New Year's Day Wager Step 1

The New Year’s Day wager has started. SPY closed down 0.99% for the day finishing at 205.54. Unfortunately, I bought it before the close in a couple of chunks with an average price of 207.30.  This points out a problem for Friday. If it goes up, the strategy says to sell at the close. But, I could still have a loss. So, what to do? We’ll see.

New Year's Day Wager

The S&P 500 data for the Santa Claus rally provided an opportunity to look at another supposition. I assume some people will sell at the end of the year for tax purposes. I also assume that some people will buy early the next year to establish positions. So is it worth buying at the close of a year and selling early to following year?

The S&P 500 went up 61% of the time on the first trading day of the New Year (over the previous days close). The average overall gain was 0.6%. The average gain was 2.1% in the positive years, while the average loss was 1.7% in the negative years.

I also looked at the second trading day’s changes. When the first day was up, the second day went down 56% of the time. When the first day was down, the second day went up 68% of the time. So following are the steps in the New Year’s wager.

• Buy the SPY ETF at the close on New Year’s Eve.
• If the market is up the next day, sell for profit.
• If not, sell the on the following trading day.
• There is a 13% chance it will be down again (take the loss).

Since New Year’s Day is on a Thursday this year there will only one trading day before the weekend.  This has happened nine previous times since 1950. Seven times the wager succeeded on Friday. The other two times it succeeded by waiting until Monday.

Santa Claus Rally

In the last several days, I have seen comments on CNBC about a Santa Claus rally. CNBC observed that, on the average, the stock market rose after Christmas and the first few days of January. To test this, I downloaded daily S&P Index data since 1950. I analyzed what happened over the next eight trading days. I computed the average change in the close from the last trading day before Christmas to the close eight days later. Out of curiosity, I also looked at the results based on which day of the week Christmas fell. Following are the results.

Next 8	All	Up	Down	Up %	Ave	Best	Worst
All	64	48	16	75%	1.3%	7.7%	-5.7%
Sun	9	7	2	78%	0.5%	3.4%	-2.1%
Mon	9	7	2	78%	1.7%	4.0%	-0.4%
Tue	10	6	4	60%	0.5%	6.5%	-5.7%
Wed	9	6	3	67%	2.1%	6.3%	-2.4%
Thu	9	9	0	100%	3.0%	7.7%	1.0%
Fri	9	7	2	78%	1.1%	3.8%	-2.7%
Sat	9	6	3	67%	0.2%	3.0%	-4.0%

Out of 64 total years, the market went up in 75% of them. The total average change was +1.3%.

Interestingly, Christmas fell on a Thursday nine times and the S&P 500 increased over the next eight days every time with an average increase of 3.0%. The increases ranged from 1.0% to 7.7%. With only nine samples, one should ask if that’s enough to invest in. It was for me; I bought some SPY ETFs.

Next we’ll have to look what happened in the following Januarys.

More on P2P

There are a few more things about peer to peer (P2P) lending that are of interest. There is a secondary market where you can buy and sell notes. There are links on the Lending Club and Prosper web site to Folio Investing where existing notes can be traded. I have bought and sold notes from both platforms. It’s pretty easy. I will be analyzing this later.

There are some residency restrictions with P2P. While Indiana residents currently can’t make loans, this will soon change because Lending Club recently went public. This apparently lowers their barrier in all states. When I inquired about their schedule, they suggested Indiana residents open an account now, and will be notified when they can start making loans. I believe Indiana residents might be able buy notes now, but am not certain. It might be worth a try.

Peer to Peer Lending

This discussion is focusing on alternative investments. I’d like to introduce a different area that I have been pursuing, peer to peer lending (known as P2P). This is a relatively new investment vehicle made possible by the internet. Just as Ebay made it possible for individuals to sell small items to others easily via the internet, P2P lending makes it easy for individuals to loan small amounts of money to others via the internet.

Investors open accounts with P2P providers and deposit funds with them. Borrowers use the same provider and request loans. The provider’s web site provides a mechanism to match the two, and execute the loan. Following is a brief description of how it works,

A borrower fills out a loan application at the web site and provides some required personal information. They use this approach because it’s easier and less expensive than trying to get a bank loan. Typically, borrowers are seeking money to consolidate debt or to pay off credit cards. A borrower might seek $10,000 to pay off credit card debt and agree to pay back the loan over 36 months at a lower rate.

The provider collects the information, runs credit reports and background checks, and rates the credit worthiness of the borrower. They assign an interest rate and create a “Note” describing the proposed loan. The provider then lists these on the provider’s web site.

Investors can review the available “Notes”. They have access to information about the borrower, purpose for loan, amount desired, length of the loan, and the interest rate. They can then offer to make part of the loan, generally something like $25.

When investors have agreed to cover the total loan, the provider issues the loan. They transfer money from the investor’s accounts to the borrower’s account. In the $10,000 example this might involve 400 investors each loaning $25 to the single borrower. The borrower makes a single monthly payment to the provider. The provider divides the payment and credits each investor’s account with their portion.

