Traditional vs. Roth IRA

Aside from company sponsored 401(k) plans, investors can use either traditional or Roth IRAs to invest for retirement.investors. In a more recent development, companies have also begun offering the choice between traditional or Roth 401(k)s. So, it is important to understand the relative advantages of each type of account. See a good summary article here, WSJ.

More Evidence for Efficient Markets

The market's performance this year has surpassed that of most professional money managers. In fact, this is the worst (relative) year in three decades for professionals (see post here, The Reformed Broker). The level of competition and the high level of fees prevent meaningful outperformance. The result -- a large influx of capital into index funds.

Fee Based Compensation Aligns Interests

Retail financial professionals have increasingly moved away from commissions and to a standard fee-based structure. This change should better align the interests of clients and advisors. For example, there is less incentive to trade. Moreover, there is little need for advisors to select funds that charge a high load, as their compensation no longer depends on the "kickback" received from the fund companies. As a result, the fund flow to high load funds has turned negative. See article here, Investment News.

2015 Macro Trends

While it is still early, Goldman Sachs has posted its 10 market themes for 2015. These may be useful in top-down analysis. See article here, Barrons.

Short Term Market Indicators

For those interested in technical analysis, some traders are suggesting that the market is set for a pull back. See article and video here, Yahoo.

S&P Breaks Key Tecnical Mark

The S&P fell below its 200-day moving average, a key negative technical indicator. Investors should pay close attention to see if this level holds. See article here, yahoo.

Alibaba IPO

Most firms that undertake an IPO subject insiders (founders, initial investors, etc.) to a lockup period of, typically, 180 days. For Alibaba, this is not the case, which suggests that many additional shares could hit the market immediately after the IPO. This may mute the initial return that new shareholders could receive. See article here, WSJ.

Update: Even with insiders selling shares, the Alibaba IPO was well subscribed, generating a 38% return on the first day. Moreover, with additional shares sold (i.e., the overallotment option), the Alibaba IPO is reportedly the biggest IPO in history, raising $25 billion. See article here, Reuters.

Fund Manager Performance

Fund managers, on average, have historically trailed the broad market. However, this year has been exceptionally bad for managers, with only 23% of large-cap funds outperforming the index. See this article (WSJ) for some explanation from Goldman Sachs.

The Future of the NYSE

Watch this video to discuss the sustainability of the iconic NYSE.

Facebook Options and IPO Expiration

After a company goes public, inside investors must hold stock until after the "Lockup Expiration." Research suggests that prices fall around this event, and investors are using options to try to benefit from this phenomenon. Watch a related video here, WSJ.

Active Managers vs. Index Funds

Watch this video to facilitate discussion about active vs. passive investing, as it reviews the large amount of money being invested with Vanguard.

ETFs that "Mimic" Buffet

Watch this video to facilitate discussion about ETFs that use criteria similar to those applied by Warren Buffet.

Diversification Revisited

Asset allocation is widely considered to carry the most weight in determining a portfolio's overall return, but we often avoid/ignore many categories that could be helpful. See article here for a discussion of why diversification matters, Fidelity.

On the contrary, though, some analysts believe too much diversification is not a good thing. See article here (WSJ) to help answer the question, "How Much Diversification Is Too Much?"

All-Time Market Highs and Market Timing

With the market at all-time highs, many investors are left wondering if stocks are still attractive investments. Based on PE ratios, the market's current level of 17.5 if slightly above the historical average, but not excessively so. Thus, if corporate profits remain strong, valuations could remain stable (so says some analysts). See article and video here, Fidelity. The video also discusses the difficulty of market timing, which is a good reminder for most investors.

Vanguard vs. the Industry

For years, Jack Bogle (the founder of Vanguard) has touted the benefit of passive investing, which is primarily driven by the relatively low fees they charge. Moreover,  Bogle has highlighted the inability of active investors to outperform the market. Recent large investor flows into Vanguard products suggests that investors are increasingly agreeing with Bogle. See article here, WSJ.

Time to Sell?

