Wednesday, January 10, 2018

Warren Buffett Wins His $1,000,000 Bet

Ten years ago, Warren Buffett bet hedge-fund manager Ted Seides that an investment in a passive index fund would outperform a handful of hedge funds over a 10 year period. The bet was for one million dollars, which would go to the charity of the winner's choice.

That bet has now officially ended and, no surprise, Buffett won. His index fund of choice, the Vanguard S&P 500 Index Fund Admiral Shares (VFAIX), returned a 7.1% annualized return compared to the group of hedge funds Seides chose, which returned just 2.2%.

That adds up to a big difference. Buffett's investment almost doubled in value, while the hedge funds' only increased by about 25%.

Not only that, but years ago, the wagers from the bet were invested into the B shares of Berkshire Hathaway stock. Those shares are now worth $2.2 million. That's a nice gain for the winning charity, Girls Inc. of Omaha, too.

Two Keys To Winning

The first key to winning this bet was the time frame. Ten years is a long time. In fact, after the first year of the bet, the hedge fund was actually ahead - Buffett's index fund had lost 37% while the hedge fund lost only about 24%. But as time passed, that edge evaporated.

The second key was costs. Vanguard's fund has an expense ratio of only 0.04%. For every $1,000 invested, they take $0.40 in fees. We don't know what hedge funds Seides selected, but the typical hedge fund charges 2% plus 20% of any gains. In other words,  for every $1,000 invested, they take $20 and, if they make any gains, they take an additional 20% of those gains!

Think about that. For your investment in a hedge fund to simply equal the performance of the index fund, the fund manager would have to beat the market by 22%, year after year. This simply isn't possible.

John Bogle, founder of Vanguard, investigated the results of actively managed funds, such as hedge funds, over the long term. Not one managed to achieve that sort of performance. Ever. Few could even do it for one year. John Bogle wrote an entire book proving it. He founded Vanguard based on that premise.

But stock picking is sexy...

Everyone loves a tale about someone who invested $100 in Apple or Google decades ago and is now a gajillionairre.

People also win the Powerball.

Against all odds, these things do happen.

Sorry to be the one to tell you, but neither of these things will happen to you.

That's not a judgement on your abilities or intelligence. It's simply a statistical fact.

Here's another statistical fact:

No long term, buy and hold investor has ever lost money with a low cost index fund.

Ever. Even if you bought at the peak of the market before any major crash since 1928.

See my post here for details.

If you want to grow your wealth over your lifespan, stick with low cost index funds.

Wednesday, January 3, 2018

Goal Update: End Of December 2017

At the end of each month, I post an update of my goals, including a brief discussion of any notable events that might have occurred during the month. The latest month's figures can always be found under the Featured menu in the menu bar at the top of the blog.

Last updated: End of December, 2017
Current value: $39,379
Change from last Month: +1,829
Percent of Goal:  36.21%

Note that the funds in this account are invested in stock, so there will be fluctuations in value that are outside my control. I never withdraw money from this account, so any dips are purely due to stock price changes.

Looking at the above chart shows I saved just over $10,000 towards the Tesla in 2017. Not bad. But I hope to increase that amount in 2018. More details to come!

Events Of Note Last Month:

My SQL courses on Udemy generated $71.74 of income. Those courses also generated $30.47 on SkillShare.

I sold my virtual currencies and made $473.17 profit.

The cash backed naked puts I sold last month ended up expiring out of the money, which is good. I wrote about this and my overall experience selling naked puts two weeks ago here.

Update On Previous Posts 

In October, I wrote about a company called M1 Finance that offers "pie-based" investing with free portfolio rebalancing. At the time I wrote that, they charged a small, completely reasonable fee for their service. Good news! They are now a completely free service! Read my updated post about them for more details.

Net Worth Update

Our net worth increased by $19,436 this month. You can see our cash reserves took a dip and our credit card balances rose slightly. This was due to holiday expenses. We did a lot of traveling from Washington to Arizona to see family and, of course, also did lots of gift buying. If you look at these monthly figures, it may seem like we are always carrying a credit card balance. We do not. I use a credit card for almost all purchases, but pay it off each week. I wrote a two part series of how to use credit cards responsibly - part one is here and part two is here. I talk about how I use them in part two. (And speaking of credit cards, remember to ask for a credit limit increase this year! It might actually improve your credit score.)

I also moved a 401(k) from an old employer into an IRA. The total value of that was about $85,000. That's why the figures below show the value of my Investments going up a bunch and my Property values dropping. couldn't access my old 401(k) provider's website, so I had to enter it manually, which causes Mint to lump it into the Property category. The figure now shows up in the Investments category, where it belongs.

November 2017
December 2017

Here's hoping you have a prosperous and happy 2018!

If you have any questions or suggestions for topics, please drop me a line in the comments section!

Wednesday, December 27, 2017

401(k) Contribution Limits Have Increased For 2018

The start of a new year brings with it many things and I’m not just talking about a bunch of resolutions you will break before February first rolls around. I’m talking about important stuff - stuff that will alter your paycheck.

Your Paycheck Is Going To Change

New tax rates go into effect at the first of the year, so you’ll likely notice the amount you have withheld in taxes changes. You could end up with a slightly bigger or smaller paycheck in 2018.

