This is just a quick note to remind you that the good folks at Lending Club are still offering a $25 signup bonus* just for opening a Lending Club account.

Here’s how it works…

1. Visit Lending Club using a link in this post
2. Open and activate a lender account
3. The $25 will be automatically deposited in your account shortly thereafter

That’s it. Note that there are some eligibility requirements for opening a Lending Club account (must be 18, certain states excluded, etc.), but those should quickly become apparent when you click through.

*Note: The signup page won’t say anything about the bonus, but they’ll be able to track and credit you using the special link in this post.

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As a followup to my earlier post about high deductible health plans, I’m curious if you guys have any recommendations when it comes to health savings account (HSA) custodians. My employer has picked one, but their terms aren’t great (too many fees) so I’m thinking of looking elsewhere.

As I noted previously, you’re free to use whoever you want as an HSA custodian. The only downside is that I won’t be able to have the contributions withheld from pre-tax dollars if I don’t use my employer’s preferred HSA custodian. Instead, I’ll have to wait until the end of the yeat to deduct our contributions.

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This is just a quick followup to yesterday’s post about Series I Savings Bonds. As I noted in that post, you are limited to purchasing $5k of these bonds in electronic and paper form each year for an annual total of $10k (per Social Security number).

Assuming that you max out, this means that you’ll be the proud new owner of bonds in two forms. Yuck. The good news is that you can convert your paper bonds into electronic form. The TreasuryDirect website explains how. In short:

1. Open a TreasuryDirect account (if you don’t have one)
2. Notify them using the “Contact Us” that you want to convert paper bonds
3. Wait for an e-mail saying your account has been prepared for conversions
4. Login to your TreasuryDirect account and click “My Converted Bonds”
5. Click “Manage Direct” and then select “How to Convert My Paper Bonds”

From there, just follow the instructions and you’ll be home free. I’m still not sure why they have separate limits for paper and electronic bonds, but it is what it is. At least you don’t have to hang onto the paper bonds if you don’t want to.

Note that I haven’t completed this process myself (yet), but I will be doing so soon, and will post more details when that happens. In the mean time, if you have any tips, please weigh in.

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Last week I noted that Series I Savings Bonds are now paying 3.36% (current as of 11/09). Given current CD rates, this makes them a rather attractive alternative to bank CDs. That being said, a lot of people aren’t familiar with them, and are thus unlikely to use them.

What is a Series I Savings Bond?

Series I Savings Bonds (also referred to as “I Bonds”) are a low-risk, inflation-indexed savings instrument issued by the Federal government. Unlike CDs, which have a fixed interest rate, I Bond rates are adjust semi-annually based on the prevailing inflation rate, in May and November.

The I Bond rates is actually made up of two components, a fixed rate that sticks with the bond over its lifetime and a variable rate that changes every six months based on the Consumer Price Index (CPI).

How to Purchase I Bonds

You can purchase I Bonds in one of two forms: electronic or paper. Electronic purchases are done via TreasuryDirect, whereas paper bonds can be purchased (with no fee) from most banks.

The primary limitation with I Bonds is that you can only purchase $5k worth of them (per format, so $10k total) per calendar year per social security number. The good news is that you can convert your paper bonds into electronic format following the purchase.

Electronic I Bonds can actually be purchased in any amount between $25-$5k, whereas paper bonds are issued in denominations of $50, $75, $100, $200, $500, $1000, and $5000.

Advantages of I Bonds

Aside from providing inflation protection, I Bonds offer some tax advantages, as well. For starters, the interest accrues within the bond itself, so you are not taxed on the proceeds until you choose to redeem the bond (more below).

A second tax advantage is that I Bonds are not subject to state income tax, such that the tax equivalent yield is actually higher than that of an equivalent, fully taxable investment.

Note: Jim also made the excellent point in the comments that interest on I Bonds (as well as EE Bonds) is tax-free if used for college tuition (with some restrictions; details).

Redeeming I Bonds

I Bonds have to be held for a minimum of one year before they can be redeemed, and they cannot be transferred through market sales. In other words, once you buy one, your money is locked in for 12 months. Period.

You can redeem your I Bonds between 1-5 years after purchase for a three month interest penalty. After five years, you can redeem your I Bonds without a penalty. If left untouched, your I Bonds will continue to earn interest for up to 30 years.

Are I Bonds right for you?

The answer to this question will depend on your circumstances, but I’m of the opinion that I Bonds can be a great alternative to CDs. The reason for this is that they provide inflation protection and they also offer a few tax advantages (noted above) as compared to CDs.

Look at it this way… If you buy one today and have to break it in a year, you’ll have earned a little better than 2.5% after paying the three month penalty (assuming rates remain the same). In the mean time, if inflation kicks up, so will your interest rate.

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As October came to a close, things were still going well with my Lending Club investments. The one loan that has gone bad has stayed bad, but everything else is being paid on time.

Even with that delinquency, however, my “High Risk” portfolio is back in the black, as I’ve earned more than enough in interest to cover the loan that I lost. Assuming things keep going as they are, that one bad loan will soon be a distant memory.

During October, a couple of borrowers paid off their loans early, so I’ve re-deployed that cash (along with some additional funds that I’ve added to my account). At the end of the month, I had 148 active loans with a net annualized return of 11.82%.

From here on out, I’m planning more of the same… I’ll be steadily adding money every month, and reinvesting the repayments as they come in. If you’ve been investing with Lending Club, I’d love for you to share your experiences in the comments section, below.

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This is just a quick note to say the new Series I U.S. Savings Bond interest rates have been released. I haven’t written much (anything?) about savings bonds in the past, but I’m planning on changing that in the near future.

In the mean time, I’ll just say this… The interest rate on Series I bonds is made up of a fixed rate component and an inflation component. Rates are updated twice a year, in May and November.

The latest update saw the fixed component increase from 0.10% to 0.3% and the inflation component went from 0% to 3.06%. In other words, they’re now offering a total return 3.36%, which compares favorably with prevailing CD rates.

For a bit of background, Series I bonds can be cashed in after a minimum of 1 year. If you break them between 1-5 years, there is a penalty of three months of interest. After five years, there is no penalty. More info here.

Source: TreasuryDirect and Bargaineering

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Are you in the market for a discount broker? If so, you might want to check out OptionsHouse. They’re currently offering 100 free trades for new customers.

Here’s the scoop:

New customers are eligible for this special offer after opening a new OptionsHouse account with a minimum of $3,000. You must apply for the commission-free trade offer by inputting promotion code FREE100 when opening the account. New accounts receive 100 commission-free trades for each stock or option trade executed within 60 days of funding the new account.

Pretty easy… New customers, $3000 minimum, use promo code FREE100. Once you use up your free trades, you can make stock trades for just $2.95/each and options trades for $9.95/each.

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Interest rates are very, very low right now. On top of that, the first “rung” on our CD ladder is coming up for renewal next week. We should be rolling that money into a new five year CD, but is that a good idea given current CD rates?

When we first started our CD ladder (Novemeber 2008), we bought a one, two, three, four, and five year CD. Rates topped at out 5.15% for the five year CD, and our overall average was 4.66%.

Fast forward to today… We’re now looking at 3.35% APY for a five year CD at the same bank — nearly 2% lower. On the surface, we should probably run away kicking an screaming, but when you dig deeper, the situation isn’t too bad.

If we roll that lowest rung into a new five year CD, the average rate will dip to a bit under 4.50%, which still isn’t too shabby. The big concern, of course, is that interest rates will spike and we’ll be locked in at a low rate. Then again, we can escape with “just” a six month interest rate penalty.

In other words, if we can hang on for a year or so, our effective interest rate would be roughly half the current rate (around 1.70%). If we make it for 18 months, we’d take home 2/3 (just under 2.25%), and so on.

When viewed in that context, the situation isn’t nearly so bleak. If rates jump, we can simply break the CD and re-deploy our cash. Sure, we’ll give up some interest earnings, but our money will still have performed on par with prevailing high yield savings rates, so we’re not risking much.

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Taxes are a huge consideration when planning for retirement. As you’re building up your nest egg, one of the big decisions that you’ll face is whether you should put your money in a traditional, tax-deferred account or a Roth-style account.

Of course, we don’t all face this dilemma. After all, access to Roth IRA accounts is limited by income (but see here and here), and access to a Roth 401(k) or Roth 403(b) is limited by whether or not your employer offers one. Many don’t, even if they offer tax-deferred versions of these accounts.

But what if you do have access to Roth accounts? How do you decide where to put your money? What follows is a quick overview of the major issues.

The tax deferred option

One of the biggest arguments in favor of using tax deferred accounts is that you’ll get your tax savings up front. These guaranteed savings can help those with limited means save/invest more money than they might have otherwise.

Taking an immediate tax break might also be a good option if you’re in a relatively high tax bracket. After all, if your income falls in retirement, you’ll have dodged higher taxes during your earning years in favor of lower taxes in retirement.

But what if tax rates increase dramatically between now and retirement? Even if you fall to a lower bracket, the applicable rate might wind up being higher. In that case, you’d have traded lower taxes during your earning years for higher taxes in retirement.

Another downside to tax-deferred accounts is that they effectively convert capital gains (currently tax at a favorable rate) into regular income. This is a very important fact to consider when deciding where to hold certain investment types.

The Roth option

Roth accounts make the promise of completely tax free withdrawals in the future in return for paying your taxes right now. This is a particularly good option if you expect to be paying higher taxes in retirement than you are right now.

Another risk that you’re running by using a Roth account is that Congress might change the rules. I currently view this as rather unlikely, but consider (for example) what would happen if we would adopt something like the Fair Tax between now and when you retire…

In such a case, you would have paid full income tax on your Roth contributions, and then you would be taxed again in retirement when you spend this money. Double taxation. Yuck.

What are we doing?

So how have we solved the problem? As with all things that involve uncertainty in the investing world, we’ve decided to diversify our risks. I honestly have no idea what will happen with tax rates going forward, and I can only project what our income might look like in retirement.

In view of these uncertainties, we’re taking advantage of both tax-deferred and Roth investment accounts. In doing this, it’ll be impossible for us to be 100% right, but we also won’t be 100% wrong. Given that we have both account flavors (not to mention a taxable investment account) at our disposal, we’ve given a lot of thought as to optimal asset locations.

In short, we keep our most tax inefficient investments in retirement accounts, with those with the highest expected rate of return in Roth accounts. Our taxable account, on the other hand, is loaded up with tax efficient investments.

What about you? If given the choice, how would you proceed?

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A common criticism of mutual funds is that many fund families have a relatively high minimum investment, often in the $1000-$3000 range. Thus, it can be difficult for someone who is just starting out to build a diversified mutual fund portfolio.

