This question comes from a friend of mine. An Average White Guy (AWG) who likes football, porno, books about war, and e-mail forwards that contain 643_fluffy_kittens.jpg. He dislikes mean things, the 2010 Philadelphia Flyers, and people who can’t wait to let you know what they know about “convertible arb hedge funds”.
Well my friend the answer you seek starts with a magnificent word called diversification. Diversification hides in the top of bell towers and straight ganks portfolio risk when it’s walking by. So it goes like this, consider you own one share in BLC (Big League Chew Inc) (ISBA: the 3 letter code there is called the “ticker symbol” or just the “ticker”. If this was too basic and you already knew that my apologies, don’t be a cock about it) and all of your money is invested in this one company because you think it’s gonna do just swell. So one day you wake up and you flick on Mildred’s Magical Morning Market Miasma to find out that it’s been discovered that the CEO of BLC has been funneling veritable oceans of company money into his crippling hooker and Faberge egg addiction for years and covering up the losses by claiming they were “loans” to a company he created called “I Hate Babies Inc.”. The stock tumbles 45%, your portfolio tumbles 45%, your retirement gets 45% lamer, and your kids resent you 45% more for having to support you in your old age. This is what’s referred to as (ISBA) “company specific risk”, “diversifiable risk”, or if you wanna super shield your ignorance “un-systematic risk”.
The idea behind diversification is to rid your portfolio of as much un-systematic risk as possible by spreading your money out over as wide a variety of investments as possible. BLC comes crashing down, that sucks, but you’re not gonna off yourself because its only 2% of your portfolio and FDP’s recent “I love babies” campaign was a huge success and they stomped Q2 earnings causing the stock to jump 6%. While this is happening your holdings in the tech sector have all taken off because the government has announced increased R&D tax breaks for these companies. So in the end your portfolio gains 1% through all of that, your retirement is now 1% better, you’re kids don’t turn bitter and stuff you in a home, and the world is all sunshine and boners once again. Now, some of you are saying “yea but if I only own one company and something awesome happens I can gain 45% in a day too!” Bro, investing isn’t a casino. Depending on how ballin, how old, how dependant you are on cash now (ISBA: your “liquidity” requirements), your ability to predict the market, amongst a bajill other things, you can juice up your risk a bit by picking higher volatility sectors or focusing more on a sector or two, but betting on one or two stocks is almost identical to lettin’er ride on black.
So you ask me “word son, but how do I get me some of this sweet sweet diversification in a cost effective manner?” The most basic way to diversify is to just buy a bunch of stocks of different companies in different industries and call it a day. However the problem with this is that unless you have a poopload of money and are investing big amounts you will be positively eaten alive by transaction costs. Transaction costs are the smelly mouth breather that drinks milk at parties of the investment world. Many an investment strategy that has looked amazing in theory has been completely de-railed by transaction costs. Transaction costs can range from about 10 bucks a trade at the dirt cheap places to upwards of 30 bucks a trade at your bank, so if you are investing 10 grand and trying to spread it out over say 10 companies (not very good diversification), a grand in each, and you are paying 20 bucks each trade, you are starting out at a -2% return already, laaaaaaaaame.
So the next option is mutual funds. Mutual funds essentially are a dude (a fund manager or manageress), deciding on a bunch of stocks to buy, and then selling you the ability to earn the return of those stocks combined….minus a tasty little bitch called the MER or management expense ratio. This is what mutual funds will charge you for the research, admin stuff, trading costs, blah blah blah and usually averages 2% annually. Mutual funds are all over the place with regards to content there are funds of small companies (ISBA: small market capitalization or small cap), which generally are higher risk higher return, funds of large stable companies with high dividends, international funds which seek to give you higher diversification than domestic only funds, etc, etc. So these little muffins give you better diversification, place your money in the hands of a professional, but still treat you like a piece of meat with holes with management fees.
