What is a stock?

June 12, 2015

A stock certifies an investor’s share of beneficial ownership in a company.  Beneficial owners are entitled to protection from liability for any of the company’s actions while receiving dividend payments from the company (at the pleasure of the company), voting on issues of corporate governance, and either selling their shares in the stock market or sharing proceeds from a liquidation of the company.

Each share is equally valued in proportion to the total number of outstanding shares issued by the company. Capitalists initially obtain shares in a private market known as the primary market and can chose to sell their shares to individual investors in a public market known as the secondary market. The secondary market is better known as the Stock market.

Here’s an example of an old fashioned stock certificate:

stockcertificate

Stock certificates were printed and distributed to shareholders who then assumed responsibility for safekeeping and transferring the certificate. The loss or destruction of a certificate meant the loss of an investment and stock transfers were a time-consuming, administrative process. Owners generally held their certificate for a long time in order to earn a satisfactory profit from dividends and growth of the stock’s price. Speed trading was unheard of before today’s methods of electronic bookkeeping and online trading platforms. Now, a responsible custodian maintains all records of stock ownership on behalf of the investor.  Confirmation messages and periodic statements provided by the investor’s brokerage firm serve as proof of ownership.

The reason that investors buy stock is to earn a profit by accumulating dividends and selling shares. Investors can protect their interest by voting on corporate matters such as board membership and executive compensation. In case the company files for bankruptcy, the proceeds from liquidation are theoretically distributed equally among stock holders according to the number of shares they own. In fact, the court-ordered company must first pay its debts, which means that corporate bondholders have priority over stockholders in receiving repayments of debt. Then owners of preferred stock have priority over common stock holders in receiving the residual funds.

Preferred stock is a hybrid form of bond and stock. The bond portion represents corporate debt to be repaid with guaranteed fixed-dividends and the stock portion represents an equity opportunity to earn capital gains without the privilege of voting rights.  Common stock represents an equity opportunity without guaranteed dividends but with voting rights. Preferred shareholders typically earn more dividends and common shareholders typically earn more capital gains.


Rates of return

March 20, 2015

Preview

The simple rate-of-return ( R ) is a measure of your investment’s profitability for any chosen time interval.  By comparison, the CAGR and IRR are rates of return that measure your investment’s profitability as if it were an orderly process with respect to time.  CAGR is the acronym for “compound annual growth rate”.  It is the constant rate at which an investment’s market value grows every year in a cumulative fashion.  IRR is the acronym for “internal rate of return”, which describes the performance of all cash flows in a financial project such as the individual investor’s program of dollar-cost-averaging or an investment club’s program of portfolio management.  IRR is an annualized rate-of-return when all time intervals are measured in years.

Return

Any profit from your investment is called a return.  There are 2 types of return: realized and unrealized.  Realized returns are cash payments from dividends, interest, and sales.  Unrealized returns are the market values of reinvested dividends and unsold holdings.

return = market value – cost  [equation 1]

Example 1: Suppose you invested $100 and held the stock for 5 years until its market value grew to $201.  From equation 1, you determine that your return is $101.  If you sell it, it’s a realized return; otherwise, it’s an unrealized return.

Simple rate-of-return

The simple rate-of-return ( R ) is a measure of your investment’s profitability for any chosen time interval, but time is not an essential factor in the calculation (equation 2).

 R = return/cost [equation 2]

R is reported as a decimal number or a percentage.

Example 2: The cost of an investment was $100 and 5 years later the return was $101.  From equation 2, R = $101/$100 = 1.01.  Multiply the answer by 100 to find the percentage.  R = 100×1.01 = 101%.

CAGR

The CAGR is a rate-of-return that measures your investment’s profitability as a growth rate.  Time is a factor in the calculation of CAGR (equation 3).

rate = (final/initial)(1/N) -1  [equation 3]

N is the number of events or time periods between

the initial and final values.

