investing

Going Long On Retail

Without going in to individual security selection, I want to touch on an idea that I’ve been formulating for a while. It first crossed my mind when Macy’s reported better than expected earnings last year and I thought it was a curious theory but then never pursued it.

Then Toys R Us declared bankruptcy. I thought back on the days when my parents took me to Toys R Us and the happiness I felt just walking the aisles even if I didn’t walk out with anything.

Then Sears filed for bankruptcy and while reading about the declaration and about what brought a once iconic American company over the edge made the idea come up once again, only this time stronger. Retail is a sector that has lagged behind the broader S&P for a while now and hasn’t really shown a promise rebounding. Amazon has taken over. Having worked for a startup that leveraged amazon’s platform, I saw first hand the dominance Amazon has in the marketplace of goods. Not only do they sell everything, they produce everything as well. From Amazon branded clothing to Amazon branded food, Amazon has gone from the little online book seller to the everything store.

But how much can their dominance grow and have traditional brick and mortar retailers felt the full effect of this? I believe so. While reading about Sears and the events that led to it’s fall, one of the major thing I noticed was the lack of spending on technology. Retail companies that have weathered the Amazon storm have a major characteristic shared among them. They invested heavily in technology over the last 5 years. It doesn’t matter if it’s Walmart’s acquisition of jet.com or Target enhancing their own online presence, brick and mortar retailers have found the secret ingredient to stay competitive and not lose any more market share to online only retailers.

Further reinforcing my theory is that online direct to consumer companies such as mattress startups Casper and Tuft & Needle have made the push in to retail stores. While these stores are limited, I believe that they have plans to expand their brick and mortar presence in an effort to give more consumers an experience and a place to test their products.

In my opinion going to a mall or store is an experience and a good reason to get out of the house. I know plenty of people that enjoy actively shopping and walking around which is, for obvious reasons, impossible to do through online stores. While my original thesis was that companies investing in technology can and ultimately will weather the storm I also believe that a push back in to traditional retail will bring back a resurgence in REIT’s that are heavily invested in shopping centers and malls.

While I am unsure about substantial growth coming in the form of new stores I would expect that same store revenue year over year will continue to increase for traditional retailers, regardless of their push into e-commerce or not. Consumer sentiment stands at 98.3 and consumer confidence is hovering around 137.9. Both of these numbers show that Americans are happy with their current financial situation and expect the good times to keep rolling. Heading in to this holiday shopping season, I would expect higher than last year spending, even with the recent volatility in the markets.

As traditional retailers adapt to e-commerce taking a larger percentage of market share I believe the focus will shift from products in the stores to getting customers in the door with the allure of an experience. Instead of investing in large stores that hold many products, giving customers an experience that will make them want to leave their house and forgo online shopping will be the key. Give me a shoe store where I can try on shoes and jump on a treadmill, show me a clothing store where I can find the best products for me and order them directly to my house. I’d rather go to a Teavana that is a cafe setting and then purchase the tea I enjoyed after casually tasting and exploring their selection.

A recent trip to a local mall showed one of our contributors how retail is changing first hand. Gone are big box stores sprawling thousands of square feet with scores of goods. They have been replaced with things like a Tesla retail store where you can purchase merchandise and sit in the most recent model. Interested buyers can be set up a test drive and learn everything they want to know about the car without leaving the mall. In another portion of the mall our contributor found a new Nespresso store which was centered more around having customers sample new flavors free of charge rather than pushing product to purchase.

With a lot of market research coming out showing that the expectation for the near term is “growing but slowing” I expect the retail sector to stay in line with that. Overall, I am long on the sector in a 5-7 year outlook and have begun the process of looking for individual companies that show the potential to not only survive the storm but come out stronger.

Understanding Investing and Speculating

It’s time to break down the difference between investing and speculating. At different points in market cycles and throughout stock market history investing has been thought of as speculating and speculating as investing. With the latest boom and bust of weed stocks, last years run up of crypto and the resulting crash, the longest bull market in US history, and now movements in to correction territory it’s more important than ever to understand the differences.

We get it, diving into the world of investing can be tough. There are so many different ways to lose money and it’s easy to fall in to a trap. One of the many pitfalls that most new participators in the market come across, and one we all definitely fall prey to, is speculation. I made a lot of uninformed and rash decisions that I would never make now and lost, at the time, quite a bit of money. And while we still learn every day about the markets, this lesson of investing vs. speculating should be learned quickly and forgotten.

