About to start a new IRA for me and my wife.

A large chunk of our 2009 income was untaxed (1099 income and poker) so I'm probably going with a traditional IRA to reduce our tax liability now, pending a recommendation from our CPA.

Anyway, is this going to be as easy as just dumping 10k or whatever into Vanguard VFORX (target retirement 2040) -- or is there anything else I should know?

I'm 33 fwiw.

there's a few things going on here. i think the answer to your question though is most readily delivered via example.

Company A has mkt cap of $100. you buy 5 shares of stock at $1/share and own 5% of the company. The company pays no divs and has a (call it mkt cap) growth rate of 1%/year. next year the mkt cap will be $101 and your 5 shares are worth > the $5 you paid for them. This is kind of the logic here. You are buying a share in a business, whose replacement cost is expected to grow over time. Now there is of course the issue of efficiency and in this example if you buy those 5 shares and there is only the next year to consider, the price for those 5 shares would be such that the price at the end of the next year discounted back to the time that you buy the stock will equal the breakeven price.

however, there is one more aspect that is often missed. if the above is how the stock market worked, who would buy stocks? well, nobody who was an even keel between risk loving and risk averse. you're taking on volatility for no expectation. further, the volatility you're taking on provides a functional use to a third party (i.e. the business). As a result, the business (company a) must, on average (i.e. on an average of all companies), pay some excess return above the discounted future price of $5*(1+g) on those shares. Therefore you can expect to have the price appreciation, given the excess returns, adequately compensate you (again on average and over a long enough time horizon) for the risk you have taken on in holding the ownership of that company.

this is why passive investing works (same reasoning for any risky asset. that asset class has to pay more than the discounted value of its current value + growth + divs etc. in order to have people take on the risk of holding that risky asset. otherwise they'd hold their money in risk free assets--> same expectation, less volatility).

Hope this helps,
Barron

in the old school logistics, traders find sellers of X at Price Y and buyers of X at price Z and bring them together. For the convenience of having this match made, the sellers and buyers of X pay a spread (basically a commission) to the trader. Traders are market facilitators for the most part (this is how, for instance, an equity trader works at a bulge bracket bank).

Buy side traders take the decisions made by portfolio managers and do the same thing as above (find sellers/buyers at the cheapest cost/spread/most liquidity/least visibility etc.) except they do it for their own book and are taking on that risk for their firm.

In the first example, the firm takes "no risk" (i put these in quotes b/c sometimes quantities can differ and the firm will hold a position on its books while it finds a seller, typically by COB). In the second, it does take on risk and purposeful exposure.

These are very simplified examples but i think they get the job done.

Barron

How is that different from a broker? Is it the fact that the trader in your example is also providing liquidity (i.e., is willing to be the buyer/seller at times)?

Also, when you say the buy-side trader does it for their own book, what do you mean by their? Do you mean their as in the buy-side firm, or their as in the trader?

And, why does the first firm take no risk, but the second firm does? I don't see where the risk comes in for the second firm?

By the way, thanks for helping me understand this stuff, I really appreciate it.

traders (in this sense) are firm dedicated. brokers keep segregated accounts for each of their clients. brokers are also (mostly) nowhere near as skilled as traders and simply execute orders they are given (i.e. client calls broker and says, "place a limit sell order for BIDU at 508"). brokers get a fee for this (they get paid, say $X/trade or $0.0Y/share). traders make their commissions (for the firm) by earning the spread between what they pay for the security and what they sell it for. And yes you are correct, traders provide liquidity to the market. They typically have the buys/sells be very very close in timing so they take on no risk (or they have both legs locked in before even executing one of them). i.e. risk = chance that the security moves against the trader while the other side of the order is being arranged.

i mean the firm.

first firm does not own the security and thus is not exposed to price changes.

the second firm does own the security. the trader executed the purchase (in this case, assuming it was a long position) at the 'best price' for the firm. owning the security = you are exposed to the price change = risk.

passing the security from participant A --> participant B while earning a spread is a virtually riskless engagement. of course firms will accommodate their best clients and sometimes take large one leg positions and then figure out themselves how to hedge out the risk while they find a suitable buyer for that position.

np. understanding the difference b/w trader and broker though and 'what traders do' is probably way less important than understanding the concept of where excess returns come from, in general.

