Market Volatility & Exchange Traded Funds

Exchange Traded Funds
The video that follows is about Exchange Traded Funds (ETF’s) and the growth seen in that type of investment product.  I have chosen this particular video for a couple of reasons.  The first reason has to do with managing expenses within our portfolios and the second is to talk about the way in which I use ETF's.  iShares used to be a separate company that offered ETF’s.  It is now owned by Blackrock and is a subsidiary of that company.  The good news about ETF’s is they are cheaper to buy and own than mutual funds.  The bad news is ETF’s are not actively managed like most mutual funds. Since ETF’s normally mirror a particular index, they don't need to be managed the same way as a mutual fund.

Expenses
Personally, I like ETF’s because they offer better diversification than individual stocks, while at the same time, controlling expenses better than mutual funds (or buying the stocks individually).  I'm not a big fan of mutual funds.  The biggest reason is their larger fees which are not justifiable given most mutual funds under-perform the markets over longer periods of time.  I have owned many, many different mutual funds in the past.  Given the growth in the popularity of ETF’s in recent years, I have long since replaced all of my mutual funds with ETF’s.

Volatility
Periodically I will also trade individual stocks, but with the volatility in the current markets, I find that ETF’s provide me with much more diversification and less volatility than simply owning a few stocks.  Since I'm not a buy-and-hold type of investor, my goal is to own whatever sector is outperforming at any point in time.

Constructing Portfolios
The discussion in the video talks about creating portfolios using ETF’s.  Personally, I think that most portfolios are way, way, way over diversified and that's largely because of the need on the part of the financial services industry to sell more products.  More product, in my experience has never improved returns.  Some would argue it's not about returns, it's about the safety of our portfolio.  By spending only a few minutes a day on my investments, I get both.  I see no reason if we're actively managing our portfolios why we need any more than the top 60 companies in the TSX.  I understand most people don't actively manage their portfolios, but I have to believe they don’t understand the magnitude of the increase in returns they can achieve in only a few minutes a day.

Less Is More
Regardless, there are a couple of portfolios listed in this video.  Some people may want to model their own portfolio on one of those shown, and that's fine for people who are not actively managing their portfolios.  Myself, I tend to largely use ETF's, rather than stocks or mutual funds, but, I hold a very small number of ETF’s at any particular time because I'm only interested in the funds that are performing.  That is why I incorporate Technical Analysis into my methodology.  The non-performers are dropped from my portfolio once they stop outperforming.  Either way, whether  you want to build a portfolio of ETF's, or you simply want to use ETF's to dampen  the volatility in the current markets, the use of ETF's will reduce expenses and, to me, provide a better alternative than mutual funds

Would you care to share your preference(s)?

Click Here To See The Video

September 2012 Returns

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September was not all that bad, this year, considering its history for being the worst month of the year.  It is a good illustration of how seasonality is based on probability, not certainty.  Having said that, I am still concerned about this market, particularly since we seem to be deviating from what I would consider to be normal seasonal patterns.  In itself, that wouldn't bother me so much, if it were not for the fact the major technical pattern called a head and shoulders, which I wrote about earlier this year, is still intact.  

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The momentum indicators I follow would indicate the market is heading lower.  If that turns out to be the case, the fact we did not make it above the previous high from last February is more bad news.  I would not be surprised to see the TSX drop below the 200-day moving average which is only some 150 points, or so, lower than the close of today's market.  We could get there in a single bad day!  

The returns shown above use the XIU ETF as a buy and sell signal.  The idea is to buy when XIU is above it's 200-day moving average, and sell when it is below.  Bad things can happen in the markets when they are below the 200-day moving average.  The real danger is, however, if we get down below the 11,000 mark.  A pattern such as this would indicate going back to the lows in the last Great Recession.  It will be interesting to watch - the markets normally finish the year stronger, but that was not the case is 2008, either.  If we do see these things begin to happen I will be looking for opportunities to short the market (using inverse ETF's) rather than looking for buying opportunities.

21 month return for TSX @ September 30, 2012 = -7.86 percent
Return for Basic Timing Model Using XIU =          11.97 percent
Return for Advanced Timing Model =                    -4.36 percent
Money for charity =                                            $0.00 

Are you expecting a year-end rally?

