The 2 and 20 rule is the standard fee arrangement at most private equity funds. Hedge fund managers typically get 2% of the assets they place at risk for you and 20% of any profits, hence 2 and 20, a scam if there ever was one. Although this is a fairly well known axiom throughout investing circles, I was originally made aware of it by reading Barton Biggs' Hedgehogging which is an insider's account of the hedge fund industry. The book states that besides the astronomically high management fees, private equity funds don't beat the S&P 500 index the majority of the time. If you are interested in reading a good investing book, especially about hedge funds, Hedgehogging is highly recommended. It should be noted that here at The Ithaca Experiment, the only fees incurred are taxes and broker's commissions. After all, this is do-it-yourself investing.
As I crawl from the wreckage of a miserable week for my portfolio, I think back to Benjamin Graham who is the father of Value Investing and his allegory of Mister Market. To Graham, Mister Market is a manic depressive who comes to the stock market each day with shares to trade. Some days he is an especially upbeat mood and will offer shares at extremely high prices and other days he is depressed and will low ball his offerings. Right now Mister Market is in an elevated state and there is no way, shape or form the indexes should be so high based on the P/E ratio of the S&P 500. I understand there is a lot of bullish market sentiment and in the short term, I am losing money, but I am not going to chase performance.
Graham is also famous for saying in the short term, the stock market behaves like a voting machine, but in the long term it acts like a weighing machine. What he means is that after a duration of time it is the earnings of a stock or index that matter most. The current P/E Ratio for the S&P 500 is 20, very high by historical averages, and the growth rate is projected to be 35% for next year according the the Standard and Poor's Web site. With an unemployment rate of over 10% and growing, I do not believe the S&P 500 earnings will increase at a rate of 35% next year no matter how much cost cutting the companies have done.
The market could rally 5 to 10% by year's end because November and December tend to be the two best performance months for the stock market, but I've taken my stand and so did General Custer at the Little Big Horn. If I were to sell my short positions now and go long for say a month or two, I'd be defeating the purpose of holding my shares for more the 365 days for long term capital gains and losses. Sure, there is a certain amount of anxiety involved when you are going against the popular momentum, but I am willing to take my chances.
Tuesday, November 10, 2009
Wednesday, November 4, 2009
Diversification
In the twenty years I have been investing, I'm currently the most diversified as I've ever been in any of my portfolios. I only own two ETFs, but these two Exchange Traded Funds mirror the performance of major domestic indexes and both are to the short side. The ProShares Ultra Short S&P 500 (SDS) tracks the S&P 500 which consists of the largest 500 American securities by market cap and the Direxion Small Cap Bear 3X Shares (TZA) emulates the return of the Russel 2000. I tend to be an aggressive investor, so I am usually running a concentrated portfolio with very little diversification. If I had been diversified throughout the years, I wouldn't have tripled my portfolio in a matter of one or two years twice in previous bubbles. I also wouldn't have lost as much after the party was over as I hung onto my positions like Captain Ahab harpooning the great white whale. Always remember that tried and true Wall Street adage of "don't confuse brains with a bull market". I learned the hard way which is why I'm short right now because I really believe in my convictions of a double dip recession.
I have been asked what I would do if I wasn't so aggressive in my investments and took more of a laissez-faire attitude in portfolio management. After all, this is what most people would prefer to do, take a hands off approach and let their money compound at a reasonable rate. Investing in the stock market can be very confusing with all of the choices available and even if you know what you are doing, you can get burned like the majority of people did this past year. If I didn't have an ego large enough to think I can beat the market, then I would be as diversified as possible with index ETFs covering domestic and foreign securities as well as good old American bonds.
Which ETFs would I purchase to build a diversified conservative portfolio? For me the prudent course of action would be to invest in ETFs offered by Vanguard because they have the lowest expense ratios. As a side note here, it should be mentioned that pioneer discount broker Charles Schwab launched some index ETFs this week with a slightly lower expanse ratio than the Vanguard offerings, but they are new to the game and will have very low volumes at the outset. Vanguard is synonymous with index funds and really knows what they are doing are far as managing their product is concerned. I'll stick with the tried and true.
For my laissez-faire portfolio, I would divide my cash into the equal parts of roughly 33% each and invest my money in the following three ETFs offered by Vanguard. For domestic coverage, the Vanguard Total Stock Market ETF (VTI) tracks the MSCI U.S. Broad Market Index. This contains 1,200 - 1,300 of the largest cap American stocks. For foreign exposure, the Vanguard Total World Stock ETF (VT) tracks the FTSE All-World Index of 2,900 stocks from 47 countries. Finally, for a bond allocation, the Vanguard Total Bond Market ETF (BND) tracks the Barclay's Capital U.S. Aggregate Bond Index. I could easily invest my money in a strategy like this and come back in 20 or 30 years and be ahead of the game as long as there was no Nuclear Winter. Would I ever use this strategy? Maybe some day down the line, but right now I've got my mojo working on something more active. Stay tuned.
I have been asked what I would do if I wasn't so aggressive in my investments and took more of a laissez-faire attitude in portfolio management. After all, this is what most people would prefer to do, take a hands off approach and let their money compound at a reasonable rate. Investing in the stock market can be very confusing with all of the choices available and even if you know what you are doing, you can get burned like the majority of people did this past year. If I didn't have an ego large enough to think I can beat the market, then I would be as diversified as possible with index ETFs covering domestic and foreign securities as well as good old American bonds.
Which ETFs would I purchase to build a diversified conservative portfolio? For me the prudent course of action would be to invest in ETFs offered by Vanguard because they have the lowest expense ratios. As a side note here, it should be mentioned that pioneer discount broker Charles Schwab launched some index ETFs this week with a slightly lower expanse ratio than the Vanguard offerings, but they are new to the game and will have very low volumes at the outset. Vanguard is synonymous with index funds and really knows what they are doing are far as managing their product is concerned. I'll stick with the tried and true.
