The Stock Market is at Record Highs. Should You Get Out?

Both the Dow Jones Industrial Average and the S&P 500, the venerable U.S. stock market indices, closed near record highs on Friday, October 13th. Both indices have been steadily climbing all year. The Dow, including dividends, is up 17.92 percent and the S&P, also including dividends, is up 15.86 percent just this year.

The run up has investors waiting for the other shoe to drop. Surely the next move can only be down. Every week there are articles discussing whether we are on the verge of another stock market bubble bursting. You’ve worked hard for your savings, and nothing is worse than seeing a big hole in the value of your nest egg. So should you sell your stock market investments to avoid that?

To see how it might turn out, look at what happened following the last stock market peak, in September of 2007, just before the financial crisis. If you had perfect foresight you would have sold then, and avoided the following drop in value of 51 percent. Then you would have bought back your investment at the low in February of 2009. By now your investment would have more than tripled.

But let’s be realistic. We only have perfect hindsight. We know nothing about the future. We can’t tell whether we are at a peak or just a nice view point along the way. And we certainly won’t be able to tell when the market has hit bottom.

To get a sense of what most investors did following the stock market peak in 2007, we can look at investor net buys or sales of mutual funds and exchange traded funds investing in the stock market during the time period. In the following chart, fund net buys (actually sales because they are negative) are in blue and the S&P 500 Total Return Index is in orange.

Funds flows and performance

Yes, investors began taking money out of the stock market as it began to decline from it’s highs. But they continued to take money out even as it rebounded. As the market surpassed it’s previous peak investors were still withdrawing money. It wasn’t until the end of 2012 that stock funds began to see steady net buys.

The biggest monthly net sale was in October of 2008 and the biggest monthly net buy following that was January of 2013. If you had sold and bought back in those months your return from September of 2007 through October 13, 2017 would have been just 11.89 percent, or about 1.3 percent per year.

Even being off by a few months would have cost your returns. If you didn’t sell until December 2007 and didn’t buy until May 2009, your money would have only doubled instead of tripled. If you had waited another six months on both ends, your money would be only 1.5 times more than at the 2007 peak.

What if you had done nothing? If you had not touched your stock market investments, by now your money would have more than doubled. Doing nothing is certainly easier than picking both the top and bottom of the stock market. Steadily adding to your investments, as you would in your retirement account, would have been even better.

Where stock market declines become devastating is when you have to withdraw your money during the decline to meet expenses.  To avoid that, don’t invest any money you will need to spend in the next ten years there. Anything that you won’t need for more than ten years can stay invested in the stock market. Historically, the S&P 500 has finished higher than it started in 26 out of every 27 ten-year periods.

Of course there will be another market down-turn. But no one knows when or how severe it will be. In the mean time you need your savings to grow for your long term goals, like retirement. So no, don’t get out of your stock market investments now and in fact keep adding to them. If you have more than ten years before you need to spend your money, you have plenty of time for your savings to recover from the next down-turn, whenever that is.

Sources: Yahoo Finance S&P 500 Total Return Index and Data Hub US Investor Flow of Funds

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There are Only Three Investment Categories

Investing your hard earned savings can be daunting. There are so many options it can be hard to figure out what to do. You likely have several investment options in your 401(k). And what about all the other options? Are IRAs or ETFs right for you?

You can untangle the mess of terminology and options if you understand that at the root of things, there are only three types of investments. Everything else is simply a container to hold those investments. The three categories are:

  1. Stocks: Also known as equities. When you invest in stock you own a small piece of a company. As an owner you share in the company’s earnings with other owners. Your earnings may be sent to you in the form of a dividend, or the company might reinvest them in the business. Growth in earnings and dividends drives the long-term value of the shares you own, though many things influence the daily prices of stock in a publicly traded company. Because the future earnings are uncertain, stocks are risky investments.
  2. Bonds: Also known as fixed income. When you invest in a bond, you own a piece of a loan made to a company or government entity. There are even bonds that bundle together mortgage loans to individuals known as mortgage backed securities.  As the owner of a bond you are entitled to interest and the return of principal (your piece of the amount loaned). The daily value of a bond is driven by changes in interest rates and the time remaining until the loan must be paid back, but if you hold the bond to maturity you will simply get the interest and principal. Because the interest and principal payments are contractual obligations, bonds are less risky than stocks.
  3. Hard Assets: Hard assets are things you can touch, like precious metals, agricultural products, oil and gas or real estate. The value of most hard assets is driven by supply and demand. Real estate is the exception. Real estate can also generate income through rent. Supply and demand is unpredictable, so hard assets are also risky investments.

