Portfolio One Updated August, 2020

Portfolio One is 19 years old. The beneficiary and trustee invested $21,000 and the total value is $66,245 for a gain of $45,245 or 215%, which is 8.9% / year adjusted for timing of cash flows. Go here for the detail or see the link on the right.

The portfolio has 15 stocks, of which 2/3 are in Infotech & payments. 31% of the stocks are foreign and 69% domestic. 17% of the portfolio is in cash, with no gold. The effective dividend rate is approximately 1%. Note that cash now has a return of 0.1% or basically zero, with the return of zero interest rate policy (ZIRP).

There is one stock ALC which we will either grow or sell; it is a fractional share from a spin off that has done OK but the position is very small.

We may want to consider moving cash into BND (the Bond ETF from Vanguard). This returns about 2%. There is some volatility compared to money market (if interest rates went up, the principle value would go down) but there doesn’t seem to be much on the short term horizon at least.

Hovering over all these portfolios are the unprecedented short term gains that have occurred in a small subset of stocks, mainly Info Tech / Payments. Participating in these stocks has driven up the value of this portfolio from around $40k a bit more than 2 years ago to over $66k today, a gain of over 65% in that period of time. Note also that almost 20% of the portfolio has been in cash, which makes that gain even larger because the stock portion drove all of it and cash contributed only around 4%.

There is no right answer as to what to do next; many pundits proclaim a “new normal” in that these digital stocks have wiped out their physical world competition and will continue to rule the future economy, vs. others that compare this to the year 2000 dot.com Nasdaq bubble that took almost 20 years to recover from.

Portfolio Two Updated June 2020

Portfolio Two is 15 1/2 years old.  The beneficiary contributed $8000 and the trustee $16,200 for a total of $24,200.  The current value is $44,019 for a gain of $19,819 or 81%, which is 6.7% / year adjusted for the timing of cash flows.  Go here for a summary or click on the link.

Last year we bought ~ $5000 worth of BND and that has returned 9% dividends & share price appreciation (annualized) which is better than the return on cash itself which has dropped from 1.7% a couple of years ago to 0.3% with the (near) return of ZIRP.  May want to move more from cash to BND (or even IAU) with the return of ultra low interest rates and the Fed even buying some debt instruments from corporations.

CD’s and Money Market Funds As of June, 2018

For many years’ the USA (and much of the developed world) offered very low interest rates on accounts with low risk (guaranteed accounts).  The policy was known as “ZIRP” or “zero interest rate policy”.

As a result of ZIRP, this author started exploring CD’s purchased through a brokerage, which offered a couple of percentage points more in return (than zero) with the same, virtually zero risk.  These brokerage account CD’s typically offered higher returns than you can get from your local bank or savings accounts.

Over the last couple of years, however, the USA has begun to raise interest rates.  Today, the VMFXX money market from Vanguard offers a return of 1.74% (with an expense ratio of 0.11%).  There is also an expectation of continued increases in the future, although no one knows for certain what will occur.

Since the “base” rate is now effectively about 1.75% (more or less), the CD forward “curve” looks like this:

  • Base rate (no CD, leave in money market) – 1.75%
  • 1 year CD – 2.30%
  • 2 year CD – 2.80%
  • 3 year CD – 3.00%
  • 5 year CD – 3.30%
  • 10 year CD – 3.40%

When you buy a CD, you essentially “lock up” your money for that duration.  If you have a 2 year CD, for instance, you can always buy or sell off that CD, but if interest rates go up you won’t receive back 100% of your investment.  For example, if you have a 2 year CD at a rate of 2.80%, and short-term interest rates move from 1.75% to 2.00%, for example, and you needed to sell your 2 year CD, you might receive 99 or 98 cents on the dollar (it could seem higher because you’d also be getting back interest accrued prior to your next payout, for example if you had a semi-annual payout).  These are really minor “losses” in the grand scheme, especially if you are dealing in the thousands or even few hundreds of thousands.

The future of our interest rate policy is (as always), essentially unknown.  Interest rate policy is also closely tied with the value of our currency, although this takes the entire conversation off into a far more complex direction.

