5 Ways to “Show Me the Money”

Ask whether these people are showing you the money. Hold them accountable for your money.

1. Your boss/company. Ask yourself first if you had a good year. If so, do some research on at you should expect to be earning.  Try starting with Glassdoor.  If you are not making what you want and are not moving in the right direction, consider moving to another company.  But, be sure to do through research and then line up a job (in writing) before giving your notice.

2. Politicians.  Are you getting reasonable benefit for your taxes?  Grade by region.  Here’s my grading:  City C, County B, State B+, Federal D.   If your grade is C or less, consider voting the bums out!

3. Social Security.  Ever work out the rate of return on your projected Social Security payments versus the amount you have and will put in.  Mine is about 0% return.  And that is *if* I ever get *any*.  Not much you can do about it, but something to consider when planning your own retirement…. What if I get nothing from Social Security when I retire?

4.  Investment Adviser.  How does my return stack up to A) The S&P500 total return (including dividends)?  B) A 100% bond profile such as Vanguard Total Bond Market Index Fund Admiral Shares (VBTLX)?  If, overall, it is under-performing both, fire your adviser.  If it beats one… ask questions like why it didn’t do better.   If it beats both, ask “what risks are you taking with my money!”?  If you are your own investment adviser ask yourself the same questions.  And, if you decide to fire yourself, consider getting advice from someone reputable and sane like Vanguard.

5.  Your credit score.  Know your credit score (FICO score).  Guess what?  If it’s below 711, it’s below average! [Technically below "median", but let's not split hairs.]  720 used to be golden, but today 750 is the new golden score.  In some cases 770.  If your score is below where you’d like it to be, start getting financially fit.  And remember, success doesn’t happen overnight.  Success takes time.

Modern Marvels of Finance

Much rhetoric today is focused against “Wall Street”, bankers, hedge funds, and speculators.  People are upset about the effects of the Great Recession, but are often misguided about the causes.  I submit the idea that the foremost cause of the Great Recession was the business cycle (or economic cycle).    If we are to blame the people and institutions behind the business cycle for the Great Recession we must also applaud them for the periods of growth between recessions.  To one degree or another we are all participants in the business cycle.

Of course, there have been behaviors ranging from ethical violations to fraud, particularly in the arena of mortgages and mortgage-backed securities, and (MBS) credit default swaps.

While there are flaws and imperfections in the US financial system, the accomplishments of the system deserve some attention.  The United States represents an economic marvel of the 20th century and 21st century financial achievements of the American financial system.  Like Rome, the United States incorporates the best of other systems.  The stock exchange did not originate in the United States, but the US and Europe improved upon it.  To the best of my knowledge, the index fund and the ETF both originated in the US.

Right now, today, US investors have access to:

  1. Low cost online brokerage accounts.   It is easy to find brokerage accounts that charge less than $8 per trade and have a list of commission-free ETF trades.  With effort, it is possible to find accounts with trades costing less than $5, or even lower.
  2. Free stock and ETF market data. (For example Yahoo! Finance and Google Finance).
  3. Superb ETF offerings. (SPY, VTI, SCHB, BND, VEA, VEU…)
  4. Excellent order fulfillment and pricing (with most brokers).

Just imagine a world without stock exchanges.  Could you imagine placing a classified ad or holding a garage sale to trade stock certificates?  Ludicrous, right?

The current US financial system is indeed a modern marvel.   English, Canadian, and  European exchanges have been similarly efficient and successful.  Other exchanges around the world are playing catch up, and doing so quickly.

The global world of finance is constantly evolving, but as of today the options available to US investors are quite spectacular.  We are wise to take advantage.

From the Financial Toolkit: Short Selling

In the previous blog post I wrote about the mechanics of options to help smooth out and reshape investment volatility.  In this blog post I want to discuss another investment tool:  short selling.

Short selling involves borrowing shares of stock and selling those borrowed shares.  This immediately does two things to your portfolio:  1) It gives you a liability for the shares, 2) It gives cash proceeds from the sale.

An investor, Alice, may choose to short a stock (or ETF) because she expects its price to fall.   She may expect one security  to fall relative to another security.  For instance, if Alice expects AAPL to outperform MSFT over then next six months, she could short MSFT and use the cash proceeds to purchase AAPL.  Even if MSFT goes up, Alice will make money so long as the value of her AAPL holdings go up more.