Within each of these broad categories is a host of sub-categories. They include US and international stocks in large, mid or small sizes, US and international corporate and government bonds and many more. There are thousands of companies and bond issues, and you can hold any of them directly. All other investments are indirect ways, or containers, for holding one or more of these three investment categories. Here are a few of the common forms of holding investments indirectly.

  1. Mutual Funds: Mutual funds can hold any or all of the three investment categories. There are single category mutual funds that invest in only one of the three, and there are multi-category funds that invest in two or more categories.
  2. Exchange Traded Funds (ETFs): ETFs are a special type of mutual fund. Mutual funds are valued at the end of each day and sold through the fund company that manages them. ETFs are sold on the stock market like a company stock. The value fluctuates throughout the day. Because the ETF must have a value at any given moment, most invest to mimic an index, which is a fixed group of investments, like the S&P 500.
  3. Target Date Mutual Funds: Target date funds are also a special form of mutual fund. They were designed for retirement savings investments and invest in at least stocks and bonds, if not hard assets too. They usually have a year in their name, like 2035 or 2050. When the target date is far in the future, these funds invest most of their holdings in stocks, and as the target date approaches their holding of bonds become larger.

There are many other vehicles that allow you to indirectly invest in the three main categories. Whether you are investing directly or indirectly to get a truly diversified portfolio, you should spread your investment money among different categories. Diversification reduces the risk of your holdings, because their values aren’t influenced by the same drivers, and therefore they will perform differently in any given circumstance.  The biggest reduction in risk comes from adding investments in the lower risk bond category to your other holdings. Different investments in the same category offer some diversification, but not as much as investments across categories.

The next container up is the account. The different forms of accounts are merely ways of titling your holdings, similar to the way you would title an account in both you and your spouse’s name or the name of a business. The different titles designate how the account is to be used. Theoretically an account can hold any kind of investment, but the institution or the provider may limit what they offer you.

  1. 401(k): You may have a 401(k) or its cousin the 403(b) account through work. Your employer has picked a list of several mutual funds for you to choose from and will include some in both the stock and bond categories as well as at least one or two investing in multiple categories.
  2. IRA: IRA accounts are available through most financial institutions. Common places to open an IRA are through a full service brokerage firm, like Merrill Lynch, through a discount brokerage firm, like Charles Schwab or directly through a mutual fund company, like Vanguard. There are many more investment options available in an IRA. You can hold stocks, bonds and hard assets¹ directly, or you can hold any of hundreds of mutual funds and ETFs.
  3. 529 Plan: 529 plans are college savings plans offered through your state of residence. The state will offer a limited line-up of investment options that will usually include a fund paying guaranteed interest, funds investing in single categories and age based funds, that like target date funds are designed to become less risky as the date of college attendance approaches.
  4. Taxable Account: Taxable accounts are simply titled in your name or jointly in you and your spouses name or the name of a business. They don’t have any tax advantages, and the title simply designates who has the authority to use the account. You can use the money in the account for any purpose including retirement and college. Like with IRAs, the investments you can hold in a taxable account are wide open.

401(k)s, IRAs and 529 plans have tax advantages. If you use them as intended your investments can grow tax free. It is still your money, and you can use it however you like. But the government will want the taxes that you didn’t pay along the way if the money isn’t used as intended, and in some cases there may be a penalty in the form of additional taxes.

Investing is a process of matching the account type with the intention you have for the money, deciding whether to invest indirectly through mutual funds, ETFs, and other vehicles or directly depending on what is available to you and how much work you want to put into managing your money, and diversifying your investments among the different categories according to the amount of risk you are willing to take. What the money is for may be the only straight forward decision here, but understanding this framework will help you know what questions to ask.

