This week August 25, 2018, we review whether entrepreneurs should have a different asset allocation than employees with steady jobs. We review whether new accredited investors should make changes to their investment strategy. Finally, we look at whether it makes sense to purchase individual U.S. Treasury bills.
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Welcome to Money For the Rest of Us Plus. This is Plus episode 218, and this is the premium podcast for Plus members.
In today’s episode we’re going to look at whether your asset allocation (your investing) should be different if you run some type of entrepreneurial startup venture. We are going to look at whether if you’re a new accredited investor with a net worth over a million dollars, or you made the income threshold to be an accredited investor – whether that should change how you invest. And finally, we’re going to look at should you buy U.S. Treasury bonds directly, or buy individual short-term (let’ say) 3-month Treasury bills, given yields are so much more attractive right now.
Three-Bucket Approach
A member sent me a link to an eBook, a very short book by Jeff Wiener. He mentions “Not the LinkedIn guy.” The book is called “The Kickass Entrepreneur’s Guide to Investing”
I read it, and I can’t say I recommend it; you don’t have to go buy it. It’s not very expensive… He recommends a three-bucket approach. One-third of your assets in reserve, one-third in real estate, one-third in stocks. The reserve would be cash, bonds, and he talks about cash and gives one optionality, which makes sense.
He made a lot of money in real estate. The real estate allocation, he points out, could be in equity REITs (real estate investment trusts), it could be on one of the real estate crowdfunding platforms, or you can own real estate directly. I do all three, and many of you do all three, although my direct real estate tends to be land that doesn’t take a whole lot of work. Often times, direct real estate is a lot of work.
Then a third in stocks. That’s just one allocation, but the point that the member said (that’s in the book) is the idea that if you have your own business – let’s say it’s a risky business… For this particular member it was sort of a startup-type business — that’s what he has equity, he has ownership in, and it’s like a stock. As a result, that potentially should be counted as a part of your one-third, or at least taken into consideration. So maybe you would have less in traditional stock ETFs.
It’s similar to what I talked about way back in episode 88, “Are you a stock or a bond?” and I talked about human capital. I’ve actually talked about human capital in other episodes. It’s our ability, our earning power over time.
As individuals, some of us are human capital. Let’s say if you’re a university professor – pretty stable. If you’re tenured, you’re not likely to get terminated, laid off as a university professor, and as a result you are more like a bond. Your human capital is more like a bond, more conservative, so potentially one could take more investing risk, knowing that you have sort of this stable employment earnings over the next 20 years not likely to get disrupted.
But if you’re running some kind of entrepreneurial startup – well, there’s certainly high potential reward, but a year from now you might not be working, in which case human capital is more risky, more like a stock, and in which case you perhaps shouldn’t take as much risk in your investing.
Now, these are just general principles. There’s not a right percentage, it’s just something to keep in the back of your mind. The way that I’ve always looked at it is just “Make sure I have an emergency fund.” Have the reserves so that (this was when I was working) if I got laid off, I would be protected.
Now, I guess my human capital would be more like a balanced fund maybe; I don’t have employment, I have income from Money For the Rest of Us. It seems to be fairly stable from what I can see, but you never know. So I guess the member’s question was — he wanted to know my thoughts on the book, and is there some truth that if I own a lot of stock in my own private venture, which is not liquid… He said “I don’t really see that asset the same as some of my ETF holdings, or even the individual stocks I own in publicly-traded companies. Should I be rethinking how I need to diversify?” I just think you need to be aware of it.
Everyone has a different risk tolerance. Personally, if I was running a startup company, I had a lot of private equity in that and it was in somewhat of an uncertain field, even if I was young, I would probably not have most of my liquid investments in stocks, because I would want that cushion in case something didn’t go as planned. But that’s sort of the principle… Something to consider.
Investments as an Accredited Investor
A member mentioned that a few months ago he crossed the million-dollar in asset value of his portfolio, and he wanted to know when I became an accredited investor – so I was past a million dollars, or I think I probably first met it on the income; I think it’s at over $300,000 in income… Did it change how I invested, and what changed?
Here’s some of his questions: “Did you change your own investment choices vehicles when you became accredited? What changes in the portfolio choices should one consider if anyone had become accredited investors? For example, asset-backed real estate debt, reduced overall bond allocation, increased alternatives allocation, invest on a real estate crowdfunding platform… What additional investment vehicles would you consider, and how would you invest a lump sum, given you’re now an accredited investor?”
