Investopedia: Hedge Fund

Hedge Fund

	An aggressively managed portfolio of investments that uses advanced investment strategies such as leverage, long, short and derivative positions in both domestic and international markets with the goal of generating high returns (either in an absolute sense or over a specified market benchmark). Legally, hedge funds are most often set up as private investment partnerships that are open to a limited number of investors and require a very large initial minimum investment. Investments in hedge funds are illiquid as they often require investors keep their money in the fund for at least one year.
	For the most part, hedge funds (unlike mutual funds) are unregulated because they cater to sophisticated investors. In the U.S., laws require that the majority of investors in the fund be accredited. That is, they must earn a minimum amount of money annually and have a net worth of more than $1 million, along with a significant amount of investment knowledge. You can think of hedge funds as mutual funds for the super rich. They are similar to mutual funds in that investments are pooled and professionally managed, but differ in that the fund has far more flexibility in its investment strategies. It is important to note that hedging is actually the practice of attempting to reduce risk, but the goal of most hedge funds is to maximize return on investment. The name is mostly historical, as the first hedge funds tried to hedge against the downside risk of a bear market by shorting the market (mutual funds generally can't enter into short positions as one of their primary goals). Nowadays, hedge funds use dozens of different strategies, so it isn't accurate to say that hedge funds just "hedge risk". In fact, because hedge fund managers make speculative investments, these funds can carry more risk than the overall market.

Why Discount Rate?

when evaluating an investment decision you must discount future cash flows.

you find out how much the cash flows will be from the future and discount them back to present value. why? because instead of putting your money in that investment decision, you could have it somewhere else - gaining interest.

Thomas Nelson Email (book recs)

Hi Devin

I don’t want you to think that I believe stock analysis, selection, and timing are a worthless activity. I just think it’s very hard to use such activities to “achieve consistent above average returns”, as you indicate. For most casual investors (most of us), this pursuit is not likely to obtain these results, and is likely to hurt returns, given the costs of trading. Only those who are full time experts close to the market are likely to achieve the kinds of returns you indicate, and even then it’s hard. Bear in mind one can certainly achieve above average returns by taking on above average risk, but to get higher returns for the same risk is difficult, especially in markets that are deemed semi-strong efficient.

On the issue of “diversified mutual funds”, I would agree that index funds (a subset of diversified mutual funds), are a good way to go for the core portion of a portfolio. These funds are typically no-load and extremely low expense ratios (see Vanguard). You mention SPR, which is an ETF, and that is fine. However, usually it’s cheaper to use the index mutuals than the ETF when you’re making regular periodic investments, because the mutuals have no charge with each investment, while the ETF will have a broker fee each time.

Here are my recommendations for reading:

The Psychology of Investing by John R. Nofsinger

The Little Book of Common Sense Investing by John Bogle

Yes, You Can Time the Market by Ben Stein and Phil DeMuth

Investment Valuation by Aswath Damadaran (a big technical valuation book)

Take care and good luck,

Tom

Investopedia: Alternative Investment

Alternative Investment

	An investment that is not one of the three traditional asset types (stocks, bonds and cash). Most alternative investment assets are held by institutional investors or accredited, high-net-worth individuals because of their complex nature, limited regulations and relative lack of liquidity. Alternative investments include hedge funds, managed futures, real estate, commodities and derivatives contracts.
	Many alternative investments also have high minimum investments and fee structures compared to mutual funds and ETFs. While they are subject to less regulation, they also have less opportunity to publish verifiable performance data and advertise to potential investors. Alternative investments are favored mainly because their returns have a low correlation with those of standard asset classes. Because of this, many large institutional funds such as pensions and private endowments have begun to allocate a small portion (typically less than 10%) of their portfolios to alternative investments such as hedge funds. While the small investor may be shut out of some alternative investment opportunities, real estate and commodities such as precious metals are widely available.

S&P 500: Total and Inflation-Adjusted Historical Returns

because this is just so fundamental.

if the graphs don't fully show up. go here:

http://etf-investing.indicart.com.ar/research/SP500_historical_real_returns.shtml

Historical prices for the Standard & Poor's 500 index can be obtained from websites like Yahoo Finance if we use the ^GSPC ticker, or Google Finance if we use .INX . Yahoo can even graph the series since 1950. Nevertheless, to study the real profitability of stock investments, it is useful to average and graph not just the price, but the effect of dividend distributions and inflation too. That is the purpose of this work.

