Sunday 30 July 2006

Money for nothing

Although, from a wealth accumulation viewpoint, you're generally better off spending your spare time on continuing education than wasting it trying to get small amounts of money for free, you sometimes need 'downtime' just vegging out in front of the TV, listening to music, or, in my case, getting a trickle of money for nothing. (It also helps subsidise the cost of the broadband connection).

Many US blogs (eg. mymoneyblog) have quite a bit of information about using a 0% APR credit card transfer offer to access to free money which is then invested to earn some interest when deposited into a savings account. In Australia things are a bit different - your credit card apps don't drop your credit rating (this isn't any), but they do appear on your credit report, and, more importantly, if you're honest in your application, there is a limit on the total line of credit you'll be able to get (based on your income and existing repayments). Also, in Australia, these interest free offers often only run for 6 months (compared to 1 year in the US) and you can only get the balance transfer from an existing credit card or other account - you can't simply get a check for the transfer amount as seems to be possible in the US.

For these reasons, I took a while to figure out a way that would make the 0% offers available in Australia work in a similar way to the US - and I think I've found a way. I'll outline the "PLAN" today, and we'll see how it actually works out...

Before, we start, let me remind everyone that I'm not giving any financial advice here (I'm not allowed!), just blogging what I'm doing myself. If you want to try it yourself, it's entirely your own choice, and you'll need to do your own investigations into the risks involved.

Now, my plan:
1. Open a new Coles Source Mastercard (currently with a bonus $20 giftcard offer) [] or any similar card offering a 0% balance transfer offer (and no annual fees) - I got one with a reasonable credit limit without any problems.
2. In the specific case of a Coles Source MC - I bought $30 worth of groceries at Coles to earn a 4c/L fuel discount voucher AND qualify for the gift card offer.
3. I'll now pay off the purchase amount so I don't have a balance on the card (otherwise it would be charged interest while I have a balance transfer amount on the card)
4. When I send in the 100 point identify check form, I'll apply for a balance transfer to my RediCredit account with Citibank.
5. As I currently have a balance owing on the Citibank account (for some margin loan interest prepayment) I'll be saving 11.99% interest on the balance transfer for 6 months. If I didn't have any current debt on the Citibank account I could draw a cheque to myself and deposit it into an online savings account earning around 5.85%
6. Don't purchase anything using the Coles MC while the balance transfer amount is owing - otherwise you'll pay the normal interest charges until the balance transfer amount has been paid off in full.
7. Before the 6 months interest free period ends I'll pay off the balance transfer amount owing on the Coles MC - either with cash I've got sitting in a savings account, or I could pay off using my Redicredit account (back to square one).

The end result - we'll see. But, hopefully, I'll have saved 11.99% interest on the balance transfer amount for 5-6 months. Assuming a balance transfer of $6,000 this will be worth around $350 - not bad for around 20 minutes work.

Saturday 22 July 2006

Which investment approach has the right stuff?

