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Roulette ETFs For Today’s Market Conditions

Mike’s note: Since I first found my way to the Bogleheads forum, one of the members I’ve most looked up to is an anonymous writer by the name of nisiprius. He’s always impressed me with his wit and insight, so when he offered a guest post in reply to last week’s “asset allocation comes first” article, I jumped at the chance to publish it. I hope you enjoy it. 😉

Investors are taking a fresh look at roulette ETFs, which invest in bets on roulette wheels at casinos. Roulette gambling has long been used by hedge funds and university endowments, but was formerly out of reach of individual investors due to the time and cost of travel, and the difficulty of diversifying among casinos. But ETFs now provide low-cost access to this asset class.

Bram Stoker, senior analyst at Transylvania Capital Management, says “roulette spins have been shown to have low correlation with stocks, making them a powerful diversifier in a portfolio.”

It is important to understand the differences between roulette ETFs, because they don’t all work in the same way, so look under the hood before deciding which of them you need to add to your portfolio today.

Mike’s note: I’m 95% confident you’ve all figured this out by now, but just in case: This article is a satire, poking fun at (among other things) the product-focused nature of the mainstream financial media.

Index roulette ETFs, such as Roquefort’s ROQ, simply bet on red and black equally. Roquefort uses random numbers generated by a proprietary atomic decay device, and cites academic research that claims this reduces the standard deviation compared to traditional selection methods.

Roquefort also offers two chromic strategy ETFs: REDS, which always bets on red, and BLAK, which always bets on black. Stoker notes that these are riskier: “Be sure you know which color you like before investing.” Roquefort has just introduced OO, which bets on the double zero. The potential for 3500% returns is attractive, but Roquefort notes that due to volatility it may not be suitable for all investors, only for better-than-average investors like you.

Nisiprius Investments Ltd. says that its global roulette fund, WHEE, places bets in Monaco, Macau, Antigua, Baden-Baden, Moscow, and Sun City, South Africa. We talked to fund manager Blaise Pascal, who said “Why are you pestering me with all these silly questions? It’s global, what more do you need to know? Global! Global! Global! Do you hear me, global!”

Strategic Cluster Asset Modeling is a new entrant, providing two actively managed ETFs, CLUS and CLUD. CLUS follows a progressive cluster roulette gambling system, backtested with 40,000 spins. Spokesperson Mary Martingale says it could offer the possibility of a conceivable potential for steady winnings regardless of what the wheel does. CLUS is only for sophisticated investors. The minimum investment is $250,000, and you must include a photograph and three letters of recommendation with your application. CLUD, the 2X leveraged version of CLUS, has a minimum investment of $500,000 and you must send two photographs and six letters of recommendation, and the existing shareholders can blackball you. With $1.35 million assets under management, CLUD is off to a fast start, and both of its shareholders think the world of it.

What is an appropriate roulette allocation? “We are currently recommending allocations of 5-10% to all our clients,” says Stoker. “We think roulette will prove to be a valuable addition to their portfolios. We follow market trends closely, and if roulette doesn’t pan out we’ll have other hot asset classes to recommend, but what with the end of QE2, the sideways trend in the VIX, and uncertainty about the possible end of the world, our analysts think roulette is the place to be today.”

I asked Stoker whether the house percentage could cause the long-term return of roulette funds to show a long-term trend in any particular direction. He replied “Investors who limit their portfolio to assets with positive long-term returns are pathetic losers who are going to miss out. An asset may do nothing but lose money, yet improve the portfolio as a whole. Some guy once won a Nobel prize for showing how bonds help stocks. The correlations for roulette are even lower! You must not consider roulette in isolation, you must consider how it works in the portfolio as a whole.”

Which of these roulette ETFs will you add to your portfolio? Only you can answer that question. But you better add at least one of them. Today!

Investing Life Insurance Proceeds

Imagine this situation: A married couple has one spouse who is a stay-at-home parent (who generates no income). The income-generating spouse dies at age 30, with an appropriately-sized life insurance policy. How should the surviving spouse invest the life insurance proceeds?

