Trying to Beat the Market?

Joel Greenblatt has done it again. Here's written another excellent book that breaks down the complex subject of investing in stocks into a way that anyone could understand. Greenblatt is also the author of "The Big Secret for the Small Investor." I'm a huge fan of the Greenblatt's down to earth investment strategies. He's what the industry would term a "value investor". In "The Big Secret for the Small Investor" Greenblatt recommends investing in value oriented index funds. To understand this concept it's best to read the book itself, but to put it in a nutshell, indexes usually weight the holding of stocks based on market capitalization. The danger lies in being weighted to heavily in stocks that have reached unreasonable highs. Thus, you would not be following the old adage of buy low, sell high if you are investing in a regular index fund. A value index fund differs in that weighting of the holdings. There are several different ways this can be done, but the important thing to understand is that the way your holdings are weighted in an index fund can help you improve your overall investment return.

In "The Little Book that Still Beats the Market", Greenblatt discusses two main metrics that should be looked at when choosing individual stocks in your portfolio. These two important metrics are earnings yield and return on capital. Earnings yield measures the same thing as the price to earnings ratio (PE) and is simply the inverse of the PE.Typically, you look for a low PE (for a value investor) because it means that you are paying less for a dollar of a company's earnings. Earnings yield is the exact opposite, so in this case you're looking for a high earnings yield.

For example, if a company earns two dollars per share a year and the shares are selling for 10 dollars a share the price to earning ratio would be (10 divided by 2) 5 and the earnings yield would be (2 divided by 10) 0.2 or 20%. Both numbers are measuring the same thing, which is the price you are paying for a dollar of a company's earnings. So whether you're looking at a low PE or high earnings yield, you're still trying to look for the best bang for your buck. This metric tells you whether you're getting a company at a bargain price.

The second metric is the company's return on capital. This statistic measures the ability of a company to convert the company's capital to earnings. For example if you invested $10 to start a lemonade stand (i.e. signs, chairs, cups, lemonade, etc...) and made $20, your return on capital would be 2 or 200% (20 divided by 2). The higher the number the better, meaning that the company is efficient at using it's capital to generate earnings.

Putting it altogether, Greenblatt recommends ranking companies by their earnings yield and return on capital choosing company that have both high earnings yield and return on capital. It's important to find both factors in the stock because it means you're buying an excellent company at an excellent price. Knowing this why wouldn't everyone be doing it. Greenblatt explains that this strategy can lead to short term under performance, but over the long term (5+ years) you can expect returns that exceed the market average.

Keep savin' and with your savings be sure to get your money working for you!

Here's Greenblatt discussing the investment strategy in this book:

Order Take-Out

Eating out regularly can be costly. The highest mark up items on the menu are desserts and drinks, especially alcoholic ones. Another additional cost of dining out is the tipping, which adds 15% to the bill.

Ordering take-out instead can save you on the tipping costs and drinking something in the fridge at home can help you avoid having to order drinks. Also, some restaurants offer discounts on take-out since it saves their staff from serving you.

Saving money while eating out:

Time to One Up Wall Street

Here are two classic books about investing in the stock market. Peter Lynch had an impeccable record when he managed the Magellen Fund for a little over a decade. In his writings, he claims that small investors can do just as well by investing in things they understand well. As consumers we may notice trends before Wall Street does, and that according to Mr Lynch gives us an edge.

But just because you eat at Taco Bell doesn't mean you should run out and buy shares in that stock. Lynch explains that shopping at your favourite store or buying your favourite product can help put these companies on your investment radar, however one should research the company thoroughly before taking the leap and investing their hard earned cash.

Lynch takes a bottom-up approach to investing, which means he researches companies and the fundamentals that drive their business. The top-down approach looks at investing within a certain country or industry until settling on a company. Lynch will invest regardless of the economic climate if an attractive enough company presents itself.

I found that both books are quite similar in their lessons. So it's probably not worth your time reading both. There are a lot of great lessons here and perhaps after reading it you'll find yourself a ten-bagger!

Peter Lynch talks about bottom-fishing on Wall Street:

Mortgage Freedom!

Mortgage Freedom by Sandy Aitken is about a strategy of converting your non-tax deductible mortgage into a tax deductible line of credit. Unlike the United States, any interest paid on your principle residence in Canada is non-tax deductible. Sandy explains something called the "Smith Manoeuvre" where one converts all their mortgage debt to a Home Equity Line of Credit (HELOC). Interest paid on a HELOC is tax deductible if the money is used to purchase investments. Investments include: mutual funds, stocks, bonds, rental property, and business investments. The definition of an investment is not clear cut and should be discussed with a tax accountant before proceeding.

The type of HELOC that makes this strategy work is call a "Re-advancable Compartmental HELOC". The re-advancable part means that everytime you make a mortgage payment, the part that pays off the principle is added to the HELOC, giving you more credit. For example, if you make a $1000 mortgage payment each month and $400 goes toward the principle of the loan, than the credit in your HELOC increases by $400. This allows you to invest an extra $400 every month. The "compartmental" part is the partitioning of accounts to keep track of your HELOC and what you invest the credit in, as well as what you do with the returns you receive on the investments. This is for book keeping purposes.

By the end of this strategy you will have converted all your mortgage debt into tax deductible debt and hopefully own an investment that is worth the same amount as the mortgage you started with (given that your investment holds its value, ideally it will have appreciated in value). The two benefits of this strategy are:

1) You get time diversification on your investments, which makes your portfolio less volatile overall. Instead of waiting to pay off your mortgage entirely and then investing, starting earlier by borrowing to invest will allow you to ride out more of the ups and downs of the market. Trying to invest over a shorter time period will leave you susceptible to the short term volatility of the markets.

2) You get a tax deduction.

The things to keep in mind in order to make this strategy work and the downsides are:

1) You need at least 20% equity in your home to start a re-advancable compartmental HELOC.

2) Your investment must provide income frequently (monthly or quarterly) so that you can keep up with the interest payments on the HELOC.

3) The return on the investment must be equal to or greater than the interest rate being charged on the HELOC.

4) The interest rate on the HELOC will be likely higher than the interest rate that you are getting on your mortgage.

If you are earning more on your investments than the amount your paying in interest on the HELOC than the extra money is suppose to go towards paying the mortgage, freeing up more credit. This will accelerate the rate at which you pay off your mortgage. Once the mortgage is paid off the investment income and your mortgage payments go towards paying off your HELOC. With all this in mind it sounds like a risky proposition. This strategy isn't for everyone but it's an interesting alternative to tap into the equity in your home.

 Check out this video for more information:

Why not have a board game night?

Going out these days is so expensive. Whether it's going to the movies or going out for a few drinks with friends, the cost of these outings can end up adding up to sizable chunk of change. Why not opt out for a board game night? One of my personal favourites is The Settlers of Catan.

If that doesn't suit your fancy check this game out: