Year: 2020

Black Swan Investing Strategy To Reduce The Risk

Predicting when the next black swan event will happen is the mission impossible. But you can create a portfolio created to reduce the risks related to black swans.

Black Swan investing isn’t quite a strategy, it is more a trading philosophy. Actually, it is a method of predicting the occurrence of black swans. The black swan is an unplanned, unexpected event in the markets. Such events come as a sudden blow and may influence the market. But black swan also can have both a positive and negative impact and we are going to discuss them here.

An example of a negative black swan is the crisis of 2008.

Black Swan investing is a trading philosophy based completely on the probability that some accidental event will hit the markets. To avoid losses caused by a black swan, traders who are trading based on black swan strategy always are buying options, never sell. They never estimate will the market go in one or another direction, up or down, they are buying. These traders are actually betting on the chance the market will move both up and down.

Protection of investments

Behind that behavior is investors’ need for insurance for their portfolio to protect against another black swan event like it was financial crisis 2007-2009.

They are afraid of is losing money as they did at the time of the crash. But losing money is a risk that you have and can determine. The black swan is a risk that you can not determine or predict. How can you plan some sudden and hidden events ahead? Hence, we can’t hedge out the risk of secret and unknown events. All we can do is analyzing past events.

The black swan investing theory is based on an old saying that presumed black swans did not exist. Nassim Nicholas Taleb developed black swan theory but in his book The Black Swan he also recommended traders to fire their advisors claiming that they don’t know enough or know a bit about investing. Brave claim indeed. His belief in the incompetence of financial advisors is based on their disregard for Black Swans.

Is it possible to predict the next event?

It sounds like an impossible task because it is. As we said, how can you predict something unknown? But what you can do is to build a well-diversified portfolio to reduce the risks. Also, now you have this tool to determine when to exit your trade and avoid money losses. Moreover, you can determine when to do that in profit.

Yes, your portfolio can be structured to reduce risks linked to black swans.

Positive or negative black swans

Okay, you would like to know how to invest for positive or negative black swans. So, first of all, you have to understand how not to depend on catastrophic predictions. Let’s say, you invested with the belief that the stocks will grow forever. Also, you are pretty much sure that the financial crisis will never come, or the company will never bankrupt. Well, something has to be changed in your beliefs. The truth can be very painful for you at this very moment. Stocks will not rise all the time. Not even in the next 20 years or even five. They will go up and down.

The main point of black swan investing is to profit from unpredictability. But such events come suddenly, they are surprising, so how can we invest in it? We cannot do it directly. All we can do is to be ready for them, meaning to be exposed to such exceptional but extremely impactful events.

How to expose to a positive black swan

How to do that? How to take advantage?

If you follow Taleb’s definition it is quite clear what to do to positive events. If you can seek exposure to something you can not predict, then seek out exposure that is unrestricted to the upside. Well, there is no need to know will some event come or not, or when it is going to happen. All you have to do is to detect exposures that have the potential to blast if meet the proper conditions.

Exposure to positive black swans may sound a bit esoteric. Some investors that are practicing a black swan strategy like to say that it is necessary to build a portfolio that is able to “invite” positive events, amazing and unexpected. We don’t have material proof that it works.

Their idea is to give a portfolio a chance by setting up limited sums of money or scale it up. If it works, it’s okay. If it doesn’t work, just give up and risk later.

This stands in firm contrast to traditional investing advice.

Behind this idea

For any trader who wants to implement the black swan investing strategy, it is necessary to create a barbell portfolio. This kind of portfolio was created by bond traders. This strategy requires owing safe short-bonds on one side of the barbell, and on another side to balance the weight of investments, riskier long-dated bonds.

By building a barbell portfolio, you’ll have very safe investments on one end and notably risky investments on the other end. The safe investments virtually don’t have risk. They will survive even a black Swan. The risky side of the portfolio opens it up to the endless upside. This kind of portfolio advances despite any circumstances in the market. That’s according to Taleb.

Black Swan investing

Since black swan traders never sell and they are counting on the crash, they are buying out-of-the-money options.

But one question arises. Can any empirical evidence account for black swans? We are afraid the answer is no. So, we cannot predict the market. Why there are still people trying that? Because we all need progress in this field. Yes, we have algos, AIs, learning machines, automated trading, etc. But yet, no one can predict the market. And it is a great challenge. By fair, that moment isn’t so far from us. One day someone will find some formula for that. Frankly, how many people were able to predict all possibilities of the internet? A very small number. Today it is part of our daily lives.

Yes, we truly believe that one day, somewhere, someone will find a way to predict market movements. Meanwhile, there is no need to give up from investing because of the lack of unreachable knowledge. Just work with what you have and know. That would be enough. At last, it was enough for the past 200 years.

Pro tip: Develop an efficient portfolio on a demo account first; (1) Examine how well it guards you from random Black Swans (2) optimize (3) only then risk real funds.

Bottom line

Banks are a negative black swan business. The upside is inadequate and the downside is complete. The examples of positive black swan investing biotechnology stocks, venture capital, publishing, etc.

The venture investor that invested in Uber in its beginning was exposed to a positive black swan, but today would be more exposed to a negative black swan with the same investment.

The key principle in black swan investing is to find extremely aggressive as unreasonable as possible assets. Hence, when you find that chance, take it.

26th January 2020
Insider Trading Is It Legal At All?

Insider trading can be legal or illegal depending on if the information used is public.

By Guy Avtalyon

Insider trading means that someone buys or sells stock based on information that is not freely available to the public. An insider could be someone from the management or simply someone who has access to non-public information. Insider trading can be legal or illegal depending on if the trade is executed on the information that is available to the public or not.

To be honest, everyone likes inside information and rumors. The problem is that most of the time they are just useless gossip. Still, we are all seeking the inside information and have something that is unknown to the majority. If it is possible, to no one.

When it comes to trading, this method of playing based on inside information is seen as insider trading. And it can be legal. Well, in some cases.

What is insider trading

Insider trading is trading based on information that is not accessible to the public. In most cases it illegal but in some specific cases, it is perfectly legal.
Insider trading is illegal when info is received from the insider and traded by traders who received that info and do it before info becomes known to the public. Insider will always give you a hot tip. But is it trustworthy? How will you know that?

That is a crucial difference for insider trading. To make insider trading, the secret information being given must be issued by an insider.

How to recognize the right insider?

Such has access to important non-public information about a company. Usually, it is some from the high-level executives, that have almost all the information about the company’s operations. Well, not all of the high-level management recognize the fiduciary interest and put it ahead of its own. Also, an insider very often owns a big stake in the stock.

In insider trading, an insider can be a trader who acts based on inside info that is not public data.

A legal insider trading

That is a completely different story.

According to the US Securities and Exchange Commission, insider trading can be legal but under some circumstances. For example when a CEO of some company purchases stock of the company he is obliged to report to the Securities and Exchange Commission. Also, legal insider trading is when workers exercise their stock options and buy shares of stock in the company that they work for.

