This week July 14, 2018, we compare investing in a short-term bond ETF versus buying and holding one and two year Treasury bonds. We answer a members question about hiring an outside money manager once he is married. We look at the new U.S. tax law on the price of real estate in New York City.
Welcome to Money for the Rest of Us, Plus. This is the companion episode to episode 212. Trade wars increase poverty and prices. It’s Saturday morning, July 14th, 2018. And in today’s episode, I have a question on why not just invest in short-term treasuries, or ladder, a short term treasury portfolio as opposed to investing in a short-term or ultra short-term ETF. And we’re going do the math, kind of look at a comparison.
I have a question from a member, on getting married, as someone of different philosophy regarding money management, from his fiancé. We’ll talk a little bit about that, particularly as it relates to hiring an outside money manager.
Then I want to share development on real estate in the New York area, which I think is just … it’s actually kind of a fascinating example, what’s going on there.
Feedback on Episode 212
First on the episode 212, I’d gotten some feedback from listeners. Some didn’t like it. Some thought maybe a little too political. Trade is a complicated topic, as you know. I wasn’t trying to be political, because I don’t really have a political view as it relates to … or at least I try to avoid conveying a political view. I don’t spend a whole lot of time talking about the Trump administration, or when the Obama administration was in, the Obama administration. I’m more interested in sort of these complex nuanced topics, like trade. Trade clearly has increased global wealth. It’s had a huge impact on China. And yeah, I’ve talked about it on the podcast, just the complexities with that. There was so much we couldn’t cover in that episode. The fact that … things that we’d covered earlier. The trade deficit with China, means China owns a large amount of U.S. government bonds. We didn’t talk about how the Chinese have kept their currency significantly weak. We didn’t even get in to the topic of every trade deficit is offset by a capital count surplus and whether the trade deficit is being driven by investment flows into a country. So I just try to focus more on the poverty elimination aspect of trade, and the complex adaptive system aspect of it, how companies automatically adapt.
Now, I guess one political view is I don’t think broad brush tariffs or blanket tariffs is the best solution. I don’t really consider that a political view. It’s just more my economic opinion, and a recognition that global trade has caused inequality, particularly as it’s pushed downward pressure on blue … or on worker wages, because they’re competing in a global marketplace. We didn’t even get to talk about the solutions for inequality, which we’ve talked about in other episodes.
Part of maybe what would seem one-sided in the episode is just, I try to keep it to 30 minutes, just because that’s typical. That’s about all I can stand to listen at any one time. So, I assume others can’t. Anyway, it was a fun episode to do. I have another interesting episode this week. My view on health insurance has changed significantly from this book Priceless that I mentioned in episode 212. Don’t necessarily agree with everything in the book, but the idea of incentives and how incentives change behaviors. So, I’ll talk about that next week.
Short-term Treasuries versus Short-term ETF
Today, though, I had an interesting question. I had to run through the math. A member wanted to ask why not use, as I mentioned, a laddered, short-term treasury bond portfolio. So, you would own some one-year treasury bonds, some two-year treasury bonds, hold them to maturity, collect the yield, as opposed to buying a ultra short-term bond ETF, such as ICSH, which is currently in the model portfolios, or NEAR, which was in there for a year or so. There’s really two reasons why I prefer, and think that ETFs are better strategy, in that we’re in a rising rate environment, where the Federal Reserve is actively raising short-term interest rates. Going out and buying one-year treasuries, or two-year treasuries will generate lower returns than owning a ultra short-term bond ETF, if the Federal Reserve continues to raise interest rates. I’ll share the numbers with you.
The second reason to … and even if the returns were the same, and they’re not, it was more profitable to use an ETF strategy … but if they were the same, using the ETF gives you more optionality, more flexibility to exit and go where there are other opportunities, because in a rising rate environment, if you own … for example, two year ago … no, a year ago, let’s say you bought a two-year treasury bond, one year ago, it was yielding 0.6%. Now, the two-year treasury is yielding 1.4%. Had you bought that two-year treasury a year ago, even intending to hold it to maturity, but if you wanted to sell it, you would have essentially the return on a one year basis of -.3%, because the rates are going up, and there’s still some duration, or interest rate sensitivity to the two-year bond.
