Tag: investing

All investing related articles are found here. Educative, informative and written clearly.

What is Alpha in Trading?
What Exactly Is Alpha?

The ability of an investment strategy to beat the market, or its “edge,” is referred to as alpha (α). As a result, alpha is also known as “excess return” or “abnormal rate of return,” which alludes to the assumption that markets are efficient and that there is no way to systematically achieve returns that are higher than the overall market. Alpha is frequently used in conjunction with beta (the Greek letter), which quantifies the overall volatility or risk of the market as a whole, also known as systematic market risk.
- Excess returns earned on an investment over the benchmark return are referred to as alpha.
- Diversification is meant to eliminate unsystematic risk, and active portfolio managers strive to produce alpha in diverse portfolios.
- Because alpha measures a portfolio’s performance against a benchmark, it’s commonly thought of as the value that a portfolio manager adds to or subtracts from a fund’s return.
To put it another way, alpha is the return on an investment that is not influenced by broader market movements. As a result, an alpha of zero means that the portfolio or fund is perfectly mirroring the benchmark index and that the manager has contributed or lost no additional value over the general market.

Advantages of Alpha

Fund managers can use alpha to get a sense of how their portfolios are doing in comparison to the rest of the market. Alpha can be a useful tool in trading and investing for determining market entry and exit opportunities.

The disadvantages of alpha

The drawbacks of using alpha as a way to measure returns include that it can’t be used to compare different investment portfolios or asset kinds because it’s limited to stock market investments.

Beta vs. Alpha

To compare and analyze portfolio results, alpha and beta are utilized together. While alpha is a measure of a portfolio’s performance, beta is a measure of its historical volatility – or risk – in comparison to the overall market. For example, a beta of 1.2 indicates that the stock is 20% more volatile than the market.

Conclusion

Alpha is a technical analysis ratio that shows how a stock has performed or given outcomes when compared to a benchmark or market index. The alpha percentage, which is commonly expressed in simple numbers like alpha 4 or 5, or alpha -1, is the amount by which a stock or portfolio has excelled or underperformed its benchmark. A high alpha indicates a strong stock, while a low alpha indicates a bad stock.
2nd September 2021
What is GARP And GARP Investing?

The definition of GARP stock can vary but is based on the P/E to PEG ratio, which divides the P/E ratio by the growth rate.

What is GARP or longer, Growth At a Reasonable Price? Growth at a reasonable price or short GARP is an investment strategy. This strategy unites the principles of both growth and value investing. How does it do that? When you find the companies that have consistent earnings growth but don’t sell at too high valuations. This term was introduced by investor Peter Lynch.

While combining principles of growth investing and value investing it serves traders to pick individual stocks. GARP investors look for companies with steady earnings growth that is higher than market levels. That means they are eliminating companies that have very high valuations. The general goal is to avoid the extremes in any type, growth, and value investing.

GARP investors invest in growth stocks but such that have multiples low price/earnings (P/E) in average market conditions.

What is GARP Investing?

GARP investing or growth at a reasonable price is a combination of value and growth investing, as we said. GARP investors seek companies that are slightly undervalued but with sustainable growth potential. Their criteria are almost the mixture of those that the value and growth investors use. Stable earnings growth is still on top position as one of the most important features but also valuation has a great influence on whether they pick a particular stock or not.

Building such a portfolio that consists of “Growth At a Reasonable Price stock” isn’t just picking the stocks with an equivalent amount of growth and value. The point is to choose the stock that each has qualities of both, value and growth.

Aggressive growth investors never pay too much attention to the value of the stock. Here are some reasons why they should consider the value of the stock. Let’s say that growth investors profiting from stocks with excellent earnings growth. Such companies are beating all earnings estimates all the time. Do they have any guarantee that the companies will resume performing with success and how long? They could make a profit only if the company proceeds to generate high profit and grow constantly. But what will happen if it stops to do so?

Here we have the value in the scene. Value is important to understand the level of investors’ expectations related to the particular stock. Also, value is helpful to gauge how far some growth stock could drop if it starts to sink. To put this simple, value adds a portion of reasonable thoughts and exact estimates into the calculation.

How does GARP work?

A basic formula for finding GARP is the PEG ratio. It is aimed to measure the balance between growth and value. The optimal PEG ratio should be one or under the one.

Here is how it works. Let’s say the company is trading at $50 per share with EPS forecasted to rise for15% over the year.

P/E ratio = $50/$5 = $10
PEG ratio = 10/15 = 0,66

This PEG which is less than 1, makes this company a good candidate for GARP.

Why does Growth At a Reasonable Price matter?

This could be an added explanation of what is GARP. GARP helps investors to avoid the possible problems or traps that they may have with complete investing in growth or value stocks. If growth stocks rise too high they may create a bubble that could burst in a minute. On the other hand, value stocks can stay the same in the price for a long time. With GARP investors could find the golden middle zone. The investment stability where they can benefit from rising prices of growth stocks but, at the same time, they’ll be protected with value stocks if the growth starts to fall.

Some may say that GARP stocks will underperform growth stocks in a growth market. Also, such will notice that GARP stocks will underperform value stocks too but in the value market. Despite these criticisms and objections, GARP could easily outperform in combined markets and could do it over a long time.

What is a GARP strategy?

It is a mixed approach to growth and value stock-picking. This kind of investor obtains a combination of returns. In other words, the GARP investing strategy is hybrid.
In GARP investing it is necessary to look for low price/book ratios and a PEG ratio of less than one, as we said.

P/B ratio = current price/book value per share
PEG ratio = P/E ratio/predicted growth in earnings

We said a GARP investor will obtain a combination of returns. This actually means, when markets are dropping it is better for value investors. Hence, markets are rising. It is better for growth investors. On the other hand, GARP investors could benefit from any market condition because they are somewhere between the mentioned types of investors but unite characteristics of both.

What is it in essence?

Growth At a Reasonable Price investing doesn’t have inflexible limits for adding or eliminating stocks. The basic benchmark is the PEG ratio. The PEG presents the ratio between a company’s valuation (P/E ratio) and its required earnings growth rate for the next several years, for example. If stocks have a PEG of 1 or less, that means the P/E ratio is in line with predicted earnings growth. This helps to find a stock that is trading at a reasonable price.

During a bear market or other declines in stocks, the returns of GARP investors could be higher than the growth investors can get. However, in comparison to the value investors, GARP investors may have average or under average returns. But since GARP investors hold stocks with characteristics of both growth and value stocks, the average returns they get is higher than average returns for growth and value investors can get from their investments separated.

Bottom line

GARP stocks are picked by a joining of earnings growth and valuation when investors want to evaluate the right picks. The idea behind this is to recognize cheap stocks with a growing possibility in the future. Hence, the earnings growth of GARP stocks is notable above that of the market.