Barron

Ok, I think I am starting to understand this better. I am going to explain what I think is going on, and you tell me if I'm more-or-less correct.

Let's say I'm a trader on the sell-side (investment bank). One of our clients calls us up, and wants to sell XYZ at $100 a share. I'm going to try and find a buyer that makes the firm the most money, and the firm will pocket the spread. For example, maybe I know someone who wants to buy the stock at $105 per share, or maybe I expect someone will want to buy the stock at $105 by days-end.

Let's say I'm a trader on the buy-side, specifically at an asset management firm. The portfolio manager decides they want to sell XYZ at $100 a share, so they tell me. Again, just like above, I'm going to try and find a buyer that makes the firm the most money, and the firm will pocket the spread. For example, maybe I know someone who wants to buy the stock at $105 per share, or maybe I expect someone will want to buy the stock at $105 by days-end.

The difference being that in the first case, our clients put in an order to buy/sell, and we're going to try and profit from making this transaction. In the second case, we put in an order to buy/sell, and we're going to try and profit from making this transaction.

Care explaining a little bit?

a few changes but pretty much 'there'... basically clients (the big ones for the sell side) have tons of shares and dont say "sell at this price". they dont give goldman sachs limit orders. they say "get rid of these for me" and goldman basically buys them at some price directly from the client, holds on books until sold or the client 'keeps' the securities in a segregated account and gs sells them as they find buyers. these types of traders spend their time on the phone, finding buyers for large blocks of shares (for equities for example. institutional traders i think are sometimes referred to as "block traders" b/c they try to invisibly unload large blocks of shares either in the mkt or to institutions/other banks trying to buy large blocks of the same shares).

buy side is not the opposite of sell side. in the simplest form, imagine the PM says "our systems say we want to buy $X worth of US tbills at $Y price"...the traders then simply try to find the $X worth at as close to $Y as possible. if the order is large, the PM may not even indicate a price but a range of prices depending on the volume avail in the mkt. they are, in this simple example, just trying to fill an order as cheaply as possible.

a friend of mine at a fund spent literally 3 weeks unloading an insane amt of chinese bonds. all day he'd be on the phone, testing the waters, seeing the demand that was out there and he eventually got them all sold. that's one example of what a trader does (though it was a favor for this large client of the fund's so doesn't really fall into the sell side above nor the buy side here).

buy side doesn't try to "profit" from the transaction via the spread. they try to get/get rid of X at the best price possible w/o having the mkt know what they are doing.

i just meant that you're concentrating your efforts on a concept that isn't nearly as important as the other one you were asking about (important in the grand scheme of things). understanding where excess return comes from is *way* more important, in general, than understanding the difference b/w buy/sell side traders or what a trader does.

Barron

I'm trying to find a site with intraday stock charts going back a few years. any help appreciated

Why can't the market know what they're doing? They are trying to buy/sell shares to others, so people are going to know, right?

Yeah, I definitely agree, and this will probably be my last post on the subject. I'm just curious about so many finance related things (such as, what are the different types of jobs, firms, strategies, etc).

ok so bear in mindthat im a pretty huge newb right now regarding the market, but im trying to just figure out HOW to do stuff. SO, say I wanted to SHORT the financial institutions before the FED announcement coming up, I have $2500 I want to do this with, how do I actually do this. is it easy to do? how big of a swing are you allowed to take shorting, cause I know you buy a contract (s) for much <$2500 right? but can still lose all $2500 through it? am I getting confused :-p ;p. Thanks for any light someone can shed for me.


