Tag Archives: cash

Short-Selling: What Are You Optimizing?

Summary What separates investing from gambling? Positive expected value. Short-selling has a negative expected value – more negative than some casino games. What are you optimizing? In theory investing is about optimizing return, but many investors’ behavior suggests they are optimizing/minimizing something else. For some heavy short-sellers, it’s intellectual stimulation. I don’t think short selling is right for me or most investors, but this is just my still-evolving opinion. Full disclosure: I’ve never shorted a stock in my life. As such, I’m probably terribly biased and not credible. Short selling is betting that a stock or security will go down. Instead of buying low and selling high, you first sell high and then buy low. You do so by borrowing someone else’s shares when you initially sell and then replacing those shares later on by buying them. For reasons I will explain in this article, I don’t think most investors, including myself, should engage in short selling. Some should, but even for those for whom short selling (“shorting”) is appropriate, it probably should not be used as a primary strategy. This argument has been hashed out many times. I could repeat what’s been discussed many times. For example, when you engage in shorting your upside is limited and downside unlimited – the unfavorable reverse of going long. Instead, I will focus on what I see as the most important points for me and perhaps where I’ve added some original thought. When you short-sell a stock, the odds are against you What separates investing from gambling? Sure, investing isn’t done in a casino, it’s much more calculated, there’s far more money in it, etc. The biggest difference though, is that when you gamble, there is a negative expected value – the odds are against you. The casino takes a cut. When you invest, there is no golden rule saying it has to be a favorable bet, but equities in the US have been increasing rather consistently for over 150 years (see Jeremy Siegel’s excellent book Stocks for the Long Run ). Studies of “rules-based” systematic investing styles like buying the lowest 10% of the market by EV/EBIT and rebalancing annually will often include the returns of the opposite decile (the highest 10% of the market by EV/EBIT in our example). The idea is that the larger the gap in returns between the two poles, the more predictive value the metric has. So what’s the point? Well when you look at these studies, it’s surprisingly hard to find one where the worst decile is actually delivering negative returns. This is significant because it means that stocks don’t only appreciate substantially on average, it’s also hard to find some that will go down at all. For myself and presumably many other investors, this odds-against-you fact is a total deal breaker. I remember in high school, I would print out the Las Vegas odds of each weeks NFL games and offer to do straight bets with anyone on any game so long as I had the favorite. I was okay with this activity because by picking the favorite without paying for it, I had a positive expected value – even though I didn’t know that term at the time. Several months ago, I was viewing the Ultimate Fighting Championship with family and someone suggested we bet on the fights. We would pool money and bet on who would win the fight and what round (or decision) they would win in The gamble was, on the surface zero-sum. No one was taking a cut of the bets. And I did research. I immediately pulled out my smartphone and looked up the favorite in each fight. I then looked up what percentage of UFC fights end by knockout versus decision. (click to enlarge) 41% of fights go to decision. Assuming a three round fight (most fights are 3 rounds, championship fights are 5), that 41% is significantly higher than the 25% it would be if each outcome were equally likely. So in each fight, I picked the favorite by decision with some confidence that I had a positive expected value. I won three out of the four fights we bet on. My approach to these situations where the game is explicitly zero or positive sum is in stark contrast to negative expected value situations. Casinos take a cut of all bets by structuring games such that odds are slightly in their favor. The lottery usually has a very negative expected value because: the winnings are taxed at the highest