GARP is the abbreviation for “growth at a reasonable price” and represents truly a combination of value and growth investing. So, GARP investors seek for a stock that is trading for somewhat less than its predicted value but has earnings growth potential. GARP stocks are slightly lowered but can grow soon. So, what is GARP? It’s all about how to find stocks that have a future.

23rd June 2020
Defensive Stocks Are Excellent Investment But…

Defensive stocks provide dividends and stable earnings but the low volatility may cause fewer gains during bull markets.

By Guy Avtalyon

Several days ago, the website U.S.News posted an article about defensive stocks. As always, great and concrete suggestions. You can find their suggestions with an explanation of why the proposed defensive stocks are best picks for this June.
Here is one quotation about these stocks.

“More conservative investors who value both capital appreciation and preservation of capital might look to these stocks.” was written The U.S. News.

This might mean this kind of stock is less risky than most of the stocks in the market.

Further, in the same article, you’ll find a short description of what criteria investors should use when picking defensive stocks. For example, market capitalizations should be above $50 billion, such companies should have at least a 10-year track of continuous paying dividends, etc. All is followed by the list of these stocks that look like the best choice for June this year.

That simply imposed the topic, what are these stocks. Why buy them? How to choose? Where to look for them?

What are defensive stocks?

A long time ago it would be very easy to answer. You could be easily trapped listening to some financial experts saying how defensive stocks are boring investments. Moreover, you could hear they are too conservative. It might be true, even today. These stocks come into utilities, healthcare, and staples sectors. Well, one could think: Yeah, these sectors are not excited, not at all, so why should I invest there. We would like to ask you something. Would you like to invest in some company that generates steady cash flow, pays dividends regularly? Yes? We didn’t expect any other answer. Would you be surprised if we tell you that, for example, tobacco companies were viewed as defensive stocks?

But recently, investors changed their views of what these stocks are. Today, you can see that some technology companies are considered defensive stocks. Even if the definition is changed, the purpose isn’t, these stocks still have to play well during the recession. Nevertheless, these stocks have, as it always was, to provide stable earnings and regular dividends no matter what condition is the overall market. Period!

Are the defensive stocks less risky?

Since there is a constant demand for such companies’ products, these stocks seem much more steady and strong during many different aspects of the business cycle.

And here is the confusing part for some investors, especially if they are beginners. They aren’t the same as defense stocks. Do you know what we mean? Defense stocks are stocks of the companies that are producing munition, guns, war jets, etc.

Nowadays, companies with stable earnings growth, but also with innovative goods, pricing strength, are recognized as defensive stocks. Don’t be surprised if they can stir the waters. If we consider cash flow and the company’s power, nowadays Alphabet could be such a company, for example.

How to recognize defensive stocks

When uncertain time in the market comes everyone would like to protect the investment portfolio, the capital invested. Especially if it is connected to high volatility. Investors are looking for stable investments during such rough times. They would like, for sure, to increase their exposure to these stocks. For example, giants like Coca-Cola are recognized as defensive stocks. Non-cyclical stocks are recognized as defensive stocks also.

These companies have stable performances and the ability to overcome weak economic circumstances. They are also paying dividends. That might be a good reason to choose them primarily because dividends can mitigate the influence of the stock’s price dropping. These companies will rarely go bankrupt during the market downturn.

When things in the stock market get insecure, why would you like to own any stock? Honestly, you could find more safe places out there to invest in. The answer is profit. Defensive stocks provide a higher dividend yield than you can get with safe-havens. For example, Treasury bills will never provide you such an amount in interest rate. Moreover, defensive stocks mitigate investors’ fears because they aren’t as risky as other stocks. Take a look at what investment managers do when uncertain economic times come. They are moving to defensive stocks.

Better isn’t always the best

Defensive stocks are better performers than the overall market during recessions, for example. But nothing is so perfect even these stocks. Due to their low beta, when everything is blooming in the market, they could perform below the market. Less risk, less profit, that’s it.

For example, suppose a stock has a beta of 0,5 and the market falls for 2% in one week. Not a big deal, you’ll lose 1% of your investment. But what if we have the opposite situation and the price increases 2% in one week? Well, the defensive stock with a beta of 0,5 will increase by only 1%.

Beta shows the stock’s vulnerability or risk. Defensive stocks have beta under 1 which means they are less volatile. A conservative investor, who is, by default, with less risk-tolerance type, will choose defensive stocks that will deliver stable returns.

Advantages and disadvantages of Defensive stocks

They are often suitable for long-term investors because they are less risky than other stocks. These stocks together have a higher Sharpe ratio than the entire stock market. With less risk involved, you could beat the market. What else we need to understand is that defensive stocks are better investment choices than other stocks.

But there are some disadvantages also.

The low volatility of these stocks is one of them. This means smaller gains when the market is bullish. That could be the reason why some investors if not many, don’t like defensive stocks. These stocks usually cannot outperform the market in such a period. So, when investors need them most to profit more, they could betray them. There is one interesting thing about defensive stocks. When the market downturn is finished, some investors move to these stocks, but the truth is they had to do that earlier. After the market downturn is too late. The only thing that investors could catch is a lower rate of return. Think ahead of these stocks.

Why should you choose to invest in them?

For example, you don’t have a decent knowledge of the market condition. Also, if you are the risk-averse type of investor. Seeking for dividend-paying stocks is one of the reasons because these stocks provide regular dividends. Additionally, defensive stocks are a great choice when the markets are volatile.

These stocks managed to perform well even during the recessions. There are some goods that people will always need no matter what the economic situation is. For example, electricity, soap, or gas, everyone would need gas or soap even if the apocalypse is coming.

To summarize, defensive stocks have beta lower than 1, they are less volatile, they provide regular dividends. The main drawback is that they usually couldn’t generate high returns. But during the recession, they are excellent as protection for your other investments. Beta indicates the stock’s vulnerability or risk factor. This kind of stock has beta lesser than 1 which implies that they are less volatile. A conservative investor who is afraid of taking risks can invest in defensive stocks that will give stable returns.
These stocks are also recognized as non-cyclical stocks because they are not deeply associated with the business cycle. Here are a few types of defensive stocks. Such stocks are utilities, consumer staples, healthcare, gas, electricity, pharmaceuticals.

21st June 2020
Goal-based investing – How Does It Work?

By focusing on investment goals, investors can easily define investments’ purpose and intent

In goal-based investing the point is to give your investments a specific goal. It isn’t the same as traditional investing where you can easily allocate the assets in your portfolio and address each of them with a specific goal. Goal-based investing means to have separated portfolios for each of your investment goals. Each of them will carry different risks, investment time horizons. So, you’ll have to adjust all these portfolios toward a particular goal. Here is one example of goal-based investing.

