Transition for Portfolio Two

Portfolio Two is transitioning to ETF’s and CD’s.  This is aligned with the “basic plan” that I refer to here.  The portfolio has $28,781 (all in cash) as of December, 2015.

At a high level our investments will consist of:

  • $10,000 in the lowest risk interest rate products (Federally insured CD’s bought through a brokerage, go here if you want to learn more)
  • $9000 low-cost ETF tracking the US stock market
  • $4500 low-cost ETF tracking the non-US stock market, unhedged
  • $4500 low-cost ETF tracking the non-US stock market, hedged

CD Investment:

In the old days you used to need to call a broker to buy a CD or physically visit a bank.  Now you can buy CD’s online through your brokerage account.  To avoid more complicated tax issues with gains and losses I am sticking to “new issue” CD’s which are always issued at par (100 cents on the dollar).  When you are buying existing CD’s (the secondary market) they have gains or losses implied as they do not sell for 100 cents on the dollar and this causes additional tax issues that aren’t significant but I want to keep this simple and at this purchase level it is easier just to buy new issues.  For each CD there is a minimum bid quantity – for the highest yielding 2-3 year CD selected below, the minimum bid quantity is 10 at $1000 or $10,000.

Goldman Sachs bank USA CD 1.55% due 7/6/2018 paid out semi annual (audited by PWC).  Thus it is a CD that will pay back the $10,000 in 2 1/2 years from now.  Here is the link to a page that shows which external firm audits each entity.

The CD is semi-annual so it pays 1.55% * 10,000 / 2 = $78 every 6 months, or $155 / year.

There are no expenses (on buy, sell) and no fees with this holding.  By contrast a money market fund pays about 0.2% (or $20) after fees.

If we need cash we can sell this in the secondary market and there will be a small gain or loss depending on how interest rates have moved since the purchase date, and likely a bit of slippage in the buy / sell.  If for some reason the bank goes bankrupt (highly unlikely since this is Goldman Sachs) the government will pay back our $10,000 and accrued interest through the last date.  This did happen to me back in the 2008-9 time frame when a number of banks were taken over by FDIC as they became insolvent and deposits were guaranteed.

Stocks:

We will put half the remaining in US stocks and half in foreign stocks.  The US stock will be in the Vanguard ETF VTI.   Vanguard is audited by PWC.

VTI has a yield of 1.91% (dividends).  We will invest $9000 in this fund.  It has an expense ratio of 0.05%.

We will put half the remaining in an overseas stock fund.  We will put $4500 in VEU which is the Vanguard all-world index except the USA.  It is not hedged.  The yield is 2.96% and fees are 0.14%.

Will put the other $4500 remaining in a hedged overseas stock fund.  We will put put $4500 in HEFA which is an overseas ETF that is owned by Blackrock (iShares).  It has a yield of 2.35% and fees of 0.36%.

Blackjack (iShares) is audited by Deloitte and Touche.

Recent Stock Moves

Rise of the China Stock Market

When you are judging the success of your portfolio against benchmarks, which conceptually is a simple exercise, the question soon arises:

1) who are you comparing yourself against?

2) what currency is your benchmark denominated in?

Whether you want to invest there or not, China has had a major rally, and the Chinese Yuan is stable against the US dollar (in the range of 6 Yuan / dollar and 6.4 Yuan / Dollar over the last 3 years) as opposed to other currencies like the Euro and the Japanese Yen which have cratered in dollar terms.

The incredible rise in stocks in Chinese stock prices has mostly gone “under the radar” of US media.  Recently they connected the stocks in Hong Kong with stocks on mainland China and not only have prices risen substantially, the same stock trades for different prices in each location.  Per this WSJ article

Shares of Chinese companies listed in Hong Kong look like a steal compared with shares of the same companies that are listed in Shanghai. Such stocks on average trade at a 32.89% discount in the former British colony, according to the Hang Seng China AH Premium Index.

Typically, under a concept called “arbitrage”, the price of equivalent items in different markets are narrowed when investors take steps to capture the “easy money” of buying that same good cheaper in a different place.  A very simple example is that you can’t have gasoline selling for $4 in one state and $3 in an adjacent state; everyone just crosses the border to buy the cheaper gas until the price differential narrows.  Gaps of a couple of percentage even across exchanges is enough for investors to jump in and take advantage; a 32% differential is extreme.

