Book review: The Index Card, by Helaine Olen and Harold Pollack

May 5, 2016

The Index Card. Why Personal Finance Doesn’t Have to Be Complicated. Helaine Olen and Harold Pollack. Penguin Random House, New York, 2016.

Genesis

The authors converged their experiences from  journalism (Helaine Olen) and academia (Harold Pollack) into the worthy effort of demystifying the world of personal finance for everyone’s benefit. Author Pollack began the process by devising an index card of rules for recovering from financial hardship and staying solvent. Author Olen’s experience with the Personal Finance Industry validated Pollack’s scheme. Together, they explain the index card to readers of this valuable book.

Rules from the Index Card

  1. Strive to save 10-20% of your income.
  2. Pay your credit card balance in full every month.
  3. Max out your 401(k) and other tax-advantaged savings accounts.
  4. Never buy or sell individual stocks.
  5. Buy inexpensive, well-diversified indexed mutual funds and exchange-traded funds.
  6. Make your financial advisor commit to the fiduciary standard.
  7. Buy a home when you are financially ready.
  8. Insurance- make sure you’re protected.
  9. Do what you can to support the social safety net.
  10. Remember the Index Card

Highlights

Rule #1. The household budget is essential for living comfortably. Be sure to save 10-20% of your income for future needs. The most important savings account is an emergency fund; every household should save 3 months of income in an accessible savings account to use for emergency expenses. —An emergency expense is both immediate and necessary; something bad has happened.—

Rule #2. Unpaid debt has top priority in your budget. Credit card debt is a preventable financial illness that must be corrected. Other forms of debt must also be managed within the framework of a budget.  Unfortunately, there may be unpreventable causes of overwhelming debt such as health care bills and other catestrophic events. Overwhelming debt may require seeking legal advice to file for bankruptcy; don’t feel ashamed.

Rule #3. The second most important savings account is your retirement fund and/or educational savings account. Start while you’re young to take advantage of the compound interest (a.k.a. compounding returns) from investments in either account. DON’T REJECT employer-sponsored retirement savings plans and DO participate in them to the full extent. You can also open personal retirement savings accounts. Facilitate your savings plan by making direct deposits into the retirement and educational savings accounts.

Rule #4. The media’s ‘toxic’ message is that playing stocks is easy and fun. But no matter how much research you do, buying stocks is still a matter of speculation. Stocks are a pay-to-play business where only the broker can always win. Forego the dream of a big win by investing in a small selection of index funds.

Rule #5. Index funds are designed to automatically match the performance of a selected stock- or bond market index. Index funds are true buy-and-hold investments. Most exchange-traded funds (ETFs) and a few mutual funds are index funds. They charge lower management fees than the actively managed mutual funds. Actively managed funds charge higher fees in order to pay for the research needed to outperform the stock or bond market. Few actively managed funds succeed in their effort to beat the market on a sustained basis. Annual management fees for index funds (~0.12%) are lower that for actively managed funds (~0.89%). The average household loses $155,000 in potential investment gains due to the unnecessary fees of actively managed mutual funds.

Rule #6. Most financial advisors are salespeople who chase a profit at your expense. They are not your friend. However, you still have to pay for good advice from a fiduciary advisor. A fiduciary advisor is responible for acting in your best interest, hopefully providing the best advice at lowest cost. The fiduciary advisor is usually a certified financial planner (CFP), registered investment advisor (RIA), fee-only advisor, or robo-advisor who is a proven fiduciary. It’s important to seek a fee-only advisor who is paid by you and only you. The advisor may charge a percentage of your assets under management, a flat fee, or an hourly fee.

Rule #7. Spend no more than 30% of your budget on housing. There are risks and advantages to either renting or buying a home. The authors discuss both.

Rule #8. Insurance is complicated but necessary. Don’t be exploited by salespeople. The 6 Golden Rules of Insurance are:

  1. buy term life insurance
  2. buy high-deductible property insurance
  3. buy a health care plan that pays your provider
  4. buy umbrella insurance that is twice your net worth
  5. avoid complicated annuities
  6. keep an emergency fund

Rule #9. We can’t protect ourselves from everything; sometimes we need a little help. The government is our insurance-backer of last resort. 96% of us have used government financial support to improve our financial situation. Isn’t it our fiduciary duty to Society to support the best government insurance programs?

Conclusions

I concur with the authors’ advice. The strength of their advice is supported by pages of references at the end of the book. Read and re-read their book.

