Investment Help

If you are seeking investment help, look at the video here on my services. If you are seeking a different approach to managing your assets, you have landed at the right spot. I am a fee-only advisor registered in the State of Maryland, charge less than half the going rate for investment management, and seek to teach individuals how to manage their own assets using low-cost indexed exchange traded funds. Please call or email me if interested in further details. My website is at If you are new to investing, take a look at the "DIY Investor Newbie" posts here by typing "newbie" in the search box above to the left. These take you through the basics of what you need to know in getting started on doing your own investing.

Monday, April 30, 2012

Spending the Nest Egg

Considerable research efforts have been directed to determine the appropriate nest egg withdrawal rate.  Many people seem to believe there is a single answer.  In truth, of course, there are too many unknowns including life expectancy, the rate of inflation, and market performance to produce a single number.  These unknowns give the problem a dynamic nature and mean that the retiree has to continually make adjustments.

In fact, there are two questions that sometimes are treated as the same. Some people want to know what rate can they spend at and have a high probability of not running out of funds.  Others are interested in the optimal rate of spending. T hey want to spend their last dollar as the plug is pulled.  If they follow the 4% rule-of-thumb and find they have $2.0 million on their death bed, they'll be upset and rant and rail about all the trips they could have taken, etc.

With this said, it is useful to run scenarios if for no other reason to at least get a feel for the nature of the problem.  As an added bonus, some readers will get some useful exposure to the arithmetic and issues involved.  The particular scenario I want to consider is as follows.  Suppose we are retiring today with a nest egg of $1.0 million, and we need an inflation adjusted cash flow of $40,000.  Note that I am conveniently neglecting taxes.  This is significant because taxes are the biggest single expense of retirees!  That's right - it's not medical expenses or anything else - it's taxes.  But taxes are messy, so we'll neglect them.

Let's assume 3% inflation.  The rate of inflation we assume is important because we are looking at a long run (hopefully!) situation.  Just as Enron was able to manipulate earnings by changing market assumptions on long-term contracts by a miniscule amount, the numbers will change here in a meaningful way if the inflation assumption is changed.  Keep that in mind.

To make this a bit different from other analyses of this type, let's think of matching our first 10-year payment needs ($40,000 adjusted annually for 3% inflation) with zero coupon Treasuries.  How much would this cost?  The Table shows the set-up.  It shows that, if inflation rises 3%/year, then by 2015 we'll need $43,709 to keep up.  To generate that payment of $43,709 in 2015, we can buy a zero coupon Treasury for $43,082.

Matching the required payments over the 10 years in this way requires $430,440.  This leaves $569,560 to invest today.  Working backwards, we ask the question of what return would it take to get us to our original $1.0 million by the end of the 10 years?

This is easy:  ($1,000,000/$569,560)^.10 = 1.057, or 5.7%.  In other words, if we can achieve an average annual return of 5.79%, we will be back to our original $1.0 million after satisfying our income needs for 10 years.

So, the good news is that we are 10 years older, have our $1.0 million in hand (especially good news for potential heirs), and have control of our money (in contrast to an annuity).  The bad news is that we have to generate $52,191 to start the next 10 years.

We'll continue with this next time.

The table presented here is really easy to do in a spreadsheet.  If anyone has questions, feel free to ask. Again, this whole exercise is useful, I think, in coming to understand the problem and challenge of generating an income off of a nest egg.

Thursday, April 26, 2012

Beta and Duration

I was talking with a reader the other night, and we started going over the basic stock metrics that novices need to know.  We started with the P/E ratio which is the most basic measure of all when comparing stocks, portfolios, and even investment philosophies.  In fact, the P/E, which shows how much one is paying for a dollar's worth of earnings, is typically the first number on which stock screening techniques are started.

Differing P/Es need to be reconciled when stock pickers are making buy-and-sell decisions.  For example, if you are comparing company ABC with a P/E of 8 and a company XYZ in the same industry with a P/E of 12, you have to ask yourself why you would pay more for a dollar's worth of earnings in the second case.

The reader and I were on the Yahoo! Finance page and next came to "Beta" as shown here for Deere:
Source: Yahoo Finance

Beta is a basic measure of how volatile a stock, or a portfolio, for that matter, is relative to the market.  A beta of 1 indicates that, on average, a stock will rise percentage wise in tandem with the market.  Thus, if the S&P 500 is up 3.5% and the beta is 1, the stock or portfolio can be expected to be up 3.5%.  It works the same on the down side, of course.

Beta greater than 1 will tend to be more volatile than the market.  For the same 3.5% market return, you can expect Deere to be up 3.5 * 1.48, or 5.18%.  This is an expectation, i.e. an average.  It is obtained by a regression procedure which assumes a certain distribution for returns which, in turn, generates a linear relationship between the market's return and the asset's return.  I know this is more than you care to know.  An important point to appreciate, though, is that it is an expected value.

Duration is Conceptually Similar to Beta

Anyways, bond people didn't want to be left out.  They wanted a measure of how volatile a bond's price is relative to changes in yields.  Luckily, they found that insurance analysts had solved this problem already with a measure called duration.  When you think about it, insurance companies have to figure out the premium to charge for a payout at an unknown future date.  But the value of the premiums over time depend on what happens to yields.  If yields go up, the value decreases; and if yields, drop the value increases.  They have to work it so that, when they include the interest they earn on the premiums, it more than covers the payout.  This is the duration question from another point of view.

So, suppose we consider the most widely used bond ETF, AGG - the Barclay's Aggregate Bond Index ETF.  At Morningstar, we put AGG in the quote box and find (after scrolling down):

Source: Morningstar

This is interpreted as saying that, if yields rise 1% (for example, if the yield on the 10-year rises from 2% to 3%), the price of AGG will drop by approximately 4.36%.  If this is over a 12-month period, you could expect a return of approximately -2.36%, because you will have earned the 2% coupon.

