Two Year Performance Review

It's been two years since I purchased my first stock as a value investor, so I figured that it's time for a performance review. Don't put too much weight into this review, as I feel that it doesn't mean much until I've been investing at least 5 years. Although, if you really want to send me your money, you can leave a comment with your contact information and I'll let you know where to mail the check.

Below are the annualized returns that I've made since April 21, 2005:

• 24.6% annual return excluding stock purchases made within the last 6 months
• 23.2% annual return for Harley-Davidson (first stock purchased as a value investor)
• 33.0% annual return including purchases made within the last 6 months (not very meaningful given the short time that I've held recent stock purchases)
  

My goal has been to earn a 15% return, so I'm extremely pleased with these results. Especially considering in two years I've only purchased 7 stocks; of which I purchased 3 stocks within the last month. (The recent activity is due to a 401k rollover that I now control versus only being able to invest in a limited number of mutual funds or company stock.)

I haven't had to spend all of my time day trading, and I haven't lost any sleep at night worrying over my portfolio. Value investing is definitely the style of investing that suits my time (limited) and risk level (even more limited). Don't get me wrong, value investing takes time to research annual reports and other material and there is always risk associated with investing; however, I find that it makes the most sense and the most cents for me.

Portfolio Mix -- Stocks, Bonds, or Index Funds?

There are quite a few different approaches to investing. One of the first things to do when investing in my opinion is to determine your strategy and then stick with that strategy. Personally, I have decided to invest for the long-term as a buy and hold value investor.

Previously, I worked for a large company that provided a 401k with 10-15 mutual funds to choose from (and company stock). Because of this, I used the 401k as a vehicle to match the market and invested in the lowest cost, index funds available. To beat the market, I invested in individual stocks via my taxable investing account or a Roth IRA.

Now I work at a small company where we offer a SIMPLE IRA for our tax-deferred retirement vehicle. This provides the entire investing universe at my finger tips, which raises the question--What portion of my portfolio should be invested in stocks, bonds, or index funds?

Reading Christopher H. Browne's The Little Book of Value Investing makes me question if having a significant portion of my portfolio (15-30%) in bonds or index funds is really the best answer. Mr. Browne states that:

"If you don't need to tap into your nest egg to live, you can afford to take the high octane approach to investing. You can ride out any bumps along the way as you try to maximize your long-term returns. However, if your time horizon is shorter and you draw money from your nest egg to live, a bit more prudence is required. I like to think of an investment portfolio as a college endowment....Individuals should structure their financial affairs in a similar way. Spend an amount you think is less than the long-term returns you think you can earn on your portfolio. Five percent is not a bad place to start. If your portfolio can grow at 10 percent, you can increase the amount you spend at the same rate as inflation. However, stock portfolios are not passbook savings accounts. Your returns will fluctuate from year to year. For this reason, I like to keep three years of spending in short-term bonds to smooth out any down years in the portfolio."

To me this is quite an eye opener and very different from other advice that I have read, especially in regards to portfolio mix as you near retirement. Dave Ramsey in The Total Money Makeover recommends that "a fully funded emergency fund covers three to six months of expenses." Combining Mr. Browne and Mr. Ramsey's thoughts has led me to ponder a portfolio mix where all of your holdings are in high-quality, value stocks with the following savings:

• Base Savings/Emergency Fund: Up to age 30, maintain 6 months worth of expenses in a high-yield savings account, such as E*Trade's Complete Savings account currently yielding 5.05%.
• Savings Option 1: For every year above age 30, increase your savings by 1 month worth of expenses. By age 60, you would have increased your savings to cover 3 full years of expenses.
• Savings Option 2: Every 5 years above age 30, pull 5 months worth of expenses out of your investment portfolio to transfer into a savings account. This would keep more of your money in your stock investments for a longer period.

In both option 1 and 2, you could use short-term bonds or CDs instead of a savings account. However, I would recommend that the emergency fund be held in a savings account for liquidity.

What to do with Cash in Investment Accounts

Having consolidated my investment accounts into E*Trade, I now need to decide what to do with cash in these accounts. For my taxable brokerage account, one option is to transfer the cash into an E*Trade savings accounts that currently pays 5.05%. However, that option is not available for retirement accounts, such as SIMPLE IRA and Roth IRA accounts. I could simply leave the cash in one of the E*Trade sweep accounts, but they only have any APY of up to 0.40% for accounts with a balance of less than $25,000 (E*Trade Uninvested Cash Rates).

Another option is to find a mutual fund for parking cash in the short-term that has low expenses and a low initial investment. To find such mutual funds, I used E*Trade fund screener to search for the following:

• No transaction fee (NTF) funds
• Expense ratios of <= 0.50%
• Minimum initial investment < $250 (for IRAs)

This screen generated the following options for investing cash, short-term. Notice that the last entry is an S&P 500 index, which could be good for long-term investing.

Fund Name	Symbol	Exp Ratio	IRA Min	1/5/10yr Ave Ann Return
American Century CA LG-TERM T/F INV	BCLTX	0.49%	$0	4.25% / 3.96% / 4.83%
American Century CA Tax-Free Bond	BCITX	0.49%	$0	4.99% / 4.72% / 5.44%
American Century Tax-Free Bond Inv	TXTIX	0.49%	$0	4.14% / 3.80% / 4.69%
American Century AZ Municipal BD Inv	BEAMX	0.49%	$0	4.25% / 3.96% / 4.83%
American Century Tax-Free Bond Inv	TWTIX	0.49%	$0	4.20% / 4.06% / 5.00%
AMF Intermediate Mortgage	ASCPX	0.48%	$0	5.89% / 3.21% / 4.99%
AMF U.S. Government Mortgage	ASMTX	0.48%	$0	5.88% / 3.94% / 5.45%
AMF Ultra Short Mortgage	ASARX	0.46%	$0	5.06% / 2.72% / 4.22%
Columbia U.S. Treasury Index Z	IUTIX	0.36%	$0	4.54% / 4.21% / 5.72%
PIA Short Term Govt Secs	PIASX	0.35%	$0	4.74% / 2.61% / 4.38%
SSGA S&P 500 Index	SVSPX	0.18%	$0	11.74% / 6.62% / 7.46%

