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Leveraged ETF Investing

Leveraged ETF Investing (How Not To…)

We are huge proponents not just of ETF’s, but of the best investments for your (or any investors) situation. Sometimes ETF’s are best, sometimes regular old mutual funds are best. Leveraged ETF investing however is never the best! 

The use of leveraged ETF’s can never be a great alternative because by their nature they can’t be used over long periods of time successfully (aside from pure luck, but you’d be better off betting on black or red). Leveraged ETF’s are short term “gambling like” investments. We’re not short term investors, and as such we never recommend leveraged ETF’s.

Leveraged ETF’s are exchange traded funds which seek to deliver a return multiple times that of the underlying index. For example a 2X ETF would seek to give you twice the upside of an index. If the S&P 500 was up 2% on a particular day, you’d hope the 2X S&P 500 ETF was up 4% that same day. If you invested $1,000 in the S&P 500 ETF you’d have $1,020. Likewise with the 2X S&P 500 ETF you’d hope to have $1,040.

It doesn’t quite work like this all the time because of rebalancing. Suppose you run a 60mm leveraged ETF designed to mimic twice the exposure of the Russell 2000. You now control 120mm worth of assets that look just like the Russell 2000, with only 60mm of investor funds. Leveraged ETF investing achieves this multiplication affect through use of derivatives, such as call or put options, equity swaps, etc.

If the Russell 2000 increases by 2% today, the 120mm you control increases by 2.4mm to $122,400,000. So you made 2.4mm on your 60mm portfolio – that’s a 4% return when the Russell 2000 went up by only 2%. Pretty good right?

Of course we didn’t take any taxes or expenses into consideration. Those factors really reduce your returns.

In an up market this sounds pretty great right? But when do the markets go up every day?

In a sideways volatile or downwards market things get a little nasty. Let’s assume the index trades at 100:


Day Index Open Index Close Index Return ETF Open ETF Close ETF Return
Monday 100.00 99.00 -1.00% 100.00 98.00 -2.00%
Tuesday 99.00 98.01 -1.00% 98.00 96.04 -2.00%
Wednesday 98.01 97.03 -1.00% 96.04 94.12 -2.00%
Thursday 97.03 96.06 -1.00% 94.12 92.24 -2.00%
Friday 96.06 100.00 +4.10% 92.24 99.80 +8.20%


So above you have a flat week for the index. The leveraged ETF however ended up .20% underwater. This doesn’t seem like much, but over time it adds up to large amounts.

Russell 2000 2x Strategy – Leveraged ETF Investing in Small Caps

Here’s a great example I stumbled on which clearly shows that leveraged ETF’s can be disastrous for your financial health because:

  • They are ONLY meant for short term trading activities which is just plain dumb, and
  • They don’t work well for long term holding strategies

Take a look for yourself:

Leveraged ETF Investing in Russell 2000


You can see clearly that the Russell 2000 was down just about 4% in 2011. That shouldn’t surprise anyone. But you can also see that the 2x leveraged ETF which mimics the Russell 2000 was down almost 4 times as much to nearly -20%! That’s amazing!

The average ETF investor would assume that if the Russell 2000 was down 4% the 2X leveraged ETF would have ended up -8%. Clearly because of the rebalancing effects that is not the case.

We haven’t even touched on fees and expenses. The internal expense ratios on leveraged ETF’s are usually quite high – 1% or more! Not to mention the trading costs within the portfolio (trading derivatives isn’t cheap necessarily) can be substantial, and the tax ramifications can also detract from your investment returns.

Avoid Leveraged ETF Investing

If you’re a gambler – go for it! Just don’t put any more money than you can afford to lose in leveraged ETF’s. If you’re a long term investor – run for cover! Leveraged ETF’s aren’t for you OR your investment portfolio!

By Greg Phelps

Systematic Investment Plans

Systematic Investment Plans

A systematic investment plan is a process whereby an investor invests into a mutual fund (or some other investment or investment account such as a 401k plan) on a regular systematic basis. The investment is the same amount each period, and the periods are always the same (monthly, quarterly, yearly etc.).