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Conditional orders for stock trades

September 6, 2014

[The basic concept of ‘price diligence’ was inserted on 3/20/2015.  The MockTrades planner was updated on 12/11/2014]

Introduction

Individual investors typically use a market order to buy and sell stocks, ETFs, and REITs.   Market orders activate the trade immediately at the next available price; this controls the time rather than the price.  You can exert more control over trading conditions by placing a conditional (a.k.a. advanced, automated) order.  Conditional orders are considered a form of ‘price diligence’ because they specify the share’s price for activating the trade at any time during approximately 60-90 days, depending on your brokerage firm’s expiration date.  The conditional order controls the price rather than the time of the trade.  After reading this article, you may wish to download SmallTrade’s MockTrades4 for free; it’s uniquely designed to account for market volatility when planning a conditional order.

The trading arena; a simplified description

Stocks and other securities are traded for cash by an auction process in the stock market.  The participants are investors who make offers, brokers who generate orders, and traders who finalize the orders.  Individual investors submit offers to brokers through a computer terminal or by direct communication.  Use of the computer terminal gives the illusion of directly participating in the auction process, but there are several intermediary steps occurring at the speed of light along with a few brief delays.  The first delay is at the brokerage firm where all offers are filtered, recorded, and transmitted to traders in the stock market.  At any moment in the stock market, there are millions of orders to buy and sell securities.

The broker’s computer program, called a trading platform, provides investors with a market quote plus commands for placing a trading order.  The market quote reports a current purchasing price (“ASK”), sales price (“BID”), last-traded price, and latest number (a.k.a. volume, quantity) of traded shares (a.k.a. units).  Valid trading orders are announced to all market participants and filled at the next available price. The next available price is determined by an auction of the available shares for which a trader serves as the auctioneer.  The price can fluctuate between trades and is not protected from fluctuation until the order is filled.  Brokers and traders are always paid a fee for their services.  Custodians are hired by brokers to store traded securities in electronic accounts on behalf of the investors.

Trading orders

As an individual investor, you may place one of several types of trading orders in your broker’s trading platform.  The simplest, called a market order, merely specifies the number of shares to be traded.  The market order is filled immediately unless a time delay is imposed by an undersupply of available shares.

A limit order specifies the preferred price of the trade.  This order is filled when the next available price either matches the limit price or provides a better price {in other words, the limit price is YOUR minimum selling price or maximum purchasing price}.  There is only one opportunity for the limit order to be filled after it is placed in the market.  In rare instances, an unusual market event may shift the next available price out of your limit’s price range, in which case the order is cancelled without an exchange of cash for shares.  Your only recourse is to place a new limit order.  The limit order is used to protect from shifting prices.

Stop and stop-limit orders are useful for protecting against losses of investment capital.  The stop is a specific price at which your trading order will be submitted as a market order.  Your stop is stored in the exchange’s computer until it is submitted or expires at the end of a time period called the time-in-force (“TIF”).   The market order is then filled immediately at the next available price, which may shift to a better or worse price than the stop’s price.  The stop-limit is a specific price at which your trading order will be submitted to the stock exchange as a limit order.  It too has an expiration date.  The limit order protects your trading price until the order is filled, cancelled by the expiration date, or cancelled by an unusual market event. Your only recourse to a cancelled order is to place a new stop-limit order.

Trailing stop orders provide opportunities to seek a better trading price in the market.   The trailing stop is a specific point spread (1 point equals $1) by which the stop price will trail the movement of market prices toward a better price.  In general, the trailing stop can move toward a better price but won’t move toward a worse price.  The trailing price resides above or below the market’s price by the cash value of the point spread.  The trailing price adjusts upward with market prices when you offer to sell shares and downward when you offer to buy shares.  Reversal of the market price initially stops the adjustment of the trailing price and eventually triggers the submission of a market order.   The trailing stop order is stored in the brokerage firm’s computer until its expiration date or the submission of a market order.

Setting the stop

Trading platforms are designed to set stops above the ASK and below the BID of a market quote.  For example, when you offer to purchase shares with a stop or trailing stop order, a market order is submitted when the market’s ASK increases to the stop price.  Or when you offer to sell shares with stop-limit order, a limit order is submitted when the market’s BID decreases to the stop price.