Suppose things don’t go according to plan for Alice.  For some crazy reason MSFT shares go way up, while AAPL shares remain flat.  As this trend continues, Alice’s portfolio net asset value (NAV) erodes.  This decreases Alice’s margin and increases her portfolios’ leverage.  If the trend continues Alice will eventually receive a margin call and have to cover her short position by buying MSFT stock to close her short position.

There are a few details to be aware of before entering a short position on a security.  The first is determining whether (and how much) stock is currently available for short-sale.  Once you’ve determined that your chosen stock is available for shorting, you should find out the particular terms for borrowing the stock.  For instance, you may forfeit a small percentage of your short-sale proceeds.  Often highly liquid stocks will be cheaper to borrow than less liquid ones.

Once you’ve found an stock with short-availability and an acceptable borrowing rate, you can execute a short-sale.  Since you will have a negative position (say -100 shares) you will pay rather than receive dividends on every share.  See also this helpful explanation of how, where, and why short-shares become available.

That’s the basics of short-selling.  Short-selling provides an alternative way to bet against a stock.  Buying puts is one method, short-selling is another.   Short-selling is allows going long-short… picking winners AND losers.  Short-selling is a tool that opens many investing opportunities and exposure to additional investing risks.

More Hypothetical Proprietary Fund Ideas

While the Σ1 Fund is currently a real 100% privately-held investment vehicle, all language and speculative plans about its future are currently (9/28/2010) STRICTLY THEORETICAL.  There is currently no SOLICITATION or even OPPORTUNITY for anyone other than Balhiser LLC shareholder(s) to invest in the fund.  Further, there is currently no SOLICITATION nor OPPORTUNITY to invest in Balhiser LLC at present. Thus the HYPOTHETICAL and SPECULATIVE language is merely just words at this point and time.  It is entirely possible that outside investors NEVER be given the opportunity to invest.

I’m wondering… should I revise my $10K minimum investment.  Perhaps $5K-$9K with a ~2% up-front load ($5000 yields $4900 of principal, $5000 yields $5100).  Increments above $5K are $1K with an up/down choice.  Increments are also $1K for investments over $10K.  Additional subsequent investments for current investors are $2K minimum with $1K increments.  Withdrawals minimums are $5K or %100 plus optional $1K increments.  Additional fund investments are subject to the same early withdrawal penalties as initial investments.  ALL requested redemptions are FIFO by default.

Distributions (realized capital gains, dividends, etc) are annual.  How they are distributed is TDB.  My initial inclination is that there is an ex-dividend date on the last trading day of each month, and dividend income is distributed in proportion to #months held * #shares.  Distributions are re-invested by default. Non-reinvested distributions are held in a non-interest-bearing manner until $500 is reached, upon which the total distribution will be paid in full by ACH or check.  Non-reinvested dividends may be paid, upon request, before the $500 minimum is reached, but a distribution-collection fee of $50 will be assessed.  For shareholders with >= $100K NAV none of these distribution restrictions or fees apply.

75% of redemption fees will be paid to Balhiser LLC, the remaining 25% will be paid to the Fund.

Requirements for potential investors:

  • Minimum of 5 years experience investing in stocks, bonds, ETFs, and/or mutual funds.
  • Acknowledgment that this is an investment of at-risk capital that may be subject to forced liquidation without notice during volatile and illiquid market conditions. This could result in severe or even total loss of investment.
  • Acknowledgment that options WILL be part of the Fund’s holdings/obligations.  While the primary target use of options is “covered-call” writing the notion of “covered” is not strict.  The fund may consider an RNM (Russel 2000 mini call option contract) to be “covered” by ownership of “an appropriate amount” of SPY (S&P500 ETF) shares.
  • Acknowledgment that ETF futures contracts may part of the Fund’s holdings/obligations.
  • Signed (and notarized) legal waiver that specifies that in exchange for participating in this fund, fund participant, fund participant beneficiaries and/or heirs, agree to hold legally blameless the fund manager and Balhiser LLC  for losses sustained by the Fund.
  • Solid familiarity with E-mail and the Internet and Internet-based “paperless” documents and communication.