For example, the one-year treasury bond right now, US government treasury bond, one year is yielding 2.39%. The two-year is yielding 2.6%. One year ago, the one-year treasury was yielding 1.2%, and the two-year treasury was yielding looks like 1.4%. You’ve had rates rise, and had you sold that two-year treasury that was bought a year ago, you would’ve sold it at a loss. The total return was -.3% over the past year.
The idea of just buying and holding, you’re essentially locking in that yield. A year ago, had you bought a one-year treasury, it would’ve matured, and you would’ve earned 1.2%, but had you bought ICSH, or NEAR, as a short term ETFs, ICSH returned 1.8% over the past year, and NEAR returned 1.6%. The reason why they’ve done better is because rates have continued to rise. Since they’re shorter term, they have very low duration, and so they’re just picking up that higher yield, and reinvesting at those higher yields, as opposed to had you just bought a one-year treasury, you would’ve locked in that 1.2% yield.
Let’s go back two years. This is ending June. Two years ago, had you decided, I’m just going to lock in, the two-year treasury yield, this would have been June 2016. It was yielding 0.6%. Your return would’ve been 0.6%. Had you held that bond, kind of a laddered strategy, then you obviously would reinvest. But a 0.6% annualized return. ICSH, over the past two years, ending June 30th, 2018 returned 1.5%, and NEAR returned 1.5% also, annualized. And so, that’s why I prefer the short-term ETF strategy, in this rising rate environment verses another strategy.
Now, if rates were falling, then perhaps, then you want to consider … if the Federal Reserve is in the process … we’ve peaked out, the risk of recession is higher, and it looks like they’re signaling that they’ve finished raising rates, perhaps starting to reduce rates, that’s when you want to lock in rates, maybe even go longer than two years. At that point, we might buy the 10 year treasury, or even the 30 year treasury, depending on your risk. Then it makes sense to lock in those high yields.
But, in this environment where the Federal Reserve has indicated, signaled they’re going to continue to raise rates, owning ultra short-term bonds through an ETF, you’d benefit from that reinvesting at those higher yields, and that will do better than just doing a laddered portfolio of short-term treasuries. They’re just going straight out and buying the two-year treasury bond.
Hiring A Money Manager
Okay, our next question, a new member, going to be married soon in a year, and says he’s likely to merge their resources to better facilitate joint investing with his fiancé. He writes, “I’m fascinated by finances, investing, and economics. But my fiancé couldn’t care less. She has a healthy amount in the bank, but it’s just sitting there. She wants to pay a money manager to invest for her, and whatnot. Well I feel I could do decently, still honing my own skill. When is the point when you feel it is best to go with a money manager? Should I ask them what their yield is? And if they’re consistently 15% to 25% plus, a year in and year out, better than I likely could do? And then maybe I’ll invest with them. Should I inquire whether they’re actively manage the money, or use that as a determining factor, good or bad? Should I clarify how they make their money? Whether they only get paid if they make me money. Or should I just abandon the idea altogether and manage my own money, rather than my fiancé’s, since I feel more comfortable enough to manage my own?”
That’s an interesting … there’s a couple takeaways on that question. If you can identify a manager that consistently earns 15% to 25% a year, and will do an incentive fee, and not charge you unless he actually earns that, go hire him. The problem is they just don’t exist. The best manager that I know, that has consistently earned … but not even consistently anymore. I’ve mentioned Seth Klarman, Baupost Group, long term annualized return is 15% to 18%, that’s net of fees. But, even the last few years, it’s been struggle for them. It seems like I mentioned that in a podcast, I think he did 5% maybe, last year.
So, the market’s going to give what it’s going to give, even if you’re a skilled money manager. The reality is, for individual investors, the managers that are really skilled … and there’s not many … they’re usually closed or their account minimums are too high. I don’t … not that one shouldn’t hire a planner to … or there have been members of Money for the Rest of Us, Plus that have outside managers, but we have to keep the expectation that they’re there, hopefully to do as well as the market, but it does take burden some individuals just don’t want to manage their own money. That’s fine. You keep the fees as low as possible, but don’t expect magic.