At the highest level I would say every market involves some sort of speculation. If you hold the S&P 500 through index funds (which is one of our favorite ways to invest) you are speculating that the US economy is going to continue to grow. If you hold treasury bonds you are technically speculating that the US government is not going to default on its debt and will have the ability to pay you back (which has actually come close to happening in recent years). There are people who purposefully make speculative investments and they have their own reasons for doing it. We are just here so you understand the difference and don’t accidentally speculate when you meant to invest.

Investors tend to seek to maximize their risk adjusted rate of return based upon fundamentals, through analysis, risk management, and due diligence. Speculators buy a security with the hope that someone else will buy that security from them at some point in the future at an even higher price than they payed for it. Burt Malkiel of Random Walk Down Wall Street fame presented this idea the best with his castles in the air analogy. Let’s dive into some examples of each:

Speculating

A great example of speculation are small cap biotechnology stocks. The underlying businesses usually don’t make much money if any and are operating with money raised by issuing equity and grants they have secured for researching new drugs. However, an FDA review of a drug they are trying to bring to market can either make or break the business. Speculators will buy up stock or short it (usually on margin) right ahead of these reviews seeking to create outsized returns. While speculators can read all the company press releases they want the FDA approval process is extremely complex. No one really knows what’s going to happen and people make small fortunes or get burned all the time.

But you don’t have to take our newest high tech example to find speculation in the markets. Ever heard of Dutch Tulip Bulbs? One of the greatest financial bubbles and speculation crazes of all time. That’s right. Tulip Bulbs. People actually bought and sold flowers that costed more than their homes. And they bought them on margin. And as all speculation crazes do and all bubbles must, they popped. People lost fortunes.

Check out these other speculation crazes to see how ridiculous and irrational people can get.

Weed stocks, biotech, Housing, dot com bubble, savings and loans, south sea company, tulip bulbs.

A good example I like to use for investing is something that you can conduct research on and conclude that it will have positive expected returns with average or lower than average risk for many years to come.

Take a large conglomerate that is in several industries. It is a top player in the industries that it participates in and returns value to shareholders through either dividends, share buybacks, or capital expenditures. An investor might choose to invest in this company to seek a modest return on the capital they put at risk as due diligence suggests that the business’s risk is relatively low. Additionally, the investor might go ahead and purchase stock of similar companies to diversify their portfolio across industries and regions.

Remember that purchasing a share is not just owning a string of numbers running across your screen with the hope those numbers go higher. It is a ownership position in the company of whose share you bought. The value of your house is not told to you consistently throughout your day and you don’t care. Your investments should be the same. Even if you are not able to know the price you should be comfortable in your investments, and I stress investments and not speculative positions, that if you didn’t know the price at this very moment you would be happy to own a piece of that company.

Conclusion

We are not saying to not speculate. Some make their fortunes on speculation but many more lose fortunes because of speculation. It’s important to understand the differences and the risks acclaimed with both. Yes, investing has it’s risks and while they are different from speculating they are always present and represent hurdles that intelligent investors must learn to navigate.

Buy A House Not A Home

If you are like me, home ownership is probably a long ways away. However, I recently read a white paper called “The Rate of Return on Everything, 1870-2015” published by the Federal Reserve Bank of San Francisco. Theres a lot of good facts and data in there and I strongly encourage you to read it (or skim it like a certain Modern Piggy Bank Founder did… looking at you Will). But if reading 123 pages of economic data and commentary isn’t your cup of tea I’ll spare you the burden and tell you what I found most interesting.

The paper looks at major asset classes over the time period 1870-2015 most notably bills, bonds, equities, and housing and analyzes their return statistics. Believe it or not housing was on par with equities with average return of 7% a year. In the post World War II era, equities have taken a marginal lead, but the investor has also needed to take on more volatility and is subject to the ups and downs of the business cycle. Where as the housing market has been much steadier over time. Additionally, housing does not correlate heavily to the global markets i.e. a bear market is less likely to have a significant adverse affect on housing prices.

Now home ownership has been seen as a rite of passage in America and a sign that someone is financially well off. Unfortunately, situations like the 2008 financial crisis show how a house can sometimes not be a wise investment especially your primary residence. I’m currently looking to apply for my first credit card which I will talk about in a later post, but I find it concerning how the Federal Government insured home loans leading up to 2008 and will loan teenagers with no grasp of the concept of credit hundreds of thousands of dollars to achieve higher education because it’s a “good investment” while private credit institutions want new credit card owners to have $200 spending limits. Anyways, I digress.