A note on the “place your money in the hands of professionals” aspect of these funds…… It is the investment world’s filthy, trampy, slutty, whorish little secret that over the long term almost no mutual fund beats the market. That is, after transaction costs (remember our mouth breathing friend from above?) and management fees, almost no mutual fund will ever beat a passive (ie. Very minimal transaction costs, you buy’er and you hold’er type deal) index of stocks such as the S&P 500 (the main US index) or the S&P TSX (the main Canadian index) over more than a few years. Mutual fund companies will try and bamboozle you by cherry picking their best funds to present their results, or excluding funds that have folded due to poor performance in the past from their historical return (ISBA: this is known as selection bias). If you take anything away from this blog it is this: It is EXCEEDINGLY hard to beat the market over the long term. 95% of the people who say they can are lying to you, cheating somehow (see: Bernie Madoff), or exposing you to more risk than you are aware of. I’ll come back to this at some point in a later post.
So after that happy little thought, let’s move on to our next diversification option, my favourite; the exchange traded fund (ETF). ETFs are generally designed to mirror an index (like the S&P or TSX), a sector within an index, a commodity index (COMEX Gold index), a currency’s performance (CAD vs. USD), or even a bond index (more on bonds later). There are even ETFs that are designed to double or triple the index return (ie. The S&P goes up 2% in a day the double leveraged ETF goes up 4%), but these are poorly designed and should only used very short term by experienced peoples. ETFs are similar to mutual funds except that they actually trade on a stock exchange like the New York Stock Exchange or the Toronto Stock Exchange, have their very own little ticker guy, and aren't trying to treat your money like a red headed step child. They are designed to mirror an index period. There is still a little bit of an expense ratio, but it is for rebalancing and other admin stuff and usually in the 0.3% range, well short of a mutual fund. This, my friends, is your way to maximize your diversification while minimizing lubeless monetary sexual harassment fees.
Feel free to fire me other questions or post stuff in the comments below. I wanna know what YOU want to learn about….then insert some fart jokes in there and go to town!
Tuesday, August 31, 2010
Thursday, August 12, 2010
I was trying to figure out how to work the word "pimp" into inflation but like "pimpflation" wasn't really conveying the desired message. Anyways...
Inflation:
- Your understanding of it: “Grandpa’s old timey whiskey cost a nickel back durin’ the quaint ole war times and now it costs 54 bucks for a handle, it’s where shit gets more expensive and it’s solidly in the lame column”
- The verdict: You’re right.... sort of. A low and predictable level of inflation is generally regarded as a good thing. The biggest thing is the predictability of it, as long as everyone knows that a buck will buy 3% less Big League Chew in one year (ie. It costs 3% more because of a 3% annual inflation), job markets will adjust to pay higher wages, and everyone can keep right on chewin’ the shit outta that shit. (ISBA: “purchasing power” is how much Chew you can hook up on your income. If the price of Chew increases more than expected due to inflation and your wages don't adjust upwards enough you can say that your “purchasing power eroded”. Boo ya.). Canada and the US generally opt for a target of between 1-3% annual inflation.
- Excess inflation (see Zimbabwe now or Germany post WW1) swallows for several reasons; In an environment where the value of a dollar changes foolishly on a daily basis no one will save money because what can buy a crate of big league chew today will likely only be able to buy a single sack of deliciousness tomorrow and then a friggin’ crusty-ass bazooka Joe the next day, where’s the incentive? So as you are watching your “purchasing power” (eh? EH?) have its fingertips fed to wolverines what do you do? You consume, you buy everything you can and then when you can’t buy anything else you borrow money to buy some more stuff. You borrow content in the knowledge that when your debt actually comes due guess what because the value of money is now so low the amount you owe is practically rien (that’s French for nothing). So now you have a ton of people out there frantically trying to buy as much shit as they can before their money becomes more worthless than reality TV stars. What does this do? Well if a store has one fountain Dr. Pepper left and everyone is in a tizzy to get it what will happen? Demand will rise...again which causes Prices to rise... again... your purchasing power gets effed... again and it’s a vicious cycle. Essentially, in an environment like this money loses all its perceived value and the economy reverts back to the barter system (“I give you 5 breads for sheep?”). Wages will increase of course to try and maintain your purchasing power, but imagine a situation where prices are 10X higher every time you go to the store and having to negotiate a new salary every day pretty much? Completely non functional.
