Diversification is the mark of a good portfolio. Modern portfolio theory shows that for any given level of risk, the best performing portfolio is a diversified one. You can diversify your portfolio by buying a large number of individual stocks and bonds, but many of us choose a simpler method of diversification - we buy mutual funds.
A potential problem with that approach is that if you own more than a single mutual fund, you may be less diversified than you think. This is because it is possible that your funds are investing in overlapping sectors or even in the same individual stocks. Even though I invest our portfolio exclusively in highly diversified index funds, I recently decided to dig into our portfolio to determine whether we truly are diversified. I did so using e*Trade's recently launched portfolio analyzer tool.
The good news is that we do appear to be well diversified. However, even in our diversified portfolio there were some overlaps between funds. For example, Vanguard's Total Market Index (VTSMX), Vanguard's Growth Index (VIGRX) and the QQQQ ETF all contain a small percentage of Google stock. The result is that our portfolio contains double the amount of Google stock it would if we simply invested in the Total Market Index fund. The same is true for Apple, Cisco, Intel, GE, 3M and so forth. All in all, there is no real problem for our portfolio, since no stock accounts for more than 0.6% of our holdings. Still, you get the idea.
So how can you make sure that you don't over expose yourself to undiversified stock positions by investing in mutual funds? Here are a few rules of thumb:
1. Check Your Portfolio - using a tool such as e*Trade's portfolio analyzer made this process very simple for me, but you can achieve the same result by simply going through your fund prospectuses. If you find substantial overlaps, consider divesting of one or more of your funds.
2. Invest in Indexes - investing in Indexes should reduce the likelihood of dramatic overlaps, since index funds are, by nature, diversified and do not place sizable bets on specific stocks.
3. Avoid Sector Investing - if you concentrate your investments in a specific segment of the market, you are more likely to be investing in multiple funds that hold large, overlapping positions of a particular stock.
4. Don't Double Up - realistically, you only need a single mutual fund to cover each major asset class. Theoretically, you could invest in a total market index fund (e.g. VTSMX), a total bond market index fund (e.g. VBMFX), a total international index fund (e.g. VGTSX), and a real estate index fund (e.g. VGSIX) and your portfolio would be very well diversified. There is no need to select more than one mutual fund that covers a specific segment. The fewer funds you have, the lesser the risk of these funds overlapping and creating an under diversified position.
There is one more complicating factor: most of us have multiple accounts with different financial institutions - brokerage account, IRA, 401K, 529 and so forth. Checking for overlapping stock positions across multiple accounts is somewhat harder, but it is a worthwhile exercise. Even if your positions are well diversified in a specific account, you may have some overlapping, undiversified positions in some of your other accounts. You'll only know if you check.
Thursday, October 25, 2007
Wednesday, October 24, 2007
Weddings in Sonoma
My wife and I went away to Sonoma for a quick getaway, last weekend. For those readers who are not familiar with the name, Sonoma and Napa are Northern California's most famous wine producing regions.
Conspicuously, everywhere we went that weekend we ran into wedding parties. When I asked one of the servers at a winery about this unusual number of weddings, she told us that Napa county has regulations prohibiting wineries from holding wedding receptions, so many wedding parties are held in Sonoma instead. She also explained the regulations were put into place with strong backing of the hotel industry association, who wanted to prevent wineries from moving into the event business and competing with them.
Think about this for a second. What business is it of the government, local or otherwise, to tell private businesses what types of events they can or can't host? Why do we allow crooked politicians to sell us all down the river for a bunch of special interests and economic pressure groups? Why do we allow weak industries to insulate themselves from competition by essentially making that competition illegal?
My philosophy: if hotels are worried about losing wedding parties to local wineries they should make themselves more attractive to their customers. What an original thought.