For example, Investor A invests $200 per month into mutual fund XYZ each month on the first day of each month automatically. That is a systematic investment plan. The investor always invests the same amount into the same investment on the same day (or same period length). Consistency is the key here, a systematic investment plan must adhere to the rules.

I’ve written about systematic investment plans here before, so I’m going to focus more on why a systematic investment plan makes sense for your investment program.

A systematic investment plan has some great advantages. It allows the investor a few things:

  • Removes emotion from the decision to invest. When an investor must decide when to invest, they always look for reasons not to invest. “Now” is always the hardest time to invest. If the market was up yesterday the investor may think it’s high and defer the investment until the market goes down (which may never happen). If the market was down yesterday the investor may defer the investment until the market stops dropping (and miss an upswing or invest in at higher prices). A systematic investment plan effectively removes the emotion from the decision on when to invest because to be “systematic” a regular recurrent date must be set for investment, and that date must be adhered too.
  • Lower average cost per share. You may remember from my prior post on systematic investment plans that in volatile markets it produces a lower average cost per share than the actual average price per share. Here’s how it works, Investor A invests $200 per month each month on the same day into a mutual fund (or collective pool of mutuals such as with a 401k plan account) and purchases shares at the following prices. This gives them a lower average cost per share because they buy more shares when prices are low and fewer shares when prices are higher:
Investment Date Amount Invested Share Price Shares Purchased
January $200 $10.00 20.00
February $200 $9.00 20.222
March $200 $9.10 21.978
April $200 $8.50 23.529
May $200 $7.50 26.667
June $200 $8.00 25.000
July $200 $8.75 22.857
August $200 $10.25 19.512
September $200 $10.00 20.000
October $200 $10.90 18.349
November $200 $10.50 19.048
December $200 $10.25 19.512
Total Investment $2,400 258.674
Average Price/Share $9.40
Average Cost/Share $9.27
  • Great investment growth and wealth building tool! Most systematic investment plans enjoy great long term growth not necessarily because of the investments themselves, but because the decision making process is on autopilot. The biggest problem investors face isn’t always picking the best investments, it’s sticking with a plan! A systematic investment plan forces the investor to stay engaged in a process rather than leave the decision making of investment timing and investment amount to randomness.

Disadvantages of Systematic Investment Plans

I mentioned the benefits of systematic investing, however there are disadvantages as well. In the example above, the investor would have invested $2,400 per year or a total of $24,000 over ten years. Let’s assume the investor earned 8% per year in whatever mutual fund or portfolio she chose for her systematic investment plan:

  • If the investor had a $24,000 lump sum to invest on day one, in 10 years they would have a $51,814 nest egg.
  • If the investor invested $200 a month per her systematic investment plan, she would have less money working for her over time, and her nest egg would be $36,833. That’s the time value of money working against her.

In lieu of having the lump sum to invest now, systematic investment plans are the perfect option! However if you have the lump sum to invest, investing now (while always the hardest time to invest) is the best option.

If you’re investing in the stock market to any extent, remember that since 1926 the S&P 500 has had positive returns 72% of the years through 2011. While it’s always hardest to invest now, the odds are against you if you wait to invest.

Top 25 Mutual Funds – Kiplinger’s

I walked into the office this morning and found this on my desk – Kiplinger’s Top 25 Mutual Funds to invest in. If you’ve read or seen any of my writing you know I’m not a fan of mutual fund ratings or touting services. Most of them just chase last year’s performance, they don’t necessarily follow a solid long term strategy.

Kiplinger's Top 25 Mutual Funds


Here’s their list of mutual funds they think will help you “strike it rich!”

Kiplinger's Top 25 Mutual Funds


The interesting thing about Kiplinger’s is they don’t necessarily bounce all the mutual funds out of the list and start over, they only replace the ones they want to. We follow a similar investment strategy with InvestPlan and our Portfolio Architect program. We maintain our recommended list and only fire mutual funds and ETF’s which fail our 11 step test created by fi360.