In a time of ZIRP for an extended period (we had it from 2008 to 2015), buying products like CD’s was essentially the only way to get any sort of risk free return on interest at all.  With short term interest rates at 1.75% and (likely?) heading upward, now there are more options on the table, including doing nothing and taking the short term rate or locking up funds for the near term or even medium term.

All of this income is taxable.  Thus the effective rate that you receive is lower, depending on your tax rate.  Tax rates did come down a bit with the 2017 tax changes, with most folks in the 12% / 22% / 24% range.  Thus if you get 2% your return is effectively around 1.5% – 1.6% after taxes.

This blog will also look into the current state of iBonds, another product that is essentially risk free that we reviewed in the past, in an upcoming post.

 

Hedging the US Dollar in the “Basic Plan”

Recently the US dollar has strengthened against most foreign currencies.  This means that you could buy foreign stocks and they could do well in their local markets (for example, the Japanese stocks were generally up for a time) and yet you would have losses when your ADR or ETF was valued in US dollar terms.

While you cannot generally hedge the currency risk in a single stock ADR (for example, Toyota), they now offer ETF’s that give exposure to foreign markets but also hedge those currencies against the US dollar, so you receive their “actual” return (good or bad) rather than their actual return PLUS the impact of the rising or falling US dollar.

For instance, let’s look at the VEU Vanguard ETF (one of my favorites, the Red line below) against a new ETF I started looking at, HEFA (the Blue line), over the last two years.  You can see that the total return was 1.1% positive in HEFA and 14.2% negative for VEU over that time span.  This difference is due almost totally to the rise in the US dollar against foreign currencies that make up the bulk of those stock indexes (the Euro, the Japanese Yen, the Australian Dollar, and the Canadian Dollar).  You can see that the peaks and valleys of the blue and red lines track together (they move in the same direction) but the red line sinks as the US dollar rises over the last two years.

 

VEU vs HEFA Last 2 years
VEU vs HEFA Last 2 years

One negative impact of this, all else being equal, is that hedging costs money and this should be expected to drive up fees on your ETF.  The ETF for Vanguard (VEU) is 0.14%, which should be considered somewhere near rock bottom.  The HEFA ETF expense ratio is 0.35%, which is also very low, but higher than the Vanguard product.  This isn’t a perfect comparison because generally the Vanguard ETF’s have the lowest expense ratios due to their member-owned structure.  HEFA is part of iShares which is now owned by Blackrock, a major competitor of Vanguard.

It should be noted that the VEU and HEFA indexes aren’t exactly the same in terms of countries that they cover and weighting of markets but as you can see above they generally move closely in tandem and the majority of the difference is due to the impact of the US dollar against foreign currencies.

This is of interest because the US Federal Reserve is considering raising interest rates soon, which theoretically would cause the dollar to rise which would make holding shares in other currencies less profitable.  Of course this is already priced into the dollars’ current level, which could mean in practice that if the Fed doesn’t move fast enough or make enough moves, the dollar would fall.  If anyone ever tells you that they can predict interest rates or currency moves you should not believe them; there is no reliable way to predict either one although there are mass industries of pundits attempting to do so.

Thus for my “basic plan“, the question is, should you also consider adding currency-hedged ETF’s and not just the two basic ETF’s (VEU and VTI).  The question is whether to replace part of your VEU allocation (how much you buy) with something like HEFA (there are other ETF’s, but this seems to be a pretty good one, with a large base of investors and from a company like Blackrock which isn’t going away any time soon).  Here’s what would happen – if the US dollar falls against major foreign currencies, you are going to make less money than you would otherwise if you hedge it.  If the US dollar rises, you will make more money than you would otherwise with the hedged product.  Also note that the hedging may not be perfect, but would likely shield you from the vast majority of the impact, especially on major currencies like the Euro.

I think that this is getting a lot of play in the financial press right now and I predict that at some point these products will be mainstream.   It took a long time to move from “active” to “passive” investing and it has taken many more years for ETF’s to begin to take a large share of new investments away from mutual funds.  This is another long term trend that started on the margin (there were very few currency hedged funds a couple years ago when I looked, and they were expensive) but is now going mainstream, and the additional expenses for hedging seem quite modest (0.14% vs. 0.35%).