For example, you would like to save for retirement, but at the same time, you want to fund the investment in your life dream vacation. Are these two goals competing? They are coming with different time horizons, also the importance is different. Hence, acceptable risks are different. Investing for a dream vacation will require less time, for example, 1 or 2 years could be quite enough. But, on the other side, investing for retirement will take at least 10 years, for instance. What do we have here? One short-term investment and the other with a longer time horizon.

Using a traditional asset allocation

If we use a traditional asset allocation portfolio to achieve these goals, the short-term investment could influence the risk of the whole portfolio. Moreover, it could be ruling for the entire portfolio. So, to meet your long-term goals could be potentially difficult. And here is one of the advantages of goal-based investing. In conventional investing, investor’s gains and failures are measured against some benchmark index but in goal-based investing your real-life situation is what balances your portfolio. Since you can be focused on one investment goal, you could avoid market noise. What is more important, if the markets are volatile, it is easier to handle these kinds of portfolios.

What is goal-based investing?

Goals-based investing is a strategy that helps investors to meet their personal goals. No matter what they may be. This investing strategy works in an easy and uncomplicated way. Goal-based investing may look like a simple concept, but it is a deviation from the standard risk-tolerance structure. In traditional investing, we can recognize investors based on their risk tolerance as conservative, or aggressive. These differences have important meanings for investment strategy and for risk management.

Well, the risk isn’t just about the volatility of some asset or market. Traditionally, the risk represents the annual volatility or the standard deviation of monthly returns over one year. For example, small-caps have the highest volatility so they are riskier investments. When it comes to a goal-based investor, for some beginners in the market, small-caps might look less risky. Hence, for older investors that are seeking the highest level of sustainable spending, large-caps could be less attractive for this kind of investor.

So, what is riskier is determined by investment and goals.

Based on return expectations, goal-based investing allocates assets to reach financial goals. So, the risk is simply explained without complicated calculations. The risk appears when assets are lacking to meet your goals. For example, retirement investment risk is when investors have to withdraw and sell their investments for everyday life.
Efficient goal-based investing needs a deep understanding of your real financial goals.

The value of goal-based investing

Goal-based investing should cover three practical purposes.

If you choose this strategy you should observe risk not just as volatility, but instead as the possibility of setting your goals. Risk tolerance isn’t abstract. It is linked to your goals, time horizon, and life plane. Based on the risk tolerance you’ll choose the investment approach. For example, an investment portfolio for retirement should consist of investments that are different than for an investor living in retirement.

Ultimately, goal-based investing could improve what has become the traditional strategy for asset allocation. Traditional investing is based on the premise that a portfolio’s value is essentially driven by asset allocation. But some recently done analysis shows that out of the portfolio’s overall return, about half of return is due to asset allocation, and the rest of returns is from goal-based investments.

Is it possible to build an ideal goal-based portfolio?

Modern Portfolio Theory claims that it’s possible. An ideal portfolio should provide you maximum returns by taking on a moderate amount of risk, mainly through diversification.

Goal-based investing isn’t something unknown. It’s actually an advanced version of the way how you manage your family finances. The same as you put money in different envelopes or accounts, you should allocate your investments. For example, if your goal is to save for retirement you’ll probably separate your money in proportion 50:50, half will be for spending, the other half for goal-based investing. But if you are investing for the purpose of a dream vacation, the better choice is to spread your money in proportion, for example, 70:30 where 70% of your money will be used for all your expenses and 30% for your current goal-based investing. It may be trickier if you have several goal-based investments and several portfolios. That would require more work while monitoring each of them.

The good news is that you can find support from professionals. But if you have less than five such portfolios maybe you should dedicate some of your spare time to monitor them. When you decide that a goal-based investing is suitable for you, you can then build the risk-adjusted portfolios to meet each individual goal.

Important to know before investing

Ask yourself some crucial questions for each goal. For example, what is the purpose of the savings? How long do you want to stay invested? Do you plan to put additional amounts in investments? Can you anticipate any need to withdraw your savings before your goal is reached? Will you spend part or the whole amount of your income from the investments during the investment period, or you plan to reinvest it? When you go through all these and many other questions for each goal, you’ll come up with the assets you will invest in.

The benefits of goal-based investing

Maybe the main benefit is that this strategy allows you to know the precise amount that is needed and when is needed to reach your goals. In this way, you’ll be able to determine how much you exactly need to invest. The other benefit is that this kind of investing gives you a better chance to pick the investment product suitable for your goals. You’ll be able to make the proper investment decision without following the crowd. One of the advantages is that you’ll have more investment discipline. The main goal of any investment is to generate returns. When you know how much exactly you invested and compare it with your financial goals, you’re able to get better returns. Maybe you’ll add different assets to meet different goals. This will provide you to diversify your portfolio to reduce the risk. Fewer risks, in this case, means more profits. That may have a great influence on your financial freedom.

System for this kind of investing

When you determine your financial goals, you have to make a clear plan on how to reach them inside the set period. You need to determine the amount of money needed to reach your goal. Pick the assets based on your investment horizon and risk and rate-of-return.
Investing in the right assets is complex and needs in-depth understanding and analytical work. If you want to grow your wealth, you’ll need to hold your investments for a longer period. Never forget the power of compounding. Reinvest your income into the same assets to produce additional returns.

Bottom line

Goal-based investing is an easy way for investors with special goals in mind. It enables investors to set risk preferences for goals of different importance and need, gauging progress, or failures against their goals. Your success isn’t related to any market benchmark index but related to real-life events.
Keep in mind, the circumstances and goals are changing and from time to time you’ll need to revisit them as the markets continue to change, go up and down.

10th June 2020
Pure Play Method In Stock Investing

Pure play method represents an approach practiced to estimate the beta coefficient of a company whose stock is not publicly traded.

What is a Pure Play method in investing? Have you ever heard about this? How do you estimate the companies when you want to invest your money in different stocks? What tools do you use? Do you make your investment decisions by looking at cash flow, dividends, the strength of the company? What are your criteria? Maybe it is easier for you to estimate the company that produces only one single product. If you do the latter mentioned, you already know what is a Pure Play method in investing. But do you know all Pure Play’s performances and risks?

Before we explain them to you we’ll explain what is a Pure Play method.

What is a Pure Play method?

Investors use this method when estimating the beta coefficient of the company whose stock isn’t publicly traded.

A Pure Play company is focused on one type of product. It is different from the companies that are conglomerates, offering many products. Pure Plays are easier for investors to analyze. When investing in Pure Plays you’ll have maximum exposure to a distinct market part. For example, if you want exposure to car makers stocks you might prefer buying Tesla stock. As compared to Yamaha Motor Co.which is engaged not only in making cars but also in many other industries. This company is producing motorcycles, boats, guitars, outboard motors, etc.

A Pure Play method is a procedure that investors use to estimate the beta of such a company. But the Pure Play method is also a way to discover the cost of capital for a product or project that is different from the company’s principal business.

