Random Stock Picking Experiment

At some point in the (near) future, I will review various investing newsletters and investing gurus. For some time I've had a theory that most newsletters and gurus that have decent performance records owe them not to their investing acumen but to the number of their picks. Over time stocks as a group tend to go up. You pick enough stocks, and your performance shouldn't be bad. That is my hypothesis.

In the late 1990s, there used to be something called Monkeydex. It was an index of stocks picked by a monkey, and its performance beat that of many professionals. Sadly, it appears that the index is no more. I've decided to create my own version. Its results will be one measure against which gurus and newsletters will be compared.

Every weekend, I will randomly pick 10 stocks, and their performance will be monitored for a year and a day (so they would be taxed at the long term capital gains rate). I will use the picked stocks' closing price on the last trading day before they are picked (usually a Friday), and keep track of them on Yahoo! Finance's portfolio feature and on Stockalicious (look for the widget on the left hand side).

My method for randomly selecting 10 stocks a week will be as follows. As I could not find a list of the stocks tracked by the Wilshire 5000 or the MSCI Broad Market Indexes (please email me or post a comment if you happen to know where a list can be found), I decided to use the holdings of Vanguard's Total Stock Market ETF (VTI). It has over 3,600 stocks at the time of writing. You can see the list here.

I will take this list, and paste it at a list randomizer. It "generates mathematically random numbers based on noises recorded by a microphone in Ireland, and then returns your list in the randomized order." The top 10 will be the random stocks of the week.

There will probably be a bear market in the near future, but I think it's too much work to have both buy picks and sell picks (I'm a slacker, after all). Over time, I think the random portfolio will do better than many professionals anyway.

So here they are, our first 10 random stock picks with their closing prices on Friday, January 18, 2008:

  1. CryoLife Inc. (CRY) $8.28
  2. Peoples Bancorp, Inc. (PEBO) $21.3
  3. Omega Healthcare Investors Inc (OHI) $15.71
  4. Dominion Resources, Inc. (D) $44.24
  5. Corporate Office Properties Trust, Inc. REIT (OFC) $28.08
  6. Parametric Technology Corp. (PMTC) $14.83
  7. Endologix, Inc. (ELGX) $2.65
  8. Peregrine Pharmaceuticals, Inc. (PPHM) $0.37
  9. Leadis Technology Inc. (LDIS) $2.62
  10. Dover Downs Gaming & Entertainment, Inc. (DDE) $9.23


International & Domestic Inverse/Bear Market ETFs

If you think the markets will continue their decline, you might want to consider inverse ETFs. Some of these have become somewhat popular, so maybe you heard of them. But you probably haven't heard of all of them.

Inverse ETFs use various derivatives to behave in the opposite way of their underlying indexes. For instance, the inverse Dow 30 ETF (DOG) does the opposite of what the Dow Jones Industrial Average (DJIA) does. For example, if the DJIA falls 1.5%, DOG will rise by about 1.5%. The correlation is not perfect, but it's close.

An advantage of using inverse ETFs is that you can hold a short position while going long. In other words, it's like holding a regular stock, but you profit as if you have sold short. As there is no need for a margin account to do this, you are mitigating or eliminating some of the risks of selling short, which include losing more than your original investment.

If you're a bit more risk tolerant, you might want to consider leveraged inverse ETFs. Like the regular inverse ETFs, they go up when their underlying index goes down, but they do so twice as much. So, for example, if the DJIA falls 1.5%, the leveraged inverse ETF (DXD) will go up about 3%.

One last thing before the list. You should remember that inverse ETFs go down when the market goes up, and the leveraged ones go down twice as much. As over the long term the market tends to go up, it's probably best to use inverse ETFs to hedge your loses in rough times or for short term gains.

Here's the list. Some of them are thinly traded, so be careful. The expense ratios on all these ETFs are .95%. Unsurprisingly, they are all at or near 52 week highs.

