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I wrote a primer on some basics of financial growth for my friends on fb. It's a lot of stuff, but you can ignore the comments and just look at the posts themselves to get to the heart of it.
I don't claim to be an expert on finances, but I see so many friends making simple mistakes or not doing obvious smart things. I want to share what I know in case it helps anyone, so I'm going to post every day or so things I hold to be fundamental and essential to growing your money. I honestly believe these concepts can make a huge difference in long-term financial outcomes. And it's painful to see so many friends lose out perhaps because they simply don't know these concepts.
But remember, I'm no expert, so don't just listen to me. Instead, use what I suggest to investigate and decide for yourself.
ED The best book on personal finance I've read:http://www.amazon.com/Random.../dp/0393340740/ref=sr_1_1...
A Random Walk Down Wall Street: The Time-Tested Strategy for Successful...
AMAZON.COM
MW So what's the first tip?
OP I imagine the first tip is to max out all of your credit cards so that you can bet on the stock market. You can make far more money in the stock market than the credit card interest rate.
MS Uhm... I am not sure about that, its seems to easy to be true
OP MS - It gets even easier if you subscribe to Insider Ivan's Stock Tips.
MS Done! lets start figuring how i am going to spend my $$$$
SR waiting...
SB I'm listening...
GA i don't even know what you're going to write or if i'll agree with it, but kudos to you, sir, for making the effort.
IC I am open
CM Jason you're amazing. Can't wait to see the rest
Yiḥezkel Jason Schoenbrun Thanks guys, I hope some of the posts help!
It's been called the eighth wonder of the world.
Compound growth is the idea that if you make the same percentage of profit on your money today as you will make tomorrow, you will make more actual money tomorrow than you did today. This is because even though you make the same percentage both days, it will apply to more money tomorrow than today, because tomorrow you have both your original money plus your profit from today.
In short, compound growth is also called "exponential growth", it's generally how money grows, and it's an extremely powerful force.
The takeaway is since growth is exponential, any small amount of change in how much you save early will have an exaggerated effect in how much you have later on. In other words, start growing your money early. If you're 30 years old and can choose between saving $200/month for 25 years starting now versus waiting until you're 40 to save $400/month for 25 years, you will have more money by age 65 in the first scenario (assuming average 7.5% annual growth, which is modest). So start saving what you can now! Future you will appreciate it much.
Here's an article with very helpful charts to illustrate how much of a difference saving early makes, thanks to compound growth:http://www.adamhagerman.com/compound-interest-calculation/
Another good article: http://www.getrichslowly.org/…/how-compound-interest-favor…/
I'm sure many people know this concept already, but I can't imagine starting such a series with anything else because of how fundamental it is.
Starting This Early Can Make You Filthy Rich
Facebook0Twitter2Pinterest0Google+0LinkedIn0 “If you could only give one piece of financial advice to a person, what advice would you give them?” I get asked this question a lot, and it’s a pretty easy answer for me. I always say, spend less than...
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CM And here is why people know this, but still aren't saving for their future: http://en.wikipedia.org/wiki/Stanford_marshmallow_experiment
Stanford marshmallow experiment - Wikipedia, the free encyclopedia
The Stanford marshmallow experiment[1] was a series of studies on delayed gratification in the late 1960s and early 1970s led by psychologist Walter Mischel, then a professor at Stanford University. In these studies, a child was offered a choice between one small reward (sometimes a marshmallow, but…
EN.WIKIPEDIA.ORG
GA preach it jason
Warning: this comic occasionally contains strong language (which may be unsuitable for children), unusual humor...
XKCD.COM
AR And the inverse is true as well: debt not paid off grows exponentially over time even if interest rate stays the same
Yiḥezkel Jason Schoenbrun That's true at 2% interest. 20% over 10 years doesn't feel like a lot.
But tomorrow's post is about the stock market, where 2% is very low.
EA So how do we save it? Where do we put it to make it grow?
OP "That's true at 2% interest. 20% over 10 years"
Don't forget the rule of 72 (70). 2% interest over 10 years is a 30% gain not 20%. Or alternatively it's 22%. Unfortunate because Ceplar had a cartoon posted with all the variables and I just missed it.
September 17 at 4:46pm · Edited · Unlike · 1
SS Yiḥezkel Jason Schoenbrun can GS get on the email list?
DJ "if you deposit $1,000 in the bank and it earns 5%" - I'd like to meet that Bank.
DZ Me, too. 5% over a sustained period of time is an awesome return rate.
GA given that american banks are offering .96% tops right now...............
FV I remembering learning compound interest in math class and getting so excited by the prospects!!
Yiḥezkel Jason Schoenbrun DJ I can't check right now, is that quote from the linked article? That is weird.
DZ and GA For now I'm just showing the power of compound growth, assuming those percentages. Tomorrow's post is about way outpacing 5% in sustained long term growth. Hint: it won't be via interest at a bank
GA of course not................i'm just sighing, thinking of 5% interest at the bank............................
GA are you gonna bring up index funds, constant value investing, or long-term value investing at all?
DJ Yiḥezkel Jason Schoenbrun: That was an example given.
Yiḥezkel Jason Schoenbrun GA that level of specifics isn't for another few days. Index investing will definitely come up, value investing probably not.
DZ Remember, you not only need to do 5%, you need to do 5% AFTER INFLATION.
Yiḥezkel Jason Schoenbrun Yes, it consistently beats 5% after inflation.
But that's not true, you only have to make sure you're comparing apples to apples. So if you're comparing the rate of return of venture capital investments to the rate of return of investment in your own business as a lemonade stand, so long as both rates are expressed consistently (adjusted vs. not adjusted for inflation), you're making a valid comparison. And sometimes it makes more sense to exclude inflation. In my experience, inflation only needs to be considered when you're looking at buying power.
For example OP referenced the "rule of 72" above, which is a helpful concept for visualizing returns. It doesn't account for inflation, nor should it.
GA for the purposes of *comparing* rates of return, inflation can be excluded...but for the purposes of understanding your *actual* rate of return, i don't see how you can exclude inflation from the tally. investing = buying, money has no purpose except to buy things (whether it's apples, equity, or promissory notes).
September 17 at 6:02pm · Edited · Like · 1
MP Check out gmo http://www.gmo.com/America/. He has an April white paper on defined benefits.
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Yiḥezkel Jason Schoenbrun GA You're right, the truest way of assessing your financial position and future is to take inflation into account. But currency fluctuations and changes in what government provides (e.g. Healthcare) should also be considered for an even truer assessment. However, not only are those annoying to adjust for, but they introduce more uncertainty and complexity.
Here I'm trying to suggest ways to maximize money. The methods which achieve or don't achieve that do so regardless of inflation. If venture capital makes you 20% annually on average and a lemonade stand 4%, we don't need to adjust for inflation to make a conclusion with regards to this comparison.
September 17 at 6:37pm · Edited · Like · 1
Yiḥezkel Jason Schoenbrun RD and ED this is what we talked about, and I'm glad I'm finally doing it
ED Yes!
RD Awesome, Yiḥezkel Jason Schoenbrun!
GA Agreed, jason. Looling forward to ur next post.
EG stupid question: where in israel can you actually save and earn money at the same time? savings accounts here are pretty ineffectual, no?
Yiḥezkel Jason Schoenbrun There are 2 problems here -
Saving in the first place is tough because the salaries are so low and the cost of living relatively high. But we just have to if we want long-term financial stability. Easier said than done, but Frugal Israel is one of many good fb groups that help people get by.
The other issue, which is what I assume you're saying, is that banks don't help you meaningfully grow your money, and on the contrary have annoying fees that reduce our savings. To address this, check out tomorrow's post about the stock market. Instead of putting our savings in banks, the stock market is a great option. I'll explain more tomorrow.
The post will be general though and not Israel-specific, so I'll say what I know about that here. Firstly, I don't have an Israeli brokerage account. I saw a great post comparing the main options (invest via bank account, via Migdal or similar brokerage, or via brokerage like IBI), I'll repost that next. But basically the fees here are higher than the US, and that's a major issue that eats into any profits. So I personally invest only in the US right now. In fact, I move my salary to the US despite a cost to do so of 0.75% because that cost is eclipsed by lower fees investing in the US.
But there are things you can do to minimize fees in either country so your money can actually grow. I'll cover these topics, which apply to Americans and Israelis alike, in future posts.
Yiḥezkel Jason Schoenbrun From Daniel Feinberg in another fb group:
"Comparison of Brokers if each purchase is less than about 2500 ILS:
Poalim (other banks similar): Buy/sell 26 ILS, 0.6% year management fee.
Migdal: 15 ILS/month, Buy/sell 3.5 ILS . 50 ILS per/month minimum fees. (So overall minimum about 75 ILS/month).
IBI (need 50 000 ILS to open account): 15 ILS/month, Buy/sell 2.5 ILS. 9 ILS per/month minimum (so overall minimum 24 ILS/month).
If you are within 10 years of aliyah and not American invest abroad and avoid tax on foreign investments. Meet with a tax advisor now and 9.5years after aliyah.
No yearly management fee for IBI or Migdal. Just the flat monthly account fee. They all have heter iska AFAIK, just ask to see. Teudot sal (Israeli version of ETF) pay dividends according to their prospectus. Kranot mechakot (index funds) reinvest all dividends. When dividends are reinvested in Israel, there is no dividend tax. You just pay capital gains. (of course if the fund is tracking a foreign index it will pay dividend tax it is liable in the foreign country but most people don't know or care about that)"
So basically, small amounts will get hit less by the high 0.6% management fee from a bank. But don't buy/sell too much (not recommended anyway per future post) or that fee will get you. If you have more, Migdal is better due to fees being lower relative to how much is invested. Moreso with IBI.
There are 2 main factors that impact how much money you'll have long-term.
Yesterday we covered one of them - timing. In summary, because of compound growth, starting to grow your money early can have an exponentially positive effect on your long-term financial situation.
The other factor is obvious - the average percentage profit you make, say, per year. There are many ways of attempting to make a profit. One is keeping your money in a bank account. Another is investing your money in your own business. Another is being a Venture Capitalist, investing in other businesses while being actively involved. What I want to focus on is investing in other businesses without being actively involved - the stock market. Buying stocks means owning a piece of the company itself, including its assets and profits.
"But the stock market is risky!" you say. You're right, it is. But I'm going to try to make the case that it's worth the risk for most people.
Anything you do with your money will have 2 main qualities - its growth potential and its risk profile. Hiding your money under your mattress has 0 growth potential yet still carries risk (fire, theft, etc). Putting your money in the bank or even a CD carries almost 0 risk, but has minimal growth potential (or worse, if we consider inflation).
So the stock market carries risk, but IMHO and in the minds of some of the greatest financial experts it provides one of the best combinations of growth potential and risk.
The growth potential of the stock market is basically how much value creation you anticipate in the world, or wherever your money is invested, in the future. But that's hard to quantify, or even think about (though we try at the bottom of this post), so arguably a simpler way of trying to approximate the future is by looking at the past. The S&P500, among the most respected ways of defining an approximation of "the stock market", has historically risen about 9 - 10.5% per year over the long term (seehttp://www.moneychimp.com/features/market_cagr.htm andhttp://www.schwab.com/…/Q-and-A-Estimating-Long-Term-Market…).
The risk profile of the stock market is evident because it goes down some years - and in fact it has in 39 out of the last 143 years, the highest annual losses being 44% during the Great Depression and 37% in the Great Recession of 2008! That's a ton of your hard-earned money being lost depressingly quickly! But if you don't sell those years, you don't lose any money (instead, it's called a "paper loss", because any gains or losses only exist on paper until you sell). The stock market has recovered greatly from each such loss, and over the long-term has only gone up, as above about 9 - 10.5% per year. Here's a simple chart: https://www.google.com/finance…
The takeaway is that you have to risk money to make money, and most financially savvy people see the stock market as one of the best places to balance risk and reward over the long term. But the presence of such risk means that the stock market is generally not for money which may be needed in the short term (say, about 10 years). You'd hate to have to take your money out of the market after 2008. And of course, even over the long term, the stock market *could* go down. There are no guarantees. That's why experts recommend "diversification", a concept we'll cover next. We've touched on it already, because owning stock is traditionally in a single company, yet here I speak in terms of owning the overall "stock market". That's intentional, and we'll talk about why next.
To apply yesterday's "power of compound growth" with today's "anticipated high returns of the stock market over the long term", consider the following: If you invest $500/month in the stock market starting at age 22, and it performs about the average of how it has preformed throughout its history, you will be a millionaire before age 50. Keep in mind that you only deposited $174,000 total of your savings into your brokerage account! When that relatively small lifetime savings sits for long periods of time compounding at rates of growth that the stock market has consistently returned in the past, you get rich.
Today's concept is dangerous to use without 3 other concepts we'll cover in the future: diversification to reduce risk, not trying to pick individual stocks (often done via index-tracking, which will probably be covered together with diversification in the next post), and not trying to time the market (aka "buy and hold").
By the way, regarding that hard-to-quantify prospect for long-term value creation above which arguably loosely equates to how well you think the stock market will perform in the future, I personally see it very optimistically. I believe we are always finding ways to make things better, and often that value creation implies higher valuations of the market. In this technological age, I only see value creation happening at a faster rate.
If you're having trouble picturing that and how the stock market affects us in general, consider the food supply of the middle ages vs. today. Due to vastly improved technologies and processes, we can now feed more people today than back then. That's value creation - there's more stuff people would be willing to pay for in the world. And the companies with those technologies and processes are therefore worth more money, which in part goes into the pockets of their stock market investors - the people who loaned those companies money to keep getting better.
This is a simplistic explanation of the stock market and how it connects perceived value creation with more money for investors, so here is a better primer: http://money.howstuffworks.com/…/financial-plann…/stocks.htm
Q and A: Estimating Long-Term Market Returns
A sound financial plan is your map to help you reach long-term financial goals. To get there, you need reasonable estimates of stock- and bond-market returns.
SCHWAB.COM|BY MICHAEL E LIND#AUTHOR-MICHAEL-E-LIND
SS "Hiding your money under your mattress has 0 growth potential yet still carries risk (fire, theft, etc)." What if you turn all your money into gold and bury it in undisclosed locations?