  1. Hard assets are held through futures and forward contracts to buy or sell the product, or in the case of real estate, through real estate investment trusts. There are a few specialty institutions that can hold title to real property.

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Home or Retirement?

The housing market in many areas of the country has seen dramatic increases in prices over the last five years. Home prices in coastal metro areas, like Portland, seem to be on fire. If you don’t already own a home, your hopes of buying one may be dimming as each month brings higher prices. It takes time to save up for a down payment, especially with today’s housing prices. Should you take the money you’ve stashed in your retirement savings and use it to buy a home?

Using the S&P/Case Shiller 20 City Composite Home Price Index, home prices have risen, on average, nearly 8.0 percent per year since the bottom of the housing market in 2012. The fast pace of price increases was at least partially due to the depths of the decline in the market. Since the last peak in housing prices in 2006, nationwide home values are still down. Longer term, home price appreciation has been much more modest. Nationwide, since 1980, home values have only increased 3.6 percent per year. Even in trendy Portland, prices are up just 4.7 percent per year. So values are unlikely to continue to run at the pace of the recent past.

Still it’s hard to not want to jump in for fear of being priced out of the market altogether, especially if you have enough money for a down payment sitting in your retirement account. But raiding that account is not the answer.

Depending on the account type there are limitations to what you can do. If you withdraw your money from a traditional 401(k) or IRA, you will have to pay taxes on the balance you take out, and you may also pay a tax penalty.  You could borrow money from your 401(k), but you can only borrow the lower of $50,000 or half of your balance.

If you have a Roth IRA, you can withdraw your contributions at any time, however if you withdraw earnings on your contributions before age 59½ you will pay both taxes and a penalty. Roth 401(k)s have similar rules, plus many employer plans limit withdrawals while you still work for your company, though loans are still an option.

If you take a loan from your 401(k), you will make monthly payments, and those payments are not considered contributions to your plan. So, unless you make a contribution and a loan payment, you will miss out on the employer match if your company offers one. Loan interest is paid to you, but the interest rate is generally lower than the return you can expect from growth oriented investments available in your plan. And if you leave your job before the loan is paid, you will have to repay the loan in full or pay taxes and penalties as if the loan were a distribution.

Let’s say you have the best situation possible. You have a Roth IRA account with a balance of $100,000, and you can withdraw enough to cover your down payment without triggering taxes. You have three choices. You can continue to save in your Roth IRA and at the same time save for a down payment for your home. You can stop making your Roth IRA contributions and use the money to add to your savings for a down payment on a home, or you could withdraw the down payment from your Roth IRA.

With option one, your retirement account will continue to grow as before. But the cost of the home you want to buy will continue to rise, and given how low interest rates are today, you will likely pay higher interest on your mortgage loan. With option two, your balance won’t grow quite as fast, because you aren’t adding money to your account. With option three, you buy today with a down payment withdrawn from your IRA. You put a big dent in your retirement savings, but your home price will appreciate and you can lock in today’s low interest rates.

To figure out which option is best, I’ve calculated the combined retirement plan balance and home equity twenty years from now using some assumptions. I’ve assumed home values will increase on average 3.6 percent per year for the next 20 years, but over the next five years they grow at a somewhat faster pace of 4.0 percent per year. Using a modest home in my neighborhood (1,100 sq ft) as an example, today’s purchase price is $390,000, but in five years, the same house would be valued at $474,000. Today’s 30 year mortgage rate is 4.25 percent, and I’ve assumed rates rise to 6.25 percent over the next five years.

I’ve also assumed that you would ordinarily save $5,500 (the maximum for 2017) per year in your IRA. The average annual return on your IRA investments over the next 20 years is 8.0 percent, because you are still young and investing primarily in stocks. The following chart shows the results.

home v retirement

In option one and two, you put off buying the home for five years while you save up the down payment. In option one you are able to save for both. In option two you opt to not add to your IRA, but you don’t take anything out either. In both cases you pay a higher price for the house and higher interest rates, because you have to wait five years. In option three, you take out enough from your IRA to cover the 20 percent down payment on the home today, leaving you with about $22,000 in retirement savings.

