New Trading Goal for 2008

I'm upping my trading goal for 2008 from $9,500 to $15,000. This means making about $2000 per month for the rest of the year except in the month when we visit China. I've had realised short-term gains in shares and mutual funds (selling the fund, not getting a distribution) of more than $2,000 for the last three months. My futures results in the last two months has dragged performance down. I'm figuring that the new options trading strategy I'm implementing in the US (more on this some time soon) can make about $500 per month currently and CFD trading in Australia so far seems to be able to generate a similar amount perhaps. Then I only need $1,000 in stocks etc. to round the number out. $15,000 also represents a similar percentage improvement over 2007's result ($9,224) as 2007's represents relative to 2006 ($5,368).

Demi-Millionaire

On an intraday basis, we just went over a half million U.S. Dollars in net worth ($US503k or $A535k). Hopefully, we can hold onto it. We are also at an all time high in Australian Dollar terms, exceeding the previous peak, last August, of $A527k. We are still 1/2 a percent below the peak in terms of Australian Dollar investment returns. We're up about $US85k from mid March. After reaching another of our annual goals I'm going to only raise the goal to $US505k, which just assumes that we hold onto our gains and save the retirement contributions from Snork Maiden's employer that we will receive in the remainder of the year. I project that if everything goes to plan we'll reach $US550k, but I'm not going to make that an explicit goal, as everything might not go to plan.

Snork Maiden asked me why we are gaining so fast after months of going down hill or struggling. The main reason, is of course, that the stock market is now going up - i.e. luck. But there are also two important things that I did - switching most of our bond holdings to stocks in March and early April until we had an effective 125% exposure to the stock market - and buying or holding onto a bunch of listed funds that were and still are trading way below book value. Those funds are beginning to return to book value.

In other news, Beazer released their last two quarters of earnings. Though they again lost their entire market capitalization in those six months, the accounts are not quite as bad as I thought. They can still go for more than a year at this rate before wiping out all their book value. They have $277 million of cash at hand at the end of March and will receive cash from asset sales in the near future. And finally, they renegotiated terms with their lenders that means they will not be in violation of their covenants - they delayed the earnings until these negotiations were complete... In after hours trading the stock went up a few cents. If it doesn't go down on Friday I will sell my puts.

As mentioned above, the market continues to stun confused bears and trade up and up. I'm currently projecting a pullback starting on Monday or Tuesday, but I doubt it will be significant. In fact I suppose the market will just keep on going until the old highs from October 2007 are again reached.

Achieved One Annual Goal

As you can see in the righthand column, I've achieved one of my five annual goals - that of reaching breakeven on my U.S. investment/trading accounts - trading accounts at Ameritrade and Interactive Brokers, my Roth IRA and my holding in the TFS capital mutual fund. I first began investing in the US back in 1997 and have kept a record of how much money has gone into those accounts - until now I have mostly been in deficit - i.e. I've suffered a net loss. Finally, I've recouped my investment - kind of like my tuition fees for learning about trading etc. Of course when compared with inflation or the returns on an index fund I'm still losing. To match the NASDAQ 100 index since August 1997 I'd need to show an 80% gain. Luckily, I've more than made up for this poor performance in retirement accounts and Australian trading accounts. Performance in the last 1 1/2 years has been pretty good (alpha = 25%):



The challenge now is to hold on to these gains in the next few months. My very short-term trading is still not going well. I had another bad loss on May 1st - though not as bad as the one on April 1st. Maybe I should just keep away from trading on the first day of the month!

On Friday we also made progress on Snork Maiden's immigration process. We need to get a police check from the FBI in the US and to do this we need to send them her fingerprints. Seems that the only people who can do that here are the police, but there is a two month waiting list in Canberra! Nearby locations in New South Wales refuse to do this for ACT residents. We finally got the Goulburn, NSW police to agree to do it and headed up there (about 85km away) on Friday afternoon to successfully accomplish the mission. Goulburn is also the home of the "Big Merino" (one of Australia's many "big things"), shown above while moving to its current location. There's a "wool museum" inside and a gift shop alongside of course.

How Could I Produce an Alpha of 9%?

