utilizing a 70/30% equity/fixed income asset allocation.

In this case, I think that looking at the return data during this 17 year time period provides a much more interesting perspective (shown in table below).

Indeed, when we inspect the data in the table above, we see that there is really not that much of a difference between utilizing the three nominal (non tax-exempt) Vanguard bond funds for the fixed income portion of your portfolio. Essentially, this tells us that any of these choices would be fine, and that it is just up to personal preference.

As expected from the 1-component analysis previously, utilizing the Short-Term Bond Index in a 70/30 asset allocation portfolio yields on marginally higher average annual return, but in fact gives the same overall return as using the Short-Term Federal Fund.

It is also quite interesting to see that incorporating the Short-Term Federal Fund yields 1.3% decrease in risk/standard deviation, but only at the cost of a 0.26% decrease in average annual return. What this indicates is that the Short-Term Federal Fund is slightly less correlated with the returns of the S&P500 than the Short-Term Bond Index Fund. This possibly could stem from the fact that the Short Term Bond Index Fund holds 20% corporate bonds, which would likely be more highly correlated with the performance of corporate equity (i.e. the S&P500).

Conclusion from 2-Component Portfolios – From the 2-component portfolio analysis above, we see that there is not a HUGE difference between utilizing any of the three nominal Vanguard bond funds for your fixed income allocation (decision would likely come down to personal preference). However, it was found that the most efficient tool at providing the highest risk-adjusted return was the Short-Term Federal Fund. 

Note: If you want to view all of the details of the calculations I used for the 1 and 2 component portfolio back tests, click here to download a copy of the Google Docs Spreadsheet.

Which Short-Term Bond Fund is Best for Taxable Accounts, Specifically?

Thus far, I have somewhat ignored the use of tax-exempt bond funds because of their lower pre-tax returns compared to the 3 nominal bond funds. Indeed, for investors that are focusing on their tax-sheltered accounts, there is no reason to invest in tax-exempt bond funds. 

However, the decision is not so simple for investors that are placing money in their after-tax accounts since you need to take in to consideration your current tax bracket.

• The general advice given by books such as The Only Guide You’ll Ever Need for the Right Financial Plan is that it is better to hold tax-exempt over nominal bonds in taxable accounts for all investors that are not in the lowest (15% tax bracket). 

While this is a good rule of thumb, let’s see how it stacks up with our numbers from the 1-component portfolio analysis above:

• To do this, we’ll compare the average annual returns of the Short-Term Bond Index (nominal – subject to federal and state income taxes) and Limited-Term Tax Exempt Funds (exempt from federal but not state income taxes). 
• The Limited-Term Tax Exempt Fund was chosen as the tax-exempt bond fund of choice since it is more efficient in a 2-component portfolio setting than the Short-Term Tax Exempt Fund. 
• For the sake of simplicity, we will assume a constant 7% state income tax rate.
• Short-Term Bond Index Fund:
• Average pre-tax annual return = 4.96%.
• – Minus 7% state income tax = 4.61%.
• – Minus 15% federal income tax (my current tax bracket) = 3.92%.
• For comparison reasons, if your federal tax bracket had been higher at 25%, the federal + state income tax adjusted return would = 3.46%.
• Limited-Term Bond Index Fund:
• Average pre-tax annual return = 3.78%.
• – Minus 7% state income tax = 3.52%.

As we can clearly see here, the general rule of thumb mentioned above was indeed correct. Taxable fixed income money should be invested in the Limited-Term Tax Exempt (Municipal) Bond Fund unless an investor (like I am) is in the lowest, 15% tax bracket.

For investors like me with low income, I am better off investing in nominal bond funds in my taxable account (at least for the time being until my income goes up after graduate school).

CONCLUSIONS, MY CURRENT Short-Term FIXED INCOME ALLOCATION, AND PATH FORWARD

So, after going through all of this investigation comparing 5 short-term bond options, what’s the overall verdict? Well, I think it can be summed up in a couple lines:

Creating Your Own Three Legged Stool for Retirement – How Much of Your Investments Should be in Tax-Deferred, Taxable, and Tax-Free Accounts?

————————————————————————————————————————
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!
————————————————————————————————————————

For the past few years since finishing college, I have been somewhat bad in regard that I have been aggressively, but blindly, saving for the future/retirement.

What I mean by this is that I have been so focused on the input of saving money for retirement that I forgot to consider how the output would be affected when I went to withdraw those funds.