Inverse International ETFs

Europe Australia Far East (EFZ)
Emerging Markets (EUM)

Leveraged Inverse International ETFs

FTSE/Xinhua China (FXP)
Europe Australia Far East (EFU)
Emerging Markets (EEV)
Japan (EWV)

Inverse Domestic Broad Indexes:

Nasdaq-100 (PSQ)
S&P 500 (SH)
S&P MidCap (MYY)
S&P SmallCap (SBB)
Russell2000 (RWM)

Leveraged Domestic Indexes:

Nasdaq-100 (QID)
S&P 500 (SDS)
S&P MidCap (MZZ)
S&P SmallCap (SDD)
Russell 2000 (TWM)
Russell 1000 Value (SJF)
Russell 1000 Growth (SFK)
Russell MidCap Value (SJL)
Russell MidCap Growth (SDK)
Russell 2000 Value (SJH)
Russell 2000 Growth (SKK)

Leveraged Inverse Domestic Sector ETFs

Dow Jones U.S. Basic Materials (SMN)
Dow Jones U.S. Consumer Goods (SCC)
Dow Jones U.S. Financials (SKF)
Dow Jones U.S. Health Care (RXD)
Dow Jones U.S. Industrials (SIJ)
Dow Jones U.S. Real Estate (SRS)
Dow Jones U.S. Semiconductors (SSG)
Dow Jones U.S. Oil & Gas (DUG)
Dow Jones U.S. Technology (REW)
Dow Jones U.S. Utilities (SDP)

European investors might be interested in these:

Inverse CAC 40

Leveraged Inverse CAC 40

Inverse DJ Euro Stoxx 50

Leveraged Inverse DJ Euro Stoxx 50


Blog Carnivals I've participated in Jan 1 through 15

As a courtesy, I'm linking back to the carnivals where my submissions have been accepted.

Investment Basics Carnival

Carnival of Twenty Something Finances

Carnival of Money, Growth and Happiness

Investment Quest: Festival of Stocks

Check out the carnivals for loads of interesting articles.


TradeKing Review

TradeKing Regular Individual Account Review

The Good:

1. $4.95 a trade for limit, stop, and market orders; $4.95 a trade plus $0.69 per option contract. Trades execute quickly.

2. Great tools for options traders, including a Profit/Loss Calculator, which calculates your profit from rising option values, an Options Calculator, which calculates volatility and risk, subject to your criteria, a Probability Calculator, which determines the probability of target stock prices in the future, and an Options Screener. These are provided by iVolitility. If you have a Zecco account, you should be familiar with them.

Moreover, TradeKing makes things faster and easier by letting you do multiple transactions on the same page. For example, let's say you want to write a covered call. At most brokers you will have to go to a couple of different places on the site, to buy the stock and to sell the call. At TradeKing, you simply go to the Options Trading menu and click on Covered Call. You do everything in one place at the same time. In addition to covered calls, they have faster ways of doing protective puts, spreads, straddles, strangles, combos, butterflies, condors, and collars. You can also trade Fixed Return Options.

3. If you don't know what all these are, there's an Education Center for new investors, with a few pretty good demos and tutorials on option trading.

4. Customer service is still good, but seems to be deteriorating. They always pick up the phone during business hours during normal market conditions. When things become a little crazy their phone lines are jammed (see comments below). Should you email them, TradeKing responds quickly, usually the same day. They used to respond the same day to emails sent over the weekend. Now I have to wait until Monday. The live chat feature is another way to talk with a customer service rep. It usually takes less than a minute to get a hold of someone.

5. Free dividend reinvestment on stocks and ETFs, but see #2 below (the not so good).

6. Wide selection of mutual funds and fixed income (CDs, various bonds). (CDs have to be purchased over the phone.)

7. In addition to the regular, low yielding cash fund, TradeKing offers three different cash sweeps that have higher yields, but see #3 below (the not so good).

8. Unlike most other brokers, TradeKing offers an ACH withdrawal option. This is much faster than requesting a check.

9. Forums, blogs, and other user generated content is available. You can post your own stuff, or get trading ideas from others. Some TradeKing users have elected to have all their trades posted. It can be interesting to watch their progress, or follow them, should they have a good track record.