This rally isn’t due to a perception that the economy in China is getting better; in fact it seems to be getting worse.  The rally has been enhanced by structural moves that allow more investors into the market (largely retail mainland investors) and lets them buy stock on margin, as well.  Per this WSJ article:

Margin lending has more than tripled in the past year to a record 1.7 trillion yuan ($274.6 billion)…The practice isn’t unique to China, where margin debt equals 3.2% of total market capitalization, compared with 2.3% in the U.S. But when compared with the value of stock that is freely traded, making it accessible to ordinary investors, the percentage for China rises because state entities own more than half of the market.  Research by Macquarie Securities Group shows China’s margin-debt ratio at 8.2% of the free float. That easily exceeds the peak of 6% reached in the late 1990s in Taiwan, the second-highest level globally in recent years.

Thus if you didn’t have a proportionate share of your portfolio invested in Chinese stocks, you were a “relative” loser, although there are many reasons to believe that this rally isn’t sustainable.  This goes back to the original question of how benchmarks are defined.

Individual Stock Moves

In one of the portfolios I follow there have been significant and immediate moves in several of our stocks.  These stocks were related to China or the the technology industry.

Linked In (LKND) recently had an earnings call and their stock price plunged by over 20% in one day.  The cause of the drop wasn’t the earnings themselves (they beat expectations), it was their “forward guidance”.  For stocks with a high price / earnings multiple like Linked In, the market needs to have continued rapid growth to justify the high stock price today.  In fact, Linked In currently doesn’t book profits, primarily due to their high amounts of stock based compensation (stock given to executives in lieu of cash).  Linked In’s guidance talked about currency headwinds (meaning that if they brought in the same revenues overseas it would “count less” towards net income because of the rise in the US dollar) and also some one time acquisition costs from recent companies they’ve purchased.

Amazon (AMZN) had their last earnings call where they continued to show no profits on a GAAP basis and yet their stock rose 6.8% due to other factors that analysts apparently found compelling.  Note that a 6.8% gain for a company the size of Amazon is a large increase in market capitalization (over $10 billion) in a single day.

China Life Insurance ADR (LFC) has almost doubled from around $40 / share to $80 / share as part of the overall China rally discussed above.  While a seemingly sound stock this performance gain is not tied to any fundamentals in how the company operates; this growth is tied to the giant overall rally.

Wynn Resorts (WYNN) dropped more than 10% in a single day after earnings were released.  Wynn has a property in Macau (China’s only location with legal gambling) and it has been hit hard with a recent crackdown on high-roller gamblers by China’s communist leaders.  Note that the scale of gambling in China dwarfs Las Vegas by any measure (total market, amount bet per player, etc…) and thus properties in China have been proportionally more lucrative than their US equivalent.  It is not known whether this will be a long term reduction of high rolling gamblers or a short term hit; that depends on inscrutable Chinese government polices.  Left to their own devices, it is highly likely that Chinese would continue to gamble at record rates.  Wynn also has long running board issues and governance issues as well.  At risk is their dividend, which “income investors” price highly in an era of virtually zero yield on debt (without taking on significant risk).

Westpac (ADR) – the Australian bank slightly missed earnings and their stock went down almost 5%, but then recovered a bit and was down 3%.  The CEO said that flat earnings won’t be tolerated in a later interview.  Unlike those companies with little or no GAAP profits (Amazon, LinkedIn), a company like Westpac won’t usually fall as much with a minor earnings miss because it has a lower P/E ratio and incredible future profit growth isn’t already “baked in” to the stock price.

Seeing large moves in single stocks can be viewed as a sign of a bull market in its last stages.  Since we invest for the long term we don’t pull in and out of the market based on short term moves but it is definitely something to consider; stocks with limited earnings and high P/E ratios or tied to giant rallies like is occurring in China today should be on some sort of watch.

Cross posted at Chicago Boyz

The Liquidation of Markets

Every weekend I read Barry Ritholtz’s recommended reading and there are a lot of gems in there. Recently he posted this Credit Suisse graphic about markets at the turn of the 20th century by market share and compared it with 2014 on the topic of global equity investing.

US_stocks

In his article he mentioned the fallacy one might fall into as a UK equity investor in 1899… why bother investing in the USA when the UK market is so much larger? And then this line of thought ends up missing the huge growth in US market share over the next century.

However, the real issue here isn’t the relative change in market share by the different countries; it is the fact that almost all of these markets were entirely extinguished at one time or another by political, economic or military events that wiped out the investors.
Continue reading “The Liquidation of Markets”

Investing – Basic Plan

If you want to invest on your own, there are some basic ways to approach it.  Here is a simple model that you might want to consider using.

The goals of this approach are as follows

  • Build a simple, consistent approach that does not require a lot of re-balancing
  • Minimize fees and expenses

The money you want to invest can be split into any grouping depending on your risk tolerance.  For the sake of this discussion, let’s assume that you want to split evenly before the 4 categories that are listed below.  If you were putting in $100,000, you might put $25,000 into each of the 4 categories below.

