Train keeps a-rollin’


With market valuations at nosebleed levels and market sectors like technology going parabolic, it is easy to make a case that a correction must be immanent. This is not a good bet. The current bull market started in October of 2009 and is now the second longest rally in the last one hundred years. Just to be clear, a bull market is a period without any 20% declines. Now lasting almost 3,200 days, we only need this bull to run for about another THREE YEARS to become the longest of all time. Using financial management language, what we have here is a failure to understand Momentum.

In a nod to one of my favorite economists, newly minted Nobel Prize winner Richard Thaler, this current state of affairs shouldn’t be such a surprise. One of the biases he observed is called the “recency effect.” Simply put, we tend to think the future will look like the immediate past. So an assumption that after one of the worst financial crisis in U.S. history people should be fearful of stock markets makes intuitive sense. It would also be wrong. That this bull run has long been called “the most hated rally in history” tells us more about human behavior than how to successfully invest our money. Just ask the folks who have been waiting since 2010 for a market correction to start investing in stocks again.

Okay, then what do we do now? Think about diversification outside of indexed funds like ETFs, even as they remain our preference as the primary investment choice for individual investors here at Invest-Notes. As discussed previously, the idea that ETFs are in a bubble, or will lead to weird price distortions or even a market collapse are just wrong-headed. But history has demonstrated pretty impressively that buying equities when valuations are high tend to mean subpar returns over time. This is where the idea of adding some individual stocks or narrowly focused ETFs might make sense for adventurous investors.

That there are specialty ETFs almost sure to fail spectacularly shouldn’t be a surprise. There are ETFs holding the stocks of Nigeria or Egypt that have lost a quarter of their value over the last three years. And if you bet on gold miners or master limited partnerships (MLP) during this same timeframe there are ETFs sitting on losses of up to 90%. Of course anyone reading this blog should know better than to even think about an ETF called ProShares UltraPro Short Financial Select Sector (FINZ), down over 40% so far this year, just as in many past years. Conversely the plain-Jane financial services indexes (like XLF or VHF) are up over 15% year to date.

Which makes for a nice segue to offer an observation about a possible investment opportunity. In August of 2016, a change was made to indexed financial services ETFs, like XLF and VHF, for the first time since 1999. No longer included with banks and their ilk, Real Estate Investment Trusts (REIT) now have their own index. A detailed explanation can be found here:

“The Difference Between Banks and Buildings”

The quick take is that previously about 20% of financial index funds were composed of REITs that provided the bulk of the dividend income generated by these ETFs. The assumption at the time was that bank-only ETFs would offer lower dividends and more volatility when the REITs were spun off. As it turns out, 2017 has proven a challenging one for REIT-themed ETFs, like VNQ or ICF. Despite a big spread between the dividend yields (REIT = 4.5% while Banks = 1.5%) the REIT ETFs are mostly lower than at the start of the year, underperforming bank ETFs by a significant margin since their Independence Day.

Another curious result of this separation of banks and buildings is their seemingly inexplicable lack of correlation. As the Boys at Bespoke have discussed recently (, highly recommended), there are asset classes that move in tandem and others that move in opposite directions. A quick example of this is the impact of rising interest rates on two asset groups that wouldn’t normally be thought of as behaving similarly. Yet both utility company stocks and long-term bonds lose value as interest rates go up. So when (not if) interest rates finally start climbing, having invested in these types of stocks and bonds will provide very little safety despite the diversification normally associated with a stock/bond mix.

When comparing a list of 18 popular asset groups (bonds and indexed ETFs, but also oil, gold and Bitcoin), the two assets most likely to go in opposite directions on most days are the REIT and Financial Services indexed funds. As noted by Bespoke, just a year ago they were traded as one asset. This suggests that REITs could provide some valuable diversification if financial equities begin to lose some of their recent altitude. The caveat here being that rising interest rates tend to boost bank stocks while often pressuring REITs.

However, it is just possible that recent headlines about the death of physical retail outlets – versus the online variety – is greatly exaggerated. This red herring obfuscates the fact that most income-producing real estate is not shopping malls – office spaces, warehouses, data centers, apartment buildings, manufacturing facilities, hotels, gas stations and convenience stores – suggesting that the recent underperformance of REIT ETFs might be an opportunity to add both value and income (the 4.5% dividend) to a portfolio at decent valuations.