How does illegal insider trading work?

Illegal insider trading is different than legal insider trading. But when it is in violation of the law?

For example, a friend of the CEO of a company heard that his friend could be accused of fraud soon. That info he uses to short shares of his friend’s company because he had the info about bad news that will occur in the future and that will cause the stock price to go down.

The other example is, let’s say, a board member of a company and woman. She knows that the merger is going to be declared in the following days and she assumes the company’s stock price will go up after that. What she is doing? She is buying more shares but not always in her name. Such can buy shares in her husband’s name or parents. That is illegal insider trading.

We are pointing only a few examples of illegal insider trading that may occur. Don’t do that, you may end up in prison.

Does insider selling suggest it’s time to sell?

Acts speak louder than words could ever do. Management is motivated to tell you why should you have to buy the shares of their company. But the insider will tell the true story about the company’s worth. A trend of selling or buying among insiders could give us a clue about the company’s future in the market.

The information that insiders are selling their stocks might give some benefits. Traders may use them to estimate where a stock’s price might go and how insiders price a stock since they have better insight. But remember all data must be public and available.

Anyway, be careful, it isn’t a precise formula. Think about the drawbacks too.

It will take you time and energy to find trends. Moreover, insiders are not always right. Don’t blindly believe in them because they might have some special reasons to sell or buy. And finally, you will get only a small part of large info and that may confuse you, so you may make a bad trade.

Where to find insider info

Speaking about the US stock markets, insiders are obliged to file SEC forms created particularly for insider stock trade reporting. But still, take your time to examine insider trades before you enter your buy or sell positions. Insiders’ information isn’t everything you need to make the right investment decision. You’ll need more.

The SEC made the EDGAR system to provide public access to the insiders’ activity. You can find it on the NASDAQ website. The point is to have the same data from a minimum of two insiders’ sources. Never rely only on one.

How to use insider information

Okay, your search gives you several reports on the company.

So, you can examine the data and find a trend. If your search of insider list displays buying actions, that should be a signal that the company’s management thinks the stock price will go up and want to profit from it as stockholders. But if you see that there is a lot of selling it is usually a sign that the stock price will go down. Insiders will always try to sell before stock prices drop. Anyway, it is only one info and you shouldn’t rely on just one. While you are looking for insider information try to read annual reports, statements, etc. Find other sources to support what you found as an insider trend. Then, you’ll be able to make a proper investment decision.

When you see the executives getting stock option grants and then selling a large part, you shouldn’t be worried. But if you see massive selling and without a visible cause, it’s time to think. Think because you have two options. One is to be a part of the crowd and sell your share or take advantage and buy a share at a bargain. And add to your portfolio to diversify it better.

Famous insider trading cases

The Wall Street Journal writer R. Foster Winans was sentenced to 18 months in prison in 1985 of giving information about stocks he was planning to write about. Two stockbrokers made about $690,000 thanks to his insider information. They were also sentenced.

Ivan Boesky paid $100 million to the Securities and Exchange Commission to compensate insider-trading charges that he made. He earned $50 million in illegal profits. Boesky pleaded guilty and was sentenced to 3½ years in prison in 1987.

Martha Stewart was sentenced. The problem was about her sale of ImClone stock based on a tip that she received from a broker at Merrill Lynch. She was sentenced to 10 months (prison and home confinement). Her stockbroker was also sentenced.

Also, a football player Mychal Kendricks was accused of insider trading after trading based on information he received from a friend. Friend? Yes, a friend who was a broker with Goldman Sachs.

And many others but don’t follow these examples, please. It’s too risky as you can see.

24th January 2020
Diversification Is Important to Your Investment Portfolio

When stock prices drop, bond prices increase. A portfolio that holds stocks and bonds plays better than the one that holds only stocks.

Diversification means to spread the risk across different types of investments. The main purpose of diversification is to enhance your chances of investment success. In other words, you are betting on every one.

Diversification is very important in investing because markets can be volatile and extremely unpredictable. If you diversify your portfolio, you will reduce the chance to lose more than you are prepared to.

And that is exactly what you would like in investing: to spread your capital among different assets. So you’re not relying on a single asset for all of your returns. The key advantage of diversification is that it provides you to minimize the risk of losing the capital invested.

What is diversification?

Diversification means building a portfolio of your investments in a way that the majority of the assets will have a different reaction to the same market performance. For example, when the economy is growing, stocks will outperform bonds. In opposite circumstances, bonds could play better than stocks. Hence, if you hold both stocks and bonds, you will reduce the risks in your portfolio from market swings.

Let’s make this more clear. What do you have in your pantry? Only beans? Of course not! When you went to the grocery you bought everything you need for the week or month ahead. The same should be with your investment portfolio. It should consist of various assets. But not too many. Too many assets mean you will not be able to follow their performances. If you are fresh in the stock market, maybe a two-fund portfolio is a good choice for you. More about this you can read HERE.

Think of these various types of groceries as the different areas, techniques, and areas available to you as an investor. If you have a variety of assets, you’ll be better protected. In the situation when one of your assets is hit by the risk you will still have the others that can give you a profit.

Reasons for diversification

Even the explanation is so simple you can still find so many investors that play on one card. You may ask how some really smart guys could avoid diversification and put all eggs in one basket? We couldn’t find the proper answer because the benefits are so obvious.

By diversification, investors lower the overall risk. It is logical how this works. When you spread your investments in various classes (diversifying them) you have more chances to avoid the negative influence in your portfolio. For example, let’s say you invested in stocks only and you hold a stock of just one company. Yes, we know you like it, it is a good company, famous, well-run. But if suddenly something unpleasant hit it and the stock price drops, let’s say, for 30%, how that occasion will influence your overall portfolio? You will lose 30% of your portfolio. But let’s consider the other situation. Let’s say that stock makes up a modest part of 5% in your portfolio. So, how much of your overall portfolio you will lose now? Can you see where is the benefit of diversification? It lowers the risk. Even during economic downturns, you will still have good players in your portfolio. Hence, if you have bonds and stocks added to your portfolio, it is more likely that even one of them will run well during particular circumstances. Bonds will play better when the economy is decreasing, but when the economy is growing, stocks will outperform bonds.

Diversification and investment strategy

You can find various investment strategies but two are most popular: growth and value investing.

Value investors tend to consider the strength of a company and its management. They would estimate if the company’s stock price is undervalued based on its true worth.

On the other side, growth investors would estimate how fast the company is growing, could its new products stimulate future earnings, etc.
By taking just one strategy you can miss out on the benefits of the other. But if you spread your investments on both of these strategies, it is pretty sure that you’ll be able to enjoy the benefits of each.

