Why do stock-market contests continue to exist? I even had them in my high school Economics class, as if they were a useful learning tool. The goal is always to have the most money within just a few months. Since it’s always done with fake money, there is no punishment (like say, poverty?) if you lose everything. Only the top 0.01% win, and the rest lose. How is this applicable to real life at all?

I was reminded by how much I dislike such fake contests when I read about how CNBC’s Million Dollar Portfolio Challenge ended with a whimper. A quiet announcement revealed that waitress who’d never owned any stock before beat out 377,000 other participants to win the $1 million prize. But what got the most attention was the fact that people figured out a loophole in the system (being able to trade after the markets had closed) and cheated their way to great gains.

What have I actually learned? First,such short-term stock picking contests are about luck, not skill. A slot machine pull would be both faster and easier. Second, there will always be people trying to cheat the system, and many will get away with it. I find it very hard to believe that the SEC catches the majority of insider trading or other short-term manipulations of the market (you know, like Mad Money guy Jim Cramer used to do.)

I continue to ignore short-term variations of the real stock market as a result, and I often urge my family and friends to do the same. It feels like a lost cause though, as watching stock market gyrations has become America’s new favorite pastime and water-cooler material.

Added: The Motley Fool also has a nicely written article on what they term the CNBC’s “Portfolio Challenge” Fallacy.

While I’m back home, my parents took the opportunity to transfer possession of some family gifts. Included in them were two one-ounce 24 karat gold bars. I don’t know much about them, except one was given to me when I was born and the other when I graduated high school. The have the words “Swiss Bank Corporation” (now UBS) and a serial number on one side, and here is a picture of the other side:

At about $650 per ounce, my two ounces would be worth $1300, or about 1.6% of my current investment portfolio. Some sources indicate I may even be able to charge a slight premium for my minted bars. In truth, I’m probably going to end up passing them along to future generations. Is it okay for me to just store these in safety deposit boxes?

I know there is heavy debate in this area, but I personally have no plans to buy any more gold. This is not to say they can’t be a useful part of a portfolio, but I’m still not really convinced of the long-term utility of buying any inanimate objects, including other precious metals and commodities. I’m keeping an open mind, however, if people want to make reasoned arguments either way.

If you are into Modern Portfolio Theory and mean-variance optimization, you might be interested in this Efficient Frontier article on gold:

Make no mistake about it: over the very long term, precious metals equity should provide your portfolio with a mean-variance boost. Just be sure that you?re prepared for the long term?the very long term?behavior of this asset class.

Months ago I did a review of Prosper, a website which allows you to earn interest by lending money directly to others (Prosper takes a small cut). After looking at the mechanics of their system as well as their own historical loan data, the main conclusions from my initial review were:

1. You should avoid loans from those with poor credit rated E and HR like the plague, as they have negative annual returns ranging from -10% to -30% annually. Prosper lenders as a whole priced this subprime market very poorly.
2. If you stick exclusively to the borrowers with the best credit score (rated AA and A), manage your cash carefully, and the default rates don?t keep rising, you may achieve average net returns of about 8% annually.

A key part of that last sentence is if the default rates don?t keep rising. Sure the initial interest rate may be a snazzy 10-12%, but these loans are all three years in length, and my theory was that as time goes on more and more people will default on these loans. Or maybe some will vary between being late and becoming current again, so that the return stays pretty constant. Now that there is more history in their database, I decided to run some number to test this theory out.

As in my original review, I took all the loans that originated in the first half of 2006. Then, I looked at the ROI (average annual return after taking into account defaults and Prosper fees) as observed on different dates ranging from October 2006 to June 2007. Here are the results:

Summary
It would appear that there is indeed a gradual “decay” of annual returns, with the rate of decay increasing as you drop into the lower credit grades. Although this is not conclusive evidence, it is something to consider if you are expecting a certain level of performance. If I were to lend on Prosper, I would stick exclusively to the AA-rated loans.

Even with AA-rated loans, right now we are less than halfway done with these loans. If these trends continue, by the end of the 3-year term, I expect the average net return to be about 7.6-7.8% annually. Again, this is an average value, and one would still need enough money spread across a number of loans to protect from individual loan risk. 7.7% actually isn’t bad, and is almost enough to make me commit some money to this if the spread above FDIC-insured equivalents remains high enough. I’m currently remaining on the sidelines until I see how the marketplace responds to any federal interest rate hikes.

I’ve been toying again recently with the core and explore idea of putting a few thousand dollars into my Zecco account and testing out some active trading theories like options, swing-trading, technical analysis, fundamental analysis, whatever. I finally feel like I have a large enough portfolio that a thousand dollars is only a few percent of the total.

The money is already there, I just haven’t pulled the trigger yet. Now, I don’t have better than a 50/50 chance of beating the market, but I do think it would be fun to try and I could learn some things along the way. Does anyone else have a similar account?

In addition, I’ll be openly sharing all of my trades, and keeping track of my performance very carefully. That’s what I’ve always wanted – to actually see people who actively trade reveal their true performance. (And mock them – like you’ll be able to do to me! 😀 )

John (Jack) Bogle is both the founder of the low-cost mutual fund company Vanguard and the creator of the first index fund available to the public. These days he spends his time speaking about corporate ethics and how index funds are great investments for the vast majority of people. But what does he invest in?

According to this Morningstar article An Inside Look at Jack Bogle’s Portfolio, the answers may surprise you.

Overall Asset Allocation?

“My current asset allocation overall is about 60% bonds and 40% stocks. There’s a fair amount of money involved here, and I feel no need whatsoever to overdo equities. After all, if stocks (surprisingly) soar–I’ll do just fine, not in percentage terms but in dollar terms.”

Stocks – Active or Passive? Value or Growth?
The article is a bit cryptic, but by how I interpret it he seems to be split down the middle:

50% Passive – Total Market Index Funds
50% Active – Vanguard Explorer, Wellington, Wellesley Income, and Windsor Funds

So Jack tilts his portfolio to the value side of the style box. That style tends to be more conservative and puts more emphasis on stocks paying dividends.

Bonds
The bonds portion seems to be conservatively invested in 50% Short-Term Bonds and 50% Intermediate-Term Bonds.

Last time we talked to Jack, he had shifted away from long-term bonds and GNMAs. This time, we see that Jack is moving into TIPS (Treasury Inflation Protected Securities). “In fact, the only investment change I’ve made in the past few years is a move of about 6% of combined assets from Vanguard Intermediate-Term Bond Index VBILX to Vanguard Inflation-Protected Securities VAIPX . The latter is essentially a similar index fund, but with a possible advantage if inflation heats up more than the present discount suggests. I probably should have added to my holdings in the inflation-protected fund earlier.”

Even though this article isn’t the reason, I am starting to rethink my bond allocation to add exposure to inflation-indexed bonds. This would provide an additional hedge against some unexpected inflation.

Before anyone uses his portfolio as a model, consider the following:

1. He’s 78 years old (76 at the time of this article), and even though he had a heart transplant, is still working. This guy likes his job.
2. He has enough money that he doesn’t even need to withdraw anything to maintain his lifestyle. I would imagine he’s probably just trying preserve wealth as much as achieve growth.
3. Since he’s the founder of Vanguard, he may have some sentimental or loyalty reasons to hold certain funds, and states as much.

I doubt many people reading this are in a similar situation 😉 Really, the only thing that I can take away from this is that there really is no “perfect” portfolio for everyone. But it certainly satisfied my curiosity; I wish more investment personalities would share their actual portfolios. You can see my imperfect portfolio here. I’m going to attempt to simplify it a bit sometime in the coming months as well.