A recent discussion on Roger Nusbaum's blog typified the diametrically opposed positions of those who think it is easy to beat the market and those that think it is impossible. I'm targeting an alpha of about 9%, so how do I think I can produce it (apart from pointing at my recent track record)? There are three main potential sources:

1. Active trading: 2-4%. 2% means earning the same amount in trading as last year. One of my annual goals is to beat that number. 4% would be doubling last year's result, which is, realistically, the best result I can imagine at this stage.

2. Passive Alpha: 2-4%. About 40% of my portfolio is dedicated to what I call "passive alpha" investments. These are actively managed funds and other financial companies which I believe can produce significant risk adjusted returns. I assume they could attain 5-10% each. Multiplied by the portfolio share that is 2-4%. 5-10% is not just hypothetical. TFSMX has an alpha of 8%. Berkshire Hathaway has been credited with an alpha of 10%. Man Financial has averaged at least 10%. And so on.

3. Timing and Security Selection: 2-4%. These numbers are purely hypothetical. But let's assume that my portfolio beta was 0.5 for the first two months of the year and I then increased it to 1. I would have avoided half the losses in the first two months of the year by timing. This assumes that the markets are relatively benign for the rest of the year and I timed in the right not the wrong direction. The MSCI lost almost 8% in January and February, while my portfolio lost around 2% in total (both in USD terms). Therefore, avoiding 2-4% of losses here through timing sounds reasonable. Of course, if I never changed the beta upwards then this result would be purely due to low beta. Hopefully, some of my few industrial stock selections will add a little value too.

To explain the timing effect, let's imagine that the market goes down for six months of a year at 10% a year and goes up the other six months at 10% per year. Also imagine that the investor has a true beta of 0.5 when the market is going down and 1.0 when it is going up. If we use a regression to estimate a constant beta for the whole period, we'll come up with the average: 0.75. Then in the declining six months my predicted market return will be -7.5% p.a. but I'll in fact only lose -5% p.a., while in the rising part of the year my predicted return will be 7.5% but I will in fact gain 10% p.a. The investor's alpha from this source will, therefore, be 2.5%.

The average of each of these categories is 3% and adding them all up we get to 9%. Of course "alpha" technically is the average excess return over a period of reasonable length. Looking at just one year is probably stretching the concept. Maybe, I should just say a "risk-adjusted excess return of 9%". But it's easier to say "alpha" :)

Revising Annual Goals (Up)

Following yesterday's post about what alpha really means I've been thinking to revise a couple of our annual goals. Specifically, the first two:

1. Net Worth Goal While I was in my trading slump late last year and the markets were going downhill the goal of just increasing net worth in 2008 seemed ambitious enough. But as I pointed out then even, Snork Maiden's employer will contribute around $A10k in retirement contributions and between the inheritance from Germany and my Mom's wedding gift, we got another $US10k. So, an easy hurdle would be to add $20k to last year's net worth. This takes us to $US470k. The contribution from alpha would be another $US40k taking us to $US510k. Allowing for taxes, some spending from investment income, and assuming the markets are pretty much flat for the year gives me a goal of $US500k.

2. Alpha Goal I'm going to revise the alpha goal to state that alpha must provide roughly the average wage. Assuming that is around $US40k alpha needs to be around 8.5% (40/(450+.5*40)). According to the time series model I'm a little above that at the moment. The previous goal was simply positive alpha.

Goals for 2008

Yesterday, I reported on performance relative to my goals for 2007. I've discussed why I think my earlier goals for 2008 were unrealistic. So here are some thoughts on more achievable goals:

1. Increase Net Worth I'm not going to specify whether in Australian Dollars, US Dollars, or in currency neutral terms. Increasing net worth in all three would be nice but large fluctuations in exchange rates may make one of the goals hard to achieve. We can compute the change in currency neutral net worth by taking away the gains or losses for the month or year due to exchange rate fluctuation from actual net worth in either currency. Probably a gain in currency neutral terms should be the minimum goal here. We get a head start from Snork Maiden's employer's superannuation (retirement) contributions of around $A8.600 for the year. Failing to meet this goal means either that investment returns were -2% or worse roughly and we spent all of Snork Maiden's salary or that we are spending more than her salary and our after tax investment returns or some combination of overspending and/or poor investment returns.

