Taxes, Portfolio Management and Emotional Pain
Posted on April 4, 2013 | Investor Update
Loss aversion may cause some investors to make portfolio decisions based primarily on the tax consequences instead of on strategies intended to provide a long-term benefit. The short-term pain of tax payment is felt more than the future pain of the increased volatility stemming from a portfolio that is not properly allocated. This is a conclusion I’m reaching from reading some of the comments to the articles about rebalancing in the April AAII Journal and what I’ve been learning about behavioral finance.
Annuities Sometimes Make Sense
Posted on March 28, 2013 | Investor Update
A friend asked for my opinion about annuities during dinner Monday night. He is nearing retirement and he followed his adviser’s suggestion to move some of his savings to annuities, but was curious to hear my opinion. I responded that under the right circumstances, annuities do make sense.
Protecting Your Portfolio from Dementia
Posted on March 21, 2013 | Investor Update
Approximately one in seven Americans age 71 or older have dementia, according to an updated analysis published this week by the Alzheimer’s Association. The analysis also estimates that one-third of Americans age 85 or older have Alzheimer’s disease. Though research shows a higher prevalence among women than men, this difference seems to be attributable to the simple fact that women have longer life spans than men.
The Market’s Unsustainable Pace
Posted on March 14, 2013 | Investor Update
Many headlines have focused on the Dow Jones industrial average’s record high and its 10-day winning streak. Less noticed is the S&P 500’s attempt at its own closing record. The large-cap index ended today just two points shy of its 1,565.15 closing high set on October 9, 2007.
Does Growth Matter?
Posted on March 7, 2013 | Investor Update
Is growth important to a rising stock price? My guess is that if I were to ask this to a random set of investors, the answer would absolutely be yes.
Growth makes a good story. Winners are preferred to losers and, when it comes to companies, winning is associated with growth. A company that is growing profits, or is expected to achieve strong earnings growth in the future, is often a company that attracts attention. Growth can put a stock in the news and it can attract investors. Growth can even lead to higher valuations.
Two Strategies for Limiting Investing Mistakes
Posted on February 28, 2013 | Investor Update
Too often the focus of investing is picking the absolute best security for today, rather than avoiding the common mistakes that hurt portfolio returns year after year. Failing to have a system in place to avoid behavioral errors can adversely impact your returns. This is particularly important when it comes to hand-picking stocks and bonds because the ability to think differently and limit mistakes is what will lead to market-beating performance.
Guarding Against Identity Theft
Posted on February 21, 2013 | Investor Update
Identity thieves may be getting more brazen. Over the weekend, Computerized Investing editor Wayne Thorp forwarded me a Reuters article about a mail carrier in Florida who was gunned down by members of an identity theft ring. The thugs were after the carrier’s master mailbox key.
Is Now the Time to Buy Stocks?
Posted on February 7, 2013 | Investor Update
January was the market’s best start to a New Year since 1997. The S&P 500 realized a total return (price appreciation and dividend income) of 5.2%. Had many companies not paid their traditional first-quarter dividend payments in December, the return would have been even higher.
Given this performance, should you buy stocks now?
An Alternative Source for Income
Posted on January 25, 2013 | Investor Update
One alternative source of income you may not be familiar with is exchange-traded debt (ETD). Also referred to as preferred equity traded (PET) bonds, these are debt instruments that trade like stocks. Like any other investment vehicle, they have unique risks that should be considered before purchase.
ETDs are debentures, notes and bonds. Unlike traditional bonds, which trade on the bond markets and are listed by CUSIP numbers, ETDs trade on stock exchanges and are listed by ticker symbols, just like stocks are. ETDs have par values of $25, instead of the typical $1,000 par value bonds are issued with. You can trade an ETD through an online broker just as you would a stock.
Though they trade like stocks, ETDs pay interest, not dividends. This means the coupon payments are taxable at ordinary income rates, not the discounted 15%/20% tax rate qualified dividends are eligible for. The coupon payments are made quarterly, where as traditional American bonds pay interest on a semiannual basis.
A Weak Link Between ROE and High Returns
Posted on January 18, 2013 | Investor Update
A popular measure of profitability, return on equity (ROE), does not hold up well as a primary screening criterion for identifying stocks with potential upside.
The ratio divides net income by shareholder equity. It reveals how much profit a company is earning of off its net assets. The more effectively management uses the company’s resources, the higher ROE will be. It is said to be a favored indicator of Warren Buffett.
Given this, it would seem logical that ROE would be a useful ratio for identifying stocks likely to outperform in the future. Yet, ROE may work better as an indicator of risk than of potential return. This is the finding of two books: “What Works on Wall Street, Fourth Edition” by James O’Shaughnessy (McGraw-Hill, 2012) and “Quantitative Strategies for Achieving Alpha” by Richard Tortoriello (McGraw-Hill, 2008). Both authors say only stocks with ROE ratios ranking in the top 20% enjoyed clear outperformance.
What was more significant was the performance of the stocks with ROE ratios ranking in the bottom 20% of all companies. These companies lagged significantly. The margin of their underperformance was far greater than the margin by which companies ranking in the top quintile for ROE ratios outperformed. The average excess returns were -9.6% and 6.2%, respectively, according to Tortoriello. Using a different database and longer time period, O’Shaughnessy calculated average annual excess compound returns of -3.9% and 1.0% respectively.