Influence of “home country bias”

Well, it is completely natural that investors are more attracted to their own state markets, the national industry. That’s how we come to the “home country bias” in investing. Of course, it is a natural tendency. But it can be a problem too. “Home country bias” can limit your investments to the offer from domestic markets. But what is needed for profitable and successful investing is to step out of your comfort zone. Foreign markets can be profitable also. What you have to do as an investor is to add some international fund or company to your portfolio. It is good protection and well-done diversification. Diversification across international markets will protect your investments if the domestic economy downturns (no one wants that, of course) or during the recession in your country. Several years ago we heard one of the investors saying it isn’t a patriotic gesture. Well, we have to say, investing isn’t an act of patriotism. It is all about profit.

Produces more opportunities

Eventually, diversification produces more opportunities if you make smart choices that deliver balance to your investment portfolio.

For example, you only invest in stocks. But suddenly some great opportunity occurs to invest in, for example, bonds. What will you do? Refuse to invest in bonds because you are not comfortable with them and risk to miss potential profit? We don’t think it is a smart idea. Never miss the opportunity to earn more, that isn’t in the nature of investing. Admit, you will never miss this opportunity to invest in bonds if you have a diversified portfolio. So, diversification gives you more opportunities to invest.

Protect and improve your finances

It is important to understand all the benefits of diversification. It isn’t hard to do. Actually, it is very simple. You have to read more, learn and be patient. If you diversify your investment portfolio you will have a chance to build stable finances over time.

How to diversify your portfolio

Firstly, never be too much invested. You will not be the winner if you own hundreds of assets. Okay, let’s say this way. Your portfolio is your team. And, as in every team, each part plays its role. No coach will put all players in one position. It’s stupid. Plus, how such a team will win anything? Of course, zero chances!

The point of diversifying is to hold investments that able to work separated tasks on your team.

Every single part of your portfolio should have a different role. For example, if you prefer stocks, diversify your portfolio to S&P 500 (that would provide you exposure to large-caps) and add some small-caps.

If you have a bond portfolio diversify it across short and long bonds, or higher-quality bonds, etc. That will reduce the risks. Or just add alternative investments in your portfolio. For example, private equity, hedge funds, real property, venture capital, commodities, etc.

Bottom line

How will you know you’re diversified? A well-diversified investment portfolio will never move in the same trend and at the same time. You must have one thing on your mind: you are the manager of your portfolio. Also, it is almost impossible for all investments to grow all the time. It is 100% sure that some of your positions will be lost, will lose you money. When that happens you will need the other holdings to balance that fall.

Diversification guards you against producing an undesired risk to your capital. Anyway, it is too risky to put all your money into one single investment. The key to diversification is to spread your money across asset classes and to allocate within classes. That is a smart approach.

23rd January 2020
No Brainer Portfolio – Lazy Portfolio

The main feature of this portfolio is the idea that most return is determined by the asset allocation of the portfolio, more than by asset selection.

No Brainer portfolio is one of the “Lazy portfolios”. No Brainer portfolio cover investments proportionately in four asset classes – US bonds, total US stock market, small-cap US stocks, and international stocks. It is very useful for investors with long-term goals. The point is that investors can favor one of the asset classes at different times. By doing so investors could gain nice risk-adjusted returns.

Designed for investors with a long time horizon that will favor each of the classes at various times, the portfolio aims to provide diversified risk-adjusted returns. This motif seeks to replicate Dr. Bernstein’s model by identifying ETFs that would be contained within the “No Brainer” asset class structure.

Dr. William Bernstein believes that asset allocation is more valuable for investors than choosing individual stocks or bonds.

This is the simplest portfolio Dr. Bernstein explains in his famous book “The Intelligent Asset Allocator”. Well, this book is generally suggested not only for the No Brainer portfolio. You can find a lot of extremely valuable info on the diversification and portfolio construction in this book. It is highly recommended among investors.

In this book, Dr. William Bernstein explores historical performance to come at an almost simple to implement a portfolio. He believes this portfolio should perform well in the long-term. No Brainer portfolio consists of four asset classes in the following proportion:

25% Short-term Bonds
25% of International Stocks
25% Small-Cap Stocks
25% Large-Cap Stocks

All you need is a simple, well-diversified portfolio

The Bernstein no-brainer tracks very strictly the “simple is better” rule. This lazy portfolio could be very suitable for any investor who dislikes monitoring the investments every day and has a longer time horizon.

Here are some stats about the total return by using the No Brainer portfolio.

Over the past 10 years, the No Brainer portfolio has had an annual return of about 5%. Not good enough? In fact, it is in line with the S&P 500. This portfolio is a wonderful choice for anyone who doesn’t like high-risk, not-assured returns.

Why the No Brainer portfolio is so special?

Diversification! Yes, Dr. William Bernstein’s No Brainer portfolio is focused on diversification through many asset classes. It covers almost all assets. There is some interesting thing about William Bernstein, according to his own words he is asset class junkie but not only because of this particular portfolio. Dr. Bernstein is the creator of many portfolios.

So, you can imagine how broadly his portfolios display diversification. It is a 360-degree portfolio.

Among others, he created Four Pillars, Cowards Portfolio, Sheltered Sam Portfolio, etc.

For example, his Cowards Portfolio consists off:

10.00% US Large Cap Value
15.00% US Large Cap
10.00% US Small Cap Value
5.00% US Small Cap
5.00% REITs
5.00% Emerging Markets
5.00% Pacific Stocks
5.00% European Stocks
40.00% Short Term Treasuries

What are the advantages?

By applying this kind of portfolio, so-called lazy portfolios, you could minimize taxes by asset location or by adding a specific asset class such as municipal bonds. You could build such a portfolio based on your age and appetite for risk. Also, you can add employees’ stocks.

All this shows the no brainer portfolio as a very helpful model for all of your investments.

The most important, Bernstein’s no brainer portfolio will never face you with the cruel reality. Contrary, it will save you from that since from the very beginning you will know what you can expect in the returns.

Why use the no brainer portfolio?

Investing is hard but by applying some of the lazy portfolios it doesn’t have to be, investing could be easier. How is that? Let’s see!

Here, in the no brainer portfolio, you have ONLY 4 asset classes. That provides you to have a quick overview of your investments. It is simple. Why would you like complexity? It may cost a lot of money and time to watch.

Moreover, this portfolio doesn’t contain any special asset classes. So they are simple to understand. Just 4 asset classes! That’s so easy!

Who is the creator of the No Brainer portfolio?

William Bernstein was born in Philadelphia and educated in California where he earned a Ph.D. in chemistry at Berkeley. Did you know that he did it in just three years? To got the opportunity to work more closely with people, he went back to school and earned M.D. from UC–San Francisco. At that time he was the only neurologist in Coos County.

From 1980 to 1990, Dr. Bernstein treated migraines, Alzheimer’s and Parkinson’s. Ten years living all of these, he was under enormous stress and was forced to cut his working hours. Also, he wanted to pay more attention to his hobby – finances and investing. And Bernstein decided to learn more about it.

The first thing he required was data. Several years later he started to write a book with an interesting premise: people are wrongly trading individual assets instead to buy entire markets.

The book was published on his website Efficient Frontier in 1996.

and in 2001, McGraw-Hill published “The Intelligent Asset Allocator”. His “The Four Pillars of Investing” was published in 2002.

