Well, technically it was in April, but we can still celebrate the good news this month. 

Vanguard is at it again, quickly following up Christmas in February. They have announced another round of cuts to expense ratios and shareholders win again. Here’s a look at the new rates for this round, there’s a good chance you own a handful of these if you’re a client:

Cheers!

A few weeks ago, the unofficial king of the do-it-yourself, financial-independence/retire-early investing crowd, Pete Adeney, AKA Mr. Money Mustache, updated his post on his Lending Club “experiment.”

I’ve been a vocal critic of Pete’s because I feel the influence he commands with his blog has led him to be a bit slimy. Long story short, Pete sets up affiliate marketing relationships with the products he recommends and in turn he makes a shitload of money from his blog ($400,000 per year) when people sign up for these products or view ads. My beef with him got started after Lending Club was revealed to have acted to defraud its investors (they lied about the loans they sold to institutional investors and also had disclosure issues regarding loans purchased by the CEO’s family) but Pete kept on recommending Lending Club and he kept on raking in the dough from his referrals.

As a certain someone might say in a tweet: “Not very nice!” I think he has a responsibility – regulated advisor or not – to behave better than this.

Here’s a blurb on why Pete is only just now deciding to ditch Lending Club:

You can read the post, but in short Pete saw his account value go down slightly (about 1%!) so he’s sounding the alarm and ditching the account. OK…? Given his reluctance to tell his followers to sell after “alleged” fraudulent activity(!) at Lending Club, it was already safe to say that if you’re getting your financial advice from internet blog posts created by a hobbyist with massive conflicts of interest, you might want to change your mind and diversify your advice sources. This update further proves my point.

But it’s a little worse.

Here’s further proof Pete just doesn’t really get what it’s like to own a portfolio of loans (the “fixed” part is only fixed until somebody decides not to pay), even if there is broad-based diversification:

The balance dropped! Oh no. With regard to fluctuation, “interest bearing loans aren’t supposed to do this” is an unbelievably naive statement. Fixed income products have to be repriced when interest rates (and other factors) change, otherwise arbitrage opportunities are available. The idea that Lending Club provides a simple “set it and forget it” super stable money making machine is just not accurate. (There is a secondary market for these loans and I suspect many investors are in for a shock if they attempt to liquidate early, as we’ll see below)

It’s one thing to say “well, I don’t want to face any losses so I’m cutting and running,” but that isn’t what Pete is doing. He’s implying that something is wrong with the way these loans are working and that’s just not the case. Delinquencies are rising and his balances should naturally take a hit. That’s not hard to understand. Interest rates, in general, are up, which naturally puts pressure on fixed income products, too.

Allan Roth wrote a great article featured at CBS News, and this passage might help:

In summary, rising delinquencies – as Pete has experienced – bring a delayed hit to Lending Club account balances since they’re not “marked to market” until they’re officially dead. Pete’s portfolio is now seeing those defaults, he thinks the system is broken (or something?), and it’s also a bit of another knock on Lending Club for promoting a snazzy, continuously updated rate of return when in reality some of the underlying loans are effectively zombies and negative returns could be just around the corner.

So what’s the deal, Pete?

The “losses” shown are basically a 1% downtick in account value. Not to defend Lending Club, but I’d love to know how this is any different than an emotional investor selling at the first sign of a paper loss. Or is there something more to the updated opinion? Unfortunately, Pete is not just a regular investor dinking around with alternative assets. He’s an influencer with a massive, money-minting megaphone and he’s dangerous to his readers. He should have backed out months ago and now he’s blaming factors he seems to not understand are 100% inherent in fixed income investing.

Conclusion: I think it’s still safe to say that following the advice of online mustaches is a task best done skeptically.

Pete, you’re out of your element.

They’re more similar than you think.

Siskel and Ebert’s (overly) simple system.

Whenever I watch a movie or get into a TV show, I inevitably end up thinking about how I’d rate it. I also inevitably end up annoying my soon-to-be-wife by forcing her to rate it, too (sorry!). But in pure nerd fashion, I’ve spent a lot of time thinking about the best system to rate movies and shows. A 3-star system? 4-star? 5-star? Scale of 10? I’ve settled on a 4-star scale – here’s why, how it relates to investing and how it likely trickles down to your portfolio if you’re a client.

