Finance 101: From the Simple Dollar, retirement on $1,000,000

Just a quick shout out to one of my favourite blogs, The Simple Dollar.  Yesterday’s entry on how to retire on $1 million (or if it can be done) well-illustrates the type of basic analysis underpinning retirement planning calculators everywhere.

My only caveat with the analysis, like most of these simple ones, is the sensitivity to assumptions.  This article tries several types of assumptions, which makes the thing stand out (in my opinion).  But particularly when long time periods are involved, small changes in assumptions can drastically change results.  Given we have basically no idea what the correct figures will be, caveat emptor for those placing too much reliance on one run of the ‘simulation’!

Sadly there isn’t a good fix for unknown parameters in the analysis, but rest assured I’ll let you know when I have a reliable crystal ball.

Confidence runs high; I’m Vix’ed out

Maybe I’m a one-trick pony.  I just happen to like playing the Vix – in particular, the Vix-related derivatives.  There are 2 main ways I like to do this:

  1. Just short it: I take advantage of a few related characteristics to short the Vix via UVXY.  In particular, I like that UVXY is the prototype of a bad long-term buy, so I short the product using medium-dated options.  After biting my nails during the past couple months’ market volatility, this trade finally hit pay dirt.  I’m out of my latest iteration as of today, after holding about 2.5 months.
  2. Spread it: when the markets get really scared, the Vix futures curve looks like the red line below (from previous post):
    Mmm...backwardation.  Source: thinkorswim by TDAmeritrade

    Mmm…backwardation. Source: thinkorswim by TDAmeritrade

    Today that red curve looks much more normal, as we’re back to daily all-time highs:

    All back to normal.  Source: thinkorswim by TDAmeritrade.

    All back to normal. Source: thinkorswim by TDAmeritrade.

    I took off the latest iteration of this trade yesterday.  About 3 weeks of holding time.

What have I learned?  First, it’s great to learn with successful trades.  My theses were researched and executed when the time was right.  Most importantly – in my mind – is patience: at one point I was looking at some pretty solid losses on the #1 trade as the Vix kept climbing higher.  Nevertheless, that’s why I chose medium-term options to express the trade, and ensured I had a manageable maximum loss at initiation of the trade.

Trading strategy – discipline over complexity

With investing, as with life... Source: Google Images

With investing, as with life… Source: Google Images

First of all, a confession: I’m becoming a Twitter junkie.  Maybe it’s due to being alone most of the day, but the trading community on Twitter is fantastic.  So I enjoy indulging in various conversations around market events and trading philosophy.  Anyone interested can find me at @financialpiggy8

So.  One of the Twitter conversations of late has been around HFT scamming, and included some pretty senior folks in the finance space.  The worries are around what data HFTs get versus the ‘average’ guy, and what that might cost us as individual investors.  Beyond the actual data feeds, I mused on some related issues/generalities:

  • Trading strategies follow Occam’s Razor: in general, simpler strategies are more robust.  At least, that’s what I have found trading at a variety of different time frames.  I think many folks unaccustomed to trading believe there’s tremendous complexity in what traders’ strategies contain.
  • Key to trading = discipline: I struggle with keeping discipline.  I’m completely in agreement with several fellow traders on Twitter that espouse the less-interesting parts of being a trader.  Namely, consistency towards rules.  It’s no accident that many traders fail due to strategy neglect – trading too large/too small, ignoring entry/exit signals, etc.  The prime example of a successful trader is someone with a solid routine, hopefully with no emotions attached.  Hence the following point.
  • Automated trading = automated discipline: seeing as I have pretty bad discipline (in my opinion), I outsource the discipline to my computer.  Now my weakness is pretty much limited to turning off the system when I shouldn’t (to wit: I have turned off the system far too many times; each time has been costly, in terms of missed opportunity).
  • The bigger picture – why we pay financial advisors/fund managers:  people like me – interested in markets, anxious to overtrade, etc. – can also impose discipline by paying an advisor or fund manager to make all decisions.  I can say with full confidence that, for many people, the 1% charged by a financial advisor is well worth the market tracking error compared to managing/overtrading their own assets.  We can debate whether other options are a better deal here (e.g. robo-advisors charge less for the similar effect, as could diversified ETFs held forever), but the point is to stay away from self-destructive overtrading or overcomplicating matters.

