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Where To Put Your Next $100K: Investing In Today’s Environment

20 Comments -- Reading Time: 7 Min

 

Some thoughts on where to put your money in today’s environment. Focused on traditional investments (alternative investments featured in weeks to come).

 

I received an interesting question from a reader this week, one which I think is on many minds. Here it is, abbreviated for clarity:

 

Hi JP,

I was hoping to get your advice on an investing matter. My husband and I are 56 and 54. We have a little over $100,000 of our savings just sitting in a bank account that pays less than 1%. Where can we put this money so it can grow for us? We plan to retire in the next few years so we don’t want to take too much risk with it. We were thinking of putting some in the market (but have we already missed the window?). Also some in the Bank of America idea you talked about.     – Candice

 

I’ve got some ideas I’ll be outlining in the coming weeks for potential investments in real estate (without being a landlord), peer lending, tax liens, etc. But for this couple – and probably many readers – we will stick to evaluating some of the more common options in fixed income and stocks.

 

It’s clear to me that Candice is a regular reader (fantastic!) as she cites several ideas I’ve talked about in depth on the blog. The two at the top of the list are investing in an index fund and investing in Bank of America preferred stock.

 

I still believe these two options are some of the most viable for today’s environment.

 

Stock Market

 

The concern about whether one has “missed the window” on investing in stocks is a common one. The S&P is up 16.4% so far this year. Doesn’t this mean one should wait for the next correction to buy in?

 

My answer is no.

 

As I talk about in the primer on index fund investing, the hypothesis most of us retail investors are investing behind is the following: when you look at historical performance for the stock market, you see 8-10% returns average over the long run (defined as 10+ years). Neither you nor I professes to be an oracle on the timing of dips and spikes in the market. By buying into an index fund, we put our faith in the idea that US companies will grow in the long-term, with past data averages of 8-10% as an anchor or starting point for what we might expect those returns to be for us in the future.

 

If you are asking yourself whether you have “missed the window,” you are trying  to time the market. You are a speculator.

 

It is perfectly fine to be a speculator, but you should acknowledge that that is what you are doing. You are saying you have some special knowledge about the timing of peaks and valleys and that your edge in investing is your ability to call these timings. You are willing to stake thousands of dollars on your special edge. Because if you sit out too early, you’ll miss years of 10%, 15%, 20% gains. If you buy in right before a crash, you won’t have gotten the buffer of the good years to smooth out your average return like all the long-term passive investors.

 

So going back to the heart of the question, no, I don’t believe anyone investing in an index fund today has “missed the window” on the stock market. But what they need to make sure they are comfortable with before investing money into an index fund is the following:

 

Make sure you can afford to keep this money in the market for 10 years or more.

 

You don’t want to have to liquidate your position when it is at a huge dip in value. A ten year horizon is doable for many, even for a couple who plans to retire in a few years. It is dependent on the allocation of the overall portfolio. If you have needs during retirement to draw regular cash, perhaps you have 20% of your portfolio in stocks which can stay at work for years, while the remaining 80% is invested in things like bonds that send you a monthly check to cover your living expenses.

 

Again, whether you want to invest some of that money in an index fund has less to do with whether you think the market is going to fall or rise short-term next year, but rather whether you can afford to leave $X of your portfolio in the stock market for up to 10 yrs without drawing down on it.

 

Preferred Stock: BAC-L

 

For those who have less of an appetite for risk or who have an imminent need for regular cash distributions to cover their expenses, fixed income options are appealing. One which I’ve talked about on the blog is Bank of America Preferred stock, specifically the Series L. Technically BAC-L is an equity instrument, not a debt instrument. I have heard preferred stock described as “a stock that acts like a bond,” and depending on the specific opportunity, that can be quite accurate.

 

I talk about the opportunity in depth over here, but the gist of it is that there is a dividend attached to the stock which meets the requirements to enjoy the qualified dividends tax rate. Depending on your tax bracket, the qualified dividends tax rate is either 0%, 15%, or 20%, making it attractive on a net after-tax basis over other options that are often taxed at your ordinary income rate.

