R², β & Other Typographic Fun

How risky are your investments?

Adjectives won’t do, we need to quantify this. Go find your mutual fund. That is, go find which investment firm operates it and what the name of the fund is.

Can’t be bothered to do what we tell you, and would prefer to just follow along? Fine. Here’s one of the biggest mutual funds in existence, the Dodge & Cox Stock fund. Dodge & Cox is a firm based in San Francisco. “Stock” in this instance just means what this one particular mutual fund invests in, as distinguished from its brethren such as Dodge & Cox’s “Balanced” fund (which also includes fixed-income securities) or its “Income” fund (mostly highly rated bonds.) Dodge & Cox Stock is doing nicely over the last year, up 25%, but that’s not the point. Is the fund precarious, or is it secure? Here are the measures of DODGX’s risk. Most of the 1st chart is straightforward, but all of the entries in the 2nd chart should leave the tyronic reader clueless:




The hell? Let’s figure out what whomever wrote this is talking about, and if it’s of any value to us.

First of all, and this makes no sense on the surface of it, β (or if you’re an ugly Roman alphabet user, “Beta”) is more fundamental than α and should get our attention before α does.

β measures the difference between a fund’s return and that of a benchmark, so now we need to explain what a benchmark is. For most funds, the benchmark is the market as a whole, represented by the S&P 500. The theory goes that a fund manager isn’t justifying much of a paycheck if he can’t beat an index consisting of the stocks of the 500 largest publicly traded companies. Which is true.

But β doesn’t measure performance, it measures volatility. A security that rises 2% when the benchmark rises 1%, and falls 20% when the benchmark falls 10%, has a β of 2. It’s twice as volatile as the benchmark.

If you believe in a permanent bull market, a β of 2 is a good thing. You’ll enjoy twice the gains the market does, but also twice the losses, but that’s a net benefit if everything appreciates in the long run.

β of 0 means that the security has no relationship to the market at all. Something with a fixed yield, like an annuity that pays 2% per year no matter what, would have a β of 0. Cash and T-bills are 0, too. Most securities with a β of 0 don’t even trade publicly.

β can be negative, too. β of, say, -.11 means that if the market rises 18%, the security falls 2%. And vice versa. Such a security is probably going to be small, like an upstart gold mining stock, given that a sufficiently large stock will make up a good portion of the benchmark and thus by definition have to move somewhat in step with it. If the S&P 500 rises 20%, Apple stock isn’t going to fall 40% or anything close, since the latter comprises a decent part of the former.

The SPDR S&P 500 exchange-traded fund, which consists exactly of the stocks that comprise the S&P 500, has a β of 1. It has to. See, here’s the proof:



As for α, like β it’s usually used with regard to derivatives (e.g. mutual funds, ETFs) rather than to pure, underlying components of derivatives (e.g. GlaxoSmithKline stock, Toyota stock.) α measures the active return on an investment, as distinguished from the passive return. Active return is the work of the fund manager, passive return the work of the market just doing its thing. If a fund includes Microsoft stock that gains 10%, that’s part of the passive return. If the fund manager sells United Technologies stock to buy Caterpillar stock, and the Caterpillar stock gains 10%, that’s active return.

α compares the security’s performance again to a benchmark. In this case, it’s again the S&P 500. You take the price of the security at the end of the period (in the above case, that’s 3 years), plus whatever dividends accrued in that period, and divide it into the price you paid. You bought Boeing 3 years ago at $70, and now it’s $119? Ignoring dividends, that’s a 70% gain. In that same period, the S&P gained 43%. Relative to the benchmark, Boeing gained 63% (which is 70%/43%), which sounds pretty good.

But we’re not done yet. Remember how we said β is more fundamental than α? You need to figure out how well Boeing performed, relative to the benchmark, but also relative to the volatility. Boeing has a β of 1.12. So the expected excess return for Boeing is 1.12 x the increase in the benchmark. (And were the benchmark to have fallen over those 3 years, Boeing’s expected excess return would have been 1.12 x the fall.) Boeing’s rise is still impressive, but less so when compared to [a combination of its own volatility and the benchmark’s performance.]

Stay with us, this gets better and will eventually reach a thrilling conclusion. At the very least, we’ve explained what a couple of those mystifying quantities in the charts represent. This is already too much arcana for one post, however. More Wednesday, if you can hold out for that long.

Exciting New IPO! Get in Now!

