California Institue of Finance (CIF) Blog

California Institute of Finance Alum is Appointed by Governor

CIF Blog — Thu, 16 Feb 2012 19:29:59 +0000

Cecelia Cuevas is a Alumni of California Lutheran University’s “California Institute of Finance’s” Financial Planning MBA program.

California Governor Brown appointment:

M. Cecelia Cuevas of Fillmore has been appointed to the 31st District Agricultural Association, Ventura County Fair Board.

Cuevas has been a senior financial advisor for Merrill Lynch since 2004. She holds a Bachelors of Science degree in Business Administration from the University of Southern California, and a Masters in Business Administration with an emphasis in Financial Planning from California Lutheran University.

In addition she was the director of development and communications for the American Red Cross of Ventura County from 2002 to 2004 and development director for the Coalition to End Domestic and Sexual Violence from 1997 to 2002. She has served as mayor pro-tem for the City of Fillmore from 2006 to 2008 and city council member from 2000 to 2006. Cuevas is the immediate past president of the California Coalition Against Sexual Assault.

Congratulations Cecelia! We are all very proud of you!

Visit our website to learn more about CIF’s Financial Planning MBA.

Day 7

CIF Blog — Thu, 16 Feb 2012 01:13:45 +0000

Friday, February 24, 2012

Morning:

Citicorp Software and Technology Services

Hujiang.com

Zuchongzhi in Shanghai Pudong

Afternoon:

Shanghai Pudong Software Technologies Services Co.

Shanghai Isvision Technologies Co. Ltd.

Guoshoujing Park in Shanghai Pudong Software Park

Day 6

CIF Blog — Thu, 16 Feb 2012 01:10:06 +0000

Thursday, February 23, 2012

Morning: Gaodong Town Government

Afternoon: LEADBANK Private Wealth Management

Day 5

CIF Blog — Thu, 16 Feb 2012 01:09:01 +0000

Wednesday, February 22, 2012

Morning: Jiangsu Ruigang Precision Mechanism

Afternoon: Jiangsu Shangci Group

Day 4

CIF Blog — Thu, 16 Feb 2012 01:07:27 +0000

Tuesday, February 21, 2012

Morning: IBM Engineering Technology

Afternoon: Metso Automation

Day 3

CIF Blog — Thu, 16 Feb 2012 01:06:31 +0000

Monday, February 20, 2012

Morning: Shanghai Wecan Group

Afternoon: Disney China (Disney Stores Shanghai)

Day 2

CIF Blog — Thu, 16 Feb 2012 01:04:23 +0000

Sunday, February 19, 2012

Culture sightseeing

Day 1

CIF Blog — Thu, 16 Feb 2012 01:03:21 +0000

Saturday, February 18, 2012

Making Money, Getting It Right

CIF Blog — Wed, 15 Feb 2012 17:59:35 +0000

This article was written by Dr. Somnath Basu, Director of the California Institute of Finance at California Lutheran University. It originally appeared in the February 2012 edition of FA (Financial Advisor) Online

The greatest fallacy is that you have to find the winners to make money. But really you need to find the winners, losers and sideways movers.
By Somnath Basu

How easy is it to make money? If you immediately answered “not easy,” you must be thinking of the current times. In other eras, when you were flush and heady making money (say, from 2005 to 2007), you may have spontaneously given the opposite answer. The question seems to take on different meanings at different times.

But if you stepped back and looked at the question hard enough, the answer ought to be the same at all times.

Consider the odds of making money in a coin toss game. If you played the game many times, you would almost certainly come away with nothing—you would have played a “fair game.” But then again, entering the game to begin with meant you thought you knew something your opponent didn’t, something that would bowl her over. You thought you had asymmetrical information. Of course, she entered the game with a similar idea. And without this conflict of expectations, the game would never have taken place.

Does such a long-term zero sum game sound too far-fetched? Too much like some academic theory developed in a void? Well, think again. Long-term currency market speculators face scenarios very close to these “fair games,” or gambles, all the time. The proper term for such games in the ivory towers is “martingale” processes.