federal income rate and by your state as well municipalities take a huge cut (it’s a significant source of revenue for them) the advertised prize is not a present value, it’s usually a long-term annuity – taking the cash up front means getting far less there could be multiple winners that split the winnings, and the probability of this increases when the pot is large and many tickets are sold, offsetting the EV benefit of the higher pot. I’ve never engaged in these sorts of activities and would have a lot of trouble forcing myself to. It is counter to the investor mindset. But short sellers do just this. On average, they will lose money. The expected value is negative. The idea, though, is that by doing deep enough research and being opportunistic enough, they can make the expected value positive. This is tough for me to accept. First, the odds are dramatically against them on the surface. If stocks appreciate 9.5-10% a year in nominal terms, those odds are far worse for the short seller than some casino games. For example, in blackjack, the odds of you winning versus the dealer are 48%. Roulette is something like 47.4%. If stocks are appreciating 9.5-10% that’s the equivalent of ~45%. And that’s just the direct costs. Then there’s taxes, dividends you must pay on the shares you short, borrowing costs on hard to borrow stocks (unfortunately, many of the stocks with the best short cases have the highest borrowing costs because everyone wants to short them). This is somewhat offset by the fact that you can (I believe) use some of the cash you receive from the sale upfront for other things in the interim. I believe this depends on your creditworthiness as perceived by your broker, the size of the short sale relative to your assets, etc. Some brokers may require you to keep the margin in cash, which eliminates this benefit. The bottom-line: short selling is a negative expected value activity, so why do it? What are you optimizing? Value Investors Club is a great site. The quality of research is very high and there are some smart people on it – some of the smartest people in the investment industry, in fact. That’s why it confounds me that some of these investors are so short-focused. Some of these investors have written 25 articles and like 23 of them are shorts. Some of the smartest investors with the highest profiles are also heavy shorters. David Einhorn and Bill Ackman come to mind. Ackman now describes his firm as primarily long but opportunistically short, which may be the case, but historically he’s done a lot of shorting. I have a theory that these investors are attracted to shorting precisely because the expected value is worse than going long. It’s harder. It requires deeper research. It’s intellectually stimulating. It’s exhilarating. These things probably really appeal to smart people with a chip on their shoulders for some reason. But what is investing about? Is the goal of investing to optimize return or optimize intellectual stimulation? Most investors agree verbally that it’s all about return, but most don’t behave that way – and there are other examples. Obsessions over volatility, dividends, minimizing taxes, etc. are all examples of other things I’ve found many investors trying to optimize through their behavior. Buffett has said a few insightful things on this topic: “You don’t get points for difficulty” The mono-linked chain metaphor The one-foot hurdle metaphor It is certainly understandable that for investors capable of analyzing and understanding very difficult situations, it is challenging to focus on easy ones. Conclusions I have some other thoughts like the idea of specialization – maybe an investor, for some reason like a deep skeptical streak, is much better at shorting than going long – but they will have to wait for another post. This article is just me putting my thoughts to paper. At this point, I’m comfortable recommending that most investors (including myself) focus on positive expected value situations to optimize return and that means avoiding short selling.

Build Your Own Leveraged ETF (ETRACS Edition)

