portfolio – The Log House

A simple method of asset allocation

Posted on April 4, 2020April 4, 2020 by The Tortoise

As I started to write this post, I decided not to rant about the Corona Virus and its effects anymore. The last two posts were dedicated to the topic and frankly it is becoming a little bit weary to add to all the deluge of information and opinions on it.

Let’s look at the current situation as nothing unexpected, at least financially. Being a financial blog, let us generalize this to another black swan event, and not worry about the statistics of no. of confirmed cases vs. deaths etc.

What is a Black Swan event?

A quick Google search yields the following:

An event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult to predict. This term was popularized by Nassim Nicholas Taleb’s book “The Black Swan: The Impact of the Highly Improbable.”

Lets leave it to that and consider we are in the midst of one such situation.

The keyword in the above definition is “would be extremely difficult to predict”.

No matter what financial experts say about the markets, about investments, using sophisticated algorithms to trade stocks, the fact remains that such events are not predictable by even the multi-PhDs of Finance.

In the beginning of 2020, most of us did not know that a black swan event is so much closer, although experts have been predicting recessionary clouds for last 2 years or more.

The effect of such an event is the havoc it can do to your savings and investments. Yes savings too, as we don’t know which banks or financial institutions will go under the water, and whether government stimulus can rescue them.

It may be a rare event so far, or some rescued in 2008 but we cannot guarantee with every black swan event. Just in Feb 2020 (when it was still normal business), a very large private bank in India went bust taking with it hundreds of thousands of dollars worth of deposits of very normal people. Ironically the bank was named “Yes” bank.

Similarly by end of March 2020, the stock and mutual fund portfolios are down 20%-50% depending on how much risky the portfolio was to begin with.

The only respite from all of this is to maintain a good asset allocation as each investment avenue has its own risks. Some of the typical risks are:

Cash – Banks going down and Government struggling to insure the deposits.
Stocks – Markets tumbling for an extended period of time due to economic fears.
Bonds – Risk of default as even good companies’ bonds can turn into junk debt very quickly. Lot of mutual funds in India were invested into Yes Bank bonds. Long term bonds can also run into interest rate risk.
Real Estate – Somewhat resilient but affected by vacancy, interest rates, unemployment.

If your finances are severely affected by this storm, how do you achieve a good asset allocation once the clouds are gone and the sun is shining again on the stock market?

KISS – Keep it simple, stupid

Its not overly complicated although some financial experts make it so. Let’s say I want to hold 25% each of the 4 asset classes and distribute my assets accordingly.

Here is a step by step method on how to achieve this. It is better done in an Excel sheet as the calculations can be automated and even graphs can be plotted, although equal allocation is easy to visualize anyway.

List down all your assets into one column which comprises your Net worth including your home and any other property you own.
Now in a second column, list the value corresponding to the asset. Be conservative, do not add any speculative value.
- For your home, just take the equity value that you have.
- For stocks or mutual funds, take the present value.
- For any bond investment, take the invested value or the expected maturity value (if the term is not too long).
Now add 4 columns for the asset classes.
The chart should start to look like this. Here is a simple example of a $100,000 Net worth.

Now based on the asset class for each, fill the right side columns in the right proportions. For example the mutual funds may consist of equity funds, bond funds and REIT funds in equal proportions. For each mutual fund, a look at the fund report will reveal the proportions of these asset classes that it invests in.
Fundrise is just an example of a private REIT that is considered real estate asset class but in paper form. It is only for illustration and I am not an affiliate of the investment fund.
Once you allocate the numbers to the 4 asset classes and add up each column, it will become visible how your asset allocation is skewed.

A visual inspection of the numbers reveals that this portfolio is heavily skewed towards Real Estate due to the largest investment in the Home. This is true for most people, as their largest investment is their home.
A more vivid depiction of this can be drawn using the Excel chart.

How to balance it? There is no ideal asset allocation as it depends entirely on the person’s situation, age, risk appetite, goals and many other factors. It is only after this simple analysis that one should approach a financial coach or investment adviser.
For example, if the person (who’s portfolio we have just analyzed) is not happy with the Real Estate skew, he can allocate future investments more towards Equity or Bonds (or even Cash), than buying more real estate or paying down his mortgage aggressively.
Being overweight in Home Equity can mean house poor and the person will find it difficult to raise funds or access cash in times of emergency or other life goals.

Conclusion

The beauty of this asset allocation method is that in a simple exercise which takes less than 10 mins and one sheet of Excel, you can look at your entire financial picture.