  1. 2 year new issue brokerage CD’s (bought at par, or 100 cents / dollar, no gain loss)
  2. 5 year new issue brokerage CD’s (bought at par, or 100 cents / dollar, no gain loss)
  3. Vanguard ETF total US stock market (ticker VTI)
  4. Vanguard ETF total world stock market except US (ticker VEU)

I wrote a lot of articles about buying CD’s from a brokerage.  Some highlights include 1) you get better rates than you get through your bank (for instance I saw 2 year CD’s at my bank at 0.7% and was able to get 1.2% through my brokerage) 2) the CD’s are guaranteed against loss – worst case you get your principal and accrued interest back (many of my CD’s were tied to banks that failed in 2008-9, so I tested this theory) 3) when you buy the CD’s up front through your brokerage account you pay no expenses except for any per-trade charge your brokerage like eTrade or Vanguard or Schwab might add to the trade (i.e. no annual fee).

What are the CD’s accomplishing?  They are your “safe money” in the portfolio.  You effectively can’t lose money if you hold them to maturity.  If you have to see early before they expire (i.e. you need the money to buy a house) your brokerage account can put them up for sale and you will have a small gain or loss depending on how interest rates have moved since the time you bought your CD.

There are other ways to do this (buying bonds, treasuries), but they are more complicated, and don’t offer significantly better returns than this.  On the other hand, you may note that some bond funds have had big gains, but these are mainly bets on interest rates and on the riskiness of portfolio items and this is fine but you need to know what you are getting into.  The CD’s should work fine for most investors.

Also note that many bond funds have fees in the 0.5% range (although some are more, and many are far less).  At this point, the fees will eat up your entire return!  We need to plan as if the low interest environment (ZIRP) that we are in will go out indefinitely, which means low returns and watching expenses is paramount unless you want to take on more risk in terms of your investments.

As far as the ETF’s, it is easy to buy them through your brokerage account, you just figure out how much you want to buy (say $25,000) and determine the current price (about $107 / share) which is 230 or so shares.  Put in an order, which might be free or might cost you up to $25 (depending on your brokerage), and voila – you are done.

Both VTI and VEU have rock bottom expense rates – VTI is at 0.05% / year (meaning $25,000 costs you $12.50 / year) and VEU is at 0.15% / year (meaning $25,000 costs you $37.50 / year).  Note that a typical financial advisor plus fees on ETF and mutual funds might cost 1.5% / year, which would mean $25,000 would cost you $375 / year.  Of course they also give you expert advice, so that is the flip side of that transaction.

How do you manage money using this model and re-balance?  Easy.  Likely semi-annually you will receive interest on your CD’s – this is about 1.5% on average between both of them – so you’d have 1.5% times $50,000 = $750 / year in interest.  That doesn’t sound like much, but that’s pretty much the best you can do nowadays.

For your stocks – you will receive the dividend yield every year as cash in your account – VEU yields about 3.5% and VTI yields 1.75%, so on average you’d probably get about 2.6% / year in dividends or $50,000 * 2.6% = $1300 in cash.

The interest income on CD’s is taxed at the highest marginal rate for you (likely 28% or higher) but the dividends will be taxed at a lower rate of about 15%.

Rebalancing?  You shouldn’t need to.  Just leave the assets where they are.  The 2 year CD’s will come due and you can buy new 2 year CD’s, and later the 5 year CD’s will come due.  Unless you need to buy a house or something I would just leave the ETF’s there forever – they are a bet on the stock markets in the US and around the world.

As your assets earn cash they will be deposited back in your cash brokerage account.  Take that cash, plus new cash you’ve saved up, and then pick one of the 4 categories depending on your risk tolerance, and invest more.

That’s it.  This is a super low cost plan that requires little re balancing and gives you a balanced portfolio.

Stock Market Performance and Our Stocks in the News

Over the 11+ years that we’ve been setting up these trust funds, tools for monitoring stock performance have improved greatly.  Today I use Google Finance to keep portfolios online for each of the six trust funds, and I update them for buys and sells and available cash.  When we first started these portfolios, it was the dawn of the Internet age (remember those commercials for e-trade), and we usually waited to receive our paper statements.

On the other hand, you don’t want to move into a mode of constant reshuffling of the portfolios.  Watching frequently is strongly correlated with frequent trading – you see and react to short term market movements, and you “kick yourself” when you don’t act on short term hunches.