April 2012 Returns

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We are pretty much past the favourable seasonality period for the markets until later, towards the end of the summer.  It seemed interesting to me, the number of talking heads in the media that were saying this year was no time to "sell in May, and go away".  Once again, this spring was going to be different.  It always gives me a pain in the butt when the very people who should represent our interests, put their own ahead of ours, instead.  The truth is, we shouldn't necessarily sell everything going into May, but taking some profits might be what a prudent person would do.

First, we generally had a good long run up in the markets since the beginning of the year.  Second, while people  felt protected by the Federal Reserve Bank's actions in the U.S., the latest effort to stimulate the markets is due to end.  Third, economic data has softened, including in China.  Fourth, Europe is, or soon will be, in a recession.  Still, the experts would have us believe that all is well, and the correction in the markets that normally begins this time of year won't likely happen.

If I sound bearish, it is because I am.  I said at the beginning of the year I would share my trades on this blog.  The reason I haven't done so is because I have hardly made any.  The markets went practically straight up at the beginning of the year, with little opportunity to get in during a pull-back, and the U.S. markets are just now beginning to look like they are breaking the uptrend, and could likely go lower for a while.  More on that during a couple of future blog posts.

16 month return for TSX @ April 30, 2012 = -8.07 percent
Return for Basic Timing Model using XIU = 5.61 percent
Return for Advanced Timing Model (my returns) = -4.36
Money for charity = $0.00

Have you taken any profits, going into the summer season?

Real Trades

You might notice a couple of changes today.  I have added a disclaimer page so that I can share my actual trades with you.  The links are on the right.

Preferences
I have always wanted to do so, but didn't know if I should.  When it comes right down to it, though, I don't know a better way of sharing the thought process that I use in deciding what to buy and when to buy.  You are going to notice that, currently, my time horizon is very short.  Also, my current preference is Exchange Traded Funds (ETF's) over stocks (or bonds).  That hasn't always been the case, but I feel it necessary to adjust to market conditions.  I let the market tell me what to do, and market volatility is the deciding factor for me, right now.

Returns
For ETF's, I divide my portfolio into five equal parts.  Sometimes, I will only take half of a position (one tenth of my portfolio), but usually I stick to using one of the five parts.  For the sake of simplicity, I will count the results of each trade as if it were one fifth.  A gain, or loss, of ten percent in one trade, for example, would translate into a two percent change in my overall portfolio (ten percent of twenty percent, or, 0.1 X 0.2 = 0.02).

Position Size
I know some people advocate changing the size of positions in an attempt to manage the amount of risk.  My experience has been that is a recipe for disaster.  For whatever reason, I end up winning the small returns, and losing the big ones.  If I am going to invest, I am going to wait for an opportunity which is worth taking the risk.  When in doubt, I wait for a situation where the doubt is gone.

So, follow along.  Despite my slow start, I remain optimistic, overall.

A New Investing Era

 

Non-Standard View
I write and say a number of things in this blog which are not exactly in line with your standard financial advice.  If all I wanted to do was make a buck from every poor soul who didn't know what to do with their money, I would be a financial advisor playing that game by those rules.  My own conscience prevents me from doing that.  I gradually learned over many, many years that what the little person is being told to do with their money has little, if anything, to do with us making any significant return on our investments.

The System
I am not saying they are doing anything illegal, but too much of what goes on is less than ethical.  Nor am I saying most of the people we get to deal with are unethical.  The people you and I and our modest retirement savings get to deal with are usually sales people with training in "the system".  This system dictates that we are to divide our money up and allocate it in as many ways as they can charge fees for and then, hope that economics work in our favour.

Lousy Luck, Or...
I guess I almost always had money to invest at exactly the wrong time.  Time and again, I would hand my money over to someone with all of the seemingly correct training and proper track record, only to end up a few years later with less money than I had started with.  Fool me once, shame on you.  Fool me twice, shame on me.  I began to wonder if I was just having a run of lousy luck, or whether there was a pattern starting to emerge.