Conspicuously, everywhere we went that weekend we ran into wedding parties. When I asked one of the servers at a winery about this unusual number of weddings, she told us that Napa county has regulations prohibiting wineries from holding wedding receptions, so many wedding parties are held in Sonoma instead. She also explained the regulations were put into place with strong backing of the hotel industry association, who wanted to prevent wineries from moving into the event business and competing with them.
Think about this for a second. What business is it of the government, local or otherwise, to tell private businesses what types of events they can or can't host? Why do we allow crooked politicians to sell us all down the river for a bunch of special interests and economic pressure groups? Why do we allow weak industries to insulate themselves from competition by essentially making that competition illegal?
My philosophy: if hotels are worried about losing wedding parties to local wineries they should make themselves more attractive to their customers. What an original thought.
Tuesday, October 23, 2007
Citibank Late Fee Update
A couple of days ago I wrote about how Citibank screwed us by "upgrading" our account and essentially making us miss our payment due date. To add insult to injury they charged us $89 in late fees and financing charges for their mistake.
Today my no nonsense fighter of a wife called Citibank and gave them a piece of her mind. Bottom line, charges reversed. Citigroup CEO should be arriving tomorrow at 5 PM to apologize in person and offer us his first born (no thanks, Chuck, we have three of our own).
Never acquiesce to unfair business practices.
Today my no nonsense fighter of a wife called Citibank and gave them a piece of her mind. Bottom line, charges reversed. Citigroup CEO should be arriving tomorrow at 5 PM to apologize in person and offer us his first born (no thanks, Chuck, we have three of our own).
Never acquiesce to unfair business practices.
Stay at Home Parents Pay a Professional Price
When our twin sons were born, my wife and I faced a decision. We needed to decide whether my wife would take a break from the corporate life to stay at home with the kids. Having me leave my job was never an option since my income is substantially higher and, quite frankly, I don't think that I could become a stay at home dad and remain sane.
At the time, my wife was working her old job, and her salary was barely enough to cover day care costs for the three boys. So seemingly, the financial decision should have been a simple one. After all, why work if your entire salary gets immediately signed over to Uncle Sam and a couple of day care centers. Right? Not so fast.
Here is the trick. Parents contemplating the stay at home option tend to make the financial portion of their decision based on their current financial situation. However, there are three additional financial factors that need to be considered:
1. Loss of Experience - as your career progresses and you gain more experience, your compensation increases. Say you are thinking of taking a five year break from work to stay with your kids until it's time for them to head to kindergarten. During that period you lose not only your current income, but also any pay increases you would have gained had you continued to work. You also lose five years of experience which are directly translatable into compensation and probably into a more senior position at work.
2. Loss of Skill - the term "use it or lose it" may be a cliche, but it's right on the money. If you stay out of the labor force, your skills degenerate. Let me give you a personal example: my readers know that I hold a law degree, but I haven't practiced law in 8 years (I like to think of myself as a reformed lawyer). At this point most intelligent people would not hire me as their lawyer, and with good reason. I am so rusty and out of shape that I couldn't even credibly play a lawyer on TV. The same is true for virtually any other skilled or professional position. Your degenerating skills mean a lot less pay down the road when you do decide to jump back in the water.
3. Rejoining the Labor Force is Tough - I am currently in the process of hiring another member for my team. I am reviewing dozens of resumes, some of them sent by people with some useful background and experience but with some unexplained gaps in their work history. Now, I am sure that many of these gaps can be easily explained away, the problem is that I review a very large number of resumes and only have time to interview a limited number of candidates. Do you think I am going to choose to interview someone with a stellar and steady career track? Or someone which has some clear holes in their resume but which could potentially be explained away? Don't get me wrong, I am not saying that people with work history gaps can't rejoin the labor force, only that it is not an easy matter, and many find themselves accepting lesser positions to get back into the game.
I am not arguing against stay at home parents. However, I am suggesting that most people underestimate the long term financial implications of the stay at home parent decision. For many people staying at home with the kids turns out to be a very smart and emotionally satisfying decision, however before making that decision, be aware of all of the career consequences associated with your plan.
