These are my top picks for innovations that most benefit personal investors.
#6: Decimal pricing. Do you remember when stocks were priced in fractions? Like 23 and 3/8? This was not cool. Not only was it clunky, but it meant that bid/ask spreads were usually stuck at 1/8 of a dollar per share, or 12.5 cents per share. Luckily, today most investments are priced in decimals. Some exceptions include bonds and the interest rates on most mortgages. How archaic!
#5: Free online investment info. Information used to largely come in paper form, and cost money. Or you could pay tons of money for Quotron… really not practical.
#4: Discount online brokers. My Dad used to pay $50-$100 per stock trade — over the phone with a broker. Today some of my ETF trades are free, many of my trades average about $1, and my most expensive trades cost $8.
#3: Exchange-Traded Funds (ETFs). ETFs fix most of the problems with mutual funds such as high(er) expenses and lack of intra-day trading. ETFs also open up a wide variety of investment options including access to commodities, leveraged funds, and precious metals.
#2: Index investing. Index investing brings two huge advantages. First, incredibly low costs. Second, maximum diversification. Index investing has, and continues to revolutionize the investing playing field.
#1: 401(k)s (and IRAs). Named after a once-obscure IRS code, 401(k)s, or 401Ks, offer investors decades of tax-deferred growth opportunity. IRAs offer a similar advantage. Finally Roth IRAs offer similar tax-deferral opportunities where the tax benefit is back-loaded.
The Crazy Ivan Account is currently up to $25,953. Current holdings are all ETFs, one stock, plus a bit of cash: DTN, INTC, IVV, JNK, MTS, PBP and XLE. “Ivan” is up slightly from its high early this year. XLE has been my worst performing investment, INTC (Intel Corporation) my best. JNK has and continues to pay nice dividends… it’s currently yielding a fat 8.55%.
I’m happy to say the Ivan Account has beaten the S&P500 slightly so far this year. I haven’t crunched the numbers, but I’d wager it has also done so with less volatility than the S&P500. The best thing though is that I can channel my financial energy and emotion through this account, while leaving my other, larger nest egg largely untouched. Plus making low-cost, tax-deferred IRA trades is fun. Bonus!
If I were to design a new currency I would design something very much like BitCoin. It is a digital currency with about 6.5 million units in circulation. BitCoin will never have more than 21 million units of currency in circulation…. ever. Bitcoin is divisible into tiny fractions of a unit down to millionths of a BitCoin and smaller.
BitCoin is digital money. Imagine PayPal but without the hassle, or the commissions. Image digital gold. Gold which is mined (by computers), but has a known maximum supply of 21 Million ounces.
Gold’s value is largely related to its relative rareness. Gold’s usefulness is pretty limited except as jewelry and a form of currency. Industrial uses of gold consume only a small fraction of gold’s supply. And gold can be mined faster than it is consumed.
Gold cannot be as easily traded or exchanged as BitCoins. Yes gold ETFs can be exchanged for cash which in turn can be used for web transactions, but this is a multi-step process. BitCoins, however, can be easily exchanged from person-to-person or person-to-business with ease.
Today each BitCoin is worth more than $13. BitCoin valuations have fluctuated rapidly. One person, according to Forbes, turned $20,000 into $3 million by buying Bitcoins early then selling them for a killing.
BitCoins may one day be worthless relics on discarded hard drives. Or BitCoins may become the E-commerce alternative replacing PayPal. Right now BitCoins seem to be priced about what the current mining cost will bear. The cost of mining is measured in 1) electricity (energy) and 2) depreciation of the graphics cards used to mine new BitCoins. This tends to put a short-term ceiling on BitCoin prices. However, the BitCoin system makes the cost of BitCoin mining escalate geometrically. Eventually, if all goes optimally, the mining cost will be come prohibitively expensive.
If BitCoins gain wider and wider acceptance I anticipate they will hold or increase in value. However if either of the following happen they will end up virtually worthless: 1) BitCoins simply don’t gain wide acceptance, and lose acceptance over time. 2) The algorithmic infrastructure underlying BitCoin is found to be flawed. There is yet another alternative: That a BitCoin-like system is created the competes with the original BitCoin. Finally one more possibility: various governments outlaw BitCoins.
In closing, BitCoin is a brilliant idea and a risky “investment”. It is riskier than gold, silver, or index ETFs. It is similar in risk to buying options, because the value can rapidly go to zero. However, it is an interesting speculative play that is potentially inflation-proof. Inflation-proof because, unlike government currencies, the printing presses (BitCoin mines), are held in check. Buying 1500 dollars worth of BitCoins is no sillier to me than buying a $1500 gold coin. Just make sure you guard your BitCoins like you would your expensive gold coin… security, security, security. Because BitCoins can be stolen, just like gold. And they can be stolen without the thief even setting foot in your house.