Example 3, simple R versus CAGR: The cost of an investment was $100 and 5 years later its final value was $201.  We know from example 2 that the simple R is 101%.  Using the growth rate formula from equation 3, we find that the CAGR is 15%.

Significance: CAGR is the acronym for “compound annual growth rate”.  It is the constant rate at which an investment’s market value grows every year in a cumulative fashion.

MATH: CAGR is a growth rate that describes the ‘future’ (or final) value of a single cash payment.  In contrast, the discount rate devalues a cash flow.  Both rates represent a common ratio that generates a geometric series of points aligned to a smooth curveref 1. Chart 1 illustrates the geometric series of an inflated and devalued investment.

 Chart 1.  Geometric series.

geometric series

In chart 1, the black circle represents a single investment.  The blue curve is a series of theoretical values related to the investment by a common ratio called the discount rate or the growth rate depending on the particular application.  The discount rate devalues the investment to lower values as a function of the time-period N.  The growth rate inflates the investment to higher values.  Both rates are calculated by the formula in equation 3.

IRR

Equation 3 is also used to calculate the IRR, an acronym for the “internal rate of return”.  The IRR is used to measure the profitability of investments with multiple cash flows.  It is a discount rate that balances all devalued cash flows in a financial project.

MATH: In the field of Finance, a devalued cash flow is called the present value.  The present value is found by revising equation 3 to calculate the initial value for time period N at a given discount rate.  The net present value of the project is the sum of all present values.  The IRR is the discount rate that sets the net present value to zeroref 2.  It is the best-fit discount rate found by an iterative process of trial and error.  The significance of the IRR will be discussed after working through example 4.

Example 4, IRR:  An investor paid $100 each year for 4 years to purchase and accumulate shares of a particular stock.  After 5 years the market value of all shares was $735.  Since the purchases were multi year cash flows, the IRR is a good choice for analyzing this investment.  In this example, the trial discount rate is 13.1%.  Table 1 (below) illustrates the analysis:

Table 1.  IRR analysis of the investment in example 4.

IRRanalysis

Row 1, N displays the time period in years for factor N of equation 3.  Row 2, ACTUAL is the series of investments that began with a $100 payment at time 0.  Additional $100 payments were made at the end of years 1 through 4 for a total cash outflow of $500.   The total market value of the investment was $735 at the end of the 5th year.  To determine the IRR, the present value ref 2 of every cash flow was calculated with the trial discount rate of 13.1% after rearranging equation 3 to solve for the initial value.  Row 3, DISCOUNTED is the series of present values for each cash flow in row 2.  Notice that the total present value of all cash outflows equals the discounted cash inflow of $396.65.  Therefore, the net present value is $0 and the 13.1% discount rate is the investment’s IRRRow 4, PROJECTED is the final value for each present value in row 3.  The final value is predicted by rearranging the terms of equation 3 and using the IRR’s 13.1% as a growth rate for the remaining time.  It’s no accident that the sum of final values in row 4 equals the $735 cash inflow in row 2.  Chart 2 (below) illustrates the growth curves for projected values.

Chart 2. Projected values for every cash outflow in example 4.

IRRinterpretation

In chart 2, N is the time period in years.  Each black square depicts an investment of $100.  Each blue curve shows the predicted growth of the investment.  Every point on a curve is a future value and the endpoint at year 5 is the final value.  The final values are listed in row 4 of table 1.  They decreased as the years progressed because there was less time remaining for growth.

Significance:  The IRR is a rate-of-return that describes the performance of all cash flows in an investment.  The IRR is an annualized rate-of-return when all time intervals are measured in years.

Time distortion

A positive CAGR or IRR always shows a profit.  Conversely, a negative CAGR or IRR always shows a loss.  Higher CAGRs and IRRs imply more profitable investments, but beware that those with short holding periods may grossly misrepresent the long term performance of an investment.

Example 5, time distortion:  Suppose that four different $100 investments grew to $200 apiece.  From equation 1, we know that the return was $100 for every investment.  If the holding periods were 10, 5, 1, and 1/5th years, what were the annualized rates of return?