While it’s no secret that I’m a huge fan of The Vanguard Group, I thought I’d point that Schwab has reduced the minimum initial investment on their mutual funds to $100 each. Their expenses ratios are also very competitive. For example, the S&P 500 and Total Stock Market Funds weigh in at 0.09%

If you’re looking to get started investing, but the high minimum investments have been scaring you off, then you should definitely check out Schwab Funds. And no, they didn’t pay me to say this.

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The topic of safe withdrawal rates is critically important to retirees. Earlier this week we talked about retirement withdrawal strategies, but that was a discussion of how to access your money rather than how much money you can safely distribute per year.

What’s a “safe” withdrawal rate?

While there are no easy answers, the stakes couldn’t be higher. If you pick a number that’s too high, you’ll run out of money before you run out of time. If, on the other hand, you pick a number that’s too low, you’ll wind up leading an unnecessarily ascetic lifestyle, ultimately dying with a huge pile of cash.

If you ask around you’re get a variety of answers. By far the most common one that you’ll run across is the 4% rule. In short, this rule holds that you can “safely” withdraw an inflation-adjusted 4% of your nest egg from the year that you retire onward.

Of course, the topic of safe withdrawal rates is very complex, and the reality is that “it depends.” In other words, it depends on your time horizon, the composition of your investment portfolio, whether or not you retire into a collapsing stock market, and so on.

The only thing that we can say for certain is that higher returns will better support whatever withdrawal rate you settle on. But how can you boost your returns without appreciably increasing your risk? Well… What would you say if I told you that the average investor can easily increase their returns by 1% per year while taking on virtually no additional risk?

Maximizing returns by minimizing expenses

Sounds too good to be true, right? After all, 1% can make a huge difference in the size of your nest egg, but there is (typically) no such thing as a free lunch. Well, consider the following.

The average expense ratio for actively managed mutual funds is in the neighborhood of 1.5%. On top of that, numerous studies have revealed that the majority of actively managed funds underperform their target indices, sometimes by a lot. Why? Mostly because of the added expense of the fund manager.

In contrast, index mutual funds (or equivalent ETFs) have dirt cheap expense ratios (often in the 0.1-0.2% range), thereby allowing them to essentially match the returns of their target indices.

So how can you increase your returns without taking on more risk? Simple. Keep a close eye on expenses. Instead of overpaying for underperformance, focus on constructing a portfolio with using high quality, low cost investment vehicles. Of course, this is often easier said than done.

For example, you might have a fee-laden 401(k) with limited options. Sure, you could lobby your employer for changes, but they might resist. In that case, your best option might be to simply contribute enough to get your employer’s match and then focus on investing outside of your 401(k), where you’ll have complete control.

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Not quite a year ago, we started building a CD ladder. We’re building a five year ladder, and that first rung is nearly up for renewal. I’ve thus been looking around for the best CD rates.

In doing so, I ran across the ten day CD rate guarantee at Ally Bank. In short, if you open a CD with Ally and the rates go up within the first ten days, they’ll automatically increase your rate to the higher level.

When you fund your CD within ten days of opening or renewing your Ally account, you automatically get the best rate we offer during that time period.

This isn’t a huge deal, but it’s nice to know that you won’t have any regrets about locking in your rate a few days before they raise them. Since our CDs are already at Ally (formerly GMAC Bank), and since their rates are still near the top, we’ll be leaving the money in place and just changing the term.

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The latest issue of Time Magazine featured an article that was very critical of the 401(k) system. In it, they argued that “the 401(k) is a lousy idea, a financial flop, a rotten repository for our retirement reserves.”

Why all the hate?

So just what is it that Time hates about 401(k) plans? For starters, 401(k) plans were never intended to replace traditional pensions. Rather, they were created as an executive perk. Over time, however, their existence allowed many employers to kill off their pension plans.

401(k) plans have also come under fire because:

• Not enough people participate in their employer’s 401(k) plan
• Of those who do participate, many don’t contribute enough
• Many participants invest too conservatively
• Others invest too aggressively

The problem here is that these things aren’t unique to 401(k) plans. Rather, criticisms such as a lack of participation, saving too little, and inappropriate allocations can be leveled at most investment vehicles, including traditional and Roth IRAs, taxable investment accounts, etc.

Beyond this, people choose whether or not they will participate, they choose how much they will set aside, and they choose their investments. If some people wind up making bad decisions, should everyone be forced to give up their 401(k)? Not in my book.

Don’t get me wrong, there are certainly a number of bad 401(k) plans out there. Some of these have very limited investment choices, others have exorbitant fees, and so on. But advocating that we should “retire the 401(k)” is throwing the baby out with the bathwater.

What are the alternatives?

Yes, it sucks that juicy pension plans have largely disappeared, but that’s the reality. With traditional, employer-run pension plans out of the picture, what other options do we have? Well…

The article advocates for guaranteed investment accounts that would essentially function as “retirement insurance.” Every pay period, you’d contribute a fixed percentage of your paycheck and, upon retirement, you’d collect a guaranteed monthly check based on your final salary.

An advantage of such plans, whether they are backed by the government or a private entity, is that they would follow you from job-to-job. You would also be free to invest in addition to these plans, though (presumably) things like tax-deferred 401(k) plans would be off the table.

Setting aside the possible disadvantages of such plans, it’s important to keep in mind that there’s nothing stopping private companies from introducing these sorts of things whether or not the 401(k) still exists. In fact, there are great many annuity products already out there that fill a similar need.

In the end, I’m trying to figure out why killing off the 401(k) is a good idea. Yes, I realize that not everyone has access to them, and that some people can afford to contribute more than others. Given all the challenges associated with saving enough for retirement, however, it seems to me that taking options off the table would be a step backward.

What do you think?

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In honor of National Save for Retirement Week, I wanted to take a minute to point out some excellent books about investing. Truth be told, I thoroughly enjoy reading about money and finance, but I’m a bit of a freak when it comes to these things.

With that in mind, here are three great books that would make an excellent “short course” in investing for the future:

The Bogleheads’ Guide to Investing

Written by Taylor Larimore, Mel Lindauer, and Michael LeBoeuf, this is an excellent introduction to investing which is broken in two main parts. Chapters 1-16 comprise Part I (Essentials of Successful Investing), which covers topics such as:

» Leading a sound financial lifestyle
» The importance of starting early and investing regularly
» The ins and outs of stock, bonds, ETFs, mutual funds, etc.
» Protecting yourself against inflation
» Asset allocation (in simple terms)
» How to invest for college
» How to manage a windfall
» Whether or not you need a financial planner

Chapters 17-23 comprise Part II (Follow-Through Strategies to Keep You on Target), which covers topics such as:

» Tracking your progress and rebalancing
» Mastering your emotions and ignoring the “noise”
» Making you money last longer than you do
» Protecting your assets with insurance
» Estate planning

All in all, this is a very well-rounded book on investing.

The Four Pillars of Investing

Written by William Bernstein, this book turns things up a notch when it comes to educating you about investing. The content is broken into five sections, including:

» Pillar One: The Theory of Investing (Chapters 1-4)
» Pillar Two: The History of Investing (Chapters 5-6)
» Pillar Three: The Psychology of Investing (Chapters 7-8)
» Pillar Four: The Business of Investing (Chapters 9-11)
» Investment Strategy: Assembling the Four Pillars (Chapters 12-15)

For those that aren’t familiar with him, Bernstein is an excellent writer who manages to make otherwise dry topics quite interesting.

The Intelligent Asset Allocator

This is another book by William Bernstein. What can I say? I’m a fan. In truth, “Bogleheads” and “Four Pillars” will provide you with rather thorough coverage of investment-related topics, and might be plenty for the average investor. If you’ve read both of them and are looking for more, then…

“The Intelligent Asset Allocator” isn’t a light read, but Bernstein once again keeps things interesting. This book drills down into portfolio theory, tackling such issues as risk vs. return, asset class correlations, how to properly construct an investment portfolio, how to implement and maintain your plan, etc.

Other options

There are, of course, many other excellent books about finance and investing out there. For example, if you’re more interested in the psychological side of the equation, and getting your head straight when it comes to longer term goals, you might be interested in “Your Money or Your Life.”

Another books that looks promising is “The Bogleheads’ Guide to Retirement Planning.” I haven’t read it (yet), but the reviews are excellent, and it appears to delve into a number of retirement-specific topics.

Finally, I’d be remiss if I didn’t point out Bernstein’s latest book, “The Investor’s Manifesto.” While this books isn’t due out until November 2009, you can pre-order it through Amazon. You can also check out the first couple of chapters for free via Bernstein’s website.

What are your favorite books about finance/investing?

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We’ve talked in the past about the merits of index funds vs. ETFs. Today I wanted to highlight the views of one my favorite financial authors, William Bernstein.

In his book “The Intelligent Asset Allocator,” Bernstein said the following about ETFs in general, and SPDRs (i.e., ETFs that track the S&P 500) in particular:

“They have both advantages and disadvantages relative to a conventional index fund. On the plus side, they can be traded throughout the day, as opposed to a conventional fund, which is priced only at the end of the trading day. SPDRs do not generate appreciable capital gains and are thus slightly more tax-efficient than conventional S&P index funds. On the other hand, the purchase and sale of an ETF incurs both commissions and spreads, and so is slightly more expensive to own. Also, ETFs reinvest dividends only quarterly, and thus will suffer a slight performance drag relative to a conventional fund, which continuously reinvests its dividends. On the whole, unless you are an active trader, ETFs hold no real advantage over a conventional index fund.”

Well said. One thing that I would add is that, while ETFs are subject to brokerage commissions, they typically have lower expense ratios, and thus have marginally lower ongoing costs to own.

As for us, all of our stock and bond investments are in an index fund of some sort. We’ve considered ETFs, but we got started back before they were widely available, and have decided to stay the course.

According to Vanguard, you can convert index fund shares into ETFs without incurring taxes, even if you do this in a taxable account. We haven’t bothered to do this, in part because we now qualify for Admiral shares (which have a very low expense ratio) in several accounts, and would thus gain very little by switching to ETFs.

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It’s widely recognized that the transaction costs incurred by investors are made up of two primary components: brokerage fees (i.e., commissions), and the bid-ask spread. While most people are familiar with brokerage fees, fewer people are familiar with the concept of the bid-ask spread.

The bid-ask spread, sometimes referred to as the bid-offer spread, refers to the difference between the prevailing price at which you could sell a particular investment (the bid price) and the price at which you could buy it (the ask price). In other words, we’re talking about the highest price that a buyer is willing to pay for an asset, and the lowest price that a seller is willing to accept.

The difference between the bid price and the ask price is the referred to as the “spread,” and it goes to the so-called “market maker.” Market makers are firms that provide market liquidity and help to smooth out buyer/seller imbalances (and ultimately profit) by standing ready to buy assets at the bid price and to sell them at the ask price.