There wasn’t a whole lot of change that I made when I became an accredited investor. The one advantage that I did have is to be able to invest in the private capital funds that my former investment firm manages. I’m in three of their funds now, and that gives me their institutional funds, it gives me access to leverage buyout, venture capital, some private real estate, private energy… And that’s an advantage.
Unfortunately, that’s not what most accredited investors get access to. We’re sort of left to platforms such as Wunder Capital, Yield Street, PeerStreet… I think with PeerStreet you have to be accredited. And they all kind of have warts. I guess all private platforms tend to have warts, because you have the fees… I have found (and I’ve talked about this) that you don’t necessarily get the transparency on Yield Street that I would like, in terms of the individual deals; they don’t reveal who the sponsors are. But in some ways, I guess, Yield Street is acting as the advisor, similar for my institutional fund of funds that I’m in – I see the holdings, but I’m not talking to the venture capital managers… There’s always going to be a level of trust when you deal with any platform, so I think that’s fair.
As an accredited investor, it does give you more options to invest in some of these platforms. I wouldn’t make it a big change. It’s not like I would now put half my money on an investment platform. It allows for more portfolio drivers, some additional diversification, and that’s a good thing… But I don’t think you have to make big changes at this point; just continue on your investment journey. You start off on these platforms small, as you’ve done, and just sort of see.
Now, one of the challenges with these platforms is they want you to prove that you’re an accredited investor, and it’s kind of a pain. In fact, I was on Yield Street the other day; we have a number of investments… All the investments I’ve done on Yield Street, by the way, have been commercial debt – debt deals linked to commercial real estate. I was in three deals; one of them already got paid back. The yield is 9%. I’ve not got involved in any of their litigation, I’ve not got involved in some marine finance… I’m fairly plain vanilla.
What’s the yield and what’s the asset backing it? And make sure that the asset is worth twice as much as whatever the borrowing in terms of some type of bridge loan.
So they had another real estate deal on there and I thought, “Okay, I’ll put some money to work, as this other deal got paid off.” Well, apparently, my accredited investor status is expired I guess; they want me to prove it again. Well, I don’t have a paycheck, so I can’t use that to show income… So I’m left to showing it based on my net worth; well, they want you to upload a brokerage statement, but that doesn’t show your net worth, it just shows your assets, so then they want you to go find a credit report, which I guess you could get — well, I guess you can get a free credit report. I’ve frozen all my credit.
Anyway, the whole point is it’s kind of a pain… “Now I have to go get a credit report?” So you kind of have to weigh the paperwork to prove you’re an accredited investor. It’s not as easy — when I did the institutional funds I’m in… It’s like a self-affidavit – “Yes, I am an accredited investor.” The online platforms don’t like to do that, so there is some give up of privacy, because you’re essentially uploading your brokerage statement onto some third-party platform, which I’ve been willing to do, but that’s sort of one of the things to consider.
So I’ve not made many changes. I think it gives you more opportunities, but you just continue on your investment journey, little by little, try new things, don’t make major changes.
Treasury Bills
Finally, I got an email from a member that said he — well, he just happened to pull up the CNBC app, and it shows bond yields on there, offering terms for essentially one, three and six months, between 1.9% and 2.2%. His question is “I was wondering, if I’m reading that correctly, and if so, I would assume if you held them to maturity, that would be a good way to safely guarantee those returns. Am I missing anything?”
I had to laugh, because I look at yields all the time, but yields have been so low for so long that we sort of forget that, yeah, 3-month Treasury bonds are yielding essentially 2%. You could buy an individual 3-month treasury bond and lock in that yield.
Now, I went on Schwab, but I don’t, I just haven’t… And the reason why is I’m lazy when it comes down to — I’m comfortable investing my cash in the iShares Ultra Short-Term Bond ETF. It has this very similar duration – a half-year duration – and the SEC is yielding 2.54%, so it’s higher than you can get on Treasuries, but it’s more risky. It’s invested primarily in commercial paper, so corporate. A lot of bank paper there.