 

It is important to note that the yield on BAC-L has changed since I wrote about it last. At the time I wrote about it in April, the dividend was effectively 6.1%, or 4.9% after-tax for those in the highest qualified dividends tax bracket. Since then, the stock has risen in price, making the effective dividend 5.6%, or 4.4% after-tax for folks at a 20% qualified dividends tax rate bracket. Great for those who bought in at the time it was discussed and picked up the appreciation and higher yield; less compelling for new buyers coming in at the higher price.

 

This may still be a good option, but at this return, I can think of some other options which might be better. It’s a good case study in how quickly the optimal investment opportunity changes, and how keeping your eye out could net you thousands of extra dollars. An extra percentage point of return on a million dollars is an extra $10,000 every year!

 

Other Fixed Income Alternatives: Muni Funds

 

One option I’m beginning to like again for fixed income is leveraged municipal bond funds. These are funds which buy bonds issued by city, state, or federal agencies. They are backed by the city, state, or government and its whole book of ‘business’ like its tax revenues. You are betting essentially that the city, state, or federal agencies don’t default. Traditionally, muni funds are considered one of the safer classes of bonds to buy given the government guarantee at play. You have probably seen a few high profile cases of cities like Detroit and Stockton declaring bankruptcy. So it does happen, but I’d say it’s still quite rare. There are funds which straight up buy a bunch of bonds, collect the payments, and distribute them to shareholders, and there are also leveraged muni funds which do the same thing but juice their return by borrowing cheap debt to buy even more of these bonds by using the existing bonds as collateral. 

 

The nice thing about muni funds is that most of them have federal (and sometimes state) tax-exempt status. That means if your tax bracket is 30%, a muni fund can yield 30% less to you than a bond fund that is taxed at ordinary income and it will net you the same after-tax return. Similarly, compared to BAC-L above at the 20% qualified dividends rate, if you could find a muni fund that yielded 20% less, it would net you the same after-tax return, and you’d probably be sitting on instruments with a higher credit rating and lower risk profile.

 

You can find options for muni funds through a screening tool like CEF Connect. Here are a few examples of national tax-exempt funds and what they’re paying:

 

 

MYI – 5.7%

MFL – 5.73%

NZF – 5.85%

 

Compare this to BAC-L’s 4.4% after-tax return. You could be earning a full 1.3%+ more per year, and you’d be invested in bonds that were on average rated higher in quality than BAC-L.

 

Should you just pick the one with the highest rate and go from there? Not necessarily. If you want to learn more about how to evaluate a bond fund, I talk about the eight factors that should be on your checklist over here. If you want an even higher bird’s eye view, check out The Ultimate Guide To Understanding Bonds.

 

Stock and Bond Allocation

 

The reader’s email was silent on the exact split they expected to use in investing in the stock market vs primarily income-generating holdings like BAC-L. This is an equally important point, and it’s the one that allows you to sleep well at night. A couple who is a few years from retirement has a very different risk appetite than someone who just graduated from college and is gunning for max appreciation as fast as possible. To figure out what the appropriate allocation is for you, you can check out this full walk-through which includes historical data and a framework for how to make the decision that fits your own situation best.

 

And if you don’t actually know what your current stock and bond allocation is, a free net worth and investment tracker will give you some much-needed clarity. I like and have been using Personal Capital myself. It not only gives you a clean visual dashboard and the ability to drill down by category and account quickly and easily, but it also offers neat benchmarking tools that will tell you things like how the expenses and fees on your funds compare to the industry average. You also get access to their pretty cool retirement calculator tool, which will pull in all your existing information to track your progress.

 

 

Conclusion

 

These are a few options I think are viable for today’s uncertain environment. Crystallizing your long-term, 5-10+ year strategy is important, and from there it’s about slotting in the appropriate assets in the right allocations to serve your needs. In coming weeks we’ll explore some of the more exotic opportunities you might find interesting for your portfolio. Until then, batten down the hatches.

 

What does your current allocation look like? Where did you invest your last $1,000, $10,000, or $100,000? Where do you plan to invest your next chunk of savings?