For those making the decision to go back to work, I have a couple of pieces of advice:
1. Don't Feel Guilty - many families feel that they are doing a disservice to their kids by sending them off to daycare at the age of only a few months. I can attest from personal experience that children of working parents can grow up to be well adjusted and happy adults. My parents both worked since we were very young and my siblings and I have all remained pretty much jail free and advanced degrees are common in my family. My own five year old is as smart and well adjusted a boy as you can hope to meet (if I do say so myself). He is a very happy child, in spite of (or perhaps because of) having started at family daycare when he was 4 months old.
2. Work to Pay for Day Care - many couples with more than one kid feel that one of them is simply working to pay for day care. Getting your paycheck and seeing that your take-home pay is more or less equal to the daycare bill, can be emotionally difficult. To cope with this, my wife and I made some adjustments. For example, we put all the kids on my company's health insurance. Health premiums are deducted from my paycheck leaving a bigger paycheck for my wife to take home. We decided that we would fund our medical and child care flex accounts all from my salary, for the same reason. Similarly, you can decide to stop contributing to your 401K for a short time, if this helps you to feel better about your salary.
These changes were more or less cosmetic. I mean after all, does it really matter which pocket the money comes from? It turns out that it matters a great deal psychologically.
3. Finally, Do what Feels Right - regardless of anything I said, or of anything anyone else may say, make the decision that feels right for you. You will not hear this frequently from a personal finance blogger, but to hell with the money. Happiness and your family are the most important considerations. Make the decision that will make you happier in the long run.
Coincidentally, Trent, from The Simple Dollar is apparently considering this very issue right now. Check out this very interesting post about his greatest financial concerns.
At the time, my wife was working her old job, and her salary was barely enough to cover day care costs for the three boys. So seemingly, the financial decision should have been a simple one. After all, why work if your entire salary gets immediately signed over to Uncle Sam and a couple of day care centers. Right? Not so fast.
Here is the trick. Parents contemplating the stay at home option tend to make the financial portion of their decision based on their current financial situation. However, there are three additional financial factors that need to be considered:
1. Loss of Experience - as your career progresses and you gain more experience, your compensation increases. Say you are thinking of taking a five year break from work to stay with your kids until it's time for them to head to kindergarten. During that period you lose not only your current income, but also any pay increases you would have gained had you continued to work. You also lose five years of experience which are directly translatable into compensation and probably into a more senior position at work.
2. Loss of Skill - the term "use it or lose it" may be a cliche, but it's right on the money. If you stay out of the labor force, your skills degenerate. Let me give you a personal example: my readers know that I hold a law degree, but I haven't practiced law in 8 years (I like to think of myself as a reformed lawyer). At this point most intelligent people would not hire me as their lawyer, and with good reason. I am so rusty and out of shape that I couldn't even credibly play a lawyer on TV. The same is true for virtually any other skilled or professional position. Your degenerating skills mean a lot less pay down the road when you do decide to jump back in the water.
3. Rejoining the Labor Force is Tough - I am currently in the process of hiring another member for my team. I am reviewing dozens of resumes, some of them sent by people with some useful background and experience but with some unexplained gaps in their work history. Now, I am sure that many of these gaps can be easily explained away, the problem is that I review a very large number of resumes and only have time to interview a limited number of candidates. Do you think I am going to choose to interview someone with a stellar and steady career track? Or someone which has some clear holes in their resume but which could potentially be explained away? Don't get me wrong, I am not saying that people with work history gaps can't rejoin the labor force, only that it is not an easy matter, and many find themselves accepting lesser positions to get back into the game.
I am not arguing against stay at home parents. However, I am suggesting that most people underestimate the long term financial implications of the stay at home parent decision. For many people staying at home with the kids turns out to be a very smart and emotionally satisfying decision, however before making that decision, be aware of all of the career consequences associated with your plan.