In sum: the more complicated a trading strategy, likely the worse it will perform in future.  Discipline is crucial in trading, as with investing.  If you can’t keep discipline, consider hiring someone/some computer to make decisions on your behalf.

Friday reading: Andy Haldane of BoE on World Growth

I’m a big fan of Andy Haldane’s economic work.  An old favourite is his work on value investing versus momentum investing over VERY long time periods.

Anyway, his latest speech on economic growth is very interesting, well-researched, and utilises some great economic history to make a typically economist conclusion (i.e. ‘on the one hand…’).  In a testament to how visualising data can really guide opinion, I present the below from the speech:

Pretty interesting stuff.  Source: BoE

Pretty interesting stuff. Source: BoE

Huh.  But that leads to this exciting chart (NB: note how arithmetic scale makes this much more powerful):

Whoa... Source: BoE

Whoa… Source: BoE

Happy Friday!

Greeks, Germans and Game Theory

Maybe I’m too deep in the weeds, but the whole charade between Greece, Germany and the rest of the EU seems like a case of ‘truth stranger than fiction’.  Here’s what I gather so far, mainly from reading Bloomberg and a Twitter stream full of insightful people (NB: once started with Twitter, it becomes extraordinarily addictive; not unlike financial markets):

  • Greece survives due to the largesse/pleasure of creditor countries within the EU.  Remember who has the power?  If the credit tap is turned off, Greece will default.  Bank deposits have fled the country so fast, there is no chance to finance itself in Euros.  Simple as that.
  • The timeline is a bit fuzzy, but seems to be end-February.  If nothing is done before then, Greece is a goner.
  • If Greece defaults, the following is likely:
    • A very uncertain time, as folks attempt to figure out how an ‘orderly exit’ from the Euro could take place – there is no template, nor legislation, for how this would work.
    • Bond yields for other countries surviving on EU credit, e.g. Spain, Portugal, Italy, will likely spike higher.  Who’s to say they won’t be ejected as well?
    • I’m unsure what happens to the Euro.  I suppose it depreciates, as event risk becomes more of an issue.
  • Greece’s government has the explicit (perhaps necessary and sufficient?) mandate to  exit the current bailout arrangement while maintaining Euro membership.  Though the campaign speeches said this would be easy, it’s turning out not so easy to achieve both objectives.
  • In my opinion, Greece’s ace up its sleeve is Yanis Varoufakis, the Finance Minister.  He used to teach game theory, which one would assume is very useful for this type of goal achievement.  His methods have been definitely interesting to watch/read:
    • Rhetoric completely shutting down the possibility of extending the status quo.  In other words, things will definitely change.
    • Pointing out the damage a Greek exit would cause for the EU.  A sort of “don’t cut your nose to spite your face” argument.
    • Proposing relatively new financial instruments – e.g. GDP growth-linked bonds.  A good idea, but controversial for moral hazard-concerned creditors.
    • Continuous confidence in a solution which will suit Greece.  Establishing the inevitable.
  • Once negotiations began, Germany’s hard-headed Finance Minister, Wolfgang Schäuble, played the ‘bad cop’ in excellent fashion.  Basically shut the door on any extension that varies the terms of the previous bailout.  Doesn’t care about fallout – he announces all is OK.
  • In the middle are Michel Sapin, France’s Finance Minister, and Jeroen Dijsselbloem, the Dutch Finance Minister.  They’re obviously trying to mediate this clash of titans, hoping to navigate the two most extreme outcomes:
    • Unconditional Greece win: extremist parties in Spain and elsewhere win elections, then campaign for similar packages.
    • Unconditional German win: Greece default, with above consequences; a demonstration that budgetary discipline will be hard-met (a problem for countries like Italy and France).
  • The methods used for this fight, beyond the usual meetings of ministers, is striking.  Newspapers, blogs, everything.  The term ‘Sources say…’ has been used so much, it’s incredible.  The amount of disinformation is also incredible – as if both Germany and Greece have full-time PR wonks writing increasingly provocative statements against each other.  This morning’s move in the S&P is a good example when both sides get to the rumour-mill:
Timeline: Greece is screwed.  Then Greece is saved!  Then Germany says 'nein'.  Source: thinkorswim by TDAmeritrade

Timeline: Greece is screwed. Then Greece is saved! Then Germany says ‘nein’. Source: thinkorswim by TDAmeritrade

  • Where does that leave us?  The markets are still hitting all-time highs, so clearly everyone expects a last-minute deal.  Given the EU’s history, that’s probably a safe bet.  In the meantime, folks like me sit chewing fingernails – my trading system really believes in a fortuitous outcome, so I’m left hoping and praying.