Buy Low; Sell High
I have always been a bit of a do-it-yourselfer.  So, at the same time as I was hiring people to look after my money, I also began to search for information that would improve my success.  I didn't know anybody who could tell me what I should do differently, so I began to read about various facets of investing.  I soon learned my problem would not be a lack of information, but rather an over-abundance of misinformation.  It was obvious a large number of people were making a lot of money by simply jumping on the band wagon and putting their spin on the things that everyone "knew" to be true.  I became suspicious of proprietary, complex, and expensive systems which were designed to make their creators wealthy while doing little for a client with a little money to invest.  After all, in its simplicity, the entire process boils down to one thing: buy low and sell high.

A New Paradigm
During this time I have seen the evolution of the financial services industry.  The first iteration was the broker-centric model.  Here, the flow of information was controlled by the broker.  People had to pay large fees to gain access to that information.  Not only were they the gatekeepers of information, they were also the gatekeepers with access to the markets.  Next, came the internet.  Eventually, more and more information became available through the world wide web.  Brokers created web-based accounts.  Now clients could enter and monitor trades on their own.  Now, I believe we are on the verge of a new paradigm - the client-centred model.

Client-Centred Investing
The client-centred model is one which places the customer in control.  Brokers who want to maintain a presence in this new world of investing will recognize their job is to facilitate, rather than control.  The primary goal of this approach is to make the greatest return possible for the client while the broker is compensated for their ability to assist in this generation of wealth, rather than the other way around.

Education
This third iteration of investing is not going to happen overnight.  The financial institutions have wealth and political power.  They will not surrender quietly.  Yet, if you have ever been to a candle-light vigil that starts with one candle, you know how quickly the light spreads and grows.  In this case, the light is the light of education.  It is time to show the world that the universe does  not revolve around the financial services industry.  It is long past time to expose the myths funded by the enormous marketing budgets of financial institutions designed to empower them and disempower those left bewildered by it all.

Please Participate
My new year's resolution is to try to do a better job educating people about this new era of investing.  There may be prettier blogs, and better written blogs, but I want this blog to be the one which makes you, the reader, the most amount of money, not just now, but for years to come.  I don't know everything, and I make my share of mistakes, so I encourage people to challenge my reasoning, and ask questions about anything they don't understand which may be wasting their money.  I would rather spend my time on the things that are of importance to you and your wealth.

Are you happy with your investment returns?  Want to do better?

Investing Expenses & Returns

The Border Crossing
I once heard the story of a man who worked as a border crossing guard.  During the time he worked there, he would often see one man, in particular, riding a bicycle across the border.  The interesting thing about his bicycle was he always carried a box of sand on the handlebars.  Needless to say, the guards felt compelled to, usually, check by sifting through the sand to make sure there was nothing there.  Finding nothing, they would wave the man through, and let him cross.  Week after week, the same man could be seen riding his bicycle across the border.  Each time they sifted through the sand in the box, they found nothing.  Obviously, the guards found this behaviour suspicious, but were never able to find anything illegal.

Sand, or ...?
Many years went by, and finally, the border guard retired from his job.  From time to time, he would remember the man on the bicycle and wonder what it had all been about.  One day, to his surprise, he ran into the man on the street, who himself was now much older.  He stopped to chat for a moment, and the subject of the man's frequent border crossings came up.  He mentioned that in all those years, they never found anything other than sand, so what was he doing with all those boxes of sand?  The man smiled and said, "It wasn't sand I was taking across the border, it was bicycles!"

Market Returns
It makes me smile when I listen to people who think financial institutions make their money in the stock markets, and that personal investors can't.  While there is a component which is made up from investment returns, don't be fooled into thinking that is how the professionals make the real money.  Financial institutions make their returns from fees and service charges (in good times and in bad).  Historically, the stock market has done something around a nine percent average annual return.  Very few managers have consistently beat the markets over a long period of time.  Ask your financial advisor what return to expect on your investments and they will say five, or six percent.

Do The Math
Are we really expected to think returns of five, or six percent account for the lion's share of financial institutions earnings?  Have you ever wondered why so few people know about Exchange Traded Funds, and everybody (almost) knows about Mutual Funds?  Might the difference in service charges and loading fees, and management expenses, and commissions explain some of the discrepancy?  I'll let you do the math.