For technical traders, it may be time to sell. While the market has yet to make a "death cross," some other indicators are saying sell. In particular, a recent WSJ article identified three signals that recently occurred in tandem: overvaluation based on earnings multiples, extreme divergence in sector performance, and excessive levels of bullish enthusiasm. This combination has occurred six times since 1970, with each event resulting in market drops of at least 22%. Will this happen again?

Do Women Generate Better Returns?

Some prior research suggests that women make for better investors, primarily because they generally trade less than men (meaning lower transaction costs). However, a new fund aims to exploit the benefit women may provide as board members. The Barclays Women in Leadership ETN will invest in companies with a female CEO or a board that has a membership of at least 25% women. See here for an article that discusses the new fund (WSJ).

See previous post (ETFs vs. ETNs) for a discussion of the fund structure.

Going Global

For diversification reasons, most investors should consider investing internationally. However, many investors have limited knowledge about how to do so or about how to determine how much exposure to have internationally. Click here for a recent WSJ article that provides some guidance on these issues.

Catastrophe Bonds

Bonds are typically viewed as very conservative investments with relatively simple terms. However, the industry is quite complicated and offers some higher risk securities. For example, catastrophe bonds (or "cat-bonds") have normal cash repayments to lenders, except if a pre-defined catastrophe (hurricane, wildfire, earthquake, etc.) occurs. In this event, all bond cash flows cease. For obvious reasons, these are popular among issuers in the insurance industry, and the primary buyers are hedge funds (primarily due to the higher risk/return profile such bonds offer). See a related article here, Bloomberg.

ROE and Leverage

Return on equity (ROE) can be decomposed into three pieces, the so-called DuPont Identity: Net profit margin, total asset turnover, and the equity multiplier. The equity multiplier is a measure of leverage, so firms that add financial leverage (i.e., debt) to their balance sheet can increase ROE, as long as the product of the other two factors (i.e.,  return on assets) is positive. In the standard growth model for pricing stocks, this would generally have a positive impact on stock price, but note that it does add risk to the potential outcome, i.e., leverage. See article here, The Economist.

Triple Crown and the Stock Market

The "Super Bowl Indicator" is widely known, as the winner of the Super Bowl has been correlated to overall stock market performance. While this does not imply causation, is does make for an interesting discussion of market efficiency. A similar item is the performance of the stock market in years when a horse wins the Triple Crown--the results are not good. So, many people may be watching how California Chrome does in the upcoming Belmont Stakes. See article here, WSJ.

Fees Matter

A 1% annual fee doesn't sound like much, but when compounded, fees paid to advisors and managers can have a significant impact on an investor's ending portfolio value. For example, consider two investors who each invest $200,000 and earn 8%/year (before fees) for 30 years. The first investor uses an ETF that charges 0.04%/year in fees, while the second investor uses a mutual fund charging 1.25%/year. The first investor ends with roughly $2 million, while the second nets about $1.4 million. The difference is purely driven by fees -- this is a huge cost. (See article here, Wall Street Journal.)

Apple Issues Debt to Buyback Stock

Apple has $150 Billion in cash, yet it has decided to issue $17 Billion in new debt to fund its stock repurchases. Why not just use cash on hand? One reason is that almost 90% of the cash is held outside the US, and repatriating the cash would trigger significant tax liabilities. Another reason is that interest rates are so low, and if Apple can earn a higher return than the cost, the added financial leverage will be a benefit to shareholders. (See article here, CNBC.)

All Earnings Are Not the Same

Two companies in the same industry with the same earnings per share (EPS) may be quite different, particularly depending on how they report their earnings. For example, companies can choose different depreciation methods (e.g., straightline, accelerated, etc.) and inventory accounting approaches (e.g., LIFO, FIFO, etc.). However, while these choices all fall within generally accepted accounting principles (GAAP) and are relatively easy to reconcile, business also have many choices with regard to reported adjustments to earnings, which are more opaque. Click here for a recent article discussing the discrepancies.

How Many Stocks Are in the S&P500?

