You Idiots Deserve To Be Poor

May 25, 2012

"I want to be young, smart and successful! So I'll do it vicariously through these people."

From Bloomberg:

Ryan Cefalu, who lives with his wife and two kids in Baton Rouge, Louisiana, saw in Facebook’s much-anticipated initial public offering a chance to buffer his retirement fund. His expectations fizzled along with the stock within the first minutes of trading.
“It’s disheartening to know that things get over-hyped,” Cefalu, a 34-year-old data-systems manager who spent about $4,000 on the stock, said in an interview.

Let’s assume that quote isn’t taken out of context, although it’s hard to imagine what context it could be taken out of. The most overhyped IPO in history, and Mr. Cefalu is expressing surprise at what, exactly? He’s implying that he bought the stock before it was overhyped, or that said hype has something to do with his losses.

Here’s another fool who deserved to soon be parted from her money:

“I thought it would be fun to get in on the initial frenzy,” said Linda Lantz, an online marketer in Granite Bay, California, who bought 100 shares. “Now it makes me think ‘Oh God, should I bail or is it going to come back?’”

Fun? Where is the fun? Is it inherently “fun” to have a line in your E*Trade account that reads:

100 FB NASDAQ 5-17-2012 $39.84?

If you want fun, go target shooting or buy a kitten. (If you want lots of fun, combine the two.) More to the point, if you’re investing for fun, you’re in even worse shape than a guy who goes into debt to film a movie and then begs for people to cover the expenses.

You invest to make money. Sweet feathery Jesus, how much more obvious a point could this be? Look, we get that an iPad or a Birkin bag conveys something about your status and tells passersby that you want them to think you have disposable income. But Facebook stock? You do know that corporations no longer issue physical certificates, right? You can’t literally show your stock purchase off to people unless, again, you invite them to look at your computer screen while you’re logged into your brokerage account.

Michael McClafferty, a freshman finance major at Michigan State University, saw his “first big investment” turn into a $3,000 loss when he sold the shares at $35.
“I didn’t want to lose more,” McClafferty said. “I didn’t know what to do.”
The 19 year-old student estimates he spent $8,000 more than he wanted to while repeating orders that wouldn’t go through on the first day, and failing to cancel them because of the technical problems.

Anyone want to bet on whether Mr. McClafferty has incurred any student loans? We hope to God that he has rich parents financing the education that he’s getting but that isn’t taking. This would be slightly more forgivable if he were majoring in sociology.

Some out-and-out lying doesn’t hurt, either:

Pat Brogan, a Yahoo! Inc. manager who trades on sites run by E*Trade and Fidelity in her spare time, called the experience of buying Facebook stock the “biggest fiasco” in her 30 years of day trading.

Two points from Ms. Brogan’s debacle. Number 1, no one day-trades for 30 years, for the same reason that no one plays day-Russian Roulette, day-wrestles grizzly bears or day-shoots up heroin for 30 years.

Also, risking your own money in the hopes of returns isn’t something you do “in (your) spare time.” It requires a little more intellectual commitment and wariness than do quilting or playing Gran Turismo 5.

Alright, a 3rd point. What was she expecting? Of the thousands of equities she could have chosen to purchase last week, she picked the one with zero history as a public company. If you’d asked her “Why’d you buy Facebook today, instead of Hewlett-Packard or Time Warner?”, what do you think she would have answered? Or any other sheep who thinks investing is about status and internal feelings of hipness rather than making a mother-loving profit?

Because they thought they could beat the system. They’d be the ones to buy Facebook at (its opening price + x), then sell it hours later at (its opening price + x + y). Which is to say, they had to know they wouldn’t be the absolute first in line, right? And that the people who did get in earlier were entitled to their own profit, right? Still, Ms. Brogan and her compatriots had it all figured out. They’d get in early enough to allow those preceding investors their profit, then enjoy their own as they cashed out to the next round of lemming/piranha hybrids on the horizon.

Oh, who are we (and they) kidding? The day traders and speculators who tried to buy Facebook stock as early as possible would have held onto it had it risen. Fortunately for them, or at least for us, it didn’t.

But no, the alleged “30-year day trader”, the college kid, and the Louisianan looking to settle his retirement in one day know more than the insiders do.