Also, is shorting fin. institutes and longing gold both in the same direction, or counter-productive?

this is volume based. imagine you have 1/3 of the mkt cap of a stock. if you put in a sell order for any 'reasonable' portion of your position, the mkt can get ahead of you and ensure that you dont get to unload the rest of your position anywhere near that first sale. so these execution traders (at large hedge funds or institutional investment shops like pension funds) do things like spread the orders across many sources, randomly allocate orders across counterparties and time and other actions to reduce the 'visibility' of what they are doing. i mentioned before how it took a friend of mine 3 weeks of non-stop calling to unload a batch of chinese bonds. he could have done it in a day if he didn't care at what price he unloaded them at. this would have cost a TON though.

the more the rest of the mkt knows when you're trying to unload or purchase a large # of shares, the more costly it can be for you.


def. there's too much to tell there though lol. there's TONS of diff jobs at diff firms etc.

Barron

This series of posts were extremely useful, thanks.

"Correct: AIG to sell AIA to Prudential plc for $35.5B - American
International Group (AIG) announced a definitive agreement for the sale of
the AIA Group, Limited, or AIA, to Prudential plc (PUK) for approximately
$35.5B, including approximately $25B in cash, $8.5B in face value of equity
and equity-linked securities, and $2B in face value of preferred stock of
Prudential, subject to closing adjustments."

Whats the difference between an all-stock deal and this kind of offer including securities? Is one more valuable than another? I assume the all cash deal is more valuable but why?

They're worth the same. But in a all cash transaction the selling party gets cash while in an equity transaction the value of the equity can change. We don't know what AIG received but it might simply be debt like equity, some people call them hybrids.

Ah yes, the value of the equity can change, that's it. I assume sometimes recipients of the buying company's shares probably can't sell their shares immediately after receiving them?

It depends. Sometimes they can, sometimes they can't.

But from reading the excerpt I don't even think they will receive common stock.

Poker is my only source of income and I file taxes as an amateur. I don't make that much.
Do I qualify to get any of the 2 forms of IRAs? (traditional and roth)

thank you Brons.

Also, why don't preferred's fluctuate as often as common stock?

"the dividends of preferred stocks are different from and generally greater than those of common stock. When you buy a preferred stock, you will have an idea of when to expect a dividend because they are paid at regular intervals. This is not necessarily the case for common stock, as the company's board of directors will decide whether or not to pay out a dividend. Because of this characteristic, preferred stock typically don't fluctuate as often as a company's common stock and can sometimes be classified as a fixed-income security."

Just because preferreds receive dividends at regular intervals doesn't mean that they should not fluctuate as much as common stock right? don't preferreds also represent equity in the company?

I'm not 100% sure about this, but I thought preferred stock also gives you an earlier claim on the assets of the company in case of a bankruptcy.

when do i need to have berkshire hathaway in my own name to attend the shareholder meeting in may? is it too late now?

Imagine you were asked to make an investment in a business venture. But to partake you had to agree to sell 50% of your equity, over time, to another investor. For the sake of argument let's say you had to invest $5,000.

How would you price the 50% stake you were oblidged to sell? For the sake of argument let's say you had an upfront agreement to sell it at equal amounts over 10 months, so 5% per month for 10 months until the share you agreed to sell was gone and the new investor was up to 50% equity.

One way would be to say since you put in $5,000, the new investor has to pay $2,500, or $250 per month to purchase a 50% share. This obviously is irrespective of how the business does. To me that means if the business is not profitable you are going to making out better than the new person since you are selling off shares at no loss and if it is doing well the new person is going to be making out better than you since they are buying shares of a profitable business at the same cost you paid when there was no profit.

The alternative would be to tie the equity stake you have for sale to the profitability. But I am not sure the best metrics to use here and how they should help determine the cost. Any ideas? You can assume for the sake of argument that this is a very simple business where profits (sales - costs) are calculated weekly, so trending the profitability week-by-week is possible if needed to determine the value of equity.

Thanks for any comments.

KJS

Shareholder on record for the fiscal year / 4th quarter report I believe.