AN While I agree with your assessment in theory, this only applies to people who live comfortably. Many of us in Israel just get by and don't earn money to put away.
Yiḥezkel Jason Schoenbrun The stock market isn't for rich people though. If someone can manage to save $100/month, this can grow to be really nice a few decades later. Growth is measured in percentage, not in actual dollars or shekels. So whatever amount you put in, you get the same percentage growth out of the market as a Mark Zuckerberg.
AN Fair enough. The growth rate might be the same, but you need to put away enough money if you want to grow a retirement fund. Especially with people living longer
GA Very good intro to the stock market... I would stress the following when it comes to truly understanding the riskiness of investing in stocks:
Speculating
Is
Not
Investing
CM If you invested in the stock market in a mutual fund that tracked the dow jones at the height of 2008 (literally the worst time to enter the market in decades), at the begining of 2009 you'd have lost 40% of your money, in 2012 you'd have broken even, and today you'd be ahead 20%. If you invest long-term, rather than speculate (as GA already said), you can expect over long stretches of time to average 8% anually. Time is critical, timing is only helpful.
Also, if you invested a bunch while it was falling, when it eventually picks back up the money does even more work for you. Invest $100 a month, then during times when things seem to be low, try to occasionally dump an extra $100 in there. That's called "dollar cost averaging", and it is highly effective.
September 18 at 11:14pm · Edited · Unlike · 2
CM (source: I looked at this graph with my eyeballs:https://www.google.com/finance?q=INDEXDJX%3A.DJI... )
Dow Jones Industrial Average: INDEXDJX:.DJI quotes & news - Google...
GOOGLE.COM
Yiḥezkel Jason Schoenbrun CM, your advice is sound overall, but I'm going to disagree with dollar cost averaging and with your 8% figure (your eyeballs picked up the growth, but not the reinvested dividends). I advocate buy and hold as better than dollar cost averaging, and I'll explain why in a future post. Also, the figure is about 9 - 10.5% average annual growth via S&P500. The Dow is surely a lower average return, but I doubt 8%. Remember to incorporate dividends into your calculation.
CM my investment folks tell me the average return of the stock market is historically 8% annually. This includes big dips, big bubbles, and all the rest, in aggregate. I imagine it includes dividend reinvestment too but I'm not sure.
CM (so that figure did not come from the graph, but the other things I said did)
OP Not so much. The S&P500 may have grown 9-10.5% including dividends. That doesn't mean you're making 9-10.5%.
The first expense that you have is your expense ratio. If you buy individual stocks then you can ignore this. If you buy a basic mutual fund then it is usually a small but not negligable percentage. If you buy a not so basic mutual fund or use a broker then you'll take a huge hit.
The second expense that you have is dividend tax. Start with federal which doesn't necessarily kick in right away. A married couple filing jointly making less than 73k in taxable income (36k for singles - best of luck to you) pays 0% on dividends. It's possible that when you're first starting out you'll be in this range especially if only one person is working. Once they're making $73k in taxable income then your dividends are taxed at 15%. They can't reinvest all of your dividend money because some of it is taxed. Of course, depending on the state where you live you also need to pay state/local dividend tax. That could cost another 5%.
Finally, the third expense that you have is long term capital gains. You can sort of get around this one. If your taxable income is under 73k a year then you pay 0%. And you don't pay that until you sell.
All of this means that you even if the S&P500 goes up 10% you may only see a 7.5% gain. And if you have to sell at the wrong time... well such is life.
CM hopefully if you have to sell at the wrong time, you can work it out to take a loss, and thus reduce your tax burden (effectively canceling some of the loss).
That's a good point, I forgot about taxes on dividends (which must be treated as income before they are reinvested). It doesn't change any of this advice, which remains good advice - but it does change the numbers slightly. Nothing anybody has said disagrees with the original point - even small amounts invested at regular intervals can make for a huge impact later in life.
Yiḥezkel Jason Schoenbrun OP, this is more about the power of the market. We'll cover the importance of minimizing things that cut into the net gain when we talk about not using an active investment manager and taking advantage of tax advantaged accounts.
So you're a few steps ahead
But I'll point out where I disagree - the expense ratio is minimal in the types of securities I'll suggest. For example, look up the expense ratio of VOO.
We're trying to compare apples to apples, so the only major point relevant to tax is the preferred tax treatment of capital gains compared to tax on other types of growth. In other words, basically all growth is taxed, so we're excluding that factor for now. Dividend tax applies to a relatively small proportion of the growth.
Also, we're not really talking about selling. I'll be advocating the buy and hold strategy, and have made it clear that we're talking about long-term, for money that's not needed in the short-term. Selling at the wrong time is a very small risk with such an approach.
Also, a 10% gain in a tax advantaged account, which allows up to about $22,000 a year single or $27,000 married, would yield a net gain of about literally 10%. In a non-tax advantaged account, the net gain should be about 8 - 8.5% after taxes. Hopefully everybody should be rich enough to max out the tax advantaged opportunities, somehow I suspect many of us don't (and thus shouldn't generally be paying taxes on investments).
Though your point is way ahead of the goal of this post and will be covered in large part later, it's a great point.
OP I stated that if you buy a basic mutual fund (I was thinking SPY) then it's usually a small but not negligible percentage. You stated it's minimal in the case of funds like VOO. What did we say that's different? My point is relevant when it comes to 401Ks where you have a limited number of mutual funds to choose from and none have great rates.
Advocate the buy and hold strategy and that the money is long-term. I presumed as much. But in 40 years, if you want that money you'll still need to sell the stocks. And if you need 40k a year from your stock accounts and its a bear market.... well you'll need to sell some shares in a bad year. And if you sell over 20 years than eventually you'll hit a bad year.
Are you implying that everyone get ROTH IRAs instead of focusing on 401Ks? If so, that's gutsy. But if you have a normal 401k then you pay taxes on distributions. I believe that's at the average tax rate and even higher if you do it before 59 1/2.
GA index funds are known to have much lower expense ratio than mutual funds..............
anyway, i'd like to see in your upcoming posts why you think buy and hold is *better* than dollar cost averaging, i think they work very well together, or at least are complimentary not conflicting
GA "If so, that's gutsy."
why? jason's not the first to recommend it...
OP I've heard of people investing in a 401K and a Roth IRA. And certainly it makes sense to consider a Roth IRA vs a regular IRA. But just ignoring the employer match of the 401k to put money into a Roth?
I don't think I've heard anyone recommend that.
GA lots of people don't have an employer matching their contributions, yet have access to an ira via online brokerages
GA it's not that people recommend roth over and against 401k, just the former is more universally relevant than the latter
Yiḥezkel Jason Schoenbrun OP you're right, we don't disagree. Except I'm just trying to stress that according to the approach I'm presenting, fees only come into the discussion into terms of proving the need to run far away from active investment managers. It's not so relevant to the approach I present in terms of the affecting the net gain of securities we buy, because I ONLY recommend things like SPY, VOO and other low fee ETFs.
I advocate buy and hold *so long* as one doesn't anticipate needing the money in the short term. In other words, per the famous 120 - age formula or how target funds do their stuff, as one gets older they should reduce their stock market holding because more of that money will be needed. When one is retirement age, the only money they should leave in the market is the money they won't need over the next 10 or so years. if they're not wealthy, that's not going to be a lot. They should reduce their holdings leisurely during non-bear markets as their age and thus risk profile changes.
At the age of us and our friends, it's just buy and hold for money we don't anticipate needing over the next 10 years.
Nope, not implying that. Not sure what I said to imply that. One should buy Roth over traditional when they anticipate their tax rates will be higher in the future. Choosing 401(k) vs IRA is more complex. More liability shielding with 401(k) and sometimes a company match, but often fewer fund options and higher fees. The only thing here I intend to cover (this is a beginner's guide, and you my friend OP, are not a beginner ) is getting any match available in full. I don't intend to advise people to choose one over the other, just to use a tax-advantaged account.
By the way, AFAIU, the final outcome for someone who did a Roth and paid on entry and someone who did a traditional and paid on distribution should be identical assuming the same tax rate for both scenarios.
OP Fair enough GA. And fair enough Jason.
We've talked about the stock market, and why over the long run it could be one of the best vehicles for financial growth. But stocks could go down, even all the way to 0! It's not likely, because as explained in the previous post, owning stock is owning a piece of a company, including its assets, physical and otherwise. But companies do sometimes fold, and we don't want to lose our money if that were to happen. I've personally owned stock in a handful of companies that went bankrupt back in my liberal-investing days! It sucks.
In brief, we can buy many stocks so that even if 1 company loses its value, it represents a small portion of our hopefully otherwise successful portfolio. The solution is called "diversification", and simply means not putting all our eggs in one basket. It's the cornerstone of conservative investing.
While an individual company may lose all its value, the majority of stocks all losing their value is not seen as reasonably possible. It has never happened before, even during the Great Depression. If a large proportion of American or Israeli companies lost all their market value we'd have much bigger issues to worry about, and I'm not sure there's another financial strategy, perhaps even including hiding money in your mattress, that would help in such a scenario. So when we (and experts) recommend owning a stock portfolio, we're only talking about a diversified stock portfolio.
Diversity can mean not only owning multiple companies, but also could include large companies, small companies, companies in your home country, companies in other established countries, companies in emerging markets, companies in this industry or that industry, bonds and cash. Just as one should not overexpose oneself to one particular company, one should not overexpose themselves to any particular category, and ideally should include companies in many or all of these categories above.
But this sounds tough - who among us has the time, energy or wisdom to pick hundreds of stocks, and in all these categories no less?! In fact, though, diversification is simple, and further, precludes the need to pick *any* stocks!
That's right, we will not really be picking any stocks. We won't even let "experts" pick stocks for us. We'll cover more reasons why not when we talk about how (un)successful stock pickers tend to be in the next post. But if we're not picking stocks, how can we be buying stocks? Basically, we're going to buy *all* stocks, or more realistically, a large representative sample.
A stock ticker symbol, which is a short codename uniquely identifying a stock which you need to know in order to purchase stock (e.g. AAPL is the ticker for Apple, GOOG is the ticker for Google, T is the ticker for AT&T), is traditionally used by individual companies. But there are stock tickers that represent many companies. Buying such a ticker means owning a share of a company which itself owns a piece of (stock in) literally hundreds of companies. These tickers therefore make it easy to diversify. But there are hundreds such tickers! Which one(s) should we buy to achieve our overall goal of maximize our profit without exposing us to too much risk?
When I said the other day that "the stock market has historically gone up 9 - 10.5% over the long term" I was talking about the US stock market in general. That includes US companies of all different sizes and in all different industries. They even include some international companies. So if you can buy one thing that represents the totality of "the US stock market", you've got diversification mostly covered. So I'm going to recommend we stick to buying stock tickers that approximate the entire stock market by literally owning shares themselves in a representative sample of companies in the overall stock market.
Warren Buffet, one of the most respected financial people in the world, advocates this same approach. He advises achieving this diversification via a low cost "index fund" (http://www.marketwatch.com/…/warren-buffett-to-heirs-put-my…).
What's an index? It's exactly what I wrote above that we're shooting for: it's a "representative sample of companies in the overall stock market." The stock market is comprised of about 10,000 companies. An index is an attempt to select a more manageable group of stable stocks to approximate the overall market. It's helpful for financial news that wants to say, "the market today went up/down X%" without having to run a calculation for every single company. It's also helpful for people who want to buy a representative sample of the entire stock market, without having to own thousands of individual stocks, like Warren Buffet and me.
An index *fund* is a single ticker you can buy to accomplish this, and is an attempt by a financial company to make it easy for the average investor to own this representative sample of the overall market. They make money by charging you a fee, called the expense ratio. But because they just buy whatever is in the index and therefore don't have to make heavy stock-picking decisions, their fees are very low compared to non-index funds.
There are many indexes. Some of the most popular US indexes are the Dow Jones Industrial Average, the S&P500 and the NASDAQ100. In Israel, the Tel Aviv 100 is popular. For each such index, there are dozens or more index funds run by different companies trying to give you 1 ticker you can invest in in order to approximate that index. This is what I recommend buying.
I try to avoid recommending actual stocks to buy (it's dangerous; the last thing I want is for a friend to rely on a recommendation of mine and lose money), but I also want to make this as unimposing as possible to the beginner. So I'll recommend some tickers for you to look up and consider. I'm personally a big fan of VOO and QQQ. VOO has an extraordinarily low fee, which is critical as we'll cover in the next post. It also tracks one of the most respected and historically successful indexes (the S&P500). I like QQQ because the NASDAQ, which it tracks, tends to be heavy on tech stocks compared to other exchanges/indexes, and I am personally a big believer in the growth potential of tech.
So far we've only bought 1 or 2 tickers. But we're not completely done with diversification yet. Those indexes are mostly comprised of US stocks, and we need international stocks to be even better diversified. So we'll want to buy another low fee ticker or two representing such categories as "international" (consider SCHF) and/or "emerging markets" (consider VWO). You can do your own research by googling "low cost [diversification category] ETF". ETF stands for Exchange Traded Fund, and basically means a ticker representing lots of companies as explained above. Mutual funds are what people traditionally used to accomplish this before ETFs existed or were popular. The practical differences between ETFs and mutual funds are generally not so significant, so you can Google for mutual funds instead of ETFs if you prefer.