Table 2.  Annualized- and Simple Rates of return

for different holding periods

TimeDistortionOfCAGR,IRR

Legend.  Equation 3 is used to calculate the annualized rate-of-return when the unit of time is in years.  For this equation, the “Holding period” is the value of N and “Final/Initial” is the quotient of $200 divided by $100.  The 4th column is the annualized rate-of-return calculated by equation 3.  The 5th column is the simple rate of return calculated by equation 2.

High annualized rates are desirable, but don’t feel exuberant about an exceptionally high annualized rate-of-return.  As shown in table 2, the annualized rate-of-return might temporarily be inflated by a brief holding period.  It’s unlikely that a short term investment could sustain the 3,100%, or even 100%, annualized rate-of-return in the long run.

Significance:  The passage of time decreases an annualized rate-of-return when cash flows are static.  ANY increase in the CAGR or IRR over time indicates a profitable increase of cash inflow relative to cash outflow.  It’s always wise to verify this impression by checking the payout of the project.

Conclusions

In the investment world, rates of return are measurements of profitability.  Positive rates indicate profits and negative rates indicate losses.  All rates of return are sensitive to the volatility of market prices; they rise and fall with the market.  The annualized rates of CAGR and IRR are exquisitely sensitive to short time periods; don’t get exuberant about high annualized rates before checking the time period and potential payout.  In the long term, annualized rates tend to decline unless supported by dividend payments and capital gains.  An IRR that is holding steady during the passage of time is revealing an underlying growth in market value.

Copyright © 2015 Douglas R. Knight

References

  1. Donna Roberts, Geometric sequences and series. Copyright 1998-2012.  http://www.regentsprep.org/regents/math/algtrig/atp2/geoseq.htm
  2. A. Groppelli and Ehsan Nikbakht. Barron’s FinanceFifth Edition.  2006, Barron’s Educational Series, New York.

2014

February 4, 2015

The SmallTrades Portfolio holds investments in five financial markets.  Tax expenses are reduced by trading the Portfolio’s underlying holdings in a tax protected brokerage account.  For tax reasons, any stock or exchange-traded index fund (ETF) issued by a partnership is excluded from investment.

The Portfolio has two subgroups:

  1. Established ETFs that are traded infrequently in the markets for global stocks, global gold, U.S. real estate, and U.S. bonds.
  2. Common stocks that are traded frequently in the U.S. market.

Both subgroups contain high risk investments which are expected to outperform a benchmark index called the Standard and Poors 500 Total Return Index.

The investment performances of the Portfolio and its benchmark index are measured graphically by plotting changes in the market value of an invested dollar (chart).

performance2014

For every dollar invested on the inception date of 12/31/2007, the market values of the Portfolio and benchmark index dropped by nearly half during the Recession year of 2008.  Recovery from the Recession left the performance of the Portfolio lagging behind the benchmark due to the underperformance of a large subgroup of stocks.  Starting in 2013, the Portfolio’s investment capital was gradually shifted from stocks to ETFs and the result was a gradual rise in market value.   Starting in 2014, the ETF for emerging-market stocks (VWO) was replaced by one for global stocks (VT).  At the end of 2014, the market values of the holdings were distributed into a 79.4% portion from ETFs and 19.7% portion from stocks (table).

 portfolio2014

The Portfolio’s performance is measured statistically by its compound annual growth rate (“CAGR”) of market value since inception.  The performance improved during 2014 (CAGR -3.3%) compared to 2013 (CAGR -5%), but still lagged the benchmark index (CAGR 7.3%) and U.S. inflation of prices (CAGR 1.8%) by considerable margins.