- Now what causes this excess inflation you ask? There are a variety of things that can trigger it, but it comes down to one root cause: a big ole increase in the supply of money floating around without a corresponding increase in goods and services to spend it on. The usual way the money supply is increased is the government, looking like the poor version of the monopoly guy, starts juicin’ up the printing presses and goin’ to town making money to pay for its expenditures. Think of it like this, all the goods in a country are puppies and the only thing people in that country want are two fluffy puppies named Napkin and Tippy Toes Mcwhispersons. If this country has a population of 2, there are two puppies available, and the GDP of this country is 6 dollars then each puppy will have a value of 3 dollars. Now say the government prints 6 more dollars, now there are 12 dollars chasing the same two puppies and their value is now 6 each without any actual change in the underlying puppy!
- An example of this (sans puppies) is Weimar Republic Germany in the 1920s. The treaty of Versailles, signed at the conclusion of WW1, saddled the Germans with a truly butthole expanding amount of “reparation” debt that the Germans, with much of their industrial land looking like the plains of Mordor from the fighting, had no chance of paying back. So one day, in an incredible simplification of a combination of complex economic effects, the Kaiser was chillin’ and in between bites of saurkraut or whatever goes “Sheisse la merde shit (he was pretty good at languages), we getting jooked here! We ain’t got no chedda’! (he was pretty hood too).” So he goes to his boy the Commish of the Reichsbank, who was eating a sausage on his printing press and says “yo! juice that fucker up lets print some billz.” At June 20, 1921 the Mark was fairly stable at about 60 Marks to 1 USD, by November the Mark had fallen to 330:1 with the USD, by December, after international talks to try and solve this inflation issue broke down, the mark had fallen to 8000:1. In January 1923, Belgian and French governments exclaimed “chazbut..... we’re getting hosed here fellas” and sent in troops to the Ruhr valley to ensure that the reparation debts would be paid in hard goods. So the German workers went on strike and appealed to the Kaiser for help... and help he did...how you ask? “JUICE THAT FUCKER UP HIGHER BOYS!! YEEHAW!”. Inflation, being a vicious cycle already, peaked in November 1923 when one US dollar was worth approximately 4 trillion marks. At one point prices were doubling every single friggin day, one firm who was helping out in printing these notes submitted a bill to the Reichsbank for 32,776,899,763,734,490,417.05. Yea that’s 33 quintillion marks, no big deal. Anyways, this wild nonsense was finally stopped when the bank stopped production of the old Marks, lopped 12 zeros off the new ones, and essentially proclaimed that each note was tied to a certain percentage of hard assets (agricultural land or industrial assets) so thats its value wasn't debateable, but fixed. So needless to say the government was interested in blaming absolutely anyone but itself, one popular target: local bankers and speculators who were... you guessed it primarily Jewish. Though the Weimar republic would persist for another 10 years of so past this period, this event was credited as one of the early contributors to Hitlers eventual takeover of Germany.
- Your understanding of it: “Grandpa’s old timey whiskey cost a nickel back durin’ the quaint ole war times and now it costs 54 bucks for a handle, it’s where shit gets more expensive and it’s solidly in the lame column”
- The verdict: You’re right.... sort of. A low and predictable level of inflation is generally regarded as a good thing. The biggest thing is the predictability of it, as long as everyone knows that a buck will buy 3% less Big League Chew in one year (ie. It costs 3% more because of a 3% annual inflation), job markets will adjust to pay higher wages, and everyone can keep right on chewin’ the shit outta that shit. (ISBA: “purchasing power” is how much Chew you can hook up on your income. If the price of Chew increases more than expected due to inflation and your wages don't adjust upwards enough you can say that your “purchasing power eroded”. Boo ya.). Canada and the US generally opt for a target of between 1-3% annual inflation.
