Investing Curiouscatblog

Tag: yield

  • Retirement Portfolio Allocation for 2020

    The markets continue to provide difficult options to investors. In the typical market conditions of the last 50 years I think a sensible portfolio allocation was not that challenging to pick. I would choose a bit more in stocks than bonds than the commonly accepted strategy. And I would choose to put a bit more overseas and in real estate.

    But if that wasn’t done and even something like 60% stocks and 40% bonds were chosen it would seem reasonable (or 60% stocks 25% bonds and 15% money market – I really prefer a substantial cushion in cash in retirement). Retirement planning is fairly complex and many adjustments are wise for an individual’s particular situation (so keep in mind this post is meant to discuss general conditions today and not suggest what is right for any specific person).

    I wrote about Retirement Savings Allocation for 2010: 5% real estate, 35% global stocks, 5% money market, 55% USA stocks. This was when I was young and accumulating my retirement portfolio.

    Today, investment conditions make investing in retirement more difficult than normal. With interest rates so low bonds provide little yield and have increased risk (due to how much long term bond prices would fall if interest rates rise, given how low interest rates are today). And with stocks so highly valued the likelihood of poor long term returns at these levels seems higher than normal.

    So the 2 options for the simplest version of portfolio allocation are less attractive than usual, provide lower income than usual and have great risk of decline than usual. That isn’t a good situation.

    photo with view of Glacier National Park,
    View of Glacier National Park (a nice place to go in retirement, or before retirement) by John Hunter

    I do think looking for dividend stocks to provide some current yield in this situation makes sense. And in so doing substitute them for a portion of the bond portfolio. This strategy isn’t without risk, but given the current markets I think it makes sense.

    I have always thought including real estate as part of a portfolio was wise. It makes even more sense today. In the past Real Estate Investment Trusts (REITs) were very underrepresented in the S&P 500 index, in 2016 and 2017 quite a few REITs were added. This is useful to provide some investing in REITs for those who rely on the S&P 500 index funds for their stock investments. Still I would include REIT investments above and beyond their portion of the S&P 500 index. REITs also provide higher yields than most stocks and bonds today so they help provide current income.

    While I am worried about the high valuations of stocks today I don’t see much option but to stay heavily invested in stocks. I generally am very overweight stocks in my portfolio allocation. I do think it makes sense to reduce how overweight in stocks my portfolio is (and how overweight I think is sensible in general).

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  • An Inverted Yield Curve Predicts Recessions in the USA

    When 2 year US government bonds yield more than the 10 year US government bonds a recession is likely to appear soon. This chart shows why this is seen as such a reliable predictor.

    chart showing 2 year v 10 year US government bond yields from 1988 to 2018

    The chart shows the 10 year yield minus the 2 year yield. So when the value falls below 0 that means the 2 year yield is higher. Each time that happened, since 1988, a recession has followed (the grey shaded areas in the chart).

    Do note that there were very small inversions in 1998 and 2006 that did not result in a recession in the near term. Also note that in every case the yield curve was no longer inverted by the time a recession actually started.

    The reason why this phenomenon is getting so much attention recently is another thing that is apparent when looking at this chart, the 2 and 10 year yields are getting close to equal. But you can also see we are no closer than 1994 and the USA economy held off a recession for 7 more years.

    Since 1970 the average length of time from the inversion of the 10 to 2 year yield curve has been 12 months (with a low of 6 months in 1973 and a high of 17 months, before the great recession of 2008).

    In addition to a possibly impending yield curve inversion it has been a long time since the last recession which makes many investors and economists nervous that one may be due.

    Related: 30 Year Fixed Mortgage Rates are not correlated with the Fed Funds Rate – Bond Yields Stay Very Low, Treasury Yields Drop Even More (2010) – Looking for Dividend Stocks in the Current Extremely Low Interest Rate Environment (2011) – Stock Market Capitalization by Country from 2000 to 2016

    Another thing to note about yield curves at this time is that the US Federal Reserve continues to hold an enormous amount of long term government debt (trillions of dollars) which it has never done before the credit crisis of 2008. This reduces the long term yield since if they sold those assets that would add a huge amount of supply. How this impacts the predictive value of this measure will have to be seen. Also, one way for the Fed to delay the inversion would be to sell some of those bonds and drive up long term rates.