The provider charges small fees to both the investors and borrowers for their services. They will also pursue collection of late and bad debts. The provider wins because of the fees they earn. The borrower wins because they pay lower interest rates. The investor wins because they earn higher returns on their money. Banks and credit card companies are the losers because they lose very profitable business.

We have opened regular investment accounts at the two biggest providers, Lending Club and Prosper. I will be reporting on our experiences over the next several weeks. In the meantime, you might do an internet search on peer to peer lending.

Allocations

The next step is to pull together the allocations recommended by the four online advisors. First, I attempted to be able to make like comparisons by answering their questions and picking plans most appropriate to my current situation. This led to the following proposed allocations.

Asset Class	Personal Capital	Wealth Front	Betterment	Vanguard
US Stocks	44%	36%	25%	22%
International Stocks	19%	33%	23%	9%
US Bonds	20%	10%	30%	55%
International Bonds	5%	7%	22%	14%
* Alternatives	13%	14%	0%	0%
* Real Estate, Metals, etc.

The allocations vary a fair amount, but would be moved closer together by adjustments to my answers on each site. One thing that does stand out is that Vanguard is far more conservative than the others.

These will be basis for the allocations that I ultimately use for my personal investments. It would be pretty easy to get hung up on trying to optimize these allocations. But the reality is that future results will be more dependent on the overall market direction than the percentages I use to allocate each asset.

Next I used the sites to get proposed allocations for my young friend. Following are the results (Personal Capital wasn’t an option because of the human interaction requirement).

ETF Asset	WealthFront		Betterment		Vanguard
	Taxable	IRA	Taxable	IRA	IRA
VTI - Vanguard US Total Stock Market	35%	21%	16%	16%	59%
VEA - Vanguard FTSE Developed Market	21%	18%	37%	37%	25%
VWO - Vanguard FTSE Emerging Markets	16%	15%	11%	11%
VIG - Vanguard Dividend Appreciation	8%	15%
VTV - Vanguard US Large-Cap Value			16%	16%
VOE - Vanguard US Mid-Cap Value			5%	5%
VBR - Vanguard US Small-Cap Value			5%	5%
VNQ - Vanguard REIT		14%
DJP - iPath DJ-UBS Commodity	5%
MUB - iSares National AMT-Free Muni Bond	15%		5%
LQD - iShares Corporate Bond		10%	1%	2%
EMB - iShares JP Morgan Emerging Markets Bond		7%
BND - Vanguard US Total Bond Market				3%	13%
BNDX - Vanguard Total International Bond			2%	4%	3%
VWOB - Vanguard Emerging Markets Government Bond			2%	2%
	100%	100%	100%	100%	100%

There is a more detailed breakdown here because of Personal Capital exclusion. Also included are taxable and IRA options because my friend has both. While there are a lot of different allocations, all come down to a stock investment of 80% to 90%.

The next step is to map these recommendations into actual investment products and amounts.

Betterment, Wealthfront, Vanguard, and Personal Capital

I’ve looked at theoretical performances of models from Betterment, WealthFront, and Vanguard.  I’ve also learned quite a bit about each simply by interacting with their web sites. In addition, Personal Capital, the firm whose advisor started this process for me, is responsible for convincing me to use the approach of allocating my investments over different asset classes and rebalancing periodically.

So, am I ready to pick between these alternatives? No. Clearly I have decided to manage my own investments. I am in the process of designing and implementing my own investment plan. It’s a lot more work than I anticipated. At the same time, I am looking at these issues for someone else. This person is pretty much the opposite of me. She is young, employed, and with less money to invest. It’s become apparent that the effort that I’m making is not feasible for her. So, one of the above choices might be a better approach in her case.

In the interim, I have not been able to eliminate any of the four alternatives that I’ve encountered. That’s because there is something to like about each.

Vanguard is the least expensive of the group. If you use one of the other three, then you will end up with substantial investments in the Vanguard products anyway.

Betterment has a lower cost of entry and may be easier to use than the others.

WealthFront offers more asset classes than the two previous choices. I particularly like the inclusion of a real estate ETF in the mix.

I am quite fond of Personal Capital. They seemed to have a more substantial approach. This is likely because they involve human interaction. But, this comes with a price, the highest cost.

So my jury is still out. Hopefully not for long though.

Vanguard Target Retirement Funds

While continuing my research in alternative investments I encountered some discussions about target date mutual funds, specifically Vanguard’s offerings. Both Betterment and WealthFront make extensive use of Vanguard’s ETF’s. Vanguard also uses these in their Target Retirement mutual funds. There are different funds spaced about every five years. So if you plan on retiring in 2040 you would invest in the Vanguard Target Retirement 2040 mutual fund which then holds Vanguards ETF’s in stocks and bonds. Initially it is weighted more to stocks and gradually moves the allocation towards bonds.

So I looked at this fund in particular. Had we invested $100,000 in this fund in 2008 we would have suffered almost a 50% loss in 2008, but now recovered to about $127,000 today. This is better than both of our Betterment and WealthFront scenarios.

