the retail investor has never had it better

Its easy to see if one brokers commission is cheaper than another's. Before now, however, it was hard to know which brokers were saving you the most money through good trade execution—for example, by getting you a stock price that's better than the quote you saw when you pressed the "Place Order" button. For such "price improvement," discount brokers squeeze Wall Street market makers to give up some of the bid-ask spread to benefit the broker's retail customers. New numbers released recently by the industry indicate that a retail trader can get the best pricing from Fidelity's discount brokerage unit. This confirms the findings of Barron's computer-aided analysis earlier this year ("The Little Guy Wins!" March 2).

***

In the furor surrounding last year’s best-seller Flash Boys, by Michael Lewis, many retail investors were spooked by the book’s claim that high-frequency traders use their technology edge to pick off the little guys, who, the author claims, were “easy kill” for the professionals. That part of the story was just wrong. While some institutional traders have fallen behind in the computer arms race, the evidence shows that retail traders enjoy some of Wall Street’s best prices on their stock orders. Surprisingly, the little guy’s advantage has grown in the past couple of years.

“The retail trader has never had it better,” says Robert Battalio, a finance professor at the University of Notre Dame who wasn’t afraid to criticize stockbrokers at Senate hearings amid the Flash Boys debate. “When you place a market order today, you pay a lower commission, you get an immediate confirm, and very rarely are you getting worse than the price you saw when you pushed the button,” he says. • The competition for retail traders’ orders actually yields a price that’s better than the published quote, on average, when small investors go to buy or sell at the market price. The resulting savings can be trivial or as large as a discount broker’s commission, but across the industry, these price improvements were worth almost $600 million to individual investors last year, according to financial-market analytics firm RegOne Solutions. That’s much less than the billions paid out in commissions, but it’s hardly chump change. As irony would have it, these savings mostly result from the computerization of market makers and retail brokers.

The public has never seen much information on which firms do the best job executing stock trades. So Barron’s spent months analyzing trade-quality reports of the big “wholesale” market makers, where discount brokers send most buy orders to find a matching sell, and vice versa.

By our scoring, Fidelity Brokerage Services finished No. 1, and Charles Schwab (SCHW) and E*Trade Financial (ETFC) tied for second among discount brokers.

in defense of active management

This month, Charley Ellis published "In Defense of Active Investing." The headline intrigues because Ellis is an indexing legend. In 1975, he wrote that active investing is "The Loser's Game." The article became an instant classic and was later incorporated into the curriculum for Chartered Financial Analysts candidates.

"The Loser's Game" argued that investment success lies not in hitting the most winners, as it's very difficult to strike winners while competing against hordes of other informed investors, but rather in minimizing the "losers" of turnover, costs, and taxes. (All right, taxes are my addition, as 1970s institutional investors never considered the subject, but Ellis would certainly have discussed them had he thought about retail accounts.)

He writes that, although it's difficult to win the Loser's Game, it is also "hard to lose." After all, the corollary of the criticism that active managers mostly hold the market is that active managers mostly hold the market. The biggest success for any prospective investor lies in getting into the game. After that, the leakage caused by active managers is modest. Besides, investing actively is good entertainment. "Since active investing is exciting and fun, investors who are losing a bit in purely economic terms surely enjoy a significant social good by being part of the action."

While I don't believe the case for active management is as hopeless as Ellis presents, as investors can improve their odds by seeking funds that share certain common attributes, I do not dispute his thesis. Active managers do set efficient security prices. They do help global markets to function smoothly. But there's no particular reason why you need to own them.

Ellis' "defense" of active management is in reality a highly effective attack. He came not to praise active managers, but to bury them.

Grexit has gone

Greece reached a desperately-needed bailout deal with the eurozone on Monday after marathon overnight talks, in a historic agreement to prevent the country crashing out of the European single currency.

Leftist Prime Minister Alexis Tsipras agreed to tough reforms after 17 hours of gruelling negotiations in return for a three-year bailout worth up to 86 billion euros ($96 billion), Greece's third rescue programme in five years.

"EuroSummit has unanimously reached agreement," EU President Donald Tusk said. "All ready to go for ESM (eurozone bailout fund the European Stability Mechanism) programme for Greece with serious reforms and financial support."