The reason that he bid-ask spread matters to people like you and me is that whenever you make a trade, you’re instantaneously “in the hole” by a small amount, even before we consider brokerage fees. It’s worth noting that the bid-ask spread is typically larger on thinly-traded (i.e., relatively illiquid) investments such as micro-cap stocks as compared to more widely traded (i.e., relatively liquid) investments.

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Earlier this week, ING Direct announced a new promotion aimed at generating more deposits. Dubbed the “Added Value” CD, they are offering a 12 month CD that pays a 0.15% premium over and above their standard rate. As of right now, that means you’ll get 2.25% APY vs. the standard 2.10% APY.

The catch here is that you have to fund the CD with “new money” that is transferred in from elsewhere. And before you try to get clever and circumvent the rules, keep in mind that they are defining “new money” as deposits over and above your balance as of October 7th, 2009.

In other words… You can’t qualify by simply transferring your money out and then back in. Nonetheless, if you’re looking for a safe place to park you cash for the next year or so, you could do a lot worse than 2.25% APY at a bank like ING Direct. In fact, this ranks amongst the highest 12 month CD rates that are currently available.

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» Linking ING Direct and Emigrant Direct

As September came to a close, I was enjoying an 11.98% net annualized return with Lending Club. Once again, I spent the month expanding my holdings beyond my original “High Risk” and “Low Risk” test portfolios. My overall rate of return has slipped a bit as the loans I’ve been investing in recently are, on average, higher quality than my original holdings.

At the end of the month, I had 133 notes outstanding, and all but one are performing as expected. That one exception is the same note that has been problematic from the start. In fact, that borrower has yet to make a single payment, and the loan has now been sent to collections. Thankfully that note is only worth $25, so it’s won’t hurt my overall portfolio too much.

Speaking of collections… Lending Club is hosting a “Credit and Collections” webinar tomorrow (Thursday) evening at 7PM Eastern. If you can’t listen in live, you should be able to access the archive at some point in the near future.

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Related Articles at fivecentnickel.com:

» Lending Club – July 2009 Performance
» Lending Club – August 2009 Performance
» Lending Club – June 2009 Performance
» Lending $100 Giveaway Reminder
» Lending Club Update – October 2009 Performance
» Lending Club Portfolio Fully Funded
» Win $2500 From Lending Club
» Our Lending Club Investments, One Week Later

As August came to a close, I was enjoying a 12.40% net annualized return with Lending Club. Throughout the month, I focused on expanding my holdings beyond my original “High Risk” and “Low Risk” test portfolios. In addition to those two portfolios, each of which has 20 loans, I’ve created an “Ongoing” portfolio with an additional 79 loans. That brings me up to 119 loans total.

In terms of loan performance, the one “High Risk” loan that had gone bad during July is still late. In fact, that borrower hasn’t made a single payment since the loan was issued, and Lending Club has now engaged the services of a collection agency. While I’d love to be proven wrong, I’m assuming that loan will end up being a total loss.

Oh, and guess what? It seems that FCN staff writer Matt Jabs is not a deadbeat. As you might recall, Matt listed a debt consolidation loan and I invested in it back in late July. Well… His first payment came in on time, just like he said it would. Keep it up Matt!

Actually, Matt’s not the only one who’s holding up his end of the bargain, as 118 of my 119 loans are being paid on time. While I’m anticipating the possibility of a few more hiccups down the line, I’m certainly pleased with how things are going thus far.

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Related Articles at fivecentnickel.com:

» Lending Club – July 2009 Performance
» Lending Club – June 2009 Performance
» Lending $100 Giveaway Reminder
» Lending Club Update – October 2009 Performance
» Lending Club Portfolio Fully Funded
» Lending Club – September 2009 Performance
» Our Lending Club Investments, One Week Later
» Free Money from Lending Club – $25 Signup Bonus

Readers often e-mail me for tips on how to keep their finances manageable. There are so many options out there that it can be overwhelming. I was speaking with my mom about this some time ago, and she felt the same way.

My mom has been responsible with her money, but she felt that she could be doing better. After chatting with her, we decided she should switch banks and automate some of her bills.

Talking with her the other week, she’s really happen with her decision. She has saved both time and money with her new bank and online bill pay. I completely agree with her. Automating your finances can be a wonderful thing if done correctly.

Why do I love to automate my finances? For one thing, I like being in control without having to spend hours tracking down bills, envelopes, and stamps. Here are some other reasons I enjoy financial automation:

I don’t pay late fees

I used to occasionally lost bills or forgot to send checks whenever I had a very busy week. Late fees can be $29 to $39 for credit cards. Even if I called my credit card company to make a last minute phone payment, I was charged a $15 convenience fee for this privilege.

How to fix it: Set up free online bill pay with your bank. Most banks and credit unions offer this money and time-saving feature. Spend an hour setting this up with your bills, account numbers, due dates, and amounts, and you’ll only need a few minutes a month to maintain your system.

I’m saving money and I barely notice

In the past, I would save money for a few weeks and then had an emergency. After getting through the trouble, I’d neglect to re-start my savings, and would go through this again and again. I felt that I was barely getting by, and that saving some money was cutting me to the bone even further.

How to fix it: Have a portion of your paycheck automatically transferred to a high yield savings account. The trick is to wait until after the transfer happens to check your balance — hide that money and you’ll never miss it.

Don’t be a hero. Start out with a small transfer. It’ll take a bit of time, but you’ll become use to the slightly smaller paycheck. You can then increase the amount gradually over time. Just be sure to do your research and select an FDIC-insured bank or a CUNA-insured credit union that offers high interest rates for savings, and also has a solid reputation for customer service.

Retirement savings is a cinch

I started saving for retirement early on, while still in college. Unfortunately, I got distracted and my savings became sporadic as I got into debt. Getting back on the wagon was tougher than I thought.

How to fix it: Call your company’s Human Resources department and sign up for your company’s 401(k) program. Check to see if the company is matching contributions, and set your automatic deduction to be large enough to get the company match. That’s basically free money in your pocket.

If you have the opportunity, also have a small portion of your paycheck automatically transferred into a traditional or Roth IRA. There are tax advantages to having an IRA, so looking into which one is best for you.

To improve the performance of you IRA contributions, try looking for low cost index mutual funds or index ETFs. Besides performing better than many actively managed mutual funds, index funds can also make investing a lot simpler.

How about you?

Do you automate your finances? If so, what are the main benefits for you? If you prefer manually working with your finances, do you have tips on making it easier?

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Target date mutual funds are designed to automatically adjust their allocation depending on how long you have until the “target date.” These funds thus invest rather aggressively early on, automatically moving to a more conservative allocation over time.

While these funds are a convenient “set and forget” solution for many investors, they’re not for everyone. I’ve previously outlined four disadvantages of target date mutual funds, so I won’t rehash them here. Instead, I’ll focus on costs.

According to a recent report from the Wall Street Journal, target date funds are cutting costs by eliminating managements fees and/or moving to a less expensive combination of underlying funds.

To be fair, companies such as Vanguard were already offering low cost target date funds. But others? Not so much. The pressure to reduce costs is coming in part from large, employer-run retirement plans, but everyone stands to benefit.

For their part, Fidelity is launching a series of “Fidelity Freedom Index Funds,” and Schwab has reduced their fees by 0.13%. The new Fidelity funds will be available in five-year increments with target dates ranging from 2000 to 2050. Presumably the 2000 and 2005 versions are for people who are already retired.

A number of others are dropping their “wrap” fees, which are really unnecessary given that most target date funds invest in funds from the same fund company. For what it’s worth, neither Vanguard nor Fidelity have been charging wrap fees on their funds.

Are you a target date fund fan?

As I noted above, I’m not crazy about them, but it’s for reasons other than cost.

Source: WSJ.com

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Last week I mentioned the possibility that 401(k) limits might be reduced in 2010. This week, I wanted to highlight some proposed retirement savings changes that President Obama outlined in his weekly radio address. Here they are:

• Auto-enrollment in retirement plans. The administration plans on clearing up some of the bureaucratic hurdles that make auto-enrollment a challenge for small and medium-sized employers.
• Tax refunds as savings bonds. To encourage savings amongst those who receive a tax refund, you’ll be able to elect to receive your refund in the form of savings bonds.
• Convert unused sick/vacation days to 401(k) contributions. The White House intends to make it easier to convert unused sick and vacation days into 401(k) contributions.

Note that these changes aren’t forcing anything on employers, they’re just clearing the roadblocks that might be discouraging employers from doing these things. Moreover, these are largely technical changes, and thus don’t require legislative approval.

As for the changes themselves… The first and third sound great. The second one, on the other hand, seems kind of pointless. While it won’t hurt anything, I can’t imagine very many people taking advantage of it.

Source: CNN/Money

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» Weekly Roundup – 09/15/06
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I’m now convinced that investing through Lending Club is (at least for me) more than just a passing fancy. As such, I decided that it was high time to start tracking things in Quicken.

I’ve actually been avoiding this task because I’ve already invested in over 100 loans, and the prospect of tracking so many independent investments is a bit daunting. But then it hit me… There’s no real reason that I have to track every loan separately.

The system that I’ve settled on is similar to my strategy for tracking CDs with Quicken. I update the data based on my monthly statements, and use just a single “meta-security” instead of tracking each loan individually.

Here’s a quick rundown of the initial setup*:

• Create a new “brokerage” account in Quicken
• Create a new security with a value of $1/share (I called mine “LC loans“)
• Transfer (XFR) your starting (cash) balance into the account

And here’s what I do at the end of each month:

• Transfer (XFR) funds in or out of your account to reflect any real-world transfers
• Buy shares of “LC Loans” in a dollar amount equal to the total of any new notes issued during the month (this reduces your cash balance)
• Sell shares of “LC Loans” in a dollar amount equal to any principal repayments for the month (this increases cash balance)
• Record you total interest payments for the month as dividends (DIV) on your “LC Loans” shares (this increases cash balance)
• Record your investment fees for the month as a miscellaneous (MISC) transaction (this reduces your cash balance)

While you’ll lose the ability to track individual loans, this system is very quick and easy to maintain, and still gives you accurate performance numbers on an account-wide basis. Another benefit is that this approach accounts for the performance drag created by your uninvested cash balance.

For all transactions, I use an effective date of the last day of the month. The order in which you record the individual transactions doesn’t really matter since everything will balance out on that same day.

What about you?

If you’re a Lending Club investor, how do you track your performance? Do you just rely on the Lending Club interface? Or do you do something more? Maybe Quicken or a spreadsheet?

*Note: These notes are based on Quicken 2007 on a Mac, so there might be some subtle differences if you’re using a different version. The overall approach, however, should remain the same.

