I’ve got a soft spot in my heart for beginning investors, because I remember my own struggles learning to how to put money to work. These days, market uncertainties are even greater than before. But also, gaining access to financial markets is easier and cheaper than ever before.
E.g., what’s not to like about zero commissions and fractional share trading? Or mutual funds with investment minimums as low as $1? This means that even tiny, tiny money can begin to gain the experience needed to put bigger money to work. So, here’s my proposal. Rather than run a paper-money investing contest, such as our dear forum hosts do with their stocks CAPS contest, let’s run one with real money, but limit the amount of money that can be deployed to $150, as well as penalize ‘recklessness’, as well as diversify by investment vehicle.
Explanation: There are dozens of places online that offer paper-trading. But there are at least three things wrong with them:
#1. The funds one can access (often $100k or more) are obscenely unrealistic.
#2. The order fills often aren’t a realistic match for where an investor would have been actually executed had the trade been done “for real”.
#3. Contest winners are scored on the basis of ‘total’ gains rather than ‘risk-adjusted’ gains.
Further explanation. A common measure of ‘risk-adjusted return’ is the Sharpe Ratio. But a better measure of risk-adjusted performance is the Sortino Ratio, because it penalizes only downside volatility, aka, one’s mistakes. (Explanations of each ratio can be found at Investopedia.)
So, my proposal is this. Let’s run the contest from now until April Fool’s Day, and the first place winners in each of the investing vehicle types (common stocks, preferred stocks, ETFs/CEFs/ETNs, and mutual funds) will be the investors with the best Sortino Ratios. The second place winners will be anyone who has increased their grub sake by whatever amount AND who has a higher Sortino Ratio than the third place winners, which will be those with the largest absolute gain in these five categories: only common stocks, only preferred stocks, only ETFs/CEFs/ETNs, only mutual funds, mixed vehicles.
So, how to fund one’s account? Here’s where beginners will get an immediate leg up on bigger, more experienced money. Schwab is currently running an offer that really is “too good to refuse”. If you open an account and fund it with $50 dollars, they will give you five slice of stocks from the SP500 that have a current market value of $100. In others words, merely for opening an account with them, you can double your money. What not to like about that, right?
You can let those five stocks ride, or you can immediately cash out of them and deploy the money on what you think might be better opportunities, which could be other stocks in the SP500, six positions in preferred stocks (which typically have a price near $25 and often pay very fat dividends), or you could buy any of the 6,283 common stocks priced under $150 there are that trade on the three major exchanges, or the 3,128 ETFs priced under $150, or the 3,128 mutual funds priced under $150, 207 of which also have no short-term redemption fees, and some of which are leveraged and/or inverses. (In other words, though mutual funds are often disparaged as being “retro” and of no interest to “serious” investors, they can be a surprisingly effective and profitable way to dip a toe into the investing game and to gain some market experience.)
Lastly, because not everyone will have the same starting date, all claimed performance records will be prorated from one’s starting date. So there’s no need to rush to get started. In fact, taking the time to think about one’s goals will the best use of one’s time. That means, as Quill keeps saying, writing a business plan and then having the disciple to stick to it on whatever time table makes sense in one’s (probably already over-committed) life.
Note: If you already have an account with Schwab and/or are already managing multiples of $150, you might not want to fuss with this contest. Life is short, and one’s time is a fleeting resource. But if you love investing for its own sake, then engaging in the challenge might be a fun thing to do for what you might learn that you didn’t already know. E.g., I’m going to run three accounts, each of whose funding is limited to the contest’s initial $150. One account will focus on just mutual funds. A second on just inverse ETFs. A third will focus on long-only ‘country’ funds.
My reasoning is this. Mutual funds price only once at end of day. That makes them easy for us west coasters to track and to submit our orders in a leisurely manner. But their EOD pricing can also be a downside, because one is always a bit late getting in and out. So the research question to myself is whether those delays can be managed and overcome. As for restricting myself to inverse ETFs only, that reflects my thinking on where we are in the current business cycle, which is very late, Stage Three, with a lot more downside to come. As for country funds, forcing myself to track them means I can dispel a bit of the provincialism that is suffered when one focuses only on one’s “home market”.
Lastly, if you’re lucky enough to have an IRA account, you can run the contest(s) in that account as a means of avoiding the hassles of having to file tax returns on a bunch of nickel-and dime investing experiments. In my case, I’ve got a small ROTH at Schwab. So I’ll run my mutual funds trades there and just keep score in a spreadsheet. For the inverse ETFs and the country funds, I’ll run those experiments in my IRA at TD and, again, keep score in a spreadsheet.
Arindam