Indexing Simplified

NONE OF THIS IS ACCURATE!

Last year I started the fourth quarter at work having only used two days of paid time off (PTO). I ended up losing a few hours of PTO without being able to exhaust it before the end of the year, so I have made the New Year's Resolution to vacation more.

Additionally, I have been planning to get a better view of the real American economy and understand people's relationship with money this year. Too many people believe the stock market is rigged in a way that proverbial wolves end up concluding that inaccessible grapes are sour. To that extreme, the media has reported that more than half of Americans have less than $1,000 to their name (determined by the responses of 518 people over 18, in reality).

Amid lotto fever, the above meme spread on social media -- and people immediately protested the calculations, but honestly, I felt the logic was equally invalid! As Dr. Robert Anthony hypothesized in his book The Advanced Formula for Total Success, "if we divided all the money in the world equally, in a short time the rich would be rich again, and the poor would be poor."

In anticipation of providing a needed service, I wanted to prepare a quick tutorial about investing for those who either tell me that they do not trust the stock markets or that they want to start investing but they literally do not know how. My hope is that, while the market declines, I can convince a few how investing can benefit them. I know it works because when an old friend got her first full-time job with benefits, she invited me to lunch to explain to her how her 401(k) worked. I told her (more or less) the following, and a couple years ago, she was praising me at a house party by saying that I was the reason for her financial stability, adding that she even bought her first car with a loan from her 401(k). That said, one of the most important things to understand about investing is the product in which you invest. The markets are always in motion, so understanding how the product works is important to avoid pitfalls like performance chasing or the quintessential "buy high/sell low" folly.

WHAT IS STOCK?
Stock is a certificate of ownership in a large corporation. You can buy shares of stock in many of your favorite brands: Amazon, Netflix, Starbucks, Chipotle, Disney, etc. As an owner, you would share in that company's prosperity. You are a fractional owner though, so you will get a fraction (minuscule amount) of their profits.

WHAT IS THE PROBLEM?
If you invested all of your available money into a single company, then you would have no impact on that company itself, but all of your financial welfare would be solely reliant upon that company. That company may not do very well in a given year, and even the strongest brands can lose acceptance by the public (such as K-Mart, Blackberry, McDonalds by large, and potentially Subway now).

WHAT CAN WE DO?
One solution is, if you and I mutually pool our money, we would have twice as much money together as either of us alone. Now we can buy into two separate companies to diversify our reliance on a single company for our financial well-being. The likelihood that both companies would fail is substantially lower (at least half). Add additional people to the plan, and that likelihood decreases even further.

WHAT IS A MUTUAL FUND?
A mutual fund is essentially that pooled concept: thousands or even millions of investors pool their money together to benefit from a shared, diversified portfolio. That pooled bank is large enough to put some of the money toward hiring a professional money manager to make the investment decisions who brings in the know-how and is paid to research the companies soundly.

Although there are countless mutual funds for a variety of markets in reality, the focus of this entry will stay within the equity (stock) market.

WHAT IS THE PROBLEM?
Historically, the economy has been going up, not just in recent years but for the past several decades. When trading individual stocks, it is said there’s a loser for every winner. All things equal, you stand to lose as much as you gain by trading in stocks, but if the economy itself continues to prosper, the investments would typically increase universally.

WHAT CAN WE DO?
If the economy is steadily increasing over time (such as 15-20 years), then that increase should suffice for most novice investors. Besides, if it is said that there's a loser for every winner trading in the stock market, then even selecting professional money managers is as risky as selecting the stocks themselves. Therefore, John C. Bogle pioneered the concept of pooling money into a mutual fund without hiring a money manager.

WHAT IS AN INDEX FUND?
An index fund is a mutual fund that merely mirrors a major market index without a hired manager. Consider the S&P 500 Index for example, which tracks 500 of the largest companies in the country today. When one of those companies falters in its performance, whether by losing money or just not making as much as other companies, it gets replaced by a company that, for sake of simplicity, was ranked at #501. As that happens, the index funds will sell the stock of the failing company and buy stock of the new company, so that the index fund itself will continue to mirror the index, owning the same 500 companies in the S&P 500.