How to create a lazy portfolio

First, keep the cost as low as you can. Define your tolerance for risk and how big returns you want. Find data for historical returns to build a portfolio of index funds. They have to hold a mixture of assets that are able to produce a balance between risk and return. Investigate among different classes value stocks, small-caps, bonds, REITs, micro-caps, everything. You may think you will need a powerful software for this. Actually, a bit of common sense is all that you need. For example, pick 60% stock and 40% bonds. That will work well for investors. The other solution is to choose some low-cost fund that includes stocks and bonds both.

Sounds simple, right?

Bottom line

According to Bernstein, all you need are several skills to be a successful investor. One is understanding the financial implications of numbers since math is what lies behind investing. Also, as an investor, you must have the ability to trade without emotions. In other words: sell when the stock prices are growing, and buy when they are falling. And be independent. You have to have your opinion. Don’t believe in everything that pricey advisers say. Have trust in your basket of assets.

The lazy portfolios offer higher returns. This kind of portfolio has withstood the test of time and will be valuable for many years. And, as final words, don’t let be overwhelmed by too much information. Sometimes, you will make better choices with less info.

22nd January 2020
What is Riskier Bonds or Stocks?

(Updated October 2021)

In some scenarios, bonds are riskier than stocks. The main problem is how to run your investments stable but not cutting the growth stocks have to give.

Do you think the stocks are riskier than bonds? Well, stock prices are more volatile than bonds, that’s the truth. Also, bonds are paying fixed income. What else is on the bond side? Well, not much. Maybe these two is all since bonds could be riskier than stocks. The whole truth is that bonds are very risky for the companies, but at the same time, less risky for investors. Speaking about stocks, they are less risky for the companies but for investors, they can be extremely risky.

So, why do so many people think that bonds are less risky? We have to solve this dilemma: what is riskier, bonds or stocks.

The most and least risky investments

There are so many factors that have an influence on how some investment will perform. Honestly, all investments carry some level of risk. Speaking about bonds, they are under the great influence of inflation while stock investors may not feel it so much. Stocks have some other kind of risks, for example, liquidity risk. Such a problem bond investments don’t have.

Firstly, stocks are the riskiest investments, but they also give excellent potential for high returns. Stocks or equity investments cover stocks and stock mutual funds.

Bonds or Fixed Income Investments cover bonds and bond mutual funds. They’re less risky than stocks but generate lower returns than stocks.

The third-place belongs to cash or certificates of deposit, money market funds, Treasury bills, and similar investments. They are giving lower returns than stocks or bonds but carry a little risk also.

What are stocks and bonds?

To understand what is riskier, bonds or stocks we have to make clear what each of them is. There are two main concepts of how companies can raise money to finance their businesses. One is to issue stocks and the other is to issue the bonds.

Stocks and equity are the same. Both define ownership in a company and can be traded on the stock exchanges. Equity defines ownership of assets after the debt is paid off, so it is a bit broader term. Stock relates to traded equity. Equity also means stocks or shares.

In the stock market tongue, equity and stocks are the same.

Stocks

Stocks will give you an ownership stake in the profits of the business, but without the promise of payment. That’s why stocks are riskier. The companies may decide to pay dividends but nothing else is an obligation. While holding the stocks the value of your investment will vary related to the company’s profit. Stocks are also dependent on investors’ sentiment and confidence. Anyway, stocks are safer for companies since they are a sure way to raise the money needed to maintain business. For investors, stocks are riskier since the companies don’t have any obligation to provide any kind of return. If the company is growing and rising profit, investors will obtain capital gains.

Bonds

Bonds are parts of debt issued by companies and transformed into assets to be able to trade in the market. Bonds give fixed interest rates also called coupons to bondholders. The companies have to pay the interest rate before any dividend to stockholders. Otherwise, the bonds go into default. Also, bonds are conversely related to interest rates, meaning, when rates go up, bond prices drop.

Can you see now? How to answer the question of what is riskier, bonds or stocks? For investors, stocks are a riskier investment, for the companies, the bonds are riskier.

Bonds vs Stocks

The majority of investments can be classified as bond investments or stock investments. In stock investment, you are buying an asset and your profit depends on the performance of that asset. If you buy a y a thousand shares of Tesla, your profit is based upon the stock dividend which Tesla pays (if any) and upon the fluctuation of the value of Tesla shares.

In a bond investment, you actually loan money to a company or a government. With a bond investment, your profit is not related to the performance of the company. If you buy a $2,000 bond from Tesla, for example, and the company earns a record profit, your profit will be the same as if Tesla didn’t make a profit at all. But here is the risk involved with the bond investment. What if the company is unable to pay back the debt? You can lose all your investment.

Stock investment is recognized as a higher risk. But risk makes a profit, therefore you will earn a higher return over the long term.

So, what is riskier, bonds or stocks?

Risks and rewards of stocks investments

Stock investments offer higher risks but greater rewards. A lot of things influence that. An increased sales, for example, or market share, or any improvement or development of the company’s business, literally anything can shift the stock price and skyrocket it. So, investors can earn by selling them or by receiving the dividends.

Any company can succeed or stumble. That’s the reason why nobody should invest in just one company. Do you know the saying: Never put all eggs into one basket? But if you hold stocks from several companies you will ensure high returns over the long term.

But, so many investors couldn’t watch the unfortunate events without selling their stocks at a loss.

Well, if you don’t have a stomach for that just stay away from the market or, which is a better choice, diversify your investment portfolio. Add some bonds-based investments, that will help you when the stock market gets rough. Moreover, a well-diversified portfolio will give you a bumper by providing lower volatility and calm play. So, you will not be forced to sell your investments and feel stress while making decisions.

Bottom line

So, do you have the answer what is riskier, bonds or stocks?
Yes, stock prices fluctuate more than the prices of bonds but that doesn’t necessarily mean more risk for the investor. There are a lot of cases when bonds are riskier than stocks.

For example, over a high inflationary period when inflation is surging quickly, the bond price can be damaged, decreased. The inflation will decrease the value of payments, and the bonds will mature less valuable.

On the contrary, stocks can boost their prices during inflation. The companies could raise prices of their products and increase their profits. That would raise the value of their stock, even higher than the inflation rate.

Can you see how the bonds might be riskier investments than stocks?

During the regular economic conditions, stocks could be much riskier than bonds.

Stock prices could sink sharply. Hold! Don’t sell! Wait for a while, wait for a stock to bounce back in price. And you know what, when the stock prices are falling, there is no better moment to buy them and hold. Just pick a well-established company.

The point is that bonds are not always the safest asset. They can be very risky. In some scenarios, stocks can be a much safer choice.

Savvy investors will buy both to diversify portfolios. Of course, how many of each you will hold isn’t set in stone. You can change it over your lifetime as many times as you want to reach your goals and earn a profit.

