Friday, August 17, 2018

Small-scale Trading That Works Similar to Income from Real Estate Investing

Part I: Upstream against Currency Devaluation

For all practical purposes, 1964 marks the last year when regular quarters minted in the USA were suitable for value storing by a regular person. 54 years later, in 2018, 1964 Washington silver quarter costs about $3. Isn't it an interesting and dangerous question - to whom  11/12 of the original value was transferred? 
Another important observation is that those- before 1964- folks were paid interest without losing the real value. A modern investor has to operate in the monetary environment constructed to deplete the principal value of a cash account by virtue of the hidden currency devaluation. Let us estimate the rate of USD devaluation using the value of 1964 Washington silver quarter -  (1-x) ^54=1/12.  The answer is x = 0.045. It means that - 

No matter what they say in their official reports, the calculation showed that the value of $1 decreases with the rate of ~4.5% per year.

Now, the formula to calculate the real return on a cash account reads:

Real ROI = (1 - Tax Rate/100) x ROI - Currency Devaluation Rate,

where ROI stands for the return on investment. Say if your tax rate is 25% than Real ROI for the cash account becomes positive if you make > 6% per year.

Part II:  Residential Real Estate Investing. 

Middle-class individuals often choose to invest in real estate as a way to receive interest without losing the real value. For example, currently a 1400 square feet, 2 bedrooms, 2 1/2 bath condo in Miami-Dade, Florida costs ~$200,000. If rented out, such a property generates cash flow of  $1300 rent per month, minus management fee of about  $200-300 per month, and minus property tax which is about $2,000 per year. Altogether it is about 5% ROI per year.

Real ROI = (1 - Tax Rate/100) x (ROI - Depreciation Rate), 

Let us use IRS allowed number, 3.636%, for the depreciation rate. In this case, if your tax rate is 25% than Real ROI in the described above residential property is ~1% per year.  For investors in Miami-Dade residential properties, it means that in 2018 all future rental incomes are nearly priced in the current price. Well, at least the wealth is protected from the silent erosion by $ devaluation. Real Estate Investing in Miami-Dade was way more attractive back in 2010-4 when the same condo yielded between 6 and 4%.

Part III:  Small-scale Stock Investing.

 SP500, Historical data.
Real estate investing is a capital-intensive business while according to some recent publications in media outlets,  many people in the USA have no $500 of free cash. Now let us think of a person who wants to accumulate wealth by small-scale savings while collecting interest. Since this individual has to beat $ devaluation (see Part I), small-scale investing in stocks of a dividend-paying company looks like a natural choice here. This choice, however, creates an additional risk cause a lot of companies tend to lose business and at some point, nearly all of them will go bankrupt.
Thus it is better for our small investor to buy a dividend-paying index fund.  For example, in 2018 before tax SPY pays ~1.8% of interest.  Similar to real estate investing, the chronical problem here is the overstretched valuation of the attractive companies which typically goes hand in hand with debt expansion cycles. A debt expansion cycle is usually followed by a prolonged period of bad ROI. From 1970 to 1980 SP500 dropped from ~$700 to $300 while, for example, WTI oil skyrocketed from $20 to ~$120. It is difficult to predict when and at what price the next top in SP500 will happen, but the phenomenon of lost decades is amply demonstrated by the historical chart of SP500 index.

Part IV:  Small-scale commodity investing.

Commodity investing is another way to fight currency devaluation. Beware that the entry point has to be close enough to the lows of a commodity cycle. Typically a long period of oversupply and of depressed prices is followed by a period when the demand becomes larger than mining supply. The price will stay depressed until the overground stocks are depleted. Usually, there is enough time to gather information and make an investment decision. 

At the beginning of 21st century, the rise of digital photography had eliminated about half of the industrial demand for silver. After it, the investment demand was oversaturated in the bubble of 2011. The price of silver was depressed since then. With the widespread adoption of electronic gadgets the situation has changed and in 2017 for the first time in many years, the total demand for silver is larger than mining supply. Silver ETF, SLV, is an ideal choice for a small-scale commodity investing. Interest can be collected by selling out of the money calls against SLV stocks (SLV has liquid options). At the same time, this approach allows profiting from price appreciation in the rising phase of the mining cycle. That easily beats currency devaluation. Here is an example of value investing in SLV stocks using just $3600.

"In 2018 Uranium supply is getting short, Uranium demand is growing while the number of the active mines is dropping worldwide. When the overground stocks of Uranium will go, the price will explode. Here one can get a solid return on the investment while participating in the liquid market.  Indeed, for the next several years, aggressive trading strategies like stock replacement by debit call spread may yield a spectacular return ...."

Stocks of Uranium ETF, URA, is suitable for small-scale value investing in Uranium market. Again, Call options can be used here to collect interest. Unlike SLV, URA is not a pure commodity ETF. As a collection of mining stocks, this ETF pays quite significant dividends.  

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