2. Positive Alpha This goal says that our investment returns should on a risk-adjusted basis beat the MSCI World Index on a before tax basis. Beating the index (in a risk-adjusted sense) could be the only justification for trying to manage your money yourself (rather than buying a bunch of index funds) apart from educating yourself about finance through the process of managing your portfolio.

3. Increasing Non-Retirement Net Worth by More than the Index This is a much tougher goal to achieve. It requires substantially beating the index on a before tax basis and/or spending less than Snork Maiden's income. Again we can measure this in Australian Dollars, US Dollars, or in currency neutral terms.

4. Achieving Break-Even on Ameritrade and IB Accounts This was a goal for 2007. Though I made progress on it, I didn't achieve it. Things will have to be bad on the trading front in the coming year if I'm not to achieve this goal.

5. Making More Money from Trading I made more money from trading in 2007 than 2006, though not as much as I'd have liked. The goal for 2008 is just to make more again. I have two measures of trading income - the net non-investment gain on my Ameritrade and IB accounts (trading and net interest) and short-term capital gains reported on my tax return (which includes short-term gains or losses in Australia but excludes margin interest). Both numbers were about $US9,500 for 2007.

2007 Goals Review

We didn't meet any of the goals we set for the year but we did go a considerable way in the right direction:

1. Increasing net worth from $365k to $470k. We are ending the year around $450k which is around 80% of the way to the goal. The merger with Snork Maiden, quitting my job, and the move to Australia were unexpected events (a positive and two negatives for net worth). I also expected to inherit a small amount of money, which didn't happen yet - as it is still tangled in the German legal system. The Australian Dollar was extremely strong which helped raise net worth a lot. Given all this, it is pretty amazing we ended up anywhere near the goal.

2. Returning the combined value of my US brokerage (and Roth IRA) accounts to the value invested in them. At the start of the year I had $41k in these accounts but had invested $60k. In other words, I had accumulated losses of $19k. Now I have around $50.5k with $58k invested. Around 60% of the goal was achieved.

3. A vague goal was to achieve the $19k in goal 2 through trading. Later, I stated $18k as a 2007 trading goal. I made around $9,800 from trading in the end or about 54% of the goal. I was much closer to the $18k goal at the end of June.

Tomorrow, I will post on my 2008 goals, which will look very different.

Update on Goals

I've kept the 2007 goals on the sidebar but I've taken down the goals for 2008 and beyond as they are looking increasingly unrealistic. Exchange rate fluctuations mean that a goal in any particular currency is hard to hit as do stock market fluctuations for buy and hold investors. Perhaps I could come up with a currency neutral measure of net worth gain. But probably I am going to go for aspirational goals going forward: Increase net worth (increase non-retirement net worth - which is harder), increase trading income, etc. It's easier also to set goals for investment and trading performance relative to a benchmark (Increase non-retirement net worth faster than the MSCI index?). As for the goal of a net worth of $1 million, I now project that that could occur by the end of 2012 rather than 2010. It remains an interim goal but setting any date on achievement of the goal is too hard. I'll do a revised set of goals later in December.

Get a Job

Yesterday lunchtime, we met with one of my friends here at the "Labor Club". In the "old days" we used to hang out at the Labor Club a lot as it was on the edge of the university campus and had the cheapest beer in central Canberra. The old building has been demolished for new development and the club moved to a new location in the city centre. It is very slick compared to its previous incarnation. Very upmarket. Maybe that's representative of what has happened to the Labor Party too. The funny thing both myself, my friend, and another guy we used to hang out with there are all Liberal Party voters now (I always was). We don't like the social conservatism of John Howard but we support the generally free market approach of the party. We all have training and work in economics related areas. The absent friend likes Howard's foreign policy which we don't agree on.

These "social clubs" are very popular in Australia. They are generally organized along ethnic or sporting lines. A big source of revenue is from gambling machines - pokies - as well as bars and restaurants. The old Labor Club was dominated by a huge battery of pokies. In the new venue they are hidden away. You don't need to belong to the Labor Party, just pay $A2.20 to join the club.