Total Return

According to Standard & Poor's, the dividend component was responsible for 40% of the total return of the last 80 years of the index. If we are to analyze the historical profitability of stock investments, this portion cannot be neglected. Therefore, it would be interesting to graph and average the total return (meaning the increase in value if all dividends were reinvested) instead of the evolution of just price, as done in the following graph:

The effect of investing $1 in 1950 is shown, in one case with all dividends reinvested (orange curve), in the other without (blue curve). As can be seen, reinvesting all dividends would have produced about 8 times the return. Note that the y-axis is logarithmically scaled, for better appreciation of the earlier trends.

Inflation and Dividend-Distribution Trends

Phrases like "one dollar invested in 1926 would be $3000 today" are often heard regardless of the fact that a 1926 dollar has little relation with a 2007 dollar. To really evaluate how much can be earned through stock investments in a long period of time, it is interesting to have the effect of inflation extracted, by adjusting the intermediate results according to an index such as the Consumer Price Index published by the U.S. Department of Labor.

The following graph shows inflation per year, together with annual dividend distribution rates. Some interesting trends can be seen in both:

Inflation-Adjusted Data

Incorporating inflation data to total returns and relative prices produces the following inflation-adjusted graph of relative prices and total return:

Averages per Decade

The following table shows average annual results for each decade:

	Price Change	Dividend Dist. Rate	Total Return	Inflation	Real Price Change	Real Total Return
1950s	13.2%	5.4%	19.3%	2.2%	10.7%	16.7%
1960s	4.4%	3.3%	7.8%	2.5%	1.8%	5.2%
1970s	1.6%	4.3%	5.8%	7.4%	-5.4%	-1.4%
1980s	12.6%	4.6%	17.3%	5.1%	7.1%	11.6%
1990s	15.3%	2.7%	18.1%	2.9%	12.0%	14.7%
2000-2006	-0.5%	1.6%	1.1%	2.6%	-3.1%	-1.5%
1950-2006	8.0%	3.7%	11.9%	3.8%	4.0%	7.8%

Notes: Figures for dividend distribution rates in the previous table present high uncertainty, of about ±5%. Geometric averages were calculated for price changes, total returns and inflation. Raw data for this work was obtained from the following sources:

quick note on stocks

...because:

1. so many people have heard these terms and don't really know what they mean

2. the words themselves sound confusing, but actually are logical and alot of can be figured out aprioi.



option

a stock option is exactly what it sounds like. you have the option to buy or sell a stock at whatever price you agree upon; you can do this anytime you want during the agreed upon period of time.

margin

buying on 'margin' means that you are buying stock from borrowed money. you must open a 'margin account' to do this.
when you buy with borrowed money your risk and return are amplified.
when you borrow money and the price of your asset goes down, you lose your money as well as money that you had to pay back in the first place. when the price of your asset goes up, you reap gains from money that wasn't yours, but you don't have to pay back all of those gains.

long vs. short
1. buying long is what is normally thought of when purchasing stock.

it refers to buying it in hopes the price appreciates.

2. selling short is sort of the opposite but a little more confusing.

when you "sell short" what you are actually doing is borrowing someone's shares (on margin) and selling them at the market price.

You receive however much money they sold for. then you hope the price drops so you can buy back all those shares at the lower price. and then return the shares to whoever you borrowed from. Your selling price - your buying back price = your profit - not including taxes, fees, etc.



call vs. put

1. call options are the option to buy a certain amount of stocks at a certain price in a given time period. in this case, obviously, you want your security option to appreciate in price, so you can buy it at that established (lower) price - that is your 'option'.


2. put options are the option to sell a certain amount of stocks at a certain price in a given time period. in this case, obviously, you want your security option to drop so you can sell it at that establish (higher) price




i hope that clarifies the normally ambiguous ideas many people hold about some confusing (at first) stock terms.

Investopedia.com Term of the Day

disclaimer: there will not always be a term of the day b/c i will only post the ones i am unfamiliar with and/or feel are good as a refresher

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Term Of The Day: Sweetheart Deal
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A merger, a sale or an agreement in which one party in the
deal presents the other party with very attractive terms and
conditions. The terms of a sweetheart deal are usually so
lucrative that it is difficult to justify turning the offer
down.


Investopedia Says:
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This term can be used to describe a variety of deals, but in
general, a sweetheart deal is a transaction that simply can't
be passed up. For example, a merger may be a sweetheart deal
for the top executives of the target firm because they get
very healthy buyout packages. This kind of sweetheart deal is
usually considered unethical, however, because it may not be
in the best interests of shareholders.