The richest 1% of Americans have access to great financial tools and advice: Firms like Goldman Sachs provide them with (legal) tricks like Tax Loss Harvesting (TLH). Never heard of TLH? Neither had I until my buddy Andrew Dumas, after reading my post titled "Show Me The Money: Six Strategies to Put Your Cash to Work," mentioned a new startup called Weathfront that was on the cutting edge of ETF fund-based portfolio management. This opened a whole new world of investing up to me, which I'd like to share with you.
But first some background: In my past blog post I talked about ETFs, or Exchange Traded Funds, which are a class of funds that create a basket of stocks based on a particular segment of the market. For example, in the past if you wanted to invest in technology companies you basically had two options: You could pick the companies you thought would be the winners, like Google and Yahoo and buy stock in those directly, or you could invest in a mutual fund that has an expert who picks the companies, and you'd pay a management fee for his or her expertise. But ETFs offer a third choice, and it's worth really understanding how they work. Here's a description from Wikipedia:
"ETFs generally provide the easy diversification, low expense ratios, and tax efficiency of index funds, while still maintaining all the features of ordinary stock, such as limit orders, short selling, and options. Because ETFs can be economically acquired, held, and disposed of, some investors invest in ETF shares as a long-term investment for asset allocation purposes, while other investors trade ETF shares frequently to implement market timing investment strategies. Among the advantages of ETFs are the following:
• Lower costs – ETFs generally have lower costs than other investment products because most ETFs are not actively managed and because ETFs are insulated from the costs of having to buy and sell securities to accommodate shareholder purchases and redemptions. ETFs typically have lower marketing, distribution and accounting expenses, and most ETFs do not have 12b-1 fees.
• Buying and selling flexibility – ETFs can be bought and sold at current market prices at any time during the trading day, unlike mutual funds and unit investment trusts, which can only be traded at the end of the trading day. As publicly traded securities, their shares can be purchased on margin and sold short, enabling the use of hedging strategies, and traded using stop orders and limit orders, which allow investors to specify the price points at which they are willing to trade.
• Tax efficiency – ETFs generally generate relatively low capital gains, because they typically have low turnover of their portfolio securities. While this is an advantage they share with other index funds, their tax efficiency is further enhanced because they do not have to sell securities to meet investor redemptions.
• Market exposure and diversification – ETFs provide an economical way to rebalance portfolio allocations and to "equitize" cash by investing it quickly. An index ETF inherently provides diversification across an entire index. ETFs offer exposure to a diverse variety of markets, including broad-based indices, broad-based international and country-specific indices, industry sector-specific indices, bond indices, and commodities.
• Transparency – ETFs, whether index funds or actively managed, have transparent portfolios and are priced at frequent intervals throughout the trading day.
Some of these advantages derive from the status of most ETFs as index funds."
So, ETFs are a great way to place bets on, say, "technology" or "healthcare" if you believe in those industries, or classes of companies like "Large Cap," "Small Cap," "Domestic Market" or "Emerging Market" stocks without having to pick specific stocks.
But back to Dumas' suggestion: There's also another way to get into ETFs -- via two startups that have created an investment management service around ETFs. Think of it as a "financial advisor 2.0," offering much lower fees (as low as 0.15%) than traditional mutual funds. One of these startups is called WealthFront, and the other is called Betterment. My wife and I have put money in both of them, at the same time, and we're going to compare which one is more effective at maximizing wealth, as well as being the most usable of the two. It's the "battle of the automated investment services."
These two services both offer access to things like Tax Loss Harvesting that once was reserved for the richest 1% of Americans. TLH is explained by Betterment here, but at a high level, it basically consists of selling assets that have depreciated in value to create a loss, then re-buying in that same asset class, and using the loss to offset your other gains. Think of it as making the bset of a bad situation -- and it typically adds 0.77% to a typical customer’s after-tax returns, annually.
This blog will be a running post with updates as we experience the two services. Let the Games begin! See the comments on this post for running comparisons between the two services.
PS -- as I wrote in my "Show Me The Money" blog, anyone can start investing with as little as $25 -- seriously. Being an investor is a mindset more than anything. So if you don't think you have enough money to start investing, put down that Venti Starbucks Frappuccino, scrape together $25, and get started.