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  • LendingClub Filters, Selecting Loans and Automated Investing

    This post continues our series on peer-to-peer lending (and LendingClub): Peer to Peer Portfolio Returns and The Decline in Returns as Loans Age, Investing in Peer to Peer Loans. LendingClub, and other peer-to-peer lenders let you use filters to find loans that meet your criteria. So if you chose to take more, or less, risk you can use filters to find loans fitting your preferences. Those filters can also be applied to automate your lending.

    There are resources online to help you understand the past results of various investing strategies (returns based on various filters). Some filter are just a trade-off of risk for return. You can invest in grade A (a LendingClub defined category) loans that have the lowest risk, and the lowest interest rates and historical returns. Or you can increase your risk and get loans with higher interest rates and also higher historical returns (after factoring in defaults).

    historical chart of returns by grade at Lending club
    Description of chart: This chart shows the historical performance by grade for all issued loans.

    This chart includes all loans that were issued 18 months or more before the last day of the most recently completed quarter. The historical returns data in the chart is updated monthly.

    Adjusted Net Annualized Return (“Adjusted NAR”) is a cumulative, annualized measure of the return on all of the money invested in loans over the life of those loans, with an adjustment for estimated future losses.

    LendingClub lets you set filters to use to automatically invest in new loans as funds are available to invest (either you adding in new money or receiving payments on existing loans). This is a nice feature, there are items you can’t filter on however, such as job title. And also you can’t make trade-offs, say given x, y and z strong points and a nice interest rate in this loan I will accept a bit lower value on another factor.

    So I find I have to be a bit less forgiving on the filter criteria and then manually make some judgements on other loans. For me I add a bit higher risk on my manual selections. I would imagine most people don’t bother with this, just using filters to do all the investing for them. And I think that is fine.

    Practically what I do so that I can make some selections manually is to set the criteria to only be 98% invested. This will cause it to automatically invest any amount over 2% that is not invested. You can set this to whatever level you want and also is how you can make payments to yourself. I will say I think one of the lamest “features” of LendingClub is that is has no ability to send you regular monthly checks. So you have to manually deal with it.

    It should be simple for them to let you set a value like send me $200 on the 15th of each month. And then it manages the re-investments knowing that and your outstanding loans. But they still don’t offer that feature.

    As I said one of the factors in setting filters is managing risk v. reward but the other is really about weaknesses in the algorithm setting rates. You can just see it as risk-reward trade-off but I think it is more sensible to see 2 different things. The algorithm weaknesses are factors that will fluctuate over time as the algorithm and underwriting standards are improved. For example, loans in California had worse returns (according to every site I found accessing past results). There is no reason for this to be true. If a person with the exactly same profile is riskier in California that should be reflected in higher rates and thus bring the return into balance. My guess is this type of factor will be eliminated over time. But if not, or until it is, fixed filtering out loans to California makes sense.

    Once you set your filter criteria then you select what balance you want between A, B, C, D, E and FG loans. I set mine to

    A 2%
    B 16%
    C 50%
    D 20%
    E 10%

    I actually have a bit over 1% in FG (but I select those myself). In 2015 the makeup of the loans given by LendingClub was A 17%, B 26%, C 28%, D 15%, E 10%, F and G 4%.

    Related: Where to Invest for Yield Today (2010) – Default Rates on Loans by Credit Score – Investing in Stocks That Have Raised Dividends Consistently – Investment Risk Matters Most as Part of a Portfolio, Rather than in Isolation

    Sadly Lending Club uses fragile coding practices that result in sections of the site not working sometimes. Using existing filters often fails for me – the code just does nothing (it doesn’t even bother to provide feedback to the user on what it is failing to do). Using fragile coding practices sadly is common for web sites with large budgets. Instead of using reliable code they seems to get infatuated with cute design ideas and don’t bother much making the code reliable. You can code the cute design ideas reliably but often they obviously are not concerned with the robustness of the code.