It is probable that a fair game may produce different results in the short run. For example, in coin toss games, you could encounter winning streaks in heads or tails. If you catch a wave, fortune certainly favors you. It’s the scenario favored by the fantasy in movies about Las Vegas gamblers. But if you were playing such a game in Vegas yourself, i.e. playing against the house, then the fortune would certainly turn to disaster, as the difference in wealth of your opponent would almost certainly lead you to what is known in statistics as “gambler’s ruin.”

At every point in time, we investors face a very similar situation. Consider the first significant outcome of your next investment. You may win, lose or draw. Figure 1 shows these expected outcome possibilities. If these outcomes followed the chance structures of fair games, then we could expect that the chances of winning or losing from the next move would be equal. In other words, assume there is an approximately 50% chance of either winning or losing from the next move in your portfolio. The expected return of 0% could then be translated to a rough rule where the chance of losing may be subtracted from the chance of winning to lead to an expected return. Thus, in a fair game, expected return equals zero as a sum of 50% – 50% = 0%. By the same token, if you could call the outcomes correctly 55% of the time, then you could expect to earn a 10% (55% to 45%) rate. Now, ask yourself this question: How easy (or difficult) is it to make 10%? Even being right just 55% of the time doesn’t sound so easy anymore, does it?

To make money, therefore, the first step is to predict the directional change in your investment correctly. If you can do so, i.e. predict an up, down or a sideways move, and if you can be consistently correct in your predictions about 55% of the time, then you will end up earning 10% over the long term. (The only other way to consistently make 10% is to be Bernie Madoff.) Furthermore, note that being correct in your predictions does not mean finding winners only; it will be equally lucrative to find losers and no-changers. Instead of buying the winning stocks or their call options, you can also short sell the stock or buy put options on them. If you expect no change in the next price movement, you can make money by writing both a put and a call (a short straddle) and you will make money just as you would in the other two scenarios.

The main point to understand is that if you are right (or wrong) in your predictions, then you will make (or lose) money. Making it or losing it hinges solely on whether you are calling the price changes correctly.

So far, we have looked only at the direction of the first price change. Next you predict the magnitude of the coming price change. Figure 2 shows both the direction and magnitude of all possible price changes. In a sense, bringing up the magnitude refines the original prediction in a very precise way by magnifying our money-making possibilities. The better our prediction, the more often (more than 55% of the time) we are right and the higher our expected profits. Being correct implies that we understand which path (in Figure 2) our investment will follow. That is, we must understand the “path dependency.” If we are consistently correct in identifying these paths, then we are one step away from the Midas touch of a Buffett or a Lynch. It does not matter if the predicted magnitude is small or large, but only that such precision in path identification is exploited for unlimited gain.

It is easy enough to see that when one is confident about the direction and magnitude of price changes, then it is much more lucrative to speculate with derivatives than to use the underlying security. In Figure 3 if the expected change is very small, not only could you buy calls (up paths) or puts (down paths), but also sell their opposites. For example, when we expect upward movement, we can also sell (write) puts and use the money earned from writing to buy the calls. In this way, we can speculate at zero cost to create profit schemes (arbitrage) as long as we are sure of our predictions. If we were to be wrong in our predictions, of course, the consequences would be dire—dire in that it magnifies the effect of buying losers. So if you are faint of heart about your predictions and expectations, these approaches are not for you. The operations described here are for stronger gutted women and men.

In Figure 3, we reasoned that positive and negative price changes would be close to 50%, but not exactly, since we wanted to leave open the possibility that the next price change has a zero value—in other words, a sideways price movement. If we are superb in our predictions, then writing a put and a call would lead us to profit from the sidewise movement. Figure 4 shows the payoff from such a positional move, the so-called short straddle.

The straddle and the exploitation of a sideways change temporarily closes the discussion about exploiting the first price change. Now consider the second significant price change for your portfolio. Note that from the current perspective, the second price change would imply a total of about five outcomes with nine possible price paths. Figure 5 shows these nine possibilities.

