Thank you to everybody who participated in last night’s live Twitter Q&A about The 3% Signal @TheKellyLetter. The following is a recap of the interaction and some further details where I think they’ll help.
@cb12131 asked: “Starting #3Sig in a non-retirement accnt. Is it a bad idea to ignore sell signals for the 1st yr to avoid tax implications?”
I answered: “Don’t ignore sell signals for the first year. Just start the plan. You’ll have to deal with tax consequences eventually, anyway.”
@Axmear asked: “To help with the tax, can I use 2 accts with one sig3 plan? Use roth, stock holder, to sell, reg acct, bond holder, to buy?”
I answered: “Interesting thought! Could work. Be sure to track both as one account somewhere, maybe a spreadsheet, to get the right signal size.”
There is no doubt that the best place to run a 3Sig plan is a tax-advantaged account such as a 401(k), IRA, TSP, or TFSA (Canada). However, even people running it in a regular account can do pretty well by tracking which shares they sell to avoid short-term capital gains, and by the plan’s issuing a sell signal only when the market exceeds more than 3 percent growth in a quarter, which is fairly generous and keeps the frequency of selling manageable. The idea proposed by @Axmear (who, by the way, is Will Axmear of Axmear Family Farm fame) is a good alternative, too. For more on this topic, see “Tax Considerations” on page 168 of the book.
@QuatroWilson asked: “Jason, using closing prices what was the overall annual return from 2000 to mid 2013 using the 3% method (ball park)? Thanks”
I answered: Mark’s plan begun with $10K and adding $13,860 new cash became $237K by end 2013. http://jasonkelly.com/resources/strategies/”
On the same page, I’ll soon show three other competing plans using the same dollar amounts running beside Mark’s plan: dollar-cost averaging into SPY, IJR, and Morningstar medalist actively-managed funds. You’ll be able to follow along as the quarters go by to see how the plans hold up.
@sirnagpal asked: “Read your excellent book. I am in the UK and cannot find a good any good small cap and bond index fund. Advice?”
I answered: “I will create a tipsheet for Canadian, UK, and other foreign investors looking to run the plan in their countries.”
Emphasis on Canadian. I get dozens of emails per week from Canadian investors wanting Canada’s answer to IJR and BND.
@Larry_Rogers asked: “Had great February. $7K ahead before burned for $1500 loss w/ HPQ late — still have it. How do you approach earnings dates?”
I answered: “In #3Sig, they’re irrelevant. They just introduce another fluctuation pressure, and the plan uses all fluctuation.”
“Not necessary for #3Sig. Typical hit/miss with stocks, 50% mistake rate. Some reports send stocks up, others send them down.”
@sawlls asked: “And in general … curious to know what do you think of using leveraged ETFs with #3Sig?”
I answered: “Lev ETFs can work, but need new allocation target, growth target, and sometimes higher frequency. Not as reliable as base 3Sig.”
@CEO_72 asked: “I had thought while reading about leveraged funds. Think I saw that this is discussed with subscribers?”
I answered: “Yes! The letter runs base-case #3Sig in Tier 1, and uses lev ETFs in Tiers 2 and 3 of its portfolio.”
@TheHenriqueF asked: “At quarter end, the qty of an ETF you need to buy(or sell) is not an integral(eg 0.7).Should u round and buy 1 share?”
I answered: “Yes. Using whole share amounts is fine. See page 162 in the #3Sig book.”
@CEO_72 asked: “Hi Jason. For the bond fund, BLV vs BND? BLV offers better yield but fluctuates more. Prefer stability in bond fund?”
I answered: “BND. Avoid long-term bond funds in #3Sig. BND and BIV are best as evergreens in all interest rate environments.”
“For more on this, see page 86 in the #3Sig book.”
@chgopace_jd asked: “I like 3sig on my 401k to start. My 401 has only one small cap fund cost are over 6%. Would it be better to forget 401K?”
I answered: “6%! Are you sure? What’s the fund name/symbol?”
@chgopace_jd: “Empower, our company switches to them end of month, don’t give a tcker symbol.”
I: “Odd. What’s the cheapest stock fund in the plan, and what’s its expense ratio?”
@chgopace_jd: “My bad Jason 6.23 per $1000.00 for a 0.62%..I can do it on 401K.”
