Monthly Archives: March 2020

Should you trust your hard-earned retirement portfolio to a robot? 

The math doesn’t lie. The answer is a resounding NO.

All automated investment services, or ‘robo-advisors’, have the same value proposition. They are easy, low-maintenance, automated investment advisors. They use algorithms to set a predetermined proportion of your portfolio in basic index exchange-traded funds after a series of questions to determine customers’ risk tolerance. The algorithm then recommends a diversified portfolio and does this automatically. If you contribute $10,000, it will allocate X% to US stocks, Y% in foreign stocks, and Z% into emerging markets, and so on. 

To give an example based on my own risk tolerance, this is what my portfolio would look like on Wealthfront. 

These services have quickly amassed billions of dollars in assets under management (AUM) from young professionals. Wealthfront reached $20 billion AUM as of September 2009, Betterment had $16.4 million as of April 2019. They market their platforms on Nobel Prize winning research to build their models. In reality, they just tell investors to buy simple index funds. 

Before diving into some research, I actually think the idea is brilliant. Investors contribute, the platform takes care of the rest for a small annual advisory fee of 0.25%. For this fee, the platform promises to lower your taxes, using strategies like “tax-loss harvesting”, and to manage your risk. On top of these annual fees, investors need to pay the individual index fund expense ratios that invest into their portfolio. This model is a great deal for companies like Wealthfront. They attract young, ignorant professionals early and invest their money for the rest of their lives, skimming larger and larger fees from their accounts as their wealth grows.

The dirty little secret is most investors do not have a grasp of compound interest. They certainly do not understand how compound fees work.

If a 25-year old invests $100,000 of retirement funds with Wealthfront, they will likely pay the company over $100,000 in fees by their 66th birthday.

If they invest additional money from their salary over that time, the fees will grow even higher. 

You might say, “I don’t want to invest myself. I would rather have someone do it for me.” I can’t fault you for wanting to pay for convenience. I have good news for you. Vanguard has what’s known as Target Retirement Funds. These are automated investment vehicles that rebalance overtime, adjusting for risk as you grow older based on your intended retirement date. In my case, the Vanguard Target Retirement 2055 Fund is what I would choose.

This is basically Wealthfront without a 0.25% fee charged on top of your account. You will not be able to avoid fees entirely, but in Vanguard’s case – they are quite small.

I’ve built a simple model to show the differences in portfolio values and costs if you invest without fees, if you invest in a simple low-cost option with Vanguard, or with a robo-advisor service. As you will see, the cost of using a robo-advising service like Wealthfront and paying 0.25% over time adds up significantly. How significantly? Spoiler alert: it’s a lot. 

Let’s take a look at some examples. 

In the first scenario, let’s assume a $10,000 initial investment, a $5,000 annual contribution, and a 7% investment return. 10 years after starting the investment, the fees are not that large. These fees start to compound and get much larger later down the road. By the time you reach retirement age and are ready to use these funds, you will find out that the robo-advisors have taken over $100,000 of your investments over the years through the 0.25% they charge.

How is that possible? Every time you pay the 0.25% fee to the robo-advisor, that money is no longer yours to invest and grow at a compounded rate. It might not seem like a lot at first, but it’s significant over a 40 year investment career. 

If you’re an aggressive saver and a successful investor, the magnitude of these fees will be even worse. Our second example will assume the same $10,000 initial investment, but this time the annual contribution will increase to $15,000 and the investment return will be 8%. By the time you reach retirement age, the robo-advisor will take over $350,000 from your account.

Are robo-advisors a scam? Well, not in the Bernie Madoff sense. But I don’t see how investors do themselves any favors by investing this way. These robo-advisors do not promise to outperform the markets any more than a regular index fund. Personally, I would not invest in something knowing the long-term impact the fees will have on my wealth. As Ramit Sethi wrote in the terrific personal finance book, I Will Teach You To Be Rich:

“Most of us have been taught to ask $3 questions. We should really be asking $30,000 questions.”

Or in this case, $300,000 questions.

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Acknowledgements: Thanks to Adam, Ben, John, and Blair for their feedback on this post.

How often have you seen statements like this? 

On this day in 1997: Amazon goes public

If you invested $1,000 in the IPO, it would be worth $1.2 million today pic.twitter.com/9nI4RP30Iv

— Jon Erlichman (@JonErlichman) May 15, 2019

I have not been investing for a very long time. I certainly have never invested through a recession. During the Global Financial Crisis, I had just graduated from college with thousands of dollars in student loan debt. By the time I finally paid those off in 2017, I thought I missed one of the greatest bull runs in history. 

Once my student loans were paid, I was able to focus more on investing over the last few years. As someone whose career is in finance, it can be easy for me to be over-confident in my personal finance decisions. Naturally, I seek out the expertise of smart people. How do they think? How do they act in challenging financial situations? How do they set themselves up to do well financially over the course of their life?