Note the directional changes portrayed in Figure 5. For us to consider volatility, we need at least two significant price changes that are not simply the result of a hit on the bid and offer. Observe that of the nine paths, there are two changes that represent the greatest volatility, four changes of medium volatility and three changes signifying the lowest volatility. This means that volatility is the least common outcome of our predictions, as it should be. At any time, the observations of heightened market volatility in security markets must then imply the dominance of uncommon or tail region outcomes. These conditions exist when we cannot reach the outcomes through more predictable paths, as shown in Figure 6, a tabular version of Figure 5.

Continuing in the same vein, if we introduce the magnitude of changes against these two periods, then we will also specify all possible price paths, illustrated by Figure 7.

Now we are in the realm of the adventurous. There are a few ways in which we can try to identify the most likely path to the most expected outcome. It’s important to note that each price path is equally probable and the sum of all path probabilities must equal one, since one of those paths will be actualized with certainty (i.e., the probability is 1). A second methodology is the Monte Carlo simulation, which tries to ascertain from the nature of the path shapes (statistical distributions) the most likely path with the associated dispersion. If the paths are normally distributed, then there is an expected (mean) path and around that path there is dispersion (with a certain standard deviation) and volatility. If the distribution is non-normal (for example, it’s a chi-square distribution or beta or another one) then the most likely associated outcomes may be in the form of ranges and scales. Now we would need a statistician to interpret their meanings before we could rattle off fancy terms such as “z-stats,” etc. Finally, we can also use mathematics of normal distributions (integration) to arrive at the same calculations, such as Black-Scholes calculations in option pricing. Nonetheless, it is obvious that if we can determine the most likely price paths, we can also reap the maximum benefits.

To summarize, let us now tabulate all possible two-period price paths and look at their speculative trading counterparts for broad path regions. Figure 8 shows these possibilities and their trading solutions. (Note: To reduce option premiums, you may buy options that are out-of-the-money. They work just like deductibles in auto insurance.)

These ideas would likely never be palatable to readers without real life examples. As luck would have it, I came across two articles in the Financial Times of December 12 as I was putting the finishing touches on this article. One, called “Fat-Tail Fears Catch Oil Traders Between $50 and $150 Bets,” by Javier Blas, the commodities editor, offered a perfect illustration. The report starts with the salvo, “Investors and traders are buying large numbers of oil (option) contracts that would profit from a price super-spike—and a collapse.” (I urge my readers to read the entire story.)

If you’re thinking of investing in the ways I’ve described, you might look out for hypothetical events that offer opportunities:

1. A downturn in the U.S. markets with a correction of about 12% in the next three to six months;

2. A European embargo of Iran, which could threaten a spike in oil prices, since much oil is shipped through the Persian Gulf; and

3. A downturn in European markets lead by the FTSE 100 and then the CAC 40 and the DAX. Nothing says we can’t profit from European woes and spats.

Now, form your own expectations and go trade! The only way you’ll lose is if you are wrong. I’ll leave the rest to your imagination. Happy scalping!

Roth vs. traditional IRA: Which is better?

CIF Blog — Tue, 14 Feb 2012 22:18:04 +0000

Steve Vernon is a Research Fellow at California Lutheran University’s “California Institute of Finance”. This article originally appeared in the February 14th edition of Mr. Vernon’s “Retirement” blog on CBS MoneyWatch. It reappears here with Mr. Vernon’s permission.

With tax season upon us, you might be trying to decide whether to contribute to a traditional IRA or a Roth IRA. You have up to your tax filing deadline — April 17 this year — to contribute to an IRA for 2011, and reduce your 2011 taxable income if you use a traditional IRA.

To see which type of IRA might work best for your situation, we’ll need to look at the rules for contributing and withdrawing from each type of IRA. First, let’s look at the key differences between the two types of IRAs:

With a traditional IRA, you reduce your current taxable income by the amount of your contribution, and you aren’t taxed on your investment earnings while your IRA grows. Years later, when you withdraw money from your IRA during retirement, the amount of your withdrawal is counted as taxable income.