Note also the "Style Map" and how it gives you a grid picture of sensitivity.

As it turns out, the relationship between price and yield for bonds is not linear.  Thus, over time, duration will change; so you will want to check it every few months or so if you are using it to make bond decisions.  Furthermore, the estimate is less accurate the greater the change.  This means that, if you are trying to figure out the impact for a 2% rise in yield, you'll be less accurate.

For homework, check out the duration on TLT, the ETF for longer term Treasury bonds and compare the relative riskiness to AGG.

Wednesday, April 25, 2012

Market Cap versus Equal Weighted

With the sharp move higher of Apple Inc. stock, investors are ramping up the attention paid to whether it is best to equal weight a portfolio or to market cap weight a portfolio.  A market cap weighted portfolio's performance can be dominated by larger holdings.  As the price of a stock goes up relative to other stocks in the index, it has a greater weighting and, thereby, influence on future performance.  It is why diversification recommendations try to hold individual holdings below 5% of total assets.  Some investors, of course, use an ad hoc approach with no discernible approach to weighting.

Weighting is an important issue, however, with indices.  The difference between equal and market cap weighting is straightforward - do you invest an equal dollar amount in each holding or do you hold an equal number of shares of each company.  Take, for example, 5 stocks and consider investing 20% of your investable funds in each.  This is equal weighting.  Instead, consider buying 100 shares of each.  This is market cap weighting.

The S&P 500 is market cap weighted.  As such, its performance can be heavily affected by larger positions like Apple.  When you think about it, this goes against the objective of buying low and selling high.  In response, portfolios of equally weighted holdings comprised of S&P 500 stocks have been created and offered as ETFs.  One example is RSP.  To equally weight the portfolio, .2%  is invested in each of the S&P 500 holdings.

It is instructive to view the performance of SPY and RSP over the past several years, as reported by Morningstar.

Return Comparison (%): RSP (Equal Wted.) vs. SPY (Mkt. Wted.)


As shown, the returns are meaningfully different, especially when the market makes big swings.  The respective expense ratios are shown in parentheses.

The average annual return over the 8-year period spanning 2004 - 2011 is 5.42% for RSP and 3.57% for SPY.  Thus, as proponents of equal weighted indexes claim, it has provided superior performance. The momentum people, which is, in essence, the market weighted camp, can point to a 3-year period that included the 2008 crash where they had superior performance.

Disclosure:  This post is presented for instructive purposes only.  Individuals should do their own research or consult a professional before making investment decisions.

Friday, April 20, 2012

Gen X Retirement Woes?

Is Steve on the road to retirement?
Headline from recent article by Jessica Rao: "Retirement May Be Mission Impossible for Gen X."  Ms. Rao talks about stock market crashes, worries over Social Security, housing problems, and a resulting general skepticism among those in the 30- to 45-year-old age bracket.  Most readers would likely say "yup," nod, and move on - there's nothing to see here.

But let's back up for a minute.  The big thing about retirement is socking money away.  For this purpose, much of the Gen X generation has arguably been in an excellent position.  They have user-friendly investment vehicles like low-cost exchange traded funds.  They have qualified plans like 401(k)s and access to all kinds of investment information.  They have control over their own investments (isn't this what the proponents of privatizing Social Security get in a tizzy over?).  And best of all, those in the 30- to 45-year-old Gen X grouping have had opportunities to invest at rock bottom sale prices.  Crashes are great for asset accumulators!!!!!!!!

For example, on 6/30/2008 SPY ( S&P 500 Index Fund ETF) and AGG (Barclay's Aggregate Bond Market Index) were priced at $118.47 and $86.98, respectively.  Today they are at $137.72 and $110.46.  Gen Xers were in perfect position to take advantage.

Furthermore, Gen Xers have well-written instruction books available on how to invest and create a financially secure retirement.  Two excellent examples that I recommend are:
  • I Will Teach You to Be Rich - Ramit Sethi
  • Millionaire Teacher:  The Nine Rules of Wealth You Should Have Learned in School -      Andrew Hallam
Granted there are life events that can overcome even the best thought-out approaches.  These include sicknesses, job losses, buying way more house than one needs at the peak of the market, etc.  Aside from these, which people face to some degree over every time frame, Gen Xers who have kept their job (and by far most have!) and haven't bought into the "woe is me" camp should be well on their way towards securing a nice nest egg and hence retirement.  On the other hand, if they spend their life as a worry wart, fed by negative media reports, then they'll play into the self-reinforcing behavior implied by the article mentioned above.

Wednesday, April 18, 2012

Flip the Classroom

There is growing buzz around a technique called "flipping the classroom" that financial literacy educators may be interested in.  One version involves creating video lectures for students to watch at home and then, in class, have students work on homework-type problems with the teacher available for help - essentially the opposite of the usual approach.

For example, you and I mostly sat in the classroom and watched a lecture on how to solve quadratic equations and then struggled on homework with one of our parents (who said they used to understand quadratic equations) as we did the odd problems 1 -30 (hopefully the ones with the answers in the back).  Flipping just turns the whole process around, and proponents even argue that it is a more efficient use of classroom time.

It fits in well with research I once saw that found certain ethnic groups achieved academically to the extent that family members worked on homework together.  The research found that some ethnic groups worked on homework as a family with the youngest and the oldest at the table and with the oldest helping.  For other ethnic groups, students go off on their own to do homework.  Maybe the missing link is that educators need to be at hand (I see the tutoring industry cheering wildly!) to get students over the inevitable roadblock challenges that problem-solving involves.

The well-known Khan Academy is based on this approach; and there is a much-anticipated book by Jonathan Bergmann and Aaron Sams due out that explains, in detail, their experience with the approach.