Nick Maggiulli is a data scientist and financial blogger at Of Dollars And Data. He writes about why most traditional financial advice has failed us. Nick helps investors see that investing decisions are never as easy as they seem. He sheds new light on personal financial decisions, using storytelling and data to help his audience understand these situations at a deeper level. 

Nick’s philosophy is that each investor experiences life and investing differently. We get married, have kids, lose jobs, get sick, experience loss, change careers, and the list goes on. Our lives are dynamic, and the financial decisions we make are dynamic too. In order to make wise financial decisions, we need to understand our biases, our wants, our strengths and our weaknesses. Once we understand ourselves, we will be better equipped to make smart financial and life decisions.   

I found Nick Maggiulli’s work in July 2018 and have been an avid reader ever since. At that time, he had 80 posts on his blog, which I read almost immediately to devour the financial wisdom he shared. Nick has written a blog post every week for 167 weeks in a row, allowing me to learn interesting and insightful data along the way. 

If you are interested in reading Nick’s work, here’s where you should start: 

Popular posts: https://ofdollarsanddata.com/popular-posts/

Of the 167 posts on his blog, I want to share five that have resonated with me the most: 

How to Invest a Lump Sum

If you only read a single post to understand the essence of Nick’s blog, this is it. As investors (and humans), we have the tendency to believe we can time the market. We think we have the power to increase our rates of return by using a dollar cost average strategy (DCA) instead of investing in a lump sum manner. Maggiulli includes a fascinating data visualization to show that DCA underperformance increases as the length of the buying period increases.

Climbing the Wealth Ladder 

As I begin to build wealth, thinking about where and how I spend and save my money is so important. This post helped me frame financial decisions in the context of “income levels”. A good proxy to use is 0.01% of your net worth. Let’s say you are at the grocery store and you are deciding whether to purchase a dozen regular eggs for $1.99 or a dozen cage-free eggs for $2.99. If your net worth was $1,000, this single choice (paying $1 extra for cage-free eggs) could have a slight impact on your finances as it would represent 0.1% of your total assets. However, if you were worth $10,000 (or more) the decision to spend $1 more would likely be trivial to your finances since it represents less than 0.01% of your wealth.

• Level 1. Paycheck-to-paycheck: $0-$0.99 per decision 
• Level 2. Grocery freedom: $1-$9 per decision 
• Level 3. Restaurant freedom: $10-$99 per decision 
• Level 4. Travel freedom: $100-$999 per decision 
• Level 5. House freedom: $1,000-$9,999 per decision 
• Level 6. Philanthropic freedom: $10,000+ per decision.

The Constant Reminder

We have a seemingly endless supply of investment advice at our disposal. The truth is the decisions we make today will have compounded effects decades later. In the short run, they are almost invisible. In the long run, however, our decisions can lead to incredible results. 

“When you increase your savings rate from 5% to 10%, you don’t get 5% more money at the end, you double the amount of money you have. The first day you form your exercise habit is the day you lose the weight. The first day you form your writing habit is the day you wrote your best work. It all compounds back to the moment when the habit is formed.”

You Have No Competition

The same is true in writing online, or personal finance. We naturally get intimidated by all the competition out in the world. Investing is the study of human behavior. It’s important to remember that we are only competing against ourselves. Maggiulli’s goal is to get the reader to re-examine their behavior. Michael Jordan said it best:

“Every day, I demand more from myself than anybody else could humanly expect. I’m not competing with somebody else. I’m competing with what I’m capable of.”

Seven Things I Learned From One Year of Blogging

As with most of the posts on Of Dollars and Data, the ideas can be applied to personal finance, online writing, or life in general. In the context of writing online, this post focuses on the perseverance to continue doing the work – as hard as it may be. Successful people in life share a common trait in anything they do, they don’t give up. Hard work and luck go hand in hand to create successful outcomes. As Samual Goldwyn said:

“The harder I work, the luckier I get.”

The Depth of Privilege

This is a non-investing article but still excellent. Nick discusses that we should all be able to step back and understand the depth of privilege in our own lives because some people unfortunately don’t have the same opportunities. Privilege goes beyond growing up with wealth or having more than others. It’s in the color or your skin, the community you grew up in, and so much more.

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Nick Maggiulli won’t give you all the answers when it comes to your finances. But that is not the point. He does an incredible job of framing complex financial problems into easy-to-understand, relatable stories backed up by data and facts. At the end of the day, each individual investor is responsible for their decisions. Nick’s writing has helped me frame my own financial goals, and has given me the data to confidently make those decisions.

You can subscribe to Of Dollars And Data here.

The biggest worldwide story over the last month has been the rapid spread of the COVID-19 virus, first identified by health authorities in Wuhan, China. As I’m writing this blog post, the virus has spread to more than 70 countries, more than 90,000 cases have been confirmed, 8,000 of which have been classified as serious. 

