Financial Activity: Feb 2008

Just a quick re-cap:

1. The QQQ Direct purchase plan was set up to purchase QQQQ on every first Thursday of the month. It is free if you only make one purchase every month.
2. Enrolled in Progress Energy (PGN) direct stock purchase plan via Computershare (formerly EquiServe). Yeah, no commission fee.
   

I'm contributing $50 to each plan every month, and intend to hold them for a long time.

As of today, I have 2 checking accounts, 1 CD, 1 Traditional IRA and 1 401k.
Things that I have yet to set up:

1. High yield saving
2. Roth IRA
   

Expense: February 2008

Tomorrow is the last day of February and I don't plan on spending any money, so I'm doing my February expense now.

	Dec 2007	Jan 2008	Feb 2008
Total Spend	$1,150.50	$1,847.00	$1,923.74
Avg Spend	$37.11	$61.57	$66.34

The three month spending trend is going upward. The average spend in January jumped 66% from December last year. This was because I made a $500 donation. February had a 79% increase comparing to December last year because I paid $534.26 car insurance premium for my parents. It is time to cut my expenses. I'm paying $805 for my 1-1 apartment as of now, and as the lease is up (June 1st), I will definitely look for a cheaper place ($600 is what I'm shooting for.) That means an extra $205 per month for investing. Another thing needs to take note is that my grocery spend seems to be going up ever since I got the Costco membership. This is not good. Since I just did my grocery shopping for March, I expect my March grocery spending goes down.

Book Review: The Intelligent Asset Allocator

There are two kinds of investors, be they large or small: those who don't know where the market is headed, and those who don't know that they don't know. Then again, there is actually a third type of investor--the investment professional, who indeed knows that he or she doesn't know, but whose livelihood depends upon appearing to know.
- William Bernstein, "The Intelligent Asset Allocator"

I used to be the second type. When I first started investing back in my second year in college, stocks were the only investment that I knew and stock price was the only thing I considered. Since I had only $600 to play, I wanted to buy a stock with price below $5.00. My logic was that it would be easy for $5.00 to jump to $10.00. Plus, how much further a $5.00 stock can drop? Though by luck, the stock price indeed jumped close to $10.00 after 6 months, and I indeed sold them to secure the profits, there were two fatal flaws in my thinking:

1. Diversification never occurred to me.
   
2. I was gambling, not investing, for the first characteristics of investing is to aim for the long term.

These two points are well addressed in the book "The Intelligent Asset Allocator," not only Author Bernstein tells you why diversification is vital by showing statistics, which was convincing to me, a math major, he also make suggestions on how to do it and what one should consider when doing it. Not only he points out the danger of the gambler's thinking, he goes further by suggesting that even thinking in terms of "recency" should be avoided. The book held in my hands was published in the year 2000, 3 year earlier than the time I made my first trade. Yeah, I could have read it if I were to do some research before jumping into the market. But it is not too late to read it now, and here are some key ideas from the book that got me re-think about my current asset allocation for my Roth IRA: (I haven't opened the IRA account yet due to the liquidity of my money. Patience is indeed a virtue.)

1. Invest on index. (Graham made the same argument in his famous book "The Intelligent Investor")
2. Dividing portfolio between uncorrelated assets. (This is not something that I considered in my asset allocation, for example, I don't have real estate or precious metal funds in my portfolio.)
3. Favor short-term bonds (of six months to five years) as your "risk diluting" asset, rather than long-term bonds. (This is something I considered.)
4. Beware of recency, and do not be overly impressed with asset class returns over periods of less than two or three decades. (This got me re-think about Dodge & Cox funds)
5. never increase your allocation to an asset because of economic or political events or because you have heard an analyst make a convincing case for doing so. (Once you are settled on a target, then you are set. I'm glad that I'm not settled yet, and so far, the only investment vehicle I have is my 401k, which I don't think significant changes needs to be made.)
6. When allocating your money, think all your accounts as a whole. (I had this idea before as well since the final goal is to measure how well your overall net wealth is doing, but I realized it would hard to re-balance such an overall portfolio as well. Mr. Bernstein recognized this as well. I guess the only solution is to give it a try and see how well it goes.)

Stay tune for my updated asset allocation.

Consumer confidence goes down, oil price goes up

The Conference Board's index of confidence dropped to 75.0 in February from 87.3 in January, lower than what Economists expected. This means us consumers are really on a tough spot. The price of gasoline rose 2.9%. Maybe it is time to prepare to jog to work? Food price climbed 1.7%, which reminded me that I just spent $198.34 for my March groceries.

Time to re-budget!

Free Tax Prep Software

Don't forget to do your tax before April.