The likelihood that daily fluctuations in market price will trigger any type of stop order depends on the width of the margin between the stop price and market price.  Exceptionally narrow margins may trigger an order the same day and exceptionally wide margins may cause the order to expire before being triggered.  The width of the margin depends on your trading strategy.  What is your acceptable price range for buying and selling a security?  Do you prefer using the same margin for all stops or customizing the margin based on price volatility?  The SmallTrades MockTrades4 is a free, useful worksheet (in Microsoft’s Excel™ format) for customizing the stop margin of your trading order.

Applications

Stop and stop limit orders are typically used to protect against capital losses when market prices are declining.  Trailing stop orders can help maximize a sales price or minimize a purchase price.   Examples of these applications can be found online in the educational materials of brokerage firms.  This user-friendly version, “Secure your position”, was a free download provided by the Commonwealth Securities Limited (“CommSec”), Sydney, web site.

Copyright © 2014 Douglas R. Knight

 


#SmallTradesFinancialAnalyzer

December 16, 2013

[Revised on 12/17/2013]

Click on this link, SmallTradesFinancialAnalyzer, to download a spreadsheet program for analyzing the financial status of a company.

The skeptical investor makes a financial analysis to confirm the advice of well-meaning tipsters, decisions of investment clubs, results of stock screens, or other sources that point to ‘good’ investments. Unless you’re proficient at reading financial statements without assistance, consider using the spreadsheet program to organize financial data for a systematic review. The process takes about an hour if you can download the latest set of annual and quarterly financial statements from the internet. I download the statements from my brokerage account at Schwab.com (1). I assume, without knowing for sure, that other brokerage firms provide the same data. If not, the data can be extracted from SEC filing forms 10-K (annual report) and 10-Q (quarterly report). At this time (December 2013), the Yahoo Finance (2) website provides historical prices.

The analysis program is used in Microsoft’s Excel worksheet platform. There are 11 pages that provide for data storage, entry, and analysis. You begin by downloading financial data onto 7 blank pages labeled Aincome, Abalance, Acash, Qincome, Qbalance, Qcash, and 6Y historical prices [e.g., Aincome signifies the annual income statement, Qbalance signifies the quarterly cash flow statement, and 6Y historical prices is reserved for the date and closing price of the stock]. After downloading the data, copy and paste selected information into blank white spaces of the data entries page. The data entries page is organized from top to bottom into annual statements, quarterly statements, and historical prices. Cells with a red triangle in the corner contain hidden comments that appear when passing the cursor over the cell. The blue-font reminders disappear when data are entered in the appropriate cells. Enter 6 years of historical prices.

The program computes and displays information in the form of charts and tables located in the pages for financial charts and market valuation. The financial charts page is organized into charts on the left hand side and legends on the right hand side. At the top of each chart is a title that contains either an error message or the title of the chart. The error message warns that incomplete information may be corrupting the charted data, in which case you should review the data entries page for missing or incorrect data. The legends contain questions and explanations; the questions are relevant to what most investors want to know about the company’s operations and financial success (3-7). The market valuation page is organized in the same way; charts on the left and script on the right. The top of the page has a link to industry stats published by Yahoo Finance (2). Industry stats are useful for placing the company’s market valuation into a broader perspective. The last page, notes, provides a general explanation of financial statements based on author Thomas Ittelson (3).

The financial analysis program is only useful if you can easily locate and enter the required information; even so, it takes about 15-60 minutes depending on your familiarity with the process.  The charts and tables illustrate the company’s profitability, business model, growth strategy, management efficiency, ownership, and market valuation.

If the program inspires your investing to support the betterment of society, consider making a tax-deductible contribution to your favorite charity or my favorite charity.

Copyright © 2013 Douglas R. Knight

References

1. Schwab.com. Charles Schwab, https://www.schwab.com/, © 2013 Charles Schwab & Co., Inc.
2. Yahoo Finance, http://finance.yahoo.com/ .
3. Thomas R. Ittelson. Financial Statements, A Step-by-Step Guide to Understanding and Creating Financial Reports. Career Press, Franklin Lakes, 1998.
4. Leita A. Hart, Accounting Demystified. McGraw-Hill, Chicago, 2006.
5. John A. Tracy, How to Read a Financial Report, 6th Ed. Wiley, 2004.
6. Christopher H. Browne, Forward by Roger Lowenstein. The Little Book of Value Investing, John Wiley & Sons, Inc., Hoboken, 2007.
7. Joel Greenblatt.  The Little Book that Still Beats the Market.  John Wiley & Sons, Inc. 2010.


