Monday, April 16, 2007

One DIY Book

I feel good about the work Lori and I have done on the house, as well as the work we've contracted out. I also feel that doing the work ourselves is in some cases a better value proposition than buying an end-product by paying more for a house. I would never extend this logic to infrastructure problems - only interior.

When does it pay to hire experts? When is DIY the right approach? When it comes to retirement and financial planning, I am way in the DIY camp. So I thoroughly enjoyed canceling my Bank of America "Premier" status today.

Premier status? Well, it turns out that somehow through a series of mergers and acquisitions, I got lumped in with Bank of America's rich clients. It turns out I had a "relationship manager" (whom I have never spoken with until today to cancel the whole thing). Since I don't have gobs of money and don't need gobs of advice, I don't think I need my relationship to the bank to be managed. Every time I have compared BoA to other institutions, they've proven uncompetitive. A professional that can "advise" me to buy these products simply illustrates the enormous conflict of interest present in financial services: it's a zero sum game between you and your banker/broker/retirement planner/financial services company. They make all their money by taking some of your money.

Can you do better on your own? I think so. There is an enormous amount written about investing and retirement planning. If you only read one book on the subject (perhaps to see if you can stand it) I suggest "A Random Walk Down Wallstreet" by Burton G. Malkiel. Four things going for it:
  • It contains real investment information that you can use to set up your own portfolio and take action.
  • It covers the academic topics behind investing, with clear explanations. This gives you the background to refute the next salesman who says "ah, but you can beat the market with our new XYZ mutual fund."
  • The book has been updated recently, important both for market perspective and for covering new investment vehicles.
  • Most importantly, it's a good read and goes quickly. I think the biggest barrier of entry to DIY finance can be the subject matter.
(John Bogle has probably done more for individual investors than anyone else I can think of, and he's very smart...I have the utmost respect for him. But his books can be dry...if you were to pick up Common Sense on Mutual Funds as a first book on the subject, it could also be your last.)

The original purpose of this blog (now it serves as a photo album) was to document my DIY mistakes on the house. But I figure financial DIY mistakes should be fair game too!

Sunday, April 15, 2007

The Walls Are Not Purple!

Someone mentioned that our lower living room walls look purple. They are not! This is an artifact of the poorly-taken digital photo I posted, with no color retouching.

The real color is "milk chocolate" (Behr color 710B-5) and it does have a purple undertone, but it really looks mostly brown in real life...the flash just lit it up funny!

Bob Vila Would Not Invest

I suppose it was only a matter of time before I started ranting on the blog about financial matters. Last week I examined Vanguard's "lifecycle" funds, one of Lori's options for her 401k. I like these funds, but the comparable idea at Fidelity ("Freedom" funds) are just awful...the devil is in the details.

The idea of these "fund of funds" is rooted in Modern Portfolio Theory (MPT). Basically:
  • If markets are efficient, you only get paid to take risk.
  • Furthermore, you only get paid to take risk that you can't diversify away.
When you add these together, it becomes clear that the true controller of your portfolio's performance is what mix of asset classes you have, not what specific assets you have.

I am not saying that you can buy just any stock...we have to consider how diversification works. If a market is truly efficient, the expected return on any one stock should be the same as any other. (If it wasn't, smart people would buy the undervalued stock, driving its price up until the expected return matched.) If we think Coke is solid and American Home Mortgage is screwed, we should see a big difference in price that exactly equalizes their differing situations.

But that doesn't mean that investing in either one is the same. On average, they should return the same, but if you invest in only AHM there's a good chance that the company will go broke and you'll have nothing. The solution is of course to invest in both, or better yet, to invest in all stocks.

In other words, MPT says there is (to paraphrase Burton Malkiel) exactly one free lunch - diversification. We don't get paid extra to hold fewer stocks so we might as well hold a lot and cut down the fluctuations in our portfolio. (Thus what's going to matter is the ratio of stocks to bonds, not which stocks, because we should be holding them all.)