If you only need to fill out 1040EZ or simple returns, here is a free option. It has free e-file as well.
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Alternatively, you can try this free download of TaxCut Basic 2007. If you want to e-file, then I believe you would have to pay $14.95

Portfolio Allocation for My Roth IRA

When it comes to Roth IRA, I want to make sure not to over diversify. This means having as few accounts as possible and as few funds as possible. If two funds can meet your asset mix target, don't go for an extra third. Since I'm looking at a 30 year investment span for my Roth IRA, I'd also want to set up the account with a fund company directly to avoid the commissions charged by brokerages. This requires me to pick a good fund company that has several good cheap funds that can satisfy my asset mix target. Vanguard is the first that comes to my mind. Their funds are relatively inexpensive. And they don't charge nothing. Not even a custodian fee. But I didn't choose Vanguard at the end because most of their funds require a $3,000 initial investment, which means for the year 2008, with the $5,000 contribution limit, I can only purchase one fund. This will not meet my target. Then I discovered Dodge & Cox. After reading everything from their website and talking to one of their people on the phone, I decided go with them. I think their funds' expense are reasonable, the way they do business is clear, and their management team are serious investors. Though they only have 4 funds, I can use 3 of them to meet my asset mix target. They are rolling out an international fund in April or May as well, so one more option for the future to choose. Their minimum initial investment is $1,000 per fund. The only less perfect thing is that they charge a $12.50 per customer (not per fund) maintenance fee every year. But I still think Dodge & Cox will serve me better in the long run comparing with Vanguard. (Vanguard will take me at least 3 years to meet my asset mix target). Here is my final portfolio with them:

1st Level		Target	D&C
	U.S. Stocks	50.0%	50.0%
	Foreign Stocks	40.0%	39.9%
	Bonds/Cash/Others	10.0%	10.2%
	Total	100.0%	100.1%
2nd level_full	Giant/Large	80.0%	89.0%
	Mid	20.0%	10.7%
	Small/Micro	0.0%	0.3%
	Total	100.0%	100.0%
2nd level_non Foreign	Giant/Large	60.0%	62.4%
	Mid	20.0%	6.5%
	Small/Micro	0.0%	0.1%
	Total	80.0%	69.0%

Portfolio Allocation for My 401K

After setting up the asset-mix target for my 401k account, I wasted no time and started building my portfolio. But before allocating my money according to the asset-mix target, I had to decide which funds to invest in. This process was relatively easy since I've only got a limited choices to choose from. (This is not uncommon for an employer sponsored 401k plan.) When it comes to picking mutual fund for retirement (meaning I will held them for at least 30 years), my first and must-followed criteria is:

Avoid Expensive Fund!!!

This follows after my philosophy: control the things that you can first. The past performance of a fund is at the end of my checklist, if it is even included in my check-list. Now, what do I consider an expensive fund? This is a tricky question to answer because the annual expensive ratio usually don't tell the whole story. If you were to dig into the fund's Statement of Additional Information (SAI), you would be surprised how much more you would be paying besides the expense measured by the expense ratio. The turn-over rate has a positive correlation with the commissions your would be paying, (the bigger the turn-over rate, the higher the commissions), but it doesn't tell us how much exactly the commissions would be. I actually examined the SAI for all the funds I picked for my 401k, and to be honest, even I was able to find all the numbers, these expense related numbers are not by any means easy to understand. I think one day I'd call the fund company and ask their guy to go through the SAI with me. But, just to give you a clue how crazy the actual cost could be, Vanguard Institutional Index Fund (VINIX) has the lowest annual expense ratio (0.05%) among all the funds in my 401k, after adding the numbers of extra costs, the actual expense ratio becomes 0.22%, which is 4 times more! It's time consuming and boring to go through all the SAIs, so I came up with the following rule:

Avoid funds with both annual expense rate > 1.2% and turn-over rate > 150%!!!

These funds would be thrown out no doubt period. Though funds on the boarder line will be considered, for example, my FID overseas (FOSFX) has an annual expense 1.00% and turn-over rate 132%, I prefer funds with expense rate below 0.5% and turn-over rate below 50%. Enough being said, here is my 401k portfolio:

Cap	Ticker	Contribution %
Large Index	VINIX	30
Mid	VHCAX	17
Small	VEXRX	20
Foreign	FOSFX	29
Bond	VBTIX	4

This portfolio meets my asset-mix target. How did I come up these numbers under the "contribution %" column? I designed this neat excel workbook (download it here).

• First, you need to fill out the "Data Entry" tab by looking up the your funds in morningstar and obtaining the corresponding info from the portfolio page. (A page like this) Look at the Market Capitalization table and Asset Allocation table on the page. You also need to subtract the foreign stock holding from the stock holding to get the U.S. stock holding.
• Second, go to the "Result" tab, enter your estimated contribution % and then notice the table on the lower right will give you the mixing result under these contribution%. By comparing this table with your asset mix target and adjusting these contribution%, you can figure out the appropriate contribution%.