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Related Articles at fivecentnickel.com:

» Lending Club Portfolio Fully Funded
» Free Money from Lending Club – $25 Signup Bonus
» Lending Club $25 Bonus Reminder
» Lending Club $25 Signup Bonus Reminder
» Prosper Resumes Peer-to-Peer Lending
» Lending $100 Giveaway Reminder
» Get a $25 Bonus from Lending Club
» Lending Club Update – October 2009 Performance

According to human resources consulting firm Mercer, the IRS might be forced to reduce 401(k) contribution limits in 2010. Next year’s limits, which are tied to inflation, will be announced in October.

Inflation has been negative since March so, unless it picks up between now and October, the IRS will have no choice but to reduce contribution limits. If this happens, the contribution limits would fall from $16,500 to $16,000 with catchup contributions falling from $5,500 to $5,000.

Robert Powell from MarketWatch has an interesting take on this. His view is that Uncle Sam would be sending the wrong message to investors by reducing the limits. At the same time, he argues that the change will have very little “real” impact because so few workers actually hit the limit in any given year.

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Related Articles at fivecentnickel.com:

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This is just a reminder that the good folks at Lending Club are offering FCN readers a $25 signup bonus* just for opening an account.

Here’s how it works…

1. Visit Lending Club using a link in this post
2. Open and activate a lender account
3. The $25 will be automatically deposited in your account shortly

That’s it. Note that there are some eligibility requirements for opening a Lending Club account (must be 18, certain states excluded, etc.), but those should quickly become apparent when you click through.

*Note: The signup page won’t say anything about the bonus, but they’ll be able to track and credit you using the special link in this post.

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Related Articles at fivecentnickel.com:

» Free Money from Lending Club – $25 Signup Bonus
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» Lending Club $25 Signup Bonus Reminder
» Lending $100 Giveaway Reminder
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» Prosper Resumes Peer-to-Peer Lending
» Lending Club – June 2009 Performance
» Lending Club – August 2009 Performance

Last night I listened in on an online discussion with Scott Langmack, a veteran Lending Club investor who has averaged 12.6% returns over the last couple of years. During the seminar, Langmack shared tips for “beating the average” with Lending Club. What follows is a rundown of Langmack’s four keys to maximizing returns.

1. Diversification is essential

Langmack argued that, in order to achieve maximal stability, you need to hold upwards of 400 notes in your portfolio. Assuming you invest the minimum of $25/note, that works out to $10k. That’s a pretty tall order for a lot of people, and it can be time consuming to assemble a portfolio of that size.

The good news is that he’s not saying that you shouldn’t invest with less. Rather, he’s saying that the fewer notes that you have, the less predictable your returns will be. At the 400 note level, the law of large numbers takes over, and your returns become much more predictable.

In other words, if there’s an expected default rate of (say) 5% for a certain credit grade, you can be fairly certain that you’ll get somewhere in the neighborhood of 20 defaults if you buy 400 notes. If you buy just 10 notes, however, it’s quite possible that you’ll get unlucky and wind up with 2-3 defaults.

While 2-3 defaults might not sound like a lot, that works out to a default rate of 20-30%, way above the 5% expectation. Then again, you might get lucky and have zero defaults, putting you ahead of the game.

2. Select for job stability

I have to admit that this is something that I haven’t paid a lot of attention to, but Langmack’s argument makes great sense. When selecting notes, don’t just look at how much money someone makes. Take a look at what the person does for a living, and how long they’ve been doing it.

If your prospective borrower is a relative newcomer in the retail sector, you might want to tread lightly. Given the current state of the economy, it’s not hard to imagine someone in that position losing their job. In contrast, government employees with a decade of experience are much less likely to experience a bout of unemployment.

3. Select the loan type

When loans are listed on Lending Club, the borrower has to tell you why they’re borrowing. The problem with this model is that you’re relying on the borrower’s honesty. I was thus surprised to learn that the reason for borrowing is actually predictive of default rates.

At the top of the heap are loans to cover vacations or weddings, or to refinance credit card debt to a lower rate. Such loans have an average default rate of 2%.

Next up are loans to cover a car or other major purchase, medical costs, home improvements, or moving expenses. Such loans have an average default rate of 3.5%.

Finally, we have loans for debt consolidation, educational expenses, house down payments, or for business ventures. Such loans have an average default rate of 5%.

Of course, there are some grey areas here… How do you distinguish between someone refinancing credit card debt vs. someone consolidating their debts? While the former is arguably a positive money move, the latter might be that last act of a desperate debtor. Unfortunately, distinguishing between the two can be a bit of a judgment call.

4. Select your rate and expected returns

The last step is to determine what sort of return you’re looking for, as well as how much risk you can stomach. At the low end, Langmack says you can get 7-8% returns with “very low volatility” and “very low risk” by investing in high grade loans. I think the true amount of risk remains to be seen, but the historical repayment rates seem to support his view.

Langmack is looking for higher than average returns — in the neighborhood of 12% — so he targets loans that are paying somewhere in the 12.5% to 20% range. In other words, he skips over Grade A and Grade B loans and heads straight for riskier notes. As noted above, by choosing his loans carefully and minimizing defaults, this strategy has resulted in a 12.6% annual return.

My personal experience

Since I used “Lending Match” to automatically select my original portfolios, I didn’t really look at pay any attention to individual loans. Now that one of the loans in my “High Risk” portfolio is overdue, however, I can look back with 20/20 hindsight.

For starters, here is the original (unedited) description of what the loan was for:

Repayment to family members. Sudden Death of Mom (repayment of expenses)

Debt Consolidation.

Reatin Legal help. (Laywer)

I’m not sure about you, but I wouldn’t have funded this loan if I had looked at it closely. The borrower actually looked quite good in terms of job stability — 14 years with a major airline, and an annual income of $75k, but…

My biggest concern with this loan request (aside from the poor grammar) is that this person appears to have problems on multiple fronts. Not only are they looking to consolidate debt (one of Langmack’s red flags), but they also need an attorney for some unspecified reason. Yikes.

The good news is that this is just one of the 78 (and counting) notes that I currently hold, so it’s not a big hit. Moreover, in the time since I made my initial investments, I’ve made a point of reviewing loan requests more carefully. Hopefully this will further reduce the risk of defaults and keep my Lending Club returns nice and high.

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Related Articles at fivecentnickel.com:

» Prosper Resumes Peer-to-Peer Lending
» Lending $100 Giveaway Reminder
» Lending Club Portfolio Fully Funded
» Free Money from Lending Club – $25 Signup Bonus
» Lending Club $25 Bonus Reminder
» Lending Club $25 Signup Bonus Reminder
» Our Lending Club Investments, One Week Later
» Get a $25 Bonus from Lending Club

Lifestyle inflation is a huge threat to your financial well-being. Unless you’re exceptionally well-disciplined, it’s very difficult to keep your spending from increasing in lockstep with your earnings.

The primary reason for this is that gradual increases in your income/spending are, more often than not, barely perceptible from one year to the next. If you step back and look at the big picture, however, you’ll see that you’ve been working for years and never really getting ahead.

What can we do about it?

One of my favorite tricks for beating lifestyle inflation is to create what I call an artificial sense of scarcity. By this, I mean that you should go out of your way to “hide” your money from yourself.

Start by moving your long-term savings out of your “everyday” bank. Out of sight, out of mind. If you don’t see the money sitting there every time check your accounts, you won’t be constantly reminded of its presence, and you won’t be tempted to spend it.

Beyond this, whenever you get a raise, make a point of increasing the percentage of your salary that goes into your retirement accounts. Also consider setting up (or increasing) an automatic transfer that draws off a portion of your income for long-term goals.

Note that I’m not saying that you should never enjoy the fruits of your labor. We all like nice things, and might reasonably want to elevate our lifestyle over time. I’m simply suggesting that such changes should be the result of a conscious decision.

Also note that this doesn’t have to be an either/or proposition… At my first “real” job, I started out stashing 5% of my salary in my retirement account. From that point forward, I increased my contribution percentage by half of each raise that I received.

For example, when I got a 4% raise at the of my first year, I contacted HR and increased my retirement contribution to 7%. Splitting my raises like this allowed us to enjoy a bit more take home pay while jacking up our savings. Best of all, it was totally painless — you won’t miss what you’ve never had.

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Time for another Lending Club performance update…

As of today, I’m enjoying a 12.50% net annualized return on my investments. In addition to my “High Risk” and “Low Risk” test portfolios, I’ve been investing additional funds in a “catchall” portfolio. This portfolio primarily contains a mix of Grade A and Grade B loans, though I have a few Grade C loans in there, as well.

While I made it through the month of June with all loans intact, July saw my first loan go late. It’s currently listed as being 31-120 days late, so there’s still hope. In fact, it appears that there’s a payment currently being processed, so it might flip back into the “Current” category before to long.

The loan in question is a Grade E loan from my “High Risk” portfolio. As I’ve noted in the past, loans in this range have a 15-20% likelihood of going bad based on historical data, so this isn’t terribly surprising.

On the bright side, 95% of the loans in my “High Risk” portfolio (19 of 20) are still paying on time, as are 100% of my other loans. As I’ve said before, only time will tell how things turn out. As of right now, however, I’m still quite happy with my Lending Club experience.

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Related Articles at fivecentnickel.com:

» Lending Club – August 2009 Performance
» Lending Club – June 2009 Performance
» Lending $100 Giveaway Reminder
» Lending Club Update – October 2009 Performance
» Lending Club Portfolio Fully Funded
» Lending Club – September 2009 Performance
» Our Lending Club Investments, One Week Later
» Free Money from Lending Club – $25 Signup Bonus

Have you looked at any stock market charts recently? The market has risen for four straight weeks, and things are looking up. In terms of raw numbers, the S&P is up nearly 50% from its March lows. Here’s the chart.

Given the above, the stock market is really on a tear. Right? Well… It’s depends on your perspective. Let’s step back and see how things look since the Fall of 2007.

Ouch. Even after the rally this spring/summer, the S&P 500 is still down roughly 35%. Let’s look back a bit further.

Hmmm… A rough ride, but the market is up 22% since the Fall of 2002. What happens if we look back even further?

Yikes. Another rough ride, but this time the news is considerably worse. Down 33% over the past nine years.

Okay, lets step way back to gain a bit of historical perspective…

Interestingly, if you look at that last chart, you’ll see a very steady progression until right around 1994. After that, you get two major spikes followed by painful periods of “regression to the mean.” Note that there was also a less pronounced blip in the runup to Black Monday in October 1987, which marked the largest one day percentage decline in stock market history. Even still, we’ve seen a better than 980% gain since 1970.

I haven’t actually played with the raw data, but just by eyeballing things, it looks like we’re still a bit short of where we would’ve been if that pre-1994 historical growth pattern had continued. I’m not going to make any arguments about whether or not the stock market is currently over- or under-valued, as I really don’t know, and you also can’t tell by looking at price alone.