  • Peer to Peer Portfolio Returns and The Decline in Returns as Loans Age

    This is a continuation of my previous post: Investing in Peer to Peer Loans

    LendingClub suggest a minimum of 100 loans (of equal size) to escape the risk of your luck with individual loans causing very bad results. Based on this diversity the odds of avoiding a loss have been very good (though that obviously isn’t a guarantee of future performance), quote from their website (Nov 2015):

    With just $2,500 you can spread your investment across 100 Notes. 99.9% of investors that own 100+ Notes of relatively equal size have seen positive returns.

    chart of expected returns

    This chart, from LendingClub, shows a theoretical (not based on past performance) result. The basic idea is that as the portfolio ages, more loans will default and thus the portfolio return will decline. This contrasts with other investments (such as stocks) that will show fluctuating returns going up and down (over somewhat dramatically) over time.

    For portfolios of personal loans diversity is very important to avoid the risk of getting a few loans that default destroying your portfolio return. For portfolios with fewer than 100 notes the negative returns are expected in 12.8% of the cases (obviously this is a factor of the total loans – with 99 loans it would be much less likely to be negative, with 5 it would be much more likely). I would say targeting at least 250 loans with none over .5% would be better than aiming at just 100 loans with none over 1% of portfolio.

    There are several very useful sites that examine the past results of Lending Club loans and provide some suggestions for good filters to use in selecting loans. Good filters really amount to finding cases where Lending Club doesn’t do the greatest job of underwriting. So for example many say exclude loans from California to increase your portfolio return. While this may well be due to California loans being riskier really underwriting should take care of that by balancing out the risk v. return (so charging higher rates and/or being more stringent about taking such loans.

    So I would expect Lending Club to adjust underwriting to take these results into account and thus make the filters go out of date. Of course this over simplifies things quite a bit. But the basic idea is that much of the value of filters is to take advantage of underwriting weaknesses.

    chart of LendingClub returns as portfolio ages historically

    This chart (for 36 month loans) is an extremely important one for investors in peer to peer loans. It shows the returns over the life of portfolios as the portfolio ages. And this chart (for LendingClub) shows the results for portfolios of loans issued each year. This is a critical tool to help keep track to see if underwriting quality is slipping.

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  • USA T-Bills Sold by Treasury with 0% Rate for First Time Ever

    European government debt has been sold at negative interest rates recently. The United States Treasury has now come as close to that as possible with 0% 3 month T-bills in the latest auction.

    The incredible policies that have created such loose credit has the world so flooded with money searching for somewhere to go that 0% is seen as attractive. This excess cash is dangerous. It is a condition that makes bubbles inflate.

    Low interest rates are good for businesses seeking capital to invest. These super low rates for so long are almost certainly creating much more debt for no good purpose. And likely even very bad purposes since cash is so cheap.

    One thing I didn’t realize until last month was that while the USA Federal Reserve stopped pouring additional capital into the markets by buying billions of dollars in government every month they are not taking the interest and maturing securities and reducing the massive balance sheet they have. They are actually reinvesting the interest (so in fact increasing the debt load they carry) and buying more debt anytime debt instruments they hold come due.

    The Fed should stop buying even more debt than they already hold. They should not reinvest income they receive. They should reduce their balance sheet by at least $1,500,000,000,000 before they consider buying new debt.

    Unless the failure to address too-big-to-fail actions (and systems that allow such action) results in another great depression threat. And if that happens again they should not take action until people responsible are sitting in jail without the possibly of bail. The last bailout just resulted in transferring billions of dollars from retires and other savers to the pockets of those creating the crisis. Doing that again when we knew that was fairly likely without changing the practices of the too-big-to-fail banks. But I would guess we will just bail them out while they sit in one of the many castles their actions at the too-big-to-fail banks bought them and big showered with more cash in the bailout from the next crisis.

