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22
Jul

You Make Your Money When You Buy, Not When You Sell.

Posted by on in Investments

In most conversations with new clients or prospective clients the subject of performance invariably arises. Whether it's related to the prospects for income generation or the comparison of one investment to another, the return that can be expected on a portfolio is among the top concerns for individuals. Most people want an idea of what their money will earn in income as well as the prospects for increases in asset values. It's very easy to look up returns on mutual funds and indexes and use them as a base for comparison. The problem with comparing performance numbers to an index, or to some other investment vehicle, is the timing of the asset purchase, whatever it might be.b2ap3_thumbnail_chasing-the-markets-1241622.jpg

You can easily compare the performance of any stock, ETF, mutual fund or securities portfolio to the S&P 500 Index. The issue remains that you can't actually buy the index. You can buy a proxy for it like the Vanguard 500 Index fund. This is not the same thing.  Let's say the S&P 500 Index goes up 10% year-to-date.  This means since January 1st (actually January 2nd since the first is always New Year's holiday) the index is up 10% and this assumes you bought it on January 1st. If you don't sell you haven't actually made anything except for a return on paper. If you bought the index at any other time other than January 1st the year-to-date return has no significance to you.  Most people comparing performance numbers just don't think about it in this way.

Let's use an easy example to show exactly what I mean. On January 2nd you invest $1,000 in a stock mutual fund. On July 1st we compare the performance of the mutual fund you purchased to the S&P 500 Index. The index is up 10% year-to-date and your stock mutual fund is up 11% year-to-date. This is very simple to compare because it's obvious your mutual fund beat the index return by 1%. What made this an easy comparison was the starting date.

Now let's use a different entry point for your mutual fund purchase. Let's assume you invested the $1,000 in the stock mutual fund on December 1st of the previous year. Now on July 1st when we review the year-to-date performance, the S&P 500 Index is still up the same exact 10%. Your stock mutual fund is still up the same 11% year-to-date. Your stock mutual fund did, in fact, outperform the index for the year-to-date period. Since you did not buy the stock mutual fund on January 1st makes this comparison irrelevant for two reasons: you don't have a common purchase date and you didn't sell on July 1st. What if the $1,000 that you invested on the previous December 1st was actually worth $970 on December 31st (assuming the stock mutual fund declined 3% during the month of December)?

Yes the year-to-date return on that July 1st is still up 10% on the index and on the stock mutual fund. The index went up 10% during those six months and so did your mutual fund. The value of the index (if you could have purchased it) would be $1,100 on July 1st and the value of your mutual fund would be $1,067. Do you still believe that the performance of the index for the year-to-date period has as much significance to your situation?

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14
Nov

A Rising Tide Lifts All Boats…(But It Doesn't Mean They Are All Seaworthy!)

Posted by on in Investments

We have all heard the saying. There is some truth to the idea that when the economy is doing very well most of the people benefit in some way to some degree. This doesn't mean that all people benefit equally or even proportionately. Even when things are going very well there are bumps in the road or waves on the ocean. We need to remember that if the economy is doing well it indicates that the country as a whole is doing well based on averages. Anytime you average any numbers, you’ll come up with an average for the set but it will also have a median. Averages can be misleading; the median tells you that half the numbers are lower and the other half of the numbers are higher. The median acts as your center point or your balancing point. Why is this important?

b2ap3_thumbnail_boats-port.jpgIt is important because if you only look at averages you will be missing a great deal of the statistical information that is available to you no matter what the subject matter is. You could be researching investments or you could be researching Fantasy Football or Fantasy Baseball players. Let’s say a baseball player had a batting average of .302 the previous season. Most people would say he hit 302 but it is actually .302 which represents the average of all his visits to the plate. If he steps in the batter’s box 1,000 times he’ll get 302 hits. Let’s make this simpler and say for every 10 at-bats he’ll get about 3 hits. Here’s a very important question: Can you deduce from this batting average that this ballplayer will get a hit for each of his next 3-at-bats if he has not had a hit his last 7 trips to the plate? No!

Where are we going with this? If the S&P 500 Index has gone up an average of 14% in the previous 20 years does this mean it will go up about 14% this year or next year? No! We put too much emphasis on the average and we don’t look deeper. There are 500 stocks in the S&P 500 Index. If the Index climbs 14% in one year does this mean that every individual stock in the index climbed exactly 14%? No! One stock might have risen 80%, another 40%, another 10%, and another 1% while several others could have had negative returns yet the index climbed an “average” of 14%. Would you rather invest in the index and take the average of 14% or would you rather invest in the individual stocks that returned 80% and 40%? What about when the index is negative? Does this mean every individual stock had a negative return in that year? No! Would you want to invest in the index knowing it would return a negative average for the year?