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

Buying CD’s Through Your Brokerage Account

For many years at this site I have advocated buying CD’s through your brokerage account (Fidelity, Vanguard, E-Trade, Schwab, etc…). If you buy a CD through your own bank you will usually get a far lower rate for what is a completely commoditized product (they are all guaranteed through the FDIC, after all) than what you can get if you shop around in a brokerage.

CD_Yields

This NY Times little data graphic found in their business section makes this point starkly. Let’s look at the differences between the “average” CD that your bank would offer versus what you can get from these other banks offering the highest yields:

– 6 month CD (0.16% average, 1% for highest paying CD)
– 1 year CD (0.27% average, 1.21% for highest paying CD)
– 5 year CD (0.87% average, 2.25% for highest paying CD)

In an era of ZIRP the difference between almost nothing (0.16%) and 1% is very significant. Someday if interest rates rise we may not have to scrape for nickels like this but in today’s environment you need to vigorously watch expenses, risks, and get returns where ever you can (without taking on more risk).

Portfolio Six Updated March 2015 – And It’s Tax Time

Portfolio Six is our newest portfolio, at 3 1/2 years. The beneficiary contributed $1500, the trustee contributed $3000, for a total of $4500. The current value is $4530, for a gain of $30, or 0.7% or 0.3% / year across the life of the fund. You can go here for details or download the spreadsheet at the links on the right.

In 2014 we earned $122 in dividends, for a yield of over 3%. In an era of no interest on deposits, that is very good. We sold one stock in 2014, Yandex, the Russian search engine, for a slight loss at $35. The stock subsequently tumbled down to $14 with the impact of Russian sanctions and the crash of the Russian ruble.

Two of the stocks are oil stocks – Exxon Mobil and Royal Dutch Shell. When oil prices fell from over $100 / barrel to under $50 / barrel (which no one saw coming, at least not the formal analysts) these stocks fell. However, they are both well run companies and pay solid dividends and we plan to hold them for the longer term, unless new adverse events occur.

Two of the other stocks remain under pressure – Coca Cola Femsa, which sells Coca Cola and other beverages in Mexico and Central America, has fallen with the decline in the Mexican Peso vs. the US dollar. Mexico is a good long term growth market but this is on watch. Seaspan, the Chinese shipper, also fell but their very high dividend (7.3%) is still holding up.

Baidu (the Chinese internet company) and Procter and Gamble are both doing well.

Portfolio Two Updated March, 2015 – and It’s Tax Time

Portfolio 2 is our second longest portfolio, at 10 1/2 years. The beneficiary contributed $5500 and the trustee $11,000 for a total of $16,500. The current value is $24,497 for a gain of $9,397 or 57% or 7.4% across the life of the fund. Go here for details or download the spreadsheet from the link on the right.

During 2014 we sold 4 stocks; 2 are near their sales price, Urban Outfitters went up about 20% since then, and Yandex halved in price. So we are about even on that.

During 2014 the portfolio generated $449 in dividends; that’s a yield of about 1.9%. That’s pretty good when you consider that cash yields pretty much zero nowadays.

For stocks on watch – we still have TransAlta (Canadian utility) which has a high dividend and also some stocks that have had big gains, such as Toyota Motor and of course Facebook. Statoil and the 2 Canadian banks also have hit problems due to the commodity price crash (especially oil) and the rise of the US dollar which makes holding stocks denominated in Canadian dollars and Norwegian Kroner less valuable.

Portfolio One Updated March, 2015 – and it’s Tax Time

Portfolio One is our longest lived portfolio, at 13 1/2 years. I remember the first day we invested very well – it was right after 9/11/01, and the markets were closed for a few days. The beneficiary’s mother asked me if investing was the right thing to do and I said that we had a long run out in front of us.

Portfolio One has a value of $34,875. The beneficiary contributed $6500 and the trustee contributed $14,500 for a total of $21,000. The gain has been $13,875 or 66% since inception, which works out to approximately 6.9% / year. You can see performance here or use the link on the right sidebar.

It’s tax time. The brokerage sends a nice form. Over the years this has gotten easier as they have the cost basis on the stock for each sale and whether it is a short or a long term gain. Apparently you have to buy the higher level Quicken if you need to do any individual stock sales which probably means that the average American filer doesn’t have much at all in terms of stock gains or losses (in a non-retirement account) and that is sad. Likely in the old days all you had to do was leave your money in a bank account and earn some interest but nowadays I don’t even receive a tax form for interest for these accounts anymore because we literally earn 2 cents / year for the cash on hand in these individual accounts.