21st January 2020
Employees Stock Options are What European Startups Need

In contrast to Silicon Valley, European startup employees are not known for earning millions from the company’s stock.
Stock options policies in Europe are a major barrier to the tech growth and that has to be changed.

Employees stock options are issued by many companies. For example, startups use them to hire talented they need because they cannot afford to pay them more in cash.
The situation is especially difficult in Europe where the policy doesn’t give a chance for companies to issue employees stock options. That causes problems for many companies but for the startups, it is maybe the biggest.

Recently, the campaign Not Optional published a letter where stated:

“Without delay, we call on legislators to fix the patchy, inconsistent and often punitive rules that govern employee ownership — the practice of giving staff options to acquire a slice of the company they’re working for.”

Some European countries started to relax rules on employee stock options. France is one of them, but employees still favor cash.

This country recently exposes a list of changes to rules on employee stock options to meet a request from French startups. Their aim is to compete with US competitors and big companies in recruiting staff.

France is changing a set of rules, for example, the price at which the companies ( including foreign companies) can offer them to employees. The goal is to make France one of the most friendly areas for startups in Europe.

Being competitive

Difficulties in implementation employee stock option rules and availability of capital, are reasons why European have problems to create large tech businesses. That’s the reason for staying behind the US but the EU wants to keep up. There is a strong campaign for changes in employee stock options in Europe now.

According to Not Optional, a campaign is supported by 500 European founders and they are lobbying new stock options policy across the continent.

They recognize employee stock options policy as a major drawback to European tech growth. Due to the problems with the fund-raising, issuing employee stock options can be a great opportunity. Well, recently many countries declared changes, France isn’t the only one.

Ireland changed some of its stock option practices, also, the new Finnish government is examining changes on how stock options are taxed. The German Startups Association has started a campaign to lobby for changes too. As a confirmation that employee stock options are on the Brussels agenda – Thierry Breton, the European Commissioner for Internal Market and Services, discussed stock options in Commission hearings.

Do employees want stock options instead of cash?

Many European tech employees are, however, at best doubtful about stock options, according to Sifted. The employees don’t have positive responses. Maybe it’s surprising how they have a lack of trust but someone has to educate them, to explain the benefits of having the company’s stock. For that to do isn’t enough just yelling that “we are all shareholders of the company”. It isn’t complicated.

So, let’s start.

Understanding employee stock options

Let’s see how the employee stock options work.

Companies give stock options through a contract that provides employees the right to buy a set number of shares of the company stock at a pre-set price.

The right to buy is commonly called exercise, and a pre-set price is the grant price.

There is one important characteristic connected to employee stock options – time, the offers don’t last forever. Employees have a strict period to exercise the stock options before the date of expiration. Also, the employer could require that an employee must exercise the options within a defined period after leaving the company.

The number of options that the company could give to its employees is different from company to company. Also, not all employees will get the same number of stock options. It depends on status, rank, seniority.

How do they work

For example, you got a new job at a new firm. Besides your salary, you will receive stock options, as part of the payments. Let’s say you will receive stock options for 10.000 shares of your new company’s stock. You and the company are both obliged to sign the contract that describes the terms of the stock options.

There will define the grant date. That is the date your options are available for you to buy. This means your stock options begin to vest. But you will not get all of your stock options immediately when you start working for a company. The options vest gradually. That period is known as the vesting period and it can last several years, for example. So, let’s say the vesting period is 5 years. This means it will take 5 years before you have the right to buy all 10.000 shares. But you’ll have access to some of your stock options before those 5 years are up. 1/5 of your options will likely vest each year over that 5-year vesting period. So, after 3 years of employment, for example, you will have the right to exercise 6.000 options.

But your contract may contain one important part – a milestone. The clause that you have to stay for at least one year with the company to have a chance to get any of your stock options. When you reach the first milestone you will receive your first 1/5 of your stock options. After that, it is possible to get every month some amount of them, usually, they are the same. For example, the rest of the 8.000 shares you’ll obtain in 48 parts each month.

But if you leave the company before reaching the milestone for the first year, you won’t get any options.

How to exercise

After your stock options vest once, you can exercise them. What does it mean? You can buy them. Until you do that, the options don’t have any value. The price of your stock options is part of the contract mentioned above. That is a so-called strike price or grant price or exercise price. This price never depends on how the company is doing. It will always stay the same.

For example, after your 5-years vesting period, you have 10.000 stock options with a strike price of $2. If you want to exercise (buy) all of your options you’ll have to pay $20.000. When you buy all your stock options you are the owner and you can do with them whatever you want. You can sell them, keep them (only if you think the price will go up) but remember, you have to pay fees, taxes, and commissions when you are buying or selling the options.

There are some ways to exercise your stock options without spending cash. For example, you can make a buy-and-sell action. To do this, you’ll buy your options and quickly sell them through a brokerage. Another strategy is the exercise-and-sell-to-cover transaction.

Practically, you have to sell enough shares to cover your buying of all shares and keep the rest. But be aware, your stock options have an expiration date. So, read the contract carefully. Usually, options expire 10 years from the grant date. After that date, they are useless if you don’t exercise them.

Bottom line

It is good to exercise options when the price is lower than the same stock on the market. For example, your stock options’ strike price is $2 but the same stock is traded at $4 on the market. Just sell them and make a profit. It is obvious, if you have some clue or expectation that your company’s stock price will grow, you can hold them as long as you want and sell them at the most favorable moment. It isn’t forbidden to sell them on the market.

But you should wait if the price of your company’s stock is lower than your exercise price. In such a case, don’t exercise them because you might lose your money. Just wait for the price to increase before exercising.

20th January 2020
CAPE Ratio Or The Shiller PE Ratio

The CAPE ratio has some predictive ability so you can create your investment strategy based on the CAPE.

The CAPE ratio is a variety of the P/E ratio. Just like the P/E ratio, the CAPE ratio shows whether a stock price is undervalued, overvalued, or fairly valued.

But, the CAPE ratio permits the evaluation of a company’s profitability during various periods of an economic cycle. The CAPE ratio also analyses economic fluctuations, both the economy’s expansion and recession. Basically, the CAPE ratio is a tool analysts use to measure how ‘cheap’ or ‘expensive’ the stock market is. We can know that only if we compare its P/E ratio with historical values over the last 10 years, that is common. And if the P/E ratio of the market is lower than it’s 10-years average we can say the market is undervalued. Hence, if the 10-years average is higher, the market is overvalued.

This metric to estimate if the stock market is overvalued or undervalued was developed by Robert Shiller, an American Nobel Prize Laureate in economics. It became very popular during the Dotcom Bubble. At that time Shiller perfectly pointed out that equities were extremely overvalued. That’s why this metric is also called Shiller PE.

How to calculate the CAPE ratio?

It is possible if you divide the current market price by the 10-year average of inflation-adjusted earnings per share.

CAPE RATIO = PRICE / AVERAGE EARNINGS ADJUSTED FOR INFLATION

That’s a big bite, so lets this formula to make a bit simpler.