To me, the most important lesson here is that you need to interpret investment news very, very carefully. Moreover, you need to keep your personal timeframe in mind when making investment decision. Over short time periods, things can get wild. As you ratchet back to much longer timeframes, however, things become more predictable.

Note: Yes, I picked and chose the start dates for these periods to make things look as good or bad as possible. That’s the point.

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Related Articles at fivecentnickel.com:

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Have you ever wished you could lock in a competitive, guaranteed rate on your savings while still retainign the flexibility to access your cash in a pinch? If so, then you might be interested in a so-called “No Penalty” certificate of deposit (CD).

What is a “No Penalty” CD?

“No Penalty” CDs are exactly what they sound like — CDs that have no penalty for early withdrawal. In the case of traditional CDs, you typically forfeit a portion of the interest that you’ve earned (often 3-6 months worth, but sometimes more) if you break your CD prior to maturity.

Given the above, “No Penalty” CDs can be a great option in a falling interest rate environment because you can lock in a decent rate but still have access to your cash. Alternatively, in a rising interest rate environment, they give you the freedom to switch to a higher rate.

What’s the downside?

As great as “No Penalty” CDs sound, there are some downsides and limitations. For starters, the rates on “No Penalty” CDs are somewhat lower than traditional CD rates. In some cases, they might be no higher than online savings account rates.

In terms of minimums, some banks require high minimum deposits for their “No Penalty” CDs, in some cases ranging as high as $5k-$25k. Fortunately, others don’t. Thus, it’s important to look closely at the terms when considering your options.

In addition, despite their “No Penalty” moniker, there might still be some limitations on how/when you can access your money. For example, while some banks allow you to pull your money back out within a week or less, others require up to 30-90 days.

Finally, “No Penalty” CDs are typically short-term CDs. In the vast majority of cases, we’re talking 9-12 months, or even less. This means that the rates won’t be all that high, as shorter-term CDs have lower rates.

Where can you get “No Penalty” CDs?

“No Penalty” CDs are offered by a variety of banking institutions. As noted above, rates and terms vary, so it pays to shop around. One bank with particularly good terms is Ally Bank, who offers “No Penalty” CDs with no minimum deposit requirement, a relatively narrow spread between their traditional and no-penalty CD rates, and you can access your money within six days of opening the CD.

Alternatives to “No Penalty” CDs

While “No Penalty” CDs can be a great deal for some, they’re not necessarily for everyone. For example, if you don’t have a lot of money, it might not be worth going to the trouble of opening CDs vs. simply using a high-yield online savings account, especially given the relatively flat interest rate landscape right now.

In our case, we’ve opted to stick with the tried-and-true CD ladder approach. We’ve built a five year CD ladder with one CD corresponding to 20% of our holdings maturing each year. This gives us a bit of flexibility while smoothing out the inevitable ups and down of interest rates. Our longer time horizon has also allowed us to lock in higher rates than would otherwise be available.

If you’re a bit more risk tolerant, another possibility would be to invest with Lending Club, which offers three year notes paying an average of 9.5% annually (my review). Because Lending Club has a note-trading platform, you can actually sell your notes to other investors mid-stream, providing a bit of liquidity.

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Related Articles at fivecentnickel.com:

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» Help a Reader: CDs at a Defunct Bank
» How to Build a CD Ladder

This is a guest post from Dawn of Frugal for Life. If you like what you see here, please consider subscribing to her RSS feed.

I’ve twice been given the opportunity to rollover my 401(k) instead of cashing it out, and I’ve twice failed to do so. In both cases, I mistakenly placed today’s concerns ahead of those of tomorrow.

Cashing out my 401(k)

The first time I cashed out my 401(k), I had accumulated a little over $5,000 before taxes and penalties. If I recall correctly, I used that money to pay off debt and buy a new washer and dryer.

Unfortunately, I didn’t hold back enough to cover my state and federal taxes, so I had trouble paying my taxes when they came due and had to set up a payment plan. This left a sour taste in my mouth, and I vowed never to make that mistake again.

The second time I cashed out my 401(k), I had accumulated a little over $2000, and once again felt that debt reduction was more important than the long-term goal of retirement. This time around I tried to hold back more for taxes, but once again fell short. Once again, I had to set up payments to the IRS to pay what I owed.

Starting fresh

With a new job and a fresh outlook, my 401(k) has once again started to grow. Moreover, I no longer review my retirement money as an expensive savings account. I’ve learned from my past mistakes, and now consider my 401(k) to be untouchable, off-limits until I retire.

Looking back, I estimate that I’d have over $10k in an IRA if I had just rolled my 401(k) money instead of withdrawing it. Instead, I have a washer and dryer that are not aging well and a few debts that were paid off, but have since grown back.

When the time comes for me to move from this company to another, I will not hesitate to roll my 401(k) into an IRA. When I do this, it will happen electronically so I don’t ever see a check. Unfortunately, I’m just now learning this at 36 years of age, but starting over now is better than never starting at all.

Lessons learned

My experiences have taught me the following:

• Retirement savings, no matter how meager, do add up
• Never pass up matching contributions from your employer
• Always check the fees associated with your investments
• Be an active participant, and move your money if necessary

I also try to imagine myself at 67 as I’m putting the money away.

Hopefully you’ll learn from these mistakes instead of making them yourself.

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» Weekly Roundup – 02/17/06
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Over the weekend, our very own Matt Jabs (FCN contributor and finance blogger extraordinaire) dropped me a line to say that he and his wife have applied a loan through Lending Club.

Why Lending Club?

As you’re likely aware, Matt is working hard to get out of debt, and has also become somewhat dis-illusioned with big banks. Following the recommendation of a friend, Matt decided to use Lending Club’s social lending platform to consolidate and effectively refinance a portion of his high interest debt.

As soon as Matt told me about this, I jumped on Lending Club, found his loan, and invested $25 $500. While some might shy away from lending money to family or friends, I’d rather invest in Matt than in a complete stranger.

Help a brother out

If you’re looking to get your feet wet with social lending, here’s your chance.

1. Open an account with Lending Club
2. Click the “Browse Notes” link under the “Invest” tab
3. Search for “betsyjabs” using the search box in the right sidebar

Assuming that it hasn’t already been funded by the time you do this, you should see an $11k loan request under the username “betsyjabs” (Matt’s wife). They’re Grade A borrowers, and the loan pays 9.32% (see below).

Just be sure to act fast! Matt listed the loan Saturday, and it’s over 60% funded.

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Related Articles at fivecentnickel.com:

» Lending Club – August 2009 Performance
» Lending $100 Giveaway Reminder
» Lending Club Portfolio Fully Funded
» Free Money from Lending Club – $25 Signup Bonus
» Our Lending Club Investments, One Week Later
» Prosper Resumes Peer-to-Peer Lending
» Lending Club $25 Bonus Reminder
» Lending Club $25 Signup Bonus Reminder

Just over a week ago, Prosper got permission from the SEC to re-launch their lending platform. For those that don’t follow this sort of thing, Prosper is a peer-to-peer lending company similar to Lending Club, and they’ve been in an SEC mandated “quiet period” since October 2008 while they registered with the SEC.

Similar to Lending Club, Prosper now has a secondary market for lenders who wish to sell their loans to other investors. This is a big step forward for them, as it significantly increases the liquidity of investments.

One interesting aspect of the Prosper business model is that the rates on loans are determined via investor bidding using an auction-platform. While I haven’t done it myself (yet!) this sounds a bit more involved than the situation at Lending Club, where rates are set based on the risk profile of the borrower.

Perhaps the biggest (apparent) negative is that the average return of their lenders is just 7.06%, which pales in comparison to the average rate of 9.61% being earned by Lending Club investors. While it’s possible that the higher returns at Lending Club are made possible by investors taking on greater risk, it’s worth noting that they actually require a higher minimum credit score for borrowers as compared to Prosper.

Ultimately, the proof is in the pudding, and I have yet to try out Prosper firsthand. That being said, my initial impression is that Lending Club is a better bet, at least for me. I’ll update as soon as I know more.

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Last week I highlighted an article about the long-term performance of stocks vs. bonds. The upshot was that, while stocks hold a slight long-term edge, bonds can (and do) outperform stock over significant time periods. Today we’re turning our attention to certificates of deposit (CDs).

CDs vs. Stocks

Did you know that CD outperformed stocks* from 1994-2008? It’s true. Check out the graph below:

In fact, if you had invested $10k each year on January 1st, you would’ve had accumulated $207,509 worth of CDs and $178,253 worth of stocks.

Once again, these sorts of conclusion are highly dependent on the time frame under consideration. After all, the second half of 2008 included of the worst bear market declines in recent history. Moreover, CD rates were considerably higher during the late 1990s and early 2000s than they are right now.

Regardless, as with the stocks vs. bonds analysis, this study makes an important point… Yes, the long-term performance of stocks is typically better than that of other investment types. However, it’s very possible for stocks to underperform over shorter time periods, even when compared to the much more conservative investments.

*Note: Based on six month CD rates vs. S&P 500 performance including dividend reinvestment.

Source: The Big Picture via Bargaineering

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While paging through the latest issues of Forbes and Money, I noticed something amusing… Both magazines were chock full of advice on how to navigate the current economy with your finances intact. No surprise there. What surprised me was that the two publications were offering completely opposite advice.

Invest in bonds!

For their part, Forbes advised readers to “Dump Stock, Buy Bonds,” arguing that history indicates that we should shun stocks in favor of corporate bonds.

Of course, this isn’t the first time we’ve heard this argument… In fact, I wrote earlier this week about the performance of stock vs. bonds when I highlighted Richard Arnott’s work showing that stocks can underperform bonds for significant periods of time.

Invest in stocks!

In contrast, Money sliced and diced the numbers differently and came to an entirely different conclusion. In fact, in an article entitled “Why Buy Stocks if Bonds are on Top?” author Paul Lim argued that:

“In all 880 rolling 10-year spans since the end of 1925… bonds [only beat stocks] 17% of the time.”

Moreover, lengthy periods during which bonds have outperformed stocks (such as we’re currently experiencing) have proved to be “great buying opportunities for … patient and value-minded [investors].”

The way forward

So which is it? Should you be focusing on your investments on stocks or bonds?

My advice is to ignore the noise. Develop an investment strategy, including a well-defined asset allocation plan, and then stick to it.

Remember… Magazines exist for one reason: to sell copies. Don’t look to them for detailed investing advice.

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Using the rate comparison tool above will allow you to compare many more accounts side by side, but I’ll also occasionally update the list below. Since interest rates at historical lows, I’ve focused my efforts here on shorter-term CDs — no sense in locking up your principal for too long when rates have nowhere to go but up!