We're almost done. Besides tracking the US market and maybe getting some international exposure, we also need some really safe (bonds) and super-safe (cash) investments. This way, even if the stock market suffered a huge crash, these guys provide another safety net. For bonds, consider ticker BND. And for cash, a bank CD counts. In general, the younger you are, the more gain you want and more risk you can handle, and therefore should be much more on the side of diversified stocks than bonds or cash. As you get older and can't tolerate as much risk, you drop some stocks in exchange for bonds and cash. The rule of thumb is you calculate: 120 - your age = the percentage of your money that should be in stocks. The rest should be in bonds, and less so, cash. If you're a more risk averse person, you can use this equation and pretend you're older than you are
We've made picking stocks easy, now let's make the percentage you put in each diversification category (aka allocation) easy too. Consider using a calculator recommended by experts, like:http://www.bankrate.com/ca…/retirement/asset-allocation.aspx
I'd also be remiss to talk about diversification without mentioning that you can achieve great diversification with only 1 ticker - by buying a "target fund". Target funds are named according to retirement date (aka when you need the money), and the pros behind the fund diversify appropriately within the fund over time. One example is the Fidelity Freedom 2050 Target Fund (FFFHX). As the years pass and you get closer to retirement (the year 2050), they'll change what's in that portfolio as appropriate for someone closer to retirement. You can own a ticker like FFFHX for literally 35 years and never touch it, achieving returns competitive to if you managed your own portfolio as I suggest above. The downside to target funds is they have relatively high fees because they're actively managed by pros, and because you have less visibility into/control over what's happening within. I don't personally use Target funds for these reasons.
That's it! Our portfolio contains 5 or so tickers, representing thousands of stocks. When "the market" goes up, our portfolio should go up by a similar amount. When "the market" goes down, our portfolio should go down by a similar amount. The market has historically gone up quite nicely over the long term, so hopefully now we can tap into that. We didn't pick any individual stocks, and don't need to buy or sell anything in the short-term (nor should we, as we'll cover when we talk about "buying and holding" in a future post).
Warren Buffett to heirs: Put my estate in index funds
Without Warren Buffett’s investment acumen or access to information, the sage recommends banking on the S&P 500 for long-term success.
MARKETWATCH.COM|BY MITCH TUCHMAN
DE was just talking about this with my dad last night! We happen to have some individual stocks which have done great, but we're now worried it can go down just as quickly as it went up, so we are starting to diversify more!!!
Yiḥezkel Jason Schoenbrun Great idea, it's definitely statistically both safer and just as much potential to be diversified. Let me know if I can help
GA "like Warren Buffet and me."
you just wanted to say that.
GA good intro to index funds. i would just add that afaik index funds have a leg up on mutual funds because they are much less exposed to mismanagement and have a lower expense ratio (computers...). and "target funds" are also known as "lifecycle funds."
That sounded too easy. We just need to buy 5 or so stock tickers and we're done? What about all those stock picking professionals who promise to do really well for you? They're pros, so wouldn't they do better managing our money?
No, they won't. A monkey picking stocks would likely do better than the pros. Buying the right stock at a low price and selling it at a high price is what the human brain is wired to NOT do. It's surprisingly difficult to not panic and sell when a stock has gone down (but perhaps will soon recover) or is in the middle of doing really well (but perhaps will soon do even better). It's difficult to not get excited and buy when the next big thing has already been discovered by everyone else, at which point the excitement is already factored into its price.
In short, we're programmed to buy high and sell low. That includes professional stock pickers, and the studies show it:http://www.marketwatch.com/…/almost-no-one-can-beat-the-mar…
It gets worse: those stock pickers who don't generally beat the market take a fee for their attempts, whether they succeed or not. So if you want to compare your gains via that pro to the gains of someone simply tracking the market with a low-fee index fund (which was the core recommendation yesterday), you need to first subtract the fee you paid the pro from your gains. Now you're even less likely to have beaten the index-tracking investor.
As an aside, this brings up another very important point which we'll talk about later when we get to taxes: your net gain is going to be lower than your gross (initial) gain. If you make 9 - 10.5% in the stock market, you won't actually get to put that much in your pocket. Expense ratios, paying the pro's fee, and taxes are all examples of things that can cut into our net profit. Anything we can do to cut those costs is just as good to us as getting a higher percentage return on our investment. That's why I personally don't invest in Target funds despite their ease as mentioned in the previous post, it's also why I avoid pros altogether, and it's why we'll cover some smart strategies to minimize taxes in a future post.
Pros may play with numbers to make it look like they beat the market. They may show you their impressive average annual growth over the last 2 years, because they in fact did have a couple fantastic years. But maybe if you expand the window to the last 5 or 10 years, they barely kept pace with the overall market even before their fee. Over the long run, a stock picker who has consistently beat the market is exceedingly rare.
So not only is picking low-fee index funds an easy way to capture the overall market's gains as well as diversify without much effort (yesterday's post), it also is generally considered more profitable than more hands on strategies. Next we'll talk about another reason why hands-off is better than hands-on, in the context of why it makes sense to buy or sell as little as possible.
Almost no one can beat the market
Year after year, decade after decade, evidence has piled up that neither individual nor professional investors can outperform broad market indexes consistently over long periods of time, writes Howard Gold.
MARKETWATCH.COM|BY HOWARD GOLD
CM There are "pros" like you are talking about, and then there are"pros". Real professional money managers won't pick stocks. My guys give me advice like yours. They help me ensure I have a balanced portfolio including funds componsed of stocks, bonds, equities, and including things from the US an internationally. They look at my annual growth of each part of my portfolio and at regular intervals, sell some and buy others to rebalance (which has the effect of not only ensuring my portfolio keeps the target distribution, but it buys parts that are low and sells parts that are high). They talk to me about what risks I am taking, what my retirement goals are, and ensure I am on track to meet them.
To do all of this, they take a perfentage of my portfolio and they do have a minimum amount they will manage which is quite high. Most people would be fine following OP's advice, but for me my guys are well worth their cut not to have to worry about it. If you need a professional, these guys are the sort to get. There is also the folks at wealthfront.com - I believe they do something similar.
JS CM what do your guys say about their advantage over something like aVanguard target retirement fund?
CM I haven't asked them that specific question, but my guess is they would say something like "if you have low-six-figures or less, things like that are simple and safe and allow you to manage risk without becoming a part-time money manager yourself. If you have more than that, however, it is worth paying someone who does this full time to manage your money to ensure your portfolio is balanced to get the best return possible given the risk you want to take."
JS I would be interested (and it might also be useful for you to know, financially) what sort of alpha over the "null hypothesis" (e.g. Vanguard) your advisors think they can deliver? Because you would want to make sure that their expenses are < the added return -- or that they are value adding some other way like risk management etc?
DF Hey person I don't know, that was TL;DR. You can prove in like 4 sentences active management is a scam. 1. Assume passive money is representative of the overall market. 2. Therefore active money is as well, on average. 3. Active means higher fees. 4. Therefore the average active dollar does worse than a passive dollar.
There is a famous very short paper:http://web.stanford.edu/~wfsharpe/art/active/active.htm
"Today's fad is index funds that track the Standard and Poor's 500. True, the average soundly beat most stock funds over the past decade. But is this an eternal truth or a transitory one?" "In small stocks, especially, you're probably better off with an active manager than buying the market." "The c…
WEB.STANFORD.EDU
CM They are also value-adding in that every quarter they send me a graph of what's up, and they handle all the buy/sell/rebalancing crap automatically. They remind me to contribute to Roth if I'm going to each year, and they also look out for new areas to diversify into.
I believe there is an international (non-us) growth fund they added last year as 2% of my portfolio that has done very well this year, but mostly, was designed to hedge against poor US performance which didn't really happen I think.
CM (I don't really follow it that closely - and that level of not-caring is also a feature they sell
JS I guess my claim is that wealthfront/vanguard/etc also sell the same thing
DF Sure auto-rebalancing and stuff is good. Just be careful picking a "financial planner". Most are salespeople for proprietary products. The magic words that mean they act in your interest only are "fiduciary responsibility".
JS so its important to understand who is charging what for what
CM From what I have heard of wealthfront, that seems to be true.
JS DF agreed. People charging hourly is also a good sign.
Yiḥezkel Jason Schoenbrun CM Your active managers might be worth what you pay them, and I hope they are able to add value. But you should be aware that sending charts and auto rebalancing is also often free. There is a chance that you can get the same or higher return, same or lower risk, and same or better ease, services, charts, etc by simply buying by yourself 5 or so diversified low-fee ETFs. If that's true, there's either some value they add that I'm missing, or you are essentially saying you don't care about the non-negligible difference between how much money you would have had you done this yourself and how much you will have using active managers.
Also, keep in mind that pros aren't always right. Many pros have difficulty holding one thing long-term and not chasing gains. Also, based on your claim of being hands-off yet advocating dollar cost averaging, it sounds like these guys may think dollar cost averaging is the best approach, which I disagree with (that'll be covered in my next post).
DF I do have a tendency to be wordy. But it's a tough balance to strike because I'm trying to explain basic concepts of finance and investing to my friends who feel overwhelmed by it. It's a tough audience because I want it to be short enough for them to read, but I want to really explain the sense behind these ideas.
CM Dollar cost averaging is something I do with bitcoin ( I think? maybe I misundersand the term). It has nothing to do with what my investment guys do, I self-originated it. I *thought* dollar cost averaging meant buying a fixed amount of a commodity in dollars at regular time intervals, like say $50 a week, or $100 a month, which *seemed* to be what you were advocating for people saving to invest in their future. This protects you from trying to predict the highs and lows by instead having you just buy spaced out, and if the stock performs well over time so do you.
Is this not what that means?
Yiḥezkel Jason Schoenbrun You're right, that is what it means. I'm going to hopefully make the next post today, and hopefully I'll mention why DCA is a good idea, but not the smartest.
I don't advocate DCA. instead, I recommend investing all money in the growth vehicle you desire as soon as you have the money.
CM Ok, well I do dollar-cost-averaging of bitcoins and I do whatever my finance people do with the money I send them for everything else. I'm not going to go into a detailed analysis of all my finances for all of facebook to see, but suffice to say, when a stock option event happens, or I come into money, or taxes rear their ugly head, my finance dudes (who are great family friends and have done my dad's stuff for over 30 years) provide invaluable trustworthy advice well worth their fees.
JS CM where's the pdf of your state & federal taxes? Inquiring minds want to validate your investment approaches
I hope I've done a decent job of showing how easy it is to position our savings so they can return what has historically been at least as good as the return most financial experts get. We just buy a few diversified, low-fee ticker symbols, and we're done. Now I'm going to talk about one of the hardest things to do as an investor - not selling.
As I mentioned previously, the human brain is wired to buy high and sell low. It's hard not to react with herd mentality when it feels like everyone is selling or when bad news comes out. But each time we sell or buy based on a short-sighted view of today's news, we're more exposed to our brains' bias, which is a big risk.
In fact, study after study shows that trying to time the market (trying to time purchases/sales so as to buy low and sell high), just doesn't work (http://www.schwab.com/…/schwab/nn/a…/Does-Market-Timing-Work). Instead, the smartest strategy seems to be simply buying and holding. This means that when you have money to invest, you don't wait to invest it. You simply buy at whatever price the shares are currently going for, without thinking about it. You only sell if you unexpectedly need the money, or, ideally, in a more planned fashion by diversifying away from stocks and towards more stable assets as you get closer to retirement/needing the money. This approach requires discipline.
Many experts recommend an alternate strategy to "buy and hold", called "dollar cost averaging". It involves investing smaller chunks of your money over time instead of all at once, just in case values go down after your initial purchase (similarly selling in chunks in case the value goes up after you begin selling). This way, if the market then goes down, your average purchase price is lower than it would have been if you just bought everything initially at once. But as you can see from the article linked to above (as well as here: http://business.time.com/…/15/is-dollar-cost-averaging-dumb/), it's generally worse (though not by much) than simply buying and holding. The reason is based on the fact that markets have tended to go up over time, so delaying investing any portion of your money causes a statistical likelihood of missing out on some of that gain.
A related concept to the temptation of "timing the market" is the temptation to read charts, which many people seem to think they can do. The human brain is predisposed to want to discern patterns in everything, and charts are ripe minefields for that bias. If, for example, the S&P500 index was trading at 1,700 one year ago, and is currently trading at 2,000, the highest price it's ever been, one might think that it grew so fast in the last year that it's overdue for a drop. The underlying issue is whether such past behavior can predict with any reasonable accuracy what it will do in the future.
The answer is generally no, though with a caveat - after all, stocks are generally purchased by humans, who are influenced by charts. If purchasers are influenced by charts, and those purchases influence the future price, surely some component of future performance *will* be impacted by charts. Further, there are such concepts as "support levels" and other technical chart concepts which may in fact influence some aspects of what a stock or the market will do in the future. However, these concepts are well charted (ha!) by rich experts who try to pick up on such predictors, and turn them into automated computer algorithms that extract profit from them before you or I even notice them. Good luck beating them.
Another reason to buy and hold is your health. Frequent buying and selling in any form can induce unnecessary stress. When you buy and hold, hopefully you won't even feel an impulse to check stock prices at regular intervals. Because what does it matter? You're holding anyway!
We've talked before about how low-cost index funds over the long-term beat the professional active investment managers both in terms of performance and in terms of fees. We mentioned how minimizing fees are just as important as maximizing our gains. Next, we're going to look at the big picture of which fees might lower our net gain and how to reduce them, with a focus on taxes.
Our research shows that the cost of waiting for the perfect moment to invest exceeds the benefit of even perfect timing. 1 And because timing the market perfectly is, well, about as likely as winning the lottery, the best strategy for most...
SCHWAB.COM|BY MARK W RIEPE#AUTHOR-MARK-W-RIEPE
OP The whole idea behind DCA is that you're reducing your risk by putting money into the stock market over a period of time (12 months). It is true that on average using DCA instead of buy and hold will cost you roughly .2% a year but you are also reducing your risk that you'll invest all of your money right before a downturn and therefore suffer losses.
But realistically, I don't understand the reasoning behind this post. Most of your friends that need this advice don't have 20k in a bank account. They're going to have to use DCA because they'll have to invest $100 or whatever they can afford a month. Their only options are DCA or trying to time the market.
Yiḥezkel Jason Schoenbrun DCA, as I define it, isn't based on frequency of putting money in the market. It's based on whether one intentionally waits to invest in intervals some money they can invest now.
For that reason, I consider 401(k) contributions to be buy and hold, even though we're buying at regular intervals, because our goal is simply to buy when the money becomes available. Maybe my definition is wrong, but I'm trying to capture a difference in attitude between timing and not timing the market.