Summary A previous article showed that the ETRACS 2x ETNs did not inexorably decay in value even over several years. Other authors have investigated the idea of using leveraged funds to build your own ETF. The application of this strategy to the ETRACS 2x ETNs are investigated, revealing the potential for additional yield. Introduction The ETRACS line-up of ETNs issued by UBS (NYSE: UBS ) provides investors with exposure to a broad range of investment classes. A number of the ETRACS ETNs are 2x leveraged, which means that they seek to return twice the total return of the underlying index, minus fees. This allows the ETNs to offer alluring headline yields, making them attractive for income investors. Additionally, some of these funds pay monthly distributions, although these can be lumpy. A recent article provides an overview of the types, yields and expense ratios of these 2x leveraged ETNs. An interesting feature of the 2X leveraged ETNs is that their leverage resets monthly rather than daily, which is the norm for most leveraged funds on the market. It is known that decay or slippage in leveraged funds will occur when the underlying index is volatile with no net change over a period of time. By resetting monthly rather than daily, this decay can be somewhat mitigated. An article by Seeking Alpha author Dane Van Domelen addresses the decay issue mathematically and shows that in most cases, the decay is not as serious as is often thought. However, this leverage does not come without costs. There is the management cost associated with providing the ETN, as well as a finance cost associated with maintaining the 2x leverage. Finally, it should be noted that investors in ETNs are subject to credit risk from the fund sponsor, in this case UBS. If UBS were to go bankrupt, the ETNs will likely become worthless. However, Professor Lance Brofman has argued that the risk of ETN investors losing money due to UBS going bankrupt is, barring an overnight collapse, minimal because the notes can always be redeemed at net asset value. I recently studied the performance of several of the 2x leveraged ETNs and found that, in general, the 2x ETNs fulfilled their objectives and also outperformed the corresponding (hypothetical) daily-reset 2x ETNs. This suggests that, over the last few years at least, that the 2x ETNs have been suitable (insofar as them being able to meet their objectives vis-a-vis their 1x counterparts) long-term instruments for the leverage-seeking investor. Just to make this point crystal clear, the 2x ETRACS ETNs have allowed aggressive investors to obtain 2x participation in a variety of asset classes in an efficient and stable manner – both to the upside and to the downside – I am not making specific recommendations as to whether the asset classes themselves (e.g. mREITs, MLPs, BDCs, and CEFs, just to name a few of the asset types covered by the ETRACS) are suitable as long-term investments. Building your own ETF In another article entitled ” Build Your Own Leveraged ETF “, Dane Van Domelen explores the possibility of combining leveraged ETFs with cash or other funds for various purposes. For example, Dane posited that a one-third ProShares UltraPro S&P 500 ETF (NYSEARCA: UPRO ), a 3x leveraged version of the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ), two-thirds cash portfolio has virtually the same properties as a 100% S&P 500 portfolio (with periodic rebalancing), but allows you to hold a lot of cash: An interesting special case is where you put one-third of your money in UPRO and two-thirds in cash. At the onset, this portfolio would behave almost exactly as if you had all of your money in the S&P 500. UPRO’s expense ratio should result in somewhat diminished returns, but not much. And it might be worth it to free up two-thirds of your money, for emergencies and so forth. UBS 2x ETN expert Lance Brofman has also considered the same idea : If this hypothetical investor were thinking of either investing $1,000 of his $10,000 in the UBS ETRACS 2X Leveraged Long Wells Fargo Business Development Company ETN ( BDCL) and keeping $9,000 in the money market fund, or investing $2,000 of his $10,000 in the UBS ETRACS Wells Fargo Business Development Company ETN ( BDCS) and keeping $8,000 in the money market fund, either choice would entail the same amount of risk and potential capital gain. This is because BDCL, being 2X leveraged, would be expected to move either way twice as much as a basket of Business Development Companies, while BDCS would move in line with a basket of Business Development Companies. This article seeks to analyze whether it is possible to “build your own ETF” with the suite of UBS 2x leveraged