What follows is a list of the best CD rates at ten well-known, nationally-available banks. Rates are for 12 months CDs unless otherwise indicated. I’ve sorted the list based on APY, and have also indicated the minimum deposit to open a CD.

Best CD Rates (12 Month Term)

(All CD rates current as of 10/30/09)

*Rate applies to sixteen month CDs.

For the sake of comparison, check out my list of the best online savings account interest rates. Right now, there’s not a whole lot of difference. However, the CD rates listed here can be locked in such that they won’t drop over the next year. With savings accounts, things may well get worse before they get better.

Finally, if you’re looking for a higher yield and don’t mind taking on some additional risk, you might want to check out Lending Club. It’s not FDIC-insured, but annual returns have been averaging 9.61% — far better than the best CD rates on the market. It’s free to open an account, and you can get started with as little as $25.

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» Investment Performance: CDs vs. Stocks
» ING Direct “Added Value” CDs
» Ally Bank Ten Day CD Rate Guarantee
» Help a Reader: CDs at a Defunct Bank

I just ran across an interesting article from back in March over at Barron’s. In it, they state that:

One of the bedrocks of modern investing has been the surety that stocks outperform bonds over long periods. Stocks’ risk premium, or excess return over bonds, has become gospel for financial advisers, brokers and pension consultants, among others.

They then go on to point out the results of a recent research paper that showed stock performance can trail that of bonds for significant periods of time. According to Richard Arnott, author of the study:

“We’ve had 30 to 40 years of building this cult of equities, where if your time horizon is long enough, it doesn’t matter what you pay for stocks. That’s dangerous.”

Arnott’s research revealed that, from 1802 to 2008, stocks outpaced bonds by 2.5% per year. However, bonds beat stocks for lengthy periods during that time.

Most recently, in the 41-year span from 1968-2009, bonds edged out stocks by a small margin (as measured by the S&P 500). Bonds also trumped stocks from 1803 to 1871 and from 1929 to 1949. From 1932 to 2000, however, stocks beat bonds handily.

As with most data sets of this sort, the results are highly dependent on how you slice things up. Overall, however, Arnott argues that stocks “have long periods of disappointment, interrupted by some wonderful gains.”

I think that the take home message here is that you shouldn’t have blind faith in the power of the stock market. Likewise, you shouldn’t be afraid to throw some alternate investments types into the mix. Not only do they help with diversification, they very well might outperform over significant time periods.

Source: Barron’s

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As of this week, I’ve collected $28.69 in Lending Club loan repayments, which corresponds to $20.09 in principal and $8.95 in interest. Since I now have over $25 sitting in my account, it’s time to reinvest in another note.

Regular reinvestment is an important part of maximizing your Lending Club returns, as your cash balance doesn’t actually earn any interest. What I didn’t realize until today, however, is that they make it extremely easy to reinvest as soon as you have enough cash on hand.

As you can see from the screen below, there is a “Reinvest” link in the box along the right side of the main screen (see below).

After clicking that link, you’ll be taken to a screen that lets you specify parameters for automatic reinvestment. Simply tell them the minimum cash balance that you want to accrue prior to reinvestment, your target interest rate, and how often you want them to contact you.

Once you have everything set up, Lending Club will automatically pick out a basket of loans that matches your parameters and send you an e-mail telling alerting you that you have a pending reinvestment. All you have to do is click a link to approve it and they’ll fill your order. Very easy.

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“It is an unfortunate human failing that a full pocketbook often groans more loudly than an empty stomach.”

-Franklin Delano Roosevelt

One of the greatest threats to an increase in income is simply the passing of time. Without proper awareness and discipline, slow and steady salary increases can go virtually unnoticed, and most definitely underutilized.

An example

Barry and Bonnie Bernstein are your typical middle-class couple. Both attended college and earned bachelor’s degrees in their respective fields of study. After college, Barry successfully landed a good job and has been slowly but surely working his way up the corporate ladder. Bonnie also landed a decent job straight out of school, and has taken on more and more responsibility, and thus has enjoyed a steadily increasing income.

The Bernstein’s are not financial experts by any stretch of the imagination, but over the years they managed to buy a nice home and save enough to go on nice vacations, purchase decent automobiles, and enjoy a stable financial existence. However, as time went by and their salaries steadily increased, those extra wages never seemed to make a noticeable impact on their savings.

Their extra money that came from regular salary increases was always absorbed by the “this and that” of life – car repairs, shopping trips, nights on the town, etc. In fact, over the course of 10 years, the Bernstein’s combined salaries increased by nearly $40,000 but they had little to show for it.

What Gives?

“If you would be wealthy, think of saving as well as getting.”

Benjamin Franklin

No change goes more unnoticed than slow, steady change. The Bernstein’s story is all to familiar. Add the American culture of spend before you earn to a lack of deliberate financial discipline, and you have a delicious recipe for false prosperity. This philosophy is sweet in the mouth, but bitter in the belly. Human nature dictates that, unless we make diligence and discipline a part of our daily financial decisions, our excess will be piddled away almost without trying.

So what’s the answer?

“My problem lies in reconciling my gross habits with my net income.”

-Errol Flynn

In short, awareness and discipline are your best friends when it comes to proper money management. Below are some specific steps you can take that, if consistently utilized, will go a long way toward solving your problems.

Beware of lifestyle inflation

As always, the first step is admitting that we have a problem. As I stated above, unless you are deliberate with your money, you will most likely succumb to the pressures of culture and advertising. Carry this knowledge with you throughout each day, and consider it whenever you’re faced with a financial decision. Remember… We’re creatures of desire and, left unchecked, those desires typically get the best of us.

My wife and I fell victim to lifestyle inflation for the first four years of our marriage. It wasn’t until six months ago that we recognized the problem and worked to implement a plan to curb it.

Maintain a long-term perspective

It’s impossible to overstate the importance of setting personal financial goals. Consider trying to run a race with no idea how far away the finish line is. You can’t devise (or adjust) the proper approach without a full understanding of what your end result is.

No matter your age, income, or debt level, make sure you consider where you would like to be down the financial road. Do you want to retire early? Set your goals accordingly. Do you want to gain financial independence so you can pursue your passions without worrying about money? Set your goals accordingly.

The latter is my long-term financial goal.

Set a target savings % — not an amount, but a percentage

Instead of (or in addition to) setting a goal to save a certain amount of money over a specific time frame, you should set savings goals based on a percentage of your income. If you easily reach your target, increase it. The power of the percentage is that your savings automatically increase along with your income.

The first savings percentage goal I had was to save 5% of my income. I have successfully reached that and have since reached farther. Now my wife and I are striving to reach a 10% savings mark. Once we reach that point, we’ll increase it further. We’ll repeat this cycle until we’re saving as much of our income as possible.

Automate your savings

“Pay yourself first.” “Set it & forget it.” “You won’t miss it.”

There’s a good reason that you’ve heard these tips many times over… They work! An automated savings plan is an incredibly powerful way to help you reach your goals. Trust me, once you set up the automatic transactions, you’ll never regret it. You also won’t believe how fast your money accumulates. Combine this with the targeted percentage approach (above) and you’ll be well on your way.

My wife and I use the “Automatic Savings Plan” feature offered by ING Direct to automate our savings plan. If you’re not already a customer of ING Direct, I highly recommend them.

Work to reduce expenses as your income increases

Lastly, don’t forget to practice frugality. Frugal living will help you to reduce expenses, and reducing expenses is arguably better than getting a raise. Once you either get a raise, or successfully eliminate an expense, make sure you follow through on your financial goals by adjusting your savings goals accordingly.

I make sure I go over my income and expenses each time I review my budget. This ensures proper allocation of newly freed up monies and provides the follow through you need to successfully reach your goals!

Just do it

Don’t be like the Bernsteins! Practice these deliberate, goal-oriented financial tips to curb your lifestyle inflation and set yourself up for long-term success.

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This is just a quick note to let everyone know that I made it through the month of June with all of my Lending Club loans intact. This isn’t particularly surprising, as most notes are paid on time when they’re new, regardless of quality.

Taken together, my high and low risk portfolios are providing a net annualized return of 12.68%. While I don’t expect things to remain this rosy forever, I’m certainly pleased with how things are going thus far.

As I noted in my last update, I’ll likely focus on higher quality notes going forward, which will reduce my average interest rate. This should, however, also decrease the likelihood of defaults, thereby bolstering my longer term prospects.

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Related Articles at fivecentnickel.com:

» Lending Club – July 2009 Performance
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» Lending Club – August 2009 Performance
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This is a guest post by Neal Frankle, a CFP and author of Wealth Pilgrim. If you like what you see here, please consider subscribing to his RSS feed.

Imagine that you just heard Jim Cramer talking on CNBC about a “guaranteed” way to make a fortune with your investments. Upon hearing this, you have three choices:

• Refinance your house so you can invest everything possible
• Call your financial adviser and ask her what she thinks about it
• Change the station to Spongebob Squarepants

What would you do?

If you said you’d change the station, you made the right decision. Nobody can guarantee how an investment is going to work out — not even Jim.

If somebody tries to sell you a far-fetched story, you might as well get some animation along with it… You’re better off with Spongebob.

While I can’t give you a guaranteed way to make a fortune, but I can guarantee that you’ll ruin your investment portfolio if you make any one of the following four financial mistakes.

Shifting your timeframe

Anytime you want, you can “prove” that an investment is either great or terrible. All you have to do is shift the period over which you do your analysis.

For example, if I ask you if stocks are a good investment, you might say, “Are you nuts? Do you live under a rock? No, they are a terrible investment. I lost 40% of my money last year!” You might even tell me that you lost a compounded 2% over the last ten years – further evidence of how bad the stock market is.

On the other hand, you might point to the fact that the last ten-year period was one of the worst ever. Instead of looking at the last ten years, you might consider the average ten-year return, which is close to 10%. Or you might point to a twenty-year average and “prove” that the stock market is pretty darn good.

So which is it? Good or bad?

All of the facts are right. The issue is which set of facts you decide are relevant to your timeframe, and whether or not you stick to that timeframe.

My point here is that, if you make an investment based on a twenty-year timeframe and then decide that you made a mistake because last year was very bad, you’re almost guaranteed to fail.

Why? Because market investments are extremely volatile, and good results can take time. If you jump out as a result of a terrible period, you won’t be in during the recovery. Congratulations — you’ve just locked in your losses.

Have you ever bailed on an investment because the pain was just too great? Investors often say they understand that investing is a long-term proposition — until they find themselves being tortured by horrific losses day after day. At some point, human nature takes over, and they bail because they’ve changed their time horizon.