 

 

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Comments

  1. JennyJ says

    October 24, 2017 at 2:31 pm

    Hi There! Love your blog! It’s really got me thinking and hoping to retire early!
    I have 401K that I contribute to biweekly. It’s now up to about $200K. I really knew/know very little about investing but recently diversified my allocation from mostly all company stock to about 70% to a Blackrock 2035 Lifepath fund and left about 30% in stock. I’m 45 and hoping to pay off my mortgage and debt and retire by age 57 – (or sooner if possible!) I plan to change the lifepath fund allocations to more conservative allocations before retiring, but am willing to be a bit more aggressive currently to beef up my savings. Is there any other investment advice you would give me?

    Reply
    • JP Livingston says

      October 25, 2017 at 10:57 am

      Hey Jenny. It sounds like you’re already taking some very productive steps. I don’t know what the breakdown of the allocation is in Blackrock Lifepath in terms of stocks/bonds/etc. Two things that might be helpful: 1) check out the post linked above on determining the proper allocation between stocks and bonds for you 2) examine what the performance of and expenses are of Blackrock Lifepath vs building the same allocation with low-cost index funds from a provider like Vanguard (VTSAX is a nice total stock market index fund). i took a quick look and the expense ratio on Blackrock Lifepath 2035 appears to be 3-5x the expense ratio of something like VTSAX depending on whether you are looking at gross or net. VTSAX will only cover the equity portion but Vanguard also offers equivalent bond funds to get the bond exposure you want.

      If you end up using the investment and net worth tracker at Personal Capital, it will do the expense benchmarking and some other neat things for you automatically.

      Reply
      • JennyJ says

        October 25, 2017 at 11:08 am

        Thanks JP! Yes I started using the Personal Capital tracker at your advice. It is a very cool program. Thanks! So the allocation is about 82% stocks and 18% Bonds for the Lifepath. Expense ratio is about .13 which is a lot more than the .04 for Vanguard, I just didn’t know if I would need to constantly revisit with a more “hands on” approach with reallocation since I’m not very knowledgeable about investments, and thought the more “hands off” approach with Lifepath might be more suitable. However – you make a really good point about the expenses, which I will definitely consider. How often do you have to pay “expenses” to these funds? Thanks again!

        Reply
  2. Cal says

    October 24, 2017 at 3:47 pm

    Awesome JP. Your bac-l analysis is still one of my faves. Just as you did bac-l would you call out a CEF Muni that you have done an analysis on and in favor of?

    Reply
    • JP Livingston says

      October 25, 2017 at 10:53 am

      Hey Cal. I haven’t got one yet. I’m actually in the middle of researching this for myself as I’ve got some cash that needs to be put to work. The three national tax-exempt funds I listed above met my initial screens. There’s a link to a post that talks about the 8 factors I like to consider when selecting a bond fund up above. That would be the place I’d start. I’ll update the post when I select one for myself.

      Reply
  3. JennyJ says

    October 25, 2017 at 11:08 am

    Thanks JP! Yes I started using the Personal Capital tracker at your advice. It is a very cool program. Thanks! So the allocation is about 82% stocks and 18% Bonds for the Lifepath. Expense ratio is about .13 which is a lot more than the .04 for Vanguard, I just didn’t know if I would need to constantly revisit with a more “hands on” approach with reallocation since I’m not very knowledgeable about investments, and thought the more “hands off” approach with Lifepath might be more suitable. However – you make a really good point about the expenses, which I will definitely consider. How often do you have to pay “expenses” to these funds? Thanks again!

    Reply
    • JP Livingston says

      October 27, 2017 at 12:41 am

      Hey JennyJ. For the major bucket of expenses we are talking about (expenses to run the fund), they are paid throughout the year. A fund will take their operating expenses directly out of the assets of the fund so that when they report the value of your holding to you, at any given time they have already taken out the costs for that month, quarter, etc. that are required to run the business. Depending on the fund, you may also have a different bucket of expenses like load fees. A load is a charge to you when you either buy or redeem (sell) your shares in the fund. This gets expensive fast.

      Reply
  4. LS says

    October 25, 2017 at 3:15 pm

    JP – I follow you and MMM pretty closely (though I err toward your “pick your luxuries” approach more than his “everything you like is dumb” style). I spend with intention and save the rest. My husband and I bring in income, though one or both of us could probably fully retire if we wanted to… BUT I cannot wrap my head around the investing portion… I’m beginning to think I’m just not a numbers person, and the best course of action is to work with that rather than against it… what would you suggest in my situation? We have an adviser that manages everything for us now, and I have no reason to believe he’s not doing a good job. In my situation, do you think it’s worth paying the associated fees? What would you consider a reasonable fee at your savings level, for example?