The best investments are those which can stand on their own no matter what the overall economy is doing, and no matter if the tide is going in or out. Over time I have slowly shifted my thinking away from indexes and geographical investments. I learned the hard way that just because there were compelling reasons why the Brazilian economy should perform strongly the last few years leading up to the Olympics and World Cup, it doesn't mean that a Brazilian ETF will realize a great return. China may have a bright future but it doesn't mean you should invest in an ETF that invests solely in China. It would be wiser to invest in individual solid companies which would benefit from a more successful Chinese economy.

You might believe that a collection might be a wise long-term investment; there are many physical items that you could choose to collect such as cars, coins, stamps, paintings, sculptures, etc. Would a Yugo command the same return over time as a Ferrari? No chance! So you would invest in a “collection” or “index” of cars if you knew they could own Yugos, AMC Pacers and Pontiac Azteks? Research is key to making sound decisions no matter the subject matter. Asking the right questions and seeking the necessary information is critical to success. The next time you hear or read that this is the perfect time to make some investment ask yourself all the prerequisite questions. If investing were so easy we would all own some index funds and there would be no advisers, wealth managers or hedge fund managers.

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31
Oct

The Twitter IPO Is Almost Here

Posted by on in Investments

Happy Halloween! It’s almost November and the Twitter initial public offering (IPO) is almost upon us.  Twitter will trade under the symbol TWTR on the New York Stock Exchange (NYSE). Many investors have been looking forward to the Twitter IPO because they believe the stock may “pop” (go up significantly) on the opening day of trading. Some people will sell and take a quick profit if the stocks really moves.  Some people might want to sell but can’t because of regulatory restrictions on their stock. Most people will buy the stock at the inflated price on opening day and hold on to it. Of course this all assumes that TWTR is priced correctly and trades far higher than its initial offering price. We all know you can’t assume anything with IPOs or with stocks in general.

The New York Stock Exchange has been preparing and testing their systems to avoid another fiasco like the one with the Facebook (FB) IPO in May 2012. Maybe Twitter management chose the NYSE over the NASDAQ market because of the fear of having similar problems. We’ll soon know how smoothly the IPO process goes for Twitter as well as the NYSE and we’ll know how accurately the shares of TWTR were priced. Twitter seems to have good IPO buzz because it is a micro blogging site where users can posts short messages (140 characters) about any subject they like and share it instantly with the world. The world is abuzz about Twitter and its new shiny stock.b2ap3_thumbnail_tweetie-me.jpg

Should we really be this interested in a Twitter IPO? Can TWTR live up to the hype? Will TWTR continue to do well after the initial day of trading or will it fall to a normal trading level and just stay there? No one really knows. I’m not so sure Twitter should be a stand-alone company, never mind going public. Yes more than 200 million people use Twitter on a regular basis and I am one of them (@PJSacchetta). There is no charge to register for a Twitter account and there is no charge to use the service. As far as I know they are not planning to charge users any fees. They plan to make money from sponsored tweets; a tweet is what they call a 140-character message that users post on Twitter. Sponsored tweets are just another way of saying paid tweets or just plain ole advertising.

Most people have liked Twitter from the start because they could rely on real people tweeting real information in real time without any funnel or editing. Breaking news has been posted on Twitter before any other media source. All kinds of important information has been posted on Twitter and then re-tweeted or shared through many other media outlets and sites. You can tweet from a computer, tablet or mobile phone. It’s quick, easy and convenient for most people. This is why I think that monetizing Twitter may not work well enough to justify a stand-alone public company. Will many people get turned off by seeing more advertisements? Will Twitter become just another site with tons of ads?

Sometimes we need to assess the facts as they are and not as we would like them to be or become. I’m sure the founders, management and early investors (venture capital) want to become super rich with their publicly traded stock or cash out. This is the American way. They have every right to list their IPO and take their chances. The question remains “is this the best course of action for the company”? Based on the mass of users who pay nothing to use the service and expect unfiltered tweets to be posted instantly, is there really a business model that can sustain long-term independent success?

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25
Oct

Others Ask If This Is A Great Investment; I Ask Is This A Great Investment Now?

Posted by on in Investments

After hearing the current events of the past week in the financial field it made me wonder if most people understand the concept of when profits are made with any form of investment. We saw stocks like Google, Amazon and Microsoft do very well after announcing quarterly results. Google (GOOG) shot up 14% in one day (Oct 18th) to close over $1,000 for the first time. The market value increase in Google stock in one day was greater than the total market value of most publicly traded companies. What changed from one day to the next that investors quickly decided that Google should be worth 14% more that day? Was Google stock really worth that much less only two days prior?