One change in 2018 that people may overlook is an increase in the contribution limit to 401(k) and 403(b) plans. The maximum amount you can contribute to these plans has increased by $500. The new maximum is $18,500. Few people actually reach that maximum, but if you were one of those people in 2017, you can now add a bit more to your savings in 2018.

As a side note, this is the first time this limit has increased since 2015.

If you are 50 years old or older in 2018, the catch-up contribution limit remains unchanged at $6,000. So if you will turn 50 years old in 2018, your maximum 401(k) contribution is $24,500.

Others Changes Are Also Happening

There are also changes to the amounts you can contribute to traditional IRAs. The phase-out income limits for who can contribute to Roth IRAs also changed. See this page at the IRS website for a list of all the retirement savings-related changes for 2018.

Make Changes, But Do So Carefully

If you are one of the lucky ones that is able to max out their 401(k) contributions, be sure to increase your contributions in January. But when doing so, please keep in mind that if you increase your contribution too much, you may end up missing out on some company matching. See my previous article here about this.

Wednesday, December 20, 2017

Option Writing For Passive Income Part Two

Back in August, I wrote about making passive income by selling cash backed naked puts. If you haven't read that post, I suggest you first go back and do that now. After four months of doing this, I thought I'd post about how it's going so far.

I made four trades total, each time selling 5 or 6 contracts with an expiration date three to four weeks out. Details of three of those trades can be found at these two posts. The fourth trade ended the day I am writing this (Dec. 15) when the options expired out of the money. Last week, Realty Income stock dropped and I thought there was a pretty good chance I would be called and have to buy the stock. However, the stock rallied 2 points this week to close at just over $57. My $55 options expired out of the money. This investment netted me a 9.11% annualized ROI

Compare This To Straight Out Buying The Stock 

The total amount of money I have received from trading naked puts since August is $899.70. How does this compare to if I had just bought the shares outright?

I sold my first puts on August 10. At that time, I sold 5 contracts, which translates to 500 shares. My other three trades were for 6 contracts, or 600 shares. So for this comparison, let's assume I bought 500 shares on August 10 and another 100 shares when I sold my second put - October 6.

Realty Income also pays a monthly dividend. If I owned the stock, I would have received this money, but, as an option writer, I do not. Furthermore, the company also raised the dividend during this period. So this comparison needs to include any dividends I might have received. (For the sake of simplicity, I'm going to assume I would not have reinvested the dividends and instead just took them as cash.)

The closing price for the stock on August 10 was $57.02. This would have been my cost to buy 500 shares. The closing price on October 6 was $56.48. This would be been my cost to buy an additional 100 shares, bringing my total shares to 600.

Had I bought the shares outright, my total gain would have been any price appreciation of the stock between when I purchased it and today plus any dividends received. Since my last batch of options expired today, we'll take today's closing price of $57.40 as a sell price for this comparison. My options figures include commissions, so we'll also take those into account for the stock purchase scenario.

Here are two tables showing the calculations. This first shows gains from the stock price going up. A negative price indicates a purchase, a positive price, a sale. The second table shows the dividends I would have received. The Dividend Record Date is the date I have to own the stock in order to be eligible to receive the dividend. The Dividend Payment Date is when the dividend is paid.

A Hefty Increase

As you can see, had I bought the stock outright, I would have made $733.30.

By selling naked puts, I earned $899.70.

I made 23% more by selling naked puts!

It Gets Better

And let's look at this another way to see how it can get even better. Assume the stock closed below the option strike price ($55) today and my options were called. I would be forced to buy the stock at $55. But don't forget, I've already been paid $0.40 per share to sell the option in the first place. Now let's also take into account the money I received from the previous three times I sold puts that were NOT called ($.55, $0.30, and $0.40 per share), that means I've already received a total of $1.65 per share. So if I had to buy today at the option price of $55, my actual net cost would be $55 - $1.65 or $53.35 per share. That means I would only have lost money if the stock closed below $53.35 per share. That's quite a bit of downside protection built in!

The more astute of you will realize that the more times I sell puts that are not called, the greater my downside protection becomes.

What's The Catch?

So why doesn't everyone do this? That's a good question. My overall profit was helped by one big factor - my options were never called. I was never forced to exercise the options, so I maximized my investment. I'd like to think this is because I'm a fantastic stock picker, but I'm not. In the long run, no one is. I happen to know this stock fairly well because it's been my main investment for over a decade.

The market is still volatile and things could have gone differently. If the the stock experienced a rally, I would have missed out on it. The price could have dropped a lot and I might have been forced to buy at a price over market value.

But here's the thing: I'm completely OK with my options being called. I wouldn't mind paying slightly over market value for this stock. Obviously, I would prefer my options are not called - I'll take that extra 23%, thank you very much - but I like the underlying stock and I would have no problems owning it. So this is pretty much a risk-free investment for me: If the options aren't called, I keep the money and do it again the following month. If they are called, I buy the stock and hold on to it. I'm happy either way.

I'm trading earning extra cash and getting a higher ROI now for the possibility of missing out on a big price increase. By only selling options with 3 or 4 weeks until they expire, I'm also minimizing this risk somewhat.

Make Some Extra Cash Before You Buy

Not everyone is in my position. This won't be a suitable investment strategy for many people. However, if there is a stock you are looking to buy, it might be worth your while to investigate this investment tactic as a way to pick up some extra cash as you buy the stock.