Terror on Wall Street, a Financial Metafiction Novel (18 page)

Investing Tips by Gordon #3

There is a group of individual investors who follow what is known as passive investing techniques—that is, they use index funds. These investors practice methods used by some of the largest pension plans and trusts. Diehards use index funds to form portfolios of stocks and bonds that obtain superior returns at reduced risk. They follow methods set down by some of the finest minds in the academic community when it comes to investing in marketable securities. Diehards use index funds managed by the Vanguard Group, a unique organization in the financial services industry, in that investors are charged only the cost of running Vanguard funds. To contact Vanguard, go to their website at
www.vanguard.com
.  Diehards use a forum sponsored by Morning Star (
www.MorningStar.com
),
a provider of data on mutual  funds. This forum has, since its inception, hosted some 350,000 conversations on approximately 40,000 topics. The forum receives some 25,000 hits daily. Once at the website, go to Discuss, then Diehards. The group has an annual get-together where some 100  Diehards meet to discuss their investments. Recently, local chapters have been formed where individual investors meet on an informal basis. Any investor with a question or problem can post his question on the Diehard forum and receive advice and counsel from the many “experts” who monitor the website.

Investing Tips by Gordon #4

Huge Dividend Payers

Retirees need an inflation-protected income stream, and the solution to that is dividend-paying stocks.  Recent tax changes have become favorable to encourage increasing dividend payouts. Companies that increase their dividends also provide inflation protection even during high periods of inflation. According to the Morningstar.com forums, dividend-paying stocks of the S&P 500 index have outperformed non-dividend payers by $514,132 to $374,912 since 1975 on a $10k lump sum investment. The new 15% dividend tax rate certainly helps attract investors to dividend-paying stocks. Today, a retired married couple using income from investments for living expenses can earn $59K annually (after personal exemption and standard deduction) in qualified dividends from a taxable account and pay just 5% tax to the federal government.

     On a practical level, I tend to agree with William Bernstein, who stated in an
Efficient Frontier
article that he would rather have the corporation pay out dividends and borrow for their new projects compared to using retained earnings. His feeling (and my corporate experience concurs) is that businesses are more conservative with their investments when they are financed as opposed to using internally-generated funds. One way to assemble a portfolio of dividend-paying stocks is to buy an Exchange Traded Fund called Dow Jones Select Dividend Index Fund (DVY). The index is composed of one hundred of the highest dividend-yielding securities (excluding REITs) in the Dow Jones U.S. Total Stock Market Index, a broad-based index representative of the total market for U.S. equity securities. To obtain current and price information, go to www.ishares.com and use the password ishares. Keep your eyes peeled for new Exchange Traded Funds that capture high-dividend payers. I expect that many new ETFs will appear soon. For those interested in income securities, see the new book by Ben Stein titled
Yes, You Can Become a Successful Income Investor. 

Investing Tips by Gordon #5

The cost savings of a tax efficient, low-cost index fund compounds at an exponential rate over time to produce awesome portfolio returns. The effect of dollar cost averaging and combining index funds, according to the Markowitz equations, add further to returns due to the bonus achieved from combining asset classes with low correlation coefficients. When tax management is performed during the regular annual portfolio rebalancing back to the selected asset allocation, additional profits will accrue to the portfolio. Using these techniques, you can easily double your portfolio return over a long period of time with considerably less risk compared to an actively managed mutual fund promoted by a broker. A series of model portfolios have been constructed for the investor who desires to achieve superior investment performance for his retirement. These portfolios have been constructed in accordance with Modern Portfolio Theory. Several automatic portfolios are also included where all these tax efficiencies and rebalancing tasks are performed for you at no additional cost. These portfolios are included in the appendix of my first book,
How to Make Money in the Stock Market – Buy 2,500 Different Stocks – Pay No Commission.
Think of this little book as a compilation of recipes for the investor who wants to achieve superior results at a level of risk below that associated with either active mutual funds or a portfolio selected by a broker. The author has compiled a suggested reading list for the do-it-yourself investor and a list of websites for you to use to check your selection with peers with far more experience than you possess.

Investing Tips by Gordon #6

Actively Managed Mutual Funds

     The majority of investors are sold actively managed funds by their investment advisor or by a stock broker. There are about 10,000 mutual funds today. Why so many? Well, they are extremely profitable for the fund sponsors and their employees. Academia and their students have been studying funds for many years and have arrived at the following conclusions: 1) Funds with a front-end load do not return profits higher than no-load funds, and 2)  About 25% of mutual funds will outperform the market in any one year. The ones that outperform by one percent or more do not outperform the following year.  There is no method of selecting, beforehand, the next years’ funds that will outperform the market. 

     Fund managers are gambling with your money, attempting to earn large bonuses.  If you want to gamble, buy the latest hot fund. The average actively managed fund before expenses will perform exactly the same as the passively managed index fund. Since passively managed funds have much lower costs and expenses, they will outperform, over time, all actively managed funds.