Many companies are pure plays. They are selling or producing one singular kind of product. So, you can understand that this kind of investing can be very risky because if interest in this particular product or service declines even a bit, such a company will be affected negatively. A Pure Play method is helpful to estimate a project’s beta or the risk of a project. For example, a Pure Play company could use this method to identify publically traded companies that are involved in projects similar to the one they want to develop.

Use it to estimate the cost of equity capital of a private company

This involves examining the beta coefficient.

When evaluating a private company’s equity beta coefficient, you’ll need a beta coefficient of a public company. The latter you can calculate when regressing the return on public company’s stock on the appropriate stock index. The resulting calculation is then applied to return the beta coefficient of a private company. Here is how to do that. Let’s mark the private company as P and public company as PB.

In our equitation, we’ll mark debt to equity ratios as DEB and DEPB for the private and public company respectively.

Unlevered Beta of PB = Equity Beta of PB / (1 + DEPB × (1 − Tax RatePB))

Equity Beta P = Unlevered Beta of PB × (1 + DEP × (1 − Tax rate))

Advantages and disadvantages of the Pure Play method

The stock of Pure play company is different than stocks of diversified ones. They are popular among investors who want to make a particular trade on particular products. In short, they are not interested in investing in a company that has different business lines. They found reasons to invest in Pure Play stocks and we’ll try to explain them. Firstly, these stocks are easier to analyze. Also, when you have to analyze a company with diversified businesses and several sources of income, you might have a problem evaluating the strength of the company. Its income is generated from many products, with different profit margins, and could be exposed to different growth benchmarks.

Further, despite the fact that investing in Pure Plays can be riskier, they can be a great opportunity for very high rewards when doing well. Should we mention Tesla? But wait! Pure Play method in investing has its disadvantages too. These companies are not diversified. What will happen if difficult times appear? When the company is focused on just one product and that one isn’t able to generate revenue, the stock price of such a company will drop, sometimes sharply. These companies don’t have other products to balance the poor production. That’s a great problem for investors.

The risk of Pure Play method in investing

First of all, the risk comes from some conditions that may affect the company badly. However, that isn’t the only reason. The additional risk might come from the type of investing style. Here is one example. Let’s assume the growth investors favor some Pure Play company. In periods of the bull market the company will perform well. Even more, its stock could easily outperform the market. But what will happen when the bear market appears? Well, we know that during the bear markets the value investing is a more successful strategy. The consequence is that the Pure Play method will have poor results if growth investors stick with it.

These companies depend on one product or one investing strategy. So they are often followed by higher risk. They are completely the opposite of diversified. However, the higher risk gives greater potential for higher profits. When circumstances are in their favor, Pure Play stocks can grow tremendously since the company is focused on a sole product with full strength.

Reasons to use it in investing

We’ve been writing so many times about the importance of diversification in investing. Also, we pointed out that investing in a single company isn’t always the smartest idea. But when it comes to the Pure Play method in investing, things are a bit different.

There are really a few good reasons to invest in pure plays. Pure Play company is considerably easier to analyze. You have, as an investor, only one type of product or business line to analyze. Moreover, it is easier to understand the cash flow and revenue of one company than it is a case with several. Further, you can with a better result predict how it will perform in the future.

Pure play can be a very attractive investment. These companies work a strictly defined niche market. They are specialized for a particular one. That is a quality per se and could be extremely beneficial for investors.

Bottom line

Pure play is a method used in stock trading and investing. It is all about companies with a focus on a specialized and particular product or service. The “Pure Play method” is also helpful when estimating a project’s beta, or the risk of a project.

8th June 2020
Difference Between CUSIP And ISIN Codes

While the company’s reports may not all be true, nothing can be hidden if you use CUSIP for the US companies and ISIN for international trading.

CUSIP and ISIN codes are some of the most well-known securities identification numbers that are used to trade.

If we have in mind that both are codes used for securities to help settlement and clearing in trading, what is the difference between CUSIP and ISIN?
ISIN stands for International Securities Identification Number, while CUSIP stands for Committee on Uniform Security Identification Purposes. Both are displayed as codes Let’s look at the difference between CUSIP and ISIN.
We already explained in the previous post what CUSIP is, let’s explain what ISIN is to understand the difference between them.

What is ISIN?

It is a security code that consists of 12 alphanumeric characters. ISIN is used almost all over the world, but it is particularly known and used in Europe. So, we said it consists of 12 characters where the first two are the country code. It is followed by 9 alphanumeric characters which are the national security identifier, and we have one more digit, the 12th.

Difference between CUSIP and ISIN

Well, where is the difference between CUSIP and ISIN if both serve to help settlement and clearing in trading securities?

The first difference is that CUSIP, mostly used in the US, North America actually, consists of 9 alphanumeric digits. The first 6 letters outline the issuer, the next two digits represent the issue, the last figure is the check digit.

Both have the same purpose to uniform the identification of securities which are settled and traded.

ISIN is accepted for shares, futures trading, options, derivatives, and debt security that are traded and settled. This code looks something like this: two letters to identify the country, for example, Germany, so they would be GE. The next we have a national security identifier formed of nine digits, for example, “275946739” and as the last but not the least one check digit.

The country code is provided by the International Organization for Standardization or shorter ISO. The National Numbering Agency (NNA) provides the national security identifier for every country in particular.

What is the check digit?

The check digit is received by using the Modulus 10 Double Add Double system. This system converts the letters to numbers by adding their place in the alphabet to nine.

To calculate the check-digit, use the first 11 digits, and start at the last number and go from right to left. Each second digit you should multiply by 2. Letters are converted to numbers. You’ll have a string of digits as a result. All numbers over 9 separate into 2 digits. Add them up. The next step is to subtract from 10 and you’ll have the ISIN check digit.

For example, when the final result is 0, that means the check digit is 0.

Alphabetical letters are transferred to a numeric value. The letter A is 10 and the others are as following:

A = 10; B = 11; C = 12; D = 13; E = 14; F = 15; G = 16; H = 17, etc where Y = 34.

To summarize, convert letters to numbers by using the model above but start from the right last digit, every other digit multiply by 2. Subtract the result from the smallest number ending with 0 to get the check digit.

The check digit for CUSIP is calculated by converting letters to numbers by using their position in the alphabet. Every second digit multiplies by 2 to get the CUSIP check digit.

The importance of these codes to investors

ISIN codes are important for companies that have investors or want to raise the capital. The main purpose of the ISIN code is to clear and settle trades.

Both the ISIN number and the CUSIP number are an official code that is required today. The numbers will help you to identify the security. They are kind of a personal social security number for the companies.

For example, the ISIN number is necessary for cross border trading. Moreover, ISIN code has many purposes.