The chance of you purchasing Facebook stock at the appropriate minute on the day of its IPO, then selling it within a day or two at a substantial profit, is nonexistent. First, you don’t know as much as the stock’s underwriters do, and second, if you’re greedy enough to try and time the market like that, you’re not going to be satisfied with a modest $4 or $5 gain. You’ll want that baby to rise to hundreds of dollars a share, just as AOL (now around $28) and Yahoo! ($15 or so) did. Otherwise you’re alleging that the avarice that got you there in the first place can be kept in check at certain points. Come on.

We do way too many sports analogies on this site, but that’s not going to stop us from doing another one. If you sink a half-court shot to win a Kia Sorrento at halftime of an NBA game, even if you hit nothing but net, the home team’s general manager is not going to offer you a contract. Not even at the league minimum. You got lucky. The ability to consistently hit half-court shots is as rare, and as practically useless, as the ability to time when to get into and when to get out of IPOs. We say “practically” useless because you can’t build an offense around 3-point attempts taken 47’ from the basket, any more than you can build an investing strategy around knowing when to board and disembark the IPO train.

Twitterer @DubaiAtNight, who was one of the most insightful commenters on Control Your Cash back when we allowed comments, put it best:

Imagine if had been Koch Industries that went public. (As if. The Koch brothers aren’t stupid.) The biggest private company in the world then opens itself up to general investors, and a combination of nefarious underwriting and technical glitches leads to a bunch of unprepared dilettantes losing their money. The U.S. Senate, the President and the SEC wouldn’t be able to land on Koch management fast enough. The 1%, keeping the 99% down, etc., etc. Meanwhile, if a tousle-headed 20-something with an affinity for hoodies is at the helm, and if the product in question is something commonplace, benign, and beyond most people’s technical understanding, no big deal.

Investing isn’t a freaking game. It can be fun and rewarding, but a) not over the course of an afternoon and b) it takes work. Here, read this and step back from the maelstrom. You can thank us when you’re rich.

Filed Under: Bad Examples, Investments Tagged With: , , , , , ,

Expose Yourself For Fun And Rewards

May 11, 2012

She's smiling because she's AB-. That'll get you $20 a quart.

A company is struggling, and the struggle has no quick resolution. (How) can you profit off this situation?

Case in point, and a real-world example. We needed an polyurethane iPad Smart Cover, which is made by Apple and sells for $40. It’s the only accessory we could find that hit the multiple criteria of a) being made especially for the product it’s supposed to accessorize and b) coming from a trusted manufacturer (Apple itself). There are plenty of knockoffs available, but we’re not interested.

While we’re certain the Smart Cover does what it’s supposed to, we still wanted to take a look at it rather than just read the description on Apple.com. So we headed to Best Buy, America’s dominant electronics retailer since the demise of Circuit City. You can touch and play with the iPad Smart Covers there. We did.

Then we bought one on eBay for $23. With free shipping and no sales tax.

Here’s an immutable law of commerce that we’re already seeing regular examples of and will continue to for the next few years: Businesses that operate as showrooms, rather than as businesses, are at a huge disadvantage. Look at the position retailers such as Circuit City and Borders (and now Best Buy, and others to follow) have put themselves in. You can walk in off the street and examine the merchandise at your leisure. The employees range from obsequious to unobtrusive, but none of them are going to give you the hard sell. (Imagine a car dealership operating the same way. More specifically, imagine walking around the floor looking at new models and responding to every salesperson with “No thanks, I’m just looking.” The car dealership would kick you out within minutes. Maybe electronics retailers and bookstores need to place their staff on commission.)

The old business model isn’t just old, it’s counterproductive. Using a retailer/marketplace like Amazon or eBay, plus the wireless provider of your choice, you can walk into Best Buy, look at the items available, buy them from someplace else, then discreetly leave the store. If you really enjoy irony (as distinguished from coincidence), you can buy the items from Amazon or eBay with a phone that you bought at Best Buy. If you’re feeling really daring, you can do it with a floor model display computer.

There’s no obvious solution to this, either, short of Best Buy drastically lowering its prices. Either that or the company could get out of the retail electronics game, and operate exclusively as a seller and installer of large appliances and car stereos. When Best Buy hires us as consultants, that’s what we’ll suggest. Until then, our ideas are merely opinions.

As a customer, your options are plentiful. As an investor, you can make money here: you just have to be resourceful about it. Imagine a market so relatively free that it lets you sell stuff you don’t own.