    Reply
    • JP Livingston says

      October 27, 2017 at 12:25 am

      Hey LS. I think there are some nuances to your question which I’ll try to tackle. Starting from least to most effort, I would say that as a baseline, the answer to whether it’s ‘worth paying the associated fees’ can be established with a quick 10 minute exercise: I would compare your adviser’s performance with your money to the performance of an index fund like VTSAX or SPY, as well as some sort of portfolio split partly between an index fund and bond exposure (as you likely aren’t taking 100% stock risk in the allocation you decided on with your adviser, so it’s not fair to compare a riskier strategy’s outcomes with your adviser’s strategy if you directed him to be more conservative and add things like bonds). To get this kind of data, you can skim the first few pages of the prospectus for VTSAX or SPY, or google ‘S&P annual returns’. You can do the same for an equivalent bond fund.

      If the performance of your adviser net of fees is not beating these kinds of passive solutions, I would be leaning pretty hard in pulling my business. If you see that his performance doesn’t match up, I’d politely ask him to help articulate the value of the services because you can see some passive strategies are outperforming what he’s providing. Then let him help you understand his value. One step up – and adding probably another 20 minutes of work – I would encourage you read about the performance data of these types of strategies yourself here and here. I realize you say you’re not a numbers person, but I’d encourage you to at least try reading a few of these introductory articles and testing whether you are truly allergic to material presented clearly and concisely (at least I hope that it will feel clear and concise to you).

      The reason why I always encourage people to understand investment – even when they aren’t ‘numbers people’ or ‘interested in investing’ – is that it has such a huge impact on your life that I don’t really think you can afford to ignore it. If your adviser is bad, he could wipe out hundreds of thousands of dollars in value. That’s years of work on your part, wiped out in a single quarter or year. So while you may not ever want to handle every piece yourself, educating yourself on basic opportunities and performance data will allow you to better evaluate whether you’ve picked a good money manager. My short answer is it is possible using an adviser is a wise strategy for you, but I think you will need to educate yourself to some degree on your investment options and what data supports the strategy so you have the tools you need to evaluate that adviser’s performance.

      Reply
  5. Michael says

    October 26, 2017 at 6:41 am

    I like the BAT stocks Baidu, Alibaba and Tencent ..

    …but there are other such local tech stocks from here …..

    Reply
    • JP Livingston says

      October 30, 2017 at 4:34 pm

      Thanks Michael.

      Reply
  6. Ten says

    October 30, 2017 at 9:57 am

    Hi JP,

    Thanks for this article. Always interesting to get your ideas in making your money your side-employee working for you while you are sleeping 🙂

    Just curious on your thoughts on duration of these CEF leverage funds in this rising rate environment? Obviously, most of these funds have much longer duration and with the leverage, it even goes up.

    Thanks,
    Ten

    Reply
    • JP Livingston says

      October 30, 2017 at 4:33 pm

      Hey Ten. I don’t consider a rising interest rate environment a necessarily poor environment for leveraged bond funds. While the cost of borrowing increases, so, too does the average coupon these funds are able to procure by purchasing bonds in the market to add to their portfolio.

      The concern to me lies in the short-term. In a rising interest rate environment, the fund may get temporarily squeezed. The cost to borrow goes up. But the coupon on their bonds doesn’t immediately jump to reflect rising rates. They need to wait until the bonds mature to take that principal and buy new bonds which offer those higher market rates. This manifests in temporarily lower distribution payments and very likely in a drop in the price of the shares as investors look for better yield that reflects the fact that new bonds are going to be issued at better returns than what the funds currently have in their stables. The amount any individual fund is impacted by this phenomenon is determined by their leverage rate, the terms of the debt they borrowed (is it floating rate? when must it be refinanced at the higher rate?), as well as the terms of the bonds in their portfolio (are they locked into a giant chunk of bonds that don’t mature for another 10 years, or do most of their current bonds expire in the next year, allowing them to go out and pick up new bonds at those higher rates quickly)?

