Saturday, July 26, 2014

bullet-proof investing

the basic idea of bullet-proof investing is to put some money in safe long-term fixed interest instruments and then use the interest that will be paid to you eventually as a budget to play the market now. i get this idea from the wall street journal website: how to build your own annuity

so what the wsj is talking about is:  

  1. buying a 10-year cd. i find that i can buy a 10 year cd in my ira brokerage account at an apr of 3.30% in units as small as $1,000. cd's are fdic insured and are just a notch down from treasuries in terms of safety.  there are issues that one might fuss about, such as early withdrawal penalties, but i plan to scale-in a little at a time so the impact of that is minimal. scaling-in also gives me the ability to take advantage of what i anticipate will be an era of increasing interest rates.
  2. calculate how much interest is thrown-off. there are many online cd interest rate calculators (such as this one) which tell me that, at 3.3% apr, $1,000 will become $1,387 after 10 years. thus, there is a budget of $387 to work with, (which doesn't sound like much but read on...)
  3. buy a broad market index etf or mutual fund. it so turns out that my brokerage offers vanguard's total stock index etf (ticker:vti) on a zero-commission basis. thus, it is totally efficient for me to buy shares in one'sy-two'sy amounts. vti last traded at about $102, so, to be 100% bullet-proof, i would buy 3 shares of vti for every 1k of fixed interest. that way, even if the whole stock market goes to zero, i come away slightly better than break-even.
however, that is over-insurance, imho. really, if the whole stock market goes to zero then it would only be because there was a calamity the likes of which the world has never seen - perhaps not even the us government could survive such a disaster to make good on fdic insurance. 

a more likely bad outcome, one worth protecting against, would be that, perhaps, the market gets chopped in half. so a 95% (about 2 standard deviations) bullet-proof strategy would be to invest twice the interest or $784 or, say, 8 shares of vti. this worst case scenario looks like this: in 10 years $816 invested in vti drops to $408, while the cd matures yielding $387 and i am down only $21. as wsj points out, the more likely outcome would be that vti doubles (a 7.2% apr by the rule of 72) in 10 years and this scenario looks like this: in 10 years $816 becomes $1632 and the cd matures yielding $387 and i am up $1,203, or a gain of about 68%.

for your pup's, maybe they save $100 week from some employment activity in a small brokerage account. after, 10 weeks, they could buy a 10-year cd at the 3.3% rate. then, for the next 8 weeks they buy 1 share of vti per week, commission-free. after 8 weeks of that they switch back to saving cash for the next 10-year cd and so on. 

also, vti is optionable. so once 100 shares are acquired one could then sell call premium to lower the cost basis. it would take only $12,500 of 3.3% cd investment (less at higher rates) to reach this level. furthermore, vti, pays a 1.7% dividend, which might be dripped to produce gains on a generational time-horizon. in any case, after 10 years the cd will roll-over ... lather, rinse, repeat!

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