BBY seems like a perfect example of something worth selling short. This is vastly different than selling a house short. You borrow the stock, hope it loses value, then buy it, then return it to the lender at the original price.

Sound like too much work? Heck, it’s an opportunity. The holder of BBY obviously thinks it’ll appreciate, so it’s only fair that there be a mechanism for profiting off daring him to be wrong.

The compact explanation is as follows. BBY is currently trading at around $20. Say you borrow $20,000 worth of shares, which you can hopefully figure out is 1000 shares. You wait 3 months, and the price has fallen to $16. You then buy $16,000 worth of shares, sell them to the entity you borrowed the original 1000 shares from, and pocket $4,000 (less borrowing charges.)

But instead of following the predicted downward trend for those 3 months, Best Buy gets a patent for a perpetual motion machine. Or finds an oil patch underneath its corporate headquarters (which would be noteworthy, seeing as it’s in a Minneapolis suburb.) The stock shoots up to $60, and the lender wants his 1000 shares back. That’s going to cost you, Ace. $60,000, to put a nice round number on it. You’ll be out $40,000 for your little exercise in semi-sophisticated trading (again, plus borrowing charges.)

What about the actual specifics of short selling? It starts by opening a margin account. E*Trade*, for instance, will let you open a margin account with a minimum balance of $2000 if you already have a regular account with them. When you use a margin account, you’re borrowing E*Trade’s money. You can’t run away from them if you come up short. They know where you live, and they have your money.

So say BBY falls in value, but not by as much as you’d like. After your arbitrary 3-month period, the borrowed money comes due with the stock sitting at $19.53. How much would you make?

This isn’t hard to figure out, and you can probably do it in your head. $470, right?

Go back and read the post again. From the top. E*Trade (or anyone else, other than a particularly dupable family member) is going to charge you interest. Your net profit for that imperceptible decline in the stock price is 0.

Never make an investment without knowing the interest rate you’ll be charged on any money you borrow.
Never make an investment without knowing the interest rate you’ll be charged on any money you borrow. 
Never make an investment without knowing the interest rate you’ll be charged on any money you borrow.

Should we say it once more, underlining this time, or did you get the message?

Brokerages start with something called the “base rate”. E*Trade set its at 4.14% a couple of years ago, and it’s remained untouched since. If you have half a million dollars in your margin account, you get to borrow money at the base rate. (Put a million in your account, and they’ll take 25 basis points off the base rate.) But the less your ability to repay, the higher the interest rate you’re charged. That’s why unsecured credit cards charge so much, which you shouldn’t be paying interest on anyway. With that $2000 minimum balance in your margin account, you’ll pay a 430-basis-point premium on the money you borrow. 8.44%. You’re almost better off borrowing on that credit card. Almost. Here’s the list of interest rates, segmented by size of account balance:

 

Making money’s a pain, isn’t it? For a beginning-to-intermediate investor, better to find something undervalued and buy it long than search for something overvalued. The worst thing that a stock you perceive to be undervalued can do is fall to 0. A stock that you think is overvalued, but isn’t, can rise so high that you’ll lose your margin account, your house, your 401(k) and the respect of your friends and family. Now, who’s up for some trading?

 

*Technically, the name is supposed to be in all caps. They should consider themselves fortunate that we’re deigning to indulge even one of their typographic fantasies by spelling the company name with an asterisk. The asterisked name spawned an asterisked comment, adding to the confusion, a confusion that this asterisked comment can’t hope to resolve. 

Filed Under: Investments, Making Smart Choices, Net Worth, Personal Finance

Play the Percentages

April 18, 2012

Unemployment line? No, but close enough

 

UPDATE 7:27 pm GMT, April 18: reader Rhett Schexnaydre pointed out that we put a decimal point in the wrong place. We fixed it. Women are right: math is hard!

Last week we good-naturedly ragged on the brilliant PKamp3 at DQYDJ.net (it stands for Don’t Quit Your Day Job). He threw away his usually tight rationality for an afternoon so he could buy…Mega Millions tickets. $60 worth, no less. Best of all, he then blamed it on his wife.