Calendar year 2014 was the inaugural year for graphing the performance of the ETFs and Stock subgroups.  The following chart shows that stocks outperformed ETFs during the first year of assessing subgroups.

subgroups2014

ETFs subgroup

The ETFs subgroup is designed to match the performance of financial market indices for global stocks, U.S. investment-grade bonds, U.S. real estate, and global gold bullion when equal amounts of cash are invested in each market.  The market indices for global stocks and U.S. real estate are expected to outperform the U.S. bond index.  The gold index is expected to fluctuate according to changes in investor sentiment for stocks, bonds, currencies, and commodities.  The gold index typically moves moves up when investors seek the gold market and down when investors seek other markets.

The main risk of losing money from established ETFs is derived from a large decline in market prices.   Consequently, the risk management strategy is to rebalance every asset class to 25% of total market value when any asset class drifts below 18% or above 32% of the total market value.  Drifts did not trigger a rebalance of asset classes during 2014 (chart).

ETFassets2014

Stocks subgroup

The investment strategy is to buy stocks at a discount price and sell them at a premium price.  Discount prices are selected from undervalued companies in several ways:

  • Use of a stock screen
  • IPO’s of potentially successful companies after the first day of public trading
  • Media disclosure of good companies
  • Previously owned stocks

Premium prices are discovered by setting alerts for rising prices and placing conditional sell orders in the broker’s trading platform.

The typical holding is selected by a stock screen, held less than one year, and sold with a conditional sell order.  Small-cap stocks characteristically offer better growth potential and higher returns – but at a higher risk – compared to large-cap stocks.  Consistent with the Portfolio’s high-risk investment goal, the total market value of the Stocks subgroup is divided into portions of 22% for large-cap stocks and 88% for lower capitalizations (chart).

MktCaps2014

Conclusions

The SmallTrades Portfolio is an unleveraged, diversified collection of high-risk securities that are traded in the U.S. stock market.  The Portfolio continues its gradual improvement in performance following the 2008 Recession, but its performance still lags that of the benchmark index.  Acceleration of the Portfolio’s performance will depend on the future resurgence of stocks in the emerging markets coupled with high performance of the U.S. real estate market.  Rebalancing the Portfolio’s holdings is expected to partially offset the potential loss from a future declining market.

Copyright © 2015 Douglas R. Knight


Conditional orders for stock trades

September 6, 2014

[The basic concept of ‘price diligence’ was inserted on 3/20/2015.  The MockTrades planner was updated on 12/11/2014]

Introduction

Individual investors typically use a market order to buy and sell stocks, ETFs, and REITs.   Market orders activate the trade immediately at the next available price; this controls the time rather than the price.  You can exert more control over trading conditions by placing a conditional (a.k.a. advanced, automated) order.  Conditional orders are considered a form of ‘price diligence’ because they specify the share’s price for activating the trade at any time during approximately 60-90 days, depending on your brokerage firm’s expiration date.  The conditional order controls the price rather than the time of the trade.  After reading this article, you may wish to download SmallTrade’s MockTrades4 for free; it’s uniquely designed to account for market volatility when planning a conditional order.

The trading arena; a simplified description

Stocks and other securities are traded for cash by an auction process in the stock market.  The participants are investors who make offers, brokers who generate orders, and traders who finalize the orders.  Individual investors submit offers to brokers through a computer terminal or by direct communication.  Use of the computer terminal gives the illusion of directly participating in the auction process, but there are several intermediary steps occurring at the speed of light along with a few brief delays.  The first delay is at the brokerage firm where all offers are filtered, recorded, and transmitted to traders in the stock market.  At any moment in the stock market, there are millions of orders to buy and sell securities.

The broker’s computer program, called a trading platform, provides investors with a market quote plus commands for placing a trading order.  The market quote reports a current purchasing price (“ASK”), sales price (“BID”), last-traded price, and latest number (a.k.a. volume, quantity) of traded shares (a.k.a. units).  Valid trading orders are announced to all market participants and filled at the next available price. The next available price is determined by an auction of the available shares for which a trader serves as the auctioneer.  The price can fluctuate between trades and is not protected from fluctuation until the order is filled.  Brokers and traders are always paid a fee for their services.  Custodians are hired by brokers to store traded securities in electronic accounts on behalf of the investors.