As a side note, when I told my friend Seth this, he said I was full of crap, because the highest return I could possibly get was in just one stock. This is true, sort of. The highest return I can get is in one stock, but not the highest expected value. The difference is between what will probably happen and what does happen. The problem with a concentrated portfolio (if you have one good stock idea, put all of your money into it) is that you have to know that that stock will do well. So if you're a "Mad Money" fan and believe that you can value stocks better than the market, it makes sense to concentrate. If you're an Efficient Market Theory nerd like me, you figure that your stock picks are probably average (or maybe worse than average) and therefore not worth concentrating in.


So MPT says we can trade off our risk and reward by changing what we invest in, and we should diversify whenever possible. The idea of the Lifecycle funds is pretty simple: you invest in the fund and the fund changes its ratio of assets over time to match a risk profile that's appropriate to your retirement date.

Consider the Vanguard 2040 retirement fund (VFORX). This is a retirement fund for people who still have on average 33 years in the workforce, so it's mostly invested in higher-risk, higher reward stock indices. Over time they'll start converting to bonds, lowering returns, but reducing the volatiliy of the fund. (That is, as you get closer to retirement, you'll expect to earn less, but the chances of your money being half-gone due to a market crash will go down.)

What I like about this fund is its low expenses. Mutual fund expenses are your money that the management company takes from you every year for the honor of fondling your money. How much you make is basically how much you theoretically would have made, minus what they pocketed. Costs are really tricky, because typically mutual funds do not charge you more if they make you more money. They simply charge you money all the time. Your interests and your fund's interests are not at all aligned.

I will comment more on expenses later, but there are two things to note about the Van Guard Lifecycle fund:
  • The effective fees are 0.21% and
  • It's invested entirely in index funds.

By comparison, I can only describe Fidelity's Freedom Fund 2040 (FFFFX) as a bit of a disaster.
  • The fund is made up of a who's-who list of large, expensive and poorly performing stock funds. I know this because (blushes) I was invested in these. The top holdings were available to me for my 401k at a previous employer. I'll have to rant separately about these funds.
  • There are so many stock funds that what we really have is "closet indexing". Basically, if you buy enough different stock funds, you've got so many stocks, and so littel of each one, that you basically get the average performance of the whole market. I don't believe that "Fidelity Growth and Income" is a better investment than the S&P 500 (hrm - it correlates with the market by 89% and yet earned 2% less on average every year) but even if you do think it's a good idea, it's only 10% of the Freedom Fund, so any unique value it has is being washed out by other funds.
  • The expense ratio of this fund is 0.76%. In other words, we're paying almost a percent for the honor of holding a little of each of these train-wrecks.
To be clear: I'm saying diversification is good, and it's better to have a lot of different stocks than a few. But it's better to buy, say, the Spartan Total Market Return (FSTMX) index fund, expense ratio 0.10% than to glom together a ton of underperforming equity funds, expense ratio 0.76%.

The other side of this equation is bond funds. Fidelity has very cheap index funds (the "Spartan" index funds). Now it may be that these funds are cheap because Fidelity subsidizes them. (This happened with their international fund...Fidelity actually lost money on it as way to keep the expenses down. International funds are expensive even when indexed due to high transaction costs, etc.) My logic is: I don't care why it's cheap, as long as it is cheap. In the case of Fidelity vs. Vanguard, I would say vigilance is needed to make sure that Fidelity doesn't slowly sneak expenses back up.

But when it comes to bond funds, it's a different situation. Most of Van Guard's bond funds are around 0.20% expenses, while Fidelity's cheapest ones (the "Spartan" bond funds) are 0.45% expenses. I think perhaps the buying public hasn't put 2+2 together and realized that cheap indexed bond funds represent the highest available bond returns to investors.

(Expenses matter even more for bond funds than for stock funds - the actual "risk premium" - that is, the increased returns of the bond fund over a risk-free investment is just tiny, so those expense points eat up a lot more of what you're paying for - improved returns by holding a riskier investment. In other words, it's one thing to steal a point from a 10% return, but a different prospect to steal a point from a 6% return.)

Of course, that's all moot, because like the stock section, Fidelity's life-cycle fund is not invested in index funds, but in actively managed bond funds, with expense ratios that vary from 0.45% up to 0.75%.


In summary, the devil is in the details - life-cycle-style investing represent a reasonable service to investors in principle - a way to buy portfolio asset-class management in a cost effective way, by pooling it with a huge group of people who will all retire at the same age. But the actual value of these offers depends greatly on the costs of the vehicle you use.