For those making the decision to go back to work, I have a couple of pieces of advice:
1. Don't Feel Guilty - many families feel that they are doing a disservice to their kids by sending them off to daycare at the age of only a few months. I can attest from personal experience that children of working parents can grow up to be well adjusted and happy adults. My parents both worked since we were very young and my siblings and I have all remained pretty much jail free and advanced degrees are common in my family. My own five year old is as smart and well adjusted a boy as you can hope to meet (if I do say so myself). He is a very happy child, in spite of (or perhaps because of) having started at family daycare when he was 4 months old.
2. Work to Pay for Day Care - many couples with more than one kid feel that one of them is simply working to pay for day care. Getting your paycheck and seeing that your take-home pay is more or less equal to the daycare bill, can be emotionally difficult. To cope with this, my wife and I made some adjustments. For example, we put all the kids on my company's health insurance. Health premiums are deducted from my paycheck leaving a bigger paycheck for my wife to take home. We decided that we would fund our medical and child care flex accounts all from my salary, for the same reason. Similarly, you can decide to stop contributing to your 401K for a short time, if this helps you to feel better about your salary.
These changes were more or less cosmetic. I mean after all, does it really matter which pocket the money comes from? It turns out that it matters a great deal psychologically.
3. Finally, Do what Feels Right - regardless of anything I said, or of anything anyone else may say, make the decision that feels right for you. You will not hear this frequently from a personal finance blogger, but to hell with the money. Happiness and your family are the most important considerations. Make the decision that will make you happier in the long run.
Coincidentally, Trent, from The Simple Dollar is apparently considering this very issue right now. Check out this very interesting post about his greatest financial concerns.
Monday, October 22, 2007
If You Could Make an Extra $10K...
Let's say someone gave you an offer: you could work 10 extra hours a week and make and extra $10,000 a year. Would you do it? How about $15,000? Or $20,000? How much is your free time worth? Patrick of Cash, Money, Life and his wife had to answer just such a question.
I make a good living and I work pretty long hours. My remaining hours of free time are worth a lot to me. I would not give them up easily, but at a certain price, I probably would. Like every other resource, money has a declining utility curve: there is a certain minimum that is absolutely necessary, more is really nice, but beyond a certain amount money really becomes much less important.
For example, do you think that Warren Buffet, Bill Gates or Richard Branson would work an extra 10 hours a week for an extra million dollars in annual income? Well, maybe they would because they enjoy their work, but I am guessing that they wouldn't do it for the money.
I am not quite at the stage where I would be able to turn down a million dollars a year (or $50,000 for that matter), but if someone offered me a job that involved a mild increase in pay in exchange for a longer work week, I would probably say "no". That was not always the case. Earlier in my career, back when I was single and without kids, my career would have come first. My career is still very important to me, and I sacrifice a lot to keep it on track, however it is now far from being the most important thing in my life.
On the same topic, Moolanomy offers this story. I doubt if it's true, but it drives home the point.
I make a good living and I work pretty long hours. My remaining hours of free time are worth a lot to me. I would not give them up easily, but at a certain price, I probably would. Like every other resource, money has a declining utility curve: there is a certain minimum that is absolutely necessary, more is really nice, but beyond a certain amount money really becomes much less important.
For example, do you think that Warren Buffet, Bill Gates or Richard Branson would work an extra 10 hours a week for an extra million dollars in annual income? Well, maybe they would because they enjoy their work, but I am guessing that they wouldn't do it for the money.
I am not quite at the stage where I would be able to turn down a million dollars a year (or $50,000 for that matter), but if someone offered me a job that involved a mild increase in pay in exchange for a longer work week, I would probably say "no". That was not always the case. Earlier in my career, back when I was single and without kids, my career would have come first. My career is still very important to me, and I sacrifice a lot to keep it on track, however it is now far from being the most important thing in my life.
On the same topic, Moolanomy offers this story. I doubt if it's true, but it drives home the point.
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