While answering a question at StackExchange regarding backtesting of investing strategies, I came upon a web site, AssetPlay, which lets you test a variety of different asset class mixes over the last 36 years or so (currently 1972-2008). While tinkering to find the returns from 1980-2008 for different S&P and 5 year t-Notes I discovered the following returns;

This shows mixes from 100% S&P index, and adds 10% increments of 5 yr T-Notes, to show the different Compound Annual Growth Rates (CAGR) and Standard Deviations (SD).  I find a few things curious about these returns. First, the addition of the T-Notes reduces volatility dramatically, yet, the first two 10% increments actually increase growth. So the 70/30 mix lagged by only 2/100 of a percent, yet the volatility was fully 5% lower. Of course, this isn’t new, it’s the basis of the Efficient Frontier, the theory that proposes the optimal mix of assets based on risk. While I still find the concept fascinating, I’d warn that part of the success shown here is based on the fact that the 5 year note by itself had a return over 9% during this time. I’m not in possession of a crystal ball, but I’m willing to bet the next  decade won’t be so kind to the bond market. Regardless of bond returns, I suspect the stock/bond mix will continue to mitigate risk will little impact to one’s overall return.

written by JOE \\ tags: diversification, efficient frontier, Finance, Investing

A recent Forbes article led me to the author’s company site Portfolio Solutions. There I found an article The Portfolio Solutions 30-Year Market Forecast. The author presents a bit of an explanation of the relationship between risk and reward, and then we are presented a thirty year projection.

Before sharing a few highlights, I’d like to mention the past 30 year S&P return, the 30 years from Jan 1, 1980 through Dec 31, 2010. 11.39%. What’s curious about his number is that the first 20 years of that period saw a 16.53%/yr growth rate which came to a halt with a “lost decade.” It seemed that there was a strong reversion to the mean that made the 30 year period a bit closer to the 10% longer term growth. Portfolio Solutions believes the U.S Large Cap Stock return will average 7.8% over the next 30  years. This number comes with little further explanation, except that it’s the total return, inclusive of a 2.8% inflation rate, and a risk (standard deviation of annual returns) of 19%. To mention bonds as well, the 20 yr treasury is forecast to return 4.3% over the same period.

Before I went to the site and saw these numbers, I was skeptical, ready to disagree with whatever was forecast. But I must admit, as long term numbers go, this is probably close to the mark. Whether the next three decades mirror the past with a run of 15% growth mixed in with a flat period, or year to year randomness that produces three similar decades, I don’t know. Absent any global disasters of a long term nature, or on the positive side, a new set of discoveries/inventions that fuel worldwide growth, I’m good with 7.8%.

What do you think? Too high? Too low?

written by JOE \\ tags: Finance, Investing, stocks

Today, I’m happy to offer a guest post from Alban:

Wherever possible we all like to avoid paying someone to do something, which we could just as easily have done ourselves. However, too often you find that you thought you could do without paying an expert for their help, only to realize that the task was actually harder than it looked. One area you don’t want to take that risk is with your investments because if you realize too late that you did need the assistance and expert advice of an investment manager, you can find there is little left to invest.

Features and Benefits of Managed Investment Funds

When you work with a financial planner you will be getting a diversified portfolio of funds, where your money has been invested in thousands of different stocks, across different asset classes and currencies. However, when you go it alone most people will only buy around 20 stocks, in one asset class, in one currency.