In reading about the flip, the classroom strategy, I am reminded of one of my outside-the-box approaches (at least for me) that I found worked better than expected.  A few years ago I was teaching online Money & Banking at the community college and had small classes - 11 max.  I decided, experimentally, to offer to interested students the opportunity to take tests in a group with open book.  Students faced with an open book test will mark up the book, highlight certain facts and passages, and generally read the material.  After all, they need to know where the answers are when test time comes.

In allowing students open book and group work on the tests,  I needed challenging questions.  To be successful, questions had to elicit discussion among the students.  Thus, a typical question would refer to a figure in the text and ask why interest rates rose over a certain period and how the Federal Reserve responded and was it a correct response and whether the student would argue that the Fed should have taken a different action, etc.  I would give fairly tough questions on risk-based capital that required some tricky calculating.  I would ask students to imagine Keynes and Hayek meeting today and having a conversation on the appropriate monetary policy to follow.

I sat off to the side, available to clarify what I was looking for but, for the most part, minding my own business and sipping my extra large coffee.  One of the students would typically bring donuts for everyone, including the teacher, to ensure that some extra credit was earned.

As I observed, I witnessed considerably more animated discussion on how to solve and answer the test problems than I had anywhere else in a typical classroom.  The poorer students learned from the better students.  They were explaining to each other what the text meant.  In essence, because it was a test, the degree of interest ramped up and the difference was similar to that between poker played for fun and poker played for high stakes.

Tuesday, April 17, 2012

Warren Sapp Bankrupt

According to Sports Illustrated, 78 percent of NFL players and 60 percent of NBA players file for bankruptcy within two years of their retirement. Is exorbitant spending to blame? A lack of financial planning and education? Or a lack of common sense?

This quote came from WP Sports blog post on the bankruptcy of Warren Sapp.  I find it hard to believe the numbers, but still there definitely seems to be a rash of bankruptcies.

Most of us can't relate to professional athletes.  They make a humongous amount of money at a young age over a very short period of time.  They are made to believe they are God's gift to their sport and, unfortunately, to the opposite sex.

I assume the player's union and their agents give them great financial advice.  Still many blow it.

Sapp is the latest to garner attention.  It is reported that he made over $60 million in his career.  Today he is $6.7 million in debt.

I had a financial advisor friend one time tell a story about going to New York in a limo with a player on the Washington Bullets (now the Wizards) - a young rookie who truly was a b-ball phenom.  In the limo was an agent and a couple of "friends."  They were headed to New York to talk about a deal to make a rap record.  Guess who was footing the bill. I n New York, the people at the table weren't happy to see my friend there.  I wonder why.

It is too late to help Sapp, but I feel I should step forward and offer my services to those with the big bucks ( where are you mega millions winners?).  I have a radical approach called "set money aside and invest it conservatively" and then do what you want with the rest.  For example, if we turned back the clock with Sapp, I would have recommended taking $5.0 million (chump change for him back then) and investing it conservatively at 4% to produce $200,000 as long as he would live.  I would have tried to explain that he didn't have to try to get rich - he was already rich.  Then we would have talked about living on $200,000/year when he retired, if that's "all" he had.

Most athletes, I believe, would be able to manage this even after paying child support and alimony. .

It should be noted that athletes get all the publicity.  How many people outside of entertainment come into the big bucks and blow it, absent all the publicity?  There are surely many.  If you get to them before I do, feel free to pass along my advice.

Monday, April 16, 2012

How to Re-Elect Obama ... or Not

The most famous economist of all?
 If the nation should ever come under zombie attack, I would suggest rounding up econ professors as our first round of defense.  Econ professors are experienced in dealing with zombies.

It was the other night in my class that I sensed heads were about to hit the desk and students roll out of their chairs when I went into a mild rant.  We were talking about the recent unemployment report and the fact that the number of jobs added was about half that expected by economists.  The discussion turned to how it shook the stock market and how employment reports from here on out could be the turning point in the presidential race.

I gave them a little back story on the 2000 election and how it was so close that it boiled down to Florida and eventually ended up in the courts.  My main emphasis, though, and what they couldn't readily appreciate, is that the world is much different today than if that election would have turned out differently.  George W. cut taxes and went looking for weapons of mass destruction which morphed into a war.  From a projection of a massive budget surplus, which could have solved Social Security and many other problems, we experienced record deficits and were promised a balanced budget by 2008 at which time the tax cuts, we were told, would have the economy permanently operating at potential. Voters were promised a smaller government and  a responsible approach to federal spending.  But that isn't how it turned out.

The path, for better or worse, would have been much different if Gore had won the presidency.  I doubt there is anyone who would debate that.

Although candidates spend considerable time in debates to hopefully enable Americans to understand their different philosophies and approaches to major issues, many times elections turn on 1 or 2 basic issues or events.  Sometimes it can be a snappy comeback in a debate like Reagan's response on age that he wouldn't exploit Mondale's youth.  This go-around, it looks like the basic issue might be employment. As the class discussion proceeded, this realization led the class to a plan that the re-election campaigns of either party can adapt.

Reelect Obama Plan  Urge every Democrat to get a job.  Take the job at Dunkin Donuts, Staples wherever; but get counted as working.  This has to be done by early October!  The goal is to get an increase in non-farm payroll of at least 400,000 for the November report on 11/2.  With over 12 million Americans unemployed, this shouldn't be that difficult, especially with the reported number of job vacancies.

If it is too much to take a job, then stop looking!  Become a discouraged worker.  If you leave the labor force, you will contribute to a lower employment rate.

Elect Romney  Here the plan is to do the opposite.  Make an arrangement to quit your job with the understanding you'll get hired back in November.  This is just a variation of Merrill Lynch's buying Enron's Nigerian barges with the promise that Enron would buy them back after Enron's earning were fraudulently increased.

Saturday, April 14, 2012

Teach Your Kids About Stocks -Dividends (Con't.)