It gives you a quick overview of your Net worth.
It gives you the current asset allocation you have.
It tells you where your financial situation is vulnerable to market, liquidity or economic risks.
It tells you what action you need to take (whether to sell some or boost up another) regarding the various asset classes.
It directs how your future investments should be structured.

The value of this exercise is immense and a good asset allocation can let you sleep in peace when the entire world is savaged by another Black Swan event.

photo of building during daytime — Photo by Matthew DeVries on Pexels.com

Investing, Personal finance, Savings

The 4-Q way of protecting your finances from coronavirus driven volatility

Posted on March 8, 2020 by The Tortoise

One of the questions all investors consider is how to spread their investments. This is super essential in a volatile economic environment that we are now being forced by coronavirus.

Coronavirus is already sending stock markets across the world in a downward spiral, companies may find it difficult to service debt and hence affect bonds, and interest rates going downwards put cash and money market funds into useless investments.

How do we then allocate our funds and make sure we are not into an all-or-none, boom-or-bust kind of situation?

There are essentially 4 kinds of investments that a simple investor like us will hold over time.

Cash and cash equivalents – CDs, money market, timed deposits etc.
Debt – Fixed duration and fixed income products like bonds bought and held till maturity.
Market Linked – Index Funds, Mutual Funds, ETF, direct stocks, REITs.
Real Estate – Properties (homes and rentals), Private REITs.

The 4 Quadrant approach

The below table shows how these investments fit each quadrant of a time horizon vs. liquidity.

Financial Planning	Liquid	Not Liquid
Short Term	Q1 – Cash and Cash Equivalents	Q2 – Debt (Bonds till maturity, other lending investments)
Long Term	Q3 – Market linked (funds and stocks)	Q4 – Real Estate

For example, cash and debt instruments are typically short term reserves. While cash in savings account is highly liquid, bonds typically have a fixed maturity duration unless they can be traded in the secondary market.

On the contrary, stocks and funds may be liquid but typically yield best results only over the long term, due to short term market volatility. Real Estate is both long term and highly illiquid since it may take months and years before a property investment can yield profit or get sold.

If we allocate our resources with the 4-Quadrant principles in mind, then the short term market volatility or conditions will not bother us much. Each of the Quadrants will have enough invested/saved to go through the current phase.

For example, if I need immediate cash or want to maintain an emergency fund, Q1 is the place. There is no need to panic sell Q2, Q3 or Q4 investments.

Similarly for a medium term (2-4 years), the required funds can be maintained in fixed duration bond products (Q2) matching the maturity to a goal horizon.

At last, stocks and real estate are for the long term (> 10 years) and should be left to grow on their own. We can keep adding to them in a well defined proportion. But we do not need to panic sell them if the Q1 and Q2 are in place.

Simplest Asset Allocation

Another advantage of this approach is automatic asset allocation. Sometimes without realizing we may be overweight in one Quadrant. For example, some people may be just lazy to invest and keep their money lying in savings accounts, hence Q1 heavy.

While others may be so overweight in Stocks and Real Estate that in case of an emergency or reaction to market movements, they may sell or trade unnecessarily and hastily. Worst is premature withdrawal from retirement funds and paying penalty and taxes.

A balanced allocation to each Quadrant based on goals is the right approach.

For example, lets say I have $200,000 net worth. I can allocate the following after estimating my monthly expenses ($3000) and near term goals (Education, buying a house etc.).

Q1 – 6 $3000 = $18,000 in money market fund*	Q2 – $40,000 for a new house in 2 years – Treasury Bond Fund
Q3 – $42,000 in 401-k and Roth IRA	Q4 – $100,000 in present home equity

Lets analyze few scenarios here.

I suddenly lose my job – Assuming it will take 4-6 months to get a new job, I can withdraw from Q1 my monthly expenses and tide over this crisis.
I need to save for a new house in 2 years – I keep saving every month in Q2 and buy investments maturing in about 2 years.
Whether the above events happen or not, the Q3 keeps growing as the funds remain invested in the market. In fact, as long as there is no crisis, I can keep making dollar cost averaged investments every single month into 401-k and Roth IRA accounts.
Q4 is even longer term and can be one’s own personal residence and additional rental properties. If Q1 and Q2 are in place, there should not be any hurry or knee-jerk reaction to sell or lose these valuable assets.

The actual amounts or assets can vary depending on a person’s goals and needs.

Overall this framework will also avoid a person to go into debt unnecessarily. Similarly paying off debt or mortgage can be considered money invested in Q2 and Q4 respectively.