While I don’t currently own any REIT ETFs, VNQ is on my radar and starting to look interesting. As a side note, over 10% of my personal IRA is in individual REIT stocks that I have owned for over a decade. That the bulk of my personal assets are real estate investments also explains why I have not been in any hurry to add real estate exposure through these new ETFs. But that might be changing.

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A Happy Anniversary


Ten years ago today the first Investnotes was sent by email to a handful of family and friends. In 2010 my good friend Rob Simons gave me a WordPress blog site, set-up and ready to go, as a birthday gift. There has since been over 400 postings on investing, jazz and art.

Here for all to see are my missteps, misguided trades and boneheaded commentary. But also a few solid suggestions and nuanced observations that when embraced by readers delivered real value for the time spent reading these musings.

Thank you for choosing to join me on this journey of discovery, as well as for your many comments both good and justly critical. Below is the first missive to appear as what is now Invest-Notes. Leaving this post unedited has been the most difficult task of the last ten years.

10/16/07 #1

Investing is not a zero-sum game. All the talk about “beating” the averages serves only to distract from the point, which is to generate a meaningful return on your investments while minimizing any risk of significant loss. What someone else makes is irrelevant as long as you can achieve the goals you’ve set based on your needs and circumstances. You don’t have to “beat” anything over time to create wealth. It is also a fallacy that someone else must lose money for you to profit. So what that someone sells you a stock that then goes up. What if that investor had been holding the stock for years and finally cashed-in for big, long-term capital gains? In this scenario one person has exited a position profitably as another enters the same position favorably.

In his otherwise excellent new book “A Demon of Our Own Design” Richard Bookstaber makes the assertion that when hedge funds win, it is because someone else loses. But he then contradicts himself during a fascinating discussion about the primary purpose of the market being to provide liquidity. Equities, for example, are bought and sold not because of economic news (the Efficient Market Hypothesis), but because someone needs money to take a vacation or buy a new home. Conversely, investment firms and mutual funds receive money that must be invested in a timely fashion. This idea of the market as an entity intended to monetize investments means that as long as the reasons for ownership of an equity are influenced by matters not pertaining to the business of the enterprise then it is impossible to assume that an investor has either won or lost in any given transaction.

Whatever your financial goals, follow your own instincts, not those of people who might view the world differently than you do. And don’t get distracted by what other people claim to be achieving. The only thing that really matters is the value of your assets when you need them.


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The Jazz of Investing

Frankly, it’s a fool’s errand to try and decide when is a good time to buy or sell equities based on movements in the stock market. Yes, valuations appear stretched and the recent, relentless upward trend in most market indexes would argue for caution. But this same comment could have been made repeatedly since the market bottom in 2009. A tired old quote is worth a revisit, “The market can remain irrational longer than you can remain solvent.” Or, put more bluntly, nobody has any real insight into what the market is going to do next. The only sensible choice is always to stick with your original investment plan. And if you don’t have a plan, then don’t do anything until you commit to one.

Almost a decade ago Lewis Sanders of investment firm AllianceBernstein made an intriguing observation, “The principal dynamics in the world’s capital markets revolve around a tug-of-war between feeling secure and making money. In the end, the feelings generally win out.” Around the same time a hedge fund manager (whose name is not in my notes) said in a Bloomberg interview that his only trades consistently making money were the painful ones. Buying stocks that are out of favor, avoiding the “hot investments” of the moment and having a plan that you stick with is not just difficult, but is indeed painful.

Looking back to 2000 there were many competent fund managers and investment professionals who underperformed the market during the dot-com bubble. Warren Buffett in particular came under withering criticism for being too old to understand the value of technology stocks. Yet it was the investors, like Buffett, that stuck to what they knew and had the discipline to execute on their strategies, even in the face of public ridicule, that avoided being burned in the subsequent crash. Probably worth noting that Berkshire Hathaway (BRK.A) hit a dot-com bottom of $44,000 per share in February of 2000. It closed yesterday at $278,670 per share.