I don't agree that DCA reduces risk. It increases risk of opportunity cost. Waiting to buy because the market might go down reduces risk in the same way that not investing at all reduces risk. Once one accepts the risk inherent in the stock market, waiting to invest any of it IMHO is silly and doesn't accomplish anything.
But experts acknowledge the role of psychology in investing, and if DCA is the only thing standing between a person's savings and investing it for growth, so be it!
September 23 at 4:28pm · Edited · Like · 1
OP Some do define buy and hold and DCA like that. That's a fine definition but I don't see how that's useful in this setting. Do you think you know a lot of people that are trying to time the market that are going to be swayed by a basic summary? If so, fair enough.
DCA does accomplish something. It protects you in case of a sudden downturn even if it is statistically unlikely.
In theory, if you lived fifty years ago you could have invested all of your money in Coke. Had you done so, you would have seen larger gains than investing in the S&P 500. But you would have taken on considerably more risk. The point is that you're not willing to accept the risk inherent in the stock market by just buying one stock. Someone else may not be willing to accept the risk inherent in the stock market by putting 100k in the market from a savings account at one time. It's psychology in investing partly. But there is a rationale.
CM OP nailed it on the head. Your advice earlier was "even if it's just 100$ a month, save every bit, as soon as you can". That *IS* DCA.
CM one of the stories my finance guys told me about my dad (as I said earlier, they have been helping my family for over 30 years) was "Your dad is a very shrewd investor, and very disciplined. He reliably sent us his normal amount, every month, except when the market was doing poorly. Whenever the market was down, and people were getting scared, your father sent twice as much". That's fucking DCA with insight.
CM (but he never sold - he always held - the core of DCA)
Yiḥezkel Jason Schoenbrun OP, I'm not so worried about people who already have some sense of control over their money and how to grow it. Such people are 99% of the way there, and I'm happy for them.
But for the people who are just learning about these concepts, I certainly want to drill in some fundamental points, and one of those is to not try to time the market. DCA is, to a small extent, trying to time the market. I'm trying to encourage strong discipline in that regard.
Let's put the risk analysis another way which might clarify. We can be in cash, or we can be in the market, or a combination of the 2. Cash has a relatively good risk and bad opportunity cost profile, and the stock market has a relatively bad risk and good growth opportunity profile.
DCA is choosing more time in cash over the market. For a more extreme example, imagine someone keeping $999 in cash and $1 in the market, claiming to have found a good risk balance with the market. I would comment that such a person clearly doesn't want the risk of the market.
Similarly DCA. If someone does a diversification analysis (our starting point; thus "you're not willing to accept the risk inherent in the stock market by..." is irrelevant) and determines what percentage of their money they want in cash and what percentage of their money they want in the market, by investing in the market via DCA they are unintentionally weighting their balance of cash to market more to the cash side. If they decided a certain amount of money should be in the market presumably because they want the growth potential, they'd be missing out on some of that objective if they don't go and do it. Not doing so is equivalent to keeping more money in cash temporarily than originally calculated during the diversification analysis.
Yiḥezkel Jason Schoenbrun CM, I don't agree. I think simply defining DCA as regular intervals doesn't capture the concept. The concept is *intentionally waiting* with money that's available and ready to invest for regular intervals.
The practical difference can be discerned by looking at 401(k)s. To me, that is not DCA because you're putting in money at regular intervals but as soon as you're able to. To me, that's a buy and hold approach, unless you're leaving your 401(k) deposits in your account as cash so that they can be invested in certain ways at certain frequencies (in other words, timing the market).
It sounds like your Dad had a sharp mind and great discipline. Many such people advocate DCA. I nevertheless think it's less good, though in a small way. Even if I'm right, someone who invests wisely overall with a few minor shortcomings is still doing really well.
OP It is true that some forms of DCA have some similarities to timing the market. It is also true that an apple has some similarities to a mango. But if I sell you an apple and charge you the price for a mango then you probably won't be happy. And you won't be sympathetic to my arguments that an apple is similar to a mango and therefore should cost the same.
IMHO, the difference is between actively trying to time the market and passively trying to time the market. DCA passively tries to time the market. Even if the market drops you're still going to get vested during that period. Actively trying to time the market is a different kettle of fish.
CM Again, I have to agree with OP here. Would it "Solve" the argument to go find the definition of DCA by some authority and see if it is "active" or "passive"?
CM http://www.investopedia.com/terms/d/dollarcostaveraging.asp
"The technique of buying a fixed dollar amount of a particular investment on a regular schedule, regardless of the share price. More shares are purchased when prices are low, and fewer shares are bought when prices are high."
Sounds passive to me. More shares are bought when the price is low by virtue of always buying the same dollar amount (or always buying the full amount you can afford to given the number of dollars you have, regardless of the share price). DCA *means* ignoring the price, and buying and holding.
The technique of buying a fixed dollar amount of a...
INVESTOPEDIA.COM
Yiḥezkel Jason Schoenbrun But OP, DCA *is* timing the market. It's an attempt to buy at a more favorable price, which is timing the market. Passive and active are no different. Not investing is an opportunity cost, which is an equivalent to losing money.
If you see a $20 bill flying in the wind, grab it, and then drop it by accident a minute later, you've done the same thing economically as if you lost a $20 bill that had been in your pocket. Either way, you lost out on $20 you could've had. Psychology has a lot to say about how we treat those different scenarios, but they're fundamentally the same economically.
CM If you say "Every month I'm going to invest $100", and then each month you try to pick the "right time" to invest it, you are timing the market. If you buy $100 worth of something on or around the 1st of every month, regardless of price, you are doing the OPPOSITE of timing the market, because BY DEFINITION OF THE WORDS I JUST SAID you are ignoring the price and buying a fixed-dollar-amount. That is NOT timing the market. I'm not sure how this can be any clearer.
CM in fact, the reason why DCA is a good idea is it is a simple way to take the "weak willed" and help them NOT try to time the market. If you instill in someone the practice of buying at regular time intervals, regardless of price, you are telling them "ignore the price", because reasons. DCA teaches people not to try to time the market.
Yiḥezkel Jason Schoenbrun CM, that's distorted. While the purchase is regardless of price, the purpose of DCA is to hope to get a better price. If most of the time prices are higher (they are), it serves no purpose. It's a psychological tool to make investing more palatable to the average person who might be apprehensive.
That's timing the market though, and it's a losing game. In that sense, it's the opposite of buy and hold.
September 24 at 12:25am · Edited · Like · 1
CM NO, the purpose is NOT to hope to get a better price, it is to hope to average out the downswings and upswings to lower variance. Do you understand what variance is? I have to presume you do. Stock markets, like poker, are a game of incomplete information. In such situations, you must always act with the best "expectation of value" given what you know and what you do not know. Since you do not know the future price, but you assume the price will, over long stretches of time, go up, you buy. Since you know over short periods of time, there will be fluctuations, you reduce your variance by buying frequently in small increments, as the wiki I linked explains. If the stock goes down, it lowers your average price. If the stock goes up, it raises your average price. But since you can't know which it will do, you are choosing to do it to lower your variance.
Are we talking past each other? Are we failing to agree on the meaning of words or something? I really can't understand what is happening here.
Yiḥezkel Jason Schoenbrun While I assure you I do know what variance is, I disagree that the purpose of DCA is to reduce risk/beta. From http://www.investisseurautonome.info/.../doc.1600...
"When the market is studied over long periods, dollar-cost averaging almost always produces lower returns than investing lump sums in diversified portfolios, and almost never reduces risk meaningfully."
The only time DCA can help with risk, is right before a big market fall which is very rare. Instead, the purpose of DCA IMHO is to be a psychological tool to help apprehensive investors invest.
It's like I wrote to OP before, DCA is just unbalancing what your plan was in the first place between how much you'd put into cash and how much you'd put into the market. So there's less risk in that more of your money is in cash, but if your plan for that money was the market, you're losing out because by waiting you're losing some upside potential.
From http://www.cass.city.ac.uk/.../Dollar-Cost-Averaging...:
"In sum, ever since it was shown that DCA is mean-variance inefficient, research in this field has developed more and more complex theories to explain its continued popularity. Nonvariance investor risk preferences have been suggested, but are not satisfactory explanations. Other more complex explanations depend upon additional – and often unverifiable – assumptions such as “folk finance” or constant investor price expectations. Occam’s razor tells us that theories which do not require such assumptions should be preferred. Indeed, we observe that in practice DCA tends to be recommended to investors without any detailed consideration of their goals, expectations or risk preferences, or the properties of the market involved. DCA is widely recommended by commentators in the financial press, in books and online. Some of these claim that DCA reduces risk, whilst many do not. But proponents almost invariably stress the fact that DCA buys at below the average price, suggesting that it increases expected returns. Addressing this argument – and showing why a lower average purchase price does not increase expected returns – is thus central to explaining DCA’s popularity."
Yiḥezkel Jason Schoenbrun Let's keep this respectful. We're discussing, not missing out on meaning of words. I'll summarize:
Where we seem to differ is that you think DCA reduces variance and/or think that's the reason why most people employ it.
I'm saying that most people who use DCA think it will result in better average prices (timing the market), and that further, the modern understanding of the concept implies that DCA does not in fact help reduce risk/beta/variance. Instead, it tends to simply lower gains.
You claim DCA can't be timing the market by definition because you buy at fixed intervals. I'm saying that each purchase is not timing the market - but the strategy itself is. By choosing a strategy that involves not investing your money set aside for investing in the hopes of lowering purchase price/raise selling price, they are timing the market.
JS https://pressroom.vanguard.com/.../7.23.2012_Dollar-cost...
OP " It's an attempt to buy at a more favorable price."
No. It ensures that you DIDN'T buy at an unfavorable price.
Yiḥezkel Jason Schoenbrun It's both, which are the same thing - timing the market!
OP We found that DCA performed better during market downturns, so DCA
may be a logical alternative for investors who prefer some short-term downside protection.
Out of the 1,021 rolling 12-month investment periods we analyzed for the U.S. markets, LSI investors would have seen their portfolios decline
in value during 229 periods (22.4%), while DCA investors would have seen such declines during only 180 periods (17.6%). Furthermore, the average loss during those 229 LSI periods was $84,001, versus only $56,947 in the 180 DCA periods. The allocation to cash during the DCA investment period decreases the risk level of the portfolio, helping to
insulate it from a declining market.
OP It's not both. Your potential returns are largest if you buy a single stock. But you're not going to do it because it's too risky. Not buying a single stock has nothing to do with timing the market but rather how risk you're willing to take on.
Yiḥezkel Jason Schoenbrun OP, that's EXACTLY what I've been saying! It's the allocation to cash from DCA that provides any risk reduction - but this is for money that was intended for the market! You already made that risk decision that you want that money invested, you're just going back on it in the hopes of a better return (though it doesn't work).
Also, you read the rest of the article, particularly the conclusion?
OP No, I only read that one paragraph of the article. Just chose it at random. Awfully convenient if I say so myself, old chap .
Yiḥezkel Jason Schoenbrun Not sure what you're saying. DCA is an attempt to both buy at a more favorable price AND not buy at an unfavorable price. Anyway, they're equivalent economically.
CM I think the problem here is false-dichotomy Yiḥezkel Jason Schoenbrun is talking about is "I have $1000, I buy $100 10 times over a 10 month period at regular intervals" versus "I have $1000, I buy $1000 worth of stock right away". BUT THERE ARE OTHER ALTERNATIVES.
What many undisciplined investors would try to do is "look for minimums" and buy "some amount" when the minimum comes. That is timing the market. Frankly, spending $1000 right away is also timing the market if anything Y has called timing the market is - it is putting all your eggs in one basket and the market is either going to go up, or down, in the short term, and psychologically you are either going to feel good or bad about it unless you are disciplined.
Let's say you have 100$ a month over the next 10 months. DCA is "I buy $100 on the 1st of every month because DCA". Y's suggestion is "I buy $100 as soon as the check clears every month" which is effectively the same thing. Then there is something else - "I buy $100 of stock each month when it looks low". Let's call that Sucky Strategy One (SSO).
I think we all agree that DCA is better than SSO. I think we are all claiming that what Y is arguing for is effectively the same as DCA also. I think Y is misunderstanding our representation of what DCA actually means for someone saving on a budget.
OP I think Jason's case is something like this. I win the lottery. I have a lump sum of $1 million dollars that I want to invest in the stockmarket. I can either dump it all in right away or I can put in $100k a month on the first of the month. The first is buy and hold while the second is DCA.
If I'm not risk averse, I'll dump that $1 million into stocks ASAP. If I'm risk averse, I'll use DCA.
Yiḥezkel Jason Schoenbrun OP Why does it say you're from Agenda, Kansas?
Also, yes, that's what I'm saying. I'm trying to make 2 points:
1) Trying to time the market (getting better buy/sell prices) is a losing game (I tried to use the simple "buy" part of "buy and hold" to convey that, but maybe that wasn't clear)
2) Go long term/don't sell (the "hold" part of "buy and hold"
CM, I don't think I implied any false dichotomy. In the Schwab article linked above, it analyzes 5 different types of purchasers (1 of them being fictitious, so really 4). There are certainly other approaches. I just gave the 2 most highly recommended approaches, and said I recommend one over the other. I just don't recommend the other approaches at all, and covered that with the blanket statement that I don't think it's a good idea to time the market.
"spending $1000 right away is also timing the market if anything Y has called timing the market is - it is putting all your eggs in one basket"
"putting all your eggs in one basket" has nothing to do with market timing. It's what we try to avoid when we diversify. If we invest lump sums but diversify (including into bonds and cash, as explained previously), our eggs are not in one basket. So investing a lump sum right away (part 1 of my comment to OP above) is not at all timing the market.
"which is effectively the same thing"
Agreed, in the case of someone getting money at regular intervals and investing it right away, there is no difference between the "buy" part of buy and hold that I advocate and dollar cost averaging. We don't see a difference in that scenario. We only see a difference in the type of scenario OP gave, when someone intentionally doesn't invest some money (or sell some stock) they have in an attempt to "average into" a better price. Those attempts are generally counterproductive, but that seems to usually be the goal of people who employ DCA according to the experts I've read (and posted here).