Conclusion

The 4-Q is thus a simple financial planning framework. Sticking to this 4-Q framework and directing one’s monthly investments to the relevant quarter helps build wealth in the long run, as well as take care of short term obligations.

silhouette photo of person leaning on arch pillar — Photo by Suliman Sallehi on Pexels.com

Budgeting, Investing, Personal finance, Savings

Who moved my cheese? How to deal with changes in financial plans

Posted on February 10, 2020 by The Tortoise

The title is taken from a famous book as below. Even though it is meant to be a management philosophy, it applies to the subject of personal finance as well.

Financial Planning does not work?

There is a proverb in the military – Plans are good till the first bullet is fired.

Some of us who are obsessed about managing or advising on personal finance can go really overboard with planning. Have you heard about those retirement numbers, college planning or even financial freedom number?

While long term planning is good, problem with personal finance is that it is a not a standalone aspect of your life. It impacts and gets impacted by life events – birth/death/marriage/divorce in the family, choice of career or college, changing goals and circumstances and finally your own priorities may change.

How my circumstances kept throwing my plan astray

Lets take an example in my case, as I transitioned from India to US.

Till 2005, I did not know a zilch about managing finances. In fact I was pretty bad at it, just enjoying my life and like many, used to blow up my entire paycheck in frivolous expenses, needless shopping and eating out. So in a nutshell there was no plan.

Then in 2005, I decided I can at least start investing some money out of my paycheck. Good plan but was it anything long term? No it was too flaky as I jumped from one hot fund (mutual fund) to another. This was the time when the Mutual Fund and Private Insurance industry was taking off in India in a big way. I also lost money investing in an insurance plan (actually a bad plan) that was masquerading as investment.

Beware of ripoffs

Eventually as I got better with finances, I actually created a long term plan complete with everything – retirement fund, children’s education fund, vacation fund and corresponding projections several years into the future. I built separate portfolios for each, and tracked them to utmost precision even calculating year after year growth.

However God had other plans for the family. In a series of unfavorable health and personal issues, we decided to move out of India at least for a few years and relocated to US.

This obviously altered my earlier plans completely, since my place of work and source of income changed. The retirement numbers started to look different, the college education fund seemed minuscule when compared to US college costs and all the plans are to be redone again.

Well what do I plan for now? I don’t even know whether I am going to move back to India again in few years or not.

In a global economy mobility is a part of life and no one stays in the same place or country throughout their working life. Moreover as you move, international taxation is another beast which can alter your long term investments (like tax sheltered) into immediately taxable entities.

Plan to adapt, not adapt to a rigid plan

So finally you have to take into account an ever changing plan, moving from Plan A to Plan B and keep adjusting according to your circumstances.

When I read about estimating expenses at retirement, I wonder how can someone calculate that? Following factors and more can make it completely non-deterministic.

Where will I retire? Different cities and countries have vastly different living and medical costs.
Will it be only me and my wife? What if the children stay with us?
What do I want to do in retirement? Will I work or travel more?
What health condition will I be in?
What other obligations (including social and family) will I have then?

So projecting your expenses at retirement based on today’s lifestyle is like predicting the weather 20 years from now, based on 20 years of past data.

Same goes for College funding. Even if you are saving in 529 or other accounts, do you have a goal or a number in mind? How do you arrive at a number for college costs, when the costs are going up every year? Isn’t that also as variable as retirement? The following factors come to my mind immediately.

Do you know what career will your 5 year old choose when he/she turns 16-18?
Do you know which college will she go to? Ivy Leagues, State or Community colleges? Are the costs not vastly different?
Are you even going to stay in the same state or country when the time comes for college?

In today’s volatile world, planning too far away (more than 3-5 years) is futile.

Planning based on solid principles, not circumstances

The best way to plan your finances is to look at your current goals, aspirations and develop good money habits.

Below steps will help you be in control and act nimbly to adapt to changing situations.

Live below your means – no matter which country or which circumstance you are in, you can always strive for this and become better. Living below your means is common sense, yet so uncommon.
Budget – Goal based budgeting – This is very important as it ensures you have control over the cash inflows and outflows. Again something which does not change with your place of work or future plans.
Invest with simplicity – Find investments that are easy to understand. Index funds, mutual funds, Real estate, CDs and savings accounts.
Keep some portion of portfolio liquid – Sometimes this can be called an Emergency Fund or Contingency Fund. No matter what you call it, it is useful. When I moved from India, I kept a portion of my India portfolio into Fixed Deposits (similar to CDs here in US) and then built up an emergency fund in US too. This gives me option in both places if I decide to just leave work for some time or get laid off.
Remain consumer debt free – This is also related to freedom. Except for one mortgage in US, I am completely debt-free otherwise or rather bad-debt-free. Being debt free coupled with a portion of portfolio in cash, gives you plentiful of options to enjoy life at your own terms.
Keep investing for long term – Unless your investments are in countries with troublesome political climate, long term investments (a part of the portfolio) can be left to grow with time. Long term investments work on the principle – its not market timing, but time in the market that will reward your investments.