We had dividends of $816.17 and long term losses of ($165) and short term losses of ($801). In 2014 we sold Twitter, CNOOC, Urban Outfitters, Yandex, Philip Morris and China Petroleum. Not that we have the benefit of hindsight at the time we make sales like this but of the 6 we sold all but one (Twitter) are below the price right now of where we sold them.

Of the stocks we currently hold, most are pretty far above their cost basis, except for Statoil (the Norwegian oil company) which was hit like all oil companies by the fall in the price of oil and then there was a double whammy because the US dollar appreciated against the Norwegian Kroner which means that the stock price hit is magnified in US terms (it did better on the local exchange if you were a Norwegian holding your investments in Kroner). Our most recent tranche of Exxon is also down but overall that is a good stock to hold for the long term with a nice dividend and a ruthless and focused executive team.

The dividends number is nice. Every year this portfolio earns almost $900 in dividends, on about $34,000 invested in stocks of average, (the cash returns interest, which is zero),for about 2.6% yield. Since cash returns zero as we discussed above this is how you earn any sort of income anymore – you need dividends back from your stock. Qualified dividends receive a lower tax rate – it doesn’t impact the beneficiary as much as it impacts us – but for some reason not all dividends qualified. It turns out that you have to hold the stock for 60 days to receive the tax benefit and often there is a first dividend payment before we hit that date.

I pass on all this information to the beneficiary and now they are adults and they need to do their own taxes. That is a sign of adulthood when you finally realize how much taxes you pay every year to social security, medicare, the Federal government, the State government, etc…

The Rise of the Dollar

When I was growing up as a kid I remember they had TV commercials against Jimmy Carter explaining how the dollar declined vs. other currencies over the decades. In the late 1980’s the Japanese Yen soared in value until their market crashed in 1989. The Euro was originally near parity with the dollar, then fell to 70 cents on the dollar (I happened to be in Europe at the time, it was great), then rose to over $1.30 against the dollar.

In general if you keep your portfolio all in US assets you are essentially “100% long” against the dollar. A few years ago the dollar effectively fell almost 40% vs. many of the worlds’ major currencies – this is the time when the Canadian and Australian dollar almost reached parity with the US dollar. For US citizens who traveled frequently across the border into Canada, it seemed strange to think of the Loonie as being just the same as a US dollar, since for years it was worth substantially less. Thus if your portfolio was all in US dollar denominated assets, your value fell 40% that year vs. the worlds’s currencies, even though you couldn’t “feel” it unless you traveled abroad or tried to buy imported goods.

Recently, however, this has all turned around. The dollar is soaring vs. most of the world’s currencies, which is good news for travelers and makes imports cheaper. However, those who own foreign stocks are looking at losses regardless of how the underlying stock performs (often many of the underlying foreign businesses IMPROVE when the US dollar rises; for instance Indian outsourcing firms who are paid in US dollars find that this money stretches further when paying their Indian based staff in rupees), just because of the rising dollar.

Rise_of_dollar

It is controversial but many central banks are taking steps to effectively debase or reduce the value of their currency in order to keep their export economies competitive. This is essentially the strategy of Japan. On the other hand, some countries are faced with dire circumstances due to the fall in their currencies, which causes inflation locally and can crush banks and those who take out home loans and bank loans denominated in foreign currencies (a surprisingly common overseas practice, although the down side is clearly on display in countries like Russia where a 50% fall in the ruble means that your mortgage just doubled). Some countries like Venezuela and Argentina are in extreme shape and basic goods are not available on the shelves and local manufacturing has mostly seized up; this happens when you stop the flow of dollars outside the country and try to prop up your local currency regime (and lack credibility).

Finally, while everyone thinks the Fed is going to raise interest rates at some point, now we need to think of the impact on the dollar. All else being equal, raising interest rates is going to make the dollar even stronger against its peers, especially as those countries remain in a zero interest rate environment (ZIRP). Given the huge rise that the dollar has already seen, further increases will make exporters even less competitive on the world stage.