Looks to me like Kiplinger’s chases fund performance. Their best mutual funds are mainly actively managed mutual funds, and as you know active managed mutual funds don’t tend to repeat their past performance.

Only 8% of the top 25% of performers from ’02 to ’06 repeated that same stellar performance over the subsequent 5 years. Investing in actively managed mutual funds because they HAD great performance is a losers game. Chances are staggeringly high they will fail to repeat, and you’re the person that bought in at their highest point!

Chasing performance is one of the worst things you can do. Keeping mutual fund fees low is one of the best things you can do.

The average blended expense ratio for their funds is horribly high. Remember that your investments must overcome their expense ratios just to break even, so I strongly advocate ultra low cost mutual funds and ETF’s.

There are definitely a few great mutual funds on their list. I’m a big fan of DFA mutual funds first however, but the problem is they’re not available to retail investors. Outside of having access to DFA mutual funds, T Rowe Price and Vanguard are the only mutual fund families on this list which have mutual funds which consistently show up on our preferred list of mutual funds.


Investors Fail Miserably At Retirement Investing

A recent survey by the Employee Benefit Research Institute (EBRI) showed that 36% of workers over 54 years old have less than $10,000 in savings and investments. This is a disturbing fact as the population ages and government programs such as medicaid and social security are on the brink of falling apart over the next couple of decades.

Retirement Investing Isn’t Our Priority, But Should Be!

Outside of their home value, 57% of all survey respondents have less than $25,000 in total household savings and investments. Almost half of those have less than $1,000 saved.

To make matters worse, the percentage those actually doing something about the problem by saving declined 8% to 57% from 2009. We have less saved and less of us are saving… what to do?

Of course some of this is due to a sluggish economy. Some of this is due to home values which still haven’t recovered (higher home values lead to greater economic activity). But seriously folks… what’s the problem here?

To offset the lower amounts actually saved 36% of workers plan on delaying retirement to age 65. I’ve long felt American workers retired too early anyway.

But is that the solution? You can’t begin a retirement investing program without a financial plan, maybe CNBC should focus on promoting financial planning instead of stock jockeying!

Personally I focus strongly on the financial planning aspect of investing. Without a financial plan does your investment plan make any sense at all? If you don’t know where you’re going how will you get there?

Get a great planner and get a plan done. You can find a great hourly planner here at

Also sign up for the InvestPlan course on the home page. You’ll get a great eBook and a course that will help make you a great investor.

Most importantly start today by saving 2% more than you currently are. You won’t even feel the pinch. 2% is one less fancy dinner out maybe, maybe it’s cutting back on Starbucks in the morning. But 2% will help you get moving the right direction with your retirement investing plan.

No one plans to fail, but many fail to plan!

Stocks Are Cheap

It sounds weird, I know. Stocks are still cheap right now even after a 4+ year stock market rally. This fact  is supported by the current valuations. But should you jump in now?

The S&P 500 index is trading right about 15 times the S&P 500’s reported profits. Since 1962 the average bull market has seen the S&P 500 trade at an average of about 19 times reported profits.

That makes the stock market cheap relative to any market high since 1980. This may in fact be just the tip of a coming waive of stock market returns, or time to stand up and reevaluate your investment plan.

This year individual investors have already added a whopping 20 billion to the stock market. That sounds like a big number, but that’s a pittance of the amount individuals have added to fixed income funds and pulled out of the stock market altogether. I saw on the news the other day a financial services firm commercial with individual investors talking about “it’s time to get back into the market”. What is this craziness going on anyway?

Here’s the thing… none of this matters. The fact is if you’re a good long term investor the valuation of the S&P 500 is irrelevant. You’re an investor for 5, 10, and 20 years from today. Today’s valuation is just a number… more white noise to confuse you.

Some investors would think it’s time to get in. Valuations are cheap. Smart investors don’t really care much because their plan is in tact and they’re thinking long term, not short term.