I: “That’s more like it, but still high. Try to get under 0.2%.”
@chgopace_jd: “OK, thank you, Large Company stock at 0.19%.”
I: “No problem with that. Good work finding it!”
@gustofson_troy asked: “Using VB for Tier 1. Easier to have dividends sweep into cash vs adding more shares? New shares add to cost basis.”
I answered: “VB is a good choice! I recommend directing all distributions and contributions to the bond fund first, then follow signals.”
@gustofson_troy: “Would be great if you could add total shares of each stock in Tier 3 to the letter. Would help in verification of 3% calcs.”
I: “Thanks for the tip. For now, you can see share quantities on the Tier 3 history page at http://jasonkelly.com/kellyletter/open/.”
@gustofson_troy: “Do you calculate 3% off desired price on limit orders or actual purchase price?”
I: “Desired – the one figured from the signal line. By always using desired prices, catch-ups auto happen in later quarters.”
@ksinghsalaria asked: “I have 20000 and want to start plan. So I put 1/4 money at each buy signal and if there is sell signal, I should sell too?”
I answered: “Yes. Add 1/4 of your cash to the next four buy signals, no matter how small. Follow sells as usual. http://jasonkelly.com/3sig/#comment-154533.”
@ksinghsalaria: “Once money is 401k can’t use it for anything else. If I use external account then Can’t put in 401k.”
I: “You can add cash to a 401(k) from outside. Limits are generous. So, keep bottom-buying outside 401(k). See sidebar p. 260.”
@phillyguy2010 asked: “Have you considered running 3 sig with multiple etfs and one common bond fund?”
I answered: “Yes, but it’s almost never worth the hassle except in short periods, and then getting the right mixture is z-val luck.”
@phillyguy2010: “Thanks. Is there any advantage to running 3 sig with a European small cap etf since European valuations are currently lower?”
I: “Maybe, but isn’t that a typical z-val guessing game? Keep 3Sig as 3Sig. Do other investing elsewhere, if at all.”
@Maggiescotts asked: “Results just as favorable if one does 4 percent 3 times a year verses 3 percent 4 times.”
I answered: “3%/qtr becomes 12.6%/yr, only 12.5%/yr at 4%/tri. Depends on time frame, etc. Easiest is to stick with quarterly plan.”
Thanks, again, everybody!
Look insideThe Kelly Letter
“Tech is 47% of the index … [A]t an average P/E of 21.5, the Nasdaq is still considerably more expensive than the Dow Jones industrial average, the S&P 500, European stocks, emerging market stocks, and the list goes on and on. …
“[T]he Nasdaq Biotech index now trades at P/E of around 50. Meanwhile, many of the Nasdaq’s hottest social and streaming media stocks this year — including Twitter, Netflix — are either profitless or trading at astronomical PE’s.
“And as Fortune magazine recently pointed out in its cover story, The Age of Unicorns, tech entrepreneurs and venture capitalists only seem to get excited these days if they can create startups that are instantly valued at $1 billion or more.
“So how sure are you that the Nasdaq isn’t partying — at least a little — like it’s 1999?”
Z-val definition and more forecasts in The Z-val Zone.
“The Nasdaq closed Monday at 5,008.10. It’s the index’s first taste of the plus-5,000 stratosphere since those heady days of March 2000, when it topped out (on March 10) at 5,048.62. …
“[Is this] the new Nasdaq, nothing like the old? The latter case is what you’ll hear from, well, Nasdaq itself. … The index has only about half as many stocks now as it did in 1999 (about 2,500 versus 4,700), the exchange observed, and on average the companies are about twice the size they were back then. Price/earnings ratios are much, much lower — 152 at the end of 1999 and only 31 at the end of 2013. (Now it’s about 27.) …
“This implies that the Nasdaq has a lot further to go before it runs out of steam, unlike the 5,000-handle Nasdaq of 2000. But there still are glimmers of the frenzy of the past. They’re worth watching very closely. One is that bidding for stocks and companies in particular segments is still euphoric. Slap a ‘social media’ tag on your company, and watch the numbers rise. …
“[I]t’s wise to recall that bubbles, like gamblers’ winning streaks, generally are only visible in the rear-view mirror. The economists Kenneth Rogoff and Carmen Reinhart came to that general conclusion for a 2009 book after studying eight centuries of booms and busts. Their title quoted the claim one always hears about market frenzies, often just before the crash. They called it: ‘This Time is Different.'”