WHAT IS THE PROBLEM?

The economy does not always go up, so when the index falls, its index fund should decline as well. Also, the grass will be greener in some (but not all) other pastures because actively traded stocks may increase more (or decline less) using complex financial strategies with successful traders (money managers). The theory that there is a loser for every winner in a trade remains though, so the over-performance of any trader will cause another trader to under-perform.

WHAT CAN WE DO?

If the performance of the economy itself is enough for you, then investing in an index fund may be the right choice. There will always be noise about how much more money you could be making in another fund, but that additional return is almost always accompanied by an even higher risk than the reward.

Typically, the only people who refute the merits of index fund investing are those who are selling a more expensive investment (or those who have recently bought into such an investment).

Credit Card Debt Rising

Rising Credit Card Debt

Recently CardHub.com ran an article titled "2016's Cities with the Highest & Lowest Credit Card Debts" (perhaps a bit of a misnomer since it was based on figures from September 2015).

Upon its conclusion, they posed four questions to field experts, which are available on the above link.  I am not an expert myself, but I found the questions especially intriguing, so since this is my blog, I took it upon myself to entertain each of the questions before reading any of the expert's responses.

What daily behaviors lead people to amass credit-card debt? It may be redundant, but the daily habits themselves contribute to amassing credit card debt more than most people may realize.  For individuals serious about tackling credit card debt, they need to stop accruing balances and pay off what is there.  Just like starting a diet where you need to monitor everything single you eat in a day, including the smallest snacks, people need to monitor every single thing they buy in a day, including the smallest items.  Being mindful of daily spending habits is an important step.  Simply changing some financial habits is as counter-productive as snacking between meals while on a diet.  It is an improvement, but the person may question if it is worthwhile to pursue because they’re not getting the full benefits.

What is the biggest mistake people make when managing credit-card debt? Thankfully I cannot speak for myself here, but I suspect people trying to eliminate their credit card debt underestimate how many factors are working against them.  For example, the minimum balance due is not there for the consumer’s benefit.  Paying just the minimum balance is not an efficient means of managing credit card debt.  Although it will eventually pay off the loan, the time frame involved is incredibly discouraging.

How does the growth of credit-card debt affect the economy? For years, I misunderstood the direct correlation until I heard it in the most simplistic terms.  Once the debts are due, there is a ripple effect.  Loans are harder to come by, and payments are needed now because others need to make their own payments with the amount due.  So people sell their assets (e.g. stocks) in order to make their payments, and when there are substantially more sellers than buyers in the market, stock prices can decrease in dramatic fashion.  Unfortunately, when that happens, even more people sell their stocks to prevent them from falling further.

What role, if any, should government play in incentivizing and encouraging people to maintain low debt-to-income ratios (e.g., through tax incentives)? I am not sure, but having healthy credit is truly its own reward.  If lower interest rates, peace of mind and/or financial security are not enough motivation, then I cannot see where other incentives would change the behavior for the majority of circumstances.

2016 Preview: Back To Basics

It's a new year and a new slew of short-sighted advice that never benefits many in the long run (and rarely in the short run).  This year the focus of the markets will indirectly be on the U.S. Presidential Elections, which draws comparisons to past election years -- especially the years when an incumbent president is not up for re-election, which has not happened in 8 years (of course, 2008's market had extraordinary influences on it, making it a poor comparison for any other situation).

While I could make predictions about the Dow and other random sectors as I have in past years, this past year was bad all-around (although, not by the previously mentioned 2008 standards).  While I generally like to invest in deflated sectors like gas or gold, the minor decline across the boards (notwithstanding heavy declines in other markets).  I have picked up a new strategy to use on my brokerage account involving ETFs, but it rates as "too soon to assess" (i.e. extol its virtues).