Initial public offering. For the uninitiated – and you really need to stop screwing around and buy the book already – it’s when a company’s owners finally decide to realize their investment potential and let ordinary scrubs buy into the company. Sometimes an in IPO is the culmination of decades of patience on the part of owners who were in no hurry to get fame nor recognition, largely because they were too busy enjoying their show horses and vacation homes as owners of an established private company (e.g. Dave and Gail Liniger of RE/MAX, which went public Monday.) Other times, an IPO is an attempt to capitalize on momentary good fortune as soon as possible. We’ll let you decide which is generally the more prosperous route. In fact, we’ll let some visual aids aid you. Here’s what’s happened to Visa stock since the day it first traded:

Visa chart


And here’s Zynga stock, over the course of its shorter but no less eventful public existence:


Zynga chart


As a general rule, being a ubiquitous global payments processor with billions of paying customers is a sounder financial strategy than creating animated time sinks emblematic of modern adulthood’s continued descent into permanent adolescence. (For Christ’s sake, they’re games, people.)

Which brings us to the latest headline in the money section: the upcoming initial public offering of Twitter.

Before we delve too deeply into this, a primer on how to read financial (or any other) news. Understand that consuming most of this stuff is not going to tangibly benefit you. For instance, from today’s USA Today Money section: “Battered Dow Falls Back Below 15,000”. Number 1, there’s nothing in the story that expounds upon the headline. Really, there isn’t. Read it if you don’t believe us. Number 2, even if there was, you can’t profit from it retroactively. A .9% drop in an index will barely affect your portfolio, especially since the index will likely bounce back tomorrow. Knowledge of the drop would only be valuable before the fact, which, as Andy Rooney and Sacha Baron Cohen demonstrated to great effect, is impossible:



Twitter’s going public, and the media can’t shut up about it. $1 billion in underwriting! Also, because Twitter is a social media service with something of a legitimate purpose, and hundreds of millions of users, the simpletons who prepare and serve news for your consumption are professionally bound to compare it to the famed IPO of Facebook even though the commonalities are only superficial. We had plenty to say about the Facebook IPO at the time, and our opinions haven’t changed. (The stock didn’t return to its initial price until 6 weeks ago.)

You know what excites us? Here, we’ll make that one of our patented multiple-choice (dual-choice, if you want to be specific) questions:

  • A. Investing in something we use every day.
  • B. Money.

Twitter is moderately useful for certain things, and can be entertaining depending on whom you follow. But it doesn’t do a blessed thing to extend anyone’s business, regardless of how badly this guy and millions more misguided fools want it to.

Here’s an actual usable paragraph we found from a New York Times story. Because it’s important, they buried it in the text:

[Twitter] has also been losing money, reporting a net loss of $79 million last year and $69 million for the first six months of 2013. Even after adjusting for stock option compensation and other items like depreciation, Twitter has still reported steady losses.

Where do we sign up, then? And how long do we have to wait to get our hands on that sweet IPO?

Unless you live in Denver, and even then it’s doubtful, you’ve likely never heard of Antero Resources. It’s a company that extracts oil and natural gas, all of it right here in North America; the Appalachian Basin, to be precise. Antero’s been around slightly longer than Twitter, the former being founded in 2002. The company predicts an opening price of between $38 and $42, making its IPO somewhere around a $1.2 billion proposition. Antero lined up every big underwriter – Barclays, Credit Suisse, Citi, JPMorgan, Wells Fargo et alia – and is expected to first trade publicly a week from today.

There are dozens of oil and gas companies. The finished products of one are largely indistinguishable from those of the rest. In fact, the finished products of most of them aren’t even anywhere near the final link of the production chain. (Most explorers stop their involvement short of the refinery, let alone the retail stores.) Created by 2 middle-aged industry veterans, Antero originated in a boardroom of a law office, not in the basement of a Silicon Valley townhome populated by 20-somethings. Celebrities don’t patronize Antero, at least not consciously. Antero was nowhere to be found during the riots in Tahrir Square.

As a private company (for another week), Antero’s financials didn’t have to be disclosed until the company filed with Securities and Exchange Commission for the IPO. Antero could have been losing money faster than Twitter is, for all we’d know. Except Antero isn’t. In fact, it’s stupendously profitable. Assuming that 60% profit margins are your thing, and in a capital-intensive industry no less. Antero has 200 employees, and most of those are seasoned petroleum engineers, rather than quasi-paid intern programmers. The company qualified for $2 billion in loans last month, meaning that either its credit is fantastic or the lenders are confident of the company’s future profitability.

No one, at least no other personal finance blogger, is going to write about Antero’s upcoming IPO when it’s easier to follow the crowd and blather on about Twitter. Anyone want to meet us back here in 6 months and see which company’s stock is doing better? Now if you’ll excuse us, we have a line to wait in.


Our Bank Loves Us And Wants Us To Be Happy, Pt. 1

Our 1st house was in Brobdingnag

Our 1st house was in Brobdingnag


Welcome to one of those rare 1st-person stories in which we give a smattering of detail about our personal financial life, which is comfortable, so that you can apply the decision to your own life and watch the benefits accrue.

