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10-Year vs. 3-Month Yield Inversions and Recessions: It’s Time Make a Plan

Last Friday, the yield on the 10-year US Treasury note was a tiny bit less than that of the 3-month US Treasury bill. This is known as a yield inversion, and depending on which article you read, this specific type of yield inversion (10-year minus 3-month) has happened before each of the past 6, 7, or 9 recessions. More overview in this :

Here is a showing the difference between the 10-year and 3-month yields since 1978. The gray areas are recessions. (Click to enlarge.)

Yield inversion. Recession. Yield inversion. Recession. Every time.

This does not necessarily mean you should sell all your stocks now. You can see for yourself that there is a bit of lag time between the initial inversion and the official start of a recession. The length of time can vary, and it could be years. That means if you jump out of stocks now, things might still go up for a while. In addition, there’s no way to know the length or severity of the recession. How will you know when to jump back in stocks again? Lots of people sat out 2008 through 2018.

In my opinion, this is like your local fire department knocking on your door and reminding you to make an emergency plan for whatever disasters you are exposed to – fire, earthquakes, tornadoes, hurricanes. A hurricane may not hit soon, or even this year, or the next. You make the plan now, so you will be prepared and know exactly what to do when it does eventually hit.

You should know that you are going to do in a recession before the recession actually hits.

  • What will you do if you lose your job and can find another one immediately? What if your business revenue drops significantly?
  • Do you know what areas of spending you would cut if you really needed to? What can you liquidate easily for cash?
  • What will you do if your stocks lose up to 50% in value and stay that way for years? Will you hold? Sell or rebalance according to a preset rule?
  • What will you do if your home value drops by 20% or more?
  • Where can you borrow money if needed? Are you sure that line of credit will still be there?

I’ve thought about most of this, but I should create a written plan that my partner can follow even if I’m not around.

Vanguard ETFs Now Permanently Cheaper Than Admiral Shares?

vglogoAfter posting about Vanguard’s most recent expense ratio drops on selected ETFs, I had skipped over the part that said this::

The growing size and scale of our funds have helped fuel operational efficiencies that lower our costs to serve clients, particularly ETF shareholders. As a result, the ETF share class of these ten funds is now lower than their Admiral™ share class counterparts.

For example:

  • Vanguard Total International Stock Index Fund Admiral Shares (VTIAX) at 0.11%
  • Vanguard Total International Stock ETF (VXUS) at 0.09%
  • Vanguard Emerging Markets Stock Index Fund Admiral Shares (VEMAX) at 0.14%
  • Vanguard FTSE Emerging Markets ETF (VWO) at 0.12%

I thought it was just a matter of the reporting dates being staggered and the Admiral Shares expense ratio would soon be updated back to being identical. This was just temporary… right? No.

Allan Roth reports in this with an interview with a Vanguard spokesperson confirming that the expense ratios of ETFs and Admiral Shares will no longer automatically be matched up:

What’s largely driving these changes is the increasing adoption of ETFs by Vanguard investors as their index vehicle of choice, which has enabled us to pass along the cost savings of scale,” Woerth said. “To put some numbers around it, even though ETFs make up only about 20% of our assets, they’ve garnered more than 35% of Vanguard’s net cash flow over the past three years.”

Another reason is that the mutual fund structure requires more administrative paperwork than ETFs and thus inherently cost more to run. Given how easy it is to buy ETFs from any brokerage account, I don’t see how the gap won’t continue to widen.

Should I convert my Admiral Shares to ETFs? Vanguard lets you convert most Vanguard mutual funds held at Vanguard to their ETF version (if it exists) on a tax-free basis. Allan Roth goes on to discuss this question as well. You should first set your tax lot tracking to “SpecID” if you want the cost basis to carry over to every specific share (otherwise they would use average cost basis on all of them).

I always liked the “slow food” feel of mutual fund investing. Your trade doesn’t execute until the end of the day. The price is set exactly at net asset value (NAV). There are no high frequency traders involved.

I won’t do it right away, but I will probably eventually convert my Admiral Shares to ETFs. Vanguard is basically telling me that mutual funds are old technology, and they won’t be spending any more resources on future updates. In the last few years, Vanguard has been aggressively converting people with old mutual fund-only accounts into brokerage accounts. I guess every basis point counts these days.

Vanguard should be careful though. If all my holdings are ETFs, it will be quite easy for me to move my assets to any other brokerage that offers better technology features and/or customer service. It was always easy to set an automatic purchase schedule with mutual funds at Vanguard, for example I could set it to invest exactly $500 each month. Vanguard doesn’t let you do that with ETFs, but other places do. I’ve been a long-time proponent of opening accounts directly at Vanguard, but I’ve been keeping an eye on , which offers fractional shares, free ETF trades, and customized DIY asset allocation with zero management fees. It looks like I’ll be trying them out soon.

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Amazon Prime Reading: Free $3 Amazon Credit w/ First Book

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