Anyway, my friend wanted to encourage me to find a job. He said that government (he works for government) is short of people. He also sent me a job ad from my former university employer here. My brother also asked me when I was going to get a job. The answer is I am going to try trading for a while. Maybe up to a year. If it doesn't work out after that, I'll then get a job. Moving to Australia to follow my partner is a good reason for leaving my previous position. And likely I would be moving industry too. I've been working on academic research for 20 years since I was an undergrad (some of that work then was later published). I want to have a break and re-assess. I'm not going to completely leave the academic game in the coming year. I remain associate editor of an academic journal, will continue advising my students back in the US, and probably will submit a paper or two for publication. My dream is to be a "gentleman scholar" :) I long realized I wasn't going to be a big academic star. I do have a very good track record in publication and citation. But the key nowadays is fund-raising and I haven't had much success there. And I have a distaste for begging for money to do research when the research really doesn't need funding to succeed. So like Steven Wolfram I am going to try to find the money somewhere else.

Weekly Trading Report and Goals

This isn't a regular feature of any sort, just an update on my trading one week into the month. The model is still short but I closed all short positions before the close today, worried about rumors of the Fed making a surprise interest rate cut on Monday morning based on the employment report that came out Friday morning that showed that employment in the US fell for the first time in four years. I doubt they will do this, but you never know what might happen. The 1998 scenario is still playing out perfectly just faster than things happened in that year. If we continue to follow the script there is only about a week to the second bottom of the market paralleling the second dip in October 1998. Unfortunately we are travelling to Australia on Thursday and Friday next week, so I am not sure how to play this. If we are still on the short side for Thursday I may keep my Ameritrade account in a hedged position (short enough SPY to hedge away market risk). This will reduce my overall portfolio beta from 0.5 to 0.4 or so and mitigate the effects of any severe drop in the market.

I ended the week down $167. I was down around $2000 on Tuesday after a stupid NQ trade. I posted that bear picture as I was feeling like a bear getting run over by bulls or maybe by a truck full of bulls. Again I was trading against the model. If I hadn't taken that trade I would be up $1100 on the week. If I'd taken the trade in the direction of the model...

My aim at the moment is very modest - earn $1500 a month from trading for the rest of the year. That would bring my total to $19000 or so which was my original goal for the year. It also means maintaining the same average pace for the rest of the year. My goal for next year - I know it is a bit early to be setting next year's goals - is to double this to $3,000 a month or $36,000 a year. That is only half way still to the real goal of making $75k per year from trading, replacing my previous salary. The $36k goal looks very doable if I reduce the number of very bad trades - all the majorly losing trades against the model for instance - and only slightly increase capital deployed. I'm also setting a goal of adding $100k in net worth next year. Here is a budget - in the same format as my monthly reports that shows how we achieve this:



I know it is silly to include everything down to the last cent but I can't be bothered to round this forecast from my projection spreadsheet.

Current other income is the sum of Snork Maiden's salary and tax payments. I will be paying taxes on investment and trading income and I've deducted these here. Half of the current investment income comes from trading and I'm expecting the Australian Dollar to rise to 87 cents by the end of 2008. The non-trading, non-forex rate of return implied is 10.5%, which does not seem unreasonable. We'll be earning $68k from salary and trading income after paying all taxes and spending $47k. Our savings rate from this active income is therefore 30%. I put this in for Enough Wealth :) Snork Maiden and her employer will be contributing $9000 a year to her superannuation fund. So, if everything goes to plan, it should be doable.

$400,000

Yes my net worth is now above $400,000. But there are no guarantees that I'll still be here at the end of the month for the reasons I discussed in my post about exceeding half a million Australian Dollars. Nice to see that 4 at the beginning of the number :)

Expected Returns

Following on from my previous post, one of the uses that this alpha/beta analysis can be put to is estimating your future expected rate of return. You just need to plug in the expected risk free rate and benchmark rate of return into the following formula:



The "hats" indicated "estimated value". This formula ignores the uncertainty in the estimates of the coefficients. You could do a Monte Carlo simulation to find the expected distribution of future returns. But for now I will assume that the coefficients are known with certainty. Based on my MSCI analysis I come up with:

alpha = 11.26%
beta = 0.72

For the S&P 500 I get:

alpha = 16.07%
beta = 0.58

(see what I mean by the MSCI being a steeper hurdle?). Now if I assume that F = 4.98% (its current value) and M = 10.5% I come up with expected rates of return of 20.2% and 20.1% based on the two benchmarks. Of course, you can assume a lower rate for M if you want. How do these compare with my actual returns?