#SmallTradesPortfolioDESIGNER

April 21, 2013

(updated 7/31/2013)

The Small Trades Portfolio Designer is used to test model portfolios that hold 1-9 sectors of financial market returns plus a cash supply of U.S. dollars.  The program is pre-loaded with monthly returns computed from broad market indices during the 15 year period of 1997 to 2011.  You create the model portfolio by entering an allocation plan, investment amount, and rebalancing strategy.  The results are displayed in tables and charts on the same worksheet. You have the option of assessing the impact of trading costs and investment fund fees on portfolio returns.  The program can be downloaded for free by clicking here: SmallTradesPortfolioDESIGNER.

Allocation plan

At the top of the worksheet, each class of securities is labeled according to a unique combination of market region, market sector, and asset class.

designer1

Consider, for example, funding a portfolio that is 54% invested in large-cap U.S. stocks, 36% invested in U.S. bonds and 10% stored in cash.   For every $100 invested, $54 are allocated to U.S. large-cap stocks, $36 to U.S. bonds, and $10 to a cash reserve.  The allocation plan consists of weighting factors 0.54/0.36/0.10 [the article designing a buy-and-hold portfolio offers advice on creating allocation plans relevant to your investment goal].  The following entries are made next to the appropriate labels:

designer2

Rebalancing strategy

designer3Suppose the portfolio is funded with $10,000 [comment: lower payments might be less efficient investments when factoring in the costs of trading fees and expense ratios].  Two methods of rebalancing the portfolio are scheduled (e.g., every year) and signaled.  Suppose you wish to test the signaled method by choosing “no schedule” from the pull down list of the “Rebalance schedule” cell and “signal 3” from the pull down list of the “Rebalance signal” cell.   “Signal 3” is a command to rebalance the portfolio when market forces unbalance the portfolio to an unacceptable degree of error.  The result is an intermittent series of rebalancing episodes that modify the historical returns.  “Signal 1” and “signal 2” evoke a different number of rebalancing episodes by modifying the boundary for unacceptable allocation error.  It’s an empirical process for finding the best result.

Investment costs

designer4

The “risk-free bond rate” is used to calculate the Sharpe ratio.  I recommend a rate that estimates the risk free return for the holding period of the test portfolio (e.g., a 10 year Treasury Note at inception of the portfolio).  The default bond rate is 2.98% for the 15 year period of this program.  Trading fees and annual expense ratios always reduce investment returns, sometimes by a considerable amount.  Assess these by entering the typical trading fee charged by your broker and an estimated annual expense ratio derived from investment funds and advisor’s fees.  Or consider testing the default costs of $10 for trading and 1% for an annual expense ratio.  These entries are left blank for this tutorial.

Results

The historical returns are summarized by statistics and charts for the  “Unbalanced” (“buy-and-hold”) and “Rebalanced” portfolio. The outcomes of the “Unbalanced” and “Rebalanced” portfolio would be identical without a rebalancing strategy [furthermore, a portfolio of one asset cannot be rebalanced].  In the following table, “CAGR” is the annualized growth rate of the portfolio’s accumulated returns.  “Sharpe ratio” is the average annual investment return adjusted for market fluctuations.   A negative Sharpe ratio implies that risk-free U.S. government bonds are better investments.  Higher values of CAGR and Sharpe are preferred.  The “final value” is the portfolio’s market value at the end of the investment period.

designer5

Chart 1 shows the returns based on test conditions.  The market fluctuations ultimately reach the final values shown in the table.  An effective rebalancing strategy creates a gap between both curves.

designer6

Rebalanced portfolio

Rebalancing may not improve the investment performance of a portfolio.  However in this example, the signaled rebalancing strategy outperformed the unbalanced portfolio (CAGR 6.59% is better than CAGR 5.65%).  Not shown is that scheduled rebalancing “every 3 years” also outperformed the unbalanced portfolio (CAGR 6.38% vs CAGR 5.65%).  In this tutorial, the result of selecting “signal 3” for the signaled strategy generated a 37.7% boundary error labeled as the “rebalance signal” in the program.

designer7

“Signal 3” also triggered 4 rebalance episodes over 15 years (chart 2) when there were no trading costs at inception or rebalance.

designer8

Warning messages

The next chart uses red arrows to show the location of warning messages.  These disappear when satisfactory entries are made in the program.  Be aware that the “asset allocations” must total 100% or else the blue-lettered message “Allocations are incomplete” reminds you to check the entries.

designer9

Applications

The investable securities of the program’s market sectors are index funds, stocks, bonds, real estate investment trusts (REITs), and commodities futures. Index funds are particularly good substitutions for market sectors of the model portfolio.