ETNs, by applying the strategy described above by Dane Van Domelen and Lance Brofman. Interestingly, the analysis reveals the potential to add on additional yield to your portfolio. Considering fees The fee required to maintain the 2x leverage of the ETRACS 2x ETNs is based on the 3-month LIBOR, which currently stands at 0.33%. This is added to a variable financing spread (0.40-1.00%) to generate a total financing rate that is passed on to investors. This total financing rate of 0.77-1.33% is much lower than is available for all but the wealthiest of individual investors. Lance Brofman writes : Many retail investors cannot borrow at interest rates low enough to make buying BDCS on margin a better proposition than buying BDCL. This means that from an interest point of view, it would usually be better to buy the leveraged fund than to try and replicate it yourself with a margin loan from your broker. Applying the strategy However, what if the investor wasn’t interested in using leverage in the first place? Can he still make use of the low financing rates charged by the ETRACS 2x ETNs? To explore this, let’s try to apply the strategy described above by Dane Van Domelen and Lance Brofman, which basically entails replicating a 100% investment in a 1x fund with a 50% investment in the corresponding 2x fund and a 50% allocation to cash or a risk-free asset. The following illustrates such an example. Example Let’s say that you had $10K invested in the SPDR Dividend ETF (NYSEARCA: SDY ). SDY charges 0.35% in expenses, which comes out to $35 per year. You could replicate that investment with $5K in the UBS ETRACS Monthly Pay 2x Leveraged S&P Dividend ETN (NYSEARCA: SDYL ), leaving yourself with $5K in cash. SDYL charges 1.01% in total expenses, which on $5K comes out to $50.50. In other words, you’d be paying an extra $15.50 per year if you decided to invest $5K in SDYL compared to $10K in SDY. But wait! You have an extra $5K in cash left over. If you can use that $5K to earn $15.50 per year, corresponding to a rate of return [RR] of 0.31%, you can break even. With any higher rate of return, you would benefit from using the leveraged ETN and investing the rest of your cash. At first glance, it seems that 0.31% is a ridiculously low hurdle to surpass, suggesting that one would nearly always benefit from using the leveraged ETNs and investing the rest of the cash. However, one also needs to consider the risk of the invested cash portion. To mimic, as closely as possible, the risk of the original scenario (i.e. $10K invested in SDY), the $5K cash left over after investing $5K in SDYL should be invested in as risk-free of an asset as possible. Bankrate.com shows that 1.30% 1-year CDs and 1.25% savings accounts are currently available. These investments are insured by the FDIC, and can be considered to be nearly risk-free. Using the above example, investing $5K at 1.30% for one year yields you $65.00. After subtracting the additional $15.5 required for the additional expenses of SDYL ($50.50) vs. SDY ($35), you’d gain $49.50, or an additional 0.495%, from using this strategy! Results The following table shows a list of 2x leveraged ETNs, their corresponding 1x fund, and their respective total expense ratios [TER]. Also shown is the rate of return [RR] required on the risk-free portion to break-even, as well as additional yield that you would be able to obtain on the entire portfolio had the risk-free portion been left in cash paying 0%, a savings account paying 1.25% or a 1-year CD paying 1.30%. A negative number indicates that this strategy would lose money relative to investing the whole portion in the 1x fund. The funds are arranged in descending order of required RR on the risk-free portion. Please see my previous article if further information is required regarding these 2x ETNs. Note that some funds such as the ETRACS Monthly Pay 2xLeveraged US High Dividend Low Volatility ETN (NYSEARCA: HDLV ) and the ETRACS Monthly Pay 2xLeveraged U.S. Small Cap High Dividend ETN (NYSEARCA: SMHD ) so not have corresponding 1x counterparts, so are excluded from this analysis. Ticker TER Ticker TER Required RR Cash (0%) Savings (1.25%) 1-year CD (1.30%) ETRACS Monthly Pay 2xLeveraged MSCI US REIT Index ETN (NYSEARCA: LRET ) 1.96% Vanguard REIT Index ETF (NYSEARCA: VNQ ) 0.10% 1.76% -0.88% -0.26% -0.23% UBS ETRACS Monthly Reset 2xLeveraged S&P 500 total Return