You read a lot of conflicting opinions about the *best* investment method for equity investments. Often these opinions are backed up by testemonials, back-calculated results, or rigorous academic research. For instance, you may be told that it is best to
a) Put your money into managed funds. The theory is that professional managers with huge research resources can do a better job than you. Supporting evidence would be out-performing funds or fund managers (eg. Peter Lynch, Warren Buffett). Debunking evidence would be studies that have shown that most managed funds, after allowing for fees, do worse than the market average. This seems logical because, as a group, managed funds must approx. to be the same as the market, but with the overhead of management fees. Some, of course, probably will outperform the market, either by luck or skill (more studies have attempted to quantify how many funds outperform due to skill - I haven't got a clear sense of the actual percentage, but it seems clear that not all outperforming funds are due to skill). The problem is that there doesn't seem to be any way to pick the winning funds in advance - chasing last years winners has been shown to be a poor strategy. Another problem is that the skill of a fund is, presumably, tied up in a few key personnel - and they can leave, taking their skill with them. Chasing managers (rather than funds) would also be a poor strategy, due to the costs of moving from fund to fund.
b) Pick your own stocks. Here you would save on fees associated with managed funds, and can control costs by using online discount brokers and minimimal trading (to eliminate tax events). The cons are that you probably do not have the resources (time, knowledge, data, contacts) to do as good a job as Warren Buffett, so any outperformance is quite likely going to be due to luck more than skill. Subsets of this option are
b-1) select on a couple of stocks to invest in - ie. "put all your eggs in one basket and what it carefully". Too bad if your stock-picking ability turns out to be poor.
b-2) select at least 10-15 stocks to benefit from diversification. With this many stocks, provided you pick sensibly (and are not too greedy - eg. chasing IPOs, tech stocks or whatever) you should not be too far off the market performance (but there have been studies showing that most personal investors tend to overtrade, and do a poor job or market timing - so the chances are that you will underperform the market even when diversified).
c) Use index funds, EFTs or similar. This approach should minimise tax and fees. Cons are that you are only going to achieve market performance.

Now, if it's not clear which is the *best* approach why pick on ANY one method?

Personally, I have my retirement funds (superannuation) in a mix of local and overseas equity funds. The superannuation provider only offers a range of managed funds (no index funds), so you are paying 1%+ extra for the dubious benefits of active management - but I get cheaper group life insurance rates through the superannuation fund, and, in Australia at least, the tax breaks make it worthwhile.

I also have some direct share investments and index fund investments, via three different margin lending accounts, as geared share investments should perform roughly the same as ungeared superannuation investments. The added benefits of this are that I can be 100% invested and use my spare margin loan capacity as my 'emergency fund' - rather than leaving 6 months salary sitting in a cash account as some people advise.

I also have some 'exotic' investments - eg. hedge funds (OMIP, Equinox), agricultural unit investments (pine plantation, almonds, sandle wood, films), private equity fund. These ARE high risk, but, again, with adequate diversification, I have seen studies that purport to show that these should be worthwhile in the long run - 1 or 2 going broke (like my film investment) will be offset by the performance of the other 8 or more areas. The cons of all exotic investments appears to be that, for the small, individual investor, management fees range from high to astronomical.

The benefit of using a 'scatter gun' approach to picking investment methods is that they can't ALL turn our to be the worst possible choice. Whereas, sticking to one particular approach could end up being a disaster.

As they say, life isn't a rehearsal. So, it's much better being partly right than risking being entirely wrong.

Wednesday 19 July 2006

Buy in gloom, sell in boom... LVA

As anyone reading this blog probably knows, there are myriad truisms about "buy low, sell high", "buy straw hats in winter" and so forth. With most stock markets now off their highs (some more than others), this might be an opportunity to buy stocks. Especially in Australia, where a 10% correction during an ongoing bull run would be a great time to top up on your share holdings - IF we're still in a bull market phase.

But, with continuing setbacks in Iraq and Afghanistan, and the latest renewal of conflict in the middle east, oil looks like it may continue to reach record highs. We may be at the start of the next great bear market - with a global recession triggered by energy costs feeding into inflation, causing hikes in interest rates by central banks? Already New Zealand appears to be facing a need to maintain high interest rates (to contain inflation running at 1.6% per quarter) while their economy is flirting with a dip into recession. Echoes of stagflation?

Without having a crystal ball handy, it seems impossible to tell a temporary dip from the start of a descent into the abyss. There a plenty of examples of 10-15% "corrections", as well as leading into a 40+% drop during a severe bear market.