Among the houses in the CYC Land Empire, which still totals a few thousand square miles fewer than John Malone’s, is a handsome 3-bed/2-bath number which we rent out in Clark County, Nevada.

(Fun Fact: The home is in Las Vegas, but that’s not the Fun Fact. The Fun Fact is that in the 1990s, and possibly still today, Citibank operated a check processing center and several other concerns on the outskirts of town. Convinced that their clientele were dumb enough to think that monies addressed to “Las Vegas, NV” would somehow end up on a baccarat table or inside a slot machine before finding their way to Citibank, the company used the county name in place of the city identifier. Beyond that, Citibank created fictional towns that people could send correspondence to without fear. Red Rock, NV was one. The Lakes, NV was another. These cities never existed in any form, but the postal service didn’t care as long as you used the right street address and ZIP code.)

In April of 2005 we refinanced the house, which we’d bought a couple years earlier, for $160,000. A couple of paper transactions later – a sale to a trust we own, and then to a limited liability company of which we’re the directors and officers – and the house is now more than ¼ of the way to being paid off. Well, that’s not exactly true. The mortgage term is more than ¼ over – 7½ years out of 30 – but we’ve dented only ⅛ of the principal. Which is how these things work. The portion of the monthly payment that goes to principal accelerates as we get approach the end of the mortgage. Math.

If you remember, 2005 was an awful time to buy a house and a similarly bad time to refinance one. The bubble was about at its limits, a nationwide mountain of unsustainable debt ready to prick it at any provocation. Still, the proper comparison at the time wasn’t to 2008 home prices. (For one thing, we didn’t know what those were going to be.) The proper comparison was to other investments. We had nothing at our disposal that would (almost) guarantee $1200 or so a month in cash flow, so we committed to the house. Which last appraised at exactly a quarter-million, which probably says less about our shrewdness as investors than it does about the appraiser’s love of round numbers.

The current monthly payment is $1078. The house is in a pleasant if not affluent area, with no visible meth labs nor signs of suburban decay. The neighbors are clean and quiet, as best we can tell. In other words, the street started off OK and doesn’t seem to be getting any worse.

ANYHOW…yesterday we received an ominous phone call from someone purporting to be from a bank. “Hi, this is Christina. Please call me back at this number.” She didn’t address the person she was leaving the voice mail for, which seemed suspicious. A few seconds of Googling did confirm that she was indeed a bank employee and not a sophisticated criminal who dupes people into calling them back with their financial information. (We may have been born at night, but…) Then our skepticism made way for good old-fashioned Catholic guilt. “Oh my God, are they repossessing the house?” No, our payment record is perfect. “Sweet Jesus, are they calling because someone hacked into our account and…?” Even if that were true, what could such a person do? Pay off our balance? We’re debtors here. Anyone who impersonates us is going to be impersonating someone with 22½ years of financial obligations.

Or 15 years. When we finally got a hold of Christina, she made us an offer:

Your credit history is perfect. You’re paying too much. If you want to refinance again, we can put you in a 15-year mortgage for only $100 a month more than you’re paying now. It costs $420 to do this. You want me to send you the paperwork?

Yes, you can send us the paperwork.
But no, we don’t want your charity.

Our current rate is 5⅞%. The new one was supposed to be 4½%. The new monthly payment would indeed have been $100 more, but we’d also be cutting 7½ years off our obligation. (Not forgetting the $420 upfront cost, of course.)

So it’d take 2 years for this to pay for itself, and again, it frees up 7½ years worth of investment potential, new opportunities to take advantage of. If we held onto the house for 2 years and 1 month, assuming the market doesn’t crash again, this would seem like a shrewd move. Except for one thing. Well, 2 things. First, the closing costs worksheet the bank employee sent us used a rate of 4⅞%, not 4½%. Baiting-and-switching us isn’t a good way to start this relationship off. Second, just look at this (changed slightly since we stole created the graphic):




The worst rate listed on Bankrate is 3.68%, that from Mutual of Omaha. With all due respect, we think we’re entitled to the 3⅜% that Roundpoint customers are paying.

Say we hold onto the house for another 5 years. Sparing you the calculations, if we take advantage of the bank’s “generous” offer we’ll have paid down an additional $14,994.89 in principal. We’ll also have forked over an extra $10,504.80 in monthly payments. Is doing this worth $4,490.09, given that it takes 5 years to realize?

No, because there are better offers out there. Paying 120 basis points over market price is insanity. Not quite as insane as staying in our current loan, but at least now we know we have options. In the interests of full disclosure, we’ll shop around and give you our findings next week. And tell you how much we’ll end up saving.