ETN (NYSEARCA: SPLX ) 1.56% SPY 0.09% 1.38% -0.69% -0.07% -0.04% ETRACS Monthly Reset 2xLeveraged ISE Exclusively Homebuilders ETN (NYSEARCA: HOML ) 1.96% ETRACS ISE Exclusively Homebuilders ETN (NYSEARCA: HOMX ) 0.40% 1.16% -0.58% 0.05% 0.07% ETRACS 2xMonthly Leveraged S&P MLP Index ETN (NYSEARCA: MLPV ) 2.26% iPath S&P MLP ETN (NYSEARCA: IMLP ) 0.80% 0.66% -0.33% 0.30% 0.32% SDYL 1.01% SDY 0.35% 0.31% -0.16% 0.47% 0.50% UBS ETRACS Monthly Pay 2x Leveraged Mortgage REIT ETN (NYSEARCA: MORL ) 1.11% Market Vectors Mortgage REIT Income ETF (NYSEARCA: MORT ) 0.41% 0.29% -0.15% 0.48% 0.51% UBS ETRACS Monthly Pay 2x Leveraged Dow Jones Select Dividend Index ETN (NYSEARCA: DVYL ) 1.06% iShares Select Dividend ETF (NYSEARCA: DVY ) 0.39% 0.28% -0.14% 0.49% 0.51% UBS ETRACS Monthly Pay 2xLeveraged Closed-End Fund ETN (NYSEARCA: CEFL ) 1.21% YieldShares High Income ETF (NYSEARCA: YYY ) 0.50% 0.21% -0.11% 0.52% 0.55% UBS ETRACS Monthly Pay 2X Leveraged Dow Jones International Real Estate ETN (NYSEARCA: RWXL ) 1.31% SPDR Dow Jones International Real Estate ETF (NYSEARCA: RWX ) 0.59% 0.13% -0.07% 0.56% 0.59% UBS ETRACS Monthly Pay 2xLeveraged Wells Fargo MLP Ex – Energy ETN (NYSEARCA: LMLP ) 1.76% UBS ETRACS Wells Fargo MLP Ex-Energy ETN (NYSEARCA: FMLP ) 0.85% 0.06% -0.03% 0.60% 0.62% UBS ETRACS Monthly Pay 2xLeveraged Diversified High Income ETN (NYSEARCA: DVHL ) 1.56% UBS ETRACS Diversified High Income ETN (NYSEARCA: DVHI ) 0.84% -0.12% 0.06% 0.69% 0.71% UBS ETRACS 2x Leveraged Long Alerian MLP Infrastructure Index ETN (NYSEARCA: MLPL ) 1.16% UBS ETRACS Alerian MLP Infrastructure Index ETN (NYSEARCA: MLPI ) 0.85% -0.54% 0.27% 0.90% 0.92% BDCL 1.16% BDCS 0.85% -0.54% 0.27% 0.90% 0.92% From the table above, we can see that the LRET/VNQ combination would be the worst pair to implement this strategy with, as it requires a 1.76% RR to break even. This means that even with a 1-year CD rate of 1.30%, you would be losing -0.23% using this method. This can be attributed to LRET’s exceptionally high expense ratio of 1.96%, and VNQ’s exceptionally low expense ratio of 0.10%, making it highly expensive to replicate 100% VNQ with 50% LRET. At the other end of the spectrum, the BDCL/BDCS combination appears to be the best pair for this strategy. The required RR is negative 0.54%, meaning that even if you left the 50% risk-free portion in cash, you would be gaining 0.27% on your overall portfolio. Investing the risk-free portion is a 1-year CD improves the performance of the portfolio by 0.92%. This can be attributed to BDCL’s below-average expense ratio of 1.16% and BDCS’ above-average expense ratio of 0.85%. The following chart shows the required RR for the 2x funds in order to implement this strategy. The following chart shows the additional yield that can be harvested by investing the 50% risk-free portion in cash (0%), a savings account (1.25%) or a 1-year CD (1.30%) for the respective 2x funds. Risks and limitations The 50% investment in a 2x fund may not correspond exactly to a 100% investment in 1x fund. It may do better or it may do worse. Periodic rebalancing may help, but this would entail additional transaction fees. In the case where the 1x fund is an ETF, you are additionally exposed to the credit risk of UBS when it is substituted for a 2x ETN (see introduction). In the case where the 1x fund is an ETF, the tax treatment may change when it is substituted for a 2x ETN. Savings accounts and CDs are only FDIC-insured up to a certain value (though if we’re worrying about this we have much bigger problems on our hands than the implementation of this strategy!). Conclusion A previous article showed that the ETRACS 2x ETNs did not inexorably decay in value even over several years, suggesting that the funds can function as efficient long-term investments for the leverage-seeking investor. This article shows that an investor not interested in leverage could still potentially benefit from the ETRACS 2x funds by “building his own ETF”. This simply costs of replicating a 100% investment in a 1x fund with a 50% investment in the corresponding 2x fund, and a 50% investment in a risk-free asset. Additional yields of up to 0.92% per year are available using this strategy. Further enhancements in yields can be achieved by investing the 50% into more risky assets such as corporate bonds, although this alters the overall risk-reward dynamics of the strategy.