There is not a lot of middle ground between managed investment funds and DIY investments and the decision is often based on your situation – how much time you have, how much time you want to spend, and how much money you have to invest. With managed funds you are getting:
• Diversification can mean average performance. A fund manager’s job is to make you a profit, and as such they will have your investment highly diversified for security. This does result in a profitable portfolio, however, there often nothing stellar about that performance.
• Management fees. Also coming out of your investment income are fund manager fees, financial product trials and financial planner retainers.
• Getting out of the market. If you experience an average year with your managed investment, it is not the responsibility of your fund manager to get you out of the market. That decision is yours, but if you want to get out, you can’t simply make a call and sell your shares.
• Expert advice and a team of investment managers. If you take the time to find the best investment fund manager, you will know that they are qualified, experienced, and backed by a team of advisors and researchers who have the time and the resources to make investment decisions, where you need to get on with running the rest of your life.
• You choose the level of risk. When you first meet with your investment fund manager, you will be able to explain your goals and your financial situation, to stipulate a level of risk you are comfortable with, and a return you would like to see.
• Compounding investments. It is also easy to reinvest your investment income and in this way you are compounding your investment returns, by earning returns on returns.
• Regular investment plan. Once you know where to invest, the more you invest, the more profitable your investment will be, so why not set up a regular investment plan where a percentage of your income each week is transferred to your managed investment fund.
• You can start with a small investment. When you are using a managed investment fund, you can often start with an initial investment of as little as $1,000 because you have access to certain investments at a fraction of their usual cost as you are sharing the cost with other members of the fund.

Don’t forget about the costs of managed investments, and make sure the benefits of these costs outweigh the deduction from your investment income:
• Approximately 4% set up fees which must be paid up front.
• Ongoing costs of around 2% per year.
• Exit fees dependent on your portfolio and agreement.

Benefits of DIY Investing

Don’t be daunted by going it alone, because the basis of investing in the stock market is choosing stocks which go up in price. This may sound overly simplistic but the information on listed companies is publicly available and if you take a little time to learn about the different companies and the types of stocks and investments available, you are immediately at an advantage.

You also need to remember that since you are making a DIY investment, you are probably invested in far fewer stocks. This gives you the chance to focus on each of your stocks individually and review their progress, and when you remain informed and in control, the health of your portfolio will follow.

Benefits of DIY investments which may suit you include:
• Minimal start up costs. There are no fund manager fees to pay and this means that more of your money can be invested, rather than simply paying to get you started.
• Higher potential returns. A fund manager is focused on making a profit for their clients, so their clients remain happy, and they are able to secure new clients on recommendations and a good track record. However, this can often mean a managed fund will play it very safe, whereas if you are in control you can seek out higher risks for higher returns.
• Keeps you ahead of inflation. With higher returns than a managed fund, your investment income returns are able to beat the three to four per cent inflation rate and maintain their value.
• Invest your dividends. You are able to compound your investment income by reinvesting your dividends, rather than having them paid out.

When making your own DIY investments, keep in mind that:
• You have limited diversity. With a smaller portfolio and less position in the market, you are less able to diversify your investments across a range of stocks. This can increase the riskiness of your portfolio, because if one or two of your stocks dip, the entire portfolio suffers.
• You pay brokerage fees. You still need the assistance of a broker when you make share trades and these fees will come from your profits.
• Higher risk. As a DIY investor you are more vulnerable to market forces and place a greater risk on your investment if you are not able to avoid these risks. As a DIY investor you often need to spend a great deal of time managing, reviewing and understanding your stocks and the market.

Remember, the important thing is that you are invested in the market in some way because you money will make more significant gains than sitting in the bank doing nothing. The way you get into the market is up to you, and depends on where you feel comfortable, and how much time you’re willing to spend on securing that comfort level.

Alban is a personal finance writer at Home Loan Finder, a home loan comparison site.

written by JOE \\ tags: Finance, funds, Investing

From the department of “time flies” – back in October of 2009 I wrote a post titled “Will Gold Break $1250 by 2011?” At the time, gold was trading for $1034, and many people were saying they expected it to go still higher. Now, I wasn’t a believer, I made that clear, but for those who were, I offered a way to make 4X on their money (a 300% return) over the next 15 month through an options spread.