Expenses
The easiest way for personal investors to increase returns is to decrease expenses.  Obviously, that would not be in the industry's best interest.  I find it interesting how returns receive so much attention, while so little interest is given to explaining expenses. 

Could it be that our bicycle riding friend also worked for the financial services industry?  It seems they both know how to distract others from seeing what really matters.

Do you still own mutual funds?  

Trading vs. Buy and Hold

Same, But Different
Everyone is entitled to their opinion.  I am posting this because I am of an almost entirely different opinion than a blog I recently read.  I agree with many of the assertions made in that post, yet I came to an entirely opposing conclusion.

Volatility
The first assertion is the discount brokerage business has changed the way the investing game is played.  According to the author, the new lower commissions combined with the excessive amount of opinions on TV, leads people to think they could be the next Goldman Sachs hedge fund manager.  Lower fees and more information,  they say, is bad because it causes people to trade too much.  I have heard a lot of theories, but I have yet to see any research that says the present market volatility is caused by lower brokerage fees!  If anything, I would say the volume of trading, on average, has decreased since the Great Recession.

Competition
Next they imply that trading does not add capital to the best companies in the stock market, and that long term holds are good, therefore all short term trading is bad!?!  Further, they assert we shouldn't even try to beat professional investors with their automated systems and state-of-the-art technology.  This suggests we are in competition with the professional money managers, where nothing could be further from the truth. We do not have millions, or billions of dollars to invest. We do not have to be in the market 24/7. We do not even have to be fully invested. We do not need to meet weekly, quarterly, and annual investing targets. We do not need to appease fund holders and shareholders. We do not need to meet any forced redemptions. However, we do want to know what the big guys are doing. Doing so gives us an edge because we can do what they are doing, only faster.

Sources of Income
Also, according to the author, Buy-and-Hold always beats riding the latest trend.  The implication is hedge fund managers make their "outrageous returns" from the "suckers" dumb enough to make trades in the market.  Personally, I don't know who this person is invested with, but in taking a close look, we can see only a very small handful of professionals manage to outperform the index.  These organizations do not make their outrageous returns from their investing ability, they make it from the fees they charge!  Have you ever noticed they collect their fees even if you and I lose money?  If I say, "Bank", what do you think of?  I think of fees and service charges!

Theory
Next they assert the efficient market theory has been disproved.  I agree.  This theory supports the idea that assets cannot be mispriced since enough people always have enough information to accurately determine the correct price.  Three things - nice theory, but it is not about what people think, but what they actually DO.  Have you ever paid too much for something, knowing that is exactly what you were doing?  (Ever just had to buy that present for your child, no matter what the cost?)  Second, are we to believe that prices are never manipulated?  Third, the "efficiency" of information has never been greater, but that applies to misinformation, as well.  If the market is so efficient, then how did so many professionals get taken by Sino Forest?  Largely because of that theory, one of the main arguments against trading has been that assets cannot be mispriced, so the odds of buying low and selling high would be zero.  The fact the theory has been disproved supports the case for trading, rather than refutes it.

For What It Is Worth
If we want to just Buy-and-Hold this market, then I would purchase a couple of index ETF's.  Not I, since I personally, have zero expectation the stock markets will be any higher a decade from now.  Think deleveraging, and demographics.  If we do want some sort of return, then I believe (based on my years of experience) a good trading strategy - one that uses low commission rates - is the only way to go.

As I said at the beginning, everybody is entitled to their opinion.  What's yours?

Position Size

80/20 Rule

Decisions, Decisions.
Size matters, or so I am told.  From "too big to fail", to sports like boxing, size is a factor.  The question is, how does size affect one's investment portfolio decisions?   For those who don't have a sell strategy (i.e.: Buy and Hold) diversification is the only hope, and what follows will be of little use.  Having a sell strategy provides me with a few more options.

Call Me Arrogant
First, I have heard it said that buying a whole position all at once is the dominion of the arrogant.  That may be true if we are not using technical analysis to time our entry points.  My method of determining when to buy has proven to me that what I call a buy signal is just that - the point in time when the odds are most in my favour.  Averaging into the market almost always reduces my returns, it does not improve them.  If I buy all at once, and I am only partially right, then I can begin to reduce the size of my position.  If I am completely wrong (read: losing money) then I sell everything I just bought.  I would rather be out the commission than lose capital.