I am reading a few books on currency wars and I didn’t realize that the US and Saudi Arabia had an explicit deal where the US provided security as long as the Saudis invested their excess in US Treasury bonds and denominated the world price of oil in dollars and not any other currencies. This gave rise to the term “petro dollars”. While I had heard the term many times I did not realize that this was an explicit not implicit relationship. Even today oil is denominated in dollars, although Putin and the Chinese are working to change that over time with their own bi-lateral relationship (which is running into a rough patch with the fall in the ruble recently, but obviously has long term potential given Russia’s huge resource pool and China’s voracious demand for commodities).

Cross posted at Chicago Boyz

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.

Stock Selection Notes

We just completed stock selections for the six portfolios. It takes a few weeks, from the time the stock selections are posted, collecting the $500 contribution from each beneficiary, matching the $500 and contributing $500 more, and then following up to actually get the selections from each beneficiary.

These decisions to pick stocks are not taken lightly. This represents a significant amount of money for each beneficiary, and it is a lot of babysitting or mowing lawns or saving allowance to save up for the purchase.

The results of the stock picks were…

Yahoo 4 (selections)
Yandex 4 (selections)
Cliffs Natural Resources 1 (selection)
Devon 1 (selection)
Seaspan 3 (selections)

This totals 13 instead of 12 because portfolio five sold Alcoa (endless Chinese competition) and purchased 3 stocks instead of 2.

No one picked:

– Philip Morris, cigarette manufacturer (they only sell overseas)
– Infosys, Indian software developer / outsourcer
– IBA, a Mexican poultry producer

It makes some sense because cigarettes seem socially awkward to buy and the Indian outsourcer and Mexican poultry producer don’t seem very exciting. In the future I will work a bit harder to “promote” some of these investments better. However, in the end, it is their money and their stock selection (from the list).

Fees and Expenses:

It is amazing how cheap it is to setup and run these portfolios. They are under the trustees “umbrella” account so they each get a number of free trades each year (far more than they actually use, since we mainly “buy and hold” unless there are exceptionally large gains or losses). The portfolios have been free to set up and run the last few years, and many of them have ZERO expenses since inception (OK, there is an SEC fee on purchases or sales, but that is a few cents).

From an expense perspective you can’t beat these portfolios. The “real” expenses that they pay is as close to zero as it comes.

On the other hand, the funds essentially earn no interest. Many months it rounds to less than one cent. They don’t even send the 1099-int (interest) because it isn’t needed if you have less than $10 or so (this is from 2008, maybe it has changed a bit). There is nothing to say anymore about “compounding” interest. Thanks to ZIRP interest is effectively nil and irrelevant on checking and savings accounts, along with money market accounts (unless you buy bonds, in which case it usually is just very low).

Tools To Select Stocks:

The tools to purchase and select stocks have gotten immensely easier to use. It was originally primitive to purchase stocks online and when you sold it didn’t even tell you how many shares that you were selling on the “sale” page (you had to remember from the previous page). The purchases didn’t “net” against your available cash so you had to check manually to see if you were going to exceed available funding.

We started these trust funds right after 9/11 and it has just gotten better and better over the years.

Portfolio Four Updated July 2013

Portfolios 4 and 5 are both almost 4 years old. The beneficiary contributed $2000 and the trustee $4000 for a total of $6000. The current value of the fund is $7186, for a gain of $1186, or 19%, or about 7% / year (when the timing is adjusted for cash flows). You can see the portfolio detail in the links on the right or go here.

Portfolio 4 seems to be doing fine. All the stocks are above their purchase price, with a couple of big winners (Westpac and Wal-Mart) and the portfolio has many stocks that pay significant dividends. Dividends are particularly valuable since there is little or no interest income nowadays with low interest rates.

Last year we sold Exelon when they hit major problems and it looked like their dividend would be cut. The stock hasn’t moved much recently.

US Markets vs. The Rest of the World

Although the US stock market has pulled back a bit as of late, we are up over 10% in the year to date. The rest of the world with the exception of the US, however, is actually down about 1% or so. The Vanguard ETF VEU is a decent, simple proxy for the rest of the non-US market (although any single measure is flawed). I started using an average of the US markets and the VUE to compare against the trust funds documented in this blog (see funds 1-5 plus newly started 6 in links to the right) because it is a more applicable mix since 30-50% of the assets are in non US stocks (ADR’s).