You do have more home equity in option three, but your retirement account has taken a nasty hit. The value is only half what it would have been if you hadn’t touched the balance and continued to make the contributions. Even if you stopped contributing to your IRA while you save for a down payment, you would be better off than if you raided it today.

To raise a down payment for the house in question, you would need to save about $19,000 per year to be able to buy it in 5 years with the assumptions I’ve made. To recover from raiding your IRA, you would need to save the same amount above your normal $5,500 contribution over nine years, or $171,000 instead of $95,000.

As tempting as it might be to use the savings you’ve already built for retirement for a down payment on a home, in the end you won’t come out ahead. You need that balance to grow for you as long as possible. Dipping into those savings takes valuable time away from growing your account. As hard as it may be, you will still be better off saving for your home, even in the face of rising prices.

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Where to Stash Your Emergency Cash

As a saver, your first priority is to build up savings for an emergency, namely the loss of your job. Most people need at least three months of expenses set aside to bridge the gap between paychecks should the unthinkable happen. But where should you put your emergency savings?

The conventional wisdom says that you should deposit your emergency savings in a “safe” investment. A safe investment could be a savings account at your bank or credit union or a money market mutual fund at your favorite brokerage firm or mutual fund company. Unfortunately, in today’s low interest rate environment, these options don’t pay much more than simply burying your money in the back yard.

The typical bank pays you a whopping 0.01 percent on a savings account. If you have $10,000 saved, that will earn you $1 in a year. Vanguard offers a Federal Money Market Fund that pays 0.38 percent per year, or $38 for ten grand, and Fidelity offers a Government Money Market Fund that pays 0.20 percent per year, or $20 on your $10,000 in savings.

Of course there are investments that can be expected to provide a better investment return over time, but the operative phrase is “over time”. They all pose risks, and could leave you with less money than you contributed if you have to spend your money too soon. Here are the options and what might happen to your savings.

Stepping out just a bit from a bank savings account, you could invest your money in a certificate of deposit (CD). A CD is an account where you commit to leaving your money for a period of time, like six months, one year or longer. These accounts have somewhat higher interest rates. The following table shows current national average rates from the Federal Deposit Insurance Corporation (FDIC). However, if you withdraw your money early, you could wind up losing the interest earned and possibly paying fees, which could cause you to end up with less money than you started with.


At the national average rates, a money market mutual fund is a better deal, however there are CDs available with higher rates. Another option would be to invest in a short term bond mutual fund. Short term bond mutual funds invest in bonds with a few years to maturity. Bonds are essentially loans made to whoever issues the bonds. Both companies and governments issue bonds, and the interest rates they pay depend on their credit worthiness and how long until the bond matures, or in other words when the loan has to be paid back. Bonds and bond mutual funds will pay higher interest rates than the savings options listed so far, and there is no withdrawal penalty. But the value of your investment can fluctuate on a daily basis.

Using the yield on a composite of two year corporate bonds from the Treasury Department as a proxy for short term bond funds, I’ve calculated the returns and historical incidences of losses from 1984 through 2016. The results are in the following table. The current yield on this composite is 1.83 percent. A sampling of short term bond mutual funds had yields between 1.08 percent and 1.70 percent.


If you invested your emergency savings in a short term bond mutual fund, and you had to withdraw it in a month, there is a good chance, almost one in five based on historical returns, that you would pull out less money than you contributed. The longer you hold on to your savings, though, your risk of an absolute loss declines. Since 1984, there has never been a three year period that produced a loss in the Treasury Department’s two year bond composite. For holding periods with losses, the losses on a $10,000 investment were less than $300.

You could reach for a higher return by moving to longer term bond mutual funds. The next group of bond funds are called intermediate term bonds. These funds generally invest in bonds that mature in three to ten years. The longer until a bond matures, the greater the yield (usually), but also the greater the fluctuations in prices. Using the Treasury Department’s five year corporate bond composite, the historical incidence of losses are in the following table. The current yield on the composite is 2.62 percent, and the yield on a sampling of intermediate bond mutual funds ranged between 2.50 percent and 3.00

For the extra earnings, you do take more risk. If you have to withdraw your money within a month you stand a more than one in four chance that you will lose at least some of your contribution. Losses were bigger for this investment. In the worst case since 1984, the loss was almost 9.00 percent, or $900 on a $10,000 investment. That is starting to hurt. But as with short term bonds, these longer bonds historically have not lost money over three year holding periods.