How I Created My Portfolio Over A Lifetime – Part V

Summary Introduction and series overview. The hardest lesson I have ever learned. The asset that always goes up in value when all other assets go down. Summary. Back to Part IV Introduction and Series Overview This series is meant to be an explanation of how I constructed my own portfolio. More importantly, it I hope to explain how I learned to invest over time, mostly through trial and error, learning from successes and failures. Each individual investor has different needs and a different level of risk tolerance. At 66, my tolerance is pretty low. The purpose of writing this series is to provide others with an example from which each one could, if they so choose, use as a guide to develop their own approach to investing. You may not choose to follow my methods but you may be able to understand how I developed mine and proceed from there. The first article in this series is worth the time to read based upon some of the many comments made by readers, as it provides what many would consider an overview of a unique approach to investing. Part II introduced readers to the questions that should be answered before determining assets to buy. I spent a good deal of that article explaining investing horizons, including an explanation of my own, to hopefully provoke readers to consider how they would answer those same questions. Once an individual or couple has determined the future needs for which they want to provide, he/she can quantify their goals. If the goals seem unreachable, then either the retirement age needs to be pushed further into the future or the goals need to become attainable. I then explained my approach to allocating between difference asset classes and summarized by listing my approximate percentage allocations as they currently stand in Parts III and III a. Part IV was an explanation of why I shy away from using ETFs and something akin to an anatomy of a flash crash. In this article I will explain one of the most difficult concepts for most investors to grasp. It certainly was for me. Why? Because we keep reading (or at least I do) that to do the opposite it is the best thing we can do. I will explain my education process as we go along in the article. The hardest lesson I have ever learned Growing up as a teenager in the 1960s I had to listen my Dad complain about inflation… a lot. Everything was getting more expensive and he owned his own business. Raising the prices he charged his customers was difficult for him but he had to do it because the cost of everything he used in his business, a small resort on the Canadian border waters of Minnesota, was rising. He kept telling me that the value of a dollar was going down. That lesson stuck with me. As I got a little older I went off to college after spending two glorious, all-expense paid year-long vacations in Southeast Asia, courtesy of my Uncle Sam. Yes sir, I got to spend time hiking trails and communing with nature with plenty of activities to keep my adrenaline flowing. What a rush! While in college I took a full load of classes and worked full time to pay my own way, helped once again by my good old Uncle who sent me 36 monthly checks to help with the cost of college. Every time I noticed that my savings had burgeoned to over two thousand dollars (I do not know why that number trigger an urge, but it did), I had to buy something. Otherwise, inflation would just eat away at that money as it became worth a little less each year. Thanks, Dad! Actually, I should not blame him because he did teach me how to save. He just stopped with that lesson and the one about inflation. The spending thing I came up with on my own. Then came my first professional job with a company car, liberal expense account, great pay, stock bonus and profit sharing. It was a nice start right out of college. This time I was so busy that my savings piled up faster than I could spend it. This was back in the late 1970s and interest rates were rising. At that point I knew nothing about stocks and very little about real estate. I had no interest in bonds, something that now I really wish I had understood well back then. By 1980 I had saved $25,000. That does not sound like much today, but in 1980 it seemed like a small fortune to me. If I had understood how bonds worked then I would have used all of it to buy 30-year U.S. Treasuries. I must admit right now that I did nothing very good with all that savings. I could explain but none of it would be very instructive nor beneficial to understand. To summarize, I did not have the same level of income but I did not adjust how I lived. While this is not the lesson of the article, it was a good one to learn early in life. Eventually, the money began to run low and I was forced to change some spending habits. Life would have been better had I had the foresight to make adjustments earlier. Live and learn. Looking back