However, the good news is that the past month, I have been doing a lot of analysis of my current investment allocation location, learning about the withdrawal treatment rules of the accounts in which my funds are in, as well as learning about new options available to me to improve location distribution of my assets.

Going along with this effort to learn more about optimized location distribution of my retirement investments, I recently read the book, The New Three-Legged Stool: A Tax-Efficient Approach to Retirement Planning, by CFP and retirement planning specialist, Rick Rodgers.

If this is the first time you are hearing about the NEW Three-Legged Stool for Retirement (the old Three-Legged Stool, which consisted of Social Security and Pensions is no longer relevant, so we’ll ignore that for now), it is a retirement planning concept that employs utilizing ALL three different types of investment accounts/locations (based on their tax treatment) shown below, in an effort to more efficiently prepare yourself financially for retirement:

• Leg # 1 -Tax-Deferred Accounts (IRA, SEP IRA, Traditional IRA, Rollover IRA, Traditional 401(k), Annuities)
• Leg # 2 – After Tax Accounts (taxable accounts – not tax-advantaged, including municipal bonds since income from that does increase your gross income, although that specific income is generally not taxed)
• Leg # 3 – Tax-Free Accounts (Roth IRA, Roth 401k, cash-value life insurance)

Rodgers introduces a concept called the R/D Factor as a way to take withdrawals from these different accounts during retirement in a tax-efficient manner. In a nutshell, he advises that an efficient way to fund your retirement is to:

• 1) Take income during retirement from your accounts in such a way that 1/2 of your total income each year is taxable, and the other 1/2 is non-taxable.
• 2) When you reach retirement, the ideal goal is to have money saved up equally in all three legs.

I really liked the idea behind this because in my experience, it’s always nice to have various options available to you when it comes to finances because you never know what the future will bring with tax law changes, etc.

However, one important question that was not expressly covered in the book is, “When you are saving for retirement, how much of your investments should be distributed in tax-free, after tax/taxable, and tax-deferred accounts, respectively?”

In searching around the Internet and reading through several of the investing strategy books I have accumulated the past few years, it seems that detailed guidance to this question is quite hard to find, although there was some good loose guidance on one Bogleheads thread I read based on other people’s asset distribution.

In an effort to seek out some sort of answer to this question, I emailed Rick Rodgers directly. Essentially, what he recommends for his clients varies on a person-to-person basis. However, the distribution decision is generally based on the person’s marginal tax bracket being at or above the 25% cutoff, or if it is lower. If you’re not sure about what the tax brackets look like based on taxable income levels (note this is different than gross income or Adjusted Gross Income), take a look at this really good page that Mike Piper over at Oblivious Investor put together – Tax Brackets 2013.

To give us a starting point, listed below are the base/lowest taxable incomes that would qualify someone to start having to pay 25% income taxes, split up based on filing status. If you can get your taxable income $1 below these amounts, you will be in the the 15% tax bracket, so a pretty nice decrease!

• Single – $36,251.
• Married filing jointly – $72,501
• Head of household – $48,601
• Married filing separately – $36,251

From here, let’s dig a little deeper to try to develop some real-life guidelines for how this rule of thumb would affect asset location distribution between the three “legs” discussed above:

Investment Distribution For People Who Are Already in the 15% or Lower Marginal Taxable Income Tax Bracket

The first possibility that we run in to in developing a set of working asset distribution guidelines is the case where someone is ABSOLUTELY certain that he or she will be in the 15% or lower marginal tax bracket.

To illustrate this situation with a few possible scenarios, this could be someone who files singly and only makes $35,000 per year in GROSS income, or if a young married couple was filing jointly and only one member of the family worked at a starting job out of college that earned $60,000 per year.

In this case, since you are in perhaps lowest tax bracket, you want to take advantage of the situation and pay taxes now instead of paying them during retirement. In Three-Legged Stool retirement language, you would want to emphasize tax-free and after-tax/taxable accounts.

To execute upon this strategy if I knew I was going to be in the 15% or lower tax bracket no matter what, I would take the following approach:

• Contribute to your 401k (preferably, a Roth 401k – be sure to ask your employer about this newer option!), but only enough to get the free money match offered by your employer. 
• Max out your tax-free Roth IRA each year.
• Invest an equivalent amount in after-tax/taxable accounts until you feel comfortable that you have enough to meet your pre-retirement needs.
• If you have a traditional 401k/IRA that you have been contributing to (perhaps too much even in the past), continue to look for opportunities (particularly when the stock market is low) to rollover your tax-deferred investments to a Roth 401k/IRA option that allows you to pay taxes on it now vs. in the future when you are at a higher tax bracket.
• Max out your Roth 401k. If your employer doesn’t offer a Roth 401k option, don’t invest further in your 401k. Invest in your taxable account instead.
• Continue investing in your taxable account.