There are two main components for the foreign markets right now

1) their currency against the US dollar
2) their market index performance

The US dollar has strengthened against many of the foreign currencies, which means that US assets are worth more and foreign assets are worth correspondingly less. We recently looked at the impact of this on the Japanese markets, where strong growth in local currency (the Yen) didn’t translate to increases in value of stocks to US citizens (unless you bought from an ETF or mutual fund that hedged the dollar / yen exposure to stay neutral, which most of them do not).

Many of the foreign indexes have declined, and European stocks in general have not recovered from the 2007-8 crash to the same extent as the US market did. A simple rule is that anything (in the US) bought in 2006-7 near the peak was way overpriced and anyone who bought during the trough in 2008 when the markets were in their nadir did very well. This rule generally applied overseas as well but some markets didn’t come back as strongly.

Every country is unique as is their impact on the markets. There have been riots and other acts of instability in emerging markets. However, it seems that the moves of the US to perhaps reduce “quantitative easing” by the Fed (QE1-3…) that are spooking the foreign markets, since a rise in the value of the US dollar and interest rates is thought to have a major impact on the relative attractiveness of these foreign markets. Today the world benefits from low interest rates and it is anticipated that at some point these low interest rates will rise and it will have various (mostly negative) impacts on countries and currencies around the world.

Investing is very complex and this blog highly recommends that you do your own research. The point of this post is that in order to judge performance you need some applicable benchmarks and if over 30% of your portfolio is in non-US assets you can’t judge against a US benchmark. You also need to understand not only the performance of the overseas markets but also the performance of their currency vs. the US dollar.

Dividend Portfolio Final Results

Since interest rates are so low I didn’t want to just renew my CD bond “ladder” and decided instead to take those funds and invest them in a portfolio of dividend stocks. Currently stock dividends are returning more than government debt, which is a very rare occurrence.

Thus I selected a dozen stocks with reasonable yields (between 2% and 5%, I wanted to avoid extremely “distressed” stocks) and with reasonable performance (not a large run up or decline in the last year). The portfolio began in July, 2012.

I could have just bought an ETF that focused on dividends but many of these ETF’s were in the 0.4% or more in terms of expenses, especially since I was looking at a substantial percent of international stocks and it is difficult to find an ETF that covers all of this. Since I had a number of free trades that I had accrued with my brokerage firm, the effective expense ratio of this effort was zero. That saved me about $500 on an annual basis, which is significant when the “net” return is around 1% – 2% on any sort of debt right now that is near risk-free.

What I learned immediately is that dividend stocks are extremely volatile, as are all stocks. Since I was not attempting to select stocks for gains, I made a rule that if stocks went up 15% or down 10%, I’d sell, and then re-buy something else to replace it in the portfolio. This rough rule of thumb said if you got 15% return that was 5 years worth of dividends at 3% / year, which was a gain to take off the table. On the other hand, you didn’t go into this to lose significant amounts of money (remember, this is my CD ladder money as noted above) so I would sell as a “stop loss” rule.

Based on this rule I had very high turnover. In the first 5 months I had sold off 2/3 of my original stock picks. This level of turnover is high for a portfolio that is supposed to earn income, not yield gains or losses.

For a baseline, I used the BND ETF from Vanguard. This isn’t just a baseline, I actually did invest roughly the same amount into that ETF as a core holding at the same time. I plan to keep the BND ETF indefinitely.

Come mid March 2013, I decided to end this experiment. Here are the results:

– for the stocks, a return of about 18% annualized, of which about 85% was capital gains (net of losses)
– for the EFT, a negative return of about (2%) annualized, which is due to a decline in the price which more than offset the returns

The specific stocks are listed on the links sidebar or you can go here.

What did I learn?

I learned that dividends are a relatively small component of a stock portfolio and that return is often dwarfed by other market forces. During this time there was a stock run-up in value so that is what the portfolio move was driven by. It is a fools’ errand to view stocks and income (dividends) from stocks as a replacement for income from an instrument such as a CD, bond, or ETF / mutual fund.