For those of us who saw our 401K plans become 201K plans during the market mayhem of 2009-2010 the pain lingers. But a refusal to panic enabled disciplined investors to subsequently enjoy one of the biggest bull market runs in U.S. history. If you were buying stocks in the summer of 2009 you were considered an idiot. Today you are a genius for being so insightful at that time.

So all this helps to explain the tendency for emotion to win the day rather than reason. Research has demonstrated time and time again that most investors tend to sell their winners too early (because it feels good to make a profit, any profit) and then hold on to losers (because to sell is to admit that we were wrong, and no one likes being wrong). Having the conviction to avoid these common, painful mistakes requires discipline and the work necessary to fully understand not just what you own, but why you bought it in the first place.

Yet the Big Decision each of us must ultimately make is whether or not to be an equity investor at all. There is no shame in admitting that any loss is too much to bear. Or, that having to make decisions about how and where to invest money we have worked very hard to earn is just too painful, even with professional help. Let’s face it, most investors are not particularly successful anyway. There is nothing wrong with simply socking money away in bank CDs or U.S. Treasuries (the “but what about inflation” caveat notwithstanding, or particularly relevant recently). For most of us, that we routinely spend less than we earn will be the driving factor in creating wealth over time.

Finally, a quick thought about investing strategies derived from the musings of jazz great Miles Davis. Don’t laugh, Davis was making over $200K annually back in the 1960’s when that was a lot of money (his New York City brownstone, Maserati and full-length snakeskin coats weren’t paid for with credit cards). Davis once said that, “If you play a note you didn’t intend to play, what determines whether it sounds like a mistake or a moment of inspiration is the note you play after it.”

Buy a stock; hold the stock, sell the stock or buy more of the stock? Only with study and practice can we become good enough investors to know what note to play next.

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Sake and CRSP

The question came from a good friend in the asset management business over a cup of sake. Talking about a presentation to his firm from Blackrock, one of the biggest ETF/Mutual fund companies in the world, he had been surprised by a trivia-like data point, “What is the percentage overlap of ETFs in the small cap space between Blackrock and Vanguard?” I guessed 80%. The correct answer was less than 10%. What?

Adding to our ongoing conversation about the importance of ETFs in the portfolios of the individual investors who enjoy reading Invest-Notes, this new data point is worth discussing. BlackRock offers the iShares Russell 2000, IWM. For no particular reason I assumed that the Russell 2000 index was the defacto choice for the biggest ETFs since it also tends to be a commonly used benchmark for performance. Vanguard uses CRSP for its small cap fund, VBR. I’d never heard of CRSP.

In last week’s Economist, there was an interesting article on the growing clout of companies that provide the indexes used to create exchange-traded funds. The article did not mention CRSP, even though there is now about $225Billion worth of indexed funds using CRSP as performance benchmarks. Who are those guys?

The Center for Research in Security Prices (CRSP), originated at the Booth Business School at the University of Chicago. So as we’ve talked about things like market capitalization (VOO versus RBC) being a driver in ETF composition worth thinking about, it might just be that the index used for portfolio composition is even more important. Who knew there were so many?

Tools like Morningstar allow for a quick look at the key components of ETFs, with the idea that an investor can make a quick – and easy? – decision on where to put their money by contrasting their differences. In reality, it becomes much more complicated when competing indexes determine the portfolios of ETFs claiming to track the same market sectors. An example of how this is supposed to work, is here:

For starters, there are also small cap funds from iShares, Charles Schwab, WisdomTree, DFA, and others. While some characteristics are easy to understand such as a tilt toward value or growth stocks, more difficult to quantify are factors such as how the portfolios are regularly rebalanced. Important because there are many thinly traded stocks in this space. Or, in this case, the criteria for the composition of the fund’s holdings.

In the case of CRSP, to be included in its small cap index a stock must be smaller than 85% of all other U.S. stocks, but bigger than the smallest 2%. Vanguard’s offering, VBR, consists of around 800 stocks with the top ten holdings only accounting for 5% of the total value of the portfolio. By contrast, iShares IWM holds, well, the 2,000 individual stocks that make up the Russell 2000, where less than 3% of the fund’s holdings are in the top ten. This makes a side-by-side comparison of the top 50 holdings in each fund mostly useless. Other than seeing clearly the lack of overlap in the two funds, each list consists of names that will be unfamiliar to most equity enthusiasts.