All these rates are annualized. For the last 12 months and the last 3 years my annualized rates of return are 23%. However, 2005 was a bad year and so for the last two years the mean is just 14%. The MSCI achieved 11.6%, 14.4%, and 15.9% for the same periods. So the index was a bit above trend in those years and my own results for 1 or 3 years are also above trend. The S&P 500 has been at or below trend, however. Over the last 5 years I averaged 13.6% compared to 10.7% and 5.8%. My alpha has been increasing over time so this makes sense. Over a ten year horizon I underperformed the indices.

Let's assume that the 20% rate makes sense, then what does it imply? 20% of my $215k in non-retirement accounts is $43,000 roughly the US average salary. It is enough pre-tax income to cover my current expenses. I could "retire" now. The quotation marks mean that I would become a full-time active investor and trader. My retirement accounts would continue to grow at a rapid rate. Real retirement could happen at a later date if I wanted it. Of course, I would like to have a huge margin of safety so that if the rate of return is lower or my expenses rise rapidly I wouldn't run out of non-retirement money. The bottom line is though that all non-retirement saving I do from now on is increasing that margin of safety.

Half a Million

Australian Dollars. I just updated my net worth for the current date in March and I am above half a million Aussie Dollars. I might not be able to hold on to that level as some day soon I am going to reduce the carrying value for Croesus Mining. But only when it either delists or trading recommences on the Australian Stock Exchange. I expect that will be a $A10k-11k hit to net worth. US Dollar net worth is currently down on last month's strong close due to the fall in the Aussie in recent days.

It is just under a year since I passed the last Aussie Dollar milestone.. $A300k was first passed in January 2005 and $A200k in June 2004. But I first exceeded $A100k in December 1998:



Superannuation refers to all retirement accounts and medium term balance to non-retirement accounts.

Got back last night rather delayed from Florida to the snow and ice of the northeast. Today has just been catching up on everything and otherwise being lazy.

How Could I Add $105k to Net Worth?

2006's results (to be reported in detail after January 1) were helped by foreign exchange gain and a small ($6-7k) inheritance amount. I doubt foreign exchange will add much this year and it may even take away unless I successfully trade foreign currency. The Australian Dollar is close to 80 US cents and it is hard to imagine it going much higher. The US Dollar could be bottoming. The second part of the inheritance could come this year or not. Legal procedures are extremely slow. I expect it would be about twice the value of the first one but we don't really know. So let's assume all these factors are zero. I also assume that my tax bill in April will be zero - I have been over-withholding and I think it is sufficient to meet the required tax.

I can expect the following - my employer contributes 8% of my salary to my 403b and I am now contributing the maximum allowed contribution. Combined these come in at $1750 per month. If I spend at the same rate as this year, I should still be able to save $1000 a month after tax. Total from "contributions" would, therefore, be $33k for the year. In my previous post I stated a goal of making $19k from trading. That would be a 46% return on those accounts mentioned. This year I only gained $3k from QQQQ/NQ trading. So it seems like a lot. If I can succeed in adhering to my model it isn't though a very high goal. Viewed another way, it is about 1/2 the average US salary and only a step on the way to becoming a succcessful trader. If we assume that I do achieve this then the required return on my investment portfolio is 14%. This also is high, but not impossible. This year the S&P 500 exceeded that. Of course returns could be much lower and my spending much higher. But this is a goal, not a forecast, and the point is that it should be hard but not impossible to achieve.

2007 Net Worth Goal

Though we haven't yet completed 2006 I have added my 2007 net worth goal to the sidebar. $470,000. At this point I look like reaching $365k for 2006 - an addition of $95k to my net worth. $5k short of my goal but far above the amount I wrote I would be happy with. So next year's goal is to add a little more to net worth than this year - $105k. Also at a constant growth rate, $470k is on the growth path to $1 million at the end of 2010. My second goal is to end the year with as much in my three self directed US investment/trading accounts - at Ameritrade and IB as I put into them ( I also have a 403b and an account with TFS Capital - those are doing fine). Currently my net investment has been $60k, but there is only about $41k in the three accounts. I've added that goal to thje sidebar with the amount achieved in parentheses - I'll update it periodically. If I add or withdraw money to the accounts the goal will shift. These two goals are pretty simple I think. A "stretch goal" as people say is pretty obvious - reaching a net worth of half a million dollars :)