To plan and execute above steps in the most efficient way, read the following posts.

Five components of a personal finance system

The SAFE plan – Simple, Automated, Flexible and Efficient

Finally do plan but let life change it

Money decisions should not dictate all your life’s decisions. Money is only a tool to live a good life.

Let your financial plan adapt to your own goals and aspirations, rather than rigidly follow personal finance gurus and templates.

If someone screams in YouTube to pay off mortgage, it does not mean you have to follow as your plans may be completely different. Similarly you may not fall for all those high reward promising credit cards if you are not going to use those benefits.

A chess player does not know what the board will look like after the next few moves.

person playing chess — Photo by JESHOOTS.com on Pexels.com

Budgeting, Investing, Personal finance, Savings

FinTech – can you be immune to it?

Posted on September 22, 2019 by The Tortoise

Fin Tech – Financial Technology is everywhere now. From Internet only banks to robo-advisors to automated loan processing to auto-invest, auto-save, the automatic word has prevailed the personal finance world.

Gone are the days when people queued up in banks to deposit or withdraw money, fill up paper forms to open an investment account and wait for hot tips to buy that fateful stock.

With the financial world so much dominated by technology, there are some tools and techniques we should employ to make our personal finance more automated and efficient, thus leaving us more time to pursue real passions.

Here are a few areas of personal finance where I think we cannot avoid the best of automation.

Banking

This is a no-brainer, however people still flock to big mortar banks like Chase, Bank of America or Wells Fargo. If you read the reviews of these banks, there are endless complaints about non-explained fees, bad customer service and old style bureaucracy.

On the other hand, I bank with a Credit Union which does not even have branches in my state of residence, and another online savings bank which is linked to the checking account in the Credit Union.

In last two years in US (and same in India), I did not feel the need for a local branch. True, once or twice when I needed to withdraw cash more than the permitted limits in authorized ATMs, I could just go to one of their affiliate Credit Union branches in my city.

Thus moving your banking to completely Internet based and using mobile apps, you are in better control of your money than dealing with the brick-and-mortar banks.

9 Best Online Checking Accounts of 2019

Savings

All the internet banks provide goal based savings accounts, the one I use definitely has that feature. It makes it extremely easy to setup savings goals (5 minutes) and let it go automatic every month.

If you still don’t want to do the planning, budgeting etc. for saving money, check out Acorns or Digit, these are two advanced FinTech companies who help you save in the background.

Acorns helps you accumulate the spare change from your everyday purchases and siphons it away to an investment account.

Digit is a bit more sophisticated in that it analyzes your spending pattern from a linked checking account, and saves off what it can. Of course you can set it up in a way you like, but they also guarantee not to cause overdraft.

Before you try out these apps and link your account, please read through reviews and understand their fees. The fees has to be justified compared to the value it will add to managing your finances.

For example, I signed up for Digit but later decided to pull back, as I already know and have set up automated transfers for my savings goals.

There are other similar apps and the following link may help.

NerdWallet’s 4 Best Money Saving Apps

Investing

Like Acorns is a micro-investing app which pulls money out of your account and forces you to invest, there are robo-advisors for bigger and planned investment.

Wealthfront and Betterment are two companies that are revolutionizing the space of robo-advisors and has features like tax loss harvesting in your investments.

This can be a completely hands-off approach to investing and let the expert designed algorithms decide your asset allocation and investment product mix.

Here is a good discussion, again from nerdwallet.com.

How Betterment, Wealthfront and Wealthsimple Compare

Moreover, the brokerage companies like Schwab also has robo-advisor options.

Tracking

What gets tracked, grows. I don’t know who said that, but tracking your Net worth and investments is important.

While you can keep the overall numbers in your head if you check your accounts regularly, there is nothing better than having an algorithm do the data crunching and show your portfolio with all kinds of analysis and charts. It is even better if it can project future growth of Net worth with reasonable assumptions.

This can be done by plain old Excel sheets and I do the same before I could trust the online sites with a consolidated view of my personal finance.

Some of the websites and services are Personal Capital, Wealthfront, Mint and Betterment who aggregates all your finances and shows the analysis reports.