Back on track. You will always need a dwelling, it will always be an expense. I will even go on to make a controversial claim that a mortgage on your primary residence is nothing more than an expense. If you weren’t paying it down every month you would be living in an apartment paying rent. When you go to upgrade homes you will now have a higher monthly expense with the total offset by the profits on your past home sale. Furthermore, theres property taxes, utilities, home improvement/maintenance, etc. Your primary residence will probably not produce a dollar of cash flow.

Enter the rental home market. Instead of adding to your expense column you can invest your money into a home for tenants. Sites like airbnb have made this incredibly easy for vacation spots. Some people even rent guest rooms in their own homes to offset their housing costs. For me, it makes sense to invest in an asset that tends to increase in value over time, although this is not always the case, while I can put it to work and pay off its expenses and maybe even a little extra. To take it a step further the white paper previously mentioned suggests that the lower volatility will protect my downside in case things go wrong as opposed to the equity markets which are heavily correlated across the globe.

If you can fit it into your budget and are willing to do the due diligence consider investing in a rental property. I mean not to discourage you from home ownership because it is something incredibly rewarding that I look forward to one day. I mean to challenge your thinking so you can minimize your expenses and optimize your savings.

Whether you like what I said or hated it feel free to reach out at founders@themodernpiggybank.com and follow us on twitter @themodernpiggy2.

Trade Like A Quant

Sometimes dubbed the rocket scientists of Wall Street the meaning of quantitative analysts often takes on a broad meaning. Quant is a fairly broad term honestly, but roughly means someone who takes an extremely mathematical approach to the markets. While some quants use Einstein level math there are some practical lessons you can take away to use in your own portfolio.

More than anything quantitative analysts apply a rigid rules based approach to the markets. They have specific buy and sell signals that they adhere to religiously and consistently. This is where their great returns come from(if their algorithms are correct). While some get blamed for things like the flash crash where the DOW dropped 9% in minutes it would be wrong to say that it was the strangest thing to ever happen in market history. A signal for a quant could be something as simple as the 200 day moving average or as complex as analyzing S&P 500 futures contracts volume and expiration and placing an order nanoseconds before the futures expire and pocketing the spread, which is the high frequency trading world.

So how can you apply this? Well a buy and hold strategy sounds great in theory, but its harder to stick to in practice. Sure its easy to say when the market has not had a down year since 2008, but it would have been really hard to hold onto your portfolio is 2008 when the US equity market shed about 40%. If you haven’t experienced a massive drawdown like that imagine draining half of your savings.

So if you are someone who can’t weather massive drawdowns, and we don’t blame you if that is the case, consider taking a rules based approach. It is great to have an investment plan that you can stick to and might even help you sleep better at night. Here is a simple rule to get you to start thinking about what you might want to do:

Apply a short, medium, and long term moving average to your portfolio. When conducting your rebalancing, best done once a year for tax benefits, tilt most towards the assets in upward trend above the moving averages, more towards the one that are not trending as strongly above one or two of the moving averages, and least towards those in a downtrend under the moving averages.

Note: This can be considered a trend following approach and is a popular investment style that may or may not suit you. Over time strategies go in an out of favor so its often wise to pick a strategy that you understand and believe in and stick with it over the long term.

Building wealth takes strong discipline and taking your emotions out of investing by applying rules to a strategy that works can often help mitigate bad decisions.

Don’t Let Trading Fees Eat Your Profits Away

There’s no point to keeping extra expenses in your life, it just weighs you down in the end. Like we said before, a dollar saved is a dollar earned. Get rid of cable and pay for streaming services of what you watch, get a credit card tailored to your most popular purchase category, cook more, etc. There’s a lot that can be done. Your portfolio is a steak, do you want a fatty piece or a lean piece that will marble when its cooked and not char? In today’s day in age, when you’re managing your investments, the same thing can be done.

Traditionally, there were very high broker and platform fees. You’d even pay commissions if you were placing orders for stocks over the phone or online. Fees have gotten lower for discount online brokerages where now instead of commission, platform fees, or managing fees, you’re paying per trade. Sometimes as little as $5 per trade. And while this seems cheap, for most people starting out these trading fees can really add up and significantly decrease your invested capital.

Younger investors in their 20’s and 30’s have flocked to Robinhood which uses Apex Clearing Corp. as their clearing house because it charges $0 in fees overall. It doesn’t offer all the bells and whistles like other online brokerages such as extended trading hours or research but you can upgrade to premarket and after market hours for a minimal sum. You even have the ability to leverage your capital up to 3x which is a nice feature for more experienced investors and people looking to amplify their returns. Quick disclaimer: Leverage trading is highly risky and we do not recommend it.