Ultimately, the safest course to pursue in such muddy water is to focus on fees. VBR has an expense fee of just .08%, handily beating the expense ratios of most other small cap ETFs where fees range from .20% to over .5%. And the performance has been pretty solid as well. I have about 5% of my personal IRA in VBR.

Finally, it should be noted that this has not been a stellar year for small capitalization stocks, their biggest siblings putting in a much better performance recently. Which might lead a savvy investor to consider adding some ETF exposure to the small cap space while prices are not as expensive as other sectors of the market.

And for any fans of Miles Davis out there, check out a new Jazz-Notes.

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The numbers say that it is so

For the last few months there has been lots of talk about the size of equity markets – specifically the dramatic drop in the number of publicly traded companies. The always interesting Jason Zweig wrote a series of articles on this topic appearing in the Wall Street Journal during spring. One of my favorite resources, Bespoke Investment Group (, highly recommended) has done analysis confirming the reality of the dwindling number of companies available to us individual investors for purchase. Another way to look at these factoids is how they support the case for using indexed funds, specifically exchange traded funds (ETF).

As Alice mentioned in wonderland – a fair comparison for equity markets we’ll argue – the beginning is a good place to start, so it is worth noting that from 1926 to 2015 there have been a total of 25,782 companies available for purchase through a brokerage account. Yet the truly astounding fact is that over this 90-year period, only 30 stocks have been responsible for almost a third of the total returns accrued to stock investors. Since it is pretty much impossible to determine in advance what stocks will outperform over time, best bet is to hold a broad basket of equities and to do so at the lowest possible cost.

Jumping forward and looking at just the last 20-years, in 1996 there were 7322 publicly traded companies, a number that dropped to 3,671 at the beginning of 2017. Putting this in a slightly different context, in the lifetime of the Internet (Netscape went public in 1995!) the number of choices available for stock market investors has dropped by almost half. Of those companies now gone from the equity markets, one third went out of business (perhaps the recent obsession with retailer’s current bout of “Death by Amazon” is just part of a longer running trend). An argument can be made that a smaller pool of investable equities offers more opportunity for holders of ETFs.

Okay, now let’s look at our favorite proxy here at Invest-Notes for equity markets, the S&P 500. As a quick reminder, the S&P 500 is an index of 500 (mostly) large cap stocks that are used to measure the overall health of the stock markets.  By contrast, the Dow Jones Index has only 30 stocks attempting to do the same thing. Only as companies are bought or go out of business, the S&P replaces them with existing equities to ensure a constant count of five hundred. Again, by contrast, the Dow makes changes to their index on an annual basis making it less valuable when looking at long-term trends in its portfolio.

Over the last ten years, the S&P has seen 129 companies go out of business and currently has 72 stocks that are trading at prices lower than they were in 2007. While big technology stocks have been responsible for a significant percentage of the gains this year, most stocks in the index are having a good year. The strength of market breadth (the number of stocks hitting new 12-month highs versus the number hitting new 12-month lows), confirms this is not a rally dependent on just a few big winners, an idea that seems to be making the rounds. Owning an S&P ETF (like VOO or RSP) has been the best bet for most investors for the bull market that began in 2009.

Perhaps the most startling number is how many private asset management firms have at least $100,000,000 in assets under management – around 3,900. This means that today there are more companies telling people how to invest their money than there are public companies to invest in. There were just 750 advisory firms of this size fifteen years ago.

Finally, there was a recent article in the Financial Times using information from the U.S. Federal Reserve to demonstrate that since 1960s the single largest purchasers of common stock – the stuff we buy in our brokerage accounts – are the publicly traded companies themselves. This helps explain why the huge shift of funds belonging to individual investors moving into exchange traded funds at places like Blackrock and Vanguard have not had an outsized impact on market prices – and are unlikely to for the foreseeable future.

Markets go up more often than they go down and the various asset classes tend to rotate over time as market leaders. So it appears reasonable to assume for the foreseeable future that individual investors are best served by maintaining portfolios anchored by a few broad ETFs that can capture gains while limiting losses. For the more adventurous investor, adding a few individual stocks with strong fundamentals and a healthy dividend is also an option, but should remain a small percentage of assets.