    How to invest in these difficult times is not an easy question to answer. I would put more money in stocks for yield (real estate investment trusts, drug companies, dividend aristocrats), I would also keep cash even if it yields 0% and actually a new category for me – peer to peer lending (which I will write about soon). Recently many dividend stocks have been sold off quite a bit (and then on top of that drug stocks sold off) so they are a much better buy today than 4 months ago. Still nothing is easy in what I see as a market with much more risk than normal.

    I am almost never a fan of long term debt. I would avoid it nearly completely today (if not completely). For people that are retired and living off their dividends and interest I may have some long term debt but I would have much more in cash and short term assets (even with the very low yields). Peer to peer lending has risks but given what the fed has done to savers I would take that risk to get the larger yields. The main risk I worry about is the underwriting risk – the economic risks are fairly well known, but it is very hard to tell if the lender starts doing a poor job of underwriting.

    Related: The Fed Should Raise the Fed Funds Rate – Too-Big-to-Fail Bank Created Great Recession Cost Average USA Households $50,000 to $120,000 – Buffett Calls on Bank CEOs and Boards to be Held Responsible – Historical Stock Returns

  • Cockroach Portfolio

    Dylan Grice suggests the Cockroach Portfolio: 25% cash; 25% government bonds; 25% equities; and 25% gold. What we can learn from the cockroach

    Each of those asset buckets protects against a different type of risk. And that is a very sensible approach to investing in the year ahead. Cash will protect you against a market collapse in anything (provided it’s cash held with a solid institution).

    Government bonds protect against deflation (provided your money’s invested in solid government bonds and not trash). Equities offer capital growth and income. And gold, as we know, protects against currency depreciation, inflation, and financial collapse. It’s vitally important to maintain holdings in each, in my opinion.

    The beauty of a ‘static’ allocation across these four asset classes is that it removes emotion from the investment process.

    I don’t really agree with this but I think it is an interesting read. And I do agree the standard stock/bond/cash portfolio model is not good enough.

    I would rather own real estate than gold. I doubt I would ever have more than 5% gold and only would suggest that if someone was really rich (so had money to put everywhere). Even then I imagine I would balance it with investments in other commodities.

    One of the many problems with “stock” allocations is that doesn’t tell you enough. I think global exposure is wise (to some extent S&P 500 does this as many of those companies have huge international exposure – still I would go beyond that). Also I would be willing to take some stock in commodities type companies (oil and gas, mining, real estate, forests…) as a different bucket than “stocks” even though they are stocks.

    And given the super low interest rates I see dividend paying stocks as an alternative to bonds.

    The Cockroach Portfolio does suggest only government bonds (and is meant for the USA where those bonds are fairly sensible I think) but in the age of the internet many of my readers are global. It may well not make sense to have a huge portion of your portfolio in many countries bonds. And outside the USA I wouldn’t have such a large portion in USA bonds. And they don’t address the average maturity (at least in this article) – I would avoid longer maturities given the super low rates now. If rates were higher I would get some long term bonds.

    photo with view of Glacier National Park,
    View of Glacier National Park, from Bears Hump Trail in Waterton International Peace Park in Canada, by John Hunter

    These adjustments mean I don’t have as simple a suggestion as the cockroach portfolio. But I think that is sensible. There is no one portfolio that makes sense. What portfolio is wise depends on many things.

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  • Continuing to Nurture the Too-Big-To-Fail Eco-system

    Fed Continues Adding to Massive Quantitative Easing

    In fact, while the Fed has pumped about $2.8 trillion into the financial system through nearly five years of asset buying.

    Bank excess reserves deposited with the New York Fed have mushroomed from less than $2 billion before the financial crisis to $2.17 trillion today. In essence, roughly two-thirds of the money the Fed pumped into the banking system never left the building.

    The Fed now pays banks for their deposits. These payment reduce the Fed’s profits (the Fed send profits to the treasury) by paying those profits to banks so they can lavish funds on extremely overpaid executives that when things go wrong explain that they really have no clue what their organization does. It seems very lame to transfer money from taxpayers to too-big-to-fail executives but that is what we are doing.