On the opposite end of the spectrum from the group of folks discussed above, we need to develop some general guidelines for higher-income earners that, despite the introduction of any amount of deductions they can reasonable execute, cannot reduce their overall taxable income below the 25% tax bracket income limits.

In this case, since you are in a medium-to-high tax bracket, you want to take advantage of the situation by deferring the payment of taxes until later when you can give yourself a chance at being in a lower tax bracket. In Three-Legged Stool retirement language, you would want to max out tax-deferred accounts and only start contributing excess amounts to after-tax and tax-free accounts once your tax-deferral options have been satisfied.

To execute upon this strategy if I knew I was going to be in the 25% or higher tax bracket no matter what, I would take the following approach:

• Contribute to your traditional 401k up to the company matching level.
• Contribute to and max out your traditional (pre-tax) IRA.
• Invest an equivalent amount (as your annual IRA contribution) in after-tax/taxable accounts until you feel comfortable that you have enough to meet your pre-retirement needs.
• Specifically, I would investigate tax-advantaged non-retirement investments such as tax-exempt municipal bond funds.
• Continue funding and max out your traditional 401k.
• Continue investing your tax-free and taxable account options
• Possibly considering funding an annuity to further shelter short term earnings.
• Consider funding a Roth IRA in some years, or if you don’t qualify for a Roth IRA due to income restrictions, consider a backdoor Roth IRA conversion.

In between the two groups discussed above of higher income earners (definitely in the 25% tax bracket or above) and earners in the 10-15% tax bracket, we have a fascinating group that is sort of “on a fiscal fence.” What makes them special is that they are looking at a significant decrease in taxes if they can get to their taxable income decreased slightly (through tax deductions) to the realm of the 15% tax bracket.

In terms of the investment accounts we’re discussing here, I will estimate that being “within reach” of the 15% tax bracket is having a currently-estimated taxable income of $5,000-$10,000 more than the income limits described above for the break between tax brackets (so $36,251 + $5-10k for single filers and $72,501 + $5-10k for joint filers). 

In this case, since you are within striking distance of entering the lowest tax bracket, you want to take advantage of the situation reduce your taxable income so you qualify for the lower tax level! In Three-Legged Stool retirement language, you would want to first emphasize tax-deferred accounts until you enter the 15% tax bracket, then switch to focusing solely on tax-free and after-tax/taxable accounts for the rest of the year.

To execute upon this strategy if I knew I was within reach of the 15% tax bracket, I would take the following approach:

• Contribute my pre-tax 401k (NOT a Roth 401k) enough to get the free money match offered by your employer. 
• Continue contributing to a pre-tax 401k or traditional IRA until you have reduced your taxable income to qualify you for the 15% income tax bracket.
• Now that you’re paying very little in taxes, max out your tax-free Roth IRA each year.
• Invest an equivalent amount in after-tax/taxable accounts until you feel comfortable that you have enough to meet your pre-retirement needs.
• Max out your Roth 401k. If your employer doesn’t offer a Roth 401k option, don’t invest further in your 401k. Invest in your taxable account instead.
• Do not focus on rolling over your tax-deferred investments to a Roth 401k/IRA option that allows you to pay taxes on it now vs. in the future since this would increase your taxable income and push you back up in to the 25% tax bracket you just tried so hard to leave!!!
• Continue investing in your taxable account. 

There are No Set Distributions Percentage Guidelines Prior to Retirement

Don’t Forget the End Goal – At Retirement, Have a Balance Among All Three “Legs”

In an ideal world, investors would naturally pass through the different tax bracket stages discussed above as they progress in their career.

For example, a 22 year old that has just graduated from college and beginning their career will likely have a lower income. Thus, this person would focus their investing during their 20’s in tax-free Roth and after-tax accounts. Then, when they are older and their income has gone up, they will scale back their tax-free investing to focus on building their tax-deferred base, throwing their remaining savings in to taxable accounts. The goal of this flow is to allow the tax-free/taxable accounts to compound longer to give them a chance to naturally be on par with the tax-deferred asset base. In this way, you naturally achieve the target 1/3 / 1/3 / 1/3 split of your assets among the three account types by the time you hit retirement.