In sum: I figured Greece did some sweet game theory-inspired strategising, in hopes of getting an extension under more favourable terms.  Germany has been absolutely, 100% defiant.  Though the markets are betting on a swift resolution, my stomach is more uncertain.  In the end, the Syriza guys can at least give themselves credit for using all available tools to make the best of a bad hand.

More market confusion

Yeah, this sums it up.  Source: Google images.

Yeah, this sums it up. Source: Google images.

I’m confused.  Let’s review:


  • Greece, despite some excellent game theory usage, looks ever more likely to drift into capital controls at the very least, and perhaps full ejection from the Euro.
  • Ukraine’s ceasefire lasted…oh…a few hours.
  • US equity markets now trade somewhere around 20-21x earnings.  Well above long-run average.

In sum: these moves kinda give me the heebies.  Glad to have a system trading for me.  With the long-run portfolio, I’m slowly but surely decreasing exposure to equities.

Finance 101: follow the interest rates, or carry is king

Interest rates are all the rage these days in the media: various countries are cutting base rates to below zero (an idea once thought impossible, called ‘the zero bound’).  The latest culprits are Scandinavian countries Sweden and Denmark – their economies are closely tied with the Euro-area, so the quantitative easing from the latter increases pressure on the Scandi countries’ exporters.  Enter negative base rates.  Longer-term interest rates have fallen as well, with multiple governments now able to borrow at near-zero for 10-year loans.

With all this in mind, let’s consider the big picture, and implications for individuals.

  • Definition: an interest rate is the cost to the borrower for getting money now, rather than later.  Seen from the other side, the interest rate is the return to the lender for giving up money now, rather than later.  The interest rate is an example of carry, or the return to an investor for holding an asset (in this case, a loan/bond).
  • Usage: we can use the interest rate to help judge one debt versus another.
    • Borrower’s perspective: suppose you have several loans outstanding, or need to borrow, and are considering different types of loans.  Some examples, with typical interest rates are below, in descending rate order:
      • Payday loansaround 400% interest per year.  No security needed, and very short term.
      • Credit cardsaround 15% interest.  No security needed, and short term (balances can be rolled forward, as long as credit card company allows).
      • Peer to peer loansaround 10-15% interest.  No security needed, and medium term (3-5 years).
      • Student loansaround 5-10% interest for Federal loans; 7-15% for private loans.  No security needed, though sort of the ultimate security: you can’t get rid of these loans through bankruptcy.  5-15 year term.
      • Home equity loansabout 6% interest.  They’re 2nd mortgages on your house. 5-15 year term.
      • Auto loansaround 4% interest.  Car title held as security; medium term (3-5 years).
      • Home mortgagearound 3-4% interest.  House title held as security; long term (15-30 years).  In the US, mortgage interest is tax-deductible at your highest marginal rate, so the effective interest rate may be much lower.
      • In sum: if I had several types of debt outstanding, I would probably pay them off in the order above.  If I needed to borrow, I’d probably borrow from the bottom up.
    • Saver’s perspective: suppose you have some cash to put to work, and are choosing between the options.  Rates help us here, as the interest rate is the maximum return you will receive on your investment.  There is a clear risk – return trade-off, though.  Anyway, in ascending order of interest rate/risk:
      • Savings accountabout 0-1% interest.  Instant access, and government-insured.
      • Certificate of deposit/fixed savings1-2% interest.  Government-insured.  1-5 year term.
      • Government bonds (Treasuries)0-2.5% interest.  Government-issued.  30 day-30 year term.
      • Corporate bonds1-6% interest.  ‘Proper’ credit risk – you may not get back what you put in.  Typical 5-year term.
      • Peer to peer lending5-15% interest.  Lending to ordinary folks, with no collateral.  3-5 year term.
      • In sum: pick your poison.  If you need the funds at any time (e.g. an emergency fund), better to stick with the earlier entries on the list.  If you’re looking for more risk, head on down the list.  Keep in mind rates are at all-time lows in most places, so maybe keeping with short duration (i.e. sticking with shorter-term stuff) is a safer play.

There you go.  Other types of carry (e.g. dividends, rental yield) we can pick up later.