Trading orders

As an individual investor, you may place one of several types of trading orders in your broker’s trading platform.  The simplest, called a market order, merely specifies the number of shares to be traded.  The market order is filled immediately unless a time delay is imposed by an undersupply of available shares.

A limit order specifies the preferred price of the trade.  This order is filled when the next available price either matches the limit price or provides a better price {in other words, the limit price is YOUR minimum selling price or maximum purchasing price}.  There is only one opportunity for the limit order to be filled after it is placed in the market.  In rare instances, an unusual market event may shift the next available price out of your limit’s price range, in which case the order is cancelled without an exchange of cash for shares.  Your only recourse is to place a new limit order.  The limit order is used to protect from shifting prices.

Stop and stop-limit orders are useful for protecting against losses of investment capital.  The stop is a specific price at which your trading order will be submitted as a market order.  Your stop is stored in the exchange’s computer until it is submitted or expires at the end of a time period called the time-in-force (“TIF”).   The market order is then filled immediately at the next available price, which may shift to a better or worse price than the stop’s price.  The stop-limit is a specific price at which your trading order will be submitted to the stock exchange as a limit order.  It too has an expiration date.  The limit order protects your trading price until the order is filled, cancelled by the expiration date, or cancelled by an unusual market event. Your only recourse to a cancelled order is to place a new stop-limit order.

Trailing stop orders provide opportunities to seek a better trading price in the market.   The trailing stop is a specific point spread (1 point equals $1) by which the stop price will trail the movement of market prices toward a better price.  In general, the trailing stop can move toward a better price but won’t move toward a worse price.  The trailing price resides above or below the market’s price by the cash value of the point spread.  The trailing price adjusts upward with market prices when you offer to sell shares and downward when you offer to buy shares.  Reversal of the market price initially stops the adjustment of the trailing price and eventually triggers the submission of a market order.   The trailing stop order is stored in the brokerage firm’s computer until its expiration date or the submission of a market order.

Setting the stop

Trading platforms are designed to set stops above the ASK and below the BID of a market quote.  For example, when you offer to purchase shares with a stop or trailing stop order, a market order is submitted when the market’s ASK increases to the stop price.  Or when you offer to sell shares with stop-limit order, a limit order is submitted when the market’s BID decreases to the stop price.

The likelihood that daily fluctuations in market price will trigger any type of stop order depends on the width of the margin between the stop price and market price.  Exceptionally narrow margins may trigger an order the same day and exceptionally wide margins may cause the order to expire before being triggered.  The width of the margin depends on your trading strategy.  What is your acceptable price range for buying and selling a security?  Do you prefer using the same margin for all stops or customizing the margin based on price volatility?  The SmallTrades MockTrades4 is a free, useful worksheet (in Microsoft’s Excel™ format) for customizing the stop margin of your trading order.

Applications

Stop and stop limit orders are typically used to protect against capital losses when market prices are declining.  Trailing stop orders can help maximize a sales price or minimize a purchase price.   Examples of these applications can be found online in the educational materials of brokerage firms.  This user-friendly version, “Secure your position”, was a free download provided by the Commonwealth Securities Limited (“CommSec”), Sydney, web site.

Copyright © 2014 Douglas R. Knight

 


April, 2014, I joined an investment club

May 15, 2014

I enjoy seeking short term returns from stocks. Active trading gives me the excuse to place crafty trading orders and check the market every day. The goal is to realize a profit from every stock in less than a year, resulting in a portfolio turnover rate of at least 100%. Read the rest of this entry »


#Bracket orders

January 28, 2014

[updated the bracket order calculator on 6/25/2014.  Updated the text on 7/18/2014]

The bracket order is a trading order to buy a stock or other exchange-traded security while also placing an advanced order to sell the entire purchase at a future profit or loss.  The profit and loss exits are the brackets.  Some brokerage firms offer the bracket order to individual investors (1).  I use it to limit the loss that I might incur any time after buying the stock for a long position.  The bracket order has 4 elements: 1) Entry share price for buying the stock from the market. 2) Quantity of shares to buy. 3) Profit exit share price for selling the stock at a capital gain. 4) Stop loss exit share price for selling the stock at a limited capital loss.  Click on this link to the bracket order calculator worksheet to follow the discussion or plan your automated trade.