    Quantitative easing is an extraordinary measure, made necessary to bailout the too-big-to-fail institutions and the economies they threatened to destroy if they were not bailed out. It is a huge transfer payment from society to banks. It also end up benefiting anyone taking out huge amounts of new loads at massively reduced rates. And it massively penalizes those with savings that are making loans (so retirees etc. planing on living on the income from their savings). It encourages massively speculation (with super cheap money) and is creating big speculative bubbles globally.

    This massive intervention is a very bad policy. The bought and paid for executive and legislative branches that created, supported and continue to nurture the too-big-to-fail eco-system may have made the choice – ruin the economy for a decade (or who knows how long) or bail out those that caused the too-big-to-fail situation (though only massively bought and paid for executive branch could decline to prosecute those that committed such criminally economically catastrophic acts).

    The government is saving tens of billions a year (maybe even hundred of billions) due to artificially low interest rates. To the extent the government is paying artificially low rates to foreign holders of debt the USA makes out very well. To the extent they are robbing retirees of market returns it is just a transfer from savers to debtors, the too-big-to-fail banks and the federal government. It is a very bad policy that should have been eliminated as soon as the too-big-to-fail caused threat to the economy was over. Or if it was obvious the bought and paid for leadership was just going to continue to nurture the too-big-to-fail structure in order to get more cash from the too-big-to-fail donors it should have been stopped as enabling critically damaging behavior.

    It has created a wild west investing climate where those that create economic calamity type risks are likely to continue to be rewarded. And average investors have very challenging investing options to consider. I really think the best option for someone that has knowledge, risk tolerance and capital is to jump into the bubble created markets and try to build up cash reserves for the likely very bad future economic conditions. This is tricky, risky and not an option for most everyone. But those that can do it can get huge Fed created bubble returns that if there are smart and lucky enough to pull off the table at the right time can be used to survive the popping of the bubble.

    Maybe I will be proved wrong but it seems they are leaning so far into bubble inflation policies that the only way to get competitive returns is to accept the bubble nature of the economic structure and attempt to ride that wave. It is risky but the supposedly “safe” options have been turned dangerous by too-big-to-fail accommodations.

    Berkshire’s Munger Says ‘Venal’ Banks May Evade Needed Reform (2009)

    Munger said the financial companies spent $500 million on political contributions and lobbying efforts over the last decade. They have a “vested interest” in protecting the system as it exists because of the high levels of pay they were earning, he said. The five biggest U.S. securities firms, only two of which still exist as independent companies, paid their employees about $39 billion in bonuses in 2007.

    Related: The Risks of Too Big to Fail Financial Institutions Have Only Gotten Worse – Is Adding More Banker and Politician Bailouts the Answer? – Anti-Market Policies from Our Talking Head and Political Class

  • Solar Direct Investing Bonds

    Mosaic offers a new investment option to easily invest in solar energy projects. Mosaic connects investors seeking steady, reliable returns to high quality solar projects. To date, over $2.1 million has been invested through Mosaic and investors have received 100% on-time repayments.

    The site provides full prospectives on each project. The yields have been between 4.5% and 5% for 8 to 10 year projects. The funds pay for solar installation and then the locations that take the loans pay them back with the saving on their electricity bill (sometimes selling power to the utility based on the organizations electricity needs and amount generated at any specific time).

    The bonds have risks, of course. And I am pretty sure they are very illiquid. But for those looking for some decent yield alternatives they may offer a good choice. They also provide the benefit of supporting green energy

    The current bond being offered, 657 kW on Pinnacle Charter School in Federal Heights, Colorado offers a yield of 5.4%. The public offerings have only been available for a few months and they have sold out quickly so far.

    Mosaic has done a good job creating a simple process to invest online. You create your account and if you chose to invest and are allocated a portion of an offering it is funded from your bank account. You can invest as little as $25.