When people talk about bonds today, more often than not the conversation will get into dividend paying stocks.  This reflects the favorable comparison for dividend-paying stocks relative to bonds. For example, Johnson & Johnson (TKR = JNJ) has a dividend yield of 3.60% (go to Yahoo! Finance and put in the ticker symbol to find the yield) compared to the yield on the 10-year U.S. Treasury note of 1.98%.

How to find 10-year Treasury yield:
  • click "Markets"
  • find "Government Bonds" in drop-down list
  • find yield indicated in the graphic
 CLICK TO ENLARGE  In making the comparison, the point is made that dividends frequently are increased over time, whereas the holder of the 10-year Treasury note will get the same payment over the 10-year period.  To truly convince yourself, go to Yahoo! Finance and check out the dividend paying record of JNJ!

To see the difference, note that, if we invest $5,000 in the Treasury, we will get $100 in interest/year (5000*.02).  On the other hand, if we buy $5,000 of JNJ, we will get $180/year (5000 * .036) based on the current yield.

Even the well-diversified iShares Dow Jones Select Dividend Index (ticker symbol DVY) yields considerably higher at 3.37% compared to the sub 2% yield on the 10-year Treasury.

Looking at the numbers,it is easy to see the compelling case for dividend-paying stocks.  It is easy to understand why people argue that the low interest rate policy of the Federal Reserve is pushing investors, especially those who need high income,  into riskier assets.  In this regard, it is useful to reflect on the essential difference between bonds and stocks.  Very simply, we know the price of the bond at a future date.  For example, the 10-year Treasury note will have a price of $100 on 2/15/2022 - its maturity date. In contrast, the price of JNJ, or DVY for that matter, is unknown going forward.

Which do you prefer - the 10-year Treasury, JNJ, or DVY?

Disclosure:  My clients and I own some of the securities mentioned  in this post.  It is intended solely for educational purposes.  Individuals should do their own research and/or consult a professional advisor before making investment decisions.

Thursday, April 12, 2012

Teach Your Kids About Stocks - Taking the Plunge

A client called the other day and said their son, who is in his late 20s, wanted to start investing.  After ascertaining he wasn't in a high tax bracket, I recommended $5,000 in a Roth IRA.  It was made clear that he may need the money before he hits his late 50s.

I recommended he go to and click "open an account."  All he had to do was fill out the application and send a check in.  I prefer Schwab, but any discount broker would do.  I also asked if he had an idea of how he wanted to invest the money.  He didn't; but, if he did, he would need to find ticker symbols of stocks he was interested in, etc.

I then directed him down the path I prefer--low-cost, well diversified exchange traded funds.  I suggested SCHB, a commission-free fund for Schwab clients that tracks the broad stock market.  I recommended that, unless he wanted to drive himself nuts, he check on the fund infrequently. I noted that the stock market would go up and down, but what he was interested in was where the market is years from now.

To carry out this recommendation, he had to click on the "Trade" tab.  That took him to the module where he entered the ticker (SCHB), the number of shares ($5,000/price of SCHB), and the circle that directed the buy to be made at "the market."  He then clicked "Review Order."  The next page allowed him to review the order.  He then just clicked the button to get it to go through.

Source: Schwab

At the bottom of each Schwab site is a quote box. Right now SCHB is $33.28/share, so with $5,000 he could bought 150 shares.

That's it.  He's in; and, as I told him, "...20 years from now you will look back and see it was one of the best things you ever did."

Nothing takes you up the learning curve like getting involved.

Wednesday, April 11, 2012


Dear Readers,

I am writing you today to tell you about an upcoming event that I am participating in that is both very important and very exciting to me.  NAMIWalks, the signature walkathon event of the National Alliance on Mental Illness, is being held in  Baltimore, MD at Inner Harbor on May 19, 2012.   

I have been on the board of NAMI Howard County for the past 2 years and have seen the outstanding work this organization does in the community.

I would like to ask you to come and walk with me or to donate to support my participation in this great event.  Visit my personal walker page to sign up:  It features a link to my team's page where you can see who else is walking with me.  There is also a link so you can donate directly to me online.  Donating online is fast and secure, and I'll get immediate notification via e-mail of your donation.

NAMI, the National Alliance on Mental Illness, is the largest education, support and advocacy organization that serves the needs of all whose lives are touched by these illnesses.  This includes persons with mental illness, their families, friends, employers, the law enforcement community, and policy makers.  The NAMI organization is composed of approximately 1,100 local affiliates, 50 state offices, and a national office.

The goals of the NAMIWalks program are:  to fight the stigma that surrounds mental illness, to build awareness of the fact that the mental health system in this country needs to be improved, and to raise funds for NAMI so that they can continue their mission.

NAMI is a 501(c)3 charity and any donation you make to support my participation in this event is tax deductible.  NAMI has been rated by Worth magazine as among the top 100 charities "most likely to save the world" and has been given an "A" rating by The American Institute of Philanthropy for efficient and effective use of charitable dollars.

Thank you in advance for your support.

Robert Wasilewski

Teach Your Kids About Stocks - Dividend Yields

In honor of Financial Literacy Month, we continue today with an exercise parents can do with their kids to learn about stocks.

Bonds pay interest and stocks pay dividends. Bond interest is usually a fixed percentage of the principal amount and has to be paid as scheduled - otherwise a company may be forced into bankruptcy. Dividends on the other hand may or may not be paid and they can be increased or reduced.

If we put on the hat of the CFO (Chief Financial Officer) of a company we realize that he or she has a choice on what to do with profits earned by the company. They can be reinvested in the company  or they can be paid out in dividends to the owners, that is the stockholders.