Trying to predict the future

You may have run across people who think they can do this. Perhaps you’ll see some genius on TV make a prediction that later comes true. Just remember that this fortune teller won’t tell you about all the times he/she got it wrong in the past. After all, even a broken clock is right twice a day.

You might think that you never try to predict the future, but let’s take a closer look…

Have you ever jumped on a hot stock because you knew it was poised to break out? Or scooped up a “bargain” because you just knew it would never fall back to this level? If so, you’re guilt of trying to predict the future. Think of the times that you’ve done this. What were the results?

Wanting to have your cake and eat it, too

Have you ever complained about about the low interest rate on your savings account or CDs? The reason for the relatively low rate on these instruments is the inherent trade-off between interest rates and security.

If you want short-term security, you have to accept low (but guaranteed) interest rates. That’s just the way it is.

If you’ve ever complained about lousy stock market performance, you’re guilty of the same thing… The higher the expected returns, the greater the risks. This translates into the potential for wild price swings and extended down periods.

If your only problem is that you like complain about such things, you might ruin some relationships, but your investments should be safe. The problem is that many people expect great returns and security. These are the same people that fall for some slick sales pitch and get their heads handed to them. Remember Bernie Madoff?

Being unclear about your goals

By far the best way to run your investments into the ground is to be fuzzy about your goals.

“Hold on Neal,” you might be saying to yourself. “My only goal is to make money — that’s why I’m reading this post. You’ve been watching too much Sponge Bob!”

I’ll admit that I do have a weakness for that cute little yella’ fella’, but I’m dead serious about the importance of being clear about your goals. Let me give you an example…

You might say that your goals are to retire and never have to worry about money. Fine. Let’s say you could invest conservatively and have a high-probability of achieving your goals. That being the case, how would you invest?
Conservatively of course.

But there will be times when you might be tempted to take advantage of a “special” investment opportunity — a “sure thing” that turns out to be a high-risk proposition that threatens your goals.

You’d be far better off letting your goals be the lens through which every investment is examined. People often forget about this and as a result get involved with investments that expose them to undue risk and (often) investment failure.

Have you ever committed any of these mistakes? What were the results? Have I missed some other major source of investment catastrophe?

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This is just a quick update to say that I’ve received the initial payment on four of the forty Lending Club loans in which I’ve invested. Because these loans funded over a period of weeks, the repayment dates are somewhat staggered, and have just started coming due.

Thus far, everything has been paid on time, though it seems to take a few days beyond the due date for the payments to post to my account. While this is a very promising start, it’ll be awhile before I have a good sense for how things are going.

I’ve included a screenshot below of my current account status. This is actually summary that averages across my two portfolios. As a reminder, I have two $500 portfolios. One is a “low risk” portfolio that pays an average of 9.85%, and the other is a “high risk” portfolio that pays an average of 15.05%.

Of the $3.39 that I’ve received thus far, $2.25 has been principal and 1.14 has been interest. Thus, the total value of my outstanding loans now stands at $997.75. Assuming that things goes as planned, I should receive a little over $33 per month in total payments.

My current plan is to reinvest payments into additional Lending Club loans on an ongoing basis. After crunching the numbers on Lending Club’s historical repayment rates as a function of loan quality, however, I’ll most likely focus shift my focus to higher quality loans going forward.

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Related Articles at fivecentnickel.com:

» Lending Club – August 2009 Performance
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» Lending Club: Invest in Your Friends
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Not quite a year ago, I highlighted SmartMoney’s rating of the best online brokers. Today, I thought I’d take a closer look at the results of their 2009 survey.

As you skim through the list (reproduced below), you’ll notice that it’s quite similar to last year’s version. There are, however, some differences. Here’s a quick rundown of their most notable findings:

• E*Trade retained the top spot, excelling in all categories across the board.
• TradeKing slipped one spot for third to fourth, though they still shines in terms of trading tools and customer service, and their commissions are still significantly far lower than their nearest competition.
• Zecco is still hanging on near the bottom of the list. They have barebones offerings, but also offer free trades if you meet their balance requirements.
• ShareBuilder climbed a few spots from the bottom of the list, primarily because they added 300 new mutual funds to their offerings.

The best brokers of 2009

Here’s a full rundown of SmartMoney’s list:

1. E*Trade
2. Fidelity
3. Charles Schwab
4. TradeKing
5. TD Ameritrade
6. Muriel Siebert
7. Scottrade
8. Firstrade
9. OptionsXpress
10. Banc of America
11. Just2Trade
12. WellsTrade
13. ShareBuilder
14. Wall Street*E
15. Zecco Trading
16. SogoTrade

Interestingly, none of Consumer Reports’ best broker picks made it onto SmartMoney’s list.

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Did you know that you can convert directly from mutual funds to exchange traded funds (ETFs) without incurring taxes? I didn’t. I’ve been operating under the impression that selling the mutual fund shares would be a taxable event.

What I didn’t realize is that, at least with Vanguard equity funds, the conversion of conventional shares of an index fund into the corresponding ETF is a tax-free event. Here’s the scoop, direct from Vanguard:

Can I convert conventional Vanguard mutual fund shares to Vanguard ETFs?

Shareholders of Vanguard stock index funds that offer Vanguard ETFs may convert their conventional shares to Vanguard ETFs of the same fund. This conversion is generally tax-free, although some brokerage firms may be unable to convert fractional shares, which could result in a modest taxable gain. (Bond ETFs do not allow the conversion of bond index fund shares to bond ETF shares of the same fund.)

Vanguard will charge $50 for each conversion. (This fee is waived for Flagship clients.) Your brokerage provider may charge an additional fee for this service. For more information, contact your brokerage firm, or call 866-499-8473.

Once you convert to Vanguard ETFs, you cannot convert back to conventional shares. Also, conventional shares held through a 401(k) account cannot be converted to Vanguard ETFs.

Source: The Vanguard Group

This appears to be similar to the conversion of regular fund shares into “Admiral Shares” once your portfolio grows large enough. This is an attractive option for two reasons:

1. ETFs generally have lower expense ratios than index funds, and
2. ETFs aren’t subject to the year-end distribution of taxable gains

The fact that you can’t make the conversion within a 401(k) isn’t a huge deal, as year-end distributions within a tax-sheltered account aren’t taxable.

As for the $50 fee, I suspect that’s in place to encourage people to wait and convert larger chunks rather than buying index fund shares and then immediately converting to the corresponding ETF following each transaction. Do so would allow you to dodge brokerage commissions, but would also create an unnecessary burden on Vanguard.

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Related Articles at fivecentnickel.com:

» ETFs vs. Index Mutual Funds, Revisited
» Index Mutual Funds vs. Exchange Traded Funds (ETFs)
» Vanguard Changes Transaction Rules
» What are Vanguard Admiral Shares?
» Safe Withdrawal Rates, Investment Returns, and the Importance of Minimizing Your Expenses
» Schwab Mutual Funds: Ideal for Investors With Limited Means?
» What is a Mutual Fund?
» Just Do It

As a followup to yesterday’s post about mutual funds, I thought I’d talk today about the merits of exchange traded funds (ETFs) vs. low cost index funds. Which is a better choice and why?

What are index mutual funds?

Index mutual funds are simply mutual funds that track a market index such as the S&P 500, Wilshire 5000, or Barclays US Aggregate Bond Index. Fund management is totally automated, so the expense ratios are much lower than for most actively managed funds. In fact, in most cases the expense ratios are less than 0.50%.

Like other mutual funds, index funds are typically bought and sold at the end of the day, which means that you don’t have a lot of control over the price at which you buy or sell. The good news is that, with few exceptions, you can buy them direct from the mutual fund company, so there are no brokerage fees.

What are exchange traded funds?

Like index funds, most ETFs are designed to track a market index of some sort. The main difference is that ETFs are bought and sold just like individuals stocks. This means that they’re traded throughout out the day, but you have to pay brokerage fees whenever you buy or sell. The good news here is that the expense ratios of ETFs are typically lower than for their index fund counterparts.

Are index funds or ETFs a better choice?

Before you make a decision, ask yourself a few questions:

• What are the exact costs for the ETFs and index funds that you’re considering? Fees can vary widely, so don’t just assume on type of investment is more/less expensive than other. Instead, make a direct comparison.
• How large is your investment portfolio? Some index funds require a minimum initial investment. If you can’t afford the minimum, you might want to consider purchasing an ETF. Then again, if you’re not buying large amounts, the broker fees associated with ETFs can kill you.
• How frequently are you going to be purchasing? Since brokers charge for buying and selling ETFs, you have to factor in the added costs. If you regularly invest small amount, you may do better with index funds. The cost of rebalancing is also an important consideration.

And above all, don’t get sucked in by the hype surrounding the latest and greatest investment products. For example, the newest trend amongst money managers appears to be offering ETFs with hedge fund-like like performances. Keep your eye on the ball and think long-term.

What about you?

Given the choice, would you pick index funds or ETFs for your investments?

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Related Articles at fivecentnickel.com:

» Converting Mutual Funds Into Exchange Traded Funds (ETFs) Without Incurring Taxes
» ETFs vs. Index Mutual Funds, Revisited
» Safe Withdrawal Rates, Investment Returns, and the Importance of Minimizing Your Expenses
» John Bogle’s Favorite Mutual Fund Companies
» Just Do It
» Schwab Mutual Funds: Ideal for Investors With Limited Means?
» Vanguard Changes Transaction Rules
» How Automation has Helped Me Reduce Debt and Save

The term “mutual fund” is so widely used in investing circles that few people ever bother to define it. That’s all well and good if you’re “in the know,” but it can be problematic if you’re not. With that said, I thought it would be worth taking a step back and providing a (very) brief overview of mutual funds.

What is a mutual fund?

A mutual fund is essentially a professionally managed pool of money from numerous investors. This allows thousands of small investors to band together to buy a large portfolio stocks, bonds, etc. The fund manager/company then invests the pooled funds according to the stated goals of the mutual fund.

Mutual funds can be actively or passively managed. With an actively managed fund, there is a fund manager who “actively” seeks to provide better returns than the broad market. Obviously, not everyone can be above average, so you’re essentially betting on the manager’s ability to outperform.

In the case of passively managed index funds, the investments are managed to mirror the holdings of an underlying investment index such as the S&P 500, or the stock market as a whole. As such, these funds seek to match the returns of the overall market (minus a small amount to cover expenses).

Mutual funds come in a wide variety of flavors including:

• Equity mutual funds, which invest solely in stocks
• Bond mutual funds, which invest solely in bonds
• Money market mutual funds, which hold cash-equivalents and behave a bit like a savings account*
• REIT mutual funds, which invest in real estate investment trusts
• Balanced funds, which hold a set mix of asset types
• Target date funds, which hold a mix of asset types that changes to become more conservative over time

Advantages of mutual funds

The primary advantage of mutual funds is that they allow small investors to achieve broad diversification. Instead of having to invest in numerous different companies, buy a boatload of individual bonds, etc., you can buy shares of one or a few mutual fund that are fractionally composed of hundreds or thousands of individual holdings.