While this is very convenient and tempting to look at all the analysis available, do this if you are comfortable linking all your accounts to one of these services. Below is a detailed review of Personal Capital, but do your own diligence and research.

Personal Capital Review 2019 – Fees, Unique Features & General Overview

Real Estate Crowdfunding

This one is my favorite and real innovations are sweeping this field.

While real estate is the most lucrative (and hyped) investment of all, it comes with high degree of everything – risk, reward, hard work, expertise and complexity.

Traditionally real estate portfolio is built by acquiring houses and buildings with part cash and part leverage, and then managing the day to day affairs of keeping a tenant, fixing issues, chasing rent cheques, vetting and evicting tenants etc. You need a lot of knowledge, time, experience and most important of all, a team of real estate agents, lawyers, tax professional, property managers to run a successful business.

Simple investors who have a different passion than real estate (or loves their own job), do not have so much time and risk appetite to run a full fledged business of rentals.

This is where sites like Fundrise, Roofstock, Rich Uncles come in play. They are making it easier for small investors (even non-accredited) to get a flavor of real estate in their portfolios without the heavy lifting of managing rentals and tenants.

However real estate is an ill-liquid investment and may take 7-10 years to get back the principal. Proceed with caution and read the prospectus, investment style and restrictions carefully before diving in.

I have personally invested with Fundrise but less than 10% of my overall portfolio.

The main risk is once invested, you lose control of the principal as you cannot sell on your own. However the convenience outweighs the risks, if you know what you are doing. With Fundrise for example, your portfolio is invested all across the United States in commercial buildings. It is simply not possible to build such a portfolio directly, unless you want to be a full fledged real estate professional.

Similarly Roofstock enables you to actually own a rental property in different states of US but once invested, you own and manage it with the help of certified property managers.

Tread with caution, surely real estate crowdfunding is going to take off, unless it runs into a major scam or something.

Conclusions

With so much automation in the personal finance industry, it is difficult to stay away and not take advantage of these tools. At the same time, it is scary to lose control of your money and investments.

Many people are still skeptical of online finance and not without reason, given the recent data breaches at Equifax and CapitalOne. Another reason for skepticism is due to the perceived loss of control. For example, lot of investors still prefer to hold physical real estate than trust online real estate crowdfunding. It reminds me of the obsession in Asian countries (especially India) of holding physical gold (bars or jewelry), till paper gold ETF came along and created lot more gold investors.

On the contrary, we leave so much control of our lives to experts. When we fly, we leave it to the pilots and the airplane auto-pilot system. When we are sick, we let the doctors take over. When we are educating our child, we send them to good schools.

So why should it be different for personal finance, if FinTech frees you from unnecessary headache and lets you concentrate on your real passions?

Let the experts and machines do the job (for a fee of course) but you have to do your research so as not to run into dubious sites and services.

The new mantra of personal finance – Learn, Automate, Delegate, Track.

adult ambulance care clinic — Photo by Pixabay on Pexels.com

Disclaimer – I am not promoting any of the services mentioned in this post nor my opinion should matter in your choice. Do your own due diligence, as I have done in selecting my own set of services according to my needs and risk tolerance.

Investing, Liabilities and Debt, Personal finance

The Net worth vs. Cash flow debate

Posted on August 11, 2019August 11, 2019 by The Tortoise

What is your net worth? Let me see, probably close to a million. So what? Are you financially independent? No. Why? ’cause I don’t have enough cash flow to replace my W2 income. Ok then, net worth is a worthless metric. But it projects my comfort into the future.

And so it goes on and on…

Does it sound familiar? There are two schools of thought. One says be conservative, save, invest for growth, have little to no debt and build your net worth slowly. The other school scoffs at this conservative approach, and instead propounds building wealth and cash flow through acquiring assets, leverage and working out deals.

None of them are wrong. However what is right for you (and me) is important. For that, it is extremely important to understand the benefits and risks attached with each approach.

In more practical sense, you will do both in the right proportions that you are comfortable with.

The Net worth approach:

Here your main cash flow is your W2 income. Your ability to live below your means gives you the leverage to save and invest the rest.

Budget – Grow the tree upside-down

As you invest your money into stock mutual funds, CD, money market, bonds and a house of your own to live in, you are increasing your net worth slowly. This is how most people start and someone starting off should. The difference between income and expenses, is the main contributor to your net worth. Additional is the appreciation and growth that your investments achieve. You also pay down mortgage of your house which builds equity, adding to your net worth.

In my opinion, this is a perfect approach to build wealth as long as you enjoy what you do in your W2 job and have a good work-life balance.