For my laissez-faire portfolio, I would divide my cash into the equal parts of roughly 33% each and invest my money in the following three ETFs offered by Vanguard. For domestic coverage, the Vanguard Total Stock Market ETF (VTI) tracks the MSCI U.S. Broad Market Index. This contains 1,200 - 1,300 of the largest cap American stocks. For foreign exposure, the Vanguard Total World Stock ETF (VT) tracks the FTSE All-World Index of 2,900 stocks from 47 countries. Finally, for a bond allocation, the Vanguard Total Bond Market ETF (BND) tracks the Barclay's Capital U.S. Aggregate Bond Index. I could easily invest my money in a strategy like this and come back in 20 or 30 years and be ahead of the game as long as there was no Nuclear Winter. Would I ever use this strategy? Maybe some day down the line, but right now I've got my mojo working on something more active. Stay tuned.
Monday, November 2, 2009
Schadenfreude
The first rule of investing is not to lose any money. With the performance I've had the last three months in my short positions, I would probably have been given the pink slip or at the least be in a major dog house if I'd been managing a mutual fund or hedge fund. After all, investors want results. With a mutual fund, you may experience a quarterly churn of clients for under performance. With a hedge fund, investors want profits every single day. The beauty of being an independent investor is you can be patient. You can also invest in whatever you want to. With mutual funds, you are pigeonholed with restrictions such as being a small cap fund or a value fund or sector specific and when your investing style goes out of favor, you get crushed. The independent investor can be nimble or slow or both depending on your portfolio allocations. Right now I'm in the slow lane with index funds.
If you don't know the gist behind the rationale of investing in index funds and index ETFs, I'll try to give it to you as succinctly as possible. Simply stated, index funds outperform actively managed funds in the long run the majority of the time once you take taxes and expense ratios into consideration. This was proven in Charles Ellis' classic investing primer Winning the Loser's Game in the mid 1970's and restated in John Bogle's The Little Book of Common Sense Investing in 2007. In fact, John Bogle launched the first S&P 500 index fund in 1975 with the Vanguard Group. If you've got money in the market and haven't read either of these books, I strongly suggest you do so. You'll save yourself a lot of time and aggravation by taking the hands off approach if you are not inclined to do your own research. Warren Buffet, Peter Lynch and Jim Cramer all recommend index funds.
The first Exchange Traded Fund was an S&P 500 index fund. Commonly referred to as the Spider, the S&P 500 Standard and Poor's Depository Receipt, or SPDR (SPY) was launched in 1993. This is the new widows and orphans fund. It's liquid, it's diversified, it contains the 500 largest American companies and it mirrors an index that has produced returns of 10% on average over the last century before taxes and expenses. If I didn't know a lot about investing and had a long term time frame, this is where I'd put my money. If you think the market is going to correct and you want to place your bets on the short side of the S&P 500, then there is the ProShares Short S&P 500 (SH) ETF.
For you thrill seekers out there, ProShares also offers leveraged ETFs for the S&P 500 to both the long and short sides. With 200% leverage, there are the ProShares Ultra S&P 500 (SSO) and the ProShares Ultra Short S&P 500 (SDS). They recently introduced 300% leveraged ETFs with ProShares UltraPro S&P 500 (UPRO) and ProShares UltraPro Short S&P 500 (SPXU). If the market is going your way, you can make a lot of money very quickly, but you can lose it just as fast, too. I'm on the short side with a large portion of my portfolio in ProShares Ultra Short S&P 500 (SDS) and on paper, have lose a considerable sum of money. With leveraged funds, invest at your own peril.
If you don't know the gist behind the rationale of investing in index funds and index ETFs, I'll try to give it to you as succinctly as possible. Simply stated, index funds outperform actively managed funds in the long run the majority of the time once you take taxes and expense ratios into consideration. This was proven in Charles Ellis' classic investing primer Winning the Loser's Game in the mid 1970's and restated in John Bogle's The Little Book of Common Sense Investing in 2007. In fact, John Bogle launched the first S&P 500 index fund in 1975 with the Vanguard Group. If you've got money in the market and haven't read either of these books, I strongly suggest you do so. You'll save yourself a lot of time and aggravation by taking the hands off approach if you are not inclined to do your own research. Warren Buffet, Peter Lynch and Jim Cramer all recommend index funds.
The first Exchange Traded Fund was an S&P 500 index fund. Commonly referred to as the Spider, the S&P 500 Standard and Poor's Depository Receipt, or SPDR (SPY) was launched in 1993. This is the new widows and orphans fund. It's liquid, it's diversified, it contains the 500 largest American companies and it mirrors an index that has produced returns of 10% on average over the last century before taxes and expenses. If I didn't know a lot about investing and had a long term time frame, this is where I'd put my money. If you think the market is going to correct and you want to place your bets on the short side of the S&P 500, then there is the ProShares Short S&P 500 (SH) ETF.
For you thrill seekers out there, ProShares also offers leveraged ETFs for the S&P 500 to both the long and short sides. With 200% leverage, there are the ProShares Ultra S&P 500 (SSO) and the ProShares Ultra Short S&P 500 (SDS). They recently introduced 300% leveraged ETFs with ProShares UltraPro S&P 500 (UPRO) and ProShares UltraPro Short S&P 500 (SPXU). If the market is going your way, you can make a lot of money very quickly, but you can lose it just as fast, too. I'm on the short side with a large portion of my portfolio in ProShares Ultra Short S&P 500 (SDS) and on paper, have lose a considerable sum of money. With leveraged funds, invest at your own peril.
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