The Coronavirus has disrupted daily life, rocked the business world, and brought the rapid climb of the global stock market to a sudden halt, turning into market correction territory quicker than at any point in history. It took just 6 days for the S&P 500 to fall 10% from its all-time high on February 20. 

As companies act to help control the spread of the virus around the world, corporate emergency plans have forced employees to work remotely. My goal is to discuss how the the scare of a global pandemic is catalysing the eventual acceptance and ubiquity of remote work.

As China’s seaports and airports are at the epicenter of global trade, one of the biggest causes of the economic slowdown has been getting goods in and out of China due to roadblocks, quarantines, and factory closings. “Due to the coronavirus outbreak, cargo volumes at U.S. ports might be down by 20 percent or more on a year-on-year basis compared to 2019,” said Cary Davis, an official with the American Association of Port Authorities.

Companies that have direct business exposure to China and its trade logistics have been the earliest to feel the effects and sound the alarms. Apple warned investors that the supply of iPhones would be affected by the spread of the virus. Apple relies heavily on production of their products in Shenzhen, China, and consumers in China make up about 20 percent of their business in terms of global revenue.

Regardless of their direct or indirect connection to China, companies around the world are taking precautionary measures to cancel any non-essential employee travel, and recommended that employees work from home, whenever possible. According to financial data platform, Sentieo, 77 public company transcripts mentioned “work from home” or “working from home” in February. This is an increase from just four mentions of the same phrase in February 2019. The vast majority of these transcripts also mentioned “Coronavirus”.

It’s hard to find definitive statistics on how many people work remotely. Gallup’s most recent survey in 2016 showed that 43% of employees worked remotely in some capacity; that was up 4 percentage points from 2012. Another survey showed remote workers make up anywhere from about 5 percent (those who typically work from home) to nearly two-thirds (who sometimes work remotely) of the workforce, depending on the measurement. What is absolutely certain is that the trend has been ticking up and a pandemic like COVID-19 has the potential to fast-track the move by making it more universally accepted and prominent. Kate Lister, president of Global Workplace Analytics said, “What these temporary uses tend to do is show companies that a) it can be done, and b) having people already accustomed to working remotely makes the transition much easier.”

Companies that help enable the transition are benefiting as a result. In fact, their share prices are actually rising as investors take notice of the benefits of remote work. Shares in Zoom, the teleconferencing software company, skyrocketed over the past week as more white-collar workers work from home and telecommunicate. Although, anecdotally, some investors mistakenly invested in shares of $ZOOM instead of $ZM, causing shares of the incorrect company to spike nearly 80% in one day.

Companies who have predominantly remote work cultures and whose businesses are not impacted by the spread of a possible global pandemic are not seeing major disruptions to their everyday activities. One company in particular that pioneered the remote work culture and benefited tremendously as a result is the project management company, Basecamp. Basecamp was founded in 1999 with 4 people. They currently have about 50 employees spread out across 32 different cities around the world. They work from home, from coffee shops, from co-working spaces, or anywhere with internet access. The co-founders of the company, Jason Fried and David Heinemeier Hansson wrote a book in 2013 called Remote: Office Not Required and have been vocal proponents of this shift.

Basecamp’s internal handbook and communication guide are publicly accessible for all those who are interested. It discusses what they believe makes them successful and able to run a business remotely that has been cash-flow positive since the very beginning. Basecamp was early to the idea that remote work increases the talent pool, reduces turnover, lessens the real estate footprint, and improves the ability to conduct business across multiple time zones, to name just a few advantages. 

Fred Wilson, investor of USV, recently published a blog post detailing his “zoom room”. Wilson said that he converted his office a year and a half ago to only have a couch, a chair, and displays for video conferencing. He describes how meetings now primarily occur through Zoom; therefore eliminating the need for a traditional desk and chair in his office.

As we think about the future of remote work, and whether this latest catalyst will have lasting effects on how business is conducted around the world, one has to wonder which businesses and industries will be able to take long-lasting advantage of such changes. In a survey of 11,000 workers and 6,500 business leaders by Harvard Business School and Boston Consulting Group, the vast majority said that among the new developments most urgently affecting their businesses were employees’ expectations for flexible, autonomous work; better work-life balance; and remote working. (Just 30 percent, though, said their businesses were prepared.) 

Technology is a big reason for the change. Nowhere is that more true than today where millions of workers and thousands of companies have already discovered the benefits of working remotely. In companies of all sizes, representing virtually every industry, remote work has seen steady growth year after year. The youngest people entering the workforce today don’t remember a time when people weren’t always reachable, so they don’t see why they would need to sit in an office to work. The average yearly cost to rent office space in Chicago, where I live, is about $7,000 per worker, per year. I’m not even talking about more expensive cities such as New York, San Francisco, or Washington, D.C.  With such exorbitant costs, the eventual push towards remote work almost seems inevitable.