In exchange for these concessions, the fund manager agrees to the following “skin-in-the-game” and transparency conditions:

  • So long as fund assets (or total net unredeemed funds invested) exceed $50K, the fund manager and/or Balhiser LLC will maintain a minimum of $25K invested in the Fund.
  • So long as fund assets exceed $50K, the fund manager and/or Balhiser LLC will reinvest all fund net distributions and net fund management proceeds into the Fund.
  • So long as FE>$50K. Fund manager and/or Balhiser LLC will be subject to same fees, terms, and conditions as all other investors PLUS will have to provide an ADDITIONAL 60-day advance notice to all fund shareholders (via email or other means) prior to any sale of holdings in the Fund.
  • 100% of Balhiser LLC/fund manager redemption fees (fees incurred for “personal” withdrawals) will be paid to the Fund.
  • End-of-month NAV reports will be delivered by email to shareholders. (delivered within 5 business days)
  • Subject to NDA: Unaudited Annual Report detailing complete fund holdings (delivered within 20 business days). Disclosure to CPA is permitted.
  • Subject to NDA: Upon request unaudited inter-year report (delivered within 30 business days). A $250 fee applies.  Disclosure to CPA is permitted.  Fee is waived once per year for investors with >= $100,000 invested in the Fund.

Base Management Fee Rates (similar, but not identical, to an expense ratio)

  • 7.8 basis points per month (0.078%) of previous close-of-month fund NAV.
    [~0.95% in simple interest, or ~0.9772% compounded annually]
  • Base management fee reduced by:
    • 10% for investors with >=    $50,000 NAV (or $50K net unredeemed investments).
    • 25% for investors with >=   $100,000 NAV (or $100K net unredeemed investments).
    • 33% for investors with >=   $250,000 NAV (or $250K net unredeemed investments).
    • 50% for investors with >= $1,000,000 NAV (or $1M net unredeemed investments).

Proprietary Trading Group

It’s official.  Balhiser LLC now contains a proprietary trading group which manages a private fund.   The fund, dubbed Sigma 1 (Σ1), seeks to be a covered-call balanced fund for the benefit of Balhiser LLC shareholders.  Balhiser LLC’s initial investment in the fund is a modest $25,000.  Like the CIA (Crazy Ivan Account) Σ1 is, in part, a test vehicle for trading and investing strategies.  Unlike the CIA, Σ1 is a Balhiser-LLC-owned tool to put my theoretical fund management skills to the test.

As fund manager, I plan to apply more rigor than necessary for an LLC  proprietary trading group.  I plan to draft unaudited quarterly reports.  I have crafted an outline of fund rules and guidelines.

With direct access to markets and exchanges, very low trading costs, and access to futures, options, forex, margin, algorithmic trading, etc.,  Σ1 should allow testing of  trading strategies that were simply not practical before.

Despite the myriad choices available, Σ1′s initial ground rules and objectives will be pretty pedestrian.   Here a some of them for the record:

Conceptual target allocation: 40% bond, 60% stock.

Bond Portion Parameters:

  • Duration 0-7 years.
  • Max. Foreign Exposure:  50%
  • Max. Corporate Exposure: 50%
  • Munis: 50% max
  • Mortgage-backed : 50% max
  • Treasuries/TIPs/Govt:  25% min
  • Bond ETFs:   Yes

Stock Portion Parameters:

  • Foreign: 40% max
  • Any single stock: 20% max
  • Total single stocks: 50% max
  • Diversified (largely index) ETFs: 50% min

Other parameters:

  • Max Overall Stock Exposure: 80%
  • Max Overall Bond Exposure: 60%

Margin:

  • Never to exceed:
    • 60% of  NPV of holdings
    • 100% of NPV of bond holdings

Stock Options:

  • Covered calls: Yes
  • (Cash/Bond)-Covered puts: Yes
  • Uncovered puts/calls:   only allowed intra-day while closing covered positions.
  • Buying puts/calls:  Yes, not to exceed 5% of NPV of holdings.
  • Paired options (e.g. butterfly):  Yes, VAR not to exceed 5% NPV.

Futures:  TBD

Other Options:

  • interest-rate: TBD  (likely only as bond hedge)
  • currency options: TBD (likely only as foreign-bond hedge)

Stock (ETF) Futures:  TBD

Commodities:

  • Futures:  No
  • Precious metals (ETFs):  Yes,  10% max
    • Covered calls:  Yes
    • Buy puts:  Yes, as hedge
    • Buy calls:  Yes, 2% NPV max.
  • Non-metal:  No

“Uncovered” (value at risk)  Derivative Exposure:

  • Total 5% NPV max (on any trading day).