A little math to sum it up: assume a very crude model: add $1000 a year to your 401k for 30 years, blending from 68% stocks at the beginning to 10% stocks at the end. We'll use 10% for the stock return and 6% for bonds. (I realize these numbers are arbitrary, but if they were lower, they would only make the point more dramatic. I think there is no risk of the market returning better than 10% on average for the next 30 years.)

The total value of your 30,000 investment should be about $99,068. In a fund with 0.21% expenses, it is reduced to $95,338 - a real drag. But in a fund with 0.76% expenses it is reduced to $86,287. That's around 8% of your money! (If we model this with more depressing returns, the fees play a larger roll and eat 12% of returns.)

Thursday, April 12, 2007

The Floor is Done (well, almost)

The floor is in! We just need to put the T-transitions on the transitions to tile - the transition strips we have didn't fit due to the height of the tile. (Well, it's fake tile.)

Here are some pics:

Wednesday, April 11, 2007

Stairway to Heaven (or at least the upstairs closet)

Work on the floor continues. These two pictures illustrate an interesting problem with the stair nosings.

Our old subfloor had stair nosings built into the subfloor stair-wood. (This wood remains in place and the hardwood is nailed and glued to it to make the final stairs. When we bought the house rug was in place using tack strips.)

But the new wood requires a square corner (no nosing) so that the hardwood can be placed directly over it. The new nosing is "built into" the hard wood.

So our contractor cut off the nosings in the subfloor.

In this picture you can see the three stages. In the top step, the hole where the nosing fit into the molding has been filled in with extra wood. On the middle step, the riser is in place, covering part of this fill. On the bottom step, the nosing is in place too, completely obscuring the work.

Someone is not very happy about the noise.

Tuesday, April 10, 2007

Installing the Floor (Do not attempt this at home)

The floor is going in - and watching these guys work, there is no doubt in my mind that having it done professionally was the right call. I mean, we knew that anyway, but I have realize that the gap between what we could do and what needs to be done is not just really huge, but really really huge.

Here you can see the basic process: boards are roughly lined up, then hammered laterally into place with a mallet so the tongue-and-grooves lock. Once the placement is right, they use an angled pneumatic nail gun (it has an attachment that makes it fit the floor perfectly each time) to shoot nails in at an angle through the side to the floor they aren't visible.

The work is done in strips from the front wall. But when they reached the stairs, they attached the first stair-nose and then fit everything against it.

Here you can see a little bit of the stair nose. First they cut the wood and hold it in place to make the joint between the nose and the riser that sits behind it. The riser is then nail-gunned into place. The nose is then coated with glue on the bottom and pressed into place against the riser, and reinforced with more nails.

Our subfloor has noses - they have to cut off the noses of the subfloor so that there is a flat edge to build the riser-nose combination against.

Nala is not very happy about this process, which involves a lot of things moving around (always scary), several new people with work boots (not a plus), and a huge amount of noise. She has been hiding behind my desk in the office, about as far from the chaos as she can get.
Like momentum, clutter can be neither created nor destroyed - it is conserved in any frame of reference.

This has been demonstrated again in our house, where Lori and I just went through the firedrill of trying to clear the entire first floor and upstairs hall and master bedroom at once. They were, before last night, how shall we say, um, abundent with clutter.

No longer!

Of course, all that stuff had to go somewhere. The two guest bedrooms are now packed.

And the true problem is my poor office, which has reached a state I can only describe as "one of enriched entropy" and highly, er, thermodynamic.

If I go onto "the hacks of life" and blog that we get a net development win by keeping the X-Plane code extra clean, that picture isn't going to make me very convincing, is it? But wait - conservation of clutter -- clutter removed from the X-Plane code base has to go somewhere.

Monday, April 09, 2007

The Floor Is Here - Part I

The floor is finally happening! Our contractor dropped off the materials and did the rugs in the two guest bedrooms. Here they are with the padding:

and the finished results.

Unfortunately we got a little bit lazy during the delays in selecting materials and didn't finish the base-board trim. It'll be slower going now that the carpet is in.

Here's 570 lbs of hardwood in the living room - in order for them to install it, I have to move all that crap out!