This is how the Three-Legged Stool approach would work in an ideal world.

However, in the real world, I don’t think it often happens that way. People make mistakes, perhaps investing too heavily in tax-deferred accounts (or not saving/investing any money at all because funds are tight and they are not wise with finances yet) in their early, low income days. Before you know it, you have been working for 10 years and are making over $100,000 per year. What happens then? Do you just forget about having any tax-free income during retirement because you missed your window at a lower tax bracket when you are younger to focus solely on tax-deferred investing?

Because mistakes are a part of life, there is likely to be a very unbalanced Three-Legged Stool if you aren’t proactive in monitoring your asset distribution levels. 

• To prevent this imbalance at retirement age, a prudent course of action (that I will likely take – read more about my personal path forward below) is to calculate your % distribution in tax-free, taxable, and tax-deferred accounts each time you assess your portfolio’s asset allocation levels for potential rebalancing.
• I’d also recommend adding a line item indicating your current marginal tax bracket to whatever mechanism you decide to use for tracking your % distribution. This will help direct the flow of new money that becomes available for you to save. 

Since there are no set % guidelines for what your specific distribution should look like prior to retirement, you will have to use some person discretion here. However, I honestly believe that people are intelligent, and simply by actively calculating your distribution each year or month, you will be able to gauge whether corrective actions need to be taken so that you gain a more ideal distribution for retirement.

To illustrate how this tracking/corrective action process would potentially work, let’s consider a fictional 40 year old man named Bob. In the early part of his career, Bob was not very fiscally responsible with saving money in a Roth IRA and/or taxable accounts to take advantage of his low tax bracket.

He now makes $150,000 per year, putting him above the 15% tax bracket. In calculating his investment distribution among the three Legs, he sees that he has the following breakdown of assets: 5% in tax-free accounts, 40% in after-tax accounts, and 55% in tax-deferred accounts. From the investment distribution rules set forth above for people above the 15% tax bracket, Bob should technically be focusing his current investing in tax-deferred accounts. However, since he has such an imbalance in that his tax-free accounts are so low compared to the others, he would want to sacrifice some current tax savings to execute a backdoor Roth IRA conversion contribution in order for him to have some tax-free income to tap during retirement.

Overall, just be sure to remember that you should be getting closer and closer to achieving a 1/3 balance between all three legs as you get within say 3-5 years or so of retirement age!

Don’t Sacrifice Access to Savings Before Retirement!

As I mentioned above and previous posts, regardless of if you’re in a high or low current tax bracket, you don’t want to go too crazy contributing to retirement accounts (where the money is locked up until you reach 59.5 years old) unless you feel comfortable you have enough money saved up in after-tax accounts first. This would be money that could be accessible if an emergency, planned expense, or other opportunity came up in the future.

In short, don’t underestimate the power of having accessible money when putting together your Three-Legged Stool.

My Personal Three-Legged Stool Distribution Percentages and Path Forward

Truthfully, I was quite surprised when I calculated these percentages since even though there is some imbalance, I have pretty good representation in all three Legs. However, as I suspected/mentioned in my post about blindly saving for retirement, it does appear that the tax-deferred (401k/rollover IRA) bucket is the largest percentage of the three.

Nevertheless, it is clear in looking at these percentages that I have some room to improve in building up the tax-free account while I am in graduate school and WELL inside the 15% tax bracket, as I shared in my 2012 taxes review post the other day where I calculated that I only paid 14.6% of my overall income total taxes last year.

In an attempt to figure out a path forward for me, let’s take a look at the action steps I listed out for folks in the 15% tax bracket above:

• Contribute to your 401k (preferably, a Roth 401k – be sure to ask your employer about this newer option!), but only enough to get the free money match offered by your employer. 
• Graduate students don’t get 401k’s, let alone employer matches, so we can scratch this off the list! 
• Max out your tax-free Roth IRA each year.
• I am well on the way to doing this. I should have this maxed out by the end of April 2013, so we can put a check mark next to this one! 
• Invest an equivalent amount in after-tax/taxable accounts until you feel comfortable that you have enough to meet your pre-retirement needs.
• Even though I have enough readily accessible, liquid money saved for my forecasted cash needs for the next 1-2 years, something tells me that it would be beneficial to build this up further to meet un-expected needs, such as a house downpayment, buying a car, etc.
• This additional savings would be a little further down the road than the extremely liquid funds I need to for example, pay my estimated taxes each year. However, I just need it to be available in the regard that it is not in a retirement account that is penalized for accessing if needed.
• Because of these considerations, I believe my path forward will be to start committing my saved money to my taxable/after-tax Vanguard mutual fund account (specifically, in a short-term bond index fund for liquidity) after I finish maxing out my Roth IRA for 2013. As far as an amount to save, I’ll be shooting for an equivalent amount as I invested in my Roth IRA for 2013, $5,500.
• If you have a traditional 401k/IRA that you have been contributing to (perhaps too much even in the past), continue to look for opportunities (particularly when the stock market is low) to rollover your tax-deferred investments to a Roth 401k/IRA option that allows you to pay taxes on it now vs. in the future when you are at a higher tax bracket.
• Since the market is rather high right now, I don’t think I will bother with doing a Roth conversion. 
• Max out your Roth 401k. If your employer doesn’t offer a Roth 401k option, don’t invest further in your 401k. Invest in your taxable account instead.
• In lieu of Roth conversions, if I have more money to save after my planned after-tax savings above, I will start contributing to my Individual Self-Employed Roth 401k that I have just now set up.
• Continue investing in your taxable account.
• N/a since I have a Roth 401k option. 

How about you all? Approximately what percentage of your investments are currently held in tax-free, after-tax, and tax-deferred accounts?

Do you think that you will be able to reach the 33% 3-way split target recommended by the time you reach retirement between the three Legs? 

Share your experiences by commenting below!

***Photo courtesy of http://upload.wikimedia.org/wikipedia/commons/0/09/Liberty_-_Stool_Thebes_-_1884.jpg

Keeping Your Sanity as the Housing Market Heats Up

————————————————————————————————————————
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!
————————————————————————————————————————

Do Your Due Diligence

Don’t Get Into a Bidding War

Consider Other Neighborhoods

 

Ugly Homes Need Love Too

Share your experiences by commenting below!

***Photo courtesy of http://www.sxc.hu/photo/1394960

Surviving Your First Mortgage Application

————————————————————————————————————————
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!
————————————————————————————————————————

The Magnitude of the Situation 

Review Your Credit Report 

Review Possible Loan Terms

Use Online Loan Calculators

How about you all? Were you scared, excited, or a little bit of both before applying for your first mortgage?

What steps did you take to prepare yourself for the home-buying process?

Share your experiences by commenting below!

Jacob’s Thoughts – Listed below are my random thoughts as I was reading this article.

• When I purchased my first home (my current condo) back in 2010, one of the most useful things I did to prepare myself for the process was to read several personal finance books, paying special attention to the sections regarding buying a home.
• By reading these books, I was able to know what questions to ask to make sure I was getting through the deal with the most chance for success.

***Photo courtesy of http://pixabay.com/get/223d8652af15a61c1e7b/1365049150/icon-41335_1920.png

Should Short-Term or Intermediate-Term Bonds Make Up Your Fixed Income Asset Allocation?

Learning about investing is an interesting process.

In 2009-2010, I really started learning about passive investing and asset allocation by reading several books by David Bach, William Bernstein, Burton Malkiel, Jeremy Siegel, and Larry Swedroe (side note – isn’t it interesting that someone can get a BS in Finance/Financial Investments, but get out of undergrad without actually knowing how to invest your own money without teaching yourself?!).

By reading these books, I was able to learn enough to put together my asset allocation, figure out which low-cost index mutual funds to buy to make it all work, and then execute/maintain my investing strategy for the past few years without any trouble.

However, as I continue to study investing, I have recently found myself reading through these same books or websites that I read several years ago, but this time, being able to pick a lot of smaller details that I might not have understood the first time through.

One of these small nuances is the decision about how to invest the bulk of your fixed income asset allocation – should the money be placed in short-term or intermediate-term bonds?

Why Not Consider Long Term Bonds?

As I mentioned in a post several months ago where I examined whether it would be wise to incorporate long term bonds in to my portfolio, the whole purpose of my fixed income allocation is to help stabilize my portfolio from the ups and downs that are caused by my equity holdings.

Unfortunately, long term bonds simply don’t do this the way I want. They have a risk/volatility/standard deviation that is on par with the movement of the S&P500 index. Clearly, this is not what I am looking for.