The riskiest place to put your emergency savings is the stock market. For a one month holding period, it is virtually a gamble. The S&P 500 stock index has lost money in more than 40 percent of the months since 1950. Losses can be large, leaving you substantially short of your ability to cover your emergency. Like with the bond mutual funds, the incidences of absolute losses decline the longer you hold your stock market investments, but even ten year holding periods are not immune to losses.

A good rule of thumb is to match your investment to your holding period. If you will spend your money soon, keep it in a savings account or a money market mutual fund. If you will spend your money in the next three years, short term bonds and bond mutual funds are a good option. If you will spend your money sometime between three and ten years, intermediate bonds and bond mutual funds are reasonable. Only money that you won’t touch for ten years should be invested in the stock market.

So which holding period does your emergency savings fall into? You may never lose your job, but for most there is at least a small possibility that you could lose your job at any time. If you are just starting out and your emergency savings are all the savings you have, the conventional wisdom applies. You can’t afford to lose any of your money, so keep it in a savings account or a money market mutual fund. As you build up your savings, and you begin to save for other goals like retirement, you could get away with a bit of risk. Losses in short term bonds have been limited historically, so the extra yield may be worth the small risk.

Save the higher risk investments for your longer term goals. The whole point of having emergency savings is that it will be there when you need it. Low interest rates may be hard to accept, but they are easier to live with than having your emergency fund come up short.

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Paying Off Your Mortgage is Worthwhile Despite Low Interest Rates

I often get asked whether you should pay off your mortgage early. In these times of low interest rates it doesn’t seem like you gain much when you do. For a number of reasons, paying down your mortgage shouldn’t be your first priority, but if you are otherwise out of debt, and you are meeting your retirement and other savings goals, paying off your mortgage should be next on the list.

Mortgage debt is the lowest cost form of consumer debt. Today a thirty year fixed rate mortgage will cost you about 4.3 percent and the 15 year mortgage will cost you about 3.5 percent. If you happened to buy your home when rates were at their lowest, your interest rate could be as low as 3.3 percent. When you tack on the mortgage interest tax deduction the rate is even lower. The following table shows before and after tax mortgage interest rates.


With rates this low, paying off all other forms of debt is your top priority. And even though holding this debt on your home is costing you money, earnings on your retirement savings out weigh the benefits of paying off your mortgage early. But if you are on track for saving for retirement, and don’t have any other debt, paying down your mortgage is a good next step.

Mortgage vs Investing

Paying down debt is a form of saving, and it provides a guaranteed rate of return. Every dollar you pay, you reduce the amount of interest you pay. Even though mortgage rates are low, they still offer a relatively high rate of return for risk free investments. One year Treasury bonds yield less than 1.0 percent. CDs offer similar returns. Slightly riskier fixed income investments, like one year corporate bonds, only pay a little more than 1.0 percent. But on every dollar of mortgage interest you avoid you earn your mortgage interest rate.

Yes there are riskier investments that have higher expected returns. Historically, the average stock market return has been 10 percent. Wouldn’t that be a better place for your money than paying down your mortgage? For your retirement savings goals yes. Those are very long term goals. But if you are meeting those goals, it’s worth considering the relative risk of investing in the stock market versus paying down your mortgage.

If you choose to invest in the stock market with your next savings dollar, rather than pay down your mortgage, you are essentially borrowing money to make the investment, all be it at a very attractive interest rate. Your net return is the market return minus your mortgage interest rate. That would be an average return of less than 6 percent at today’s mortgage rates. Not much more than the guaranteed return of paying down your mortgage, but with a lot more risk. Your actual return in the stock market fluctuates widely from year to year. It only has to dip down to 4.0 percent to give you a negative return after your mortgage interest. That has happened in about four of every ten years.