So, we might ask why not just use this target fund approach? WealthFront addresses this on their web site in an FAQ, “How does the WealthFront service compare to a target date fund?”  In summary, they make four points. First they argue that they are more efficient at tax loss harvesting (a way of reducing taxes). Since I do my investing primarily in IRAs, this doesn’t apply to me. Also, they only do this for accounts with balances greater than $100,000 which probably doesn’t apply to most of my friends and family.

WealthFront also argues that they might achieve higher expected returns because they deal with about twice as many asset classes. They also argue that with more specific tailoring, they can do a better job at risk tolerance. Finally they argue that while their costs are higher than Vanguard’s, these costs would be offset by better performance.

So do the performance results make Vanguard a better choice than Betterment and WealthFront? Not necessarily. You can find individual components in the ETF’s used that outperform all of these. Just once again, hindsight is a wonderful in investing.

I am going to continue the analysis with two goals in mind. First, how will I modify my personal investment strategy? Second, what should I recommend to someone else?

Betterment Wealthfront Comments

It is important to remember that the numbers presented do not represent the actual performance of Betterment and WealthFront from 2008 (I’m not sure either existed then). They do represent what would have happened in my Fidelity IRA account if I used the recommended allocations (made in 2014) starting in 2008.

The primary purpose was to determine what kind of results one would have achieved by using ETFs and an allocation scheme over the years. My reactions to the results are pretty positive. They tend to support the underlying changes I’m going to make in my own investing strategy.

The results also provide an opportunity to compare the Betterment and WealthFront recommendations. The WealthFront models performed better than the Betterment ones. The best results were in the more conservative models. They performed better in years when the overall markets were down and not as well when the markets were up. An initial $100,000 in 2008 would be worth $123,079 with the WealthFront allocations and $116,737 with the Betterment allocations. The more aggressive allocations would be worth $113,774 with the WealthFront allocations and $107,232 with the Betterment allocations.

The annual return rates varied quite a bit. That’s not unexpected with the major decline in 2008 followed by some very good rebound years. The average return rates were higher with the more aggressive models as expected, but the variances were lower with the more conservative ones. The more important results were that the average annual return rates ranged from 4.3% to 5.5%. This was in spite of including the terrible 2008 year. If the models had started in 2009, the average annual return rates would all have been double digits with the variances half as much.

The SPY ETF (tracks the S&P 500 index) actually outperformed all. It would have returned an annual average of 10.2% over this period. Interestingly the Vanguard Total Market ETF (VTI) had an annual average return rate of 10.9%. Of course hindsight is a wonderful way of investing.

If one allocates funds over a few different investments, one is guaranteed that some individual components will outperform the conglomerate, while others will underperform. Reallocating periodically will take advantage of this phenomenon and implement a dollar cost averaging approach to one’s investments. I think this is a good thing.

A little more in depth look at the recommended allocations shed a bit of light on Betterment’s underperformance. All four scenarios had the Vanguard Total Market ETF (VTI) as a significant component ranging from 11% to 18%. Also, they all had the Vanguard FTSE Developed Market ETF (VEA) also. But Betterment had it as a more sizable allocation (37.5% in one case) and it performed poorly over the period (3.4% average annual return). I suspect that alone explains the performance difference.

I do not consider these performance results to be a factor in deciding between these two alternatives. The scenarios the models were based on are too far removed from reality to be much more than a global view that these investment alternatives are worth considering. I will be revisiting these again.

Betterment Analysis

I used the same techniques on my Betterment analysis. There were a couple of complicating factors. In the more aggressive scenario Betterment did not include an IRA option and they did include a municipal bond ETF in my allocation.  I dropped the tax free ETF and increased the other ETFs proportionally to cover for this missing ETF. Also Betterment changed some of the underlying ETFs a year or so ago. A couple of them were not in existence in 2008. These were also dropped in the initial 2008 allocations and only included beginning in mid 2013.

Following are the Betterment results with the preceding adjustments.

Reallocation Frequency	Betterment 55/45		Betterment 90/10
	From 2008	From 2011	From 2008	From 2011
No reallocations	$98,093	$99,845	$90,930	$90,930
Six months	$112,109	$127,007	$102,554	$133,427
Quarterly	$116,737	$131,277	$107,232	$138,141
Monthly	$113,352	$129,850	$99,288	$134,426
	Betterment 55/45		Betterment 90/10
Year	From 2008	From 2011	From 2008	From 2011
2008	-35.0%		-48.4%
2009	22.3%		32.0%
2010	11.8%		14.0%
2011	-2.1%	-2.1%	-7.1%	-7.1%
2012	13.3%	13.3%	17.5%	17.5%
2013	13.1%	13.1%	21.3%	21.3%
2014	6.4%	6.4%	7.6%	7.6%
Average Annual Return	4.3%		5.3%
Standard Deviation	18.85%		26.59%

Once again, reallocating quarterly led to the best results. It’s problematic to start in 2008, because there was a loss of a third to a half of the initial investment in the next fifteen months. Since then a pretty steady rebound has occurred. The average annual rate of return has been 4.3% and 5.3% (including the disaster in 2008). The standard deviations do show that the more conservative allocations tend to perform at a steadier rate, but produce lower returns.