Let’s say, some farmer is selling apples for $20 each. WOW! This guy may make a fortune. But who will pay $20 for just one apple? Is it golden? Everyone would think the price is insane. But let’s take a look at historical data for the last 10 years. For example, we found one single apple has been selling at $40 over the past 10 years. This would change your opinion and we suddenly believe the price of $20 isn’t high, it is contrary, very cheap. Something different we would believe if we found the apple average price was $2 over the last 10 years. Who would buy now?

So, we estimated what was the average apple price in 10 years to have a comprehensive idea of how much apple costs.

Let’s this example apply to the stock market which has a historical price called a P/E.

P/E is when the price per share is divided by the earnings per share each year. If the farmer mentioned above started a company and makes $2 a share and the stock market values each share of the company at $10, what would the P/E ratio be? The P/E would be 5.

Let’s use CAPE

If the CAPE ratio is extremely high, which means that we have a company with a higher stock price than the company’s earnings show. So we would easily conclude that the stock of such a company is overvalued. Of course, we can expect that the market will ultimately correct the stock price by shifting it down to its fair value.

How the CAPE Ratio Works

A good position for following the CAPE ratio is to estimate the basic P/E ratio as first. It is a generally-accepted metric, but Shiller noticed a restriction in it.

Well, a company’s earnings can be reasonably volatile from year to year particularly during top and not so good years in a business cycle. To have accurate info about some company we have to minimize the effect of the short-term business cycle on the valuation. That was the problem that Shiller noticed. Instead of looking at just one year, he created the ratio that takes into consideration the average earnings over the past 10 years. This provides comparing valuations over a longer period of time.

One disadvantage of the popular P/E ratio is that it is related to the past 12-months earnings only. But what if something temporary happens during that period? For instance, a big store-chain has to close some of them for restoring them. That would reduce the earning for sure but the company finished what was planned and made progress in earnings. But you didn’t buy a share of that company just because you made your decision based only on one metric – P/E ratio. And you missed the profit. By using the CAPE ratio you would be able to make a better choice.

Ability of Forecasting

The CAPE ratio showed its importance in recognizing possible bubbles and market crashes. It was determined that the historical average of the ratio for the S&P 500 Index was inside 15 and 16. The maximum levels of the ratio passed 30. The record-high levels occurred several times. The first was in 1929 before the Wall Street crash that flagged the Great Depression. The second occurred in the late 1990s and announced the Dotcom Crash. Also, we had signals before the 2007-2008 Financial Crisis.

Speaking about investors and investments, there is held to be a relationship between the CAPE ratio and future earnings. Shiller noticed that lower ratios give higher returns for investors over time.

Nevertheless, there are critiques regarding the use of the CAPE ratio in predicting earnings. The main problem is that the CAPE ratio does not calculate the moves in accounting reporting rules. For example, what if changes in the calculation of earnings under the GAAP appear? That could change the ratio and present a pessimistic sense of future earnings.

Bottom line

The CAPE isn’t the only metric you should use when investing but of course, it is one of.

It’s mostly used to the S&P 500, but can be applied to any stock index. The advantage is that it is one of several valuation metrics that can help you. It is important to find the current relationship between the price you pay for stock and future earnings. If the CAPE is high, and other measures are high, it is a good idea to cut your stock exposure. Also, you can invest in something cheaper.

A savvy investor should always compare the price that pays and the value that gets. Regularly, all investors want to buy a company when its stock is trading at a low P/E ratio. That will give them a better profit.

But that could be the problem too. When a recession, the stock will fall. At the same time, the company’s earnings will fall, and that can quickly raise the P/E ratio. But it is temporary. The consequence is that we are receiving a false signal that the market is expensive. And what we are doing? We don’t buy the stock when certainly it’s the best time to buy it. And here is the point where the CAPE ratio is fully useful.

It shows a more realistic relationship between current prices and earnings based on 10-years average adjusted for inflation over the latest business cycle.

When you are choosing which assets to sell, CAPE can be a great support. If you see that CAPE shows the S&P 500 is undervalued, sell bonds. And when CAPE shows the S&P 500 is overvalued, sell those holdings first.

19th January 2020
Lazy Portfolio – How to Make Wealth With Minimum Engagement

A lazy portfolio is a diversified portfolio that allows you to grow your wealth without stress or a lot of work.
There is no active trading, no monitoring your stocks every day, and no paying to handle your money.

Let’s make clear what’s a lazy portfolio? In short, the lazy portfolio is passively managed, low-cost, diversified and tracks an index.

Actually, a lazy portfolio is a simple set-it-&-forget-it strategy. It requires a minimum of maintenance so we can easily say it is a passive investing strategy. Due to its nature, it is suitable for long-term investors. In essence, it is a buy&hold strategy that working very well for investors that feel fears when they have to make investing decisions. Even more, this strategy provides investors to avoid greed, maybe the most dangerous feeling in the stock market.

The lazy portfolio isn’t only for lazy investors, this has to be clear. It is for investors who want to avoid high risks while investing. We will introduce some of the best lazy portfolios that could provide above-average returns with below-average risks.

How to recognize the best lazy portfolio?

Actually, it is yours, the one that you maintenance. Each investor has its own style of managing, a different approach, so the way of investing is absolutely individual. But the goal is the same – to outperform the market and generate the highest-as-possible returns.

In most cases, a lazy portfolio can do that. Even Warren Buffett believes in a lazy portfolio, you can ask him. Also, many other successful investors built a lazy portfolio instead of fancy strategies.

But in most cases, a lazy portfolio will not give you to time the market, or to beat it. Also, it will never give you a chance to pick individual stocks but, at the same time, it is low-cost and loaded with fewer fees.

A selection that makes money

Index funds are a good choice as being less volatile. Well, you will not earn your money fast but you could stay in the market for a long time, over 10 years, for example. And you’ll make a profit.

Index investing is essential for laziness. Trust us. You don’t need to actively manage ETFs. What you have to do is to choose among several different recipes but generally, they come into three categories:

Two-fund portfolios
Three-fund portfolios
Four-fund portfolios

Two-fund portfolio

A two-fund portfolio is suitable for investors who want an easy asset allocation portfolio. The two-fund portfolio is built of one fixed-income fund and one equity index fund. You will find your selections depending on the asset class and asset type.

It easy to create a two-fund portfolio.

There are almost 2,000 ETFs out there and you can pick any of them.

First, decide which assets you need. Stocks and bonds are of the core asset classes and your lazy two-fund portfolio will need them. Stocks perform well when the economy is good. But, bonds will protect your portfolio from market uncertainty. Of course, you don’t need to hold stocks and bonds, you can choose something else, as we said.

If you are a very lazy investor your two-fund portfolio could be consists of 60% of total world stock index fund or ETF and 40% of US diversified bond index fund or ETF, for example.

Three-fund portfolio

A three-fund portfolio is composed of only three assets. They are usually low-cost index funds. It requires very little maintenance on your part and that’s why it is another example of a lazy portfolio.