Mortgage vs Security

While we can quibble about the attractiveness of a higher risky return versus a lower, but attractive, risk free return, one thing is certain. Eliminating all forms of debt makes you more financially secure. That is particularly important when you aren’t getting a paycheck. If your scheduled mortgage payments would have you continuing to make payments beyond your retirement date, it is important that you find a way to eliminate your mortgage before you stop working.

According the Consumer Financial Protection Bureau, in 2011, those over the age of 65 who owned their home and still had a mortgage were paying nearly three times what those without a mortgage were paying for housing. With no mortgage payments, your draw on your savings will be smaller, making them last longer. If your savings have suffered from an investment market downturn, you will be better able to weather it, because your overall expenses will be lower.

Compare two women, Valerie and Jocelyn. Both are single and recently retired. Valerie has a pension from her government job, while Jocelyn has retirement savings. Both women will have about the same amount to live on, around $4,000 per month.

Valerie, due to a recent divorce, will have to take on a mortgage of around $100,000. Her payments will be at least $500 per month excluding taxes and insurance.  With the new mortgage payment, Valerie’s expenses will consume all of her income. As other expenses increase with inflation, Valerie may find herself pinched and need to find ways to cut back on her lifestyle. Jocelyn’s home is paid off, and as a result she has much more financial flexibility. Her cost of living is low and has plenty of room to grow if inflation forces it up. Jocelyn is much more financially secure than Valerie.

We are lucky to live in an era of low mortgage interest rates. It makes the cost of housing more affordable. So paying off your mortgage, unlike other forms of debt, doesn’t need to be a priority. But when you run out of other savings goals to fulfill, paying off your mortgage is well worth it. It’s hard to find a better guaranteed rate of return and getting rid of your mortgage payment before you stop working for pay will make you more financially secure.

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Robo-Advisers Can be Better than Human Advisers for Small Accounts

Do you work with an investment adviser?

How often do you meet with your adviser?

What do you talk about beyond the investments?

What are you paying for your advice?

Unfortunately, for too many people who answer yes to the first question, particularly those with small balances (less than $1 million), the remaining answers are never, nothing and I don’t know.

Over the last several months I’ve reviewed a number of investment portfolios for people who work with advisers. Sometimes it’s good to get an unbiased second opinion, especially if it is free and not given with the intention of winning business. In general, the investment strategies have been just fine, but what has caused me concern is the high fees combined with a lack of service.

In one account, the adviser was charging what seemed to be a relatively low annual fee of 0.60 percent of assets under management (about $6 per $1,000), but he was investing the money in class A shares, which not only had high internal expense ratios, but also had a front end load of 3.50 percent. The internal expense ratio is what the mutual fund manager gets paid to manage the mutual fund. The front end load is paid to the adviser for selling the mutual fund to you. The investor was depositing $1,000 per month, and every month’s deposits were being hit with the 3.50 percent load. That was in addition to the management fee. Average expenses were nearly 2.0 percent per year on the account.

What was the adviser doing for this compensation? Nothing. The owner had never met the guy. He had taken over the account from the previous adviser who no longer worked for the firm.

In another case, a friend left one adviser because he didn’t think his investments were doing as well as they should have been. He moved his investments to an adviser at his credit union. The new adviser charged a 1.0 percent per year management fee and invested the money in a variety of mutual funds. All of the mutual funds had above average internal expenses, making total expenses close to 2.0 percent again. At least in this case, my friend had met with the adviser. But only once. There was no financial planning. There was no assessment of estate planning needs. There was not even any subsequent review of the investments.

Below is a table showing the average investment advisory fee charged by a sample of advisers nationwide from a survey conducted by Advisory HQ.  If your portfolio is less than $1 million it is pretty typical to pay an adviser at least 1.0 percent. These fees don’t include any investment expenses, which could increase total expenses a little or a lot depending on whether the adviser uses cheap index funds or expensive actively managed funds.


Advisers need to make a living and smaller accounts just don’t pay for themselves. Some advisers work on an hourly fee, but most don’t like to do that. There is no leverage in that fee model. The adviser can only make as much as she has hours in the day. Most advisers work on a percent of assets under management structure, where their income can grow with the amount of assets they manage. But that means advisers have an incentive to work with larger accounts. An adviser can make almost as much money with one $1 million account as she can with ten $100,000 accounts.