Test other model portfolios.  The 60/40 Stock-Bond Portfolio, exclusive of a 10% cash holding, is a favorite of many investors.  The 60/40 unbalanced portfolio’s 6.07% “CAGR” and 0.29 “Sharpe ratio” provides a standard for comparison with other allocation plans.  Try creating higher returns by experimenting with different allocations.  Consult the article designing a buy-and-hold portfolio for advice on creating allocation plans relevant to your investment goal.

Apply the rebalancing strategy.  Either the scheduled or signaled strategy can be used to rebalance a portfolio of index ETFs that match the allocation plan of a model portfolio.  The scheduled strategy is straight forward.  Simply rebalance the ETFs according the best schedule determined by this program.  The signaled strategy is not straight forward.  It requires transcribing  data from this program to the Small Trades Portfolio REBALANCER program in the following way:

1. Enter the “Rebalance signal” from the Results of this Designer program into step 1 of the Rebalancer program.  In this example, the correct entry would be 37.7%.

2. Result 1 of the Rebalancer program will display a “Rebalance” message when any of the portfolio’s ETFs satisfies criteria for correction.

Conclusions

A leap of faith is needed to apply the model portfolio to your investment goals.  This program is based on recent 15-year returns and your best bet is to assume that the next 15 years will provide a different investment performance due to market uncertainty.  Even so, I don’t know any investor who completely ignores history.

This program tests strategies for rebalancing a model portfolio.  I know of no other program that provides such information!

The potential impact of trading fees and fund expense ratios is considerable when many portfolio holdings are rebalanced frequently and the expense ratios are high [that’s why respected authors recommend minimizing costs by seeking high-quality, no-fee, no-load investments].  A good rebalancing strategy should augment the expected return of the unbalanced portfolio.

You can download this program free of charge by clicking on SmallTradesPortfolioDESIGNER.  If the program inspires your investing for the betterment of self and society, consider giving a tax-deductible contribution to your favorite charity or my favorite charity.

Copyright © 2013 Douglas R. Knight  


#Investment-Returns-Calculator for Young Investors

April 9, 2013

Young people have limited resources for investing money.  But they can still invest if they make a realistic plan.  Simply click on this link, investment returns, to download a calculator that will help plan a retirement savings program.  The calculator predicts several possible outcomes from investing for 50 years.  Here are four examples of how the calculator works for different investment plans:

Jackpot Plan

Suppose you receive a $50,000 Jackpot.  After paying taxes you have $39,600 to invest in a stock index fund with the trading symbol YAY.  Assume that YAY’s annual rate of return is 8%, the stock broker charges a $10 trading fee, the fund manager charges an annual management fee of 1%, and the inflation rate is 2%.  Also assume that you don’t plan to make additional payments and don’t have a job that pays an annual salary.  You make the following entries in the calculator:

entrysingle

[COMMENTS ABOUT DATA ENTRY:  The calculator always assumes that you start investing at an early age and then plan to hold the investment for 50 years; otherwise, no results are displayed.  The white cells contain comments and suggested values; place your cursor over the cell to read the comment, then click on the cell to enter data.]

resultsingle

 The results are displayed next to the cells where you enter data.  In this example, the calculator uses the 8% annual rate of return to compound your investment returns from the stock market for the next 50 years resulting in an accumulated market value of $1,166,204.  The calculator assumes that you automatically reinvest all dividends and other cash payments earned from the market.  The “accumulated market value” will be your retirement savings.  You gave the Jackpot money ($39,600) to a stock broker and he took $10 of the money to pay the cost of trading.  That left a principal amount of $39,500 to invest in YAY.  The calculator subtracted the principal from the accumulated market value to determine the total return.  The total return is how much money you can expect to earn (or lose) from your investment.  In this case, you could earn a total return of $1,126,614 from YAYThe 2% inflation rate will reduce the purchasing power of your retirement savings [e.g., if your favorite book costs $10 today and $20 tomorrow, then tomorrow’s purchasing power = 100*(($10/$20)-1) = -50%; today’s dollar will only be worth 50 cents tomorrow].

SURPRISE!  You can expect to become a millionaire in 50 years, but that nasty inflation will reduce the purchasing power of your retirement savings by -61% to $453,994.