"I think we all agree that DCA is better than SSO."
Agreed.
"I think Y is misunderstanding our representation of what DCA actually means for someone saving on a budget."
If you want to present it as if I misunderstood some aspect of DCA, that's fine. But I don't think I did, and I think the article Jacob posted demonstrates that pretty clearly. But we seem to be on similar pages now, so who misunderstood what isn't important.
CM ok, I think our only remaining disagreement is that the theoretical lottery winner should absolutely not use DCA. I still think DCA in that situation (partially - maybe invest 75% and then DCA the remaining 25%?) can reduce risk. Perhaps there are better ways to reduce risk though (by investing in, say, 75% stocks 25% guaranteed return investments or something).
Yiḥezkel Jason Schoenbrun Exactly, that's probably where we differ on this. I think you'll agree with the next topic about minimizing taxes though
MP in the lottery example relevant considerations are a) time until funds are needed b) relative "price" of the stock market
Your financial outcome is a simple calculation: your gain minus the expenses you incur to in order to achieve that gain. All components are typically in the form of a percentage. Maximizing the gain and minimizing the expenses are equally important.
We talked about how to maximize the gain, and we talked about minimizing 2 types of expenses - expense ratios by avoiding actively managed investments, and fees by not relying on pros to pick stocks. The remaining major expense which I want to talk about is taxes.
Current tax policy in both the US and Israel treat investments favorably. You will generally pay less in taxes on stock market gains than on earned income from your job. Particularly for the form of investing I'm advocating (buy and hold), preferential long-term capital gain tax rates apply, which are generally 15% or even 0%, depending on income levels. This further underscores the benefits of investing in general, but let's try to bring that number down for all income levels, perhaps even to 0%.
The US and Israel offer certain tax advantages in order to encourage societal behavior that they see as beneficial. For example, the US (and many other governments) wants to encourage saving early and responsibly for college. It therefore legislated a special type of investment account called a "529 plan". It differs from state to state, but in general this special type of account shields from taxes any investment growth in the account, and also deposits into the account are often deductible from your state income tax. Another example is the US' desire to encourage citizens to save for their retirement, hence 401(k) and IRA accounts (and Israeli Keren Hishtalmut). In such accounts, investment growth is not taxed. There are many other types of tax-advantaged accounts, but these are among the more popular ones.
My main point for this post is that if we can avoid paying capital gains tax, we'd be foolish not to. If I make 10% this year in my taxable account, I only keep 8.5% owing to the 15% long-term capital gains taxes on it. But in a tax-advantaged account like an IRA, my gain for the year will be the full 10%. That's as good as an extra 1.5% gains for the year!
There are caveats. The government isn't giving up some of its tax income for nothing; they're trying to influence societal behavior. So for the 529 plan, the money has to be used for somebody's (not necessarily your) higher education expenses. And for the retirement plans, the money must sit in the account and may not be used until retirement age. (there are more limitations as well as exceptions, but that's the gist of it)
Those caveats are less imposing when you consider the following: If you anticipate needing a certain amount of money for higher education expenses for your family, you're going to need to save up that money anyway. Why not save it in a way that eliminates some (you still pay federal income tax, so not all) of the taxes on it? It's free money! To borrow an example from T. Rowe Price, "Covering $40,000 in college costs would require $32,000 in 529 plan contributions over that child's first 18 years, or $61,000 in total payments on student loans."
Similarly, if you anticipate needing a certain amount of money for retirement, why pay taxes on both the principal (usually wages) and growth in a regular account, when you can instead pay taxes only on the principal in a retirement account?
Bottom line: Try to save up into each type of tax-advantaged account at least as much as you think you'll need for that purpose anyway.
A crucial tangent is that many companies will match a certain percentage of your 401(k) contributions. So if you make $50,000 per year and contribute 10% of your salary to your 401(k), and the company offers up to a 3% match, at the end of the year your 401(k) will have the $5,000 you deposited + $1,500 the company donated to you. So don't pass up any such opportunities! In our example, make sure you contribute at least 3% per year so you can get the full amount of free money your company's willing to give you.
As another important tangent, http://fidelity.com/myplan is a great retirement calculator that helps you visualize how much you may need to save for retirement, and how much to save along the way in order to get there.
You can save a lot in tax-advantaged accounts. Though specifics may differ based on various factors, you can generally put in many thousands (depends on the state) per year per beneficiary in a 529 plan, up to $5,500 per year per spouse into an IRA account, and $17,500 per year per working spouse into a 401(k) plan. That's more than $50,000 per year a typical dual-income family can shield from investment growth taxes! Since the typical family doesn't make or can't afford to save that much money each year anyway, and saving for retirement often requires at least as much as the maximum the average family can save, nearly all of your long-term savings should probably be going into tax-advantaged accounts.
The takeaway is that with the buy and hold mentality, there's not much effort you should have to put in to grow your money. So use some of that free time to make sure you have no major expenses, like fees, taxes, etc, that make a notable impact on the final percentage profit you will be able to put in your pocket.
I have a few more things to say, but that's it for concrete financial concepts that you can hopefully start implementing today. So our next post will be a summary of the previous 6 posts, presented in the form of practical steps you can take if you want to implement the approach I've presented.
Fidelity Investments: MyPlan Snapshot
Learn how much you'll need to save for retirement by answering a few key questions.
PERSONAL.FIDELITY.COM
AR Anything like this in Israel? The only tax free savings plan I am familiar with is Keren Hishtalmut
Yiḥezkel Jason Schoenbrun As far as I know, Keren Hishtalmut is all there is. But as I understand it, it has a big benefit over US retirement accounts - you don't pay taxes on the growth, and I believe you also don't pay income taxes on the principle either.
I have to look it up, but there are a few smart tax strategies in Israel too. The best would be for someone who has flexibility in which country they get paid in who's been here for fewer than 10 years.
I have to check my notes from a lecture I went to about a year ago.
In terms of lowering Kupot Gemel fees, check out feex.co.il. I've used them and they're pretty informative and helpful.
AR Thanks - yes I got my agent to lower fees a few months ago
If you want to implement what I've been talking about, I'm including here some concrete steps.
First, I want to mention the factors that I consider to be relevant to how I invest my money:
a) Taxes - an American living in America will have fewer tax considerations and can generally invest as they please compared to an Israeli-American living in Israel. A prominent example is the US-tax-prohibitive PFIC status that many Israeli mutual funds have. On another tax topic, a tax-advantaged 401(k) account typically has no commission per trade, which we'll discuss below.
b) Whether your money is available to invest in small amounts at regular intervals, or on less-frequent occasions but as larger chunks. Israel typically has more of a percentage-based commission structure, while America uses an almost exclusively flat-fee commission structure. That means that if smaller amounts become available to invest at regular intervals and each chunk was invested immediately, you'd still pay the, say, $7 per trade each time, resulting in a relatively high percentage you're paying in commissions. Because Israel's commissions are typically more percentage-based, you'll pay about the same amount regardless of how many separate transactions you make. If you have larger amounts to invest at less regular intervals, the flat-fee in America will probably eat a significantly smaller percentage of your investments than if invested in Israel.
c) How long-term your money can be invested. Remember, any money you invest in the stock market is at risk of being lost. Historically, there has been a limit to how far the market has fallen at a time, and as covered earlier has purely risen over the long-term. Also, it's logically unlikely to fall to 0. But it can fall, and you need to base your risk tolerance significantly on how soon you may need your money. If you are very confident you won't need that money for at least 30 years, you may choose a diversification approach very heavily weighted towards stocks. If you are somewhat confident you won't need that money for about 10 years, but acknowledge you might be wrong, you may choose a diversification approach with more bonds or cash-equivalent securities, like US Certificates of Deposit or Israeli "pakam".
Keep these 3 considerations in mind as we discuss practical steps below.
1) Open a brokerage account, if you don't already have one.
*In what country should I open the account?*
If you're an Israeli-American, consider that investing in an Israeli account can be complicated tax-wise. There are many instruments you probably want to avoid, including perhaps ETNs and Teudot Sal, which are precisely the instruments that I prefer. This is due to US regulations that term such investments "PFIC"s, and tax them so heavily so as to make them not worth investing in. Israelis-Americans therefore may want to consider investing in an American account only, especially during the first 10 years after aliyah when Israel doesn't tax growth in American accounts anyway.
Keren Hishtalmut investments are generally considered to not be taxed as PFICs, depending on how it's treated on your US tax return, so I consider that to be safe. But for this reason, I only invest in America with the exception of this tax-advantaged Israeli account. Of course don't rely on me for tax (or any) advice, and speak to an accountant to confirm or advise regarding your situation.
*What type of account(s) should I open?*
The two main types of accounts are tax-advantaged and regular. You generally don't pay tax on the money you make in the first type of account, but are usually restricted regarding when you can withdraw money from the account. In America, the two main accounts of this type are 401(k) and IRA, and they both generally restrict withdrawals until around retirement age (else, you pay a penalty).
In Israel, the primary tax-advantaged account type I know of where you can invest and withdraw the money is called Keren Hishtalmut. Money in Keren Hishtalmut is at least partially income-tax-free, grows tax-free, and can be accessed without penalty after 6 years. The income-tax-free provision is more generous and the 6 year withdrawal restriction are much more liberal compared to its US counterparts, though if a KH is part of your retirement plan (I think it generally should be), you obviously will be ignoring the 6 year option and will wait to withdraw until retirement anyway.
As discussed previously, saving on taxes is equivalent to your stocks going up a higher percentage because both result in more money in your pocket. So if you can handle locking up your money for the long-term, go with a tax-advantaged account. If your work offers a 401(k) matching or Keren Hishtalmut matching, strongly consider making at least the minimum contribution necessary to get the maximum employer match. You don't want to lose out on free money, do you? As I understand it, many employers offer a KH match, some have to by law due to their industry, and among those that do, most allow splitting the contributions such that the employee gives 2.5% and the employer contributes 7.5%, the latter being income-tax-free up to a legislated maximum.
The additional benefit of a 401(k) is that as opposed to most US brokerage accounts, you generally don't pay a flat-fee per trade. So you can feel free to save a small amount every paycheck and have it invested without having to worry about commissions eating into your earnings. Just make sure to pick low-fee stocks so that doesn't entirely compensate for the lack of commissions.
Go to http://fidelity.com/myplan and see how much you're projected to need for retirement. If the tool indicates that you have more saving to do in order to have a secure retirement, a tax-advantaged account may make most sense as the first place to invest your money. You have to save that money anyway, so it might as well happen now and in a tax-advantaged account.
Note that if you report earned income on your US tax return, you can likely contribute to an IRA for both you and your spouse. The total you may contribute may be no more than the lesser of the total reported as earned income on that year's return and the IRS annual IRA contribution limits ($5,500 per spouse in 2015). Of course this assumes many things that you should verify with an accountant.
There are 2 different types of 401(k)/IRA accounts - Traditional and Roth. They differ on whether you pay tax on the principle upon withdrawal (typically at retirement age) or now, respectively. Experts generally recommend Roth if you think your tax rates will be higher at retirement, due to government policy and/or changes in your salary/income. A strategy I appreciate is depositing by default into a Traditional account so you don't have to pay taxes on the income yet. Then, in a year of low income compared to other years (perhaps after aliyah if getting a lower salary than in the US or during a year when one is out of a job for several months), you will be in a lower tax bracket that year, which might be a good tme to convert some of that money from that Traditional account into a Roth by paying taxes on it during that year. The taxes during that year will be particularly low.
This strategy has risks though, particularly whether Israel will respect the US' intent that withdrawals from the Roth account be tax-free due to taxes having already been paid on it. If Israel does tax Roth withdrawals, you may have to pay taxes on any appreciation after 10 years after aliyah. IMHO, the fact that this is no worse than a taxable account combined with what a (perhaps well-) below-100% chance that Israel will tax such withdrawals make Roth contributions and Traditional to Roth conversions options worth considering.
If you have more money left over after maxing out your IRAs, 401(k)s, etc, consider funding other tax-advantaged accounts, such as 529 education savings plans.
If you really can't handle not having access to that money until retirement, or if you've already maxed out your retirement accounts (good for you!), you'll be opening a regular brokerage account.
*What company brokerage should I open?*
If you have a 401(k), your company will designate the company for you. For IRAs, regular American and Israeli brokerage accounts, and all Israeli tax-advantaged accounts, the choice is yours. Since per a previous article I do not believe there are benefits to active management by you or a broker, I would personally choose the company primarily based on lowest fees. That might not be easy to identify, so let's discuss some ideas you can start with.
If money becomes available for you to invest in smaller amounts and at regular intervals (e.g. every 2 weeks with your paycheck), you'd probably prefer to pay commission as a percentage of what you invest as opposed to a flat-fee per trade. Israel has many such accounts, but generally all American accounts (except for 401(k)s) charge a flat commission per trade (about $5 - $9). If this is your situation, one option is to go with a $5/trade brokerage (e.g. https://www.tradeking.com/). Automatic investing allows you to pay less in commissions despite making frequent purchases (e.g. the Automatic Investing tab ofhttps://www.sharebuilder.com/shareb…/investment-options.aspx#). There are new innovative companies that achieve lower fees for you (e.g,https://www.betterment.com/), though I cannot vouch for them. You can also try a brokerage that has a large list of commission-free ETFs (e.g.http://research.tdameritrade.com/…/commi…/commissionfree.asp). Lastly, even commission-free trades are a possibility (https://www.robinhood.com/), and I can send you an invite if you'd like! Why not try this last option?
If you go with a brokerage that has a large list of commission-free ETFs, just be sure the list includes low-fee index-trackers, if you agree with my investment approach. TD Ameritrade, for example, includes in its commission-free list the S&P500 tracking ticker IVV, which has a fee of only .07%. That's not as good as my favorite S&P500 tracking ticker VOO whose fee is .05%, but to save $5 in trades if you plan on buying at regular intervals on a reasonably-sized amount of money, it's worth the slightly higher percentage-based fee.