- Excess inflation (see Zimbabwe now or Germany post WW1) swallows for several reasons; In an environment where the value of a dollar changes foolishly on a daily basis no one will save money because what can buy a crate of big league chew today will likely only be able to buy a single sack of deliciousness tomorrow and then a friggin’ crusty-ass bazooka Joe the next day, where’s the incentive? So as you are watching your “purchasing power” (eh? EH?) have its fingertips fed to wolverines what do you do? You consume, you buy everything you can and then when you can’t buy anything else you borrow money to buy some more stuff. You borrow content in the knowledge that when your debt actually comes due guess what because the value of money is now so low the amount you owe is practically rien (that’s French for nothing). So now you have a ton of people out there frantically trying to buy as much shit as they can before their money becomes more worthless than reality TV stars. What does this do? Well if a store has one fountain Dr. Pepper left and everyone is in a tizzy to get it what will happen? Demand will rise...again which causes Prices to rise... again... your purchasing power gets effed... again and it’s a vicious cycle. Essentially, in an environment like this money loses all its perceived value and the economy reverts back to the barter system (“I give you 5 breads for sheep?”). Wages will increase of course to try and maintain your purchasing power, but imagine a situation where prices are 10X higher every time you go to the store and having to negotiate a new salary every day pretty much? Completely non functional.
- Now what causes this excess inflation you ask? There are a variety of things that can trigger it, but it comes down to one root cause: a big ole increase in the supply of money floating around without a corresponding increase in goods and services to spend it on. The usual way the money supply is increased is the government, looking like the poor version of the monopoly guy, starts juicin’ up the printing presses and goin’ to town making money to pay for its expenditures. Think of it like this, all the goods in a country are puppies and the only thing people in that country want are two fluffy puppies named Napkin and Tippy Toes Mcwhispersons. If this country has a population of 2, there are two puppies available, and the GDP of this country is 6 dollars then each puppy will have a value of 3 dollars. Now say the government prints 6 more dollars, now there are 12 dollars chasing the same two puppies and their value is now 6 each without any actual change in the underlying puppy!
- An example of this (sans puppies) is Weimar Republic Germany in the 1920s. The treaty of Versailles, signed at the conclusion of WW1, saddled the Germans with a truly butthole expanding amount of “reparation” debt that the Germans, with much of their industrial land looking like the plains of Mordor from the fighting, had no chance of paying back. So one day, in an incredible simplification of a combination of complex economic effects, the Kaiser was chillin’ and in between bites of saurkraut or whatever goes “Sheisse la merde shit (he was pretty good at languages), we getting jooked here! We ain’t got no chedda’! (he was pretty hood too).” So he goes to his boy the Commish of the Reichsbank, who was eating a sausage on his printing press and says “yo! juice that fucker up lets print some billz.” At June 20, 1921 the Mark was fairly stable at about 60 Marks to 1 USD, by November the Mark had fallen to 330:1 with the USD, by December, after international talks to try and solve this inflation issue broke down, the mark had fallen to 8000:1. In January 1923, Belgian and French governments exclaimed “chazbut..... we’re getting hosed here fellas” and sent in troops to the Ruhr valley to ensure that the reparation debts would be paid in hard goods. So the German workers went on strike and appealed to the Kaiser for help... and help he did...how you ask? “JUICE THAT FUCKER UP HIGHER BOYS!! YEEHAW!”. Inflation, being a vicious cycle already, peaked in November 1923 when one US dollar was worth approximately 4 trillion marks. At one point prices were doubling every single friggin day, one firm who was helping out in printing these notes submitted a bill to the Reichsbank for 32,776,899,763,734,490,417.05. Yea that’s 33 quintillion marks, no big deal. Anyways, this wild nonsense was finally stopped when the bank stopped production of the old Marks, lopped 12 zeros off the new ones, and essentially proclaimed that each note was tied to a certain percentage of hard assets (agricultural land or industrial assets) so thats its value wasn't debateable, but fixed. So needless to say the government was interested in blaming absolutely anyone but itself, one popular target: local bankers and speculators who were... you guessed it primarily Jewish. Though the Weimar republic would persist for another 10 years of so past this period, this event was credited as one of the early contributors to Hitlers eventual takeover of Germany.
More necessary than Mr. at the start of a pet name
This blog is not designed to be a comprehensive financial education, it is not designed to try to explain to you the difference between a straddle and a strangle option strategy or to allow you to thrust your massive finance boner into the sweet sweet nether regions of lady ignorance. It is designed to serve as a crutch for whenever someone expounds that "the fed cut rates again today, anyone who is long the US dollar should be having terror poos right now" you can offer something up to the conversation instead of "yeaaaa.... tooooootally" and watching as the new intern spouts something about "the Fed sacrificing the dollar like a virgin in Tenochtitlan" to raucous laughter and admiring glances.