Another benefit for small investors is that mutual funds reduce costs as compared to direct investments. Because mutual funds make fewer, larger trades, they experience much less in the way of transaction costs. Yes, you have to pay for management, but that cost is spread across everyone that has invested in a particular mutual fund.

It’s worth noting here that index funds are typically far cheaper than actively managed funds. Either one, however, is likely much cheaper than making a bunch of small(ish) trades, even if you would otherwise use a discount broker.

Finally, mutual funds offer simplicity. For example, you can buy in with a set dollar amount instead of buying a round number of shares. Moreover, you’re effectively outsourcing the day-to-day management of your investments to a professional money manager or mutual fund company such that you can sit back and focus on the big picture.

Disadvantages of mutual funds

As much as I like mutual funds, there are some distinct disadvantages to these types of investments. Perhaps the biggest of these is a lack of control. This is especially true when you buy into an actively managed fund. While such funds typically have guiding principles, the investment strategies can be quite broad/loose, such that you’re essentially putting your faith in the judgement of the mutual fund manager.

A related problem is tax inefficiency. When mutual funds managers make trades, they incur capital gains which result in taxable distributions at the end of the year. While index funds typically have fewer trades, and are thus less prone to this sort of problem, they still generate taxable distributions on a yearly basis. Thus, you’ll end up paying at least a small amount of capital gains taxes on an ongoing basis even if you never sell a single share.

Another problem is fluctuating share prices even if you’ve bought a fund that specializes in fixed-income investments. While the underlying securities will maintain their value if held to maturity, the mutual fund itself is traded on a daily basis, and fund prices can (and do) fluctuate based on prevailing interest rates, investor sentiment, etc.

Finally, while your investments are protected against fraud by SIPC insurance, they’re not protected against market losses. This is a particularly important point in the context of money market mutual funds (see note below), which are often treated by investors like savings accounts.

*Note: There is a big difference between money market savings accounts and money market mutual funds. The former are typically FDIC insured, whereas the latter are simply managed to maintain a stable share value of $1, but with no guarantees.

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As a followup to my recent posts about investing through Lending Club, I thought it would be interesting to crunch some numbers related to historical loan performance. One obvious concern when it comes to peer-to-peer lending is that the borrowers will default. At best, this will severely dent the return of your overall portfolio. At worst, you’ll wind up losing money. So how bad is the risk?

Lending Club repayment rates

What follows are three tables reflecting the current status of loans issued during 2007, 2008, and 2009. Since Lending Club notes have a three year maturity, none of them have actually matured yet. While it might be more informative to calculate these stats in terms of dollar amounts, I decided to use numbers of loans for simplicity.

As a reminder, Lending Club grades their borrowers based on perceived credit risk. Grade A borrowers are those that have been judged to be the least risky, and thus they have the lowest interest rates. Grade G borrowers, on the other hand, are the most risky and have the highest interest rates. For more details, check out my Lending Club review.

For reference, Lending Club issued 603 loans in 2007, 2393 loans in 2008, and 1681 loans thus far in 2009. The 2009 numbers are, of course, much less useful. After all, we’re only six months into the year, so there hasn’t been much time for these loans to go bad. Regardless, I’m including it here in the interest of providing full data.

Current status of loans issued in 2007:

Current status of loans issued in 2008:

Current status of loans issued in 2009:

Lessons learned

One of the most obvious things that you’ll see from these data is that the Lending Club default rate does, in fact, generally correspond to the loan grade. Interestingly, there hasn’t been a single default (120+ days late) on a Grade A loan regardless of the timeframe. Move down the list, however, and things change quickly.

Looking at the 2007 data, the default rate for Grade B and C loans is approximately 10%. As you get into Grade D and E loans, things deteriorate further as the default rate climbs into the 15-20% range. Finally, the Grade F and G loans have a 25-30% default rate.

These data also suggest that the overall default rates are artificially low due to the young age of the average loan. In fact, looking at 2009, the seven loans grades look essentially identical. Move back just one year, however, and the expected pattern of higher defaults amongst the lower credit grades begins to emerge.

Looking ahead

It will be very interesting to see where things settle out as those first loans begin to reach maturity. As for me, I suspect that my Lending Club experiment will have mixed results.

While it looks like my “high risk” portfolio (composed of Grade D/E/F/G loans with an average rate of 15.2%) might be headed for trouble, my “low risk” portfolio (composed of Grade A/B/C loans with an average rate of 9.9%) stands a decent chance of delivering solid performance.

If you have any thoughts or personal experiences regarding loan repayment (or lack thereof) on Lending Club, please share them in the comments.

Source: Lending Club Performance Statistics

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Related Articles at fivecentnickel.com:

» First Lending Club Loan Payments Received
» Lending Club – July 2009 Performance
» Lending Club – June 2009 Performance
» Prosper Resumes Peer-to-Peer Lending
» Lending $100 Giveaway Reminder
» Lending Club Portfolio Fully Funded
» Free Money from Lending Club – $25 Signup Bonus
» Lending Club $25 Bonus Reminder

This is a just a quick note to say that my Lending Club portfolio is now fully funded. I have twenty $25 notes in my “Low Risk” portfolio with an average rate of 9.85%, and twenty $25 loans in my “High Risk” portfolio with an average rate of 15.16%.

Since these loans didn’t all fund at the same time, the payment due dates are a bit spread out. The first payment is due on June 13th, so we’ll have to see how things go from there. I plan on posting periodic updates, so stay tuned if you want to know how things turn out.

If you want the full story, here are some of my previous posts:

• Lending Club Review and Account Opening Process
• Investing With Lending Club: Low vs. High Risk Loans
• Our Lending Club Investments, One Week Later

If you have any questions about how Lending Club works, please let me know and I’ll do my best to answer them.

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Related Articles at fivecentnickel.com:

» Our Lending Club Investments, One Week Later
» Lending Club – July 2009 Performance
» First Lending Club Loan Payments Received
» Lending Club: Invest in Your Friends
» Lending $100 Giveaway Reminder
» Lending Club Update – October 2009 Performance
» Lending Club – August 2009 Performance
» Free Money from Lending Club – $25 Signup Bonus

What would you say if I told you that, on average, the majority of stocks lose money over time? Would you call me crazy? After all, we all know that the stock market has done nothing but increase over the long term. Right? Well…

According to an interesting piece in the latest Money Magazine by William J. Bernstein (author of The Four Pillars of Investing), it’s not that simple. In fact, looking at the past 30 years, “the top-performing 25% of stocks were responsible for all the gains in the broad market.” The remaining 75%, on the other hand, “collectively generated annual losses of around 2%.”

If stock market’s long-term gains have been produced by a relatively small proportion of stocks, why not just invest in these “superstocks” and ignore the rest? The problem here lies in accurately identifying the superstocks. Make a few mistakes and you’ll dramatically underperform the market.

As Bernstein puts it:

“Remember that the point of investing isn’t to aim for the highest possible returns. It’s to make sure you don’t die poor. Yet trying to optimize your performance by seeking out the needles in the haystack is a sure way of becoming, well, poor.”

The solution? Diversify your equity investments as broadly as you can. Perhaps the easiest way of doing this is to buy total market index funds that cover both domestic and foreign stocks.

Source: Money Magazine

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I come from middle-class roots and was brought up with what I’ve recently heard referred to as a “middle-class money mindset.” By that, I mean that I’ve been primarily concerned with:

• Getting an education
• Developing a skill/career
• Honing that skill
• Using that skill to work and trade time for money
• Saving that money
• Working to a ripe old age, and then retiring
• Living happily ever after

More recently, I’ve come to realize that this isn’t what I want out of life. Rather, I want to develop a “wealthy money mindset.” By that, I mean that I want to:

• Embrace the concept of compounding interest
• Always spend less than I earn and avoid debt
• Save/invest as much of my income as possible
• Achieve financial independence
• Spend my “work” week pursuing my passions
• Never retire, but rather continue pursuing my passions
• Give generously

Wealth is, of course, a very personal concept, so your definition might differ from mine. That’s fine — to each his own!

My story

The following is a brief synopsis of how I came to realize that I need to abandon my middle class money mindset and replace it with one of passionate, wealthy living.

After graduating from high school, I secured student loans and worked part-time as a waiter to put myself through college. I chased after the “middle class dream” of getting a degree and building a career in hopes that it would lead me down the path toward wealth and peace of mind. At the time, I had no personal definition of wealth. The only “goal” that I had was that I wanted to do whatever I wanted whenever I wanted. I was truly ignorant and clueless.

In May of 2000, I graduated from college with a degree in Information Technology. I had over $30k in student loan debt and more than $5k in credit card debt. As far as the world was concerned, I was finally ready to start my career and begin trading my time for money!

As I continued down the path of modern consumerism, I was indifferent toward my personal debt. Then, about six months ago, I finally had my fill of running on the hamster wheel of life and getting nowhere fast. I started a personal finance blog, committed myself to debt reduction, and vowed to pursue my newfound passion all the way to financial freedom.

My extreme mindset makeover

In a recent discussion with my father I told him that I had rewritten my entire view of money and wealth. Intrigued, he asked me to elaborate. I explained to him that I had come to the realization that I needed to get out of debt, reduce my standard of living, spend less than I earn, give generously, save the difference, and eventually live off the interest. Knowing me from birth, and knowing my traditional spending habits, he was flabbergasted to hear such words coming out of my mouth.

I actually fell off the middle class mindset cliff the day I sat down and figured out exactly how much of my money goes toward interest payments month in and month out. If you’re in debt, I suggest that you do the same. Once I realized how much of my money was going toward interest payments, I was able to put my debts in proper perspective. From here, I:

• Developed a financial philosophy based on sacrifice – The more I sacrifice in the short term, the faster I’ll reach my financial goals. I’d much rather sacrifice when I am young, than worry about money in my later years.
• Discovered the importance of financial mentors – My mentors are people who have already accomplished what I have set out to accomplish, and are currently living the life that I want to be living. Conferring with these mentors helps me to continually transform my financial thought process from that of a middle class man to that of a wealthy man.

I’m now committed to doing the following in pursuit of financial freedom and wealthy living:

• Eliminating all debt including my mortgage
• Simplifying my life
• Saving aggressively, increasing as my debts dwindle
• Giving generously, increasing as my debts dwindle
• Pursuing my passions and developing income from them at my own pace
• Continuing saving/investing until I can live off my nest egg

These last points are going to be unique to each of us, but the general principles of my extreme mindset makeover stand. Now I just have to figure out how much I want/need to save before I start giving the surplus away, but that’s a topic for another day…

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