Stock Purchase: JNJ

Purchased Johnson & Johnson (Google: JNJ) today. Here are the reasons:

• In business for 120 years
• Consistent earnings and revenue growth -- 73 consecutive years
  
• Consistent dividend increases -- 44 consecutive years
• Margin of safety around 35% based on 10% owner earnings growth for the next 10 years with an 11% discount rate
  

Stock Purchase: MMM

I purchased shares of 3M (Google Finance: MMM) today. Reasons that I purchased:

1. Two year stock buyback program of $7.0 billion approved in February
2. Over 60% of earnings are from outside the U.S. -- provides good international exposure
3. Historical earnings growth -- 20% annual growth in last 5 years
   
4. Dividend yield of 2.51%
5. Margin of safety around 40% based on 10% growth for next 10 years with an 11% discount rate
   

Financial Simplification

After changing jobs and moving, I found myself with way too many accounts....rollover IRAs, Roth IRAs, brick & mortar checking/savings accounts, online savings accounts, investment account, etc.

I realized that with so many accounts, I wasn't checking all of them regularly. More importantly, or more egregiously, I have been allowing money to sit idle. Having a cash position intentionally while you wait for a good stock to buy is one thing, but letting money take a vacation in the form of cash is not good.

So, I've decided to consolidate my financial accounts into as few as possible in an attempt to 1) simplify my financial life and 2) increase my performance/usage. While there are many good financial services companies out there, I've chosen the following two companies because they offer the features that I want while sacrificing the least.

1. Bank of America
1. Checking account -- On this account I've setup direct deposit on all paychecks, automatic payments for utilities and monthly bills, and
   
2. Visa
3. Rollover IRA -- Consolidated all 401ks and pensions from previous employers. This replaced accounts that had been at Fidelity or with employers
2. E*Trade
1. Taxable investment account -- Previously this account was with Scottrade, so I have had to sacrifice $7 trades for $12.95, but given the buy and hold nature of my investing, while it's unpalatable, I'm willing to accept it in the name of simplification.
2. Roth IRA accounts -- Previously these two accounts were with Scottrade as well.
3. Online savings accounts -- One account for Jessica and myself, and another account for our daughter. Previously these were at ING Direct, but the 5.05% is much more appealing than the 4.50%.
4. Coverdell Education Savings account -- This is a new account, but my goal is that as our daughter's savings account accumulates, and I find a good stock or mutual fund to invest in, I'll then move the money here to save for her education.

Below are the accounts that I still have and whether or not I'll keep them:

1. Discover -- I love the secure, single-use online number that Discover can create for online shopping. Plus the 1% cashback is nice. For now, I'll keep.
2. HSA Bank -- This is a Health Savings Account that I'll keep open.
3. Mortgage -- I'll keep where it's at. I rarely look at this account online, since the payment is made automatically from my checking account.
4. Auto loan-- Same as the mortgage, so I'll keep. This will end within 12 months, so not worth the effort.
   
5. School loan -- Same as the mortgage, so I'll keep.
   

Commentary: Sure, The Trade Deficit Is Scary -- But We Can Handle It

Commentary: Sure, The Trade Deficit Is Scary -- But We Can Handle It: "Which is more important, big trade deficits or high productivity? For now it looks as if productivity wins. Why? The net wealth of the U.S. is huge compared to 10 years ago, even after taking into account that Americans owe foreigners some $3 trillion because of cumulative trade gaps. Rising net wealth means the positive influence of higher productivity -- which boosts economic output -- has been stronger than the negative impact of big trade deficits. Think about it this way: The U.S. is like a family enjoying rising income even as it takes on sizable debt -- not too unusual in these days of big mortgages. You'd worry if such a family had to sell off assets or draw down savings to pay for today's consumption, a sign that it was living beyond its means. The family would soon be in trouble if it didn't curtail spending. But if the family's net worth -- assets minus debt -- is going up, its financial position is actually improving. That's essentially what's happening to the financial position of the U.S.: Not only is it getting better, it's getting a lot better. The best way to show this is to look at a new measure of national wealth that I call 'net real wealth per capita.' Start with the net worth of households as reported by the Federal Reserve. Then subtract federal, state, and local debt, and adjust for inflation and changes in population. What's left is a figure that measures, somewhat imperfectly, the average net value of the liabilities and assets of Americans, assuming that they are responsible for the government's debt as well as their own."

The comment about worrying if a "family had to sell off assets or draw down savings to pay for today's consumption" is what really drew my attention. Maybe Michael Mandel is correct and we're not selling off assets or drawing down savings, but we're taking on debt and the collateral is our assets.

I think that Warren Buffett states it pretty well in the Berkshire Hathaway 2004 annual report. "The balancing item to this one-way pseudo-trade -- in economics there is always an offset -- is a transfer of wealth from the U.S. to the rest of the world. The transfer may materialize in the form of IOUs our private or governmental institutions give to foreigners, or by way of their assuming ownership of our assets, such as stocks and real estate. In either case, Americans end up owning a reduced portion of our country while non-Americans own a greater part."

I personally don't think Mr. Mandel's attitude toward the trade deficit is safe for us as a nation. I obviously need to do more research into the impact of our twin deficits, but it always seems safest to have less debt and no more than what is manageable...as a family or as a nation.