What do the Books Say? – Intermediate vs. Short-Term Bonds

Before I jump in to a long-winded investigation/discussion of my own, I generally like to share any relevant advice from people that are much more qualified than myself. Listed below is what I could find in the literature about deciding between short and intermediate-term bonds for the fixed income portion of your portfolio:

• Larry Swedroe (probably my favorite investing author I have found to date)
  • In his newer 2010 book, The Only Guide You’ll Ever Need for the Right Financial Plan, Larry discusses how at a 60/40 asset allocation between equity and fixed income, Intermediate-Term Bonds give investors the highest Sharpe Ratio (or risk-adjusted return). However, as you increase the asset allocation to 80/20 equity/fixed income, Long-Term Bonds give investors the most efficient risk/return ratio. Quite an interesting finding!
  • Intriguingly, in Larry’s very good 2001 book, What Wall-Street Doesn’t Want You to Know, he states fairly globally that holding bonds with a longer maturity than 2-3 years causes a DECREASE in the Sharpe Ratio (decrease in the risk adjusted return). Clearly, this is different than what he stated in his 2010 book, and it is likely due to the fact that bond returns during the 2000’s were so good compared to stock returns. This same sort of recommendation for 2-3 year maturity bonds is given in the 2005 edition of his book, The Only Guide to a Winning Investment Strategy You’ll Ever Need.
• Burton Malkiel
  • In his famous and amazing book, A Random Walk Down Wall Street, Malkiel isn’t very specific about the short-term vs. intermediate-term bond decision. However, in one location, he does recommend a sample portfolio consisting of the Total Bond Market Fund, which is an intermediate-term (overall) bond fund. 
• William Bernstein (my 2nd favorite investing author I have found to date)
  • In his 2002 book, The Four Pillars of Investing, Bernstein generally sticks to recommending short-term bonds. However, he does mention that you get “the most bang (return) for your buck (risk) at a maturity of 5 years,” meaning intermediate bonds are the most efficient. But, a few sentences later, he recommends keeping the maturity of your bonds between 1-5 years because the stock portion of your portfolio is where you want to take risks, not your bond portion. Since the average maturity of most intermediate-term bond funds are between 5-7 years, it would seem to reason that Bernstein is sticking to recommending short-term bonds.
  • In his 2001 book, The Intelligent Asset Allocator, Bernstein also acknowledges that 5 year Treasury Notes (Intermediate-Bonds) are the most efficient at in returns of return with the least amount of risk. However, he does not actually recommend using Intermediate-Bonds in any of his sample portfolios in the book. Instead, he only recommends short-term bonds.

Clearly, this is a substantial amount of ambiguity based on the recommendations from Bernstein, Swedroe, and Malkiel above.

However, from a conservative perspective, I think I will interpret this mixed-bag of advice as meaning that although intermediate-bonds may be more “efficient” from a mathematical perspective, at a practical applications angle, it is likely better for investors to hold short-term bonds to minimize risks (and leave risk to be taken with the equity portion of the portfolio).

Short-Term vs. Intermediate-Bonds as a 1-Component Portfolio

Having taken a look at the somewhat confusing advice given in the literature about whether to hold short-term or intermediate-bonds in one’s fixed income allocation, I then wanted to do some of my own analysis and number crunching to see how things looked for myself over a time scale I could control.

To do this, I went to Yahoo Finance (the site where I always get my historical pricing data) and downloaded the historical price information for the two Vanguard bond mutual funds shown below:

• Vanguard Short-Term Treasury Fund, Ticker Symbol VFISX.
• Vanguard Intermediate-Term Treasury Fund, Ticker Symbol VFITX.

Whenever I do these types of back-test analyses, I generally like to pick the longest time period I can get access to. In this case, the historical pricing data only went by 16.67 years, to 1996. Therefore, the time period I chose for the analysis was 1996-2013 (present).

First, I wanted to analyze the pure fluctuations/growth of the individual mutual funds (1-component portfolios) over the time period. To do this, I simulated the growth of a $10,000 initial investment in 1996 in each of these funds.

The graph below shows the overall results, where the blue line = Vanguard Short-Term Treasury Fund and the red line = Vanguard Intermediate-Term Treasury Fund. I have also included the growth that would have occurred if the same $10,000 was placed in the Vanguard Long-Term Treasury Fund (green line) and the Vanguard S&P500 Index Fund (purple line).

In general, the chart above shows us some interesting findings.

• Long-Term Treasury bonds have outperformed the equity markets over the past 17 years or so.
• The price volatility appears to be in increasing order of – short-term bonds < intermediate-term bonds < long-term bonds < S&P500 Index, as we would expect.
• Intermediate-Term Treasuries have significantly outperformed Short-Term Treasuries the past 17 years or so.