This is also the simplest since there is no extra debt burden (except probably your house, which you can pay down if you want). Your investments are also passive and takes hardly any time from your schedule, except occasional re-balancing and tracking.

Investing in the High Five portfolio

With a spreadsheet like Excel, you can easily calculate your projected net worth in “t” years in the future, assuming a “r” rate of interest (or growth).

However this approach takes a lot of time and patience, disciplined living on a budget and regular investments. You will not have something to brag about in a few years, but you will sleep in peace as you have liquidity, less or no debt and enjoy your work.

The risk of this approach is if you retire early and do not have enough corpus to live off for the rest of your retired life.

The Cash Flow approach:

The cash flow approach on the other hand, only focuses on generating cash flow. It means you have enough assets or mechanism (businesses, activities) which generate cash month after month, in a predicable fashion.

This can be achieved with several avenues for example:

Rental property investing
Commercial property
Dividend paying stocks
Passive income from books, royalty of other IP, YouTube videos etc.

There are many resources on Internet to give a list of passive income ideas.

However in the cash flow investing approach, I wish to draw attention to the big ones like Rental Property Investing and Dividend Stocks.

These are two ways which makes a very predictable cash flow stream if done right.

However to get this predictable cash flow, one has to do the investment right. For example, real estate has many hidden costs and running expenses, which if not taken into account will quickly convert an on-paper cash flow asset into a black hole for your money.

Similarly dividend stock investing, if not researched correctly can cause the principal investment value to go down. Same for income producing corporate bonds, where the ability of the company to make the regular payouts needs to be researched.

Last but not the least, income producing real estate is typically obtained through leverage, which means steadily increasing debt.

For example, if you want to generate $5000/mo in cash flow from real estate, you need to buy as many houses that will in total produce that much positive cash flow. Lets say each house produces $200/mo in positive cash flow after mortgage, taxes, insurance and expenses. Now you will need to manage at least 25 such properties to generate the requisite cash flow. Self managing 25+ properties is more than a full time job, and if you hire a property manager you will have to part with the cash flow (fees), and hence no. of houses under management will need to increase. This is all not to mention that now you have 25+ mortgages in your name. The risk – 10 out of 25 properties suddenly loses the tenants and remains vacant for 3 months. Now you have to be able to make 10 mortgage payments every month from other sources of income for an extended period of time.

I am not saying Real Estate Investing is bad, lots of millionaires and billionaires have achieved their wealth creation through this. However you need to know yourself and act accordingly after you understand all the risks involved.

A combined approach:

Is it possible to have best of both worlds? Sure there is, if you are not in a hurry to get out of your job and have the patience to slowly build both your net worth and cash flow.

A few simple ideas which comes to my mind are below. I have done some myself and plan to do the rest.

Increase your income and live below your means. This is very obvious, yet the most difficult to do consistently.
Invest consistently 15-20% of your income into stocks, bonds and cash. See post: Emotional Investing
Live in and then rent – Convert your existing house to a rental once you move out to another one. Or just rent out a portion of your house. This has the advantage that the mortgage you have is an owner occupied one (less interest rates typically), also it is paid up consistently as you spend more years and gets factored in your regular budget. See post: Don’t twist your ARM, fix it !!!
Pay off your old houses completely but do not sell. Convert your equity play into a rental now. The paid off house will generate much better cash flow with substantially less risk, as there is no mortgage payments to worry about. See post: The Paid Piper of Hamelin
Find sources of passive income which you can buy with your accumulated savings, like investing in a profitable business, crowd funded real estate etc. These have much less risk if you do your homework, at least there is no risk of foreclosure etc.
Write a book or start an online course about your area of expertise.

In short, increase your net worth and cash flowing assets in a sensible fashion, with less to no debt and consistent action.

Here are some of my previous posts which may inspire the above principles.

Know yourself and your investments

Shun that perfection

How a cassette player caused debt aversion

Enjoy the journey and the destination will follow.

Investing, Personal finance

Know yourself and your investments

Posted on August 5, 2019 by The Tortoise

I am back after a long hiatus, as I enjoyed a fabulous vacation in India. These are times when I can introspect and know myself better and deeper. Nothing to do with the spirituality of India, but just an opportunity to separate my mind from the daily rat race, and consider what is really important.

Like everything else, personal finance is also very personal. You got to know yourself thoroughly to understand how to restructure your finances, savings and investments to fit and serve your own unique needs. It cannot be driven by advertised claims from pundits, or hyped up investment professionals.

There are several occasions when I made the mistake of trying out something which did not fit my personality or immediate goals. It was just giving in to the popular notion of what I should be doing, without thinking twice about it.