Interesting question. I probably don't know the answer, but I'll take a crack at it just for fun.

Are you saying that you'll set up a contract where you agree upfront on the total price for the 50% stake, and then sell off 1/10th of it every month? I guess you could do it that way, but it seems like a weird contract. If you're doing it this way, you may also want to get a premium, so if you invest $5000 you could charge interest (unless maybe by investing $5000 now, you're going to earn some premium off the business anyway).

There's obviously numerous ways to do it. I'm not sure what the best one would be, but here's some ideas.

1. You could try to do it like an option? For a fee, you give the owner the right but not the obligation to buy 50% of the company 10 months for now at some strike price. Not really sure how you'd set the strike price and fee.

2. You could do a discounted cash flow. You'd have to forecast what the cash flows from owning 50% of the business would be from months 11 and on. And then figure out what that's worth today (i.e., the present value of that stream) and what price you're gonna agree to sell it for. In practice, you'd probably have put together a contract that both parties could agree to ahead of time. For example, if you both think the profits of the first 10 months will have some relationship with profits for months 11 and on, then you could specify that relationship and write a contract based on it. Like maybe you think that profits in the first 10 months will be similar to profits for months 11+, then you could use those as estimates. Or, if you think profits will be higher/lower in months 11+, you could try to specify that with some functional form (like exponential or logarithmic) and write a contract around that. If you have any financial statements for the company, I'd love to take a look at them and see if I could come up with something that you could use since I think this is a pretty interesting problem (assuming this is related to a real investment opportunity).

Edit: I assumed this was a startup. If it's an established business, then I guess you wouldn't necessarily have to use only those 10 months, and go use historical figures.

This is a real opportunity and since you showed some interest I will give you the real facts. I left out details to simplify it and get some responses.

The opportunity is a food cart, in other words a trailer converted into a kitchen that is parked in a downtown area and sells food at lunchtime. Like this..

It would be a start-up, the investment covers the purchase of an existing cart and their lease and all the materials to get it prepped and ready for business.

In fact, my investment is only a 50% stake itself. The $5000 figure for my share was accurate. An existing restauranteur is the other partner. My friend wanted to do it herself but doesn't have the capital, so she wants me to put up a 50% stake with the promise to sell her half of my equity. I think it is a good opportunity due to the location and the know-how and experience of the restauranteur. As an anecdote, one of the carts in the same area sells $700 per day on a good day. Carts in this area are only open weekdays 10-3. Also the cart itself has some concrete value and can be re-sold if we totally fail, so I don't see losing my whole investment.

So I am promising to give up shares of my equity to get involved. I am OK with that because I think I can gain some income at both a 50% level and a 25% level. I just want to make sure that the exchange I agree to with my friends is fair for both she and I.

The root of all issues comes down to the changing value of the business over the time which it takes for my friend to purchase her whole equity share. As I said in my OP, it doesn't seem right to say her first share, bought when maybe we have only been open a week and have no idea how we are going to do, is worth the same as a share she buys months later when she knows we are banking $3,000 per month in profits. Obviously they mean different things to me since I am losing shares in that profit. Conversely, if we are tanking my friend can just stop buying shares, putting added risk on me at no cost to herself. That is obviously bad and should be avoided.

I am starting to think of this more as a loan and less as selling shares in a business the more I write about it. Which makes me think we should just draw it up that way. That way she is in on the risk and reward from the outset and just paying me for helping her get involved on the ground floor.

Another idea I had is that my friend is going to work at the cart for a wage. I thought perhaps we could structure her wage as such that it is part cash, part equity. That way her investment is more guaranteed to be forthcoming.

Since this is a small investment we can be creative. I am new at all of this so the best way to do it is not obvious to me. Thanks for taking the time to respond.

I see. I guess it is a lot like a loan. You might just want to charge an interest rate, one that takes into account two factors: risk and the time value of money. Once you determine an appropriate interest rate, you can sell it, or offer it as compensation.