End of the Year Summary – 2014

2014 was yet another great year to be an investor.  In a year that never saw a full 10% correction (but came very close once), investors didn’t have to try hard to have a good return for the year.  At 43 years old (maybe half of the way through my working career), I no longer try to beat the major indexes, but still like to compare my results to the S&P 500 as a benchmark of what could have been if I didn’t diversify and actively manage my account.

Based on results published in Yahoo! Finance, I would’ve had a better return if I stuck my full portfolio in a single ETF, such as SPY (13.75% return in 2014), but MDY (8.49%), IWM (2.08%) and BND (5.76%) lagged my 2014 return of 11.41%.  A more reasonable comparison would be to view my actively managed account to a well-balanced, diversified portfolio of index ETFs.  If I wasn’t actively managing my account, I could have split my funds among various low-cost domestic equity index ETFs, foreign index ETFs, a REIT ETF, a bond ETF and cash.

I think an allocation like this would be reasonable for my age and risk tolerance: SPY (20%), MDY (15%), IWM (15%), FEZ (5%), EEM (5%), VNQ (5%), BND (30%) and cash (5%).  A portfolio allocated like this would’ve returned 7.28% in 2014, well below my return of 11.41%.  That’s a difference of 4.13 percentage points or 36% lower.  Of course, it’s not an apples-to-apples comparison since I’ll pay short-term capital gains on my realized gains.  If I account for the 28% hit from taxes (not factoring in any deductions), I’d still be ahead of a buy and hold approach, especially since the theoretical buy and hold gains would still incur a 20% tax whenever I got around to taking the gains.

What could be considered more important than simply looking how I beat a diversified buy and hold portfolio (which is great by itself), is that I ran through 2014 with much less risk.  I was under-invested for most of the year (one of my poor decisions from 2014) and didn’t lose as much during the dips as the indexes did.  Part of my lower volatility came from leaving some cash on the sideline and the rest came from selling out of the money puts.  The premiums I received and the extra cushion from selling out of the money options allowed me to weather the few periods of increased volatility without much worry.  It’s the same approach I’ve followed for years and plan to continue following for years to come.

I ended 2014 with a Net Liquidation Value (NLV) of $111,321.02 and a Net Asset Value (NAV) of $111,452.37 according to Interactive Brokers (IB) after finishing November with an NLV of $110,593.44.  That gave me a gain of $727.58 (~0.65%) on paper for December and a realized gain for the month of $971.30 on only one closing trade.  I received no dividends in December and don’t expect any in January since I don’t have any long positions (not counting my long TLT calls).  Quicken reported that I have $111,452.37, the same as Interactive Brokers.

For the full year, I had a gain of $11,321.02 on paper and a realized gain of $11,161.18.  I’m carrying approximately $3,000 of unrealized gains into 2015, much of which I’ll take this month.  This morning, I initiated my annual withdrawal from my Interactive Brokers account to bring my net liquidation balance back to $100,000 to start the year.  I’ll move these funds to another account I keep at TD Ameritrade that I don’t write about.

I play a game each year of what we could spend these earnings on if I didn’t reinvest.  In 2012, we spent 10 days in Paris.  In 2013, we bought a new car.  In 2014, we didn’t have a fun big expense.  We remodeled our master bathroom due to a leaking shower pan, but these gains didn’t cover much of the costs since we upgraded considerably.  These gains would’ve covered a basic repair job, but that’s not fun.  It looks like we’ll roll these gains into a different family vacation in 2015 and keep the rest invested for future adventures.

If all of my naked puts were assigned, I would be 95.3% invested in this account.  At the end of November, I was invested 5.17 percentage points lower than I am now.  While my allocation increased again, I still left money on the table since most of my naked puts were out of the money and didn’t have a lot of extrinsic value left.  I have some major cleaning up to do in my account in the coming weeks as I take profits and rebalance my account based on the planned reduction in cash I mentioned above.  It’s close to mid-day on the first day of trading in 2015 as I write this and stocks are down, so I don’t have to rush into dumping my out of the money puts, but won’t wait much longer because I still don’t expect a bear market to start in 2015.

This is my asset allocation in my IB account as of the end of 2014:

• Large-cap ETF: 11.23%
• Mid-Cap ETFs: 23.81%
• Small-Cap ETF: 26.59%
• International: 0.0%
• Oil: 0.0% (So happy I abandon this trade before the slide started!)
• Individual Stocks & Other Sector ETFs: 30.09%
• Bonds: 1.37% (based on money at risk from bearish call spread)
• Short ETFs: 0.0%

These are my returns according to Quicken through December 31, 2014:

• 2014 Return: +11.41%
• Realized Gain for 2014: $11,161.18
• Average Annual (not cumulative) Return since November 18, 2009 (when I opened my IB account): +8.42%

According to Morningstar, here’s how I compare to the major indexes (including dividends) through the year’s last trading day, December 31, 2014:

• Dow Jones Return: YTD/1 year change +10.04%
• S&P 500 Return: YTD/1 year change +13.69%
• NASDAQ Composite Return: YTD/1 year change +13.40%
• Russell 2000: YTD/1 year change +4.89%
• S&P Midcap 400: YTD/1 year change +9.77%

The VIX ended the month at 19.20 and the VXN ended at 19.64.  Both of these are up about 5 points (or ~35%) from the end of November.  The increase in volatility will help pump up option prices for those of us rolling positions out from January into later months.

The CBOE SKEW Index finished December at 133.84, close to two points above its November close and still not showing much fear.  When I look at the VIX/VXN and the SKEW together, I see a risk of near-term weakness, but not a high expectation of a major breakdown.