My current employer is radically revamping its 401K plan. I have noticed that companies tweak their 401K plans about annually, and dramatically change them every 5-7 years. This time it’s big. One of the choices allows for both ETF and mutual funds purchases. The EFT option has me excited.
So far in my career I have worked for three Fortune 500 technology companies. Long story short, I have two 401Ks and a couple IRAs. Between them I have about 8% invested in ETFs and the rest in mutual funds. After the 401K redux, I’ll likely have about 30/70 ETF to mutual fund mix. I’ll keep my asset allocation largely the same, but I’ll work out a bit of math here and there to do so. Some mutual funds stay, some funds go, some switch to higher expense-ratio versions, and some are frozen from new money after a certain date. Over time my retirement assets may approach a 50/50 ETF-to-mutual-fund ratio.
A similar 401K change may be coming your way soon. The booming ETF trend is continuing unabated with over $1 trillion dollars in assets under management in 2010; some predict that doubling by 2015. Why? 1) Institutional investors like ETFs, 2) retail investors like ETFs, 3) exchanges like ETFs, 4) brokerages like ETFs. Generally for the same reason: lower costs.
The upside of more options is access to better options and greater potential for diversification. The downside is trading fees for ETFs… $7.95 under the new 401K paradigm. Wise, infrequent purchases can mitigate trading costs. This requires a bit of financial planning, but is not really a big deal for serious investors. And there are ~25 ETFs that trade for free. One can invest in them every paycheck (like buying EEM for free) then periodically, every 6 months or one year, bite the bullet to sell EEM (for free) and buy the better ETF VEU. Brilliant — low fees and true dollar-cost averaging. [Not my idea, but a good one.]
In summary, fear not the change to more ETF-centric investing. Your particular company may pull a fast one on you… but in many cases not. Read ALL the fine print before determining the case. I’m glad I did, and I sense greater investing opportunity.
Take for instance the recent run up in stocks, up ~20% in the last year, and up a total of ~40% in the last two years. This stock run up in the financial economy is in spite of the dismal real economy which was (still is?) in the midst of the Great Recession. The classic explanation for this jump in stock prices is anticipation of strong economic growth that many were guessing was just around the next fiscal quarter or two.
But continued lackluster economic growth, high unemployment, and inflation fears have the stock markets retreating 4% in the last month. QE and QE2 have driven commodity, gold, silver, and oil prices up (and the dollar down to a degree). Low interest rates have also helped fuel the commodity boom. I don’t say commodity bubble, I say boom, because I don’t believe it is a bubble… merely a precursor to higher inflation.
Further the prospects of Congressional legislation past and present loom as large economy and business-dampening prospects.
- Dodd-Frank Act regulating all sorts of financial and non-financial items.
- Obama Care.
- The real possibility of tax increases as part of debt ceiling deal.
The danger of Dodd-Frank, which deals primarily with the financial economy, is that it may spill over into the real economy as well — a form of fiscal contagion. Obama Care hits right in the solar plexus of the real economy soon. Potential tax increases are a kidney shot to the real economy.
Also on the horizon is the debt crisis in Europe, currently centered around Greece, but with dominoes in Portugal, Spain, Italy and Ireland ready to fall.
So, why on earth would I be neutral to mildly bearish (long term) on US equities? The title “Wired on High Finance” sums it up.
- Wired, as is in connected, by wire, cable, fiber optics, or wireless. The continuing computational and connectivity revolution is only accelerating. This helps business productivity, which helps business (the real economy) and inevitably the financial economy (the stock market).
- High Finance. High finance in the US eventually finds a way. Take for instance GE which managed to pay zero income tax last year. Big money always finds a way. Call it industriousness, creativity, or greed… it gets things done.
Without all of the governmental fiscal and regulatory “headwinds” (as Bernanke has called them), my outlook would be bullish. Despite them, I believe that the power of a wired world of high finance will find ways to resist the government onslaught. Either through back-room deals (the new and no-so-new crony capitalism) or the ballot box (voters tired of 9% unemployment), these “headwinds” will be reduced, skirted, or avoided.
And while CPI stands for Consumer Price Index, most commonly, it also stands for Cycles Per Instruction — one measure of computer processing speed. So while the mainstream CPI may understate prices, the other CPI is very favorable to computation power. (In both cases keeping true CPI down is desirable.)