For these portfolios there is a secondary consideration that I want the portfolio beneficiaries, who will ultimately receive 100% of the value of these stocks, to be as large a part of the decision making process on purchases and sales as possible.  This is a key purpose of these trust funds – to teach the beneficiaries about money and to show the real and substantial long term gains that can occur from systematic investing in a thoughtful way over a long period of time.  For purchases we are able to accomplish this by making it an annual process, tied with the annual back-to-school ritual.  For sales, I am attempting to make this more of a joint decision making process by setting “stop loss” levels up front and communicating these levels rather than selling when I think something is 1) overvalued 2) headed for a big loss.  I still have to move unilaterally on an occasional sale when I want to move relatively quickly, however, but I try to minimize those activities.

With all this said, I do watch the markets relatively closely (usually for a few minutes each night I scan the google finance portfolios for the six trust funds and see if alerts pop up for any of the stocks).

While it is easy to say that “the market has rallied this year and gone up by x%” and then to compare this return vs. your stocks, in reality every stock has its own story based on nationality (about 1/2 of our stocks are non-US), its industry, and then finally there is the large “joint” component of economic moves by the Federal Reserve starting with ZIRP and then moving into “Quantitative Easing”.  These events greatly influence all stock pricing, which can be seen clearly when the entire portfolio moves up and down in unison based on news (or perceived consensus on behavior) from the Feds.

Another entire path is how the international markets are faring – the Chinese economy is built on capital expansion, both in real estate and in manufacturing, and they have their own version of high leverage in various trust products and local debt and banking relationships that are starting to flash major warning signals.  When you listen to the news on economics 90% of it is about the US and our policies, when we represent maybe 20% of the world wide economy and we are heavily influenced by what happens elsewhere.  Of high interest to stock investors is the fact that Chinese markets have been in a slump for years, as they anticipated high growth before the growth became reality and then Chinese investors have since moved on to the (perceived) “easier gains” of local real estate.

Thus with all of this background behind us, here are some of the stories that I’m watching…

Australian banks seem to be the most expensive in the world, and are booming due to a real estate and highly valued currency.  We own Westpac, and this is something to watch.  Note also that when evaluating a high dividend stock (they currently yield almost 6%), it is important to look beyond just the stock value to see the total return.

Yahoo! is a 2013 pick and has done very well recently, up over 40% since we selected it in late Q3 2013.  The new CEO (Marissa Mayer) recently fired her hand-picked head of advertising who had a $60M pay package and their advertising revenue isn’t growing.  However, this doesn’t matter much since almost all of the value of this stock is in its China (Alibaba) stake and Japan stake – the US operations are mostly irrelevant (or a possible upside) to the stocks’ total valuation, per this article.

Shell (we own the “B” shares because they are out of the UK and don’t have the dividend withholding that we would have if we owned the “A” shares out of the Netherlands) recently issued earnings guidance that was touted as “Shell shock” about bad quarterly results.  The stock went down and now we are watching to see what happens next.

Beyond Shell we have a large exposure to the oil industry, including Statoil (Norway), SASOL (South Africa), CNOOC in China (we sold CEO recently when it hit our stop loss), Exxon, and also Anadarko (natural gas).  Thus we need to monitor these companies, to some extent, but we mainly buy and hold them because this is an essential part of the world economy and they pay strong dividends (mostly).

We continue to monitor these stocks and will close down our stop-losses pretty soon and create new stop-losses going out into 2014 for a few months.  We want to keep some down side coverage going both for stocks that have had a great run but also for stocks that might be headed for a fall.  Our stop loss strategy is summarized in this post.

Portfolio Six Updated November 2013

Portfolio Six is two years old and is our newest portfolio.  The beneficiary contributed $1000 and the trustee $2000 for a total of $3000.  The current value is $3287 for a gain of $287 or 9.6%, which works out to 6.2% / year over the life of the portfolio.  Go here for details or go to the links on the right side of this page.

The portfolio has 3 ADR’s (foreign stocks) and one US stock.  Since there are only four stocks changes in the value of any one stock will impact the total portfolio value.  We will continue to add to this portfolio in the years to come.

Portfolio Five Updated November 2013

Portfolios Four and Five were both set up four years ago. The beneficiary contributed $2500, the trustee contributed $5000 for a total of $7500. The current value is $9,116 for a gain of $1616, which is 21%, or 6.6% / year over the life of the portfolio. Check results here or in the links on the right side of the page.

Recently two outstanding items in the portfolio were cleared up when we gave up on the metals company Alcoa, which is well run but faces ferocious state-supported Chinese firms willing to work at a loss.  We also sold Riverbed when it bounced up a bit as a raider considered a stake in the company.

The remaining stocks are either brand new (too soon to judge) or doing well.  We will watch Siemens which is near a 5 year high and not ride it all the way back down.  The current portfolio has 9 stocks, with 7 of the 9 being foreign ADR’s (the two recent sales were US companies).