    Related: Looking for Yields in Stocks and Real Estate – Taking a Look at Some Dividend Aristocrats – Pay as You Go Solar in India – posts on solar energy on Curious Cat Science and Engineering blog

  • US Treasury Yield Fall to New Record Low

    Us treasury yield hit a incredibly low level years ago and they have continued to fall further. Granted this is mainly due to the bailout of the economy necessitated by the politicians favors to the too-big-too-fail financial institutions that have given those politicians so much cash over the years. Other factors are at play but the extent of the excessive punishment of savers is mainly due to political bailouts of bankers and bailouts of the economy caused by the bankers actions.

    This extremely low rate environment is crippling to many retirees. The small percentage that actually did what they were told to have been blindsided by years of artificially low rates (and it is likely to continue for years). This has pushed some that would have been comfortable in retirement into an uncomfortable one an has pushed some from a challenging balancing act to essentially having to eliminate every possible expense (and even that may not be enough).

    I can’t believe long term bonds are a sensible investment now. Of course I haven’t thought they were for 10 years, but they are even worse now. Bonds of “strong” governments (USA, Germany, Japan) are paying less than inflation (sometimes even less than 0 nominally – I think this has just been for short term issues so far).

    I cannot see putting more than token amounts into long term bonds at these rates. Corporate bonds are not much better. The economic damaged caused by out of control too-big-too-fail institution is huge and continuing. And the politicians that have been paid lots of cash by those too-big-too-fail institutions continue to treat the too-big-too-fail players are favored friends. The yields are corporate bonds are not good for companies that are strong.

    The alternatives are not great. But real assets, strong dividend stocks, strong company stocks, and short term bonds seem like better options to me in many cases. And hope we elect people that will put the economic interest of the country ahead of a few well paid friends at too-big-too-fail institution. They also need to eliminate the captured “regulators” that have facilitated the continued wrecking of the global economy. I don’t hold out much hope for this though. We keep re-electing those given lots of cash by the too-big-too-fail crowd and they continue giving them favors. We are getting what we deserve given this poor performance on our part but it is pretty annoying having to watch us vote ourselves into economic calamity.

    Related: Buffett Cautions Against Buying Long Term USD Bonds – Is Adding More Banker and Politician Bailouts the Answer? – Bill Gross Warns Bond Investors – Congress Eases Bank Laws (1999)

  • Looking for Yields in Stocks and Real Estate

    The extremely low interest rate environment created by the too big to fail financial institution bailouts has severely harmed savers. Most severely harmed those in retirement that didn’t count on irresponsibly regulators and bankers creating a situation where to avoid a depression they had to punish savers to favor large banks (and others).

    For some savings that might normally go into bonds (if the bond market were not so manipulated by the central banks to punish savers) dividend stocks are a good option. The stocks have risks but frankly with extremely strong companies with huge amounts of positive cash flow the future looks brighter than it does for those debt ridden governments.

    Apple (AAPL) announced they will start paying a $2.65 quarterly dividend which works out to $10.60 annually. At the current stock price, this is a yield of nearly 1.9%. That is hardly going to make you rich but it is extremely attractive when you can get a much higher yield than savings account, treasury bills… and have the potential gains in stock price. Yes you do also have risk of a declining stock price, but as I have said I think Apple’s stock is an extremely good investment now.

    Other good options include: Intel (INTL) which offers a 3.3% yield and Abbott (ABT) which offers a 3.4% yield. I own those 3 and also ONEOK Partners (OKS) which sports a 4.8% yield (but is a bit tricker situation that is suitable for a lower investment I think).

    Even a stock like Toyota (TM), which I like as an investment, while it offers only a 1.8% yield that is much higher than you get for savings or treasury bills. So even stocks that are not about yield in the normal market conditions offer an attractive yield today.

    I am a bit nervous about health care dividend investments but Pfizer (PFE) is worth considering at 4.1% (as are JNJ and MRK). I really like ABT (they have raised dividends for over 40 straight years, I think), sadly they are splitting into 2 companies. Even so I am planning on staying invested but it is avery big change and would make me worried about having too much committed to ABT.

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