     Excessive turnover creates taxable events, and the money lost to taxes compounds to build your retirement portfolio.  There have been fund managers who have outperformed the market in the past. There is no known method for finding these geniuses. Their performance could have been just sheer chance. Out of 10,000 funds, only one individual has outperformed the market over the last 14 years. His name is Bill Miller and the fund is the Legg Mason Value Trust. In 2006, his winning streak ended. If you feel lucky, go buy the fund and let me know how you make out. More about actively managed and passively managed funds appears in further tips.

Investing Tips by Gordon #7

Roth IRAs

     You are eligible to make a regular contribution to a Roth IRA even if you participate in a retirement plan maintained by your employer. These contributions can be as much as $5,500 (or $6,500 for 2015).  There are just two requirements. First, you or your spouse must have compensation or alimony income equal to the amount contributed. And second, your modified adjusted gross income can't exceed certain limits. The amount you can contribute is reduced gradually and then completely eliminated when your modified adjusted gross income exceeds a certain level. Make a rollover
to a Roth IRA if (a) your modified adjusted gross income is $100,000 or less, and (b) you're single or file jointly with your spouse. You'll have to pay tax in the year of the conversion, but for many people, the long-term savings outweigh the conversion tax. Distributions from Roth IRAs are tax-free until you've withdrawn all your regular contributions. After that, you'll withdraw your rollover (conversion) contributions, if any. Special rules apply when you withdraw your rollover contributions. When you've withdrawn all your contributions (regular and rollover), any subsequent withdrawals come from earnings. The withdrawals are tax-free if you're over age 59½ and at least five years have expired since you established your Roth IRA. Otherwise (with limited exceptions), they're taxable and potentially subject to the early withdrawal penalty. (Information credit of the website listed below.) Like everything the government does, the Roth rules are tricky. For a complete review, see:

http://www.fairmark.com/rothira/thumb.htm
.

Investing Tips by Gordon #8

Financial Euphoria

Financial euphoria occurs when the market goes completely mad and bids up the prices of securities beyond reasonable limits.  The first documented episode occurred in the seventeenth century and is referred to as “Tulip Mania.”  Speculation became rampant, and one single tulip bulb was valued at $50,000.  

     Here is how these rare occurrences begin. A new artifact or development appears, and the price goes up. The increase attracts new buyers, and yet more buyers appear and the speculation goes on. There are those who are convinced that some new price-enhancing circumstance has taken hold of the market. And there are those who are in the market simply to ride the price spiral up, knowing that madness has taken hold, and who plan to get out at the last possible moment. There are those who warn of the coming episode, but they are not welcome and are said to be motivated by either deficient understanding or uncontrolled envy of the process of enrichment. Those involved with the speculation are experiencing an increase in wealth. No one wishes to believe that this is fortuitous or undeserved; all wish to think that it’s the result of their own superior insight or intuition. What happens next is that some event triggers a panic. Those who had been riding the price increases get out. Those who thought it would go on forever find their illusion destroyed. The speculative episode ends with a bang. And it repeats itself again 20 years or so later in some new form.

     The most severe case occurred here in the U.S from 1999 to 2000 during the dot com craze when companies with no sales or earnings were bid up beyond reason. Many millions of dollars were lost by speculators and those who became convinced that price appreciation would continue forever.

Investing Tips by Gordon #9

Cost and return comparisons

Compare results over a 30-year period looking forward. Why 30 years? Well, a 43-year-old will go on full social security benefits at age 73 (an estimate by those studying future SS benefits). We will be comparing the average mutual fund with an index mutual fund. I am going to compare the costs and returns for an aggressively managed mutual fund and a passively managed index fund.

     Aggressively managed mutual funds study and analyze securities in the pursuit of gains that exceed the market return, while an index fund seeks to match the market. We are going to compare, specifically, the Vanguard Total Stock Market Index Fund, an exchange traded fund symbol (VTI). This fund is extremely tax efficient due to the fact that it contains in excess of 3,800 securities and trading is seldom required to match the index, whereas the average mutual fund attempts to outperform (and on average turns over its portfolio) every 15 months, incurring trading costs and capital gains distributions for its shareholders. The costs and profits for management of the actively managed mutual exceeds that of the above-mentioned index fund by a factor of 1.5% to .07% or 21 times. All of these costs and expenses reduce the return on the portfolio each and every year for the 30-year period under examination.  In fact, they reduce proceeds each and every year on a compounding basis. The average investor is not aware of the magnitude of the reduction in end portfolio value—their retirement nest egg. Buy just one fund and here are the results after 30 years:

     It’s the high portfolio turnover that kills the profitability of actively managed mutual funds which causes the increased transaction costs.  It’s the cost of security analysis and management that kills the return, and the taxes paid on capital gains that reduce the total return on a compounding basis. It is a fact that only 25% of all aggressively managed funds before taxes beat the index. It is also a fact that this hasn't happened in the last 20 years.