To add some definite numbers to the performance of the 1-component portfolios shown in the chart above, I generated the table below, displaying year-to-year, month-to-month, and total return data for the 1996-2013 holding period.

If we specifically compare the Short-Term Treasury Fund to the Intermediate-Treasury Fund, we see the following things:

• Intermediate-Term Treasury Fund resulted in a 46.2% and 72.9% increase in average annual and total return, respectively, compared to Short-Term Treasuries. 
  • However, this increase in return only came at the cost of a 25.2% increase in standard deviation of annual return, indicating that the Intermediate-Term Treasury Fund is more efficient in terms of risk/return trade-off.
• Another noteworthy finding is what I found in terms of the minimum annual and monthly returns for the two funds.
  • What we find is that at the annual level (cells highlighted in blue above), the Short-Term and Intermediate-Term Treasury Funds have practically the same return minimum.
  • However, at the monthly return level (red text above), the Intermediate-Term Treasury Fund has a minimum return almost 4x more negative than the Short-Term Treasury Fund.
  • What this means is that even though the Intermediate-Term Fund might be more volatile in the shorter term, over a year, the volatility has tended to equal out over a year-long period.

Conclusion from 1-Component Portfolios – From this analysis, I think we can conclude that although the Intermediate-Term Bond Fund is more volatile at a monthly level, it is more efficient in terms of risk vs. return  than the Short-Term Bond Fund. 

Short-Term vs. Intermediate-Bonds in a 2-Component Portfolio

While examining the “personality” of an asset class in the isolation of a 1-component portfolio is interesting, an even more important thing to look at is how the fund will perform when mixed in as part of an investor’s real life asset allocation.

To investigate this activity, I simulated the growth of the same $10,000 initial investment from 1996-2013 (present) using a 70% Vanguard S&P500 Index Fund equity allocation and 30% fixed income allocation utilizing either the Vanguard Short or Intermediate-Term Bond Funds mentioned above.

The growth of the $10,000 initial investment in the various 70/30 2-component equity/fixed income portfolios  can be seen in the graph below, where the blue line = using the Vanguard Short-Term Treasury Fund, red line = using the Vanguard Intermediate-Term Treasury Fund. For reference, I have also included the growth that would have occurred if the Vanguard Long-Term Treasury Fund (green line) was used for the 30% fixed income allocation and if the Vanguard S&P500 Index Fund was used by itself (100% equity, no fixed income – purple line).

As we might expect, utilizing the Long-Term Treasury Fund for the 30% fixed income portion of the portfolio results in higher performance than using the Short or Intermediate-Term Treasury Fund. Interestingly, it also results in out-performance of the 100% equity portfolio during the time period as well.

The table below shows the year-to-year total return data for the 1996-2013 holding period utilizing a 70/30 fixed income/equity allocation of the 2-component portfolios.

If we focus in on the cells highlighted in blue on the table, we see something rather intriguing. Moving from the use of the Short-Term to Intermediate-Term Treasury Fund as the fixed income portion of the portfolio results in a 10% increase in average annual return, but the exact same risk/standard deviation. By using the Intermediate-Term Fund, you also experience a less negative minimum annual return than the Short-Term Fund! This is quite amazing! It would seem that this is a “free lunch,” so to speak

Conclusion from 2-Component Portfolios – Clearly, the results in the table above would indicate that Intermediate-Term Bonds are without a doubt the most efficient at delivering the highest risk-adjusted return. 

However, there are a couple things that hold me back from being so enthusiastic about jumping on the Intermediate-Bond “wagon.”

• The first “red flag” that gives me pause is the seemingly smooth performance of including Long-Term Treasuries as the 30% fixed income portion of the 2-component portfolio above.
  • By including this highly volatile bond asset class, you get almost a 10% increase in average annual return at the cost of only a 4.5% increase in standard deviation.
  • These numbers seem to indicate that the Long-Term Treasury Bond, in this holding period and using this asset allocation, is actually the most efficient portfolio. 
  • This would seem to be in line with Larry Swedroe’s reports in his more recent 2010 book mentioned above.
  • However, as mentioned by the books in the late 1990’s and early 2000’s (a couple by the same author, Larry Swedroe) Long Term Bonds were NOT efficient in that their increased volatility is not adequately compensated by the increase in return. 
  • Because of this, I cannot help but think that this analysis is somewhat tainted by recency bias. What I mean is that due of the great performance of bonds during the 2000’s-present, holding intermediate/long maturity bonds looks “rosier” in this analysis than it actually is if you were to include a longer 20+ year period.
• My other reservation is in regards to the increase in monthly variations in performance of intermediate-term bonds compared to short-term bonds. I’ll discuss this more in the conclusions section below.