10. TradeKing offers check writing and debit cards for qualified accounts.

11. If you follow a newsletter and buy the stocks it recommends, TradeKing offers to make these trades automatically for you for some newsletters, should you want to.

12. People seem to really love the Maxit Tax Manager, a tool that tracks gains, losses, and other information to help you with your taxes. (My own experience with this program has not been very good, as the information the tool provided me was wrong. This is probably the result of my having transferred some stocks into the account from another broker).

13. Transferring from another broker to TradeKing is a quick and painless process. They frequently have promotions where they reimburse you the transfer fee your other broker charges.

The Not So Good:

1. Real time quotes are provided for active traders. If you trade only once in a while, real time quotes show up only at trade preview screens.

2. If you want to reinvest your stock dividends, you have to contact customer support. You have to tell them for which stocks you want your dividends reinvested. Should you decide to stop having your dividends reinvested, you also have to contact customer support. It would be much easier if TradeKing had a mechanism like Firstrade, SogoTrade, or Sharebuilder, which lists your positions, and with a simple click, lets you choose whether you want to reinvest dividends for each position separately.

3. If you want to use one of TradeKing's three cash sweeps, you have to contact customer support.

4. No physical location to visit in person, if you prefer that sort of thing.

5. The ETF and stock screeners and stock research tools could stand to be better. MSN's free screener is much better.

6. The site can be a bit difficult to navigate at first, but you get used to it.

7. You can only have one linked bank account at a time for ACH transfers. This can be a pain if you like to fund your TradeKing account from more than one bank. Each time you want to do it from a different bank, you have to delete the one listed, add the new one, and then wait 5 days for it to be authenticated. It's easier--and faster--to send a check.

8. No instant verification of the funding bank account for ACH transfers. You have to wait 5 days.

9. No load mutual funds are $14.95 a trade. While cheaper than many other brokers, this is still rather expensive.

The Bad:

1. The site becomes noticeably slower when the markets experience unusually high volumes. September 19, 2008 had a quadruple witching (lots of different options contracts expiring). Some TradeKing customers could not access the site or contact customer support (see comments below). I only experienced problems at the end of the day. This can be catastrophic for someone looking to unwind lots of contracts on expiration day. No doubt thousands of dollars were lost on 9/19/08.

2. I have experienced execution problems with options a few times. My limit order matched the ask price, but the order was not executed on a few occasions.

3. I have also experienced a glitch when attempting to buy fixed return options. These are cash settled options invented by TradeKing's CEO, where each contract is either worth $0 or $1 at expiration. I tried to buy several GE "finish higher" calls. My order was rejected. It said I didn't have enough account equity to buy the underlying shares if the contracts were exercised. But these are cash settled options (that is, I could either lose the amount I paid, or I could have my account credited with $1 per contract), and I had enough money in my account to buy them.

4. 10/6/08 While I tried to change one of my option orders, TradeKing became inaccessible, and stayed that way until market close.
Any broker can work great when the market is peaceful. What makes one broker better than another is how it performs under stressful conditions. TradeKing, it appears, is not up to it.

The Bottom Line:

Given at least two site outages on very important trading days in two months, I can no longer recommend TradeKing at this time.

Updated: October 6, 2008

This TradeKing review will be updated at least every six months.

Are you already a TradeKing user? Please share your experience with potential customers by posting a comment.


Reinvesting Dividends -- Good Idea or Bad?

Investors sometimes wonder whether they should reinvest their stock and mutual fund dividends. I'd like to go through some of the advantages and drawbacks of doing so.

But first, what's a dividend anyway?

Usually a portion of a company's profits,* dividends come in three forms: stock, cash, and property. The two most common are stock and cash, with cash being the most popular. Sometimes distributed monthly, semi annually, or annually, the most common dividend distribution is quarterly. This depends on when the company's board of directors decides to declare a dividend.

Mutual funds are required by law to distribute most of their income and capital gains, which are usually taxed at different rates. They usually do so at the end of the year.