An ISIN or CUSIP number isn’t a ticker symbol that spots stock at the market. For example, the company may have several ticker symbols. That depends on trading platforms but its securities will have the same ISIN number. ISIN code is required but companies cannot create the ISIN code themselves. When a company wants to have an ISIN number it has to contact the numbering agency, for example, the Association of National Numbering Agencies (ANNA).

How to convert CUSIP to ISIN?

The CUSIP number is entirely included in the ISIN number. The ISIN is a larger code with 2 prefixed letters, for example, the “US” for the United States of America. CUSIP number doesn’t have this prefix because it is entirely a North American identifier.

For example, ISIN US0328974369 is extended from CUSIP 032897436. Keep in mind that this is an imaginary example, and as such not a real example. Let’s go further! You can notice that country code is added on the front of this numeric phrase, and the check digit is at the end. So. we can easily recognize that the issuer is from the US.

Let’s determine the digit at the end. Just a bit of math more.

Let’s convert letters to numbers.

U = 30, S = 28.

So we have

US0328974369 as 30280328974369

The next is to collect odd and even numbers.

30280328974369 = (3, 2, 0, 2, 9, 4, 6); (0, 8, 3, 8, 7, 3, 9)

Now we have to multiply the group containing the rightmost numbers (meaning the FIRST group) by 2:

3×2 + 2×2 + 0x2 + 2×2 + 9×2 + 4×2 + 6×2

which is

6 + 4 + 0 + 4 + (1+8) + 8 + (1+2)

Now, add up the individual digits

6 + 4 + 0 + 4 + (1+8) + 8 + (1+2) + (0 + 8 + 3 + 8 + 7 + 3 + 9) = 72

Then use the 10s modulus of the sum.

Bottom line

The CUSIP number is important to help the settlement and the trading securities. The CUSIP consists of nine characters, with letters and numbers. It is assigned to securities that are traded in the United States and Canada. CUSIP numbers are publicly available.

ISIN Numbers are expanded CUSIP numbers and represent the International Securities Identification Number system.

This is how the international system for the clearance of securities is established. The difference between CUSIP and ISIN is in 3 digits and we showed you what they are and how to calculate them. Both can simplify trading, selling, or buying securities, especially in international investing.

3rd June 2020
The Settlement Period For Stocks – What is T+1, T+2, and T+3 Timeline?

When trading stocks, the settlement refers to the approved, an official shift from the buyers’ account to the sellers’ accounts. This never happens quickly, it will take a few days.

By Guy Avtalyon

The settlement period for stocks means that the trade became official at the end of one, two, or three days. For example, you aren’t an official owner of the stock on the day you bought it, you have to wait for 3 business days while your purchase becomes official, meaning to settle. The settlement period for the stocks refers to a period after the trade date. Terms T+1, T+2, T+3, are broadly used to indicate the settlement period is one, two, or three days after the trade of any type of security is executed.

Today, when almost all trades are done electronically, these terms are used to show that the stock you bought doesn’t yours officially until the third-day from the purchasing day. So, technology does not influence this, it is an exchange rule. To be honest, this is an important rule because it could happen that you bought or sold by mistake or you made some errors, so you’ll need some time to fix that.

Without a doubt, some people buy stocks accidentally, random. Later they would like to cancel their purchases when they notice a mistake or change their mind. In case the trade is a real mistake, both participants are agreed to correct the problem. And they would like to do that at the less cost possible.

Also, there is another group of people in the stock market that don’t want to pay stocks with some weird idea that their buying will be characterized as a mistake if they prolong the time to settle them. In short, they are expecting to obtain these stocks for free. Hence, the settlement period for the stocks is an important period for the sellers or exchanges to clear up such a trade.

The basics of the trade

There are three phases of any trade. First is the execution which is an agreement between buyers and sellers to buy or sell a stock for a specified price. When the buyers and sellers are agreed, the exchange registers the trade on its ticker tape.

The next step or phase is clearing. It is an accounting process. When you bought your stock, meaning the trade is executed, the exchange should send the detailed report to the National Securities Clearing Corporation to verify the accuracy.

The last step is the settlement. On the settlement date, the buyers execute payment for the stock and the sellers deliver it to the buyer. Typically, the settlement period for the stocks happens three days after execution.

Purpose of settlement period for the stocks

The settlement period for the stocks provides both sides of the trade to fulfill their side of the settlement. For example, the buyer will get more time for payment to do, also the seller might need time to fix something, like to deliver the stock certificate. Even today when the whole trading process is done digitally, the trade is official only after the number of days assigned by trade settlement rules. When the last day of the settlement period comes, the buyer becomes the true owner of the stock and registered as that.

What are T+1, T+2, and T+3?

Every time you buy or sell a stock, or some other asset, you’ll have two dates to keep in mind: the date of the transaction and the settlement date. This T refers to the date of the transaction. The figures T+1, T+2, and T+3 point the settlement dates of stock transactions that happen on a day of the transaction plus one, two, or three days

The day of the transaction or the transaction date is the day when you traded a particular stock, no matter if you bought or sold it. For example, you sold your stock on May, 29. That date is the transaction date. and nothing will change it.

The settlement period for the stocks is important for investors interested in companies that are paying dividends. The settlement date can decide which party will receive the dividends. If you are a buyer of the stock, keep in mind to settle the trade before the date of the dividend payment to get the right to receive the dividend.

The end in the settlement period for the stocks, the last day, is the day when the new owner is assigned and the ownership is transferred. The transaction date and settlement date will not occur on the same day. It depends on the type of security.

Consequences during the settlement period for stocks

You have to understand what the two-day settlement period for stocks means. Let’s say you are selling the stock and expect money immediately. That is not going to happen. Yes, you’ll see that money in your brokerage account but it will not be available until the trade settles. Only after the T+3 period, you can withdraw your money.

What could happen if you are the buyer and the stock price dropped during the settlement period? Or you don’t pay in the three days? That will not get you out of the trade and the consequences are serious.

If you do not pay for the stock during the three days, the broker will sell it at any price. So you’ll have to pay for losses and penalties.

Also, selling stock through the 3 days to profit and not paying for the stock is outlawed. It’s a so-called freeriding and refers to cash accounts. It’s better to use a margin account if you trade frequently.

Stockholder of record and dividends

When you buy stocks, you are not the stockholder of record until settlement completes. The investor who purchases stock, for example, two days before a dividend record date will not get the dividend. So you have to buy a stock at least three business days before the record date. In investors’ lingo, such a stock goes “ex-dividend”.

To decide which investor is qualified to get a dividend, the record date is part of a dividend announcement. The amount of the dividend and the payment date are included also. You must own the stock on the record date. Meaning the settlement date must be before or on the record date. The dividend payment date will occur a few days (sometimes a few weeks) after the previous date, the record date.