Here’s the OTHER thing. Individual investors aren’t benefiting. That’s why the “it’s time to get back in” commercial is so disturbing – because it illustrates individuals aren’t reaping the rewards. The individual investor by and large has not participated in this rally, in fact individuals have pulled out a net 600 billion from the stock market over the last six years.

Institutional investors are killing it. Individuals are still making the wrong decisions. As humans we prove time and again we are not wired properly to be successful with investing.

Investors Don’t Trust Brokers

Investors Don’t Trust Brokers

A new study put out by Cerulli Associates today reinforced that investors still don’t trust brokers. A whopping 36% claimed they thought brokers were NOT looking out for their best interests. 27% of respondents weren’t sure if brokers were looking out for their best interests or not.

It’s a sad state of the industry, sad but true. It’s not hard to see why investors don’t trust brokers or Wall Street in general. Scott Smith of Cerulli stated “There’s only so many times a firm can pay a $100 million fine before people start questioning their integrity.”

While distrust is clearly rampant in the industry, there are solutions. Investors do need help, but qualified help, expert help, and most importantly help in their best interests – not help that simply lines the pockets of some Wall Street firm.

Investment Fiduciary Is The Word Of The Day

A fiduciary is a person who occupies a special position of trust. A fiduciary must act in their clients best interests only. Doctors, lawyers and accountants are fiduciaries. Why shouldn’t your financial advisor be a fiduciary as well?

I place some of the blame on investors themselves. If you’re not going to take the time to find an excellent financial advisor who acts as a fiduciary what can you expect? You get a paid salesperson, not a trusted advisor.

I just googled “financial advisor who acts in my best interests”. There were plenty of Merrill Lynch and Edward Jones advertisements. The quick reaction would lead you down the wrong path.

But the second organic link that popped up was an excellent article from the Wall Street Journal – How To Choose A Financial Planner. In the article it mentions and the Garrett Planning Network – the very same two organizations I endorse for finding a financial advisor.

With decisions this large – it’s your finances after all – isn’t it worth looking beyond the paid advertisements and actually doing a bit of research? I say yes! Give NAPFA or Garrett a look – you’ll be impressed with their members if you spend the time to get to know what they promote and believe in.

By Greg Phelps

Active Mutual Funds Are Expensive

Active Mutual Funds Are Expensive!

If you’ve followed this blog for any length of time you probably already realize we are big proponents of passive investing. There are many reasons – including the fact that passive funds beat active mutual funds most of the time (about 75% of the time based on a recent study.) But there’s another huge reason… active mutual funds are expensive!

Mutual fund fees and expenses always reduce your investment returns. In fact, the mutual fund manager has to make up the commissions, fees and expenses just to break even before you make a single dime! For this reason, the lower the fees and expenses the better for you the investor.

Take a look at all of the active mutual fund fees and expenses:

  • Expenses. The following expenses are all added into the mutual fund or ETF expense ratio. These are NOT specific commissions or trading costs that an investor would incur directly, they are costs which are rolled into what they call the “Annual Report Net Expense Ratio”. The average actively managed stock mutual fund has an expense ratio of 1.64% (source Morningstar data ended 12/31/12). The average passively (or index based) managed mutual fund has an expense ratio of .69% (although.69% is still far too high, our clients pay between .21% and .35% for a balanced diversified portfolio.) Why anyone would pay 2 to 5 times the amount in fees to have an actively managed fund is completely baffling to me! Here are some of the costs that go into that expense ratio for actively managed mutual funds:
    • Trading Costs. Each buy and sell of any stock, bond or other investment asset always has a cost to it. These costs come in the form of commissions on stocks, or possibly mark-downs or mark-ups on bonds. The more the fund manager trades the more costs are incurred. Passively managed funds don’t trade any more than absolutely necessary.
    • The Spread. The spread is the difference between the bid and the ask on a stock price. For example, here’s a current quote for AAPL (Apple) stock:

Bid: $485.21 * 100

Ask: $485.30 * 500

The difference between the bid and ask is the spread. Here’s how it works: If I’m an AAPL SELLER, I can put in a “market” order which will be executed immediately at the bid price. There is buyer somewhere willing to buy my block of 100 shares at $485.21 per share.