Allow me to recap the strategy. First, gold is traded as an ETF priced at 1/10 the price of one ounce of gold. The above snapshot is from October 2009 when I wrote the first article. Now, a brief explanation of options. An option gives you the right but not the obligation to buy the underlying stock at the strike price you choose. For example, $1450 gives you the right to buy 100 shares (options are priced per share but trade 100 at a time) of GLD until Jan 21, 2011 for $100/share. If GLD rose to $120, your $1450 would rise to $2000. Make sense? At $120 you would make the profit from the $100 strike to the $120 current price, a $20 gain or $2000 for the contract. For this play, however, I suggested buying the $115 strike for $9.50, and selling the $125 strike for $7.10. This way, you are out of pocket $2.40 but can gain watch that $2.40 rise to as much as $10 as GLD goes to $125 (or gold to $1250). Keep in mind, even at $120, this bet would have doubled your money. The downside is that if gold didn’t rise to at least $1150, the entire investment would be lost.

Really, it would have be sweet if I were a gold bug and claimed to put my money where my mouth was, putting up, say $25,000 and claiming it’s now $100,000. No such luck. But in the end, if anyone were so bullish on gold that they followed this strategy, they would have seen a 27% move in gold produce a 300% return on their money. Not bad. I believe gold is in bubble territory and there are similar trades that when the bubble bursts, there’s some good money to be made.

Joe

written by JOE \\ tags: Gold, Options

These plans have become more popular over the past few years. Let’s look at a few pros and cons of 529 plans;

Pros
You may deposit up to 5X the annual gift limit (in 2010, the limit is $13,000, so you can give $65,000 per recipient and treat it as 5 years’ of annual gifts. No gift tax is due, but you must file form 709 to declare the amount over $13,000)
Money can grow and be withdrawn tax-free (current tax law).
Funds can be designated for a different relative should the intended child not go to college.
The ‘approved relative’ list follows;

1.Child or descendant of a child.
2.Brother, sister, stepbrother, or stepsister.
3.Father or mother or ancestor of either.
4.Stepfather or stepmother.
5.Son or daughter of a brother or sister.
6.Brother or sister of father or mother.
7.Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law.
8.The spouse of any individual listed above.
9.First cousin.

There is no required distribution, thus you can save early for a yet unborn grandchild if you wish (by designating a child and then changing the beneficiary once the grandchild is born.)

Cons
Should you need to withdraw the funds and not use for school, regular income tax rates (not cap gain) apply as well as a 10% penalty.

Fund choices are typically very limited, and you may only change funds once per year.

Tip – MBNA offers a credit card linked to a Fidelity 529 account. You get 2% cash back on all purchases with no cap. There is no annual fee on the card and no annual fee on the 529 account. This is a painless way to save and a far better return than ‘miles’ cards.

written by JOE \\ tags: college, Finance, Savings

It seems this is not such a simple question. What do you prefer, a stock that grows, long term, doubling in price every 7 years or so (this is an average 10% annual return) or one that grows more slowly, say at 5% per year, but offers a 5% dividend? I’ve seen arguments on both sides, those who take the dividend as a sign of strength, reflecting steady profits and the company disbursing a share of those profits with its shareholders each year.

I’ve also heard those who say that a dividend is akin to a company saying, “We have no idea how to invest this money. We don’t intend to expand our reach either geographically or by delving into new markets. Instead of keeping it on our books and waiting for the next opportunity, you take it, shareholder.”

Legendary investor Warren Buffet, CEO of Berkshire Hathaway has never issued a dividend and ha not authorized a stock split (now there are B shares which are reasonably priced, not quite a split). The A shares trade at over $110,000 per, with a cash per share of nearly $17,000. No one is pushing Mr. Buffet to declare a dividend, that I know. Yet, Apple, trading at $240 or so with $26/share cash on the books has all kinds of speculation what they will do with this cash. A dividend? A takeover?

What do you think? Should we look more favorably on companies that issue regular dividends or should we just trust them to reinvest the money?

On a similar note, What is a Price to Earnings Ratio? Answered by Tom Drake at The Canadian Finance Blog.

Joe

written by JOE \\ tags: dividend, Investing, stock