For example, a company declared a $0.50 dividend payable to stockholders of record as of Jun 4, 2020. To have the right to the dividend, you should buy stock on or before Jun 1, 2020. That is three business days earlier. The following day, Jun 2, is recognized as the ex-dividend date. It will be the first day when the stock will trade without that dividend attributed.

Why the settlement period for stocks is important?

There are several reasons. This rule is important to limit the probability of errors, even today in this digital world. Also, it keeps the markets in order. For example, if the market is in a downturn too long settlement times might cause your failure to pay for your trade. When we have a limited time for the settlement period for stocks, the risk of financial difficulties and losing money is reduced.

29th May 2020
Trading Bonds – How to Start Making Money

A bond is a loan that the bondholder gives to the bond issuer. Governments, corporations, and municipalities issue bonds when they need cash.

Trading bonds may seem unusual and difficult. But it isn’t. Actually, the whole process can be quite simple. Anyone interested in trading bonds shouldn’t have a problem getting started. You can find plenty of opportunities in trading bonds and the bond markets. But some things are special for trading bonds and bond markets. If you are not familiar with them, trading bonds might be very confusing. Honestly, it is important to trade bonds so let’s see how to do that.

First of all, bond markets are much bigger than, for example, stock markets. One of the most important differences between bonds and stocks is that there is no exchange for trading bonds; it is done on the “over-the-counter” market but some kinds of bonds can be traded on exchanges. For example, convertible bonds are possible to trade on exchanges. Actually, trading bonds can happen anywhere where the buyers and sellers can make a deal.

Trading Bonds: The participants in trading

There are two types of participants in trading bonds: bond dealers and bond traders.

Traders can trade bonds among themselves, but trading is customarily done through bond dealers. Well, to be more precise, these places where you can trade bonds are dealers’ bond trading desks. Bond dealers are kind of intersection points. They have all types of connections available. Phones, computers are on their desks. But also, they are connected with some traders whose job is to gather all information about bonds, they are quoting prices for buying or selling bonds. To make the story short, these traders are responsible for creating the market for bonds.

Dealers and traders

Dealers’ job is to provide liquidity for bond traders and make it easier to buy and sell bonds with a limited concession on the price. But they have some other possibilities to take part in trading bonds. Dealers can also trade bonds between each other. Sometimes they do so through bond brokers, meaning anonymously. Dealers make money from the spread between the bonds buying and selling price. This also the way how they can lose money.

Bond trading can be very lucrative. That’s the reason why pension and mutual funds, financial organizations, and also governments are involved in trading bonds. When you have such powerful players in the market, it isn’t surprising that $1 million worth of bonds is small initial capital. The bond markets don’t have any size limit, trades may worth over $1 billion but also $100 million. That isn’t the rule for the institutional markets, there are no size limits for individual traders, also. Their trades are ordinarily below $1 million.

Trading bonds strategies

Trading bonds can be passive or active. Both approaches are legit and can produce you the gains.

You can make money from bonds in two ways. You can invest in them and hold and receive interest payments after the maturity date. It is usually twice per year. That is a passive way of trading bonds.

The other way to make money from bonds is by trading them. You can sell your bonds at a higher price than you bought them. For instance, you bought bonds at a nominal value of $20.000. After some time, their market value increases by 20% and you can sell them at $24.000. You’ll earn $4.000.

Bond laddering is also one of the more active strategies and very convenient to start trading if you hold bonds with different maturity dates. You can use the profit from bonds with shorter maturity dates to buy bonds with longer maturity dates. This is named “income stream” and you don’t need a lot of money to use this strategy. It is pretty much economical and cheap.

Bond swapping is another active approach to trading bonds and very attractive for skilled traders. Where is the catch? Let’s say one of your bonds isn’t a good player and it is more likely a losing one, it’s not going to recover. Traders usually are selling these bonds to get a tax write-off for the loss. The money gained from the selling bond they reinvest in high-yielding bonds. That helps them to build a firm portfolio.

The differences between the trading bonds and investing

In trading bonds you are actually speculating on the price changes during a short period in time. You are buying bonds only when you believe they will increase in price. And vice versa, you are selling them only when you believe their prices will drop. So, your profit is coming from the bonds’ price movements. Trading bonds is also when you use the advantage of leverage. To be honest, that might magnify your profits but also, you may be faced with great losses.

Investing in bonds means that you are holding bonds for a long time. You decided to hold them whatever is happening and you are taking the risk to lose your money if bonds prices decrease. When investing in bonds the profit will come from interest payments. Further, on the maturity date, you will put down the total value of your position.

Should you trade stocks or bonds?

Bonds and stocks are the most traded assets but in different separated markets. When trading stocks, you are actually buying ownership in some companies. When the company or companies are doing well, the value of your shares will grow.
When trade bonds, you are actually lending money to the issuer of the bonds for a fixed period of time. For that you’ll charge interest. Bonds are often seen as safer than stocks. People use them as saving for retirement, for example.
So, trading bonds is an investment strategy. You can use them as we mentioned above, but also, bonds are very useful if you want to diversify your portfolio.

What to look out

Buying bonds can be a difficult path when you aren’t purchasing them right from the underwriter or you are buying used bonds. What to look out, how to know you’re making a good deal?
Look out for the credit rating. It is important to know if the company can pay its bond. Standard and Poor’s and Fitch use a rating system that ranks bonds, the best quality is marked as AAA and the worst as D. Between these two marks you’ll find, in range of quality from good to less good, AA, A, BBB, BB, B, CCC, CC, C bonds.

Further, you’ll need to know the bond duration. That is an indicator of how unstable the bond can be in terms of changes in interest rates. If the duration is longer, that means a higher fluctuation when interest rates shift. The problem is in the nature of the bonds. If interest rates increase, the price of a bond decreases. Also, be careful when buying bonds through the brokerages. They will charge you the fees. Check it before any bond-buying. Use publicly available data on the pricing of bonds, or bonds with equal maturities, interest rates, and credit ratings.

Why trade bonds?

Trading bonds can boost the yield on your portfolio. The yield represents the total return you’ll receive if you keep a bond to its maturity, but you’ll want to maximize it. The point is to sell bonds with lower yield and buying bonds with better. You are selling bonds with low yield and buying another to earn from the spread. For example, you hold a bond that yields 4,75% and you noticed a similar bond but it yields 5,25%. That is 0,50% more. So, you can sell your bond and buy this better yielding one and you’ll have a spread gain – yield pickup of 0.50%.

Credit-upgrade trade is used when a trader assumes that a particular debt problem will be upgraded soon. When an upgrade happens on a bond issuer, the price of the bond will rise and the yield will decline. A credit-upgrade means that the company is marked as less risky. Traders want to catch this expected price increase and buy the bond before the credit upgrade. For this type of trade you’ll need some skills for credit analysis.

You might like to take credit-defense trade.