Negative returns may sound like bad news for the market, and a decline would come as bad news to most investors, but I think it will be a reasonably decent year with a fourth quarter that pushes the markets into positive territory.  More importantly, a sound strategy of rebalancing quarterly (as I have been doing) or a comfortable allocation among various sectors is the best way to plan for the coming year of uncertainty.  Not surprisingly, this strategy is also the best plan for any year.  It is the most basic strategy, but I do not anticipate many people profiting from any individual sector, so focusing on one would be unlikely to bear fruit (maybe even more unlikely than in other years, although high rewards never accompany safe bets).

eBay-Like Investing

Being a hockey fan, I buy a lot of jerseys on eBay. They're cheaper and usually in great condition. I bought my first one in May 2010 for my 33rd birthday when Montréal Canadiens had an improbable playoff run to the Eastern Conference Final, getting a white (Away) jersey to complement my red (Away) jersey, which was already so old that home teams wore white back when I got it.

Since then, I have bought several more jerseys (more than necessary, admittedly). While a team jersey can usually be found (well) below $50, most of the player jerseys still sell for $75 and (way) up. I bought my first player jersey this summer when I found a reasonably priced Patrick Roy jersey for $55 (before shipping & handling). Patrick Roy is the reason I'm a hockey fan today, and even more so, the reason I am a fan of Les Canadiens.

A few weeks later, I happened across a bid on a jersey for Alex Galchenyuk who was the third overall draft pick in 2012. The auction started at $19.99 with a Buy-It-Now price of $99.99. The shipping was reasonable as well, and it worked out that if someone won without another bid, then they would pay $27 (fittingly, since Galchenyuk's jersey number is 27). I followed the auction for a day, and with only three days left and no bids, I bit just to see how it ended.

Unfortunately, Alex Galchenyuk's contract had yet to be renewed during the auction. Therefore, no one else was willing to bid on the item. The auction closed with only my bid, so I happily paid the $27. The day after the jersey arrived, Galchenyuk re-signed with the team. Therefore, I tweeted about how I had just gotten his jersey off eBay for $27 (USD) the night before, a.k.a. #HumbleBrag.

I got a quick response asking for the name of the seller because that person wanted to see what else the person had available. The reality is there was nothing else that great of a deal. Truthfully, my jersey wasn't even that great of a deal when I bid on it because there was still a solid chance that he could have gone into free agency, and that jersey would have been outdated before I even got it.

However, I had high hopes for Galchenyuk regardless which team he represented, and the fact that Montréal is my favourite team would be a reminder that he started with the Habs. Putting money on it before he re-signed resulted in a sharp profit of owning a current player jersey at a fraction of its retail price.

Same as investing.

By the time you hear about a stock by word-of-mouth, its run is generally over. Buying a stock because someone you know got it for a deep discount would be on par with paying retail on a jersey that someone you know got for cheap. However, if you still believe in the company's future the way I believe in that of this hockey player, then the profits could be realized in the long run.

I have been investing in individual stocks for a little over a year now so there is not much personal wisdom that I can share. But I have only bought as much as I was willing to lose, and I have not backed down from any individual stock yet. It is entirely possible that one or more will become completely devalued. In fact, my first stock purchase was for a company in Chapter 11 bankruptcy, so I can reasonably expect that stock to be worth nothing soon, but even still, the amount remaining in that investment is as much as I would be willing to bet on an improbable turnaround. (Nevermind that stock became part of a pump-and-dump in September, rising from $0.06 to $0.64, but still below doubling in value for me, which has been my target amount.)

Based on my experiences thusfar, however, I am even more steadfast in my belief in index investing.(Not that trading stocks isn't a bit of fun in its own way.)

The Full Motley -- 4Q, 2015

As the tide rolls in and rolls out, the markets rise and fall alike, at least during business hours save on a few national holidays.  After a choppy third quarter, the markets saw a strong rise throughout October.  Unfortunately, it's not October anymore and the Santa Claus Rally (which is more lore than rule) is several weeks away.  The markets have been recently retreating, and as much as ever, the possibility of any day rising or falling is anyone's guess.

While this tumultuous uncertainty may inspire many questions, more opinions and few answers, the most productive steps for your financial health may be considering every possibility and then weighing each against its corresponding probability to revisit your asset allocation and assess that the percentages are a true reflection of your long-term view of the market.  Then, rebalance accordingly.  

When things were at their most dire in early 2009, I remember considering the probability that the US dollar would become worthless and that the markets would zero out to nothing.  The former scenario was vastly unlikely and the latter hypothetical was borderline impossible, requiring virtually every business to file bankruptcy (which, even then, it would take a few years before the stock values would be zeroed out).  Compared to the chances that the market declines were irrational overreactions, it became easy to justify not just maintaining my investments in the market but increasing them at the time.