The new rescue for Athens is the country's third since 2010 and came after a bitter six-month struggle following Tsipras's election in January that put Greece's membership of the eurozone in the balance.

Greek banks have been closed for nearly two weeks and there were fears they were about to run dry due to a lack of extra funding by the European Central Bank, meaning Athens would have had to print its own currency and effectively leave the single currency.

"Grexit has gone," European Commission President Jean-Claude Juncker told AFP, ruling out the threat of Greece leaving the single currency, which could potentially destablise not only the euro but the world economy.

Tsipras insisted the deal was good for Greece despite the fact that the harsh terms were near identical to those rejected by Greeks in a referendum just one week ago.

Mitch Zacks 2015

[7/19/15]  There’s a big piece missing from the Chinese ‘stock market mania’ narrative, and it’s probably the most important part of the story – explaining how China’s equities markets actually work!

The basic premise is that Chinese equities are divided into A-shares and H-shares. A-shares are available for trading almost exclusively by Chinese investors, meaning that the market is missing two critical components of efficiency: maximum liquidity and global participation. It follows that A-shares have virtually no correlation to global markets—one zigs and the other zags, one soars while the other only nudges higher.

It’s the A-shares that are creating all the hubbub in the press. Over the last year (through July 14), A-shares climbed almost +150% through June 12, then fell nearly 35% to their low on July 8. That’s the type of market activity investors are wise to avoid.

Chinese H-shares are a different story, and they matter more for the narrative. H-shares trade on the Hong Kong exchange, which is an open market where international investors can participate. The difference in the market action is astounding: H-shares went up a little over +40% to a peak on May 26, and have fallen about 20% over the last month or so. That’s eyebrow raising volatility, but it’s not an Armageddon-like swing many are now associating with China.

If you look at global stocks over the same period, you’ll notice that they have virtually no resemblance to Chinese equities, A-share or H-share. The MSCI World is essentially flat over the last year.

[7/12/15 Mitch Zacks] If you had just one word to describe the market so far in 2015, it might be: volatile. And, this can be concerning. Regardless, for all the market machinations, performance essentially finished flat eking out a 0.7% (S&P 500) gain. So, what do we think will happen next?

At first glance, the economic backdrop might raise eyebrows: a second estimate of U.S. GDP shows contraction of -0.7% in Q1 and incoming data point to a tepid rebound in Q2, perhaps +2%. Additionally, if you consider uninspiring domestic growth, an escalating Greece situation, the wild China stock ride and imminent U.S. rate hike(s), you might conclude the odds are stacked against a strong finish in 2015.

And, you may be right. But these factors are not enough to turn bearish for these four reasons:

1. Markets Tend to Do Well in Rising Rate Environments – the last three rate hike cycles have corresponded with strong market performance. In 1994 – 1995, the Fed raised rates 7 times and the S&P 500 annualized 18% in that period; in 1999 – 2000, there were 6 hikes and the S&P 500 annualized 5%; from 2004 – 2006, 17 rate hikes and 16% annualized on the S&P. It makes sense why this occurs: if the Fed is raising rates, it’s because the economy has underlying strength! Stocks tend to do well when that’s the case.

2. We Expect GDP Growth to Average 3% Over the Next Four Quarters – we expect earnings to recover and for the economy to expand at a moderate, but reasonable, pace. This should push unemployment down to 5.1% by the end of Q4 with core inflation, based on Personal Consumption Expenditures [PCE], creeping up to 2% by 2017. Not too hot, not too cold. With multiple expansion that has come with Fed easing the last six years, we think the market should move more in-line with earnings growth versus seeing P/Es climb much further. That could mean single digit S&P 500 growth in the next year or two.

3. Greece is a False Fear, Creating a Wall of Worry Markets Love to Climb – the Greece story is now over two years old, which means the market has had plenty of time to price-in the worst. Even if there is a “Grexit,” we think it’s probably only capable of inciting a bit of short-term volatility. All this talk of the European banking system collapsing or systemic issues surfacing (if Greece leaves) are over-reactions in my view. False fears are almost always tailwinds for stocks.