It’s not like PKamp3 was without company. 1.5 billion Mega Millions tickets were sold for the recent record-breaking jackpot. That’s 5 tickets per American, maybe 7 or 8 per American adult. We’d love to know how many people bought tickets (or equivalently, how many tickets the average player bought.) Alas, we can only guess. But at least some smart people are buying 60 tickets at once. Other, less smart people are making 70-mile excursions to wait in line for 4 hours to buy tickets, and it’s probably safe to assume that an irrational lottery ticket buyer isn’t going to burn 5+ hours and maybe $13 worth of gas to buy just a solitary $1 ticket.

The record $462 million Mega Millions jackpot came and went, and today a meager and pathetic $30 million jackpot sits in its place. Clearly $30 million isn’t enough to change the lives of any of the myriads of people who bought tickets for the record jackpot, but are sitting this week’s drawing out.

The point of this post isn’t to decry lottery ticket buyers. We’ve done that repeatedly on this site. Rather it’s to answer what was then a rhetorical question in last week’s Carnival of Wealth – what does the mean lottery prize look like, vis-à-vis the median prize?

Obviously, the expected value of a $1 ticket is somewhere south of $1. But is that enough to say it’s a bad investment?

Say the expected value of a ticket was, for some reason, 10.2 times its price. Maybe whoever’s running the lottery is feeling particularly eleemosynary. By simple measures, an average return of 1020% means that you should invest all your money in lottery tickets. In the long run, you couldn’t help but win.

Okay, but what if that lottery worked as follows?

-only 100 tickets are sold.
-1 ticket wins $102 million.
-99 tickets lose.
-each ticket costs $100,000.

Hold on, soldier. Even though the “expected” value of your ticket is $1,020,000, no one expects to win exactly that much. You’re either going to win $102 million, or nothing. (Keep in mind that winning “nothing” means losing $100,000.)

You can’t just add up the prizes and divide by the tickets sold to estimate how much you’ll win or lose. You have to look at how often particular prizes occur.

So say you bought 175,711,736 tickets for the aforementioned $30 million Mega Millions drawing. In other words, you covered every combination. You’d guarantee yourself a share of the jackpot, but how big a share (and what else)?

 

45 of those tickets will each win a quarter million. So that’s $11,250,000.

255 tickets will each win $10,000. Another $2,550,000.

24,225 tickets will each win $150. Add $3,633,750 to our pot.

208,250 tickets will each win $10, for $2,082,500.

573,750 tickets will each win $7, another $4,016,250.

We’re almost done. Sorry this is so boring. Go ahead and attempt to plow through The Simple Dollar’s latest, and you’ll appreciate how riveting a post this is.

1,249,500 $3 winners total $3,748,500, and 2,349,060 $2 winners add up to $4,698,120.

Cumulative total, $31,979,120 plus the variable jackpot. Call it $30 million, making our total $61,979,120.

Cumulative number of winners? 4,405,086. Remember how many tickets you need to cover the bases? See above.

97.5% of tickets are losers. By extension, 97.5% of lottery players are…well, we don’t call people losers on this site. Retards, maybe. If you finished in the 97th percentile of players, your ticket would return you a payment of 0.

This applies with regard to real investments, too. The science of investment advice hasn’t yet progressed to the point where advisors disclose the likelihood of receiving a particular payout for a stock, although it’d be awesome if they did. (“Your Sprint Nextel stock has a 4.2% chance of closing above $5 by year-end, an 11.9% chance of reaching at least $4, a 43.2% chance of falling below $2, etc.”)

(NB: Why can’t we do this? We have markets for everything from sports wagering to political races. But among securities, we do this for commodities only. Anybody know why we don’t extend it to other investments? That’s a sincere question, not a rhetorical one.)

That being said, the likelihood of a payout is every bit as important as the magnitude of the payout. You can’t explain that concept to someone who plays the lottery every week, or even to someone who’s proud that he has a “system” for winning at blackjack, but the idea is beyond critical for every successful investor. Even if the investment itself is
modest. (If you spend $30,000 on a taco truck, at 4.9% financing, then spend another $5000 modifying it to incorporate a mobile kitchen, not to mention $20 a day in gas, what’s the likelihood of you selling enough tacos to enjoy a 10% annual profit margin? Or a 50% one? If that’s the business you happen to be in, those questions aren’t rhetorical either.)

One thing’s certain, though. Almost any real business you choose to invest in is going to have less than a 97.5% chance of wiping out your investment.

This article is featured in:

**Totally Money Blog Carnival-Big Bang Theory Birthday Edition**

Filed Under: Investments, Math Tagged With: ,
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