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Sunday, December 06, 2009

End of Year Financial Advice

I'm reminded that it's the end of the year by the number of financial planning questions I get. Despite having written on the topic many times, I'm having to dig up old articles for the sake of my friends who aren't subscribed to my blog (tsk tsk).

Q: What is Tax Loss Harvesting?

Previous post on tax-loss harvesting One thing to note is that if you own one of Vanguard's funds, tax-loss harvesting is an all or nothing affair, because Vanguard only tracks your shares on an average basis. This is a good reason to switch to Vanguard's VIPER ETFs. Unfortunately, not all Vanguard funds have an equivalent VIPER, and vice-versa. The most notable one is the Vanguard Energy Fund, where the ETF and the fund are not related.

Q: I'm a Fidelity user, and I've noticed that the Vanguard funds are actually more expensive than the Fidelity equivalents. Why do people have such brand loyalty to Vanguard?

It turns out that index management is not at all easy or obvious. There have been several articles and analyses on Vanguard funds. For instance, William Bernstein has written about transactional skill on the part of Gus Sauter, the positive tracking error that Vanguard funds frequently exhibit, and how Vanguard funds frequently outperform what ought to be equivalent ETFs. No equivalent analysis of Fidelity funds have been made. There is also some evidence that transactional skill is persistent, unlike skill in say, picking stocks.

Q: I noticed that you bought a house recently. How does that relate to your portfolio, and are there any books equivalent to Random Walk Down Wall Street for real estate investing?

I view my purchase of a house as a consumption decision, not an investment decision. In other words, I don't expect my house to appreciate any more than my big screen TV (though perhaps it wouldn't depreciate like one), and moving into a house actually cost me money.

I did look into real estate investing several years ago, and it sounded like a massive hassle. However, it is possible to make money at it, and there are several people who do. (There are just as many people who don't) If you wish to hear the truth about real-estate investing, the no-nonsense guides by John T. Reed are the ones I recommend. You might decide (as I did) that this stuff is not for you, but at least you won't be suckered into thinking that real estate is a "get rich quick" scheme, unlike many others.

As far as valuing an individual house is concerned, I like to tell folks that as long time renters, they are expert at rentals. So estimate how much you would pay in rent to live in a particular house, and divide the purchase price by the annual price of renting that house. In the US, the long term price/rent ratio calculated this way is around 19. For the Bay Area, it's around 21. In 2007, the average price/rent ratio in the area was an astounding 50. At that price, it definitely made more sense to rent. Now, you can easily get 21, or even 19. There's good reason to believe that prices will decline further (remember, the average means that there are times when prices are far below average), so keep those ratios in mind when making your buy/rent decision.

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