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Berkshire versus Blackstone

A lot of pixels have been lit up here at Invest-Notes discussing Warren Buffett, Charlie Munger and their amazing enterprise, Berkshire Hathaway (BRK.A and BRK.B).  While the B-shares have been added over time to most of the portfolios I manage since their creation in 1996, the case to be made for adding shares now is more uncertain than usual. There is no doubt BRK will continue as a viable entity after Buffett and Munger have left this mortal coil. Still, even Buffett has suggested that at this time a better option for smaller investors might be an indexed fund of the S&P 500 instead of BRK.

There are two reasons for considering this advice. First, Buffett and Munger have yet to announce a formal succession plan despite their respective ages (87 and 93), so when the inevitable occurs we should expect a knee-jerk sell-off by the public. Which, following Buffett’s own advice, would likely mark the next really good buying opportunity of BRK shares. Second, BRK pays no dividend (though it prefers to own stocks that do), which typically account for a significant portion of total long-term returns for most equity investors. That the A-shares cost $256,000 each and the B-shares around $170 can also be intimidating for individual investors.

The benefit of having BRK in an investment account – beyond being associated with one of the best investing minds ever known – is that the size and breadth of its holdings allow for meaningful diversification. BRK functions more like a mutual fund or ETF than a typical publicly traded stock, offering the opportunity for individual investors to participate in ownership of asset classes not available through equity or bond holdings.

One alternative investment worth considering is Blackstone Group LP (BX), which I have been adding in modest increments to a couple of accounts since the beginning of the year. Uncommon among other publicly traded asset managers because BX also invests across four primary asset areas; real estate, credit, private equity deals and hedge fund-like investments. Interestingly, this means BX doesn’t just invest on behalf of its clients (mostly institutional) and collect management fees. BX participates as an investor with its own profits creating additional revenue streams. And like the Berkshire Boys, senior managers are major owners of BX shares. The recent dividend yield of over 6% is also compelling, though due to the quirky nature of many BX deals the annual yield over the last few years has vacillated between 3% and 9%.

If all this sounds complicated, it is. Most investors know of BX only tangently through the controversial cofounder and CEO, Stephen Schwarzman. Unjustly in my opinion but a potential positive for investors, BX has suffered from Schwarzman’s reputation as much as BRK has benefited from Buffett’s.  Started in 1985 and taken public in 2007, during the financial mayhem of 2008-2009 BX executed on Buffett’s dictum to buy when blood was in the streets brilliantly. Today, BX employs some investment strategies pretty much unknown a decade ago. This makes some investments hard to understand and others potentially requiring decades for a payout.

Additionally, there is another important reason the stock has remained so long under the radar. BX is structured as a limited partnership that brings tax complications and accounting issues such as K-1s. This also makes owners of the stock unitholders instead of shareholders, giving senior management pretty much complete control of the company. Though this lack of investor influence applies equally to owners of B-class Berkshire shares.

A final reminder however that this is uncommon fare and BX is probably not appropriate for most individual investors. There’s quite a bit of risk and much of it is not easily discernable. Yet the concept is important because we tend to think of stock and bond investments in fairly narrow terms. With stock, we own a piece of a business, while with bonds we are lenders to a business. ETFs, indexed and mutual funds tend to own a variety of assets, but almost always in the form of equities and fixed income instruments.

Equities like BRK and BX own stock in other companies (like a mutual fund or ETF) but also own many businesses outright (privately held companies not publicly traded). They both make direct loans and provide variable financing mechanisms while simultaneously owning traditional bond portfolios. BRK is a major player in the insurance industry, BX is an innovator in real estate investments. In summary, BRK and BX offer a unique and typically overlooked opportunity for the adventurous investor.

Note: I attended the annual meeting of BRK a few years ago and wrote a two-part article on my experience and impressions, links below. There’s new stuff in Art-Notes, too.

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Cigarettes and soda pop

Serendipity is a beautiful thing. The recent sell-off in the technology sector made for a perfect demonstration of why seemingly arcane subjects like the capitalization weighting of stocks within exchange traded funds matters. There have been a couple of days lately where S&P 500 indexed funds – which contain the exact same stocks, but in different proportions – saw their performance bifurcated. Meaning, one ETF went up, while others declined. All this is explained in the post below this one.