In order to make small accounts work for advisers, they often streamline the service model. If your account is small, you may see your adviser less often than larger accounts do. Your service may be limited to investment management, which will include creating a portfolio of mutual funds. The adviser will review your investments regularly and maintain the portfolio structure over time, though they may not speak with you very often. If that is all you are getting, you can do just as well for a lot less money.

Enter robo-advisers. The very name seems derogatory. However they are a great solution for people who aren’t getting much service from their current human adviser. Robo-advisers use automated systems to create an investment portfolio for you based on your investment objectives, time to meet those objectives and other information designed to gauge how much investment risk you can take without running for the exits.

These advisers generally use low cost exchange traded index funds or index mutual funds, so the investment expenses are low. Because the investments are maintained automatically, there is no human to pay, and therefore the fees charged by the advisers are low too (some are even free). That leaves more of your investment return for you.

Two of the top rated robo-advisers are Betterment and Wealthfront. Betterment offers investment management using exchange traded funds from 12 different investment categories. Fees for service are tiered and range between 0.15 percent for accounts with more than $100,000 invested and 0.35 percent for accounts with less than $10,000 invested. There is no account minimum. Average investment expenses are just 0.13 percent. For a $100,000 account, you would pay just $380 per year all in. That is $210 less than the average human investment adviser’s fees alone, without taking the investment expenses into account.

Wealthfront offers a similar service. They use exchanged traded funds from 11 different investment categories. They charge no fee for the first $10,000 and then charge 0.25 percent for higher balances. Their investment expenses are about 0.12 percent per year. Annual expenses on a $100,000 account would be about $345. Nerd Wallet has done a good review of several different robo-advisers that is worth checking out.

Robo-advisers are registered investment advisers that take fiduciary responsibility for their clients’ accounts. Fiduciary responsibility means they are required to invest in their clients’ best interest. However they have been criticised. The main concerns are that they can’t offer advice on money they aren’t managing, because the systems simply can’t see it, and the information gathered by questionaires may be too shallow.

If you aren’t getting a lot of service from your adviser, he isn’t in any better shape than a robo-adviser. If you have an account he doesn’t manage, like your 401(k), your investments with your adviser and your 401(k) investments may not come together in a cohesive investment strategy. Human advisers tend to tout the advantages of their customized approaches, but unless your advisor is meeting with you regularly, his investment strategy will be based on limited information too.

The primary driver of investment strategies in general is your time horizon. Your time horizon dictates how much risk you can reasonably take, and therefore how much of your investments should be in risky stock market investments versus lower risk income oriented investments. Time horizon is something that can reasonably be collected through an electronic questionaire. I’ll bet your adviser had you fill in that information on a form when you opened your acount.

A good adviser is worth the money that you pay. A good adviser will help you with saving as well as investing. She will meet with you regularly and take into account all of your investments, even the ones she doesn’t manage. She will advise you on how to put an estate plan in place, how much insurance you should own and how to manage your tax burden effectively. She’ll help you understand what you need to retire, and how long it will take you to get there. If you are getting this kind of service, 1.0 percent of assets under management is a reasonable fee. It is low if your account is less than $1 million.

If you are not getting this kind of service, 1.0 percent is way too expensive. If your adviser isn’t going to do more than put together a few expensive mutual funds for you and send you a statement once a quarter, you shouldn’t be paying him so much. All you are getting is a faceless automated solution. A robo-adviser will do the same thing for a lot less money.

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Rental Property – Good Investment or Money Pit?

I’ve been asked more than a few times whether rental property was a good investment. Many people feel more comfortable with an investment they can go and visit than with the stock market which seems so out of our direct control. When a duplex went up for sale near us, it seemed like a good time to do an analysis.

A good investment is one that provides you a good return for the risk that you take. Of course good and risk may be in the eye of the beholder and depends to some degree on how long you expect to hold the investment. For comparison, we’ll use the return on the S&P 500 and it’s range of historical returns over ten year periods to gauge the return on this rental property.