It’s a tricky question, and I don’t have a perfect answer. (I’m not sure there is one.) Still, I think that anyone who could potentially find himself/herself in such a situation would be wise to make a plan ahead of time.

It’s akin to planning a super-long retirement. We have to determine how to invest a portfolio from which you want to take a stream of inflation-adjusted withdrawals over a very lengthy period (potentially more than 50 years).

  • What asset allocation would you use?
  • What rate of withdrawal would you be comfortable using?

A part of what makes these questions so difficult to answer is the fact that we can’t learn much from backtesting various asset allocation/withdrawal rate combinations to see how they’d hold up over historical 50-year distribution phases. After all, we only have two such independent 50-year data sets–not exactly a large sample size.

Asset Allocation

On the one hand, for such a lengthy period, it seems that it would be difficult to achieve the long-term returns necessary to sustain 50+ years of withdrawals without a hefty stock allocation.

On the other hand, the “sequence of returns risk” problem that plagues retirement planning becomes even worse when we’re looking at such a long period. If the investor uses a stock-heavy allocation and the first few years go particularly badly, the portfolio could easily fail to generate the desired income for another 50+ years.

Personally, I’d attempt to minimize sequence of returns risk by using a fairly conservative allocation–something like 40% stock, 60% bond (with a healthy portion of the bond allocation being invested in TIPS). But I’d only be comfortable using such a conservative allocation because I’d also make sure to…

Use a Low Withdrawal Rate.

The most important piece of the puzzle is to use a very low starting withdrawal rate (3% or lower). The goal is for the portfolio to last almost indefinitely. If you aim for the portfolio to be depleted at the end of the 50-ish-year expected time horizon, but you overestimate the sustainable withdrawal rate by even 1%, you could run out of money far earlier than desired.

What Would You Do?

As I mentioned above, there simply isn’t enough data to get a very conclusive idea of how well any given strategy would have held up historically over 50+ year periods. As such, the above thoughts are what I would do with the money, but I absolutely cannot say that there would be no better approach.

What would be your plan if you were faced with the prospect of having to draw from a portfolio for (potentially) more than five decades?

Teaching Kids About Investing: Giving Shares of Stock

Over Christmas, I got to thinking about one of the neatest gifts I ever got: When I was 8, my mom bought me some shares of Proctor & Gamble stock. She explained that I now owned a piece of the company.

Of course, as an 8-year-old, I had never heard of Proctor & Gamble. So my mom took me around the house showing me all the products we regularly bought that were made by P&G: Tide laundry detergent, Charmin toilet paper, Bounty paper towels, etc.

Then, she took me along on the next grocery run and showed me the same thing. I was amazed. Not only did this company make a nearly-unending list of famous cleaning products, they made Pringles potato chips. Every kid in my class loved Pringles potato chips!

And now I owned a portion of this company. Boy that was cool!

Focus on the Profits (not the Price)

Over the next few years, my mom made a point to maximize the educational potential of the gift.

My mom explained that, as a shareholder, I could choose between receiving money for my share of the business’s profits, or I could use that money to automatically buy more shares of the business–thereby allowing me to earn even more profits in the future. That sounded like a good plan to me!

She never even mentioned the market value of the stock. In fact, I didn’t realize until years later that the stock could be sold. The entire focus was on owning a company in order to receive a share of its profits. There was no mention whatsoever of the lottery of short-term stock price movements.

Every time there was a shareholder vote for new board members or important company policies, my mom explained everything to me so that I could choose what I thought would be best. (I distinctly remember voting against testing products on animals.)

My mom did everything she could to make the lesson as concrete as possible: When you buy a stock, you become a business owner, and you earn a share of the business’s profits for as long as the business is around. I was hooked. I wanted to know more, and I wanted to build my collection of businesses.

Why Not Give a Mutual Fund?