Since I wasn't able to find a free and user friendly portfolio allocator that does what I want on google, I came up with my own. Let me know whether this small tool is helpful to you.
Here is the comparison of the resulting mix with my target:

1st Level		Target	401K
	U.S. Stocks	65.0%	64.7%
	Foreign Stocks	25.0%	25.2%
	Bonds/Cash/Others	10.0%	10.2%
	Total	100.0%	100.0%
2nd level	Giant/Large	55.0%	58.0%
	Mid	25.0%	27.4%
	Small/Micro	10.0%	10.6%
	Total	90.0%	96.0%
3nd level_non foreign	Giant/Large	35.0%	36.7%
	Mid	20.0%	19.9%
	Small/Micro	10.0%	10.5%
	Total	65.0%	67.0%

Asset Allocation for My Roth IRA

After I'm done with asset allocation for my 401k, I move on to Roth IRA. I decide to max out the its contribution limit ($5,000 for year 2008) as well. Since I'm not limited to pick from a few costly but mediocre performing funds like in the case of my company 401k, and my 401k is really a conservative approach, I can afford to be more aggressive for my Roth IRA. I set the mix target via the following aggressive-conservative-conservative levels:

1st Level		Target
	U.S. Stocks	50%
	Foreign Stocks	40%
	Bonds/Cash/Others	10%
	Total	100%

2nd level	Giant/Large	80%
	Mid	20%
	Small/Micro	0%
	Total	100%

3nd level_non foreign	Giant/Large	60%
	Mid	20%
	Small/Micro	0%
	Total	80%

Like my 401k, when I do my contribution allocation, I will follow the above target in the level-ordering fashion because I think the first level has most dominant power on my portfolio. To avoid things going wild, I have to hedge the risk involved in the second and third level significantly by allowing only 20% exposure to the mid/small caps.

Asset Allocation for My 401K Account

Deciding an asset mix has to do with one's tolerance of risk.

I've decided to max out my company traditional 401k for the year 2008. This means most of the money I'm going to put to investment will go to this account this year. Surely I want to play safe. But I don't want to have a bland year either. So I came up with a three level mix of which the first two levels being conservative and the third level being aggressive.

1st Level		Target
	U.S. Stocks	65%
	Foreign Stocks	25%
	Bonds/Cash/Others	10%
	Total	100%

Though I think the foreign market will perform better in the coming and next 3-5 years. Our recent market turbulence showed that U.S. market still leads the rest of the world. So I settle 25% on foreign stocks. Next, I set a mix target regarding to the market caps:

2nd level	Giant/Large	55%
	Mid	25%
	Small/Micro	10%
	Total	90%

Mid and small caps usually generate more returns over time but have more fluctuations and risks as well. With 35% in mid and small caps, plus a 10% in bond and cash, I feel pretty comfortable in terms of both risks and potential returns. Next, I want to make sure the non-foreign part has a reasonable mix regarding to the market caps as well:

3nd level_non-foreign	Giant/Large	35%
	Mid	20%
	Small/Micro	10%
	Total	65%

As you can see, the proportion of Giant/Large VS. Mid/Small/Micro is close to 1:1. This will hedge the safety net built by the first two levels by increasing more exposure to mid and small companies. When I do my portfolio allocation, I make sure to follow the level ordering of these three targets. This way, it will ensure a conservative solid backbone and the potential to bigger returns as well.

Note: I distinguish Giant and Large (Small and Micro) because Morningstar report this way and I use the data published on their website to conduct portfolio allocation. The actual difference between Giant and Large (Small and Micro) matters little to me.

About

Updated February 20, 2008.

Beyond Small Money is a personal finance blog. The information published here, unless the sources are explicitly given, are the author's his own. The author is not a financial professional. Readers should use their own judgment and assume the full responsibility when it comes to making important financial decisions. Please consult a trained financial adviser if you want solid financial advice.

The author of this blog, Frankie, graduated from college in May 2007. He took an entry level position for a mid-cap corporation immediately afterwards. Soon he discovered that he was too independent for the corporate environment. He wants intellectual freedom, but he doesn't want to be like a crazy scientist who neglect his personal life and let others take care of himself especially financially. So he started asking himself how to make money without working for it. Well, there is only one answer:

Let money make itself.

Beyond Small Money was hence born, with the goal to serve as a journal of Frankie's path to financial freedom and his research, learnings and thoughts about investment, finance and Economics., as well as a communication channel between you and him.

Welcome and Enjoy!