If investing in Israel, find an account that charges most of its stock-trading commission as a low percentage of the amount being traded. Be careful though - many brokerages charge an annual fee on your account balance as well, besides any fees charged by the ETNs or Teudot Sal. These can really add up. I believe there are some that don't do that, or at least charge a significantly lower percentage than the rest. Your bank is probably a brokerage option as well in Israel, so check that out and compare fees.
Here's a helpful comparison I saw someone named Daniel Fienberg put together, assuming each purchase is less than about 2500 NIS:
- Poalim (other banks similar): Buy/sell 26 ILS, 0.6% year management fee.
- Migdal: 15 ILS/month, Buy/sell 3.5 ILS . 50 ILS per/month minimum fees. (So overall minimum about 75 ILS/month).
- IBI (need 50 000 ILS to open account): 15 ILS/month, Buy/sell 2.5 ILS. 9 ILS per/month minimum (so overall minimum 24 ILS/month).
If on the other hand larger amounts of money become available to invest at rarer intervals, commissions will eat less of your profits anyway and you would probably end up paying less with a flat-fee structure. Paying $8 on a $5,000 investment is only a .16% fee, which is lower than percentage-based commissions I'm aware of. I very much like Charles Schwab and Fidelity for these kinds of situations. There are many other brokerages that I'm sure are worthy of your consideration: http://en.wikipedia.org/wiki/Comparison_of_online_brokerages_in_the_United_States
2) Fund the account
The easiest is probably an Electronic Funds Transfer (US)/bank transfer (Israel) from another bank or brokerage, but you can also send in a check if you're feeling retro.
3) Invest
*How much should I invest, and how often?*
If you are convinced as I am that the stock market is the fastest, most reliable way to grow your money over the long-term - as much as you can, and as soon as you can. For any money you don't need in the short term, put it straight into an investment account.
The bigger picture is that you probably need 3 types of savings: short-term (under 5 years), long-term (5 years - 15 years) and longer-term (20+ years to retirement). You might not have the longer horizons if you're closer to retirement. The first category will likely consist of mainly short-term Certificates of Deposit/pakam and cash. The second will likely be in a brokerage account. The longer-term would probably best be in a tax-advantaged account. I prioritize those needs as: first save for the short-term, because that's money you need now, then save for retirement until you're on track for a secure retirement, and only once you've done those two should you invest in regular, taxable accounts.
It's very difficult to save, especially on an Israeli salary. But there are many strategies personal financial planners can help with. For example, automatically setting money aside monthly into a separate account so you will be less likely to miss it psychologically. A future post will cover my personal strategies for saving.
*What should I buy in my accounts?*
After you transfer money to the brokerage account, you can begin buying investments. Use a diversification calculator (e.g.http://www.bankrate.com/ca…/retirement/asset-allocation.aspx) to decide how much to put in stocks, bonds and cash (CDs/pakam count). Within stocks, diversify a bit further into a few other categories such as international and emerging markets. One sample conclusion for someone in their 30s and not too risk averse might be:
Broad US stock market - 60%
International - 15%
Emerging markets - 10%
Bonds - 10%
Cash - 5%
For each diversification category, pick one or two US ETFs/Israeli ETNs/mutual funds that track the broad categories above and have low fees. In the US, the fees are called expense ratios.
I've suggested googling "low cost ETF [category]", and have personally considered VOO and QQQ for US stocks, SCHF for international stocks, SCHE for emerging markets, and BND for bonds. Do not construe that as investment advice.
A helpful Israeli site for finding low-fee index-tracking securities I know ishasolidit.com
The Israeli tax-advantaged accounts are by default quite limiting. They only offer a set of "maslulim", which are basically actively-managed mutual funds. As you know, I prefer to stay away from actively-managed investments. One option to avoid them is via a Keren Hishtalmut IRA (http://www.hasolidit.com/%D7%A7%D7%A8%D7%9F-%D7%94%D7%A9%D7…) instead of a Keren Hishtalmut. I believe by law all companies must allow employees to have both their and their employer's contributions to go into such an account if the employee wishes. This type of account allows access to any type of security, including non-actively-managed low-fee index-tracking funds. Consider though that this type of account may have tax implications for US citizens, so some US citizens may feel more comfortable sticking with a regular Keren Hishtalmut account despite the lower returns and higher fees.
If you are investing in a regular Keren Hishtalmut account, I would suggest mostly ignoring the maslul's past performance metrics. Instead, I simply prefer the "maslul" that best tracks the stock market. The maslulim with the highest stock market exposure I've found are in 70% stocks, so I suggest finding one of those that tracks the market most broadly, and does the least active management.
If you deposit small amount of money at frequent intervals in an account with flat-fee commissions (i.e. most US accounts), reduce your commission costs by just buying 1 security each time you make a deposit. Each time you make a deposit, rotate which security you buy. Try to generally achieve the diversification percentages, but it's better to invest right away in 1 security thereby throwing off your target diversification percentages than to wait unnecessarily before investing the money you have available to invest.
2 postscripts:
- I'm pretty familiar with financials from a US-perspective. I've been here in Israel for almost 3 years, and think I am gaining fluency here too. But I can be wrong regarding facts in either country, particularly the latter. If you spot an error, I humbly accept and appreciate your correction. This is a forum, so your corrections will furthermore help many people.
- I've mentioned how much I loathe giving actual advice. I'd feel horrible if something I suggested caused a friend to be worse off/lose money. On the other hand, my advice is really just a reflection of expert advice, and I'm toeing the line of giving advice because I want to make it as unimposing as possible. How do I not give advice while still making concrete recommendations? Like this: Look at what I say as one possibility. Then, use those recommendations as a springboard to learn about these concepts yourself and make your own decisions. You may throw out everything I say (maybe you think you can time the market), or your may refine my recommendations to fit your own slight deviations. Either way, I hope the concrete steps above helped you gain confidence to move forward, but I fully assume you won't just parrot what I say and instead understand and make the appropriate decisions for yourself.
Misc Practical Financial Advice
On the one hand, I'm opinionated. On the other hand, I hate giving advice because I'd hate for someone to rely on any bad advice I may give. I may have my convictions, but I know that doesn't make me right.
So please read the following with that in mind - these are some practical day-to-day financial tips that I think are right for me, and may or may not be right for some other people.
Buy cars second-hand from craigslist. Take it to your mechanic to verify its condition before purchasing.
Buy a desktop computer if you don't need portability. They're much cheaper for the speed you get.
Buy Android phones off-contract. Like a convoluted insurance product, phone-contract pairs obfuscate what you pay into/get from each, and are often more expensive. My personal sweet spot is when a middle-of-the-line phone has a slickdeal for $150.
Use cashback credit cards instead of mileage, point or other rewards cards. IMHO only the most-frequent flyers stand to gain from mileage cards over cashback. As of early 2015, I use 1.5% cash back Capital One Quick Silver with no foreign transaction fees and 2% FIA Fidelity IRA AmEx for my USD purchases.
Use price alerts on slickdeals and the CamelCamelCamel price alert website/browser plugin. The latter is super super easy to use, and automatically saves you a ton of money for anything you want to buy but don't necessarily need now. Basically, you just install the plugin and create an account. Any time you see a product on Amazon you want, you click on the plugin icon, look at its price history, and based on that enter your desired price target. Literally 2 clicks + typing the price target. Then you get an e-mail when the product hits that price. Saves me 20+% regularly.
Know when to buy cheap crap from China (e.g. DealExtreme, AliExpress), and when to get a well-reviewed product from Amazon. My rule is electronics cannot be from AliExpress, et al. If you assume the worst about quality from China and that's OK with you, buy from China. Eyeglasses from a reputable place (e.g. Zenni) might be much smarter from China.
Save by default. If you get a bonus or otherwise come into money, train your instincts to want to save it instead of spend it.
Train yourself to be disgusted by bad deals. I can imagine feeling pain buying anything (except a slurpee) from a 7-11. Buying candy at a rest stop should bother you enough that the thought of it be sufficient to remind you next time to pack snacks bought from the supermarket before the trip. If you can imagine a scenario buying a soda from a vending machine at Disney World that doesn't involve hypoglycemia, we're probably living on different financial-approach planets.
With this attitude, you will likely scrutinize large expenses. If it's unnecessary, you're disgusted with the fact that you made that purchase, and will try to make sure it doesn't happen again.
Be fiscally conservative. Future you will thank now you. See how being fiscally liberal has literally bakrupted some of the wealthiest people. See http://business.time.com/2012/02/16/top-9-celebrity-bankruptcies/ and http://www.dailyfinance.com/photos/10-of-the-ugliest-celebrity-bankruptcies-in-history/#!fullscreen&slide=978593
On the other hand, money doesn't do you much good if you don't spend it. Just spend it wisely to keep you and your family happy, but save the rest to give you and your family financial security for the future.
The most important takeaway of all this fiscal philosophy is to spend less than you earn: http://www.getrichslowly.org/blog/2009/10/12/to-build-wealth-you-must-spend-less-than-you-earn/
One of the top pieces of financial advice is to plan. I personally don't plan much, because I'm particularly conservative anyway, so I'm not sure how much a plan would help me - I save as much as I can either way. But if you're less fiscally conservative than I am, planning is a must. At the very least, it'll help you have a realistic understanding of where you are financially.
When vacationing, consider a cruise. You probably have to fly RT to its port of embarkation. After that, they work out to be significantly cheaper per day than alternative vacation paradigms. I use vacationstogo.com whose deals tend to be well under $100/night, including lodging, Kosher food, sufficient entertainment (paying for more, such as excursions, can double that daily cost), fees, taxes and tips.
When choosing a career, earning potential should be a consideration. If you anticipate enjoying a field 8.5/10 and its average salary after 10 years is $45k and another field you'd enjoy 8/10 and its average salary after 10 years is $90k, consider how the additional financial security in the second one may in and of itself allow you to enjoy life more than that .5 differential in how much you'd enjoy the field.
Take advantage of educational opportunities at work. Most fields require being on top of its latest developments, and many companies have formal or informal programs to helps you do that. That includes tuition reimbursement for another degree that can cover most of its cost! Most companies have a training budget too for individual courses.
Try new things that seem to disruptively bring down prices. E.g. Uber instead of a cab. I'm teaching my son guitar using Rocksmith instead of regular lessons with a teacher. If it's sufficiently inexpensive, there's little downside to giving it a shot.
Second-hand can be really cheap. It also is an automatic savings in sales tax. For example, furniture. You can pay a boatload less for used furniture compared to new. Enough people buy new that there's a large secondary market, meaning you can even be a bit picky. Other than a few bookcases from Target, some beds and maybe a couple things from Ikea, I never bought any furniture new.
Don't waste food. That's probably one of your biggest costs, and may represent your biggest opportunity for savings.
Be deliberate with your tzedaka. If you're putting 10% towards a cause or a few causes you really believe in or have particular significance for you, you might not consider it a 10% loss - on the contrary it may make you happier. I used to scatter my ma'aser roughly evenly among whatever organizations send me mailings. It took me a while to realize many of those causes are antithetical to what I believe in. I now give most of my tzedaka to 1 cause that is very personally meaningful to me, and which I believe is making a tremendously positive impact on the world. That feels good.
Your TV service (other things?) monthly cost is probably negotiable. If you call them and ask for a discount, they reportedly simply give you one, no questions asked or strings attached. Better yet, cancel TV and use Amazon Prime, Netflix or Hulu Plus.
If you have debt, pay attention to the interest rates. If you can consolidate to lower rates, do it. Pay down the highest rate first. Credit card debt should be avoided at all costs.
In Israel, use American credit cards. If you had money in America from before aliyah, you won't have to lose anything to currency conversion. Further, American credit cards give 1.5% or higher cash back, something that is a shame to pass up and unheard of in Israel. You also get tons of other benefits with a US credit card, including doubled warranties, price protection, easy merchant dispute process, no random "shem mishtamesh" to memorize and American customer support.
Don't let money sit uninvested for very long. It should be in different types of investments depending on how long your money is anticipated to not be needed, but it should probably be invested if sitting for more than a few months.
Don't let your kids' savings be eaten by fees, slowed to near-0 growth, or represent a missed opportunity to teach finances. In other words, avoid banks. We opened bank accounts with the "Bank of Mommy and Daddy". It's just a Google spreadsheet for which they have read-only access, that adds interest at 5%/year compounding weekly (frequency of their allowance) and keeps track of deposits, withdrawals and interest events. Very simple - it took me 10 minutes to set up. They get the same benefits of a bank, learn how interest works, have more control, and see first-hand the abstract concept of how giving us their money means we get their money, but we up the number representing their balance. We invest our money, so over the long-term we're almost definitely *making* money on their deposits - like a real bank! If the size of the account were to break 1,000 NIS, I'd recommend they allow us to move it over to their actual investment accounts so they can actually watch it generate real returns.
Enjoy your life. So if any of the above would make you significantly unhappy, it's probably not for it may be financially valuable to take the concepts above to heart.
Please comment with your tips, and I'll make a new post in the future compiling them (with due credit given, of course).
Buying an Apartment vs. Stock Market
Buying an Apartment vs. Stock Market
The attached article (http://lifehacker.com/renting-is-throwing-money-away-is-completely-false-1747050568) serves as a good summary for the analysis I've expressed over the years, which I'm compiling below:
Many people, particularly in Israel, see renting an apartment as throwing money down the toilet, and clearly deficient compared to buying.
If buying a place is looked at as an investment and you ignore such considerations as space, ability to make customizations, psychology of having to move every so often, and concerns about bad landlords, determining which option is better is a simple equation. Sometimes renting is cheaper and thus the better investment, and sometimes buying is. Do not just assume that buying a home is a good investment compared to alternatives. Again, here we are only speaking from a financial perspective.
How can renting be better? Simply stated, if you took that down payment you would've paid on buying a place, and instead invested it, you can often get a much better long-term return than if you are non-speculatively buying a house.
Everyone knows someone who has done well in real estate. I've heard things like, "An apartment in Rosh Ha Ayin that 15 years ago sold for $100,000 is now worth $300,000+. What investment is better than this?"
To address that, first consider that anecdotes are never a good reason to choose one investment over another. People tend to share their successes more than their failures, so that gives us a skewed understanding of residential real-estate appreciation. What matters is *average* long-term returns of different investment types.