Notice I am neutral to mildly bullish on the US (and global) economy. That is why I, personally, am increasingly invested in investments that reflect that believe — namely covered-call market-index strategies. That is why I have switches some of my ETF investments from SPY (an S&P500 index EFT) to PBP (an S&P500 covered-call ETF). Inflation fears and low interest rates have continued to cause me to shy away from most bonds and bond fund… with the exception of high-yield (junk) bonds.
Disclaimer: These are my personal investing thoughts, opinions, and choices as of today. No one can reliably predict the markets (stock, bond, futures, options) or interest rates, certainly not me.
The Crazy Ivan Account (CIA) is currently up to $25,730. Current holdings are all ETFs: 100 shares JNK, 100 shares SPY, 50 shares EFA, plus some cash. So there’s some large-cap U.S., some high-yield (junk) bonds, and some foreign stock.
Right now “Ivan” is pretty sane, vanilla, and diversified. And he has been doing very nicely.
I can’t say enough about index investing. The best, perhaps only, free lunch in investing is diversification. And index funds are superb instruments with which to achieve diversification. There is, however, a potential dark side. Don’t worry, this dark side won’t effect you much… not really. At least not directly.
What has me a bit worried is “giving up the vote.” Yup, when you buy shares of an EFT, mutual fund, other fund you forfeit your voting rights to the underlying shares. Say you own 1000 shares of SPY. Cool. That means you own a couple shares of Apple and a handful of XOM shares. But, guess what? You can’t vote them!
Do I care that I am giving up my votes to iShares? Not enough not to buy ETFs. But I care a little bit. Enough to mention it in my finance blog.
The term “indirect investment” is not precise because saying “direct investment in stock” is perhaps not technically correct. Nonetheless, I am slightly annoyed at institutions voting my shares. I’d rather these shares not get voted… so that direct shareholders would not get overridden by institutional votes. Better yet, I’d like to be able to set some parameters for how my shares should get voted. Difficult to implement… but I’d like it.
So while index ETFs are the best thing since sliced bread, finding a solution to shareholder disenfranchisement would be a welcome improvement.
I went to a get together tonight with some friends, and talked about all sorts of topics. The least popular, by people’s reactions, was personal finance.
People, in my experience, find Madoff somewhat interesting. They sometimes find a bit of Wall Street bashing a bit entertaining. And they find John Bogle and ETFs plain boring.
My issue is that I find the details of ETFs, markets, exchanges, and bonds fascinating. I want to get inside of people’s heads to understand just why is finance boring or even vaguely repulsive? My first thought is that somehow people feel that making money from investments is less morally redeeming than through work. Another thought is that “respectable people don’t talk about money.” Perhaps they find finance and all its jargon overwhelming. Perhaps they have other more important things to focus on than their portfolio.
My mission with this finance blog is to find ways of helping people make better financial decisions. A secondary goal is to bolster confidence in these financial decisions; to help people sleep easily at night with their financial strategy. Finally, if possible, I would like to help people see finance through my enthusiastic eyes… as the minor miracle that it is.
The first two goals seem very achievable, while the third seems ever remote. Really making sound financial decisions, and feeling secure in those decisions is important. Perhaps, making finance interesting is not so important. There are a handful of people, like myself, who find finance intrinsically interesting, while the vast majority of people could care less about money, investing, stocks, commodities, ETFs, options, futures…. hey, you in the back, quit snoring… mutual funds, gold, ETNs, annuities, insurance, loans, equities… oh, crap I think I might have dozed off a bit myself.
I’ve crunched my first set of numbers. Specifically I’ve computed the beta of XOM (Exxon Mobil) vs. SPY (SPDR S&P 500 ETF) for 365 days ending Feb 4, 2010. My computed beta is 0.125. This is based on daily sampling of closing prices for a 365-day period. Not content with non-uniform sampling (e.g. discarding holiday and weekend data when the markets are not open), I recomputed beta over the same period with interpolated weekend/holiday data and came up with a beta of 0.117. I have not yet bothered to compute R-squared.
These are surprisingly low betas. Also interesting is the difference data interpolation can make… a not insignificant difference of 8.6%
Next I checked out reported betas from other sources. Yahoo Finance reports a beta of 0.35 for XOM (without specifying a time period, sampling method/frequency, or even reference index). MSN Money reports a beta of 0.43. This is a difference of about 23%. This could probably be accounted for by different time periods, etc. But what is most annoying is that these betas are presented without any such context.
I’ve only just started to explore this topic, but I think I’ve started to show that there is significant room for improvement in computing beta. And because beta underlies CAPM and modern portfolio theory, I think this is a big deal.
I’ve already got some more ideas for part III of this series, I just have to crunch some more numbers.