Everybody who’s ever driven past a farmer working in a field knows that farming is hard work. What you might not know is that farm finances are tricky, too. Cash flow varies from one year to the next with crop conditions and commodity price fluctuations. After a good harvest, a farmer might be tempted to overspend on equipment such as tractors and combines in hopes of growing into them, only to find in leaner years that the assets aren’t being fully utilized and are tying up too much capital. As with other businesses, a farmer wants to maximize profits while minimizing costs.
When the hard work of farming is done right and the finances managed wisely, a farm generates profit which the farmer then wants to put to work with the same attention to detail used in operating the farm. Just as with the operations of their farms, farmers want to maximize their investing profits while keeping expenses as low as possible. The last thing a farmer needs is another set of risks to manage and a new set of headaches from the financial markets.
Researching how best to handle his family’s profits led Iowa farmer Will Axmear to buy The Neatest Little Guide to Stock Market Investing in early 2014. He’s the fourth generation to work the land. Will’s great grandfather bought 240 acres for $100 per acre and later sold them to his grandfather for $50 per acre when he got married in 1939. The land looks much the same today as it did back then, except for the addition of hog buildings. The Axmear family grows corn and soybeans; raises hogs; and operates a seed corn harvesting service and a manure-hauling business. Their biggest financial challenge is price fluctuation in the grain market, which produces profits in some years, none in others, and occasional losses.
The Axmear family name has an interesting story. It originated in the 15th century as Eysema in the Friesland province of northwestern Netherlands. In the 16th century, it became Eisma, which means “son of Eisse,” the latter being a Dutch first name. In the early 1800s, an Eisma man immigrated to the United States and worked for the railroads. Family lore has it that a bank clerk consistently misspelled his surname as “Axmear,” and it stuck when the man changed his name to it for ease of collecting pay and managing bank accounts. Following the death of his first wife, the man remarried and migrated west, thereby bringing the Axmear name to the area around Keswick, Iowa, where Will and his family operate their farm.
Will’s father Joe’d (correct spelling, pronounced “Jody”) ran the farm business as a partnership with a family member for many years. He managed the farm while his partner handled the money, which included a stock market portfolio. After dissolving the partnership, Joe’d found himself in charge of a portfolio he knew nothing about. He turned it over to a manager at a financial firm in Cedar Rapids, but the manager quit the business and passed the account to a younger person. This seemed like a perfect opportunity to research others ways to manage the money, and that’s what prompted Will to start reading stock books.
Meanwhile, Joe’d contacted several financial management firms around the country about taking over his sizable portfolio. He received fee quotes ranging from 0.75% to 2.18%. He was leaning toward a firm in California, whose commercial he saw on television, when Will looked more carefully at the existing account and discovered that his dad was overpaying, and getting ready to do so again. Will told Joe’d about The 3% Signal, or 3Sig. He had seen it in action in Tier 1 of The Kelly Letter and read articles about the system in the letter prior to the publication of The 3% Signal book. He told his dad, “It would enable us to manage the portfolio on our own with very little time spent and much lower fees.” Joe’d was interested in this.
Will remembers standing with his dad in a corn field they were harvesting, waiting for trucks to pick up the grain, and explaining how he’d done better by value averaging into and out of a stock than he would have done by just buying and holding it. “It’s like breathing,” he said. “You breathe in and breathe out, no emotion. Neither one is better than the other, just part of the process. It can be the same with stocks. No emotion, just buying and selling in response to the prices.”
This appealed to Joe’d for a couple of reasons. First, he’d always kept the stock market at arm’s length, never losing sleep over it while he focused his energy on running the farm. It wouldn’t be hard to maintain an indifferent treatment of the market after taking over his own account. Second, he wondered how much worse it could be than what he’d already endured. He’d seen business partnerships come and go, bought additional farm acreage that dropped to half the value he’d paid, and suffered a 50% loss in the stock market when professionals were in charge of his portfolio. “I think I take things in stride,” he says when asked how he responds to hardship, and he figured he’d be able to take his own portfolio management in stride, too.