It is a pure 60/40 rule. This one recommends investing in international index funds and stock market index funds. For example, according to Taylor Larimore, an advocate of holding investing simple, all you need is to handle with three mutual funds. That will require an hour per year managing your money, he said. You may diversify your three-fund portfolio on 40% of bonds, 42% of stocks and 18% global stocks. According to some experts, it is the best proportion.

Four-fund portfolio

The best example of this kind of lazy portfolios maybe is Dr. Bernstein’s “No-Brainer” lazy portfolio.

Dr. William Bernstein wrote “The Intelligent Asset Allocator” and “The Birth of Plenty”. He has promoted the capability of the index fund over individual stocks and bonds.

One portfolio that he proposed in “The Intelligent Asset Allocator” is named the “No-Brainer” portfolio. It is composed of 4 equal funds: 25% bonds, 25% global stocks, 25% US stocks and 25% small-cap US stocks. No-brainer indeed.

But this portfolio will give you a chance to diversify the risk over time.

If you are smart, you can be lazy

You will show you are a really clever investor if you set up all of your buying to be automatic. For that, you will need SIP – a systematic investment plan. Mutual fund or brokerage could help you with this. In this way, you will lessen the risks of market fluctuations. Moreover, this will provide you invest a fixed sum in a mutual fund plan at regular periods. For example, you can invest $500 in a mutual fund each month. It is a helpful tool.

Manage no-load funds

As we said, a no-brainer is really good. If you use no-load funds for your lazy portfolio you will avoid sales charges, so-called loads. Well, to make this clear. You are dealing with mutual funds and it is quite possible to do all the necessary things related to your portfolio and investments, yourself. So, why should you pay any additional fees? The point is to keep your cost low to boost your returns, right?

Rebalance your lazy portfolio

Re-balancing a lazy portfolio is simply turning the current investment allocations back to the initial investment allocations. So, you will need to buy or sell shares to bring back the allocation percentages into the initial balance.

Re-balancing is important maintenance and you should do it periodically, for example, once per year. Well, there is always a possibility with, for example with mutual funds, to set up automatic rebalancing.

Advantages of a lazy portfolio

Lazy investing could be the best way to invest. First of all, it is simple Holding just a few funds makes things easier. Further, it is low-cost investing since you don’t need to pay any fees for trading, managers, etc. If you build a lazy portfolio you just have to buy some cheap assets and voila. But the most important feature is the diversification. You can hold thousands of stocks and bonds with just several investments.

Disadvantages of a lazy portfolio

It isn’t easy to find some disadvantages, but there are some things to consider before starting.

One of them is tax-loss harvesting. if investing with 2 or 3 funds, you might miss out on some tax-loss harvesting possibilities. The other problem is the lack of customization. You can’t customize a lazy portfolio like you can with others. But that is the point, to keep it simple. Simplicity is the amazing part of it.

17th January 2020
7Twelve Portfolio – Craig Israelsen Strategy

The Israelsen 7Twelve is intended to protect the portfolio against losses. The portfolio has 7 different asset classes and 12 different funds. Each fund has the same weight of 8.3% or 1/12 of the overall portfolio.

7Twelve, a multi-asset balanced portfolio, is developed by Craig Israelsen, Ph.D. in 2008, today he is a principal at Target Date Analytics. As a difference from a traditional two-asset 60/40 balanced fund, the 7Twelve strategy covers various asset classes in an investment portfolio. The purpose is to improve performance and reduce risk. This represents a totally new school of a balanced portfolio.

The number 7 describes the number of asset classes proposed to add to your portfolio. The number 12 (twelve) outlines the number of separated mutual funds that fully represents the 7 asset classes in your portfolio.

The roots

Craig Israelsen was a teaching family finance at Brigham Young University. One day he got an interesting question: What should be in a diversified portfolio? Even if he thought how the question is interesting, Israelsen didn’t have the right answer at that very moment. The subject was so provocative that Israelsen developed a unique formula for portfolio diversification. It was 2008.

which has been catching on with financial planners. The name 7Twelve Portfolio came from Israelsen himself.

The reason is simple. His new portfolio consists of 12 equal parts of mutual funds pulled from seven fund types: real estate, natural resources, U.S. equity, non-U.S. equity, U.S. bonds, non-U.S. bonds, and cash. But it was the first version based on historical data to 1970. Later, as the markets changed, he added U.S. midcap, emerging markets, natural resources, inflation-protected bonds, and non-U.S. bond funds.

7Twelve strategy

Each mutual fund in the 7Twelve strategy is equally weighted and represents 1/12th of the portfolio. This allocation is managed by adjusting the portfolio back to equal parts monthly, quarterly or annually.

7Twelve model is the “core” of an investment portfolio. Any investor may add individualized assets around the core. But one thing is obvious, using 7Twelve can improve the efficiency and the portfolio performance for the investor because it is a strategic model and doesn’t rely on tactical moves or changes.

Investing by using 7Twelve strategy

There are some statistical data that support the idea of how Israelsen’s portfolio model is better than traditional. For example, if we observe the Vanguard Balanced Index fund (consists of 60% U.S. stocks and 40% U.S. bonds) from 1999 to the end of 2014, we will find that it had an average annual compound return of 5.7%. In the same period, the 7Twelve portfolio would return 7.6%, as Israelsen calculated it. The result showed that the 7Twelve portfolio had smaller losses in bad years, and that is the point of a well-diversified portfolio, right?

Some experts argued with Israelson, claiming that he made 7Twelve by back-testing which allocations have had the best performances in the recent past. If yes, why and how would he equally weight assets? In such a case, the returns would be different.

The value of 7Twelve is its simplicity. Actually, it can be easily adjusted for each investor individually.

The advantages

7Twelve portfolio gives a wide diversification because all known asset classes are covered. So, you can get excellent diversification across many asset classes. Simplicity is a great part. It is so easy to follow 12 funds or ETFs, equal-weighted. Moreover, this model is one of the rare that includes mid-cap stocks. Maybe the most useful part is a great opportunity for rebalancing monthly, quarterly or annually. That possibility is giving reduced risk and increased returns.

Rebalancing the 7Twelve Portfolio

Rebalancing is an important part of the 7Twelve plan. It is very simple. All you have to do is bringing each of the 12 funds in your particular 7Twelve model back to their given allocation (1/12 or 8.33% in the core 7Twelve model).

For example, if you had some funds that performed better in the, let’s say the prior quarter, just deposit more into the funds that were underperformed in the same quarter. In this way, you are rebalancing the account of all funds in your portfolio. That is how you have to manage your portfolio, without emotions.

Let’s say your investment 7Twelve portfolio is $10.000 worth. If you don’t re-balance it, you will lose 13 bps over 20 years. That is empirical evidence. In money, it is almost $920.

The full info you can find HERE

It is a strategic portfolio. All you have to do is to set the percentages and rebalance them when they get out of balance. And you can stay relaxed until some market events ask for you to rebalance. Generally, a good idea. Just view this portfolio graphically.