It should be noted that half stars are tempting but should always be fiercely denied by all reviewers. Moving on…

The reason why I’ve settled on a 4-star system is I think it maximizes the sum of the simplicity of the system plus the forced thoughtfulness from the reviewer.

A 2-star system, like the “Thumbs Up or Down” Siskel and Ebert used, is overly-simplified and too binary for me. “Yes” or “No” just doesn’t cut it. I’d end up with about 90% in the “No” category. Siskel and Ebert never held true to their 2-star system, anyway. They’d say things like “mild thumbs up” or “two thumbs way down.”

A 3-star system is overly simplified and allows for “cop-out” 2-star rankings. It’s too easy to just land at a 2 and call it good. Only having three choices means movies or shows are either bad (1), great (3), or in the middle (2).

A 5-star system forces a little more thought and gives more options  – “very good but not great” at 4 stars, for example – but it still offers the cop-out 3-star, middle-of-the-road rating.

A system with the scale of 10 goes overboard on choices and you inevitably end up with ratings that have no meaning. Is there really a meaningful difference between a 7 and an 8? If you watched the movie again a year later, there’s a chance you could rate it anywhere from a 6 to a 9 depending on whether the popcorn was good that day or not. The scale of 10 system does, at least, avoid a cop-out middle ground. 1-5 and 6-10 are distinctly either on the “good” or “bad” side of 50/50.

Don’t even get me started with a 1-100 scale.

The 4-star system is perfect. It’s neat, forces thought and has no cop-out rating. 1-star is terrible and wasn’t worthy of finishing. 2-star is watchable but not twice. 3-star is good but not top shelf. 4-star is great and is reserved for only a few shows or movies per year, at very most. Personally, I guard the 4-star rating like it’s gold. I’m probably too stingy about my 4s but we won’t go down that path. An even more simple breakdown:

1-star = Hated It

2-star = Tolerated It

3-star = Liked It

4-star = Loved It

What’s the point?

Building an appropriate investment portfolio is remarkably similar to the movie ratings system: Prefer simplicity, avoid middle ground cop-outs and be thoughtful.

The biggest factor in determining how risky a portfolio is will always simply be its exposure to equities. Yes, you could fill a portfolio to the brim with extremely risky bonds, but I’m assuming you’re not crazy and you use low-cost index funds and are globally diversified in any scenario.

Let’s now apply the 4-star rating system to portfolio management (which I do practice), and we will see how four distinct results work really well:

1-star = Preservation

2-star = Conservative

3-star = Standard

4-star = Aggressive

20% Stocks / 80% Bonds: Preservation

Better suited for an emergency account, a retiree with more immediate liquidity needs, or for someone with a large aversion to risk. Will not feel much pain even in the worst equity bear markets.

40% Stocks / 60% Bonds: Conservative

Leans conservative but has higher equity exposure and is best suited for someone with either a below average risk tolerance or a shorter time horizon.

60% Stocks / Bonds 40%: Standard

This mix has been a fixture for a reason. 60/40 leans aggressive (there’s that forced decision when you don’t have a middle ground to settle on). 60/40 makes sense for someone with an average risk tolerance and a medium-term time horizon. Will take a significant hit in a bear market but even in the 08/09 crash, a 60/40 portfolio took less than two years to recover.

80% Stocks / 20% Bonds: Aggressive

This “4-star” equivalent is for those investors with both longer-term time horizons and above average risk tolerance (and not just one or the other, a very important distinction). This allocation will get shellacked in a bear market, for sure, but that’s why you have me to tell you it’ll all be just fine.

(Note: A 0% stocks / 100% bonds portfolio or 100% stocks / 0% bonds portfolio violates the sacred law of diversification and thus doesn’t make the cut for consideration, no matter a client’s circumstances or risk appetite)

I’ve seen plenty of portfolio allocations that explicitly recommend something silly like exactly 43% stocks. Truth be told, there really isn’t a material difference between 43/57 and 40/60 and it’s exactly why I recommend these simple, round targets for client portfolios. Diving deeper within those round targets, there’s much more to getting a prudent spread between different factors like small/large capitalization, domestic and foreign, as well as value versus cap-weighted, but that’s for another blog post.

So what do you think? Thumbs up or thumbs down? Let me know! tyler@aldercovecapital.com