Once I was nominated or elected for a post in the HoA (Homeowners Association). While the work or responsibility was not very complex, but the surrounding politics and conflicts required a lot of different people handling skills. I utterly failed in this endeavor and quickly realized that it is not for me. I have better things to do and spend my time on.

Similarly as I read more on Real Estate Investing and the numerous strategies, I wonder is it possible for everyone to jump in and spend so much time or build such skills to be successful? Or is it better to stick to your own vocation and invest passively, thereby spend your valuable time doing what you can do best. This will also increase your income and put you through a better path to success. This is of course provided you like your job and not desperate to get out of the 9-5 routine.

Some of the investment avenues that people jump into without much education or risk analysis.

Direct stock investment
Real Estate investment
Life Insurance coupled as investment
Crypto-currency
Exotic Art and collectibles

If you are like me, who likes to keep things simple outside his area of expertise – here is a no-nonsense investment plan.

Try as hard as you can to stay out of debt. Create a budget to track your income and expenses and live within your means. See the post: Budget – Grow the tree upside-down
Maintain an emergency fund and create a cash cushion. See the post: One essential comfort zone
Invest in simple Index Funds and create a goal based portfolio. See the post: Investing in the High Five portfolio
Keep emotions under check and have a realistic plan. See the post: Emotional Investing
Last but not the least, Get Started. See the post: Shun that perfection
Use the following tools to get started. See the post: The Starter Kit

Finally invest in what you understand fully and comfortable in dealing with.

Rest everything can be ignored and continue a stress-free financial journey.

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Investing, Personal finance

Emotional Investing

Posted on May 27, 2019 by The Tortoise

How are emotions and investments linked? Or should they?

The two are actually intricately linked in our financial lives.

Emotions define investments, and investments define emotions.

For example, most people who invest in stocks buy the next stock based on hot tips, be it from the last night party or the media channels doling out expert advice on stocks.

Or even the general euphoria about the economy and stock market makes us greedy and plunge into get-rich-quick behavior.

Thus an investment is made based on emotions for most people.

Now the same investments cause further emotions. The stock market is down, there is a trade war with China, the media is predicting a crash and so on.. We give in to the noise around us because we are now invested in the market, and it is our duty to become emotional with the world. Otherwise we are deemed too careless about the investments we made so emotionally.

Proven? – Emotions define investments, and investments define emotions.

However the above linkage can be controlled and severed at the right place to make it advantageous to long term investments.

There are only 3 steps to build a successful investment strategy.

Take your emotions into account in planning your investments and portfolio. See which areas of your financial life needs more focus, be it retirement, kids education, emergency fund or long term wealth. This is where most of the emotions should be used (as every one has different life goals and situation), but this is planning only – not yet buying any investment product.
Once you have decided what to invest in and how much, automate your plan. All banks and brokerage services provide automatic transfers and investments.
Take rest of your emotions elsewhere. Just forget the investments as they build up. You just need to tweak it once a year. However this is where people pour in maximum emotions as the noise in the market and the economy rise and fall. Instead hold your investments for the long term as if the account is locked, and you forgot the password.

Note that after step 1, there is no more emotion.

Here are few previous posts on step 1.

Budget – Grow the tree upside-down

One essential comfort zone

Investing in the High Five portfolio

For step 2, where you take action.

Shun that perfection

Emotions are used to our advantage to plan the portfolio and then automation and ignorance (to the market) is the bliss.

For step 3, the following quotes by Warren Buffet will help.

“If you cannot control your emotions, you cannot control your money”

“I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.”

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Investing

Investing in the High Five portfolio

Posted on May 5, 2019May 11, 2019 by The Tortoise

What does investing mean to most people? Investing can be as complex or as simple as one wants to make it.

There are many theories for constructing a portfolio and it is not easy to ascertain which would work for one’s financial situation. Some common ones which are taught by most financial advisers are as follows.

Risk/return trade-off achieved with diversification.
Goal based portfolio – retirement, education, short term, passive income.
Age based asset allocation.
Robo advisor created portfolio.

The result is that one ends up creating multiple portfolios out of haphazard investments. The portfolios are also spread across multiple accounts as one’s financial life builds up.

As the accounts and portfolios spring up at different times, they lose the meaning of the overall asset allocation and financial goal of the person. There is no common theme or string to bind these accounts or portfolios together.

Here I present a 5 portfolio approach if you have multiple accounts and assign a meaning and goal to each. I have faced this dilemma and this solution/characterization comes from my own personal investment analysis.