Is there some way to benefit from the known facts (a 10%-15% drop, which may just be a dip or might be the start of a bear market) without needing to correctly guess the future? One idea I've been toying with is using a leveraged or Biased version of Value Averaging [VA]. With Dollar Cost Averaging [DCA] you regularly purchase the same dollar amount each period (say $2000 per month) of a stock/mutual fund/index CFD or whatever. With Value Averaging you plan on a regular increase in the Value of your total holding and buy the amount required to bring you up to your planned amount. For example:

DCA: Purchase Total Holding
Month Price QTY Amount QTY Value
JAN $1.00 2000 $2000.00 2000 $2000.00
FEB $0.90 2222 $1999.80 4222 $3799.80
MAR $1.05 1905 $2001.30 6127 $6433.35
APR $1.00 2000 $2000.00 8127 $8127.00

Change in value of stock in period 0%
Amount invested $8001.10
Change in value of holding in period 1.57% (8127/8001.10)

This is only an rough sketch - the actual outcomes will depend on exactly how the stock price varies during the period of your investments, and the % gain isn't an annualised ROI or anything fancy.

For comparison, with standard Value Averaging, you would do the following:

VA: Purchase Total Holding
Month Price QTY Amount QTY Value
JAN $1.00 2000 $2000.00 2000 $2000.00
FEB $0.90 2444 $2199.60 4444 $3999.60 (aiming for $4000)
MAR $1.05 1270 $1333.50 5714 $5999.70 (aiming for $6000)
APR $1.00 2286 $2286.00 8000 $8000.00 (aiming for $8000)

Change in value of stock in period 0%
Amount invested $7819.10
Change in value of holding in period 2.32% (8000/7819.1)

Now, using Biased Value Averaging [BVA], you would do the following:

VA: Purchase Total Holding
Month Price QTY Amount QTY Value
JAN $1.00 2000 $2000.00 2000 $2000.00
FEB $0.90 2938 $2644.20 4938 $4444.20 (aim: $4000*1/.9 = $4444.44)
MAR $1.05 504 $ 529.20 5442 $5714.10 (aim: $6000*1/1.05 = $5714.29)
APR $1.00 2558 $2558.00 8000 $8000.00 (aim: $8000)

Change in value of stock in period 0%
Amount invested $7731.40
Change in value of holding in period 3.47% (8000/7731.4)

This is a simplified calculation where no "typical" rate of increase in holding value is assumed - in practice you would build in a realistic real rate of return when calculating the Values you are aiming for - say a real return of 8% pa for the Australian All Ords Accumulation Index.

I haven't read of this version of Value Averaging anywhere else, but it's probably not an original thought - let me know if you've seen it somewhere else, and what it's properly called (I just coined the catchy "BVA" moniker). I doubt this will pan out into a Nobel prize for economics ;)

Also, if anyone knows of a study of it's effectiveness, I'd be interested. Otherwise, I plan on doing some comparisons using historic data - maybe back-calculating using monthly data for rolling 20 year periods of the Australian All Ordinaries accumulation Index.

My theory is that using this method [BVA] you would automatically start investing in "dips" and increase the scale of purchases as the market dropped below its long term average. (You'd have use an assumption of the long term average rate of increase when calculating the total value you were aiming for each period, otherwise over time you'd be buying smaller and smaller lots until you never made another stock purchase)

I'm not sure a straight reciprocal of the deviation of the index from the expected value (as used in the example above) is best for calculating the target value for each period - I'd have to fine tune it to allow for the expected size of peaks and troughs - say 10-15% deviations above and below the long term average happening for several months every two years, and the odd bull or bear market pushing it +/- 40% from the long term average for 6-12 months every decade or so. Easiest way to "tweak" the parameters would be to back-calculate using various scaling factors. (Of course this is optimising the model for historic data - which may bear no relationship to what acutally happens in the next 20 years!).

Another consideration is at what rate you wish be investing into the market - if you are accumulating, say, $2000 per month to invest, then DCA or BVA is fine. But if you are sitting on a large sum of money to invest (say you're overweight in cash, "waiting for the right moment" to invest in stocks), then you need to consider the opportunity cost of leaving a large part of your funds in cash while you average into stocks over several years.