Most traditional managers will not work for an incentive fee, or some type of performance based fee. I think in this situation, it probably makes sense to keep … to manage your own money and kind of let her do with her retirement how she wants to do it, for now. There’s so much that comes together when you get married. When I got married, we had no money at all, so this really wasn’t an issue. But, there’s enough going on when you first get married that … just, I wouldn’t … this would not be something that I would overly concern myself with. Continue to manage your skills. Eventually, several years out, you can kind of revisit the topic. But, for now, I wouldn’t … this is not something I would worry about. I don’t think there’s a manager that can achieve the type of returns that you’ve talked about there.
New York Real Estate
Some of the resources that I use, I occasionally get asked, “Well, what are you subscribing to? Or, what do you find interesting?” I used to get, I still get, what was a free newsletter called The Daily Shot, which is a daily email, I guess when the market’s open. Puts together just really interesting economic grasp for things that are going on. And then, it got taken over by the Wall Street Journal, and I actually subscribed to the Wall Street Journal just to get this Daily Shot email. So, that’s something that I look at on a regular basis, just because I find it fascinating.
The other thing that I read, when the market’s open, a daily newsletter, is called Almost Daily Grants. It’s by Grant’s Interest Rate Observer. It’s free. Just go on their site, you can sign up for it. They usually have some interesting stories. Sometimes they pull from … update a recent story that they did for their paid newsletter, which I went ahead and subscribed. They offered an incentive, so I subscribed to it. It’s like $1,000 a year, which is a lot of money for a newsletter, but I did it anyway, because there are some interesting stories. But, the Almost Daily Grants is free. So, sign up for that.
They sent a story the other day, update. They were talking about real estate. We talked about housing, a couple episodes ago. They pointed out that nationwide … well, basically housing prices have increased over the past year, nationally. I think it was up 5% to 6%. The reason … one of the statistics is, Redfin shows, the average home was only on the market for 34 days in May. That’s a record. The record low is 36 months and that was a year ago. In Denver, the average listing lasted just six days in May. That’s amazing. There’s not a whole lot of supply. It’s pushing up prices. Inventory is dropping. And we talked about, in that what do you do when there’s a housing boom that there is very little inventory. You kind of have to … if you really want to buy a house, you kind of have to know what the whisper listings are, who’s thinking about listing their house.
But, this is the interesting part, they talked about what’s going on in New York, residential real estate in Manhattan. The sales plunged in May, or the second quarter. They’re down 16% from a year ago. That’s the lowest since 2009. The median sales price has fallen 7.5% over the past year. Inventory is up 11% in the second quarter. They mentioned this is not just in one borough, you’re seeing this in Brooklyn, Queens, the Westchester suburbs. The question is why? Well, again, this is where actions by government can have an impact on our finances, which is why we can’t ever not talk about government actions, or political actions. In this case, it’s the Tax Cuts and Job Act, where it capped state and local tax deductions at $10,000. Then in a high tax state like New York, that’s having an impact. It’s a less desirable place to own.
I like this quote from Jonathan Miller, he the CEO and co-founder of the real estate appraisal firm, Miller Samuel. And Grants asked him, “How much have the change in the tax code, how much do they think that change is impacting behavior?” Here’s what Miller replied. “There’s nothing positive in the tax law as it relates to housing. The best case is neutral. The worst case, as negative as you can think.” The tax law is impacting some of these high priced, high tax states, and certainly, on top of that, we’ve had mortgage rates are up. The mortgage rate, for a 30-year mortgage is 4.39%, this past week. It’s up from 3.7% in September. So, that’s making it more difficult.
That’s kind of an update to see, are we … we’ve had some booming housing markets, rates are higher, but the impact of the change in the tax code certainly is impacting it. I don’t know if we’re at the end there, I just thought it was an interesting data set.
So, that is Plus, episode 212.