What should be included in our analysis? Well of course we’ll include our annual rent and an estimation of the increase in the value of the property. But we’ll also need to subtract the costs involved in owning the property. Those include property taxes, insurance and maintenance. If we take out a mortgage to buy the property, we’ll also need to include the interest on the loan. Finally we’ll need to make an assumption for inflation on both the income and expense side.

The duplex that is for sale has two 1,000  square foot, two bedroom, one bath units. Here are the reasonable expectations for this property here in Portland.


There are two rules of thumb about what to assume for maintenance costs. One suggests using 1.0 percent of the purchase price, and the other suggests using $1 per square foot. The property for sale was built in 1957 and likely could use some tender loving care. So I’ll take the higher of the two and use $4,950 per year as an average maintenance cost estimate. That puts our net annual rent, after expected expenses at $14,449. If we were to take out a 30 year mortgage to buy the property*, deducting the interest cost would leave $710 in annual rent. That’s not much, but property values tend to increase over the long run. Will the increase in value provide our return?

Using data from the Federal Housing Finance Agency the following chart provides the average annualized rate of increase in home prices over different periods within the 1991 to 2016 time frame. The Portland market data is from Zillow.


As you can see, the Portland market has been hot, but the increases in prices over the last five years here are not sustainable. The best ten years nationally, at 6.8 percent, ended in 2006 and there is not another period with price increases of that magnitude. So we’ll exclude those two data points. The last ten years were also an anomaly. The price declines from 2006 to 2011 were the worst in the 1991 to 2016 time frame. A reasonable assumption for the increase in the future value of our property would be the longer term national average annual increase of 3.4 percent.

A few other assumptions can go into our analysis. Rents and property taxes go up more or less with inflation, so I’ll include an annual 2.0 percent increase in these values as well as the cost of insurance and maintenance. With all of this information what is our expected investment return?

While the price of the property is $495,000, if we mortgage the purchase with a 20 percent down payment, our investment is only $99,000. The mortgage leverages our return, so our net rent and price increases would be judged on that basis, not $495,000. As we make mortgage payments the base does grow, however. Given these assumptions the expected average annualized return over a ten year holding period would be 9.9 percent. That is comparable to the historical averages for the S&P 500.The NYU Stern School of Business data set has the average annualized return for the S&P 500 from 1991 through 2015 at 9.7 percent with similar returns for the full data set which goes from 1928 to 2015.

What could go wrong? Well it’s not likely that we’ll be able to rent the property all of the time, but we’ll have to make loan payments every month. If we assumed that we average ten months of rent per year the return drops to 8.6 percent.

It’s possible that we’ll have to put more into the house than our down payment in order to make the rental units comparable to similarly priced apartments in the neighborhood. If we had to put in an extra $50,000, our return would drop to 7.0 percent. Or alternatively we could rent the units for less; say $750 per month. That would drop our return down to 4.9 percent.

Finally our return is sensitive to the gain in the value of the property. If the next ten years were like the worst ten years for residential real estate prices, our return would be 1.8 percent. If everything works against us, we need to put more money in, rents aren’t as high as we expected and real estate values don’t rise, then we would lose 2.7 percent per year. But if everything works in our favor, we could gain more than 14 percent per year.

The worst ten year period for the S&P 500, ending in 2009, had a loss of 1.3 percent. The best ten year period, ending in 1999, had an annual return of over 19 percent. The same numbers for the full series were also similar.

One other thing to consider is personal effort. While the expected return on a rental property could be in line with what you would expect from an investment in an S&P 500 index mutual fund, the rental property will demand time and attention. An investment in an index fund is passive and requires no effort at all.

So is a rental property a good investment? It’s not a bad investment. In any given time period the return on a rental property could be better or worse than the return on an S&P 500 index fund, a reasonable passive alternative. Over long holding periods, expected returns on a rental property are in line with historical returns on the S&P 500, given the uncertainty of the projections.

Most people will only be able to own one to a few rental properties, and those will be in a single geographic region, which increases the risk of the investment. Rental property requires time and attention. If you value your own time in line with the cost of a property manager, your return would drop further (by about 1.0 percent per year). But if you like the idea of being able to visit your investment, rental real estate might be a good alternative or addition to your stock market investments.

*30 year mortgage loan interest rate: 3.5 percent per

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