Traditionally, the answer is 500, as the index was constructed using the 500 largest companies. However, Google's upcoming stock dividend will change all this. As of April 3, 2014, Google is undergoing a 2:1 split via a stock dividend, as owners of record will receive an additional share -- but of a different nonvoting class stock. This means that there will be two Google share classes being traded. To keep the value in place, the S&P will retain both share classes, meaning there will now be 501 stocks in the S&P500. See article and related video here, CNBC.

The Benefit of Financial Advisors

Many individual investors believe that the primary role of a financial advisor is to "pick stocks." However, research shows that not only are active managers not able to outperform the market consistently, but that the security selection piece is really not the most important determinant of portfolio return. The key issue is asset allocation. A recent report (see article here, InvestmentNews) suggests that financial advisors can add value, but primarily from activities unrelated to security selection: determining asset allocation, helping clients avoid behavioral errors, facilitating rebalancing, reducing fees, and managing taxes and withdrawals.

High Frequency Trading and Market Efficiency

Arbitrage is, essentially, taking advantage of mispricing across (or within) markets to earn a risk-free profit. In an efficient market, such opportunities would be rare. A recent Fed report (see article here, Bloomberg) finds that high frequency traders have effectively reduced the number of arbitrage opportunities, thereby improving market efficiency.

Active vs. Passive

Market efficiency suggests that passive funds are the way to go, and average returns tend to support this. However, other investors prefer active strategies. Maybe the answer is not "either....or." As a recent Wall Street Journal article reports, both may provide benefits. See article here.

Technical Analysis

While many investors (particularly those who subscribe to market efficiency) suggest that technical analysis is worthless, market participants still generally track charts, including resistance and support levels, as well as moving averages. With the market recently testing its support and bouncing to higher levels, technical analysts will continue to monitor charts to see if the positive momentum can continue. See article here, Reuters.

Levered ETFs

Levered ETFs are designed to track a particular benchmark, but in an exaggerated fashion. For example, the Pro Shares Ultra S&P500 (SS0) is a 2X fund, meaning its performance should be twice the level of the index. However, this performance only matches short term. In particular, since volatility reduces compounded returns, levered funds "lose" performance through time. In fact, some funds may actually produce a negative buy-and-hold return during even if the underlying benchmark was positive. Unfortunately, many retail investors are flocking to these funds without understanding their risks. (See article here, Reuters.)

Asset Allocation, Risk Tolerance and Shortfall Risk

Asset allocation is the biggest driver of portfolio performance, particularly over the long-term. Moreover, it also is reflective of an investor's risk tolerance. The recent financial crisis has negatively impacted investment psychology, particularly among younger investors. As a result, the so-called "Generation-Y" has over half of their assets held in cash -- a "non-earning" asset. While this is safe, there is a risk of loss in value, as cash does not even hold up with inflation. In the long-term, such an allocation means a lower retirement balance--i.e., shortfall risk. Thus, these investors have essentially traded one type of risk for another. See article here, Investment News.

Volatility and Derivatives

There are six primary inputs used to determine the price of a stock option: underlying stock price, exercise price, time to expiration, volatility of the underlying stock's price, market interest rate, and dividend yield on the underlying stock. Each has a particular relation to option value. For example, as stock price increases, the value of a call would increase, while the value of a put would decrease. For volatility, an increase in volatility has a positive impact on the value of both puts and calls, since payoffs are asymmetric. That is, no matter how low the stock's price goes, all an investor can lose is the premium. Last year market volatility was low. This led to a good year for equities, but the derivative market lagged as a result of the lower volatility. See article here, The Trade News.

Rising Interest Rates

Interest rates have remained at historically low levels since 2008; however, with the recovering economy and the prospect of the Fed reducing its intervention, it is likely that interest rates will rise. Such a move will reduce bond prices, particularly longer-term bonds, so what asset classes should investors consider? A recent Wall Street Journal article suggests that certain equity sectors (e.g., energy, financials, and consumer discretionary) tend to perform well (at least relatively) in such environments. See article here.

The Wolf of Wall Street

With the recently released movie (The Wolf of Wall Street), the fraudulent activities of the IPO underwriting firm Stratton Oakmont have come back into public view. For a detailed review of how the fraud took place, see here (Wall Street Journal).