This blog is aimed at a wide multitude of demographics and stereotypes: the graduated fraternity gentlemen who can no longer solely rely on rakish charm, boyish good looks, or a money beirut shot to get by in social situations. Let's face it, college is the tits and you need nothing more than the ability to binge drink enough for a small island nation and a wide array of boner synonyms to succeed but, come on Peter Pan, everyone has to grow up at some point. It’s aimed at middle aged people with kids who needs ways to explain stuff to their teenagers without resorting to a poor choice of props (that picture of Grandma and the frog fetus in a jar? Common man) and still like to titter girlishly at weiner jokes. It’s aimed at the the hipster, whose usual currency is irony, but also needs to simultaneously understand how to maximize his/her neon wayfarer consumption. It's aimed at human resource graduate girls who can absolutely still rely on a big bountiful heaving mass of boobage all mashed together to.... get.... but..... what?..... uhhhhh you can read it too! Most importantly, it's aimed at anyone who’s had the realization that the force that simultaneously holds the world together and tears it apart is finance and economics and its time you had more knowledge about it than that talking condom mug you're drinking out of right now.
A few things for you my friends to get your minds around:
- Over the course of this blog I will use a buttload of examples because it’s the easiest way to explain shit. The real world is complicated and filled with things that are shiny and distracting so for the purpose of your sanity my examples will assume a world that consists solely of two simple delicious commodities; Big League Chew and fountain Dr. Pepper, other details will be added as necessary.
- You know what shields ignorance like nothing else (except boobs THEY shield ignorance like nothing else, but aside from those)? Motherfucking buzzwords. A well dropped and appropriately used buzzword ratchets up your finance street cred immeasurably. So as I’m droppin’ hot knowledge on you I’ll make sure to point out gangster buzzwords with an Ignorance Shielding Buzzword Alert (ISBA). Write a few of these down and you can add some hood-ass rings to Adam Smith’s invisible hand (you’ll get that joke later, or go google it now... I’ll wait.)
This blog is aimed at a wide multitude of demographics and stereotypes: the graduated fraternity gentlemen who can no longer solely rely on rakish charm, boyish good looks, or a money beirut shot to get by in social situations. Let's face it, college is the tits and you need nothing more than the ability to binge drink enough for a small island nation and a wide array of boner synonyms to succeed but, come on Peter Pan, everyone has to grow up at some point. It’s aimed at middle aged people with kids who needs ways to explain stuff to their teenagers without resorting to a poor choice of props (that picture of Grandma and the frog fetus in a jar? Common man) and still like to titter girlishly at weiner jokes. It’s aimed at the the hipster, whose usual currency is irony, but also needs to simultaneously understand how to maximize his/her neon wayfarer consumption. It's aimed at human resource graduate girls who can absolutely still rely on a big bountiful heaving mass of boobage all mashed together to.... get.... but..... what?..... uhhhhh you can read it too! Most importantly, it's aimed at anyone who’s had the realization that the force that simultaneously holds the world together and tears it apart is finance and economics and its time you had more knowledge about it than that talking condom mug you're drinking out of right now.
A few things for you my friends to get your minds around:
- Over the course of this blog I will use a buttload of examples because it’s the easiest way to explain shit. The real world is complicated and filled with things that are shiny and distracting so for the purpose of your sanity my examples will assume a world that consists solely of two simple delicious commodities; Big League Chew and fountain Dr. Pepper, other details will be added as necessary.
- You know what shields ignorance like nothing else (except boobs THEY shield ignorance like nothing else, but aside from those)? Motherfucking buzzwords. A well dropped and appropriately used buzzword ratchets up your finance street cred immeasurably. So as I’m droppin’ hot knowledge on you I’ll make sure to point out gangster buzzwords with an Ignorance Shielding Buzzword Alert (ISBA). Write a few of these down and you can add some hood-ass rings to Adam Smith’s invisible hand (you’ll get that joke later, or go google it now... I’ll wait.)
Subscribe to:
Posts (Atom)