As investors we are interested in the dividend yield of stocks for a few different reasons. Dividends act as a cushion when the stock market drops and are therefore stocks that pay dividends are generally considered less risky than non-dividend paying stocks. Dividends provide an income stream to investors who are in retirement and living off of their investments. Many dividend stocks today actually yield more than bonds and have the likelihood of increasing their dividend over time. Simply stated, investors would rather have a stock like Johnson & Johnson (ticker = JNJ) that pays a dividend of $2.28/share to yield 3.50% than the 10 year U.S. Treasury note that yields 2%.

Not only does JNJ have the higher yield but it also has the potential to raise the dividend payout significantly over the next 10 years, Keep in mind, however, that JNJ is riskier than the U.S. Treasury note - what we are describing here is the basic risk/return trade-off.

After reading the posts of the last 2 days it should be easy for you to find the dividend and yield of any stock. Just go to the Yahoo Finance site described in those posts and you'll find, for example, the yield discussed here:

Source: Yahoo
CLICK IMAGE TO ENLARGE  Take the dividend (2.28) and divide by price(64.20) to check the yield calculation. If you follow the procedure to get historical prices that we looked at on Monday you can actually see the quarterly dividend payouts. It would be a good exercise for a young person to write-up the process of getting the actual dividend payouts for a stock (Coca Cola say) for the last 2 years.

Investors, as you might imagine, keep track of which stocks have increased their dividend over a long period of time. These are called "dividend aristocrats".

Today dividend investors are fortunate because there are a number of good blogs devoted to dividend investing. They do excellent research and give the dividend investor good ideas. Here are a couple I follow:

To me one of the best ways for the DIY investor to participate is with dividend exchange traded funds. They provide you with immediate diversification. Some I use are DVY, SDY, and SCH . Using the method described yesterday  find the 5 top holdings in these funds and compare their yields.

Disclosure: I own some of the stocks and exchange traded funds mentioned in this post. It is intended for educational purposes only. Individuals should do their own research or consult a professional before making investment transactions.

Tuesday, April 10, 2012

What is Buffett saying now?

For those thinking about their investments, this post by Andrew Hallam, author of the best selling Millionaire Teacher:  The Nine Rules of Wealth You Should Have Learned In School, that sets out Buffett's "Latest Investment Tip" is worth reading and thinking about.

Teach Your Kids About Stocks - P/E Ratios

Humans like to classify things and to put things in a framework.  It helps us to think.  In the stock market, important questions are how much should be paid for a stock, how do investors determine if stocks are worth more than their current price (in which case, we want to buy) or worth less, how can we compare stocks?  We need a framework.

An easy exercise for parents and kids to do builds on yesterday's post.

Find the P/E

The starting point for those who use fundamental analysis is the price-to-earnings ratio--aka the P/E.  Suggest a stock to an investor, and one of the first questions is usually what is the P/E?

Let's get at this measure by starting as we did yesterday.  Let's go to Yahoo! Finance.  Find the "Get Quotes" box and type in the ticker XLK.  XLK is an exchange traded fund that indexes (i.e., seeks to match) the technology stock portion of the S&P 500 we learned about yesterday.  Just like yesterday, you come to the page showing the information on the ticker you put in. 

The advantage of using a fund is that it is well diversified.  An exchange traded fund also usually has low expense fees.  It is important to know also that they trade like stocks and, therefore, may have a commission when they are bought and sold.

On the page you are on, look down the left hand side, find "Holdings," and click.  This will bring you to:

Source: Yahoo

CLICK IMAGE TO ENLARGE  You surely recognize some of the names on this list.  Also, you are probably not surprised that Apple Inc. is the largest holding percentage-wise on the list.

As an exercise, you want to find the P/E ratio of the stocks.  The P/E ratio is a measure of how much you pay for a dollar's worth of earnings. Think about this, and you'll see that it is a neat way to compare stocks.  It gets you to start to think about why you would pay more for a dollar's worth of earnings for Apple Inc. than for Kellogg, for example.

So click on the symbol for each stock.  Doing this for Apple Inc. gets you to:

Source: Yahoo


As you can see, the P/E for Apple Inc. is 18.11. This means that if you buy AAPL at the price shown, you would be paying $18.11 for a dollar's worth of earnings.  You can actually check this because you have the earnings and price on the same page.  Divide 636.23 by 35.14. By the way "ttm" stands for "trailing 12 months."

As you become more sophisticated, you'll learn that there are different ways to calculate P/E.  For example, some analysts prefer P/Es based on predicted earnings.

For now, it would be a great exercise to do what we did for the other top holdings in XLK.  You'll find the P/E for IBM is 15.69 and then start to wonder why investors pay more for $1s worth of Apple Inc. earnings than they do for IBM's earnings.  Now you are on the path to stock analysis.

If you need another sector, check out XLE.  This is the energy sector of the S&P 500.  For homework, find out the P/Es of the top holdings in the energy sector.  It would also be worthwhile finding the historical prices of XLK.  For example, find where it was on this date last year; and calculate the percentage change in its price as we did yesterday for the S&P 500.

Monday, April 9, 2012

Teach Your Kids About Stocks

April is financial literacy month and a great time to learn about stocks.  Here is a simple exercise parents can do along with young people.

Where was the market when you were born?

Generally when investment people say "where is the market?" there are a couple of stock market averages they are talking about - the Dow Jones Industrial Average and the S&P 500.  As an exercise, it would be good to look them up and write a short 1 or 2 paragraphs describing them.

What we want to do is go to a financial website and find the value the S&P 500 the day you were born and compare it to where it is know.  Then we can figure out how much it has gone up or down in price since then.  But more on that later.  Let's begin by going to, a site you may already be familiar with.

On the lefthand side, you should see an icon for "Finance."  Click and you'll come to 

Source: Yahoo

CLICK TO ENLARGE  The arrow points to what we are after - the S&P 500.  Click on it.  You see the most recent value of this index.  If you are doing this while the market is open and trading, the index will be changing.  Now, as you can see, it is at 1398.08.

