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Archive for January, 2013

My Trading Skills Continue To Beat The Market

January 25, 2013 2 comments

A few months ago I wrote about how a trade I thought up on a whim would have generated enough profits to buy the world after a year. Since people are still talking about Apple I decided to check on the trade again. If you didn’t take my advice to sell out 2 months ago and instantly become the best stock picker of all time, here’s what would have happened after holding on another 2 months:

  • Apple has fallen further. It started at $681.32 4 months ago, it was $571.50 2 months ago, and it’s at $445 today.
  • RIM has continued rising. It was at $7.14 4 months ago, it went up to $11.66 2 months ago, and it’s $18.06 today.
  • You would pay another $153.30 in margin interest to keep shorting Apple stock for 2 more months.

So if you held this trade for 4 months it would play out like this:

  • Short 30 Apple shares in September and collect $20,439.60
  • Buy 2862 RIM shares the same day for $20434.68
  • Net cost: $16 including trading fees and loose change
  • Pay $306.60 in margin interest over 4 months
  • Sell your 2862 RIM shares today and collect $51,687.72 (OMGWTFBBQ@$&@$^%*@#&%*@$%!!!!!!!!!!!!!)
  • Buy back 30 Apple shares today at a cost of $13,350 (oops!)
  • Pay another $20 in fees

Therefore your total cost would be $340 and your profit would be $38,317.72. That’s a 11,269% return in 4 months. Overall it’s a bit disappointing since that’s only an annualized return of 143,140,400% compared to an annualized return of 76,117,945,311,128% if you had closed the trade after 2 months and found another similar opportunity.

So if you were considering buying Apple stock 2 months ago because it’s so popular you could have chosen any of these alternatives instead:

  • Buy the S&P 500. You would have 50% more cash today (compared to buying Apple stock).
  • Buy RIM. You would have twice as much cash today (compared to buying Apple stock).
  • Run my long/short trade. Since you barely need any money to do it, it’s hard to quantify how much more you would make. On a position of $20,000 you would end up with a profit of $15,207.90. But you wouldn’t have to put up the initial investment so you could still use that cash to buy more RIM stock and end up with 3x as much cash as you would have if you bought Apple two months ago.

Even at its best I don’t think Apple shares were putting up gains like this. Now the bandwagon is going off a cliff (and everyone thought it was the US Congress that would do that). Without a doubt this timeless lesson in investing will be forgotten next week. Next time there’s a tension this big in the market I may have to actually jump in!

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Government Pension Plans May Be More Reliable Than You Think

January 21, 2013 2 comments

It’s become common to talk about how plans like Social Security in the US and OAS in Canada will not be available to people who are young now, because of the wave of baby boomers who are about to shift the balance. However like a good contrarian I have to point out a major oversight in this analysis.

The common criticism is right: these are a transfer from people who are working to people who are not, recalculated each year. In all their wisdom our politicians didn’t anticipate a change in the numbers on each side ahead of time (funnily enough they will threaten to jail corporate executives who fail to prepare like that). Or maybe they expected a lot of deportations. Who knows.

We can correctly assume that in 20 years there will be a larger number of people not working, supported by a smaller number of people who are working. That much is already written. But let’s go a bit further. Take someone who is 25 now. The standard retirement age will probably rise over time, so let’s say they start to collect government pensions at 75.

That means their government benefits will be supported by people who are 20 – 75 at the time, or in other words people who are up to 55 years younger than them. Given that they are 25 years old today, how many people will be 0 – 55 years younger than them? Er… good question! We’re not even half-way to being able to count that.

Changes in societal behavior or government policies could have a large impact in that time. All those people who want to ban birth control don’t hate women, they’re really just trying to improve the balance of retirement benefits! Another baby boom may be too much to hope for (plus it would be unsustainable for them) but it’s possible that those who are young now will retire as part of a more balanced demographic with sustainable government plans to support them.

This doesn’t apply to pension plans at specific employers since those are typically funded by a pool of investments and aren’t allowed to operate out of the current year’s revenues alone. That means a large group of retirees that get overpaid can drain the pension plan, possibly leading to bankruptcy of the employer.

Of course this is all assuming that governments are smart enough to cut benefits or raise taxes to maintain benefits and not take out debt that they can never repay. I’m not taking my chances. Once I’ve made my fortune I’m buying a private island and getting out while the doors are open!

Active Managers Are About To Outperform The Index

January 11, 2013 4 comments

Active mutual fund managers always seem to find a reason for their collective failure to beat the index (other than the simple fact that it is mathematically impossible). First they say that they provide protection during bear markets. Then when a bear market comes along and they lose more than the index, they say they can find the stocks that will grow in the recovery. All too often those turn out to be companies that never recover. Recently they have taken to claiming that the rise in indexed assets is making their job harder, when index investors should be an easy target for a smart active manager – I have already announced what I will buy next year!