Bottom line

Every single investor would admit that diversified investing is a great and ultimate thing for everyone in the market. But the reality shows that the ordinary investor hasn’t too much experience in building a diversified investment portfolio. Most investors are holding a portfolio of several mutual funds. That isn’t diversification. 7Twelve provides investors the possibility to build a diversified, multi-asset portfolio.

In many articles and books, Craig Israelsen explained how simple it is to maintain a strong portfolio with a plan. And it is. Moreover, it provides investors to reduce risks of investing.

The deeply diversified portfolio avoids losses efficiently, decreasing the usual deviation of return, and frequency of losses. A well-diversified non-correlated portfolio provides a good return and low volatility.

What people don’t like about 7Twelve? Firstly, some think there are too many commodities.

Secondly, some stated that this strategy is boring. Investors who like to check their portfolios every hour a diversified portfolio could be. The same comes to investors that like to detail-manage their investment. But no one says this is an unreasonable portfolio. Contrary. Literally, you can find plenty of good portfolios and this is one of them. The main problem is that only a small number of investors have been using this portfolio for a long time despite the fact it is created more than 10 years ago.

The most important thing is to choose one and stick with it, through the highs and deeps.

16th January 2020
Microcap Stocks – Recognize The Risks And Get The Rewards

The main difference between a microcap stock and other stocks is the amount of reliable publicly-available data about the company but potential growth can be great in the long run.

The microcap stocks can be riskier, sometimes significantly than other assets. A lot of them are traded over the counter. They are not in the investors’ focus so, due to the lower demand, the prices of microcap stocks are cheaper. Since they are OTC traded they do not have to match the listing standards created to protect investors. Microcap stocks are relatively anonymous and whoever wants to invest in them has to follow very closely.

Microcap stocks are viewed as risky investments for a reason. They often belong to the corpus of new companies in the beginning stage, so it can be difficult to gauge how successful they can be in the market. Firstly due to the fact they don’t have historical data for investors to examine. Moreover, this lack of data may increase the risk of fraud.

But the favorite Wall Street maxim is: “The higher the risk, the greater the reward.”

That is true, especially for the microcap stocks. Because these companies are small and their stock prices are low, they can be a great potential for growth and great returns.

The risks of investing in microcap stocks

Investing in microcap stocks is connected to numerous difficulties. Finding some to research is the last in the list of many challenges. First of all, there is a lack of historical data and you have to be prepared for more hands-on methods and additional work. For large and midcap stocks you can find a lot of valuable data, even for the smallcap stocks. Well, investing in microcap stocks requires deeper digging. But if you do your homework well you can expect a handsome reward.

The additional risks come with a lack of liquidity.

How to deal with it when buying the stock?

Let’s examine the following situation.

For microcap stocks, the price is low, the volume is small. So, when most of the sellers sold their microcap holdings, liquidity will dry up. So, the interest of buyers becomes smaller. But this is the right time to buy them.

Management of microcap companies often meets tremendous challenges in bringing liquidity to the company’s stock.
Generally, microcap stocks have a liquidity problem.

And everyone in the company would like trading volumes to increase. The question is how to reach the investors and increase liquidity. Maybe the main problem for those companies is that Wall Street isn’t interested in them. Let’s be honest. Microcap companies are under their radar.
This could be one of the reasons why most investors don’t invest in microcap stocks. Well, when you invest in stocks with high liquidity you expect they are highly efficient. Your transactions will be executed in seconds and your returns will be at best average.

That’s the problem, where is the possibility?

Microcap stocks are companies whose market value is usually between $50 million to $300 million. If you are looking for additional long-term investment they could be the right choice. Even if you are building your wealth by investing in large-cap stocks microcap stocks could provide you a good mix in your portfolios.

Microcap stocks are less followed but offer benefits. They offer higher returns over the long run. Microcap stocks have the high-returning quality combined with greater alpha potential.

Let’s say, small companies tend to outperform large companies over the long-term. For example, in the past several decades, from the 1970s, they have outperformed large-cap stocks by more than 1% annually. Speaking about higher alpha, you must know that less investor attention leads to greater chances to recognize quality, growing companies before they have been identified by the market.

Microcap stocks can have powerful roles in asset allocation.

They offer many of the benefits such as access to early-stage, high-growth companies. Moreover, they do that with higher liquidity and transparency than private equity, for instance. Also, microcaps don’t have a problem with valuations and a lack of deal flow.

Furthermore, a microcap can be a complete strategy that fills out the rest of an investor’s equity allocation.

In comparison with larger companies, microcap stocks have a better spot when it comes to growth. Hey, you are investing in microcap stocks because of a chance to get in the market before a company bounces and skyrockets. The only way to go with them is up. We suppose you will pick a successful company, though. When the company you invested in growing, you will profit.

Diversification is important because it provides to spread out the risk. A diversified portfolio will give you some protection from market volatility. Never miss out on the chance to invest in different kinds of assets. By investing in microcap stocks, you can create balance in your investment portfolio.

Benefits of microcap stocks investing

If you are seeking market outperformance you will have it by investing in microcap stocks.

First of all, they may give unlimited growth potential. Well, some of the famous companies, started as microcaps. And, honestly, that is the pure beauty of investing. Finding a small company and watch how it is growing over time. That is the privilege. Your stocks were almost worthless when you bought them but look at them now! You were smart enough to recognize the potential. Great! Small companies have more space to grow. Find the one like this and you will have great returns.

Further, follow the example of Warren Buffett. As a young investor (everyone knows this story) he was buying by the market undervalued stocks. If you are familiar with the efficient market hypothesis, you may think that stocks are fairly valued by the market. Well, they are, theoretically.

But this is not the case in micro-cap investing. Because micro-cap companies are almost unknown and generally below the radar of big investors, you can buy them at a discount. What do you think about this advantage against other investors?

The additional advantage appears here with investing in microcap stocks. Micro-cap companies are very often (when they are successful) acquisition targets. The truth is, the majority of small companies never become corporations because some big sharks bought them. For investors, it is a jackpot.

On the other hand, micro-cap companies are really focused on their long-term outlooks. Their businesses are efficient and sustainable with great growth potential. This feature can serve as a winning acquisition target.

Bottom line

The downside of holding microcap stocks is their selling.

Selling a microcap stock can make you feel like you are doing something illegal. You can meet discrimination and refusals and sometimes it’s so hard for holders to find a buyer.
Microcap stocks, sometimes called penny stocks, trade below $1 per share or in the best scenario up to $5. Their market cap is less than $100 million. But, if you really want to start investing and enter the stock market but don’t have a lot of money, microcap stocks are a great opportunity.
As you can see, microcap stocks offer the potential for a notable upside. It can be a fuel for charging your portfolio. But before you jump in microcap investing, it is important to realize the risks of microcap stock investing.

For the first time, they should be a smaller part of your portfolio due to the risks and volatility.

15th January 2020