High-Tech Portfolios

When I think about the phrase “high-tech portfolio”, I don’t think tech stocks.  Instead I think about using technology to build a smarter portfolio.   Most actively-managed portfolios are constructed, in full or part, using 50-year-old “modern portfolio theory” methods.  I’m working to change this by bringing superior portfolio technology to market.

So, while writing for this financial blog remains a passion of mine, I will likely be spending much more time refining software and building a financial software business.  Much of that effort will be off-line at first.  Occasionally, however, I will provide business and software updates on the Sigma1 Financial Software Blog.

Developing portfolio-optimization software combines two of my long-term passions:  software development and finance.

Rest assured, that I will keep this blog up and going.  I think it contains some hidden gems that are worth discovering.  I will also continue to blog here when inspiration strikes.

Stock Beta Computation, 6 Closing Thoughts

When I wrote about computing stock betas in 2010, I had no idea it would be this blog’s third most popular topic. I wrote a handful of blog posts about stock beta, but my heart wasn’t in them.  Today, driving home from the airport, I was inspired to blog about beta for perhaps the last time.  Previously I held back and focused on the mechanics of beta computation, and the discrepancies I was seeing between various website’s beta values.  This time I provide an example beta-computation spreadsheet and don’t hold back on the math or the theory.  Before I launch into this final word on beta, here a few highlights.

  1. Beta is easy to find online.  Not all sites agreed on value, but the delta seems less than it was 2 years ago.   Why compute beta when you can simple look it up?
  2. Beta is less useful if it has a low R-squared.  Luckily, sites like Yahoo! Finance provide R-squared values.
  3. Even with a high R-squared, beta is not a very useful risk measure.  Standard deviation is better in many ways.
  4. In theory high-beta stocks (>3) should go up dramatically when the market goes up.  In practice this is often not the case.
  5. In theory low-beta stocks (<0.5) should be “safer” than the market.  Again not so true.
  6. In theory low-beta stocks (<0.5) should “under-perform.”  Not necessarily.

If you are still interested in beta, simply click to read the full-beta blog.

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.

Negotiating Financial Setbacks

We all face occasional financial setbacks.  One way to increase feeling of financial loss is to check your portfolio daily.  Since I have a private fund that I manage, I feel obliged to stay on top of it daily.  I’ve noticed that when the fund is up I feel modestly happy, but when it is down I feel doubly disappointed.

Sometimes various financial stresses come together at the same time.  Recently minor financial setbacks have converged for me:  modest potential issues with my rental business, and a few percentage points drop in my fund, and long hours at my day job.  Navigating these financial stresses involves 1) avoiding impulsive decisions, and 2) carefully considering available options.  For example part of me wants to sell the rental property in the next year or so, namely to avoid the occasional headaches of being a landlord and property manager.  Another thought is to contract with a property management company, who charges a fee, but helps manage some of the day-to-day property management duties.  Finally, I impulsively want to deleverage some of my investments.

I am approaching my latest bought of financial stress as I always do.  With contemplation and composure.  At least outwardly I am composed and seemingly unflappable.  Internally, I am stressed and a bit anxious.  This comes with the territory of managing a wide range of investments.   This occasional stress is one of the few things I dislike about finance and wealth management. Of course it too shall pass.

I simply wanted to share the fact that, at times, maintaining a financial course can be emotionally challenging.  I spend a lot of time talking about how successful investing can be easy… and in many ways it can be.  Creating a financial plan can be fairly simple, but sticking to it at times can be stressful and nerve wracking.  Financial discipline is worth it, and financial impulsiveness should be kept to a minimum.  That is what I intend to do; even when it is not so easy.

Money and Investing Celebrities

Jim Cramer, Suze Orman. Warren Buffett, Peter Lynch, Bill Gross, John Bogle. The first two are the closest to household investing celebrities and arguably have the biggest media presence. The latter four are perhaps the biggest names in investing when it comes to mutual funds.

While I occasionally enjoy Cramer’s style, I generally dislike his advice. I believe that his high-energy style encourages high turnover, higher trading costs, reduced tax efficiency, and decreased diversification. Suze’s style is more focused on emotion, spending habits, relationships. I believe she offers a kind of emotional support and tough love that can help folks get out of debt and overcome financial life challenges. Suze’s style is particularly well-suited towards women investors (I’ve heard this from several of my female friends). She has a good grasp of mortgages, credit, foreclosures, and debt management. However, when it comes to stocks, bonds, mutual funds, ETFs, 401Ks, and the like, I find her advice spotty, inconsistent, and occasionally wrong.

