Where did these millennials put their money?
The Index, the Robot, and the Crowd
Several years ago I took a personal finance class at BYU. Unfortunately, I don’t remember everything presented in the course but two things did stick with me: 1) take advantage of the time value of money and 2) drive a Buick sedan. Alright, so the Buick part wasn’t as significant but my instructor was convinced it is the most cost effective vehicle on the road.
As I remember it, the time value of money is the idea that a given sum of money now is worth more than the same sum later. That is because money can earn interest over time. There are some formulas that go along with this idea but they are beyond the scope of my writing here.
Recently my wife and I realized we had some cash saved up and no major foreseeable expenses in the next two years. We wanted to do something with our savings so it would accrue interest (and I could obey my personal finance professor without buying a Buick) while it wasn’t being used. The question was: how should we do it?
We decided to run an experiment. We would choose a few different strategies and invest equal amounts in each. After two years we would compare the outcomes and those findings would help guide our financial planning in the future.
The three investment strategies we chose were the following:
This is the most traditional of the three approaches we chose. Index funds are designed to track a market index and have become increasingly popular over the past few decades. They are usually low-cost funds and often outperform actively managed funds. One interesting story I discovered on NPR’s Planet Money podcast describes a $1 million bet made between Warren Buffett and a group of hedge fund managers that pitted an index and hedge fund against each other. For the experiment, we decided to invest in Vanguard 500 Index Fund Admiral Shares (VFIAX) which track the S&P 500.
For the uninitiated, robo-advisors are automated online investing services, driven by algorithms instead of human money managers. Perhaps you have heard about one of these tools (e.g. Wealthfront, Betterment, etc.). These services are probably more attractive to younger investors who are quicker to adopt online services. Robo-advisors are designed to allow easy automated investing at set intervals. For our purposes though, we would make a single lump sum investment. After some research we opened an account with Schwab Intelligent Portfolios. Schwab asked us a few questions to establish a risk profile and allocated our investment accordingly. The portfolio is made up largely of stocks (about 60%) spanning 12 different categories. It also includes domestic and international bonds as well as precious metals. That’s right, we’re in the gold game now.
Peer-to-peer lending (sometimes called crowd lending) services like Prosper and Lending Club connect people who need money with people who have money. Groups of investors fund loans and receive returns based on the risk of the loan. Like a traditional loan, risk is determined by a borrower’s credit history, employment, etc. We were first exposed to Lending Club by my wife’s grandfather who boasts a impressive return with the service. For the experiment we opened an account with Lending Club and spread our investment across 477 individual notes, or loan fragments. Some of those borrowers will default, but lenders hope to diversify away some of the risk by purchasing small pieces of many different loans. The site currently claims we can expect a 9.87% annualized return with our portfolio.
The experiment has been running for several months now. Each account has experienced positive growth and we’re already enjoying the benefits of the time value of money. In 18 months we’ll declare the winner and offer what other insights we have. We’re definitely not financial experts but this has made investing fun for a couple of young millennials.
The experiment began on May 15, 2016. Click above to see how each account is performing after the first few months.