An additional chart is displayed on the graphs worksheet to show the expected growth of your Jackpot during 50 years of compounding the returns:

growthsingle

Dollar Cost Averaging Plan

A generous uncle wants to help you invest in YAY by contributing $2,500 every year until you can continue the additional payments.  A $10 trading fee is taken from each payment and YAY’s manager charges an annual 1% management fee.  You make the following entries in the calculator:

entryregular

[COMMENTS:  The calculator assumes that you, or your uncle, will pay the stock broker $2,500 at the beginning of every year for 50 years.   At this time, you do not plan to set up an allotment from your future salary.]

resultregular

The calculator automatically constructs three Regular Payment Plans depending on whether you pay $2,500 at the beginning of every year, every quarter (a quarter is 3 successive months), or every month.  Since your uncle offered to pay every year, we will focus on results from the yearly payments.   The total payment ($127,500) is the sum of the initial payment and 50 additional payments.  The total trading cost, which is the sum of 51 trading fees, reduces the total payment to a principal amount of $126,990.  You can expect the compounded returns to generate a retirement savings of $1,156,463 based on the sum of the $126,990 principal and $1,029,473 total return.

growthregular

SURPRISES!

  • Compared to the single payment plan of investing a Jackpot, the dollar cost averaging of yearly payments is expected to increase the purchasing power of your retirement savings; that’s a good deal!  [Inflation reduces the purchasing power of your retirement savings by -50% when making regular payments (better!) compared to -61% when only making one payment (worse!).]
  • Look at the fantastic growth of retirement savings by making the same payment on a monthly or quarterly basis!

Salary Allotment Plan

Not everyone hits the Jackpot or has a rich uncle.  But anybody who gets a good education can plan on getting a job at some time in their life.  Let’s assume that you save $100 a year from your allowance to invest in YAY.  Fifteen years later you start earning $65,000 per year and invest 10% of it.  You make the following entries in the calculator:

entrysalary

[COMMENT:  The calculator assumes that you make the first payment at an early age (e.g., age 10 years) and begin earning wages 15 years later (e.g., age 25 years).]

resultsalary

Your salary allotment plan predicts $1,061,559 of retirement savings.  Inflation reduces the purchasing power of the retirement savings by -37% (best!) when making salary allotments compared to -50% (second best!) when making regular payments and -61% (worst!) when making only the first payment.  Here’s what happens to salary allotments during 50 years of compounding returns:

growthsalary

Thrifty Investing Plan

Two ways of reducing the total cost of investment are to purchase a no-fee index fund that charges a low management fee.  Some discount brokerage firms don’t charge a trading fee for investing in their sponsored index funds.  Some index fund managers charge a very low 0.06%-0.08% annual fee for stock funds that invest in a broad-market index (e.g., Standard & Poor’s 500 Index).  Assume that you repeat the same money management plan that was previously used in the Yearly Salary Allotment Plan, but this time you reduce the costs of trading and management.  You make the following entries in the calculator:

entrythrifty

This thriftier investing plan should increase your retirement savings compared to the more expensive yearly salary allotment plan.  The reduced costs of investment predict a good improvement in total return without significantly changing the purchasing power (-38% in this example).

resultthrifty

NO SURPRISE!  Thrifty investing can increase your retirement savings [by $271,871 in this example].

Summary

Unless young investors have a lot of money, they will probably invest small amounts during their formative years until they get a job in adulthood.  They should still make small investments as early as possible if for no other reason than to start acquiring the skills of money management and investing.  Regularly scheduled investments throughout life are essential to maintaining the purchasing power of retirement savings.  This investment returns calculator helps young investors (and their parents) plan for retirement.

Copyright © 2013 Douglas R. Knight

Links to previously published calculators of compound returns

Previously published calculators predict the long-time return from an initial investment1, a series of annual investments2, a series of monthly investments3, or a mutual fund4.

1.           Dividend.com: http://www.dividend.com/tools/compounding-returns-calculator.php (calculates growth of initial investment)

2.           Moneychimp.com: http://www.moneychimp.com/calculator/compound_interest_calculator.htm (calculates growth of initial investment and annual additions)

3.           Math.com: http://www.math.com/students/calculators/source/compound.htm (calculates growth of initial investment and monthly additions)

4.           SEC mutual fund calculator: http://www.sec.gov/investor/tools/mfcc/get-started.htm (calculates growth of investment after deduction of various fees)


#ETF-scorecard

June 28, 2012

Click on this link, ETF scorecard, to download a spreadsheet-program for appraising the strengths and weaknesses of an exchange-traded fund (ETF).  The program is not designed to appraise mutual funds, exchange-traded notes, and closed-end funds.  If the program gives an incorrect appraisal, please send a comment at the end of this article and I will make an appropriate update.  The latest version is dated 7/18/2012.