So now you have an online brokerage that you hooked your bank account to for free. But businesses need to make money and now you’re probably wondering how they make theirs. To keep it simple, they invest your uninvested capital. Don’t worry, your capital is still yours to invest as you wish whenever you wish. It’s also been rumored that they also sell your order flow and trading information to High Frequency Trading firms (HFTs or firms that trade using algorithms). If these rumors are true, they sell this information for a higher premium than your traditional brokers. This shouldn’t change your investing habits unless you are trading large blocks of shares at once.

For us at The Modern Piggy Bank, we use Robinhood for our discretionary accounts and allocate only a fixed percentage towards it after allocating into our other investment accounts like a Roth IRA and 401k’s using more traditional platforms like Fidelity which recently just announced that that they were offering zero fee ETF’s from Ishares in what will be direct competition to Robinhood.

Just know your cost of investing is less than what your father paid, and less than his father. You don’t have the excuse of having hidden costs or that you’re paying fees for x,y, and z. So don’t make excuses when you can make money. We truly do trust Robinhood implicitly when it comes to our money and our accounts. While we would like to see more features added in the future if you see us on our phones, it will most likely be us with the Robinhood app open checking our portfolios.

Main Street’s Edge

One thing that new investors, myself including, usually grapple with is the belief that investing is a zero sum game. There is a winner and loser on every end of a trade. Furthermore, another hesitation plaguing retail investors is the belief that Wall Street has the edge with their superior research and execution ability.

The bad news is Main Street is completely right. In the short term, trading is a zero sum game, there will be a winner and loser on either side of a trade. This is especially true when we look at the options and futures markets. If that’s not bad enough, fund managers have armies of PhDs at their disposal to conduct cutting edge research and legions of engineers designing computer systems to place trades in nano seconds essentially cutting the line in the execution queue.

If you’re still reading good! There may be hope for Main Street yet. First, I would challenge you to think long term. Investing education is fundamentally flawed in the sense that most people learn that the best way to invest is to pay close attention to a handful of hand selected stocks. This causes us to over trade and exposes us to a lot of unnecessary risk. If we look at the major indices we see a steady increase over time. This makes sense because as the economy expands due to things like population growth which increases the labor force, technological advances which makes workers more productive, etc. All of this steadily increases corporate earnings which is reflected in the steady increasing of major indices like the S&P 500.

In the past 90 years an investor could expect a 10% return annually on average from the S&P 500, though don’t take this at face value because annual returns fluctuate widely. A modern investor could capture this utilizing the ETF SPY or the Vanguard 500 fund which have both minimal tracking error and costs. You would continue to collect dividends, eliminate single company risk, and significantly outpace inflation in the long term all at a cost of less than 20 basis points per year.

So why doesn’t Wall Street just buy and hold if it’s that easy? If you look at a hedge fund’s fee structure you may see that most charge 2 and 20. 2% on your total account value and 20% on returns. The truth is Wall Street relies on investor money to pour in to make money. To attract that money they have to outperform the benchmark S&P 500 and unfortunately few managers can consistently outperform ultimately resulting in being canned by their investors. This is not to say that all money managers don’t deserve their paychecks. In fact, there are countless managers who provide amazing strategies that outperform with low correlation to the equity markets you just have to do your due diligence to find them.

The edge that the small investor has is that they can buy and hold over long periods without having to answer to stakeholders. While money managers were begging people to stay in 2008 the average investor could smile and pour more money into their IRAs buying US equities at huge discounts.

“Our favorite holding period is forever” -Warren Buffet

A prime example of this is Warren Buffet. AQR published a paper on how he generates his alpha, a measure of market outperformance. They concluded that Buffet’s philosophy of buying and holding great companies trading at fair prices outperforms because of two main factors. First, Buffet believes in his strategy as his market holding period is “forever.” If you’re still not convinced, Buffet has seen his holdings decline by over 50% on two separate occasions in his career. His sheer ability to sit through massive drawdowns is a big reason he is regarded as the greatest investor of all time. Second, he is able to strategically apply leverage, a concept we’ll discuss in articles to come.

So there you have it. As a retail investor you have the luxury of not answering to stakeholders who want consistent outperformance and are less tolerant of drawdowns which every portfolio is subject to. Of course you have to have the discipline to sit through them, but being able to accept market returns over long periods of time is usually all the edge an investor needs to build wealth.