Notice on the lefthand side "Historical Prices."  Click and you'll come to:

Source: Yahoo

CLICK TO ENLARGE  As you can see, I changed the "Start Date" to 3/3/1998. This is where you want to put your birthday.  I also filled in the circle for monthly prices - you can also do daily or weekly.

Now all you have to do is click "Get Prices." This gives you monthly prices and, if you click "Last," you will find that the S&P 500 was at 1101.75 on 3/3/1998.

Calculate Return

Now you have the information to calculate the return.  But first notice that, if you had invested $1,191.75 in the index on the day you were born, it would be worth $1,398.08 today just from the change in the index.  There is more, but first we should calculate the percentage return of the index.  To do this, we take the ending value 1398.08 and subtract the starting value 1101.75 and then divide this amount 296.33 by the starting amount of 1101.75.  Multiply by 100 and you have it in percentage terms of +26.9%

As I said there is more.  Stocks pay a dividend.  The dividend on the S&P 500 has been around 2%/year.  So that would add another +30% approximately to the return   (2%/year over 14 years compounded).  The bottom line is that, if you had invested $1,000 in the S&P 500 on the day you were born, it would be worth over $1,500 today.

Find Returns For Individual Stocks

The same exercise produces returns for stocks over whatever period you are interested in.  First, however, you need the stock's ticker symbol.  This is easy.  In the quote box at the Yahoo! Finance home page, just type in the name of the company you are interested in.  For example, I'm sitting here noticing that Kellogg produces the cereal I'm eating.
My computer is so smart it lists what I am looking for before I even finish typing.  Now with the ticker symbol K, I can go through the exercise above.  I can find prices and I can find dividends and consequently calculate returns over various periods.

Homework Pick 2 stocks and find out how they have done (i.e. their return) over the past 10 years.

Sunday, April 8, 2012

Some Like it Complicated

The infamous Robert Citron
I'm in the middle of an RFP to manage $4.6 million.  The process was for each of 3 responders to submit a proposal and later to critique each others' proposal.  I've just critiqued the other proposals.

My competitors are brokers--a regional broker from the birthplace of Davy Crockett and an entity that would have gone bankrupt had it not been bought out by a bank who itself was very shaky in 2008.

My proposal is very simple.  It amounts to investing the account in several low-cost well-diversified exchange traded funds and possibly a chunk in a Virginia muni fund.  It mostly focuses on asset allocation and managing the cash flow.  The investment part is very straight forward--as readers of this blog would expect.

In contrast, the other proposals involve using funds of funds and actively managed mutual funds.  One includes buying individual municipal bonds.  The fund of funds does not have information available on the fund's holdings, and forget the availability of a publicly available price.  Needless to say, the muni bonds have all kinds of bells and whistles that are difficult for even bond traders to analyze in different interest scenarios.

Nevertheless, the other two proposals appear considerably more complex than mine.  Sometimes, in the investment world, people find this to be attractive.  Complex is seen as sophisticated.  I saw this firsthand a couple of decades ago when investors were falling all over themselves buying esoteric collateralized mortgage obligations (CMOs).  Many were super complicated and investors sopped them up.  I sat in on meetings where the people at the table had no idea how the instruments worked and yet wanted to buy them.  It became clear that the presenters were smart; and the line of reasoning seemed to be that, if you buy complicated instruments from smart people, it must make you smart.  It makes you look like you are working hard analyzing these complicated instruments.

But the bottom line, though, was that, in the restructuring process, highly liquid instruments--basic mortgage backed securities--were carved up into illiquid tranches and sold at higher prices!

The presenters, of course, were brokers.  They had rocket scientists back at the shop structuring products to fit what the market wanted.  When interest rates moved sharply higher, the market wanted instruments that would do well in a rising interest rate environment.  The brokers provided them--at super attractive commissions.

Robert Citron is one case that went from being brilliant to being an idiot.  He single-handedly bankrupted Orange County--the richest county in the U.S.  He resigned as county Treasurer in disgrace.

My experience has led me to the point where, if I can't price a security on an ongoing basis, I'm not interested.  If I can't calculate a time-weighted return and compare it to a benchmark, I'm not interested.  If I don't understand the compensation package exactly, I'm not interested.

Steve Jobs said,
“Simple can be harder than complex: You have to work hard to get your thinking clean to make it simple. But it’s worth it in the end because once you get there, you can move mountains.”
I agree.  Fortunately, we've had giants in the field of investing break down the process to make it simple.

Friday, April 6, 2012

Bond Index vs.Bond Ladder

Many times, when investors contemplate the difficulty of forecasting interest rates, they turn to a strategy known as a bond ladder.  With a bond ladder, you just space out the maturities so that they come due at regular intervals.  This creates a dynamic that lessens the harmful impact of falling bond prices due to yields rising and enables greater control of cash flow.  It also sets up a great way for brokers to generate commissions.  Buying individual bonds is not cheap. Typically, commissions are high and bid-ask spreads are wide, especially for the odd lots that investors trade in.  All of this in an over-the-counter market!  To get a feel for this, pick out a 5-year single A corporate or a muni for that matter and ask 2 or 3 brokers for a bid.  Brokers should be thankful that retail investors rarely look at bond laddering from a total return perspective.

Bond ladderers take comfort in the fact that the bonds will be held to maturity; and, therefore, no matter what happens to yields, they can't lose money.  This eliminates the fear that an active bond manager buys and sells at the wrong times.  It is worth noting that parking funds in a money market fund is also a way to avoid the possibility of a loss.

How does all this compare to indexing?  I'm glad you asked.  Indexing is actually highly efficient.  Bonds are replaced in the index essentially for free.  A broad index like the Barclay's Aggregate Bond Index can be tracked with a low-fee exchange traded fund like AGG, which includes all investment grade bonds with a maturity greater than 1 year.  Think about this.  When bonds hit the 1-year mark, they leave the index.  This is a time at which the yield on the bond is essentially a money market yield and, therefore, a good time to roll to a longer maturity in a steep yield curve environment.  Professional bond managers use this 'riding the yield curve' strategy on an active basis.  By doing so, they exploit the steepest part of the yield curve.