So, now we’re going to talk about an adjustment in sector allocations that I made about a month ago inside a couple of IRAs. First, I am not suggesting you make this shift in your personal accounts. Second, please note that one reason for making these changes was purely emotional.

For me, one of the more confusing designations is the distinction between Consumer Staples versus Consumer Discretionary. A comparison of these two sectors using Vanguard ETFs helps explain the good and bad of augmenting a pure S&P 500 ETF with additional holdings. VCR is a consumer discretionary EFT with 374 individual stocks, though the top 10 holdings comprise 50% of the total valuation. VDC is a consumer staples ETF with 107 stocks and the top 10 holdings representing a whopping 60% of the fund.

My confusion revolves mostly around why any individual stock is considered a “staple” as opposed to a “discretionary” choice that consumers can make. For VDC (staples) the largest position at 10% of the fund is Proctor & Gamble (PG). With 65 consumer brands, twenty-one that each generate over $1-billion in annual sales, most folks probably need something from their product lines (laundry, baby care, feminine care, and grooming). But the other four stocks in the top five holdings, comprising a third of the entire fund, are either tobacco companies or soft drink manufacturers. How cigarettes and sodas can be classified as “consumer staples” elude me completely. An additional holding is Molson Coors Brewing. While beer strikes me as a perfectly acceptable daily requirement, it is safe to assume most people would disagree.

For VCR (discretionary) the largest holding is Amazon, weighing in at 12% and Home Depot a distant second at 6% of the fund. That Home Depot provides more products necessary for day-to-day living, as a home owner or a renter, than a brewery or cigarette vendor seems to be stating the obvious. Another top five holding is Disney (DIS) and lots of people like cartoons, Star Wars and theme parks.

Now, a quick interlude focused on the S&P 500, the favorite proxy for U.S. equities here at Invest-Notes. The stocks included in the S&P are, mostly, the largest and most respected companies in the U.S. However, smaller companies tend to outperform large cap(italization) stocks over time. But as a group smaller cap stocks tend to be more volatile, and hence riskier for individual investors. Sector funds can provide exposure to smaller companies while increasing exposure to the core holdings of pure S&P funds.

In May I sold all of the VDC funds in two IRAs and redeployed the proceeds into VCR. Here is a quick summary of the reasons that drove this decision. Understand that this list gives the conclusions of my thinking, not the information that underpins these statements.

  • Diversification is better achieved since VCR has over 370 stocks and VDC only 107
  • Individual equities in VCR are more appealing based on current consumer trends, like the shift toward online purchases (Amazon), increasing home ownership (Home Depot) and a preference for experiences over stuff (Disney)
  • Personally, I don’t want to own businesses that hurt their customers – tobacco and soft drinks
  • As for beer, I’ve been a longtime owner of Heineken stock and will remain so
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Hitting the reset button

Apologies for the delay in delivering this post. Frankly, I’ve been struggling a bit with what to do about Invest-Notes. Not for the first time my enthusiasm around writing articles has waned. And if I’m not excited about what’s being written it is unlikely readers will be excited about they are reading. October will mark ten years that I’ve penned this blog and while I debated about winding the site down, I’d honestly rather not.

The first time I struggled with “what to do different” a decision was made to not force an article every Sunday – as I did for the first few years. This change was well received by readers. The second time, a couple of years ago after my personal portfolio had migrated to exchange traded funds, I determined not to focus on stock picking but discuss the philosophy of investing. This change hasn’t worked out as well.

So thanks to my friend, and long-time Invest-Notes reader, Rick who over a glass (or two) of wine recently asked the question that originally jump-started this enterprise a decade ago, “But what should I do with my portfolio?” Valuations are high by historical standards and the world a more confusing place on so many levels. Yet we know that a major impact on our future financial status is driven by the money we have invested in both taxable and retirement accounts. Yes, the market mayhem of the dot-com bubble in 2000 and the financial crisis of 2008 represent the painful side of investing. Nonetheless those who have stayed the course – and stayed invested – have profited handsomely. Nobody ever said it was going to be easy.