This analysis assumes a person like me who is still 15-20 years from retirement, has children going to college in next 4-8 years and a starter in real estate and wealth building strategies.

The Portfolios

P1: 401k – The All Equity Portfolio

Term: 15-20 years

Most working people will have a 401-k or IRA plan.

401-k has two very important kickers to deserve an All Equity portfolio.

Long term – You cannot withdraw money before age 59.5 without penalty. This forces you to be committed for long term, which is good for holding equity.
Tax deferred – The contributions and earnings grow tax deferred, hence can compound tax free for a long time (till withdrawn).

Hence it makes sense to hold a predominantly equity portfolio, since equity investments are known to minimize loss and provide best returns over a very long term.

For example, one can be invested in just 3 index funds in a 401-k. You can find similar funds in your own 401-k plan.

Large Cap Blend (Growth and Value) Index Fund
Small Cap Blend (Growth and Value) Index Fund
International Index Fund

If you have Roth 401-k or Roth IRA, treat them as same although the restrictions of withdrawal are slightly more flexible in a Roth IRA. See the link below for a discussion on the topic.

Roth 401-k vs Roth IRA – which is better?

P2: Taxable account – The Diversification Portfolio

Term: 7-10 years

The second portfolio is also long term but not restricted. It is created to accumulate wealth and then use it for any long term purpose.

This gives one the flexibility to withdraw it for early retirement, kids college, medical emergency or any other unforeseen circumstances. Or simply to buy a new house or invest further into real estate.

This portfolio can be maintained in a taxable account with any brokerage firm. Although it is not tax deferred or tax shielded, it’s purpose is flexibility and use of the money in a medium to long term.

The characteristics of this portfolio is to hold a mix of different investments (low cost index funds or ETFs) which provide diversification across market caps, asset classes and risk/return profile.

It can also be optimized for tax savings if you design it that way, but then the goal is steady appreciation and not necessarily just tax savings.

This portfolio can be constructed using following types of index funds.

Total US Stock Market Fund (or S&P 500)
Total US Bond Market Fund
Emerging Markets Fund
Global Real Estate Fund

One can add more mix and diversification to this portfolio, for example, International Developed Markets Fund or a Commodity Fund.

If the 401-k already has a sizable allocation to International Fund, this portfolio may not have one but gravitate towards more exotic ones like Emerging Markets, Global Real Estate etc.

P3: Special accounts – The Stable Portfolio

Term: 4-7 years (or custom)

This portfolio is for special purposes like kids college savings, medical savings and so on.

These are some important and unique goals, which needs both appreciation yet reasonable capital preservation. In this portfolio to gain steady returns, there can be a perfect balance between equity and bonds.

For example, a 529 (kids college fund) and Health Savings Account portfolios can be simple:

Total Stock Market Fund
US Treasury Bond Fund

Typically a 50-50 allocation in two funds is good enough.

P4: The Daredevil – The Risky Portfolio

Term: 10+ years (longer the better)

This portfolio is not for everyone, but for people who are keen on more sophisticated investments in search of that extra kick (either the return or in your life).

This portfolio needs active monitoring and work to pick the investments. This portfolio has the potential for total loss, but at the same time may generate very high returns.

For example, these two accounts below can form part of this portfolio.

Fundrise – Real estate crowdfunding
Robinhood – Buy and hold individual stocks – dividend yielding and growth/value stocks at zero commission

However one can invest in a variety of similar high yield, high risk investments, for example, PeerStreet, YieldStreet etc.

P5: Cash Account – The Safety cushion

Term: 1-3 years

This is the most essential one to provide peace of mind. This account can be a high yield savings account or a FDIC insured money market account.

This portfolio serves two purposes.

Emergency Fund – This is typically 3-6 months of expenses stashed away for a rainy day.
Cash for next opportunity – This is money you save for down payment on a house, or next investment like buying a rental or invest more in stocks when the market tanks.

Any good online bank provides these savings account with reasonable yield.

Click here for a list of such savings options.

Conclusion

The budgeting technique described in a previous post can help one allocate investments to all these portfolios.

So what do these P1 – P5 portfolios achieve?

Purpose and time horizon
- Assigns a purpose to each portfolio and defines its contents
- Assigns different time horizons according to requirements/goals
Asset Allocation
- Diversifies across different types of asset classes, yet keeps each one simple (2-4 funds)
- Right fund allocation according to risk appetite and age or financial situation.
Easier tracking
- Tracking and action is based on the particular portfolio, for example, when market goes up or down, not all portfolios need to react
- Each portfolio can have a separate target growth number

Now give a High Five and start investing in the High Five Portfolio.