Furthermore, with the index you have a type of ladder going on.  A certain portion of the portfolio is invested in each year--just like with a ladder.  The big differences are that the index is marked to market and it is very well diversified.  It would be interesting to see a study comparing performance of a laddered portfolio with a similar duration bond index.

According to Morningstar data, the lowest return of the Barclay's Bond Index over the past 10 years has been 2.43% (2005) and the highest return has been 10.26% (2002).

Thursday, April 5, 2012

My Take on The Stock Market Game

Get a bunch of kids together and create a competition to see who can pick the best stocks.  Get  schools to compete on the basis of their portfolio performance.  This is what The Stock Market Game is about.

Anyone with classroom experience knows what competition can do.  I recall one time when I had a student in the back of my Economics class practically sleeping through class (I know - hard to imagine), when one day I introduced a goofy "Jeopardy" game.  You would have thought the student had sat on a fire cracker.  He insisted I put the questions in the library so he could study them and then win the next Jeopardy challenge.

Lesson plans for The Stock Market Game involve interactive, hands-on learning as kids do the actual analyzing of the economy, industry, and specific companies.  They examine a bit closer the products that they use and like on an everyday basis.  They argue among themselves, present the case for their picks, and then follow them like a hawk.  All of this is great.  I wish we had it when I was a kid.  I would note that I am competitive and surely would have enjoyed it.  I do wonder, however, if some kids don't come away from the experience with the thought that investing is too complicated for them or disappointed because their portfolio didn't do well.

There is a problem with all of this that concerns some professionals.  Simply, it misleads kids on what investing is really about.  It gets kids to think that, to be a successful investor, one needs to spend a lot of time analyzing stocks and that it is short term in nature.  It leads to kids thinking that investing is more like the mega millions lottery game than what it really will be for them in the real world.

When they enter the real work world, they will have the opportunity to participate in qualified plans such as 401ks and in vehicles like IRAs and Roth IRAs.  This is where most kids will come face-to-face with real investing.  In 401ks they will have to pick funds, not individual stocks.  They will likely be given a presentation by a commissioned broker.  They need to understand that, from the beginning, they have the most valuable asset of all in the investment realm--time--and that time means they don't care about the value of their portfolio next week, month, or even year.  In  fact, they should understand that it is to their benefit if stocks drop while they are accumulating assets. What is important is the value of their portfolio/nest egg when the day comes where they will be drawing on it for retirement purposes or to create a new career in their late 50s or whatever.  They need to know the evidence on how costs affect investment performance over the long term.

In short, kids are going into a world where they are responsible for their own retirement.  They shouldn't be faced with a "learning on the job"situation.  Combining instruction on managing a 401k over a lifetime with the shorter-term orientation of The Stock Market Game is a way to put kids on the right investment path.

Wednesday, April 4, 2012

The Grand Pooh Bah Price Fixing Committee

Interest rates are among the most important prices in a credit economy.  Your monthly mortgage payment depends on the mortgage rate.  Your car payment depends on bank loans rates.  Longer-term rates are linked to short-term rates and short-term rates are set by The Grand Pooh Bah Price Fixing Committee, also known as the Federal Open Market Committee.

The Committee meets behind closed doors to set the price of money.  Some details on their deliberations are presented in the form of minutes on a delayed basis.  Yesterday the minutes of their most recent meeting was released, and markets took it on the chin.  Confusion reins.  In their ever-increasing arrogance, the Committee previously announced they would keep rates low to the end of 2014.  Now, with stronger economic data, dissension to that view is increasing.  Are they going to raise the price sooner?  Should we buy a house now or is it OK to hold off?  Is it safe for car dealers to hire sales staff or is the FOMC going to slam it with a 2x4?

One wag on CNBC pointed out that this Committee, that had boasted of transparency, has, in fact, created more uncertainty than ever.

Economics 101 teaches the folly of price fixing.  It emphasizes the distortions that occur over time because of price fixing.  The ex-Soviet Union learned the hard way.  The U.S. is following in its footsteps.

Tuesday, April 3, 2012

Morningstar Stars

Mrs. Zitnay would be proud.  At the annual elementary school field day, every competing group got a ribbon.  Even the last place group got a ribbon because, as Mrs. Zitnay said, "you tried your very best."  And the parents clapped and cheered.  And it was good.

The practice is alive in the mutual fund industry.  Morningstar will give your mutual fund 1 star even if its performance  came in the bottom 10% of its peer group.  You get 2 stars if you came in the bottom third.  Mrs. Zitnay would be proud.  I doubt the participants in those funds are clapping though.

I'm starstruck this morning because last night I read my copy of Financial Planning magazine and every other page is peppered with advertisements for mutual funds, most of which have 4 or 5 Morningstar stars.  Unless you're a Taliban warlord hunkered down in the mountains of Afghanistan, you've seen these ads.  They are in most major magazines.

What do they tell us?  Are these the funds we should be investing in?  Does the evidence show that having 5 stars predicts strong future performance?  What is the relationship between Morningstar and the fund companies?  How come when I go to a fund site I see the predominance of funds have 4 and 5 stars?  Are they all producing superior performance?  When I see a claim that 8 funds out of 30 received 5 stars, does that mean the 10-year period started with 30 funds or are those that bit the dust from poor performance not included?

Actually, there is evidence on these questions.  Numerous studies over various periods show that superior performance in one period does not tend to be followed by better than average performance in subsequent periods, when all costs are taken into account.  In fact, Morningstar itself has produced studies showing that costs are a better predictor of future performance than their star system!  Guess what?  There is no mention of costs in the ads!  And for good reason, but that's been the subject of other posts.