      The decision to invest in these funds is a balancing act. On one hand, they appear to be offering pretty reasonable yields for this environment, particularly if you are bearish on the stock market or you frankly need to have income-producing stuff in your portfolio because you no longer generate an income. On the other, you may get squeezed if interest rates rise quickly. This is partially mitigated by the fact that if you can hold through the temporary squeeze, you won’t actually lose a bunch of money on depreciation of the shares (because eventually the fund will stock up on bonds that pay the market rate, and the price of the shares will reflect that dividend rate). But even if you can hold through the temporary waves, you do eat a potential temporary decrease in the dividend payouts, which may be less than, say, the 5.7% you originally signed up for for a period of time until the fund gets rid of lower coupon bonds and can repalce them with bonds at the higher going rates.

      For a while, I was employing a strategy that involved my portfolio being majority in funds like this. I sold them all off for a major profit towards the end of 2016 when it sounded like the Fed was planning to raise interest rates 75 bps/3 times in 2017. My concern was the we would be on the losing end of the dynamic described above. As I look at what’s actually happened as well as the Fed’s most recent signalling, plus that huge kerfuffle about the Fed realizing they might have been mistaken in their tracking indicators for the health of the economy, I deem it less likely we will see significant or rapidly rising interest rates. Definitely a point worth consideration, though.

      Also, on the (entirely probable) chance that I’ve misread your question and what you’re actually asking about is how long to hold these funds, the beauty of purchasing a bond fund like this is you can enter and exit at will. When one set of bonds matures, these funds will take the payments and just invest them in new bonds. So they can effectively go on forever. You can hold them for a long or as short as meets your portfolio’s needs.

      Reply
  7. Robert says

    November 12, 2017 at 12:57 pm

    Would love to see you link to the next chronological article you post… currently i’m not seeing an easy way to keep reading your blog in chronological order. Specifically you mentioned discussions of alternatives to high yield savings accounts for better yields in your article on Sept. 7th… and i’ve been trying to find that article for several minutes now without success. If you could link in chronological order, or go back and link past articles to the future articles once they are written to take the guess work out of finding which article you were actually foreshadowing. Appreciate your blog – i’ve been enjoying some unique perspectives you bring to the FI arena that I haven’t seen on other blogs so far.

    Reply
    • JP Livingston says

      November 12, 2017 at 3:56 pm

      Hey Robert. Thanks for the suggestion – I looked back and you’re right, it sort of just teases there on that post. I ended up not posting my allocation post which is why you couldn’t find it. I ended up putting my money in BAC-L described in this post (Where To Put Your Next $100k) many months ago. An alternative I would consider now given the change in yield is leveraged muni funds. They obviously are riskier than a high yield savings account, but they I deem it a better risk-reward tradeoff for cash to buy stocks at a discount, and those funds will do well in exactly the scenario I would need to sell them (when stocks are doing poorly, investors tend to flock to the security of bonds). Hope that helps. And very glad you’ve enjoyed the content! It makes me happy to know I’m contributing something unique to the space.

      Reply
  8. Susan says

    January 24, 2018 at 10:40 am

    And what about Forex? I saw a post recently where i was convinced it might be another good option to invest my 100K.

    Reply
    • JP Livingston says

      January 25, 2018 at 5:08 pm

      Forex isn’t for me. I wrote a post about cryptocurrency which touches on the ways I think currency investments/trades are very different than other asset classes we as retail investors are evaluating. What was the compelling argument for forex that appealed to you, out of curiosity?

      Reply
  9. Cal says

    April 11, 2018 at 1:51 pm

    Hi JP -I hope you are having a great time with JP Junior. I wanted to see if you’d be willing to do a quick update on the CEF munis. They have furthered their discount from NAV since you last wrote about this. What do you think? Thank you!

    Reply
  10. Deb says

    August 17, 2018 at 7:24 pm

    How come the posts are no longer dated? Even being subscribed I’m not seeing new posts on Tuesdays and Thursdays, how often do new posts come out?

    Reply
    • JP Livingston says

      August 28, 2018 at 12:16 am

      Hey Deb,

      Apologies, I’ve been off my regular posting schedule as I work heavily on a new project I’ll be revealing on the blog in a few weeks. I should resume regular posting in the fall. Stay tuned! And very glad you found the site.

      Reply

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