But I may have found the most creative and hilarious excuse yet. Doug Cronk’s fine blog links to a piece by a manager at AllianceBernstein who takes the idea of mean reversion, commonly used by indexers, and applies it to active managers:

Performance probably falls into the cyclical camp, as it tends to be mean-reverting – bad performance is often followed by good and vice versa. […] the fact many typical active managers’ strategies have underperformed passive strategies for the last five years means the odds are very good that performance in the next few years will be much better.

While this might sound good if you only look at it superficially, it fails to account for things like fees that will most likely not revert to the mean. Unless active managers cut their salaries by 90%, they will continue to have a major drag that keeps their returns lower than the index. Most amusingly it ignores the reality that the index used by passive strategies is simply the average of the largest active investors, so they can never outperform themselves.

There is a small element of truth in this. There may be active managers who consistently outperform the market. If they do so it’s only because they sometimes have a few years where they look very bad, only to come back later (some of them never recover though; hope you picked the right ones!). This fact is blown into something much bigger here which is ultimately impossible.

Active managers as a whole cannot revert to the mean. They seem to have underperformed the index for just about as long as there has been a reliable index to measure against. Unlike bonds, which have experienced  a 30-year bull market that probably is about to revert, I don’t think this history of pain (which is much longer than the last 5 years) is about to stop any time soon.

Even if they make major improvements they can’t deviate much from their past performance where 60-90% of active managers have under-performed the index and last year’s winners tend to be this year’s biggest losers, creating a constant rotation in the top funds that leads many individual investors to lose money. But on the plus side they can be entertaining!

Portfolio Returns for 2012 and How To Calculate Your Returns

January 5, 2013 1 comment

When I read this post recently, I knew it was time for a personal first: calculating our actual portfolio returns. You can see how our asset allocation has shifted a bit and I wanted to find out the results over the last year. Last year we added 2.5x the starting value to our portfolio so the market return is too small to see.

When I started out investing most of the funds went into bonds to give us a down payment for a house. This was around the time a bad smell started coming out of American housing so the bonds did well and we bought some stocks on the cheap too. When we bought the house it was a good time to cash out the rest of the portfolio too so we reset to 0 and have been building back up since then.

At that time I had started using Quicken but I found that it was very hard to enter details of the transactions, the automatic import didn’t help much, and the display where it shows the portfolio returns was very confusing. I went back to my investment tracking spreadsheet which is much easier but shows a nearly-useless number telling us how much the market value exceeds the amount we’ve invested (8.4% right now).

Finally I did the only thing that makes sense: open Excel and use the XIRR function to calculate returns. We make a monthly addition to our portfolio which was the same amount every month last year, and also had 4 extra additions throughout the year. I made a list of those, entered the function, and found that we got a return of 9.4% in 2012.

I was expecting something around 10% since we have nearly equal weightings in 3 major equity indexes that ranged from 7 – 16%. We let the bond allocation continue to slide to almost nothing this year so it didn’t drag down the returns much. The MSCI World index returned about 11.5% since it holds less in the Canadian index so you could say we under-performed the nearest benchmark this year. That’s good because I want to buy more at low prices!

This calculation doesn’t include a small workplace pension (with a current value that is 6% of our portfolio) or the RESP we opened this year, mainly because it would take a few minutes to find the information and I would have to enter twice as many transactions. The pension plan is invested entirely in the Canadian index as part of our overall allocation and the RESP is similar to that allocation so I don’t think this affects the results too much.

If you want to calculate your own returns this is simple to do. For example if you started the year with a $100,000 portfolio, invested $5,000 each quarter, and the balance was $132,000 at the end of the year, you would make a table like this:

A B
1 Amount Date
2 $100,000 1/1/2012
3 $5,000 2/15/2012
4 $5,000 5/15/2012
5 $5,000 8/15/2012
6 $5,000 11/15/2012
7 -$132,000 12/31/2012

Important: The final balance has to be a negative number, as though you sold your whole portfolio, to do the calculation correctly. It will fail if you don’t put in at least one positive and one negative number. 

Then in another cell you would enter this formula:

=XIRR(A2:A7, B2:B7)

If you entered the information above this should give you a rate of 10.9% (make sure the cell is formatted as a percentage). This is always shown as an annualized return rate even if you put in numbers over a shorter or longer time. Excel is just putting different interest rates into an NPV calculation to see which one gets a value closest to 0 which is why you need the negative number for the final balance.

And that’s all it takes to figure out your returns. If you have withdrawals from the portfolio you can enter those as negative amounts to adjust the results. It really is simple to do this calculation as long as you have the information readily available. It’s so easy I may start doing this every quarter and putting it in our net worth spreadsheet. If I dig out some more old transactions I’ll have nearly 2 years of information to get started.

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