But let's assume an apartment's value tripling over 15 years *is* the average so we can put those impressive stories in context compared to investing in the stock market.
300% in 15 years is an average annual geometric return of about 7.6%. The stock market's average geometric return, including dividends, over the long term is about 10%. So to answer the question of what investment can beat that apartment, the answer is the stock market. If you invested $100,000 over most random 15 year periods of the S&P 500's history, you'd end up with more than $400,000 at the end of those 15 years.
When the cost of renting is as low as it is now, the equation is even more unbalanced in favor of renting. This will probably change cyclically, but see that the current cost of renting so low here http://www.globalpropertyguide.com/Middle-East/Israel/Price-History
Let's consider other downsides to buying a home.
One of the primary points I try to make in my posts thus far is that one's investments should be diversified. Buying an apartment/house violates that concept for people who don't have 10s of millions of shekels. For someone who bought without at least as much money invested in non-real estate asset classes has more than 50% of their investments in real estate. That's not good diversification, IMHO.
There are many costs associated with owning a home that can be glossed over by people excited to own. Maintenance and repairs represent a significant cost. These costs alone may not be enough to make renting better, but they need to be factored into the comparison.
If one truly believed in the investment potential of the residential real estate market as much as they imply when they tout the financial benefits of buying a home over renting, they should keep in mind that it is nearly financially equivalent to invest in a similar residential REIT (real estate investment trust) - a security, often traded on the stock market, that attempts to provide investors with a way to invest in various types of real estate without having to personally buy any real estate. If such people truly believed in the potential of residential real estate, and don't yet have enough money to buy a home - invest that money in a REIT!
And for those of us who *don't* believe as much in the investment potential of the residential real estate market - we can place a much smaller percentage of our investments into REITs and achieve approximately the same financial performance on that investment as a real estate purchaser, but with the proper amount of diversification in their overall portfolio.
Other benefits of a REIT over buying real estate include liquidity and transaction costs. Buying and selling a REIT can be as quick as buying and selling stock - taking seconds. But how long does it take to buy or sell a house from the time one decides they want to do so to the time they have money in their pocket? More time than that :-)
Transaction costs of buying or selling a REIT is as low as stock transaction costs - about $8 in the US and about .09% in Israel. Transaction costs for physical real estate is significantly higher - agent fees, inspections, appraisals, administrative fees, lawyer fees, etc.
The discussion above has essentially boiled down to comparing the following 2 scenarios as starting points -
1) You've wanted to buy an apartment, and to that goal, have just now finished saving the 300,000 NIS you need to put down. At this starting point you pay that down payment and buy the apartment.
2) You don't want to buy an apartment, and starting at this point you have 300,000 NIS invested in the stock market.
Those 2 scenarios yield different results in terms of statistical expected values at the end, political and legislative environments, risk profiles, liquidity profiles, and diversification profiles. I suggested that for many of these reasons the stock market may often fare better than real estate.
What I want to point out here, which I haven't heard mentioned before on this topic, relates to *getting* to those 2 scenarios. To someone who wants to take advantage of the stock market and has no interest in buying or at least is in no rush to buy, getting to scenario 2 is simple. Your want to invest 300,000 NIS, so to get there you invest with whatever smaller amount you have now. Whatever arbitrary amount of money you want to have invested in the future, you try to reach that goal via the same investing.
But to someone whose goal is scenario 1, you need to get to the point that you have 300,000 NIS. But you can't invest that money in the stock market, because it's too risky to someone who needs a certain high sum by a near-term date. So all along while they're trying to reach the beginning point of scenario 1, they have to keep their money in comparably far-lower return instruments than the person in scenario 2. However many years they save to buy an apartment, their money is not growing for them.
Such a chaval, IMHO, all the money lost to this opportunity cost of both buying an apartment, and also saving to buy an apartment.
Studies confirm how renting is often financially advantageous over buying: http://mobile.nytimes.com/2016/04/02/your-money/to-buy-or-rent-a-home-weighing-which-is-better.html
All that said, buying a home can push people to save who lack the discipline to do so otherwise. Owing a mortgage forces the buyer to earmark money every month which is going towards their equity. This amount is likely less than the amount of equity that individual would have would they rent and invest the money instead, but there are people who lack discipline to save without a direct impetus.
For those who think Israel is different, read this article which addresses this buy vs. rent head-on for the Israeli real estate market: http://www.themarker.com/realestate/1.2622444
A rough English summary of the article, per a gracious draft from Ben Ohayon, is:
1. Everyone thinks there's a massive real-estate (RE) bubble.
2. 25% of RE buyers are 'investors' (people who already have an apartment). Many of the 75% left are investors in disguise - parents giving money for their kids to buy apartments in their name.
3. People here have a very strong bias towards RE (as oppose to stock market).
4. To mitigate the bubble, treasury is contemplating raising a lot of RE taxes substantially.
5. It is very hard to compare RE and Stocks, first of all because of the timing (when do you start the graph). stocks have been amazing since 2009 for example. In this paper they will look at the market from 1995.
6. The above graph doesn't take the yield (תשואה?) from rent. Which is usually assumed as ~3%.
7. from 1995, stock made ~6.4% (annualized return ('per year')) (corrected for inflation) and RE ~2.9%.
8. Add rent to RE (2.9%+3%=5.9%), remove damages 1% (blai - things you have fix in the apartment from time to time). you get 4.9%.
9. Now, taxes on stocks are hard, so remove ~1.5% from stocks yield (I don't agree here, since you can postpone paying taxes for years, which is worth something). there is little taxes on RE, It depends on your situation. Also they assume that the future of RE will have taxes same as stocks...
10. at the end they got to 4.9% RE (net after taxes, with rent, some damages, corrected for inflation) and 4.8% stocks (well within the margin of error). They didn't include mortgage here, nor apartment insurance. don't know why. It can actually increase your yield if it is cheap and you have some luck, and is pretty risky if you have not.
11. Stocks have more deviation than RE (Not sure I agree completely, they only look at the swings on the graph, what if you can't find people to rent to? or your renters are giving you problems)
12. If you take a mortgage, apartments may become much riskier (deviation wise).
13. People who buy RE actually get something close to the yield. People who invest in stocks, rarely keep them for 20 years, (in israel they usually do pretty lousy - my touch :))
14. In conclusion, it is complicated! if it is your first apartment, and as long as they exist (!), RE tax benefits are the name of the game. If you use your mortgage as cheap leverage, you can have a very good yield on capital but you are exposed to a lot of risk (they didn't consider the act of taking a cheap loan and investing in the stock market - which sounds weird, but everyone who invest money in the stock market whilst paying a mortgage do it). If you opt for stocks you need to be very very rational! (and listen to the great advice we got on this group for example from Yiḥezkel Jason Schoenbrun).
15. My touch: remember that there is a consensus that there is a bubble in the real estate market, meaning that it will burst the moment someone pricks it - like when someone raises taxes on real estate...
16. I know some people say there is a bubble in the stock market, but there is less of a consensus on that. Just look around, people are getting crazy for real estate and not so much for stocks.
17. My touch: they haven't mentioned in the article some more considerations, which make the difference for me. Stocks are very easy to buy - you just need to open an account in an investment firm (your bank is killing you) and press a button once every month/year. real estate usually involves leg-work, lawyers, contractors, damages, fixing stuff, haggling with your bank, getting worried about what happens to the neighborhood, appraisers, tenants...you get the picture :-)
How to Make Use of Airfare Deals
How to Make Use of Airfare Deals
Flying is a part of Israeli life. I see 3 main demographics:
1) Native Israelis - they love to fly, much much more than my friends from America. I understand this to be related to Israel being a small country.
2) Olim who want and can afford to regularly travel back to their country of origin.
3) Olim who don't care or can't afford to regularly travel back to their country of origin, but who have simachot or other obligations necessitating trips back. (we personally fit in here)
Since airfare can represent a big percentage of a budget, I've automated a way to save a significant amount of money on airfare.
Background: Every so often there are significant airfare deals, but either they're short-lived, or the dates you need get booked up quickly. I'm familiar with the American landscape, so I'll focus on those. For example, at current fuel rates, cheapest airfare to JFK with a reasonable stopover tends to be about $700 RT during non-peak dates. But using one of these deals, it can go as low as $450 RT, or lower! How do we get to be one of the lucky few who got in early enough to take advantage of those lower fares for the dates we need?
We need 3 ingredients:
1) A deals site - I personally like Dan's Deals, as I consider him to be fastest and most thorough for Israel airfare-related deals (let me know if you have a better suggestion)
2) Knowledge of how the deal site posts the deals so that we can set up a system to send ourselves a notification as soon as a worthy deal goes up on the site - in the case of Dan's Deals, he says his deals first go out on twitter.
3) A system for identifying as quickly as possible when a worthy deal is posted, and notifying us via our preferred notification method. I prefer to be notified via e-mail.
Then, of course you have to book soon after you get the deal notification e-mail. So you need to be *ready* to book, including knowing which dates work and which dates don't work, well in advance so you can book quickly when a deal comes up. Keep in mind that most airfares with an American origin/destination allow a cancellation period of about 24 hours - and Dan indicates when this is the case - so often it's worth just booking to capture the deal even if you're not yet 100% sure about dates. European cancellation policies may be similar.
Here's the process:
TweetyMail.com is the crucial component that makes this work. This free service monitors an account (in this case, DansDeals) for new tweets, then can apply filters to any results (in my case, "Israel", "Aviv" or "TLV"), and then sends you resulting tweet via e-mail.
They have 4 types of alerts - I use a "List" alert.
For this to work, you need a Twitter account. I don't use Twitter, so I made one just for this.
For the particularly serious among us, consider also using Blogtrottr.com, a free service that monitors a blog (in this case, dansdeals.com) in realtime for new posts that match filters (in my case, "Israel", "Aviv" or "TLV"), and then sends you an e-mail with a link to the post. Even though Dan claims to tweet before posting, and I suspect BlogTrottr polls less often than TweetyMail, I signed up for this too for 2 reasons:
1) His tweets link to his website posts. So even though he claims he tweets first, as far as I can tell, the posts must logically come before tweets.
2) When it comes to saving hundreds of dollars on flights, I don't mind double e-mails smile emoticon
Over the past few years of me using this, I usually get the Tweetymail e-mail first, and then within about 20 minutes the Blogtrottr e-mail. About 5% of the time the Blogtrottr e-mail comes first.
Just go to 1 of or both of those 2 sites, sign up, and create 1 alert on each site per the attached pictures.
Bank of Mommy and Daddy
Bank of Mommy and Daddy
I see many people trying to come up with a solution to 2 distinct, but related, problems: Trying to save money for their kids, and trying to teach their kids financial concepts.
We attempt to solve both by "opening" "bank accounts" with the "Bank of Mommy and Daddy".
It's just a Google spreadsheet for which they have read-only access, that adds interest at 5%/year compounding weekly (frequency of their allowance) and keeps track of deposits, withdrawals and interest events. Very simple - it took me 10 minutes to set up.
They get the same benefits of a bank, learn how interest works, have more control, and see first-hand the abstract concept of how giving us their money means we get their money, etc, but we avoid having to deal with a bank (and their fees).
We invest our money, so over the long-term we're almost definitely *making* money on their deposits - like a real bank smile emoticon
If the size of the account were to break 1,000 NIS, I'd recommend they allow us to move it over to their actual investment accounts so they can actually watch it generate real returns (and in turn learn those concepts).
It's worked really well so far. He now spends less, as he sees the effect withdrawals have on his compound growth (interest). When he gets money, he immediately gives us the cash and understands the concept of why that's a win-win for both the bank and the customer.
Here it is: https://docs.google.com/spreadsheets/d/1Zf7ORlcUAESg0cRziz9JiS75q2CBjWURIKkt75wugc4/edit?usp=sharing
Feel free to make a copy within your own Google Drive or download it as an XLS so you can use it for your kids.
Halachically, I asked a Rav about giving interest to our kids like this, and after a detailed discussion he said this was OK. I can go into more detail another time, but you should probably ask your own Rav either way.
Develop a Wealthy Mindset
Develop a Wealthy Mindset
Is being wealthy or poor a function of what our parents’ socioeconomic situation, or of our own behaviors?
Statistically, there is truth to the former having a significant impact, and knowing that can be frustrating for those of us without a head start who want to get ahead. However, it’s also easy to overestimate its impact. Most of these socioeconomic barriers to wealth in our formative environment are psychological and based on lack of knowledge. In other words, by not growing up in a financially successful environment, we’re less apt to believe in our abilities to succeed financially, and we’re less likely to have learned the kinds of ideas that we tend to need to be successful financially. These however, can be changed, and if you’re reading this, you’re surely at an advantage to remedy both of these disadvantages.
The corollary of overestimating the impact of socioeconomic status is the self-defeating underestimation of the impact of our own behaviors on our financial outcome. I firmly believe that wealthy people tend to be those who consistently practice intelligent financial principles.
Consider that wealthy people tend to clip coupons and shop sales more than poor people (http://www.dailyfinance.com/2012/02/22/guess-who-clips-the-most-coupons/). One might think that once you’re wealthy you no longer have to clip coupons. On the contrary! The practices that help people to become wealthy are the same practices that help people to remain wealthy. Let’s call that a ”wealthy mindset”.
On the other hand, when people who are born wealthy start doing financially unintelligent things, they’re beginning on a trajectory of becoming poor, and can easily get there over time. No matter how wealthy they were to begin with! Let’s call this a “poor mindset”. We’ve seen this countless times with uber-rich celebrities filing for bankruptcy. I’ve already posted these links, but they’re eye-opening if you haven’t seen them before - http://business.time.com/2012/02/16/top-9-celebrity-bankruptcies/ and http://www.dailyfinance.com/photos/10-of-the-ugliest-celebrity-bankruptcies-in-history/#!fullscreen&slide=978593. So the wealthy can become poor by doing the wrong financial things, and the poor can generally become wealthy by doing the right kind of financial things.