4. Global Growth Should Continue Apace – in spite of Europe’s Greece dealings, the region should see growth in the range of 1% - 2% this year, which is more than it has grown in a few years. Having Europe back in the plus-column is good for global GDP, and I think the U.S. and China will hold up in spite of the jitters that appear to be surfacing. China is willing to ease and the U.S. should recover in the back half like we did in 2014.

The Bottom Line for Investors

With the Fed tightening, modest corporate earnings growth, and a further decline in the equity risk premium, we expect the S&P 500 to notch up +4% to finish the year. While 4% isn’t the kind of return we’ve become accustomed to as of late, it still beats what you can get from U.S. Treasuries, or much of what can be attained in fixed income markets. And, the outlook for equities beyond 2015 remains positive with the possibility of upside surprises in my view. For the long-term growth investor, equities likely remain the best asset class for now.

The Five Richest Superheroes

It’s pretty good to be a superhero. As if it weren’t enough to have the awesome fighting powers themselves, the men and women who grace our comic book covers and headline blockbuster action movies also get spiffy outfits, cool names, dashing good looks, and, in many cases, a huge fortune to help fund their crime-fighting adventures. As Comic-Con kicks off in San Diego, we at Money decided to research how much the wealthiest caped crusaders are worth and see which champion is the most (economically) powerful.

[Surprise spoiler: the richest is not Bruce Wayne or Tony Stark.  And it's not even close...]

China's crash continues

China’s stock rout spread to the country’s commodities markets as investors rushed to raise cash.

Everything from silver to sugar to eggs tumbled with the Shanghai Composite Index, which crashed to a three-month low on Wednesday. Government measures to stabilize equities are failing to stop a stock market collapse.

“People are selling everything in sight to get their hands on cash,” Liu Xu, a trader at private asset-management company Guoyun Investment Co. in Beijing, said by phone. “Some need to cover their margin calls in the stock market, while others are gripped by fear that the Chinese economy will be affected by this crisis.”

Metals including nickel and silver on the Shanghai Futures Exchange fell to their daily limits, while rubber entered a bear market. The volume of copper traded was almost six times the three-month average. Steel rebar and iron ore, as well as eggs, sugar and soybean meal dropped to the lowest level allowed by their exchanges.

“Agricultural products in my view are collateral damage in this selloff,” said Liang Ruian, a fund manager at Shanghai-based Jianfeng Asset Management Co. “Pigs are still going to eat, so what does this stock market stampede have to do with soybean meal?”

***

SHANGHAI — Stock prices in mainland China fell sharply again on Wednesday, continuing a decline that began last month despite another series of government measures meant to restore confidence and stabilize a market that has grown increasingly turbulent.

Just days after Beijing introduced a number of bold measures to prop up share prices, including a pledge by some of the country’s largest brokerage houses to create a $19.4 billion stabilization fund, regulators announced new initiatives early Wednesday, including an easing of rules to allow insurers to invest more money in stocks and the creation of a fund to buy up shares in small and midsize companies.

Still, China’s biggest exchanges were battered. The main Shanghai index plunged 5.9 percent Wednesday, and the Shenzhen index fell 2.5 percent. The Shanghai index is down 32 percent and the Shenzhen is off 40 percent from the highs reached in mid-June.

In Hong Kong, which had escaped much of the mainland market’s rout, the Hang Seng index fell 5.8 percent.

The sell-off has also spread to other parts of the Asia-Pacific region. In Japan, the Nikkei 225-stock average dropped 3.1 percent, Australian stocks were down 2 percent and South Korean shares fell 1.2 percent.

Fear is gripping the markets after a phenomenal bull run in which mainland China’s major stock indexes doubled, tripled and even quintupled over the last few years. Sentiment has turned down too sharply and investors have lost confidence, analysts said, and because buying shares with borrowed money was a critical part of the increase in prices, there is now pressure to sell.

“China’s stock market remains under stress, as investor confidence will take some time to recover,” Li Wei, the China economist at the Commonwealth Bank of Australia, wrote in a report to investors.

Panic selling may also be extending the downturn because each day trading is suspended for hundreds of stocks after they drop by 10 percent, under exchange rules. Some companies are even asking that their shares be temporarily suspended, hoping to ride out the downturn.

