Editor’s Note

Posted on July 6, 2014 | AAII Journal

John Bogle and Jack Schwager are two names not commonly mentioned in the same sentence. John Bogle started a mutual fund company to offer index funds in 1975 when nobody thought the idea would work. Today, Vanguard is one of the largest fund companies in the world. Jack Schwager interviewed several top traders and wrote about his conversations in 1989. His book, “Market Wizards,” became a bestseller and sits on my bookshelf at home. (Yes, I know John Bogle goes by “Jack,” but to avoid confusion here, I’ll use “John” to refer to him.)

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Which IRA Should You Contribute to and When?

Posted on July 3, 2014 | AAII Journal

Contributing to a Roth IRA early in a tax year results in the greatest ending wealth.

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Avoiding Probate Through Account Titling

Posted on July 1, 2014 | AAII Journal

Joint ownership can make transferring assets at death easy, though the three types have implications that must be thought through.

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Valuation Ratios: The PEG Ratio

Posted on June 25, 2014 | AAII Journal

The PEG ratio factors in a company’s growth into its valuation, allowing investors to compare companies with different rates of growth.

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Investment Knowledge Boosts Portfolio Returns

Posted on June 23, 2014 | AAII Journal

Investing knowledge enhances risk-adjusted returns by at least 1.3 percentage points annually. Over a 30-year investment span, the improved portfolio performance leads to 25% greater wealth. This was the finding of a study, possibly for the first time, linking results from a test of financial knowledge to actual portfolio performance. The researchers believe their conclusion may understate the actual return differential.

A key driver of the return differential is a willingness to invest in stocks. The most knowledgeable investors had a 66% allocation to stocks, whereas the least knowledgeable held about 49% of their retirement assets in stocks. The larger stock allocation did lead to more volatility, but also higher risk-adjusted performance.

Researchers with the Pension Research Council at the University of Pennsylvania’s Wharton School gained access to the retirement plan of a large financial institution with 22,000 employees. The defined-contribution [401(k)] plan offered 16 funds. The plan’s offerings included stock funds, bond funds and a real estate investment trust (REIT) index fund. The study’s authors used this data to analyze account balances, returns and volatility.

Employees were also invited to take an online survey. The survey measured the ability to do a simple interest rate calculation, tested respondents on their understanding of inflation, looked to see how well respondents knew the difference between a stock and a mutual fund and how well they understood risk diversification, determined their understanding of the impact of tax incentives for saving and measured knowledge of employer match incentives.

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Stocks’ Price Volatility Increased by ETF Ownership

Posted on June 19, 2014 | AAII Journal

Stocks owned by exchange-traded funds experience 16% greater daily price volatility because of arbitrage.


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Assembling a Covered Call Portfolio on Dividend-Paying Stocks

Posted on June 18, 2014 | AAII Journal

Covered call writing is one of several ways options are traded.

While often done on an ad hoc basis, one can assemble and manage a portfolio of covered call option positions as either a part of a larger portfolio or on a stand-alone basis. Such an approach does require more detailed attention than managing a stock-only portfolio. Nonetheless, systematically managing a portfolio of covered calls has much for me to recommend it.

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Peculiar Facts From 500 Years of Finance

Posted on May 30, 2014 | AAII Journal
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Lesser-known but notable events that not only have led us to the present day, but also had an impact beyond the financial markets.

If you are like most people, you learned history in classes that largely covered facts related to dates, places, and people…and you probably couldn’t wait until the school bell rang.

Sadly, children’s exposure to history is often framed in a way that is less interesting and engaging than it could be, and it robs students of a curiosity about the past that could benefit their own future by understanding the richness of the human experience.

When it comes to the intersection of the financial markets and human history, there is a kaleidoscope of tales drawn from centuries of market mischief, mishaps and mayhem. This article reveals a few less-known but notable events drawn from the past half-millennium that might pique your own interest in the rivers of time that have led us to the present day.

You are probably acquainted with the fabled “tulipmania” that gripped Holland during the early 1600s. What most people don’t know is that two viruses played central roles in this drama.

The tulip bulbs themselves were classified into three groups: the single-colored, the multi-colored, and the “bizarres.” This last category is most important, as bizarres were the rarest and most sought-after tulip. The reason these unusual flowers came about was due to a virus that interfered with the plant’s ability to create a uniform color on the petal. It is today known as a “breaking” virus, since it breaks the plant’s lock on a single petal color without killing the plant. The effect on the flower was striking, producing mosaic-like flames of color on each petal. Of course, the Dutch of the time knew nothing of such things; they merely took a strong liking to these rare and unusual flowers.

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Relative Portfolio Returns Influence Happiness

Posted on May 29, 2014 | AAII Journal

How a portfolio performs relative to your expectations may impact how happy or unhappy you will be.

Whether an investor is happy or unhappy with his performance is significantly influenced by how his portfolio performs relative to the market. Investors are likely to be happy even if they lose money as long as their portfolio declines by a smaller magnitude than the broad market. Conversely, the proportion of investors likely to be unhappy rises during periods of strong market returns.

This conclusion is based on a study of British individual investors. Over 600 self-directed investors at Barclays Stockbrokers were surveyed during the period of September 2008 through September 2010. Respondents had a median age of 53 and median wealth of approximately $252,000. Answers were compared against actual returns.

The average threshold for anticipated happiness was a three-month gain of 5.4%. The average threshold for anticipated unhappiness was a three-month decline of 0.2%. Expectations for the level of returns that would lead to happiness did not alter much after the initial quarterly survey period, even though the FTSE All-Share Index (benchmark for the UK equity market) rebounded strongly from the financial crisis. Individual thresholds varied greatly; some respondents were happy even with a modestly negative return, while others required returns in excess of 20%. A strong positive relationship existed between return expectations and the minimum return an investor would be happy with.

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10-K Filing Size Impacts Volatility

Posted on May 27, 2014 | AAII Journal

The size of a 10-K report, an annual filing required from public companies by the Securities & Exchange Commission SEC, is correlated with a stock’s price volatility. Stocks of companies with larger 10-K file sizes experience more price volatility in the period immediately following the filing date. These stocks also experience larger earnings surprises and have a greater dispersion of forecasts by the covering analysts.

These were the conclusions reached by two University of Notre Dame professors, Tim Loughran and Bill McDonald, in a forthcoming Journal of Finance paper. The two professors proposed replacing The Fog Index, a commonly used measure, with file size as a gauge for determining how readable a 10-K filing is. The professors believe the goal of readability should be “the effective communication of valuation-relevant information, whether it is directly interpreted by individual investors or assimilated and distributed by professional analysts.”

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