That doesn’t necessarily mean those who are struggling financially can adopt all of the recommended wealth-building behaviors. For example, in many cases poor people simply don’t have the time or tools to shop more intelligently. But I strongly believe that in general, if one wants to be wealthy - whether or not they already are, they should adopt as many of the financial best practices as they reasonably can. I’ve seen countless examples from similar-minded blogs of people in all different types of terrible situations rising up out of poverty and achieving financial independence.
On that note, I would like to introduce the most popular similar-minded blogs I know of:
Jlcollinsnh - http://jlcollinsnh.com/
Mr Money Moustache - http://www.mrmoneymustache.com/
Go Curry Cracker - http://www.gocurrycracker.com/
Mad Fientist - http://www.madfientist.com/
Those who want to develop a “wealthy mindset” should consider not just reading, but *studying* many of the foundational posts in the blogs above. Those posts are typically featured on the home page and sidebars, the ones that are most popular, and the ones written towards the inception of the blog.
A famous experiment that demonstrates a “wealthy mindset” trait was the Stanford Marshmallow experiment, wherein kids were given a marshmallow and told that if they wait to eat it, they will get a second marshmallow. Long-term follow-up demonstrated that kids delaying the immediate gratification in exchange for the doubled reward correlated with higher rates of success in their life more broadly. If we assume there’s an element of causation, someone serious about being financially successful should therefore focus on improving certain traits and behaviors, including training oneself to appreciate the value of delayed gratification when appropriate.
There have been studies of what beliefs and behaviors correlate with (not necessarily cause) being wealthy. Excerpted from https://www.daveramsey.com/blog/20-things-the-rich-do-every-day:
81% of wealthy maintain a to-do list vs. 19% of poor.
63% of wealthy parents make their children read two or more non-fiction books a month vs. 3% of poor.
70% of wealthy parents make their children volunteer 10 hours or more a month vs. 3% of poor.
67% of wealthy watch one hour or less of TV every day vs. 23% of poor.
6% of wealthy watch reality TV vs. 78% of poor.
86% of wealthy love to read vs. 26% of poor.
86% of wealthy believe in lifelong educational self-improvement vs. 5% of poor.
63% of wealthy listen to audio books during commute to work vs. 5% of poor people.
In summary, your parents’ socioeconomic status statistically correlates with how wealthy you’ll be. Nevertheless, you are almost certainly in control of the behaviors and attaining the knowledge that *most* correlate with how wealthy you’ll be. Reading about finance is one important such step. Keep doing that - prioritize reading the foundational posts in the blogs I link to above.
Banking in Israel Sucks - Let Me Count The Ways
Banking in Israel Sucks - Let Me Count The Ways
There are very few things that I significantly miss from America - banking is one of them. Let’s delve into the ways in which it’s inferior here.
In Israel, banks are open about 8:30 - 1:00, with a “bonus” 2 hours later in the afternoon one or two days a week. I’ve asked, and they tell me they need to be closed so much so they have sufficient time for paperwork. (If that’s accurate, they need to get their paperwork load to be more in line with the 21st century.) In America, banks are open about 9:00 - 6:00, 5 days a week, plus usually a half day on the weekend.
In Israel, opening a new account takes about 1.5 hours, signing literally 30+ times. In America, you provide some information, sign about 2 forms, and are out within about 30 minutes.
In Israel, everything comes with a fee. Every transaction, not transacting enough, paying your credit card bill, withdrawing from an ATM with your debit card, talking to a teller, blinking, everything! I’ve asked many bankers about this, and they respond dumbfoundedly by asking how else they’re supposed to make money - as if they don’t understand the underlying principles of how a bank works. They seem to think bank is doing you a favor by letting you lend them money! There are some banks that don’t charge fees, like Bank Yahav and Bank Igud, but these types of accounts come with non-trivial stipulations, including minimum monthly deposits (usually around 7,000 NIS/month) and minimum credit card usage (usually around 1,000 - 3,000 NIS/month). In America, fees are only for reasonable things, like withdrawing from the account without having sufficient funds to cover it. If you have a positive balance, you won’t be charged any fees ever. (I’m ignoring the American banks that are consistently ranked worst, like Bank of America, which do charge monthly fees for checking accounts and for dropping below some minimum account balance. But people who do their research don’t sign up for such banks anyway.)
In Israel, accounts don’t just charge you fees, they also don’t bear interest. To get interest, you have to give up access to your money for a predetermined amount of time - like an American Certificate of Deposit, whose rates are not similar to American CDs but instead are in line with American bank account interest rates. In America, accounts are interest-bearing, with especially relatively high rates at online banks like Ally and Capital One. If you want an even higher rate of interest, you can open a CD. Interest rates are low now, but as I like to mention, I believe that achieving financial independence requires a mindset.
In Israel, the branch in which you opened your account matters. By default, they don’t share some of your account info with other branches of the SAME BANK because they feel like you are specifically that specific branch’s customer. Because of this, some actions can only be done in the branch in which you opened your account. They see this as a good thing, as one banker told me, “Why would you want the whole world (read: another banker employed by the same bank) to have the ability to see your personal bank information?”. To be fair, this is changing and most things can be done in any branch. On the other hand, once in a while there are still things I must physically show up at my home branch to accomplish, and for things that *can* be achieved at another branch, I first have to coordinate the when and where with a banker in my “home branch”. In America, there is no significance to the branch (or Internet) where you opened your account. Do whatever you want at any branch, as long as it’s the same bank.
In Israel, many people recommend having a personal relationship with a particular banker, because similar to some other aspects of Israeli life, rules are treated as recommendations. If you want the rules to be more flexible for you, you have to bargain for it, and the best bargaining position is attained by dealing with lots of money, or by having a personal relationship with the banker. In America, doing something requires it to be permissible according to the same bank rules everyone follows. If a rule is too strict to people’s liking, they will go to another bank and free markets will generally change the rule for the better over time for everyone.
In Israel, your bank login ID and ATM PIN are set for you. You’ve got to memorize random strings of 4 - 8 alphanumeric characters, or write them down in your phone or on paper in your wallet, sacrificing significant security. In America, you pick your online username, and usually, PIN too, resulting in both greater convenience and greater security.
In Israel, credit cards have monthly and other fees. The credit card company is doing you a favor by giving you credit. In America, the most common credit cards are free.
In Israel, credit card companies try to entice with deals and coupons, but those are not impressive and expire quickly. In America, credit cards give 1% - 2% (or more) cash back on all purchases. This, clearly, is worth a hell of a lot more than the Israeli 1+1 deals or coupons. They also come with a slew of impressive benefits, like doubled warranties, zero fraud liability, rental insurance (even in Israel for certain cards), a simple dispute process if a merchant screws you over and sometimes no ATM fees nationally. Some cards even reimburse ATM fees worldwide for any fees charged by the ATM bank.
Our next post will discuss what I personally do about my distaste for Israeli banking.
Banking in Israel Sucks - What I Do About It
Banking in Israel Sucks - What I Do About It
My previous post discussed what I think the Israeli banking industry can learn from the American (or probably mostly any foreign) banking industry.
For those reasons, if you’re American, I personally think it’s a no-brainer to use American banking and credit cards as much as possible. There are 2 caveats.
One is for those interested in paying with tashlumim (installment payment plans). Many stores, and especially ones in which people tend to rack up big bills (like furniture and supermarkets, among many others), allow you to pay in installments for free. For those who don’t tend to spend beyond their means when they’re able to delay having to pay, it makes good financial sense to do so. Since tashlumim do not work with foreign credit cards, it may makes sense to use an Israeli credit card for large purchases in Israel in order to take advantage of this benefit. On the other hand, Americans who do their research know that many American credit cards, including the high-cash-back types that I prefer, offer 0% APR for the first 12 months. You can take advantage of such deals yearly. This effectively delays nearly all payments until 1 year later, which is a much sweeter deal than tashlumim.
The other caveat is that there are places in Israel that only accept Israeli credit cards. I’ve only encountered 2.5 such places in 3 years - 1 was HOT Mobile (but not Golan, who are much better anyway :-) ), I forgot the other, and the half is for gas stations. Most Israeli gas stations preclude executing the transaction by yourself if you’re using a foreign card. Instead, you’ll need to call over an attendant for what would effectively be full service (though at self-service prices). Further, they impose a limit of 200 NIS per transaction on foreign cards, so if your tank needs more than 200 NIS of gas, it’ll takes an extra couple minutes for the employee to get the gas pumping twice.
Choosing a foreign credit card and ATM card can be overwhelming, but using a chart like the following makes it much easier:
In terms of credit cards, I personally only consider cards which don’t charge a foreign transaction fee, which when charged is generally 1%, 2% or 3% of the transaction amount. Many cards meet this criterion, but I then filter by how much cashback they give. This filter is a critical component of my financial strategy, as an automatic refund on all my spending ends up being a large number over the long run. The card I use is the Capital one Quicksilver, which gives 1.5% cash back, representing a significant financial impact on my bottom line. I also have a FIA Fidelity Amex 2% cashback card, but that charges foreign transaction fees, and so I only use it for American purchases, like from Amazon.
In terms of ATM cards, I only consider cards which don’t charge a foreign transaction fee, don’t charge an ATM withdrawal fee, and automatically reimburse the ATM owner’s ATM withdrawal fees if applicable. Only a small fraction of the cards fit those criteria, but those that do provide us with the ability to withdraw ILS from our USD account at no cost whatsoever - in my experience including any exchange rate differential. That benefit is significant - withdrawing ILS from your USD account at no cost. Due to the availability of this option, it is generally unnecessary to ever exchange USD into ILS any other way. The only exception I can think of is when making a large ILS purchase you didn’t know about in advance, since such ATM cards have daily withdrawal limits - usually about $500 - $1,000. The ATM card I use is the Schwab Bank Visa ATM card. I’ve also used Bangor’s ATM card.
As you should already know, I invest whatever money I can afford to invest. With the ability to invest that money in either an American or Israeli account, the clear choice to me is an American account. The reason is that America taxes heavily (40+%) any investment profits her citizens make from non-American baskets of stocks - including mutual funds, ETFs/ETNs, etc. Since I only invest in baskets of stocks as opposed to individual stocks, I must only invest via American securities in order to preserve these gains from outrageous taxation. Someone who insists on investing via an Israeli broker can still avoid the high taxation by buying American securities via their Israeli broker, but my impression is that there would be unnecessarily higher fees/costs for this compared to investing in the same securities via an American broker. My understanding is that investing in baskets of non-American stocks in a Keren Hishtalmut, Keren Pensia or Bitu’ach Minahalim is not subject to the exorbitant taxation.
Considering the benefits I perceive regarding American accounts and the easy and free ability to convert USD to ILS at will via the ATM method above, I even transfer my salary from ILS to USD when I have enough to transfer (a couple times a year) so that I can perpetuate my American banking approach indefinitely. So long as the cost of converting ILS to USD costs less than the 1.5% cash back I earn on all spending of that money, and less than the fees of buying American baskets of stocks via an Israeli broker compared to an American broker, it’s a financially net-positive approach. For me, it certainly is - I have used IsraTransfer, which charges .75% of the transaction with no other costs. Clearshift has been recommended as well, with an even lower fee.
I do keep some money in Israel - that’s where my salary is deposited and I have to pay rent in ILS anyway. I use no-fee Israeli accounts - Bank haPoalim gave us as olim 1 year without fees, and when that expired we went to Bank Igud for 3 years until their deal (for everyone, not just olim) expired, and are now at Bank haBeinLeumi. They require that we use our Israeli credit card for 1,000 NIS/month in order to not have to pay fees, which isn’t ideal, but is the best offer we’ve found among banks in our area.
One notable downside to living life in Israel yet keeping money principally denominated in ILS is currency exchange rate risk. This makes your buying power particularly susceptible to fluctuations in the USD/ILS exchange rate. In practice, this can as easily be a good thing as as it can be a bad thing. It can be good if the USD appreciates relative to the ILS, in which case your USDs will buy you more in life here. So the problem with risk isn’t that it’s more likely you will lose - indeed, with currency exchange rate risk I consider the likelihood of it benefiting me as equal to the likelihood of it harming me. Instead, it’s the fact that something out of my control can cause me to lose more than I’m comfortable with, and with a likelihood that’s larger than I’m comfortable with. There are many strategies to hedge (basically, make go away) your currency exchange rate risk, but I’m too far from being an expert in those areas to preach it here. Just know that those who live in one currency but whose money is principally denominated in another are exposed to the risk of gaining/losing a significant amount of spending power via currency fluctuations, and there are easy securities you can buy to act as nearly-free insurance against that risk.
In summary, my approach is to bank in America whenever possible, which is 99% of the time. I transfer money I earn in Israel to the US. If I need ILS, I use a fee-free ATM card, and all purchases go on an American credit card which gives 1.5% cash back. I do all investing in the US too, except for work plans such as Keren Hishtalmut and Keren Pensia. Currency exchange rate risk is worth considering, though I haven’t presented any strategies to deal with it. We have accounts in the US in Ally, Capital One and Schwab Bank for banking as well as Fidelity and Schwab for brokerage (though am strongly considering Betterment for taxable accounts) and Schwab Bank ATM card and Bangor ATM card for ILS ATM withdrawals. In Israel we have Bank haBeinLeumi for banking, and a Club HOT fee-free credit card.
Negotiated Rates on Keren Hishtalmut and Keren Pensia
Negotiated Rates on Keren Hishtalmut and Keren Pensia
As you probably know about me, I maintain that a big part of achieving financial independence is lowering fees. One particularly high, but unnecessary, set of fees are those associated with Keren Hishtalmut, Keren Pensia and Bituach Minahalim.
My company negotiated particularly low rates with a number of such companies, and among the lowest fees are with a company called Klal:
Keren Hishtalmut - .35% on balance annually
Keren Pensia - 1% on deposits, and .18% on balance annually
I in turn asked my Klal representative if they could offer such rates to others, and he said he'd try. He said it would depend on how much money you have; if you have a lot, perhaps you can get these rates, and if you don't, hopefully he can give something close.
So anyone who's interested in trying to get rates like the above please message me so I can make the referral.
Tangentially, if you want to see how your fees compare to the average, https://www.feex.co.il/ is a really easy, free site to show you that.
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