Since late June, on almost every trading day, there have been more than 900 stock trading suspensions, according to Xinhua, China’s official news agency. On Tuesday and Wednesday, 900 to 1,700 stocks were suspended from trading. That means that among the approximately 3,000 listed companies on the two major exchanges, up to half may have been suspended during the first two days of the week.

“This is wrong,” said Francis Cheung, the head of China and Hong Kong strategy at CLSA, the brokerage firm. “It just delays the correction. So it delays the downturn.”

The Chinese authorities have been moving swiftly, apparently worried about the potential impact the sell-off could have on the financial markets and on a broader economy that is relatively weak. Although experts say they doubt there could be systemic damage, banks and brokerage firms could be threatened because of the huge amount of margin trading, or borrowing to purchase stocks.

By some estimates, margin trading may have amounted to as much as 3.4 trillion renminbi, or nearly $550 billion. And because some of the borrowing probably took place in the shadow banking sector, no one is quite clear how big it was.

The bubble seems to be bursting on a stock market run that began last summer. In a rally that began roughly a year before the market’s high point on June 12, the Shanghai index jumped 157 percent. The Shenzhen index rose even more during that period, rising about 208 percent. A smaller stock market in Shenzhen called the ChiNext, geared toward technology companies and start-ups, began its own bull run much earlier, in late 2012, and soared about 540 percent before the markets began to falter several weeks ago.

Based on company earnings, the prices of many Chinese stocks began looking incredibly expensive, trading at far higher prices than could be found in Hong Kong or the United States, worrying analysts and investors.

“It’s gone up too fast, and it’s too much borrowed money,” said Wendy Liu, an analyst at Nomura Securities in Hong Kong. “A lot of first-time equity buyers were too excited and didn’t know how to temper their excitement.”

Even after the big sell-offs, though, stock prices in China are still considerably higher than they were a year ago. The Shanghai composite is still up 74 percent from mid-2014, and the Shenzhen composite is up 84 percent since then.

the single biggest risk

Investors who do the least will likely do the best over time. For the huge majority of people, investing a set amount of money each month consistently over a long period of time will outperform any trading strategy they attempt. The evidence on this is overwhelming. It's so overwhelming that I think the single biggest risk you face as an investor is that you'll try to be a trader. It's the financial equivalent of drunk driving -- recklessness blinded by false confidence. "Benign neglect, bordering on sloth, remains the hallmark of our investment process," Warren Buffett once said. It probably should be yours, too.

The Penny Hoarder

Somehow I have started seeing these Penny Hoarder stories on facebook.  Maybe they're paying to be seen.  Or maybe some of my friends like them.  Anyway, they have some handy stories which appeal to penny-pinchers (like me).

So I created this post to list some of their articles.

[7/2/15] 10 Ways You Waste Money

9. Paying for Extended Warranties
Almost a third of consumers buy extended warranties each year, according to a study reported on CardHub.com. These policies provide manufacturers with 50 to 60% profit margins, because appliances and electronics just don’t break down that often.

In other words, don’t buy this expensive insurance. Yes, your printer could break just after the regular warranty expires, and you’ll have to pay cash to replace it. If this happens, just remember all the money you saved by not buying extended warranties on the other items — the ones that didn’t break down.

[This one I noticed on 5/6/15] 32 Ways to Make Money at Home

questions to ask your financial advisor (or yourself)

If I was going to trust someone to manage my life savings for the years and decades to come, I would make sure that all of these questions were answered beforehand:

(1) What is your investment strategy?
This should set your expectations if you ultimately decide to invest with this person; it also gives you a way to confirm that they’re sticking to the strategy. I would want a rough idea of how much turnover the manager expects in the portfolio, the number of holdings, any cap on position size, etc; the advisor should be able to clearly explain what it is that they will do for you. If you don’t understand what they’re talking about, ask questions and make sure that it is clear before you walk out of the door; if you’re still confused when you leave, I’d personally look elsewhere. You might find it odd that people wouldn't ask this; you would think it would be the first item addressed. In my experience, the issue is that this rarely goes deeper than a few sentences from the advisor hitting the high points, with no follow up from the client; there really should be more.