How do you get a dividend? In the case of both companies and mutual funds there is something called the ex-date. This is the date on which and after which the seller of the mutual fund or stock would be entitled to the dividend previously declared, but not the buyer. On and after this date, the stock or mutual fund is said to trade ex-dividend. Let's say the stock or mutual fund trades for $100 a share and there is a $1 a share declared dividend. On the ex-date, let's say the price as determined by trading, remains unchanged. Trading ex-dividend, that stock or mutual fund is now at $99 a share, the $1 having been taken off because of the dividend.

The ex-date is generally two or three days before the record date, which is the date established by the company or mutual fund declaring the dividend to determine who is entitled to receive the dividend on the payable date, when the company actually sends out the payment. How you receive the payment likely depends on how you purchased and hold the stock, for example directly from the company or through a broker. For instance, you may get a check in the mail from the company, or see the money deposited in your brokerage account.

If I've been unclear, this article may be helpful.

Reinvesting Stock Cash Dividends

By reinvesting, you get more shares in the company.

The Good:

1. If the stock goes down, you are automatically lowering your dollar cost per share because you are buying shares at a lower price. If the stock later goes up, you will break even more quickly and get more profits if it continues its assent than if you would if you did not reinvest your dividends. If the stock goes up, you are buying less shares. This is also good, as your average dollar cost does not go up as much. In other words, following the old adage "buy low, sell high," you are buying more when the stock is cheaper and less when it's more expensive. As you are not adding any extra money, that is, as all new shares are coming from your dividends, this is a good thing.

2. My favorite reason for reinvesting dividends is that it compounds your dividend payouts. Reinvesting gets you more shares, so your future dividends, as long as the company does not cut the payout, are larger.

For example, say you buy one share of a company for $100, and let's say the company pays out a quarterly dividend of $1 a share, giving out $4 a share per year in total. For the sake of ease, let's say this stock remains flat, trading at $100 a share for a year.

For the first quarterly dividend, you get $1 and reinvest it. (This example assumes you are buying the stock either directly from the company that allows fractional shares, or through a broker that has automatic free dividend reinvestment). As the stock remains at $100 a share, after reinvesting the $1, you now have 1.01 shares. That is, with that dollar, you've just bought 1/100 of a share.

For the second quarterly dividend, you get $1.01. That's because you received a dollar per share and have 1.01 shares. Once again, assuming the stock remains at $100 a share, if you reinvest it, you get an additional .0101 shares. You now have a total of 1.0201 shares.

When the third quarterly dividend comes around, you get $1.0201. Reinvesting this, again assuming the stock stays at $100, you get another .0102 shares, bringing your total to 1.0303 shares.

Your fourth quarterly dividend will be $1.0303. If the stock stays at $100, reinvesting this will get you an additional .0103 shares, bringing your total to 1.0406 shares.

So, starting off the year with one share, at the end you have 1.0406, without putting in any extra money. Had you not reinvested the dividends, you would have gained $4. Having reinvested the dividends, the total payouts received from the company amounted to $4.0604. That's a 1.5% greater return by doing nothing. Looking at it another way, not reinvesting the dividends would give you a 4% yield on the stock. Reinvesting them would give you a 4.06% yield. These sums are tiny, sure, but imagine this process with many shares and over a greater period of time.

As I've repeated, the example assumes that the stock remains flat. Had the share price fallen and you reinvested your dividends, your payout would be greater still. Had the share price risen, your payout would be smaller than in the example, but still larger than if you didn't reinvest the dividends.

As long as the company does not cut its dividend payout, reinvesting dividends compounds your dividend returns. When you retire and decide to start collecting your dividends, you'll find that your original yield has skyrocketed. Your payouts may eventually be greater than your original investment! Even factoring in inflation, which the article in the preceding link does not do.

3. According to one of the Motley Fool's many other infomercials on the subject, which I love to read, from January 1926 to December 2006, "41% of the S&P 500's total return" came from dividend reinvestment. As another example, also from Motley Fool, by investing $2000 in Pepsico (PEP) in 1980 and reinvesting dividends, you'd have $150,000 today. Doing the same with Philip Morris (now Altria) (MO), you'd have about $300,000 today.

4. If you do it manually, dividend reinvestment encourages discipline. You're buying more shares dispassionately, in accordance with a previously well thought out plan.