I have a better overall opinion of the advice of Lynch, Buffett, Gross, and especially Bogle. I’ve found Lynch’s books useful and I’ve liked his advice about almost everything except bonds. And the performance of the Fidelity Magellan Fund under his management was exceptional. Gross balances out Lynch, because Gross has an impressive track record of bond investing with PIMCO. Buffett also boasts an impressive investing and management record. Finally, Bogle popularized and perfected index investing through Vanguard Funds.

It’s a shame that there is no investing superstar celebrity that provides solid, clear, and broadly applicable investing advice. Perhaps that is because prudent investing advice is somewhat boring. So generating excitement is done through either stock-picking mania (which I consider imprudent) or human interest stories (which tend to be getting out of debt, or get-rich-quick). Another challenge is appealing to a wide range of investing situations and widely different levels of financial literacy.

I’m frequently looking for ways to make this finance blog appeal to a wider audience. That’s why I’m looking at investing celebrities today for clues to make this blog’s message more powerful. As of now, my biggest takeaway is that if I focus more on the emotional and relationship aspects of investing and spending, I may be able to more effectively connect with women investors.

The Thrill is Gone, but the Love (of Finance) Remains

When I was born, my birthday gifts included US savings bonds ($50 dollar face value, I believe).  I’ve had a savings account since about age 7, and started reading brokerage account statements at around age 9.  My brokerage college fund started with $1000 and nicely grew to about $4000 by the time I started college at the tender age of 17.

Before the age of 10, I was enthralled by the concept of compound interest.   I was curious about the difference between monthly, weekly, daily, hourly, and by-the-second, even instantaneous compounding.  Little did I know at the time that this concept lead to the mathematical concepts of limits, calculus, and the number e, Euler’s  number.

Needless to say, I love math and finance.  But I first experienced a truly heart-pounding thrill when I started online trading sometime in the late 90′s.  I could see the bid and ask constantly moving, and tried limit orders.  The asks kept rising, and I kept inching up my bid.  Eventually my bid got hit and I was an owner of my first online stock.  This was different than buying mutual funds on the phone from Vanguard, and getting quarterly paper statements.  This was in real time and it was exciting.

I’ve read a lot about Peter Lynch, including his books, and I’ve learned some lessons good and bad.  The bad lesson, as I read his words, was “Don’t buy bonds unless they paying at least 8 or 10 percent.”  The good lessons were “Don’t buy what you don’t understand.” and “boring investments are good… boring names, unsexy, but solid investments are good.”

My next financial thrill revolved around options sales and purchases.  I even recall making a 20-option spread trade that was scary, but ended up netting me about $3000 in a very short time.

I have also has some thrill involving real-estate offers, counter-offers, counter-counter offers, and purchases.   Mostly, tension and anxiety are better descriptors than excitement.  Mild disappointment mostly describes failed attempted real-estate purchases.  Moderate to exuberant happiness describes my successful real-estate bids.

In the last year or two, my trades have not elicited an significant cardiac or endocrine event.   While almost always cerebral and well-considered, my trades have occasionally made my heart go pitter-patter and my endocrine system give me a pleasant rush.  But lately the trill is gone.  My pulse is steady and the motions are vaguely methodical and systematic.

My love of research, introspection, and contemplation remains.  Trading, for me, is just a means to an end.   Increasingly dispassionate.   In the end I hope and believe this makes me a better trader.  As always, time will tell.

GE and We: A Tale of Income Tax

By most accounts I paid more federal income tax than GE for 2010.  Personally, I paid more in regular federal income tax than I did for my brand new car.   When you factor in social security tax, medicare tax, state tax, and property tax that is an additional $16,700 or so.  I probably paid about another $4200 in sales tax, gas tax, liquor tax, fees, tariffs,  assessments, regional assessments, urban renewal, licensing, and other government fees.  I’d bet I paid more (federal income) tax than GE, and I’d bet almost everyone reading this blog did too, but I’m even more sure that GE paid it’s accountants more than I did.  I wonder how many millions GE spent on accounting, preparing, and filling its 2010 return?

I don’t blame GE for taking advantage of the system… minimizing tax is one of the key responsibilities to its shareholders.  But I am troubled by the corporate tax system.  Why should GE pay 0.0% and IBM pay 24.8%?  Shouldn’t large U.S. corporations play by the same rules?  Shouldn’t the rules be more even across companies?  Who wrote these crazy rules?  Well, that last question is rhetorical, obviously!

I think a 35% base corporate income tax rate is way too high, but 0% (for GE) is way too low.  My opinion is that a 15-25% corporate tax is much more internationally competitive.  But even at 15%, GE’s 14.2 Billion USD profit should be taxed at a little bit more my than my way-way-way less than a million, barely-6-figure, USD income.

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.