something that did not sink in at the time but has since become clear is that when interest rates are extremely high and housing values fall it is a great time to buy real estate. Interest rates will eventually drop providing an opportunity to refinance resulting in lower mortgage payments. Falling interest rates also tends to help boost real estate values at a higher rate than average. But that is not the lesson of the article either. The lesson that was so hard to learn was to unlearn what I learned from my Dad and from many other sources: holding cash without receiving any interest or income is a sure way for your savings to lose value because of inflation. I learned that not earning more than inflation on my money would cause me to permanently lose buying power. That is what I had learned all of my life. The hard part was to learn that what I had learned was wrong! Am I losing you? Stick with me a little longer and you will understand that what I am saying is true. It is not what any financial institution wants you to understand. Having money sitting in an account that may not keep up with inflation seems ridiculous, does it not? That is what we keep hearing. But that way of thinking just gets people to invest when they should be on the sidelines waiting for a better opportunity. Wall Street cannot make a profit on your money if you let it just sit there. They need transactions! The asset that always goes up in value when all other assets go down Cash is the one asset class that goes up in value when all other assets go down. Think about it for a few moments. If you have $10,000 in cash that you could invest in a the stock of a great company at $50 with a dividend of $1.25 now, would you do better than holding the cash until the share price went down to $40 two years later with a dividend of $1.40? The answer should be obvious. But rather than looking at a hypothetical situation I want to offer two real examples from my own portfolio. I decided back around the beginning of 1997 that I wanted to own shares of PepsiCo (NYSE: PEP ). My reason for liking PEP so much was that I was drinking several cans of the stuff every day at work. Most people drank coffee for the caffeine, I drank soda and my favorite was Pepsi. I know that is not a great reason, but I was just starting out. Besides, I knew I was not the only one who liked Pepsi products. After studying the stock I had some regret for not having bought it earlier and decided that I would only buy it if the price dropped back to $33 per share again. All of 1997 went by and the price did little other than rise. It was little different over most of 1998. I almost threw in the towel and bought the stock in March of 1998 at around $40. But at that price the dividend yield was under one percent. I decided to wait. Finally, sometime in late summer I learned about good-until-canceled buy orders. So, I placed an order to buy some shares at $33 per share, good-until-canceled and stopped worrying about it. In early October the shares traded down below $30 and I go my fill. I ended up buying the shares at $33. I could have done better, but I reminded myself that I was doing better than if I had bought at $40. It helped. I have since made another purchase of PEP and will go through that example in a minute. Now I want to show you how I did and the difference in results between my actual purchase and what would have happened had I pulled the trigger earlier at $40. To keep the math simple I will assume in both this and the next example that I had $10,000 to invest each time. If I had invested in PEP at $40 per share in March 1998, I would have gotten 250 shares. I would have collected a couple more dividend payments but the total of dividends I would have collected from then to now would be $5,814. My total gain would be $13,617. My original $10,000 investment would now be worth $29,431 and my dividend (as indicated) this year would be $680 for a 6.8 percent yield on my original investment. That all sounds pretty good. Here are the results of what the type of return I got by waiting for the price I wanted compared to the above example in table form. Date Price Shares Total Dividend Gain Original Value Current Value Comp Anl Rtn 2015 Dividend Yld 03/98 $40 250 $5,814 $13,617 $10,000 $29,431 11.4% $680 6.8% 10/98 $33 303 $6,967 $18,625 $10,000 $35,592 13.5% $814 8.1% The column for Compound Annual Return (Comp Anl Rtn) does not include reinvested dividends. The column labeled Yld represents the annual yield now earned on the original investment. Next I want to take a look at what I did later in life, after I had learned a little more about how the value of cash increases when other assets go down. But first, a little rant. I get tired of hearing that it does not matter if an investor buys shares in a company at the peak of a bull market or at the bottom of a bear market as long as they hold those shares long