But you could also invest in the iShares Short Treasury Bond ETF. Its SEC yield is 1.96%. The expense ratio is 2.15%. It just owns 25 bonds; it owns Treasury bonds, which are essentially Treasury bills, to some extent… Or you could just buy directly. The problem with going directly is generally there’s a minimum.
When I went on Schwab, which is what I was saying earlier, the minimum is $25,000 to purchase one… And I probably should do it just for practice, because I know Robert, a member of Money For the Rest of Us Plus, has been very diligent in buying individual bonds… It’s just not something — for so many years, the spreads or the price you got… Because bonds don’t trade on an exchange, so you’re getting it through a dealer… It just was never comfortable that I would actually get the yield that’s being promised. Somehow there’s going to be a cut there, and I guess you learn by doing.
So I’ve just always been more comfortable using an ETF, because I want a bond portfolio. But you can do it both ways. The advantage of buying the bond directly is that you do get the yield, because you hold it to maturity.
But what I thought was interesting… I went into Morning Star to look at this iShares Short-Term Treasury Bond ETF – year-to-date, it’s returned 1%. Now, the SEC yields close to 2%. The reason why it isn’t a higher return than that is because the Federal Reserve has been raising rates this year, they’ll probably increase the short-term rates again next month, so it’ll be even higher. But the reason why we forget that — it’s been a long time; it’s been almost ten years since we got this type of yields.
If you look at the annual return — in 2008, the annual return on the iShares Short Treasury Bond ETF was 2.84%. Not bad. But then, in 2009, 0.16%. In 2010, 0.12%. In 2011, 0.07%. Then we have like five years of effectively no return. So zero in 2012, 2013, 2014 and 2015.
Finally, because the Federal Reserve started raising rates for the first time in December 2015, the return in 2016 was 0.41% for the entire year, and in 2017 0.67%. Now we’re finally getting some yield… It still doesn’t beat inflation, but it’s getting close at 2%. It’ll be interesting… That’s the biggest wild card as the Federal Reserve continues to raise rates – how long will they be able to do that before we head into the next recession? In other words, how much dry powder will they have to be able to cut rates then?
Capital Economics believes that the Federal Reserve will have to pause raising rates by mid next year, and will start cutting in 2020, because the economy is slowing.
As they’ve been raising the short-term rates, the 10-year Treasury hasn’t been increasing… So the bond market is wagering that “Yeah, there is a recession.” Because what are 10-year yields driven by? They’re driven by expectations of what the Federal Reserve will do in the future, so it’s the path of short-term interest rates, so what will short-term rates be in 2019 and in 2020? And based on that, that influences what the 10-year Treasury is yielding, plus a term premium. What do investors expect, or what additional compensation do they want in case inflation comes in higher than expected, in case the Federal Reserve raises rates higher than expected? Term premium essentially is zero to negative.
Now, I saw one article – and a member actually sent it to me, and I saw it somewhere else – one of the things that could be holding down longer-term Treasuries is just how many institutions and individuals are buying long-term bonds as a hedge. So instead of going out and hedging their stock portfolio by buying VIX options or options on volatility, they’re buying long-term bonds to hedge… Because if the stock market falls, typically Treasury bond yields fall… Unless you’re Peter Schiff and you believe that that won’t happen because of a dollar crash, and that as the economy falls, we’re going to get very high inflation.
If you believe we’re going to get very high inflation, hedging through long-term Treasury bonds would not be a prudent course, because yields could go higher.
The bottom line is I was pointing out that because the market is not convinced that the economy will continue to expand going out three, four, five years, and perhaps because investors are hedging through long-term Treasury bonds, the 10-year Treasury bond yield compared to the 2-year Treasury bond yield – it’s called the 10/2 spread – is very narrow. It’s down to 0.19%, or 19 basis points. That’s the narrowest it’s been in over 11 years.
In Plus episode 211 I talked about an inverted yield curve, where the 10-year Treasury bond yield would be less than the 2-year, and what that means for the economy in terms of a potential recession… So we’ll continue to monitor it, but yes, you can get much higher yields holding 30-year Treasury or 30-day Treasury bills than you could even a year ago, and that’s a positive thing, to actually get some risk-free income… But I choose to do it where it’s not completely risk-free, but it’s still very little (if any) interest rate risk through the iShares Ultra Short-Term Bond ETF.
That is Plus episode 218.