Hyperopia

Interesting academic article which I found from today's New York Times Magazine. I've pondered whether some PF bloggers, particularly those in their 20's are being over-responsible and self-denying. At least based on what they write publicly. I don't regret not saving money during that period of my life and going into debt in order to study, travel, and enjoy life. Nowadays, I am pretty frugal but mainly because I have only gradually increased my material standard of living over time. I am not in any kind of struggle to avoid spending money. I just don't want a lot of "stuff". My saving also isn't directed at some distant "retirement" but rather at achieving "financial freedom" as soon as possible.

Anyway, the point of the article is to test the idea that over time feelings of guilt about not being responsible and overindulging oneself tend to decline, while feelings of regret about missing out on life's pleasures tend to intensify over time. The authors believe that their experimental results support these hypotheses.

Reinstating My Previous Goal for the Year

Seems I was too hasty in lowering my goal for the year to $350,000 from $370,000. I have passed a net worth of $US350k and $A450k. So I am reinstating the old goal and seeing how close I can get. Finally I am on the right side of the stock market and the Aussie Dollar has been performing very nicely too. If I was more confident I would have benefited even more from the latter. Made three quick trades so far on the Aussie, all profitable.

Reality Check

At this point there doesn't look like any way I am going to meet my original goal of getting to $370,000 by the end of this year. So I am lowering the goal to $350,000. That would still be a 30% gain in net worth and more than my minimal goal of a $50,000 gain. The same growth rate implies goals of $450k for 2007, $575k for 2008, $775k for 2009, and $1M for the end of 2010. These are still very steep goals. But they are something to aim for that is not totally unrealistic.

Stopped Out Again

Again the model was stopped out today. I lost a lot of money. The majority of my profits from this experimental trading period have been lost. In fact I am back to the return the market has given over this period. From that perspective I guess it hasn't been too much of a disaster? :) If one stuck exactly to the model a day like today wouldn't be disastrous. But if you don't trade the system properly days like today are very bad news. Over this period I have improved the model and decision rules a lot. It is a much better system than at the beginning of the period. So it hasn't been a waste. I am not giving up. I still have some profits left and a tool that in theory can produce tremendous profits. I'm not sure what the problem has been. Too much leverage does make me nervous and do dumb things. I plan to use less leverage going forward and try to stick more closely to the model signals. Doing what are really two full time jobs at the same time is hard. I end up doing neither very well. On the other hand trading more than one thing simultaneously in smaller amounts in each instrument would be psychologically easier. Soon I will be able to start paper trading at IB (I initiated the transfer of $5000 today). I am thinking to experiment with trading two or three instruments simultaneously. As it won't be real money I won't be worried about losing money. Probably trading NDX, bonds, and Australian Dollars would be a good combination as the three assets have little correlation with each other. I won't have time to model bonds and dollars so I will trade these purely on the basis of charts. Right now I'd be long the AUD and short bonds probably.

Interactive Brokers Application

I finally got around to submitting an application for an account with Interactive Brokers. Security checks are now running before I can actually fund the account. My plan is to initially deposit $5000 from my HSBC Online Savings account which I have been saving up. That's the minimum amount required to open an account. At this stage I signed up for all US stock, options, and futures markets. You can also trade a number of foreign markets, but I don't have any need for that at the moment and one can always add additional permissions as required. IB has a paper trading facility and I plan to use it initially to get used to futures trades which is what I plan to use the account for initially. Once I get used to trading I will initially trade one E-Mini NASDAQ contract which is equivalent to 800 QQQQ shares. I also will look at trading Australian Dollar contracts to hedge my Australian Dollar and US Dollar exposures. The reason I want to trade stock futures is because under the 60/40 rule they are taxed at lower rates than short-term stock trades. Being able to modify my currency exposure without wiring money between the US and Australia is also attractive. The Australian Dollar ETF (FXA) is not a viable alternative. To sell short $A100,000 requires margin of about $US37,500. Using futures the required margin is only about $US1,500 for the same transaction (and the taxes on gains are lower). My new short-term goal is to reach a total of $65,000 in my three U.S. trading accounts.