“Uncovered” Derivative Loss Limits:

  • Not to exceed 10%  in 4 rolling consecutive quarters.  (10% of 4-quarter average starting NPV).
  • How enforced:  If previous 3 (or 2 or 1 or present) quarter(s) uncovered net derivative loss (NDL) is in excess of 5%, max uncovered-derivative VAR cap is lowered to 10%-NDL.

Short-selling:

  • TBD, likely only allowed as a hedging technique.

Futures Options:  TBD

That is a brief outline of Σ1.  I will be providing updates as it moves forward.

Disclaimer:  Σ1 is a private proprietary trading account and is not available to the public.   Balhiser LLC is a privately-held company.

Stock Beta Computation.

I’ve now got a spreadsheet where I can enter 3-year daily stock price data and get a beta versus the S&P500 as modeled by the ETF SPY.  There are still a few finer points I don’t like about the modeling.  The biggest remaining gap in the computation is that the model doesn’t account for dividends on either the stock or the S&P.  Ideally it would add the dividend into the price on the ex dividend date.  If I could find a source where that data is built in or I took the time to merge the data it I would be set… but I haven’t bothered to do so.  Another nice feature would be an R-squared computation.

So now what?  Probably nothing for a while.  I’m already thinking about different things.  Most are things I wish other people would do :).

  1. Create a low expense-ratio ETF that tracks a passive covered-call index like BXM.  (No, and not an ETN… I want collateral!)
  2. Create an open-source format for storing and sharing stock, index, portfolio, bond, ETF data.  Perhaps XML-based.  Nice features would be handling of splits, ticker symbol changes, dividend and ex-dividend dates, and market holidays.  Support for different time periods would be a must.  Support for earnings, book values, revenue and other supporting data would be nice.  Perhaps such a format already exists?
  3. Glue together this format with cool graphing software like Open Flash Charts and/or something HTML5 based.
  4. Open source statistical tools to work with this format to compute volatility, beta, R-squared, P/E ratios, etc.

Until next time, happy financial modeling.

Real Estate Diversification

Balhiser LLC is entering the real estate investing world. As president, I am working on the last steps of financing a payoff and transfer of a ~$175,000 property to Balhiser LLC. So far, I have secured 65% of the capital and financing. Financing the remaining 35% is in the works, and I am hopeful that a line of credit Balhiser LLC has applied for will help close the gap. Alternately, I am prepared to liquidate some of my Vanguard portfolio, as required to complete the transfer.

The goal is to lease the property, a 3 bedroom townhouse, for $1150/mo. Info about the property is available here.

Investing can be more than just stocks, bonds, ETFs, and options. It is exciting to extend Balhiser LLC into the arena of real estate investment.

Idea Publication: Investing Automation for improved dollar-cost averaging

Just a quick note to…

Get this idea out into the blogosphere before someone tries to patent it:

Flex-flow deposits that automatically (and dynamically) re-balance a portfolio.  A target asset allocation is set.  Weekly/monthly inflows are initially proportioned account to these ratios.  As time goes on and investments go up and down the inflows are adjusted to help keep to asset allocation close to target.  More $ are invested in under-weighted funds (below tgt funds) and less $ are invested in funds that are over asset allocation targets.

There are lots of neat mathematical/algorithmic implementations.  The simplest contributes to the most under-weighted fund 100% or whatever amount is need to bring into balance.  Then the next most out-of-balance fund… etc.  Another strategy is to perform a linear delta-weighted scaling factor.  Another means is any number of non-linear delta-weighted scalings.  In any case a unit-sum “percentage” vector (M-dimensional , where M is the number of funds in the target).

Buying new Vanguard Funds

I’ve been reading through the prospectus for some of the Vanguard tax-exempt funds.  There are four that generally cover the municipal funds markets:

Comparing Vanguard Tax-Exempt Funds

They all have great expense ratios of 0.2% and credit ratings (for what they’re worth) of AA or AA-.  What is most interesting to me is a comparison of duration to yield.  Duration, in brief, is a standardized measure of bond price sensitivity to changes in interest rates.  High duration bonds (or funds) swing more to a 1% change in interest rates than lower duration bonds.  When I graph the relationship I get a very straight looking line:

vanguard_tax_exempt_yield_vs_duration

In essence this is the current yield curve for this family of funds.  The leftmost point is the short-term tax-exempt bond fund, followed by limited-term, then intermediate term, and finally long-term.

So what was my decision?  I bought into 3 of the 4, the short-term, medium-term, and long-term.  They all look like great funds.  I’ll keep you posted.