Diversification
Next, we should talk about the size of a position.   I have seen academic studies that demonstrate even twenty stocks is not enough for any one portfolio.  (That study was probably commissioned, pardon the pun, by the financial services industry - cha ching!)  Note that a single broadly based Exchange Traded Fund (ETF) can contain well over the twenty stocks required to provide me with enough diversification.

Market Correlation
What I am saying is holding broadly based ETF's provides me with all of the diversification I need, thank you, even if I put my whole portfolio into one ETF!  "Wait!" the experts will say, "You need diversification between various regions of the world!"  Do you hear the cha ching in the background, again?  Since I have a sell strategy, if my investments in the TSX are under performing, when I do sell, nothing says I have to buy the TSX, next time around.  Understand that markets around the world are highly correlated, these days.  By that I mean when one market tanks, the others are likely to do so, also.  Maybe not at exactly the same time, but close enough.  

80/20 Rule
Having said all that, I believe in the 80/20 Rule.  Applied to investing, the rule tells us that 80 percent of our returns will come from 20 percent of our holdings.  Rather than watering down my returns by casting my money into everything in every market, I use seasonality, technical analysis, and fundamental analysis, to focus on the areas of the market that are working, and simply forget about everything else until the conditions change, again.

Returns
The major lesson the market has taught me is I don't have to have all of my money in the market all of the time.  I used to think I was wasting opportunities by not being all in!  Nothing could be further from the truth.  If I divide my portfolio into five, how much of a return do I need to make 20 percent, over all?  You get it, I still have to make 20 percent each time.  Each fifth of my portfolio that makes 20 percent contributes 4 percent to my overall results.  Do that five times, and at the end of the year I end up with 20 percent.  Or, I can make 10 percent on any one position (each time contributes 2 percent), and do that 10 times, and still end up with 20 percent per year.

Better Than Average
Do you get what I am saying?  I only need to have 20 or 40 percent of my portfolio in the market at any one time, and as long as it returns 10 percent in a month, or two, I can take two months of the year off, and still make a twenty percent return.  Not bad, when the average annual rate of return for the markets is around 8 or 9 percent! (Which, by the way, most active fund managers fail to do over the longer term, after expenses). 

Sleep Tight
I am not saying this is what you should do with your own portfolio.  I am not qualified to give that kind of advice.  I am saying, with practice, and experience, it is possible.  Consider the possibilities that not having everything in the stock market all of the time creates.  If nothing else, it helps me sleep better, especially in these crazy markets!

How do you decide how much to put into any one investment?

May Portfolio Update

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My portfolio gains in the month of May came primarily from energy stocks during the second half of the month.  After reaching a peak early in March, prices for energy companies came back down to the 200-day moving average and may have put in a bottom.

Bonds began their usual summer rally early this year.  20 year plus U.S. Treasuries bottomed in February.  It remains anybody's guess whether we will see a significant pullback as a good entry point before summer's end.

Meanwhile gold seems to be the only thing showing promise, currently, as most sectors continue flat, or trending down.

Five month return for TSX @ May 31, 2011 = 2.88 percent
Five month return for Basic Timing Model using XIU = 2.27 percent
Five month return for Advanced Timing Model (my returns) = -3.76 percent
Money for charity = $411.27

March Portfolio Update

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We saw a minor correction in the stock markets during the first couple of weeks in March.  While commodities are still down from the highs, they have not broken the upward trend.

My attempt to play technology stocks as they come down from their high has not paid off, yet. Seasonally, April/May is not the best time to own them, so that opportunity may still exist.  This also tends to be the case for Canadian financial companies. 

Meanwhile I would not bet against the energy and materials sectors at this time of year, although the energy sector does not look like a great buy to me since it has been without any real correction since late last summer.
 
Three month return for TSX @ Mar. 31, 2011 = 5.21 percent
Three month return for Basic Timing Model using XIU = 4.27 percent
Three month return for Advanced Timing Model (my returns) = -3.34 percent
Money for charity = $411.27