If I’m a BUYER, I can put in a “market” order which will execute immediately at the ask price. There are 500 shares for sale at $485.30. I don’t need to buy all 500, generally I can buy less without any problems (a portion of this sellers shares for sale.)

Why is this important to you? The spread is .09 cents per share. That means for each share you purchase, it’s automatically worth .09 cents less if you were to sell it immediately. This may not seem like much, but it all adds up! It especially adds up when active managers are trading excessively.

  • Marketing Costs. All of those big fancy mutual fund and ETF managers have to promote their funds right? You see it on TV all of the time, “our funds beat their Lipper averages blah blah blah.” Those ads aren’t free, and actively managed funds always spend money promoting their funds (far more than passively managed mutual funds.) These marketing costs are embedded in the mutual fund expense ratios.
  • Taxes. More buying and selling not only increases your transaction costs and the spreads paid, but it can possibly increase your taxes as well. In fact in many cases investors will realize capital gain payments they didn’t even earn! “That doesn’t sound right!” you’re thinking, and no it doesn’t. However it is true. If an active mutual fund (and in full disclosure to some extent with their lower turnover passive funds) has multiple buys and sells in a bull market they distribute a great deal of capital gains at the end of the year. If you invested in the mutual fund later in the year you may have enjoyed little or no gains at all (possibly even losses), yet still you’d be required to pay taxes on the capital gains distributed out at year’s end which other investors actually earned.

Active mutual funds always will have the allure of outperformance. There will always be the lucky manager who did great last year – there has to be… statistically it’s impossible to NOT have some stellar performing funds!

But when you look at long term investing, those years of outperformance are few and far between. Fees and expenses are the opposite – they’re a constant every year!

Keep your mutual fund fees and expenses low, and you’ll set yourself up for a great investing experience!

By Greg Phelps

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The Best Stock Trading Formula

What is the best stock trading formula?

You’re not going to like the answer. The best stock trading formula is NEVER TRADE STOCKS!

That’s right, don’t ever ever trade stocks. There’s no reason for it. You don’t need the extra risk, headaches, stress and frustration.

Why you ask? Simple, there are two types of risk:

  • Systematic Investment Risk – Systematic risk is the risk associated with an entire asset class.  It cannot be diversified away (with the exception of long/short strategies which is beyond the scope of this article).  Each asset class has it’s own systematic risk that one must tolerate to achieve the expected long-term returns of the asset class. For example it’s the risk of all stocks, the risk of all international stocks, or the risk of all small cap growth stocks.
  • Specific Investment Risk – Specific risk is the risk associated with individual investment securities.  It can be diversified away by adding more similar securities to the portfolio. It’s the risk associated with specific companies. For example it’s the risk that IBM will have government regulation, a bad product launch, or a lawsuit negatively impact it’s bottom line. It’s the risk specifically associated with a particular company rather than the risk of all stocks as a whole.

This begs the question “why would you engage in stock trading when you are taking on such unnecessary and excessive risks”? There is no “best stock trading formula” because the best investors don’t trade stocks.

Think about it this way: any stock trader would do so because they’re trying to beat the market. If they weren’t trying to beat the market, they would simply accept market investment returns (such as the returns from the S&P 500, etc.)

Do you really think you can beat the market? I know I can’t. I’ve been a financial and investment advisor for 18 years now. Not once did I beat the market by trading stocks, and I had the world’s best resources right at my fingertips (Morgan Stanley, Goldman Sachs, etc.) for most of my career.

If I can’t beat the market (and you can’t either, at least not consistently or predictably) why take on excessive risks to make the attempt?