This question is at the heart of understanding what makes Wall Street tick. One would imagine that folks who invest money professionally do so in an unemotional way and only focus on facts and figures. If this were true, how do you explain a stock moving 14% in one day? Many stocks don’t move that much in months or a year. Is it possible that these professionals had no idea that Google would announce the numbers they did? Emotion made people take profits and other people jump on the bandwagon. Gordon Gecko would call it greed. There is only one way for you to have made a 14% profit on Google stock on that day…you would have had to purchase the stock at least the day before. Simple right?

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What’s my point here? The profit on Google stock was not made on Oct 18th, the day it shot up so much.  It was made on the day whoever bought the stock before October 18th. Profit in stocks is determined at the time of purchase rather than at the time of sale when the actual gain is realized. The calculation of your profit in any stock trade is dependent on the price you paid versus the price at which you sold. This is very similar to the market value of homes. Let’s assume the average house on your block is valued at $400,000 today. Who would you imagine would be a happier homeowner, the person who purchased the house at a cost of $300,000 many years ago or the person who purchased a house several years ago at a cost of $475,000? Both are worth approximately $400,000 today. The homeowner who paid $300,000 and sells for $400,000 realizes a $100,000 profit. The purchase price was key to this profit.

The next time you read or hear about a great real estate deal, a great stock, or any other great investment, just remember that every investor’s personal profit is determined based on the date of purchase. This is true of the market returns you hear about every night on the news or see on your smartphone. If you read Yahoo Finance after the market close today (10/25) you’ll see that the S&P 500 Index is up 19.81% for 2013 year-to-date. Does this mean that everyone who was invested in a S&P 500 Index fund or ETF is up almost twenty percent? Sure, if you purchased the fund or ETF at the closing price of the last trading day in December of 2012. It is more realistic to assume that people buy investments at different times and sell at different times than the first day of the year.

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17
Oct

Macro vs Micro: A Study in Economics (and Investments)

Posted by on in Investments

If you think back to your college economics class, you'll remember the difference between macroeconomics and microeconomics. Microeconomics is the study of people and businesses with respect to the decisions they make regarding the allocation of resources and pricing of goods. Macroeconomics is the study of the economy as a whole including entire industries and economies.1 In simpler terms, micro is looking at individuals or specific companies where macro is looking at the big picture. When you research an investment, whether it be a stock, bond, ETF, mutual fund or any other security, you must look at the specific investment as well as the entire market as a whole. Macro and micro forces affect the price of securities on a daily basis.

Let's look at an example. Suppose you wanted to invest in a company that supplied parts or machinery to the oil industry. The individual management of the company would be important to you to ensure effective leadership going forward. The financials of the company would be important to make sure the company will grow, be profitable and which will increase the stock price over time. The product line and the pricing would be important to you so that you would be confident that this company could compete well for new business. The reputation of the company would be important in helping it grow. These are all factors that the individual company can control in some way. Can the company control the price of oil? No! Would the price of oil affect the sales of this company? Yes!b2ap3_thumbnail_economics.jpg

This company you are researching may be the best managed supplier to the oil industry and it might be the most competitive company in its field. But if the price of oil were to suddenly drop precipitously, this company's sales might also drop substantially because oil companies would drill and pump less oil at lower prices. Actually, at this time oil companies are producing and refining more oil than ever before because of the continued high market prices. Market forces drive prices up as well as down. What we are saying is that the stock price for the company you are researching may rise or fall based on macroeconomic conditions that have nothing to do with its own management and financials. This means you are investing in not only the individual company stock but the oil industry and the U.S. economy (and world economy) as well.

Timing is critical to making a sound investment. It is our belief that money is made when a security is purchased not when it's sold. The price at the time you sell a stock represents the proceeds you will receive upon the sale. The profit you make depends on the price you paid when you bought the stock. The key to any successful investment strategy is the discipline behind it.  Warren Buffett invests in companies that he can understand, that are superbly managed and which are highly competitive in their respective industries. Once he invests he is committed for long term. He knows that the decision to invest was made based on a sound discipline and that over time his investments will perform. His track record is pretty remarkable.

Building a solid portfolio that outperforms the market is not easy. If it was every investment manager would outperform his/her respective benchmarks. Comparing your investment returns to some outside benchmark is not as relevant as it used to be. Would you happy losing only 10 percent of your portfolio value in a year where the overall market went down 20 percent? No! Simply outperforming some index is not enough. Buying the right stock at the right time and holding on to it will yield great value over time. Sometimes stocks move quickly and sometimes they take a long time to move. By investing in well managed competitive companies that have solid financials you give yourself the ability to outperform the average companies. We strive to do this for our clients every day. We focus on solid investments that we believe will perform well in the long-term no matter what the macro market forces do in the short-term.

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