It is very popular. When uncertainty in the economy and the markets increase, some sectors are weaker to fulfill their debt obligations. If you hold this kind of bond, just take a more defensive position. Pull your money out of that sector, don’t hesitate to get out.

Also, you can trade your bonds to adjust a yield curve and change the duration of the bond portfolio you are holding. In this way, you’ll get an increase or decrease in sensitivity to interest rates, whatever you prefer. Keep in mind that the price of the bond is inversely correlated to the interest rate.

The reason for trade bonds might be the sector-rotation. For example, you want to reallocate your capital to bonds from the sector that is supposed to outperform the industry or some other sector. If you are trading bonds in the same sector, one strategy could be to switch bonds form cyclical to the non-cyclical sector or vice versa.

Bottom line

To trade bonds, you’ll need an account. Choose your bond, when trading bonds, you can buy or sell assets from all over the world.
Now, decide when you would like to open the position. Timing the opening and closing of trades plays the greatest role in how you are successful in the markets.
Open your position by using some online trading platform. Determine how much you want to put on the position and do you want to go short or long. Add stops and limits orders.
If your trade isn’t closed automatically by stops or limits, close it yourself to take profits or cut the losses. To calculate your profit or loss, subtract the opening price of your position from the closing price.

Simple as that.

26th May 2020
Cyclical Or Non-Cyclical Stocks – Where To Invest During A Recession

When we ask ourselves what is a better choice during a recession, cyclical or non-cyclical stocks we have to know, as first, the differences between them.

A recession is not the time to make an experiment with risks on your investments, so why dilemma cyclical or non-cyclical stocks? Well, it isn’t a dilemma for most people. The crucial aspect of an investment strategy during the recession should be to play it safe. This means no one should take the big risks at uncertain times but should find the companies with stable cash flow and low debt. The terms cyclical or non-cyclical show how much a share price is related to the changes in the economy. You, as an investor, cannot control the cycles of the economy, but you can adjust your investment strategy but you first have to understand how the whole economy is connected to your investments.

What are cyclical stocks?

Cyclical stocks have a straight correlation to the economy.

Cyclical stocks represent companies that are very favorable during the times when the economy is doing well. For example, carmakers, restaurants, branded wear makers, travel, construction are that kind of companies. But when times are difficult almost everyone will cut spendings on these products and services. When people stop buying these products, the companies’ revenues will fall for sure. Also, their stock price will fall. If there is a long downturn in the economy, the company will bankrupt or go out of the business.

Having this in mind, you should avoid cyclical stocks when the uncertainty is present in the market or in the economy. For example, during uncertain times such as a recession, you shouldn’t invest in companies that are extremely leveraged or unsafe.

Cyclical goods are not essential things. You are spending money on them less frequently. Your spendings are maybe determined by the season of the year, the current financial situation, and many other factors that can determine when and why you would buy these products and services. They are in the first place on your stop-to-buy list.

The cyclical stock’s prices are affected by economic cycles, for example, recession and recovery. Hence, they will grow and drop depending on shifts in the economic cycle. Very often you can predict these changes and as a responsible investor you will sell or buy the cyclical stock. For instance, furniture manufactures. In periods when the economy is doing well, everyone would like to remodel the house and change the furniture. But when a downturn is in the economy, who will care about buying the new furniture? The buying will drop, hence the stock price will drop along with lower demand.

To know what stock to choose, cyclical or non-cyclical stocks, we also have to know how the non-cyclical stocks perform.

What are non-cyclical stocks?

Non-cyclical stocks generally outperform the market when economic growth decreases. They are profitable no matter what are the trends in the economy. These companies are producing services and goods that we’ll always need. For example, utilities: water, electricity, gas. That is something we will need in any economic condition. These stocks are also called defensive stocks. The reason behind – they can be used to defend the investment portfolio against the consequences of economic downturns. It is always good to invest in these stocks when bad days come. In case of a recession they are safe-haven investments.

For example, toothpaste, shampoo, soap, and detergent. How can we reduce them? There is no way. Who can wait a year or two to wash the dishes?

We already mentioned utilities. These companies are a great example of non-cyclical stocks. We need energy, electricity, water for us and our families. Because of that utility companies increase and do not slip dramatically in any economic circumstances.

The disadvantage of these stocks is that they will never produce huge returns even when the economy is expanding and growing. They are safe investments but their price will never skyrocket or it could happen but rare.

Investing in non-cyclical stocks is a good strategy to avoid losses during the recession. So, cyclical or non-cyclical stocks, where to invest during a recession?

Investment strategy with a mix of stocks

You have several ways to add both cyclical or non-cyclical stocks to your investment portfolio. That can be a mix of bonds, cash, and stocks, but also the mix of growth stocks and value stocks. Another strategy is to add cyclical and non-cyclical stocks to offset changing business cycles.

When the cyclical stock drops in value you’ll have a great defense in non-cyclical stocks. During a downturn economy, cyclical stocks are less valuable and their price starts to move very fast. The truth is that it is moving up and down almost at the same speed and dramatically, within the economic cycle. Non-cyclical stocks never move that fast and radical. We described the fundamental differences but to repeat, non-cyclical stocks are practically immune to economic changes. That is their great advantage. Returns are something else. They are not huge, but these stocks will keep your nose above the water during the recession.

When the markets are growing, a good investment strategy could be to buy cyclical stocks at the beginning of the economic increase. But when you have some assumptions or signals that the recession is possible to come, sell them just before it happens. Sadly, trying to predict a future recession is a lost battle. That is the reason to hold a mix of cyclical and non-cyclical stocks in your portfolio. Why should we even ask or have a dilemma with cyclical or non-cyclical stocks when we should hold them both in our portfolios.

That way, we can provide a well-position to benefit when the economy is expanding. But, at the same time, we will have a shield when the economy takes a turn for the worse.

Where to find cyclical stocks?

Since it isn’t possible to name every cyclical industry (there is not enough room here) we can give you some clues where to look at.

For example, hotels, restaurants, carmakers, airlines, banks. They all have something in common. In periods of strong economies, they are all expanding. People are traveling, need a place for vacations, they want to stay at the hotels, they would like to buy a new car, or rather want to eat in restaurants than at their homes. Also, some high-tech stocks can be cyclical. People really want them in prosperous times. Companies tend to invest money in developing new technology, new products. Startups are growing, also.

Not to forget banks. They are also a good example of cyclical stocks during the growing economy.

Where to find non-cyclical stocks?

These defensive stocks can be found among retailers, utilities. Consumer staples stocks are one of them, also. These stocks have modest growth but they are considered safe investments, that provide stable profits, and are defensive, and dividend-paying stocks. The most important role is that they can outperform the down markets.

These non-cycling companies work in a strong sector, their products are always in demand. We cannot cut our needs for them. They are able to survive great challenges and economic cycles. That’s why they are so much attractive especially during the recession if you add them as defensive stocks to your portfolio.