5. If you have it set on automatic, you're getting more shares without thinking about it.

The Bad:

1. Reinvesting dividends in a company that goes out of business or whose stock tanks is pretty bad. If you hadn't reinvested, your loses would be lower, because you'd have gotten some of your money back through dividends.

2. Reinvesting dividends can create a nightmare at tax time when you decide to sell all your shares. This is because you will have many purchases, all with a different cost basis. Depending on how long and how often you've been doing the reinvesting, it can be a lot of work to figure out your gains and losses at tax time. This doesn't apply to tax deferred accounts such as IRAs.

3. Reinvesting dividends in an all stock portfolio may make it too concentrated. You might want to think about using the dividends toward the purchase of some other asset class, such as bonds or commodities.

4. Similarly, reinvesting dividends may deprive you of cash you could use in a better way. That is, there are opportunity costs, and you may get a better return by using the dividend in some other way. Perhaps when deciding to reinvest dividends, you should think about whether you can do something better with that money instead. If you cannot, you should reinvest.

Reinvesting Dividends In Mutual Funds

The good and bad here are pretty much the same as above. There is, however, something to consider.

Stock prices fluctuate throughout the trading day. Mutual funds, on the other hand, are priced at the end of the trading day. This is determined by the market value of the mutual fund's net assets, divided by the number of outstanding shares. It's called net asset value (NAV).

People use many different ways of evaluating stocks, including share price divided by earnings (P/E), sales divided by earnings, etc. When a stock goes ex-div, its price drops by the corresponding dividend. The P/E falls, as do most other measures of the stock's value, making it look cheaper to investors. This does not happen with a mutual fund, as the cash distributed as a dividend lowers its NAV.

In other words, as a stock's price depends on the buying and selling of it, the dividend payout does not affect the stock's price as much as it does a mutual fund's. While a mutual fund's NAV depends somewhat on the amount of cash it has, most of its price movement comes from the market value of its other assets--stocks, bonds, etc. What this basically means, if it means anything, is that reinvesting a mutual fund's dividends gets you to the same position you would have been in if there were no dividend. You get more shares, but they are worth less than before. The same can be said with a stock, as in my reinvesting example above, but since a stock's price does not depend on net asset value, after dividend reinvestment your total position could be worth more than it was before the dividend. Of course, it could be worth less as well. Is this good or bad? I don't know, but it's something to consider.

As an aside note, unless you are doing this in a tax deferred account, you should avoid buying mutual funds at the end of the year before the ex-date. This is because you'll be taxed on the dividend, but won't have participated in the gains throughout the year.

Exchange Traded Funds (ETFs) and Closed End Funds (CEFs)

As these trade like stocks, even though their NAVs are calculated at the end of the day, reinvesting in them is much like reinvesting in stocks.

One thing to be aware of is that dividends from these, especially from CEFs, are sometimes taxed at different rates. Usually, most dividends are taxed at long term capital gain rates, but occasionally, depending on the fund's turnover rate and investments, a percentage of the dividend may be taxed as short term capital gain or ordinary income.

Additional Considerations

Some companies and closed end funds offer investors a choice between cash and stock dividends. If you're going to reinvest anyway, stock dividends are probably better. While still taxed, these are often given at a discount to the market price. For example, the share price might be $100, but your stock dividend gets you shares at $98. That's a pretty good deal. My position in Royce Focus Trust (FUND), a CEF focused on international small caps, gives me this option. An example of a company that gives investors a choice between cash and additional stock is HSBC.


If you're interested in looking at what the dollar was worth in years past, adjusted for inflation, go here or here.

If you're interested in what a stock or ETF investment would be worth with and without dividend reinvestment, Sharebuilder has a neat tool, which goes as far back as 1996. (Where it says "get a quote," enter the stock you're interested in, and to the right of that, select charts. Click on "go." Then click on the link that says "What if I Had Invested.") One thing the tool lacks which would be helpful is showing the total amount of dividends you would've received. Nonetheless, it's pretty useful.

*This is not always the case since sometimes unprofitable companies give dividends.