Please allow me a short side rant for a moment on the whole star business.  The global economy has just come through a period in which it was brought to its knees by misleading ratings on packaged mortgage securities by the major rating industries.  At the time, bankers and investment banks looked the other way as rating industries gave the highest possible ratings to securities that were comprised of bankrupt payees. The reason was simple - in the short run, the high ratings generated billions in fees as the securities were bought by naive investors.

Here now we have stars jumping out at us with the explanation of the Morningstar star system in small print footnotes that most people would have a hard time deciphering.  The message that the funds are superior investment vehicles jumps out at the magazine reader.  The evidence shows that individuals, as well as even administrators who choose mutual fund providers for 401(k) plans, are misled by these ratings.  But again it's about big bucks.

Down the road, as baby boomers retire and their nest eggs have been eaten up by high-priced 4 and 5 star funds, everyone will act as if they don't know what happened.  And again Wall Street will walk away with the big bucks.

Monday, April 2, 2012

Some Bond ETF Data

One of the challenges facing do-it-yourself investors in recent years has been the bond portion of their portfolios.  Frankly, most don't know how bonds work.  They come with an asset allocation that suggests 30% fixed income, but what next?

They aren't comfortable with the inverse relationship between prices and yields; they aren't familiar with different sectors of the fixed income market; they aren't familiar with the difference between brokers and dealers, and the different yield calculations are a puzzle. Throw into the mix the fact that yields have been at historical lows, and it is easy to see that many investors mismanage this part of their portfolio.

And bonds aren't easy to learn about.  If there was an all time list of boring books, undoubtedly bond investing books would rank high on the top of the list - maybe along with this post. Rumors are that doctors sometimes recommend them for sleep-challenged patients. 

But they are important to understand for the DIYer.

My work around, when asked how to learn about bonds, is the simple suggestion of tracking bond prices.  My preferred way to do this is by tracking bond ETFs.  I do this on an ad-hoc basis - meaning, when I feel like it.  Here's my table from Excel where I keep prices and where it is easy to calculate relative returns:


19-Dec 87.67 110.17
108.05 104.02 122.19 106.15

23-Dec 89.04 109.9 51.41 107.93 104.03 121.74 104.97

6-Jan 88.92 110.11 51.57 108.05 104.18 121.87 105 108.5
17-Jan 89.2 110.58 51.82 108.32 104.38 122.3 105.77 108.31
12-Feb 90.25 110.41 51.82 108.19 104.75 122.19 105.24 110.98
23-Mar 90.5 109.7 51.53 107.85 104.88 120.78 103.09 112.7
31-Mar 90.72 109.85 51.49 107.95 105.09 121.1 103.28 112.71 24.58

The data shown is price data for various sectors:

HYG:  high yield, i.e., junk bonds.  These are below investment grade.  This sector is a top performer over long periods of time; but, when the first whiff of a downturn comes, their spreads can widen out dramatically and result in significant underperformance.
AGG:  indexed to Barclay's Aggregate Bond Index - the investment grade bond market.  Everything with more than 12 months to maturity.  This is the bond market benchmark equivalent to the S&P 500 in the stock market, i.e., it is the most widely used benchmark professional bond managers seek to outperform.
SCHZ:  Schwab's version of AGG.  Commission-free to Schwab customers.
MBB:  Mortgage -backed securities.  Offer really attractive yields, but subject to negative convexity. This just means they have great performance in stable yield environments but can underperform otherwise.  For example, if mortgage rates drop sharply, homeowners refinance leaving the bond holders significant principle to reinvest at lower rates.
CSJ:  indexed to 1- to 3-year credit bond index.  Has been a good holding in the low-yield environment.
IEI:  indexed to 3- to 7-year section of Treasury yield curve.
IEF:  indexed to 7- to 10-year section of Treasury yield curve.
EMB:  indexed to emerging markets bonds.
BKLN:  indexed to senior loan leveraged index.

Under normal circumstances, i.e., 10-year Treasuries yield 5% or higher, it would be perfectly fine to use AGG for the entire bond portion of assets.  It would be similar to using S&P 500 for the large cap stock portion of the asset allocation.

But, because yields are abnormally low and face the risk of a push up in yields, I typically put about half the bond portion in AGG or SCHZ and then spread the rest among some of the other sectors like CSJ, HYG, EMB, and MBB.  I have not used BKLN.  I am still tracking it to get a feel on how it trades.

IEI and IEF are used as yield curve trades whereby you take a position based on whether you believe the yield curve will steepen or flatten.

I also collect data on the yields of the ETFs, although, admittedly, I'm not sure how the yields are calculated.  They are not yields-to-maturity corresponding to bond yields - which makes sense, given that they don't have a fixed coupon payment.  Here's that table for what it is worth:


7.97 3.21 3.4 2 1.78 2.59
7.97 3.21 3.4 2 1.78 2.69
7.97 3.21 3.4 2 1.78 2.69 4.97
7.69 2.86 3.34 1.92 1.68 2.56 4.89
7.48 2.84 3.32 1.9 1.66 2.53 4.82
7.26 2.81 3.28 1.65 1.62 2.52 4.69
7.26 2.81 3.28 1.85 1.62 2.52 4.69

As you can see, there is quite a pickup in going from AGG to junk bonds represented by HYG.  Also, look at the spread between the longer maturity IEF and the shorter maturity IEI.  This represents the reward for taking the longer duration risk - i.e., when rates move higher the prices of longer duration bonds will fall more!

CSJ is worth considering for those parked in money funds or low rate CDs.

It is easy to get detailed information on any of these ETFs.  Just google the ticker symbol and  get the providers link as well as alternative links.  As a rule, aside from AGG and SCHZ, I never put more than 5% of total assets into any of the other concentrated ETFs.

Disclosure:  This post is purely for educational purposes.  Individuals should do their own research or consult a professional before making investment decisions.