Taking the long position

Taking the ‘long position’ means to purchase a stock with the idea of selling it at a higher price.  But if the price falls, you suffer a loss in proportion to the size of the investment.   You can manage the risk of a loss by deciding how much money to sacrifice and using the bracket order to limit your loss.  Some investors typically plan to lose between 1% and 3% of their capital in a single trade.

Bracket order’s prices

LongPositions

The chart shows price movements for two imaginary stocks during a recent time period.  The wavy black lines are series of historical stock prices that end at the latest price on the right hand side.  Assuming that prices will continue to behave in the same way, the future prices will fluctuate between the levels of support (red dashed line) and resistance (green dashed line) until a substantial event dictates a change.  The support is the price ‘floor’ and the resistance is the price ‘ceiling’.   In between are the opportunities for profit and loss.  The ideal situation is to buy any stock near its support level and then sell near its resistance level, repeating the process over many trades to accumulate wealth.  The bracket order helps plan for these outcomes.

Suppose the latest price is suitable for investment.  Then plan to purchase the stock at approximately the latest price by placing either a market order to trade immediately at the current price or a limit order to trade at a specified or better price. Your desired purchase price is called the entry (yellow circle on the chart).   Your bail-out price is called the stop loss exit (red square), an automated order to sell the stock at a planned loss.  Your price for earning a profit is the profit exit (green square), an automated order to sell the stock for a capital gain.

Bracket order’s quantity

The final step is to calculate the quantity of shares to purchase.  The quantity is constrained to the planned loss on a per-share basis.

  • “Planned loss” is the amount of money you are willing to lose from a trade in the event of a market downturn
  • (loss/share) = entry – stop loss exit
  • quantity = planned loss / (loss/share)

The planned loss is typically less than the principal amount spent to purchase the shares (principal = entry x quantity).  You may choose to reduce the quantity in order to lower the principal.

Comments

CAUTION:  There’s no guarantee that the stop loss exit can prevent losing more than the planned loss when market prices are exceptionally volatile.  Prices typically move in small increments except in rare instances when they might plunge below the stop loss exit by several points to create a deep loss.  That’s why the SEC recently enacted “circuit breaker” rules to stop trading for any stock whose price changes sharply within a five-minute period (3).

RECOMMENDATION:  The future prices of any stock are uncertain.  Put more effort into determining the stop loss exit than in determining the profit exit by using historical prices to select a safe level of support (red square in the chart).  The profit exit reflects how quickly you want to sell for a gain; it’s better to think high and wait longer unless you’re a bonafide day trader.   Expect a longer holding period for the higher profit exit. If your brokerage firm’s trading platform allows changes, you can update the bracket order to protect gains and reduce losses as the prices rise with time.

Consider using the bracket order calculator to plan your automated trade.  If the program inspires your investing to support the betterment of society, consider making a tax-deductible contribution to your favorite charity or my favorite charity.

References

1.       Jean Folger. The pros and cons of automated trading systems.  Investopedia.com, August 24, 2011.  © 2014, Investopedia US, A Division of IAC.

2.       Investor Bulletin: New Measures to Address Market Volatility, SEC.gov, 4/9/2013.


#ETFscorecard_SPY, SPDR S&P 500 ETF

July 12, 2013

SPY was the first exchange-traded index fund sold in the U.S. Stock Market.   Today’s investment goal remains the same from inception: to earn returns, before expenses, that correspond to the price and yield performance of the S&P 500 Total Return Index.  The S&P 500 index measures the intraday value of the 500 largest stocks listed in U.S. stock exchanges.  SPY’s annual expense ratio is 0.09% and the Fund is considered to be tax-efficient.   It is structured as a unit investment trust (UIT) to protect the Fund from management error.  The following profile and scorecard support a long-term investment in SPY.