Strategies to choose the stocks

It is the same as any investing strategy. You have two ways: the top-down or the bottom-up strategy.

The top-down strategy means to observe the economy as a mass and select stocks that will perform well during specific economic conditions. When applying this strategy you must be sure you are well informed about the macroeconomy, that you understand different sectors. You have to recognize how a particular industry will perform during the various business cycles, also when the stock price will rise when it will drop.

For both cyclical or non-cyclical stocks, this top-down strategy is the most suitable.

The bottom-up strategy means you have to look at the stock alone and to decide what stock to buy or sell.

This strategy is a good one when choosing cyclical or non-cyclical stocks only when they are in correlation, meaning the stocks are moving synchronized. For example, the jewelry manufacturer will have a decline in the value during the recession. People will stop buying jewelry. But at the same time, the stock of the electricity provider will perform well. So, keep in mind that you have to have both in your portfolio.

Bottom line

There is no need to ask yourselves what stocks to add to your portfolio, cyclical or non-cyclical stocks. You must hold both of them if you want huge returns and protection during market downturns.

During economic growth cyclical stocks will increase more. Hence, during recessions, people will decrease their spending and will squeeze the budgets. They will continue to buy and spend money only on the goods they really need. So, the companies that have these products will bloom.

25th May 2020
What Is a Good Rate of Return?

The rate of return measures the profit or loss of an investment over a particular time. A good rate of return shows how smart an investor you are.

By Guy Avtalyon

What is a good Rate of Return is the question that many people continually asked, but it is almost impossible to get an answer until we explain what the Rate of Return is. So we have to make this clear before we answer what is a good Rate of Return.

A Rate of Return represents both gains and losses of your investments during a particular period. To know what is the Rate of Return on the investment we have to compare these gains or losses to the cost of our initial investment. RoR is shown in percentages of the initial investment. If the Return of investment is positive, meaning over the zero, we call it the gain. But if it is negative, in the minus area, below the zero, it represents our losses on the investment.

In essence, RoR represents the net gain or loss and can be calculated. When we do that, we are actually looking for the percentage of which the investment was changed from the beginning until the end of a particular period of investing.

To know what is a good Rate of Return let’s see the formula: The formula to calculate the rate of return (RoR) is:

Rate of Return = ((Current investment value – Initial investment value)/Initial investment value)) x 100

Deduct the initial investment value from the current investment value, divide the result by initial value, and multiply by 100.

For stocks and bonds, some dividends should be added. You have to calculate the RoR for stocks a bit differently. Suppose you bought a stock for $100 and hold them, let’s say, 5 years. After 5 years you sold them at $140. Your per share gain would be $40, but you also received dividends for that stock and it was $20 per share. So, your total gain is $60.
The RoR for this stock is $60 per share divided by the initial cost per share which was $100 and multiplied by 100. So, the rate of return on this stock is 60%.

What is a good Rate of Return?

First of all, you must have a realistic expectation of return on your investment, to understand how compounding works, how to calculate it, etc. That is to say, every single percentage that increases in profit can boost your wealth every year. It is all about geometric growth.

So, you know how to calculate the rate of return on investment, but how could you know what is a good rate of return?

There is one interesting rule in investing, everyone who has guts to take more risks will have higher returns.

Stocks are maybe the riskiest investments because you will never have guarantee the company will proceed to work or exist. It could fail quickly in an uncertain environment and leave investors with empty hands. So, as being an investor you have to protect your investments and to reduce the risks. And the best way to do so is to invest in different sectors and different asset classes. In other words, you have to diversify your portfolio. And do it over a longer period, at least five years. That will not provide you the best returns of, for example, 30% but can save you from market crashes.

Keep in mind, the answer to what is the good RoR depends on the market condition. What was good in one period could be a complete disaster during some other. Market standards can change and what was “good” easily can turn into “very bad.”

For example, the S&P 500 has a 7% annual rate of return, if your investment has a 9% rate of return, it is doing better and outperforming the market. Okay, RoR of 9% maybe isn’t what you wanted but still, your head isn’t under the water.

Remember, the rate of return can be negative also.

What a good RoR has to beat?

However, if you are a more aggressive investor you would like the higher RoR. So, let’s see what is a good RoR for more aggressive investors. Let’s find the answer to this eternal question. Don’t be surprised if it is quite simple.

A good rate of return has to beat the market, must beat inflation, taxes, and fees. But, as always, there is another point of view. What is a good rate of return depends on the investment you choose. It isn’t the same for stocks, bonds, or some other asset. Generally speaking, a good rate of return has to beat inflation at least.

We know that the average inflation rate was about 2% per year over the past 10 years. This means that you had to earn 2% or more on your investment to keep your purchasing power and to keep the real value of your investment.
But if you invested in bonds that have 4% annual interest, your RoR will be 2%. Can you see, you have to decrease this annual interest, and for the rate of inflation and you will not have 4%, instead you’ll earn 2% of your initial investment.

What is a good Rate of Return for aggressive investors?

So we come up to value investing which is the best way to make money. It is a simple “buy and sell” strategy. So, you buy a good stock at an excellent price and sell it at a profit. Simple as that. The only thing you should take care of is to figure out what is the right price of a stock, in both situations, when you buy it and when you sell it.

Figuring out the right price for a stock requires you to know how much you want to earn when you sell it. In other words, you have to know how much you would like to earn. For example, an excellent rate of return is 15% per year. It might look like an aggressive approach, but we are talking about more active investors, right?

How can you achieve this?

You’ll have to look for bargains. That will take some time until you find a good stock at a bargain, but it isn’t impossible. Let’s assume you found a stock that produces the rate of return of 15% annually. After taxes and inflation, it will be about 12%. At that rate, you’ll be able to double your purchasing power after a few years and beat the market. That’s the point, that’s your intention, of course. If we know that the lowest rate of return for the stock market is about 7%, this is a really good return.

And as we said before, if you want a higher rate of return you must be ready to take a bigger risk. But we think that repeating average returns over a long period is a better choice. Yes, it’s possible to have the great winnings from time to time, but if you take a look at historical data and your trading journal, you’ll notice that it is followed by poor performances. And it is more likely you’ll have losses than you’ll have profits in the final balance sheet.

Maybe a better way to understand what is a good return is to recognize what the bad RoR is. We explained that a good rate of return is when it beats inflation or it is equal to it. Also, we know that a good RoR of stocks is when it outperforms the benchmark index, for example, the S&P 500 index.

A bad rate of return is when investment returns are under the rate of inflation, or underperforms the benchmark index. No matter if the investment has a positive return, in case it is as described it is recognized as an investment with a bad rate of return. The negative rate of return is useless to talk about. This word ” negative” explains everything.

20th May 2020