In answer to Rick’s query I shared a couple of equity purchases and sales in my own accounts over the last few weeks. These included ideas for my retirement accounts, but mostly my gambling account. Long term moves for the former, short term plays for the latter (and much smaller account). The original justification for moving away from providing specific trade advice was the discomfort of talking about investment ideas that I personally never followed through on. Going forward the plan is to only talk about specific actions I have taken within the investment accounts I am responsible for. And since I don’t really trade that often, we’ll also spend some time talking about the decision making processes that lead to what account adjustments are shared here.

Which brings Invest-Notes full circle. Originally I wanted to ensure that I could explain to myself what I was doing and why. This, in turn, allowed family and friends to have access to investment ideas beyond the popular press – for better or worse. You have been warned.

Now we’re coming up to the end of the first half of 2017. It has been a very profitable ride in most market sectors and the BIG question is can it continue. While I can’t answer that question, there’s a couple of ways to think about what to do next if, like me, you make quarterly purchases in retirement accounts.

So far in 2017 just ten stocks account for almost 50% of the gains in the S&P 500. Now, the S&P is “cap weighted” meaning that the more valuable a company is, the bigger proportion it occupies within the index. For example, Apple (AAPL) is the biggest company on earth, so it receives the largest “weighting” of the 500 stocks in the index. Currently, AAPL is over 3.5% of the total of the index. By contrast, Exxon is 1.5% of the index and Home Depot is less than 1%. If the index was not “cap weighted” then no stock would comprise more than 0.25% of index value. This simply means that when AAPL goes up or down it has a much bigger impact on the value of the index than other stocks. This is reflected in the price of S&P 500 exchange traded funds like VOO and SPY, two of the largest ETFs available.

To sum up the paragraph above, the top four holdings in the S&P 500 index are Apple, Microsoft, Amazon and Facebook. These four stocks account for 10% of the total value of the entire index. The S&P is up around 9% year-to-date, while the Dow Jones Index is only up about 7%. But then the DJI does not include Amazon or Facebook, both up about 35% so far this year. Now, at some point, the rocket ride will end. Maybe these four stocks simply quit shooting higher, or maybe they peak and their stock prices drop? Either way the impact on the S&P will be to deliver an underperformance with an outsized impact on the entire index.

Around the end of June, or first part of July, I’ll make an addition to my holdings of S&P 500 index funds in retirement accounts. That addition will be the Guggenheim S&P 500 Equal Weight ETF (RSP) where none of the 500 stocks makes up more than 0.25% of the total index value. When, not if, a market correction occurs, the high-flyers tend to fall furthest. Twenty-five percent of my retirement accounts are in VOO and RSP. While VOO is my largest single holding, RSP is quickly catching up.

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Through a glass, darkly

Recently accused of seeing the glass half-empty instead of half-full, I replied that the analogy was not a good one for the issue at hand. I couldn’t even find the glass being discussed and so really had no insight as to the contents. Similarly, the newest breed of ETFs (Exchange Traded Funds) have begun to look a lot like the mutual funds, and even hedge funds, they were supposed to replace. It isn’t that any particular ETF is good or bad, the question needs to be what is in the ETF.

We’re big fans of ETFs at Invest-Notes, and have been for several years. Yet what they originally were versus what many are becoming is a concern to be aware of. In a nutshell, an ETF is a portfolio of (usually) equities that matches a common benchmark. The most well-known example is the Dow Jones Index, a collection of the forty biggest and most recognizable companies in the United States. Another major index is the S&P 500 (the preferred proxy for the overall market here at Invest-Notes), which includes most of the Dow components and another 350, or so, companies meeting requirements about market capitalization and share price. The single biggest ETF is also one of the first, SPY, which mirrors the S&P 500 index.

So, it should be pretty straight forward. You purchase an ETF that holds the same stocks that are in the index. Because the fees for these funds are typically a fraction of the cost of similarly structured mutual funds, they provide a better return (or less loss of capital in down markets). Since equity markets have a long history of going up more than they go down over time (up 60% of the time, down 40%), investors see improved returns. Ideally, an investor decides where they are most comfortable – and suitably diversified – making regular contributions over time.

But there are now a lot of ETFs without indexes, holding low quality bonds, physical gold (bullion and coins) as well as foreign stocks and bonds from other countries. This helps explain the recent news about troubles at some new ETFs that invest in very small companies, assets that can be hard to sell, or even other tightly focused ETFs.