I’m as convinced as anyone regarding the benefits of index funds, but I’m of the opinion that a share of an individual stock (and a lot of time spent teaching) makes a superior educational gift for a young child. It’s far more concrete and, therefore, easier to understand and easier to get excited about.

Lessons such as diversification, minimizing costs, and so on can come later, after the child is interested in investing.

Are You A Long Tail Investor?

This is a guest post by The Digerati Life, a general personal finance blog covering topics such as 0% purchase credit cards and top credit card deals.

Long tail investing means looking outside the norm regarding potential investments.

For example, if traditional investing means opening an account with a cheap online broker and putting your money into stocks, bonds, mutual funds, and ETFs, long tail investing might be any of the following:

Get into a new kind of trading: No, I’m not talking about day trading stocks. I’m talking about building a simple trading business that involves buying goods in another country and selling it in America. For instance, you can buy goods from China and find a way to distribute them in local stores.

Investing in foreclosures: With the real estate investment climate still in the doldrums, foreclosures are common. If you take your time to shop around, researching numerous different properties, you may find one with the potential for very high returns.

Buying websites: Would you consider buying virtual real estate on the web and turning it around for a profit? It may not take much to monetize such websites to help them increase their value.

[Mike’s note: If I had more free time, I’d be buying defunct blogs left and right. After they quit blogging, many writers let their sites sit there (making no money), despite the fact that they continue to get traffic from search engines.]

As you can see, long tail investing is often a combination of investing and entrepreneurship.

Is Long Tail Investing High Risk?

You may think that long tail investing is riskier than traditional investing. That’s not necessarily the case. Yes, such investments can be high risk, but I’m not at all sure they’re riskier than, say, a small-cap value mutual fund — something which in many circumstances is considered to be a prudent investment.

Long tail investments have two unique risk-mitigating factors.

First, when searching for long tail investments, you have the opportunity to narrow the field to niches with which you’re intimately familiar. With large, publicly-traded companies, there’s no way to have this intimate level of knowledge unless you work for the company — in which case it becomes a terrible idea to put much of your money there.

Second, after making the initial investment, you play a direct role in the outcome via your resourcefulness and work ethic. This is quite different from stocks or mutual funds where you have no control over what returns are earned.

Finding Long Tail Opportunities

The trick is to look for niche strategies, because that’s where the undiscovered opportunities will lie. Do not simply go for the first potential investments you come across.

With this type of investing, you may stumble upon a niche that may become more widely known as time goes on. If you explore the options now, you can potentially get a good return on your investments before many other people realize what is happening.

HDHP Insurance: When Does a High-Deductible Health Plan Make Sense?

With many employers, you’re given two choices for health insurance:

  1. A High-Deductible Health Plan (HDHP), or
  2. A traditional, copay-based plan with a higher monthly premium.

Which plan is likely to be better for you depends on your healthcare costs. The lower you expect your healthcare costs to be, the more attractive an HDHP becomes relative to a copay plan.

The goal is to answer this question: How high do my healthcare costs have to be before a copay plan makes sense? To figure that out, we calculate the break-even point: the point at which your costs will be the same regardless of which plan you use.

Let’s say your choosing between two plans:

  1. An HDHP with a monthly premium of $112 and an annual deductible of $1,750, after which the insurer picks up 80% of costs. (This is actually my own plan, purchased through eHealthInsurance.)
  2. A copay plan with a monthly premium of $287, a $15 copay per visit, and no deductible.

In other words:

  • Your annual out-of-pocket cost for the HDHP would be $1,344 ($112 x 12), plus any healthcare costs up to $1,750, plus 20% of healthcare costs beyond $1,750, and
  • If we ignore the small copays, your out-0f-pocket cost for the copay plan would be $3,444 per year ($287 x 12).

Here’s how it looks visually:

So what level would your healthcare costs have to exceed in a given year for you to be better off with a copay plan?

$3,500, determined as follows:

  • Annual cost for copay plan = annual premium for HDHP + amount of healthcare costs you’d be responsible for with an HDHP.