Profile

SPY1

Scorecard

SPY2

Copyright © 2013 Douglas R. Knight


#ETFscorecard_VWO, Vanguard FTSE Emerging Markets ETF

June 28, 2013

VWO is an index fund that invests in stocks issued by companies in the emerging markets.  The following profile shows that VWO is an established fund that operates at a low rate of turnover.

 VWOprofile

The VWO scorecard (below) reveals a wealthy, experienced index fund that offers tax-efficient returns.  The risks to underperformance are 1) market uncertainty and volatility, 2) erroneous judgment in management of the portfolio holdings, and 3) unfavorable exchange rates for foreign currency.

 VWOscorecard

Fund operations

The Fund is a registered investment company for tax purposes.  The annual expense ratio is 0.18% and the net assets are about $46 billion.  The Fund’s strategy is to invest 95% of assets in stocks of the index diversified across industrial sectors (financial 27%, energy 13%, technology 11%, basic materials 10%, etc.) and regions of emerging markets (China 19%, Taiwan 13%, Brazil 12%, India 8%, South Africa 8%, Russia, 6%, other).  Dividends are distributed quarterly.

The FTSE Transition Index currently tracks ~800 stocks from emerging markets, including South Korea.  In 2014, the “transition index” will be replaced by an FTSE Index that excludes South Korea.

RISKS:  Emerging market stocks may be more volatile and less liquid than domestic stocks.  Emerging markets are less regulated than developed markets.  Foreign countries have different regulatory mechanisms and risks of disaster.  Foreign currency may decline in value, lowering the stock values.

VWO is a good investment for diversifying your ETF portfolio.


#ETFscorecard_VNQ, Vanguard REIT ETF

June 28, 2013

VNQ is an index fund that invests in U.S. real estate properties by purchasing shares of real estate investment trusts (REITs).  The following profile shows that VNQ is an established fund that operates at a low rate of turnover.

VNQprofile

The VNQ scorecard (below) reveals a wealthy, experienced index fund that invests in a well-developed market for REITs.  The fund may be tax inefficient when cash distributions are taxed as ordinary income.  The risks to underperformance are 1) erroneous judgment in management of the portfolio holdings, and 2) generic risks of investing in the real estate market.

VNQscorecard

 

Fund operations

The Fund is a registered investment company for tax purposes and issues quarterly dividends.  The annual expense ratio is 0.1% and the net assets are valued at approximately $17 billion dollars.

The benchmark Index measures the performance of 85% of the U.S. Equity REIT market (~116 REITs) and is rebalanced quarterly.  The equity REITs are diversified among residential and commercial properties.

Real estate is an illiquid asset, but equity REITs are easily traded in the stock market.  Equity REITs own and manage real estate.  They must receive 75% of income from rents and sales and they must distribute 90% of taxable income to shareholders.  Equity REITs earn income by attracting tenants, renewing leases, and financing property purchases/improvements.  REIT stocks are typically small and mid-cap sized.

The main investment risks are: 1) concentrated investment in the REITs/real estate industries, and 2) competing interest rates may attract investors away from REITs.

VNQ is a good investment for diversifying your ETF portfolio.


My portfolio on 12/31/2011

January 14, 2013

Portfolio performance as of December 31, 2011.  Chart (below) displays the compound annual growth rate (CAGR) of my portfolio since December 31, 2006.  The S&P 500 TR is an index for the total return of the largest 500 U.S. stocks as determined by rankings according to market capitalization.  My portfolio is underperforming the Investment goal and the S&P 500 TR.

Perspective.  According to recent data, many hedge funds underperformed the S&P 500 during this time period.

Portfolio holdings.  Table data (below) show the year-end assets held in my portfolio.  Ticker is the stock exchange trading symbol.  % of Total Market Value is calculated by the formula “100 (year-end asset value/year-end portfolio value)”.


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