(2) What are your thoughts on active investing versus passive investing?
The person you’re talking with should be able to put this in terms you can understand (read around online before you visit with them if you’re unfamiliar with the debate or else asking won’t do you any good). If they plan on taking a passive approach, I have no problem with that: I still see a need for some clients to do this through an advisor (primarily for having someone to talk to). However, the fees in that scenario should be quite low; I think that anything above 50 basis points or so (0.50%) would be excessive - and even that might be a bit steep. If they make the argument for an active strategy, that’s fine as well; at that point, I’d ask the following:

What makes you think that you can outperform the major indices like the S&P 500 over time? What is your competitive advantage as an investor long term?
People all over the country and the world wake up every day hoping to make money in the stock market. Many are essentially gambling, while others have a near infinite set of resources at their disposal (or even insider information). I think that if you plan on being successful long term you must have something that distinguishes you from the herd; being different on its own obviously doesn’t guarantee success, but it is a requirement for performance that differs from the index (hopefully to the upside). I would simply want to know why they believes they can do better than the market over time. Hopefully this was touched on when you asked about their strategy.

(3) How do you make money from my account?
I’m a big believer in the power of incentives; I would want to be assured that my advisor’s interests are aligned with mine at all times. If someone is being paid to sell you a certain product or fund, you better take a hard look at whatever it is that they’re selling you. My personal opinion is that you would be better off taking your business elsewhere.

I want the fees generated from my account to be correlated with changes in the account value; that would call for either a fee based on the assets managed or a fee based on annual returns (like Warren Buffett’s arrangement when he ran his partnerships); I can’t think of any other way of paying my advisor / manager that I would be comfortable with.

(4) What type of returns can I realistically expect long term?
As with the first question, it’s important to ensure that you’re on the same page with the person who will be managing your money. If you’re only comfortable with limited volatility and they tell you 15% a year is attainable, there’s a misunderstanding that needs to be addressed. Just for clarification, I wouldn’t expect (or necessarily want) a specific number – a range is fine.

(5) How long have you been investing personally, as well as for other people? What have your returns been over the past ten-plus years, or since you started managing money?
This question is quite direct; suffice it to say that it’s worth dealing with a bit of discomfort to ensure that the person you’re about to entrust with your retirement money knows what they’re doing. While the returns are obviously front and center with this question, it also gives you a clear opportunity to consider another potential issue: closet indexing. If the long term returns for the manager are nearly identical to the index, it is worth considering whether or not you really should be paying this individual for “advice” that could easily be replicated for a few basis points on your own with Vanguard. I wouldn’t have thought this is nearly as common as it actually is (or has been in my experience reviewing prospective clients account statements).

(6) What benchmark do you judge your results against? Why?
Most people use the S&P 500, but some use other indices (for example, Wedgewood Fund uses the Russell 1000); simply ask for an explanation and make sure the response is logical if it’s anything besides the S&P 500. It’s worth remembering that if they show you their returns and the index is blended (some mix of stocks and bonds), take that into consideration if you’re looking at their returns from a stock only (or more heavily weighted) model / portfolio.

(7) Can you tell me about one of your worst investments in the past few years? What did you learn from the experience?
This sounds like something you might hear at a job interview, but I think it’s important (and fair game): I want someone who is willing to admit that they’ve made bad investments in the past, and more importantly, has learned from those mistakes.

(8) How much of your own money is invested in the same securities that you plan on purchasing for my account?
Again, this seems direct, or even impolite. My opinion, as someone who sits on the other side of the table from clients, is that this is fair game; in fact, I would be happy to be asked this (which gives you a good idea of what my answer would be).

Any advisor / money manager that’s offended by this or the other questions mentioned above should be avoided in my opinion. As for the answer, I think that at least half of the invested assets for the decision maker at the firm (hopefully the person you’re talking to) should be the same as what they put their clients in, and hopefully even more than that (for comparable asset classes – equities to equities). Maybe I’ve been spoiled by Warren and Charlie, but I think 90% or more sounds like a reasonable number. The person you’re giving money to should be personally investing in the same stocks that they’re buying for you – and in a big way.

Conclusion
This isn’t meant to be a complete list; I’ve focused on the issues that are often overlooked (in my experience) that prospective clients should be asking. I’ll reiterate what I said above: if the person you’re meeting with is offended or put off by your questions, look elsewhere.

The person managing your life savings must be someone that you can trust and ask difficult questions to. Hopefully these questions will help you find the person that’s right for you.