Or plugging in the actual numbers:

  • $3,444 = $1,344 + X (up to $1,750) + 0.2(X — 1,750)

Solve that equation for X, and we get $3,500.

Or you can substitute your own premiums, deductibles, and coinsurance percentage to determine the break-even point for your own healthcare options.

Remember, though, that an HDHP plan carries more risk than a copay plan. With a copay plan, you have a pretty good idea of what your out-of-pocket costs will be for the year. With an HDHP, your costs can (and probably will) vary significantly from year to year, which can make budgeting somewhat more difficult.

HDHP Insurance and HSAs

One last point to consider when choosing between an HDHP and a copay plan is that, if your HDHP meets certain requirements, it will allow you to contribute to an HSA, thereby allowing you to use pre-tax money for healthcare costs.

In order to be eligible to make HSA contributions, your HDHP must have an annual deductible of at least $1,200 ($2,400 if it’s family coverage) and maximum out-of-pocket expenses of less than $5,950 ($11,900 if it’s family coverage).

Calculating Real Estate Investment Return

Many people refer to their home as their “best investment.” Others argue that a home isn’t an investment at all because it may not go up in price or because you may never sell it.

In my opinion, anything that has a calculable (usually positive) rate of return is an investment. And it’s worth noting that buying a home can yield a positive rate of return even if the home never increases in value. (Conversely, it can have a negative rate of return even if the home does increase in value.)

Rate of Return Involves More than Home Value

The rate of return on a home purchase involves more than just the home’s market value. If you only consider the change in home value, you’re leaving out:

  1. Part of the price of the investment — maintenance costs and property taxes,
  2. The biggest part of the payoff — the fact that it replaces your rent, and
  3. The fact that the investment was probably leveraged (i.e., paid for using a loan).

I think it’s easier to first look at the purchase as if you were buying the home with cash. That way, it’s easy to calculate the expected return on the purchase:

Expected Real Return = D + G – C, where

D = imputed rental dividend (calculated as the size of the annual rent bill that you’d eliminate by owning instead of renting, divided by the purchase price of the home),
G = inflation-adjusted growth in home value, and
C = costs (insurance, property taxes, and maintenance), expressed as a percentage of the purchase price.

For example, if you’re currently paying $1,000 in rent per month, and you buy a home for $180,000, your imputed rental dividend would be 6.67% ($12,000 ÷ $180,000). From that, add the inflation-adjusted rate at which you expect the home to appreciate, and subtract any non-mortgage costs of owning the home.

Then you can determine how your return would be affected by using borrowed money for the purchase. (In short: It only makes sense to borrow if you expect a return greater than the interest rate you’d have to pay on the loan.)

Rate of Return When Prepaying a Mortgage

A recent Get Rich Slowly post asked whether it’s better to prepay a mortgage or invest elsewhere. In the comments, several people asked questions to this effect:

“Isn’t it risky to put a bunch of money into prepaying your mortgage? After all, we’ve seen in the last few years that home prices don’t always go up.”

It’s true that home prices don’t always go up. But if you own a home, you’re already exposed to that risk — whether you decide to prepay your mortgage or not. The rate of return you get when you prepay your mortgage is simply equal to the interest rate on the mortgage. It’s got nothing to do with changes in the market value of the home.

Why I’m Not Buying a House (and Likely Never Will)

For many people, owning a home provides an emotional benefit, so they’re happy to buy a home even with an expected return that’s somewhat less than the return they could get with other investments.

I find myself in the opposite boat. From where I’m standing, owning a home looks to be:

  1. A huge pain in the butt,
  2. Illiquid, and
  3. Extremely undiversified.

…whereas putting money into an ETF portfolio is the opposite. It’s easy. It’s liquid. And it’s diversified. As a result, I’m only going to be interested in buying a home if it appears that the expected return is significantly greater than that of other investments.

Of course, given that there are so many people willing to accept a lower return (i.e., pay more for the home), that may never happen.

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