While markets are only down 10% at most, the long-term views should not be influenced on whether the market is going to retreat 15% or even 20% from its all-time high, but merely whether today's all-time high will continue to be the all-time in another decade or two.  The money invested in stocks, including equity mutual funds, will be working for you.  Those efforts are not always an instant reward, but historically, they have been.

Therefore, while others celebrated Singles Day online (mostly in China), I rebalanced my portfolio as quickly as I could, moving about 0.1% from four funds to split between two trailing equity funds, namely Vanguard Total Stock Market Index and Vanguard Explorer Fund.  And now I'm done for activity in my 401(k) for the rest of the year (in fact, until February 10, 2016, which marks the 7th anniversary of this blog).  While I will likely keep an eye out to see how things develop in between, I am committed to my asset allocation and there is no need or temptation to adjust the portfolio any further.  The most complicated part of investing is how simple it is.

Pop Quiz

It's the end of the month.  Tomorrow is Friday and a payday.  Your checking account has $400, and tomorrow's paycheck will cover your expenses for the next two weeks.

You have a mortgage payment at 5%, a car loan at 4%, a credit card balance (although no trouble paying it off every month), a Roth IRA, and a money market fund earning <1 do="" excess="" following="" hich="" nbsp="" of="" p="" should="" the="" with="" you="">
1) Put it toward your mortgage;
2) Put it toward your car;
3) Put it toward your credit card;
4) Put it in your Roth IRA; or
5) Put it in your money market fund?

Did you answer?  If so, you're not wrong!  Aside from talking to a computer screen (which could be a little weird), the fact that you are living below your means with an excess at the end of the month puts you ahead of the game.  Ideally, paying down the mortgage with a higher rate before the car loan would put you slightly ahead in the long run, but if that's the worst financial mistake you made, then again, you are still ahead of the game.

Financial success is often more about avoiding the wrong decision than making the right choice.

Many financial experts (and, according to them, financial studies as well) support the notion that periodic reallocation is more critical to long-term financial success than the investments themselves.  Interesting theory, and considering I reallocate quarterly, I would be foolish to dispute it.  In my past year of investing in individual stocks, I have felt the panic of making the wrong decision (and how it, ironically, usually becomes a self-fulfilling prophecy).

The Full Motley -- 2Q, 2015

Time to rebalance, but it's worth noting a pet peeve of mine.  It is more of an investing myth, an over-simplified statement restated into meaning without having as much strength behind it as it sounds like it has.  The saying is "buy low, sell high," but that's the biggest myth of investing.  For the most part, the real truth is that there no "sell high" in investing.  Regardless when you sell, that money will go somewhere else, and it will then outpace the performance of the other investment -- or any other investment option at that given time.  There are a couple exceptions: one of which is retirement where you are using the assets to live and the other is rebalancing.  Rebalancing is the act of buying low, selling high, although the statement itself in the context of rebalancing is overly simplified and not the complete truth.  As a myth, "buy low, sell high" provides more understand than a million other words would, so it is useful and reachable.  But, at the same time, if you understand investing well enough, then the limitations of the advice make it less than useful.

That said, my quarterly rebalancing is all the more effective because it answers the question that would otherwise lead to "paralysis by analysis" (as Mo Ansari loves to say) of where to put the money sold high in order to get as much (or, ideally more) out of it than leaving it where it was.

This quarter, I got to see the international markets boom personally.  I had been hearing about it, but I had yet to see the evidence as clearly as it is here.

I moved small amounts from Vanguard Total International Stock Index Fund and (perhaps surprisingly) Vanguard Explorer Fund and I split the sum among Vanguard High-Yield Fund, Vanguard PRIMECAP Fund, Vanguard Total Bond Index Fund (which, as of the end of last month is the largest bond fund in the world, overtaking Pimco Total Return Fund) and Vanguard Total Stock Market Index Fund (which has been the largest mutual fund in the world since overtaking Pimco Total Return Fund at some point in the past year or two).