One particular story revolves around gold-focused ETFs finding it hard to invest all the money that had been pouring in as gold caught a bid this spring. Some funds were buying physical gold, but also small gold mining stocks and even other ETFs also holding the same assets. Needless to say, all the folks rushing into gold ETFs as they went up have recently tried to get out as the price moves the other way. This in turn has caused some serious gyrations in the market. Can a glass be half full of itself?

Now we have a simple idea – low cost funds tied to recognized benchmarks – being made more and more complex in order to attract buyers as well as providing excuses for additional layers of fees. And, much like the manipulation of home mortgages by investment banks that became gasoline fueling the financial meltdown of 2008-2009, there are now ETFs that have gone bad. Caveat emptor, indeed.

Yet there are a couple of simple solution. ETFs are not stocks to be bought and sold – they are intended to be long term holdings that increase wealth over time. Forget the idea of market timing in the ETF arena and avoid jumping on the hot play of the day. Both my kids both started IRAs last fall and asked for suggestions on how to get started. Again, I recommended keeping it simple:

An S&P 500 ETF – VOO (though I prefer RSP) = 50%

An all-world fund with no U.S. stocks – VUE = 25%

A small cap fund to counter-balance the large cap stocks that dominate the S&P – VBR = 25%

Last year a three-part series giving the history of ETFs and how they work was posted here on Invest-Notes. For those wanting more information:

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Heaven is not the day after tomorrow

During a recent conversation with fellow board members of a not-for-profit organization the topic of “unrealized” gains came up while reviewing financial statements. In discussing how this number (a big unrealized gain in 2016) was mostly irrelevant to our operating budget, it was interesting to see the different responses. It occurred to me that this topic is relevant to individual investors and complimentary to the last Invest-Notes post on calculating investment returns. When is a profit or a loss not really either one?

An unfortunately common story heard from investment managers is about the tendency for people to panic during market drops. The problem is multifaceted with otherwise sober investors suddenly trying to time the market, taking losses on stocks, giving up dividend income and often generating unnecessary tax bills. And when the panic ends? How to determine when to start purchasing equities again, yet another opportunity for market timing – an activity long demonstrated to be harmful for your portfolio.

Now this is not to say that an investor should never sell, just that any decision to make changes in the holdings of an IRA or other investment accounts should be done deliberately and with intention. Not during a time of emotional and financial stress. As the Boys from Bespoke pointed out recently (, highly recommended) eight years after the market crash of 2008-2009 only 16 of the stocks that were in the S&P 500 at that time are down. In contrast, 39 stocks in the S&P have seen gains of 1,000%, or more, over the same period.

So let’s do a thought experiment today. We’re going to look at a gold coin (let’s make it a one-ounce Gold American Eagle) and ten shares of Apple stock (AAPL). Let’s assume that these assets are in a retirement account that is unlikely to see any withdrawals for another decade. Today that gold coin is worth about $1,250, and the ten AAPL shares around $1,400. Now for the fun…

In 2015 that gold coin was worth $1,000, and in 2012 it was worth about $1,700. It is the same coin and has never been removed from the safe deposit box since 2006 when you originally purchased it. With a current value of $1,200, have you made $200 or lost $500? Yes, a trick question, since you paid $600 in 2006. Same with AAPL; in 2015 the shares were valued at about $1,000 and in 2012 they were worth $750. But in 2006 you paid $150 – yes, one hundred and fifty dollars for ten shares.

Until you sell an asset it is only worth whatever anyone will pay for it. Gold has demonstrated an ability over very, very long periods of time to be an asset that holds it value. Consider that Benjamin Franklin wrote that in his lifetime an ounce of gold would buy a very nice suit. And a bespoke suit can be had today for $1,250. As for AAPL, well, the first iPhone was sold in 2007 spurring a revolution in communication that led AAPL to become the most valuable company on the planet. But whether a share costs $12 or $140, it still represents only a miniscule ownership of a publicly held company, and a stake you have absolutely no control over in terms of pricing.

Successful investing is almost always a result of critical thinking (don’t panic as markets move dramatically up or down) and patience (it’s a marathon, not a sprint). Heaven is not the day after tomorrow.

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