With a Roth IRA, it’s the other way around: You don’t get a tax deduction for the amount of your contribution, but you also won’t have to pay income tax on your contribution when you withdraw it after you retire. Like a traditional IRA, your investment earnings from a Roth IRA aren’t taxed while your money grows, but unlike a traditional IRA, you’ll pay no taxes on your investment earnings at all if you’ve had your Roth IRA for at least five years.

As a result of these differences, one of the most important factors to consider when comparing the two IRAs is whether you expect your current marginal income tax rate to be higher or lower than the marginal income tax rate that will apply after you retire and withdraw from your IRA. I should point out that if your current and future marginal tax brackets are equal, there’s no difference mathematically between the two types of IRAs in the amount of after-tax income you’ll receive in retirement.

Here are some other key differences between the two IRAs:

With a traditional IRA, you can’t contribute after you attain age 70-1/2. At that age, you must start making minimum withdrawals or incur substantial penalties. With a Roth IRA, you can contribute at any age, and you’re never required to make minimum withdrawals. So if you’ve attained age 70-1/2, your decision is made for you — you can only contribute to a Roth IRA.
With a traditional IRA, you’ll incur a 10 percent early withdrawal penalty if you withdraw your contributions or investment earnings before age 59-1/2, unless an exception applies. With a Roth IRA, you can withdraw your contributions at any time. There will be a penalty if you withdraw your investment earnings before age 59-1/2, unless an exception applies.

Some of the exceptions for the early withdrawal penalty include withdrawals to help first-time home buyers or pay for college education, or in the event of permanent disability.

Next, let’s discuss applicable limits. With either IRA, the maximum amount you can contribute for 2011 or 2012 is $5,000 if you’re under age 50. If you attained age 50 by the end of 2011, you can contribute $6,000 for 2011. This limit applies to all your contributions to either type of IRA — if you split your IRA contributions between a traditional and Roth IRA, the total amount of your contributions is subject to this limit.

Also, be aware that if you or your spouse are covered by an employer-sponsored retirement plan, you might be limited in your ability to deduct contributions to a traditional IRA, depending on the amount of your adjusted gross income. If neither you nor your spouse are covered by a retirement plan at work, you can deduct your contributions to a traditional IRA, regardless of your income.

The income limits for a Roth IRA aren’t determined by whether you’re covered by a retirement plan at work. The income limits are different for traditional and Roth IRAs, and they get somewhat complicated. Here’s a useful chart that summarizes the rules for both types of IRAs.

Note that in most circumstances, the income limits are higher for Roth IRAs than for traditional IRAs. If your income is above the limit for a traditional IRA but below the limit for a Roth IRA, your decision on which type of IRA you should contribute to is made for you — you’re only eligible for a Roth IRA.

All of the above rules apply to federal income taxes. Most states follow the same rules, but it pays to learn about the rules that apply in your particular state, in the event that they’re different.

Now let’s apply these rules to see which type of IRA makes sense for you. A traditional IRA makes the most sense if you expect your marginal income tax rates to decrease when you retire. This will happen to most people who are currently in their peak earning years. Even if you believe that tax rates will increase to help pay for the federal deficit, there’s still a very good chance that your marginal tax rate will decrease.

Are Roth IRAs and 401(k)s better because tax rates will increase? Don’t count on it
Roth 401(k) vs. traditional 401(k): Which is best for you?

A Roth IRA makes more sense if you think your marginal income tax rates will be higher when you retire compared to today. This can happen for younger people who aren’t yet at their peak earning years or if you’ve had a temporary drop in income. You might also consider contributing to a Roth if you want the flexibility to be able to access your contributions penalty-free before age 59-1/2, say, as an emergency reserve. And a Roth IRA makes sense if you want to keep your IRA growing after age 70-1/2, since you aren’t forced to make withdrawals at that age.

Don’t know what your marginal income tax rates will be when you retire? Still can’t decide? Then consider a form of tax diversification and split your contributions between the two types of IRAs. Whatever you do, don’t let these rules deter you from making any contribution to an IRA. You’ll be better off saving money for your future than just spending it all today.

Visit our website to learn how CIF can help you prepare for the CFP while furthering your education with an MBA in Financial Planning.