enough. The difference will become less over time, we are always told, and eventually become inconsequential. The problem with the examples they use to explain the difference is that they usually assume that the investor buys the same number of shares in both instances. Such examples do not consider the reality that an investor will be able to buy more shares at a lower price with the same amount of cash. Those additional shares result in more gain and a higher dividend yield and the difference increases over time. If I had followed the conventional wisdom that says it does not matter when you buy and invested $10,000 in PEP shares two months before the stock hit its high in 2007 I would have bought 142 shares at about $69.96, the average price on September 1, 2007. The stock traded as high as $77.41 in November 2007, so I am not taking the top of the market. I actually made a purchase on June 1, 2009, almost two years later. I missed all the dividend income that would have been collected for those two years, but I am glad I did. Check out the results in the chart below. Date Price Shares Total Dividends Total Gains Original Value Current Value Comp Anl Rtn 2015 Dividend Yld 9/1/2007 $69.96 142 $2,358 $3,480 $10,000 $15,772 5.9% $386 3.9% 6/1/2009 $52.82 189 $2,467 $7,872 $10,000 $20,339 9.3% $514 5.1% The results are obvious. Waiting for a better buying opportunity allowed me to buy more shares, collect more dividends, lock in a much higher yield and created a superior compound annual return. Again the returns do not include reinvested dividends or any income on the cash accumulated from collecting those dividends; doing so would only make the comparison more lopsided. Each time we go through another cycle I try to get better at identifying when an asset such as equities no longer offer me a bargain. At that point I stop buying and just begin to accumulate until the next time we experience a significant economic recession. I provided the two examples of my purchases of PEP shares for a reason. The first example, in 1998, represented a modest bear market swoon. The second example, 2007-2009, was a much more sever recessionary period. The point of the two examples was that it can be beneficial to wait whether the bear market is deep or relatively small. Summary The main point that I hope I have made clear is that when stocks, or any other asset, fall significantly in value the amount of that asset an investor can purchase with the same amount of cash increases. Stated differently, when the value of other assets falls, the value of cash increases. We need to stop thinking in terms of inflation eating away at the value of our cash and begin thinking in terms of how much more of an asset the same cash today will buy when the value of that asset drops. Cash has value, not only in terms of the everyday items that we buy. As an investment we need to think of cash as increasing or decreasing in value relative to other assets. This does not mean that we should only buy at the bottom after an asset class has crashed. What it does mean is that buying assets that are deeply undervalued will provide better returns than buying when those assets are fairly valued or above. After a crash like we experienced in 2008-09 real estate and equities remained deeply undervalued for several years. There were bargains everywhere I looked. I didn’t have enough cash to take advantage of all the opportunities. But I had more than most. And I benefited from my patience. Do not expect to be perfect. Just try to do better through each cycle. At our current point in time I believe that cash is king, but that does not mean I plan on selling any of my long-held holdings. I like my positions in most of my portfolio and I also like the dividends that help me accumulate more cash. In the next article of this series I plan to explain how I do trim some of my holdings systematically and why. After that I want to address the topic of tax efficiency in the following article. That is an area where some very simple planning can help a lot over a long holding period. I do not plan to cover the entire universe of tax planning because most of us do not need to understand it all. What I will cover are the simple things that we can all do if we just understand a little more about how to invest to avoid or defer taxes better. After that I would like to delve deeper into how to develop a plan for saving and investing, especially for those starting out, but also for those mid-stream of their accumulation and investing phase of life. One can always make adjustments and improve a little here and there. As always I welcome comments and questions and will do my best to provide details and answers. This is one of the best aspects of the SA community. We can learn from each other and share our perspectives so that other readers can benefit from the comprehensive knowledge and experience represented here.