The ETF scoreboard is programmed to:

  1. recommend a general trading strategy appropriate for the ETF’s primary risk
  2. guide you through the fund’s prospectus and/or annual report with a sense of purpose
  3. provide a no-cost rating that’s independent of vendors’ fee-only ratings 1,2

Instructions

The do-it-yourself ETF Scorecard requires you to enter essential information from easily accessible regulatory documents.  That information is automatically translated into a profile of risks and benefits.  The famous ETF called “SPY” is used as an example.  Begin by opening the program to the SNAPSHOT spreadsheet.

The first column lists the information that can be found in websites (next paragraph).  The second column contains “INPUT CELLS” that are white for keyboard entries –“(click here to make an entry)”– and black for multiple choice entries –“(click here for drop-down list)”–.  A third column of “WARNINGS” (not shown) contains error messages that disappear when the required information is entered.

Websites.  Open the home page of XTF.com1 and type the ETF’s trading symbol (in this example it’s SPY) into the Search cell in order to access the appropriate Ratings tab.  There you will find the ETF symbol, ETF name, inception date, geography, underlying index, index composition (weighting), and (majority) asset class.  The sub tab Structural integrity provides the date of information, legal structure, annual yield, and net asset value.  The sub tab Fund holdings provides an accounting of the majority of assets which is useful for the investor, but not a required entry.

Now open the Welcome page of Morningstar.com 2 and type SPY into the Quote cell in order to access the quote page.  The Quote tab provides the ETF’s name and symbol, today’s total assets (an approximation of net asset value), and top holdings (an informative accounting of the majority of assets).  The Fees & Expenses tab provides the recent net asset value, primary benchmark (Index), (portfolio) turnover ratio, leverage, (annual) 12 month yield, legal structure, inverse/short, investment strategy, and inception date.  The Filings tab provides access to the prospectus and annual report filed with the SEC.  The filings usually provide additional information about the minority of assets, portfolio diversification, and tax structure.  The filings also provide more detailed information about the investment strategy, portfolio management, and risks of investment.

Risks and benefits.  Turn to the SCORECARD spreadsheet to read the program’s appraisal of SPY.

  • Net worth- Funds with very low net asset value are at high risk for an unplanned termination of operations 3,4.  More information is available in the article on fund experience and size.
  • Strategy- The widely accepted strategies of “replication” and “sampling” are forms of passive management that seek to match the performance of the fund’s benchmark index.  Higher-risk strategies involve the use of derivatives and/or active management to either underperform or outperform the benchmark index.  Information is available in the article on investment strategy.
  • Experience- Inexperienced management may enhance any losses incurred by high-risk strategies.
  • Tax burden- Taxes on ETF returns are paid by the shareholder unless the ETF is held in a tax deferred brokerage account.  More information is available in the article on tax burden.
  • Tax advantage- Most passively managed ETFs have a tax advantage over mutual funds by avoiding unrealized capital gains.
  • Portfolio- The fund’s legal structure determines whether the investment portfolio is “managed” or “unmanaged”.  A managed portfolio is more likely to commit an investment error than an unmanaged portfolio.  The managed portfolio can incur risks of lending, borrowing, and rebalancing assets to the extent that management error reduces the fund’s net asset value and subsequently reduces the share price in the stock market.  Supplemental information is available in the article on management.
  • Asset risk- The majority of the portfolio’s assets form a unique risk of investment.  The minority of assets may contribute to management error when used for hedging purposes.  A brief description is given in the article on assets.
  • Geographic region- Funds that invest in foreign markets provide diversification to the shareholder’s investment portfolio.  But foreign markets are risky with respect to the fluctuation of currency exchange rates, possible nationalization of private companies, and a variety of trading barriers.
  • Index- The Index is constructed by use of one or more weighting factors that affect the index value.  The weighting factors also affect the investment performance of passively managed ETFs.

The table of PRIMARY RISK AND BENEFIT renders an opinion about the main disadvantage and advantage of investing in the ETF.