But you CAN beat the markets you think??? That’s pretty incredible considering the best managers ON WALL STREET with resources, tools and software you and I will never have can’t beat the markets consistently. Just take a look at the facts:

Best Stock Trading Formula - Don't Trade Stocks!

Clearly the overwhelming majority of equity mutual funds don’t beat their passively managed counterparts. In fact it’s SO BAD, that when you add in fixed income mutual funds ABOUT 75% of actively managed funds FAIL TO BEAT THEIR BENCHMARK INDEX!

SO, if the best and brightest minds on Wall Street with tools, resources and software we mere mortals don’t have can’t consistently beat the market, why should you even try?  You’d be better of learning the best roulette strategy and coming to Vegas!

Stock Trading Is More Like Gambling Than Investing

The best stock trading formula is never trade stocks!

What Is Investment Planning?

What is investment planning?

Most private clients understand the process and procedures behind investment planning. Still other novice or beginner investors don’t grasp the concept of what investment planning truly is. So just “what is investment planning”?

Investment planning is the process of matching your financial goals and objectives with your investment resources. It’s critical to note that investment planning IS A SUBSET OF financial planning. Good investment planning cannot be done without a great financial plan first!

Investing your money takes a great deal of time, tools and resources. Much of the time, tools and resources are required because financial planning must come first.

  • Without a financial plan you don’t have well structured financial goals.
  • Without well structured financial goals you won’t have well defined investment objectives.
  • Without well defined investment objectives – how can you invest successfully?

The key is you need to understand what you’re trying to accomplish prior to investing a dime. If your financial goals are modest why would you invest aggressively if you don’t need to? If your financial goals are extravagant you may not be able to achieve your goals without an aggressive investment plan.

What Is Investment Planning

Investors often wonder “what is investment planning” without asking the question “what is financial planning” first. This can lead to disaster. I place such a high priority on financial planning for every investor because without knowing where you want to end up how can you chart a path to get there?

Assuming you do have well defined financial goals, you now can chart a path to reach them. The what is investment planning question becomes more simple to answer.

I define investment planning as creating a clear cut path to achieve your financial goals. Your financial goals hinge on reaching your investment objectives.

For example, If your financial goals include retiring with a $5,000 per month income when you’re 60 years old, and dying broke at age 90 because you want to enjoy your assets – you need to start by saving $500 per month at age 30.

Saving $500 per month at age 30 will create a $704,000 portfolio value at age 60 (assuming an 8% rate of return, not including fees, taxes or inflation factors). That same $704,000 (if it continues earning an 8% rate of return) will be able to generate about $5,000 per month in income for 30 years until it reaches a zero balance.

That is investment planning! It’s understanding where you want to be and figuring out what it will take to get there.

The path you’ll create to earn that 8% per year return is also part of investment planning. For example, for about the last 40 years a moderate portfolio of 60% stocks and 40% bonds would have earned a bit over 9% per year. Take away fees and trading costs etc. and you’re left roughly in the 8% per year range. Now you have a handle on where to start your investment planning quest – a basic moderate 60% stock and 40% bond portfolio.

But investment planning is more than that. In the example above the financial goal is retirement at age 60 with a retirement income of $5,000 per month for 30 years. The investment objective therefore is to earn an 8% annual return. Investment planning however is also:

  • What investments should I own to average 8% per year
  • What asset allocation model is best to average 8% per year
  • What types of investments (individual stocks, bonds, mutual funds etc.) should I own to average 8% per year
  • What criteria for adding these investments should I follow to average an 8% return per year
  • What portfolio strategy should I use to average 8% per year
  • How often should I monitor and rebalance my portfolio to average 8% per year
  • And on and on…

There are many aspects of investment planning. Investment planning – as a term – can be described as simply as the process of defining your investment objectives (which are a function of your financial goals) and creating the most low cost efficient path to reach those investment objectives.

Investment planning is a process – not a one time event. It’s a lifelong endeavor that will have twists and turns and knock you on your head once in a while. But if your investment plan is built on a solid financial planning foundation, you’ll be prepared to weather the storms which invariably will come your way!