If you’re interested in looking through all of the details/numbers of this analysis, you can access the Google Docs spreadsheet by clicking here.

Conclusions, My Current Fixed Income Allocation, and Path Forward

So, after going through all of this investigation comparing short-term and intermediate-term bonds, what’s the overall verdict? Well, I think it can be summed up in a couple lines:

• An investor will be fine holding either short-term OR intermediate-term bonds (or even a mixture of both) as the bulk of their fixed income asset allocation.
  • There are pluses and minuses for each, and it really just comes down to personal preference and what volatility they want their fixed income holdings to have.
• However, I am comfortable concluding that as far as risk-adjusted return goes, intermediate-term bonds are the most efficient, and I believe they will continue to be going forward based on William Bernstein concluding the same thing in 2001 (prior to big run-up in bonds in recent years).

In the interest of putting a personal application to this topic, I wanted to share how this investigation applies to me. I currently use a 70/30 fixed income asset allocation split in my portfolio. Of the 30% fixed income total, 5% of the total portfolio is in TIPS, 10% in cash, and 15% in short-term bonds.

Path Forward – For me personally, the case presented above isn’t strong enough for me to feel the need to swap my current strategy using short-term bonds in exchange for intermediate-term ones. This is due to the fact that I like the fact that my fixed-income portion of my portfolio is “rock solid,” meaning that it doesn’t vary much (for example, the minimum intermediate-term bond fund monthly return was almost an 8% decrease compared to only a 2% decrease for the short-term bond fund). This makes me feel better about focusing on taking risk and improving returns using the equity side of my allocation.

How about you all? What type of fixed income securities do you currently hold in your asset allocation?

What do you think regarding the decision between short-term or intermediate-term bonds? Which would/do you prefer?

Share your experiences by commenting below!

Three Biggest Benefits of Holding a Bank Account

————————————————————————————————————————
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!
————————————————————————————————————————

The following is a guest post. Enjoy! 

In the past, it was far more difficult to open a bank account than it is today, and the benefits would have been significantly lower. Nowadays, it is almost impossible to think about managing your money without a bank account. Listed below are three of their biggest benefits:

1. Effective money management

In today’s world, the largest transactions are made by electronic transfer, which means that even the most basic things, such as receiving your wages, will happen without any direct involvement from you. All you have to do is provide the necessary details of your bank account and the funds are automatically transferred on the agreed date – so you never even see it change hands.

Managing your money is therefore far easier, as you only need to take out cash needed for day to day expenses, leaving a lump sum in the account to accrue interest.

2. Safer access to your cash

Only a few decades ago, it was uncommon for people to have a credit card, but today most of us have a range of plastic cards in our pockets. Using credit cards needs to be approached with caution as they can lead to debt, but using the debit card which comes with your bank account is completely safe, as you can only use funds that you already have at your disposal.

Most people now carry very little cash and use their cards for purchases. Recent developments with near-field technology, such as contactless payment, are making it even easier to pay for goods and therefore even more important to have a bank account.

3. Save money

Having a bank account actually helps you save money too. Most companies, from energy providers to mobile phone firms, either give a discount if you pay by direct debit from your bank account, or add further costs if you choose to use another method of payment.

Having your money in an account makes it easy to transfer a set amount each month into a savings account, pension or other type of investment, so the money saving potential is endless. Using your bank account sensibly will also help you build a good credit rating, which can be extremely important when it comes to larger financial matters, such as getting a mortgage in the future.

How about you all? Would you consider having a bank account to be a “necessity” of modern life?

Share your experiences by commenting below!

Jacob’s Thoughts – Listed below are my random thoughts as I was reading this article.

• Truthfully, I don’t know what my financial life would be like without my bank account.
• I use my free checking account with Bank of America as the “hub” for all of my transactions, ranging from credit card payments to receiving my salary to disbursing money to savings and investing accounts. I really couldn’t imagine what I would do without a bank account that I could make electronic transfers with!
• Aside from that, another major benefit that my bank account provides me is the access to guaranteed cashier’s checks when I need one for buying a house or moving.

***Photo courtesy of http://pixabay.com/get/0e74fac29191fba6666e/1364495837/money-29154_1920.png