The Fund’s PRIMARY RISK of uncertain investment returns is selected from the following risk factors that are listed in a descending order of priority:

  1. A portfolio of derivatives (e.g., ‘geared’ fund, leveraged fund, inverse fund) with net asset value below $25 Million offers the greatest uncertainty of returns.
  2. Even without the portfolio of derivatives, a very small fund is at risk of unplanned termination.
  3. Either a portfolio of derivatives or an actively managed portfolio is a high risk investment.
  4. Fund’s that require special tax reports or have a high turnover of portfolio assets can increase the shareholder’s tax burden and erode the shareholder’s investment profit.
  5. The managed portfolio may acquire derivatives and/or illiquid collateral assets that diminish the net asset value.
  6. An inexperienced fund is at risk of making management errors that diminish returns.
  7. The capital markets of developed economies are less risky than those of emerging and frontier economies.
  8. The class of majority assets in the portfolio determines the shareholder’s returns.  The uncertainty of returns varies among asset classes.
  9. The composition and fluctuation of the Index are strong determinants of portfolio composition and performance.
  10. The infrequent cash distributions of some funds can delay the shareholder’s opportunity to benefit from reinvested dividends (a familiar risk called “dividend drag”).

The PRIMARY BENEFIT of investing in an ETF is either the opportunity to trade ETF shares in the stock market or hold them as a long-term, frugal investment.  This program assigns the trading opportunity to high-risk funds and the investment opportunity to comparatively low-risk funds.

Editing

The scorecard spreadsheet is programmed to automatically provide a risk-benefit analysis.  You can edit the SCORECARD by un-protecting the spreadsheet (there is no password).  For example, you might wish to edit the scorecard’s automated output for SPY by changing the phrase “infrequent cash distributions” to “quarterly cash distributions”.  Beware that editing deletes the formula embedded in tan colored cells.  If one or more cells are corrupted beyond use, simply start over by downloading a new scorecard and re-entering data into the SNAPSHOT spreadsheet.

Conclusions

This App is free software dedicated to the do-it-yourself appraisal of ETFs.  There’s sufficient information in internet websites to perform the appraisal in a couple of hours.  A broader discussion of the ETF Scorecard is available in Appraising ETFs with a scorecard.

Copyright © 2012 Douglas R. Knight

References

1.  XTF ETF EXPERTS.  © 2012 XTF Inc., all rights reserved.    http://xtf.com/Ratings/

2.  Morningstar®,  © 2012 Morningstar, all rights reserved.    http://www.morningstar.com/Cover/ETFs.aspx

3.  J. Alex Tarquinio.  Should more ETFs shut down?  SmartMoney.com.  ETF Watch, September 28, 2011.  Copyright ©2012 Dow Jones & Company, Inc. All Rights Reserved http://www.smartmoney.com/invest/etfs/more-etfs-should-shut-down-1315932598095/

4.  Ron Roland.  ETF deathwatch criteria for 2011.  InvestWithAnEdge.com.   January 5, 2011.  Copyright © 2012 · AllStarInvestor.com, Publisher of InvestWithAnEdge.com  http://investwithanedge.com/etf-deathwatch-criteria-for-2011


#Sell-signal

May 4, 2012

A sell signal is useful in alerting you to dispose of your investment at the desired price.  I prefer using a sell signal based on the 30% annualized rate-of-return, but you can create a signal based on your own desired rate-of-return.  Here’s how it works:

Suppose you purchased 100 shares of stock at $10 per share on January 1, 2012.  Today, May 4, 2012 (124 days later), the share price is $11 and the sell signal is $10.93.  Today is a good day to sell the shares because the share price exceeds the sell signal.  I determined today’s sell signal by making the following entries into the following spreadsheet (found in App, sell signal):

The first result is a chart (below) that compares today’s share price, $11, with the sell signal.  The sell signal is the share price expected from a 30% annualized rate-of-return after 124 days, $10.93.

The second result (chart below) is the ratio of today’s share price to today’s sell signal.  Any ratio of 1.0 or higher is justification for selling the shares.

The third result (chart below) is a line graph of the daily annualized rate-of-return during the first year.  Notice that the line graph reaches the 30% annualized rate-of-return on the Y axis at 365 days on the X axis.  The line graph extends higher after the first year of holding.

You can download the calculator by clicking on this link, App, sell signal.

Copyright © 2012 Douglas R Knight

Appendix

Create your own sell signal calculator with the following spreadsheet formula:

signal = purchase price * power (1+R, N)

  • R = annualized rate-of-return
  • N= (today() – purchase date)/365

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