“An investment manager is like a farm manager,” Will told his dad that day in the field, knowing this analogy would strike a chord with Joe’d, who can’t stand farm managers. A farm manager is somebody who’s hired to manage a farm on behalf of its owners or alongside the owners. The manager oversees employees, plans production targets, creates a marketing plan, tracks equipment, and so on — basically runs the business. Based on his own experience and what he’s heard from other farmers, Joe’d thinks such managers are useless because they cost a lot while adding little value to a farm. In some cases, they even worsen the farm’s results.
“Brokers are the same!” Will said. “They’re overpaid for their services, which aren’t anything we can’t do on our own for the same returns or better.”
“That’s absurd,” Joe’d replied. He reiterated, “Farm managers are overpaid for their services.”
“Yep,” said Will, “and so are some investment brokers.” He said The 3% Signal would improve the performance of the Axmear family portfolio and cost far less, “and simplify things,” he added.
This last point was not a small one. Over the years, Joe’d had collected a myriad of positions based on ideas from advisors and the media. He owned shares of Allstate (ALL), Boeing (BA), super market operator Groupe Delhaize (DEG) (owner of the store brands Food Lion, Bottom Dollar Food, and Hannaford in the United States), McDonald’s (MCD), Procter & Gamble (PG), and Wal-Mart (WMT), in addition to a wide assortment of mutual funds ranging from large-company stock funds such as ClearBridge Value (LMVTX), to international stock funds such as American Century International Growth (TWIEX), to hybrids such as Putnam Fund for Growth & Income (PGRWX), and even a sector fund: Invesco Energy (IENAX).
Portfolios like the one Joe’d’s advisors assembled for him are common. American investment accounts are filled with them. The problem with such hodgepodge approaches is that they’re overly diversified, which causes them to lose to a focused stock market fund while charging exorbitant fees. For example, according to Morningstar, over the past ten years ClearBridge Value returned 2.4% annually while the S&P 500 returned 8%. For the service of losing to the unmanaged market, ClearBridge charges an expense ratio of 1.8%. Other funds in Joe’d’s portfolio charge similarly high fees: 1.2% at American Century International Growth, 1.0% at Putnam Growth & Income, and 1.2% at Invesco Energy. On top of these fees, Joe’d paid his advisors, too.
Will wanted to put an end to this. He showed Joe’d how The 3% Signal system works to extract additional profit from the stock market’s most profitable segment, small-company stocks, at a fraction of the expense charged by Joe’d’s current funds. Over the past ten years, for instance, iShares Core S&P Small-Cap (IJR) averaged 9.2% annually while charging well under 0.2%. Its current expense ratio is just 0.12%. The only other fund involved in the signal system is a bond fund for safety and dividend income with a minority of the capital, and such funds are even cheaper. For example, Vanguard Total Bond Market (BND) charges a mere 0.08%. Because The 3% Signal is self-managed with only four check-ins per year, there are no advisor fees, either.
With their research complete and their minds made up, the Axmears declined overtures from other financial management firms in favor of starting their new 3Sig plan at a self-directed brokerage account, which offers free trading of the only two funds their plan will use. Another cost savings!
With their portfolio safely on autopilot toward higher returns at a much lower cost, the Axmears are free to concentrate on what they do best: run the family farm.
“It’s good to check off this part of our financial picture that’s been eating at me,” Joe’d said.
Will nodded. “I’m glad I could help my dad out.”
“Sentiment has rarely been higher … Nothing, it seems, can shake the faith investors have in this market. And that has me worried. …
“US economic data is rolling over … with a variety of data points — from factory orders to retail sales and consumer confidence — recently missing to the downside. On Tuesday, we got soft readings on the housing market via the NAHB housing market index and factory activity via the Empire State Manufacturing Index. …
“This is a dangerous situation, with expectations so high and separated from the situation on the ground that it won’t take much disappointment for reality to come rushing back in. Maybe that’s why the CBOE Volatility Index (VIX), Wall Street’s ‘fear gauge,’ increased 7.6 percent for its first gain in a week.
“How dangerous a situation? How about July/October 2007 dangerous? … Plan accordingly and resist the urge to top-tick this market.”