Optimal Risk Portfolio

            In order to create the best portfolio for each individual client, goals have to be set for the investment. Some clients saving for there retirement in there early thirties will be better off with higher risk to allow the initial capital to grow more as the volatility of the market won't affect there portfolio in the long run. Others closer to retirement need a steadier investment that can provide an income. Bonds are an potential solution to achieve this goal.When investing bonds offer a lower risk investment that isn't as volatile as the stock market. Vanguard offers an ETF of United States investment grade bonds that mimics the entire U.S. bond market. Bonds offer a steadier source of income than stocks, helping investors reach long-term goals. The downside of bond are they don't provide same opportunity for growth as stocks. The BND exchange traded fund has an average annual return of 3.83%

To build the optimal risk portfolio of SPY and BND lets compare 100 portfolios with 0%  BND and 100% SPY all the way to 100% BND and 0% SPY with a risk free rate of 0%. If you refer to my previous article about SPY it is an ETF that mimics the S&P 500 which is made up of 500 U.S.large cap  stocks. Comparing these to large ETFs that mimic the stock and bond market will simplify the comparison instead of complying a portfolio of diversified bonds and stocks. The average monthly return for SPY is 0.75% compared to only 0.29% for BND. SPY offers nearly three times the return. BND offers a standard deviation of .0107 compared to .0425 for SPY displaying that is more consistent result. Correlation coefficient between SPY and BND is -.0002892 displaying there is not a strong correlation between the returns of the two ETFs. The portfolio with the most optimal risk would be 86% BND and 14% SPY. This portfolio provides a return of 36%. While this isn't the allocation with the highest return it has the best return to risk ratio when the risk free rate of 0. When you adjust the risk free rate to that of U.S. Treasuries of 0.1% the optimal portfolio allocation changes to 83% BND and 17% SPY with a return of 38%.

The Sharpe Ratio which measures the excess return of this portfolio accounting for risk is .843 for the year which is good not great. A portfolio with a higher Sharpe ratio is SPLV which is compromised of the 100 stocks in the S&P 500 with the lowest volatility. SPLV has a Sharpe ratio of 1.25, which is 48% better than a portfolio compromised of 83% BND and 17% SPY. The average annual return of SPLV is 12% compared to 13% for SPY during that same time frame. SPLV standard deviation is .025 compared to SPY of .0425 which is why SPLV has provided a greater excess return for the rick taken. SPLV is weighted almost evenly among the 100 least volatile stocks in the S&P 500 and isn't weighted based on market capitalization.

Uncertainty exists with every investment and the possibility of the risk free rate rising needs to be considered. If the rate rises to 1% it will erase the excess return for bonds and you should allocate you portfolio to almost entirely SPY. If the rate rises to 1% I would pick to add a stock that has a negative correlation to BND and SPY because as rates rise there excess return above risk starts to become negative. If you are able to short sell stocks I would short BND ETF as the value of bonds decreases as interest rates rise and the Federal reserve is currently in the process of slowly raising rates to limit inflation.

IRA-SPDR S&P 500 ETF Trust

       Most Americans don't think they have enough saved for retirement, either they started to late or don't know of different investing opportunities out there. Thanks to the invention of exchange traded funds ordinary people can acquire extraordinary wealth in retirement by saving just $500 a month and watching their money multiply, they can become millionaires. State Street Global Advisers created a great investment category when they created the first exchange traded fund SPDR S&P 500 ETF Trust (SPY) in 1993. Currently there is over 4.5 trillion dollars in ETF's around the world. SPY trades like a stock on the New York Stock Exchange allowing investors to buy and sell when they want. SPDR S&P 500 ETF can be  acquired through a traditional broker. SPY mimics the growth of Standard and Poor 500 index, a group of large cap U.S. stocks. There are no load fees and an expense ratio of .0945%. Since its inception in 1993 SPY has an annualized average return of 9.70% compared to 9.85% of the S&P 500.

       The histogram above displays the returns of SPY after 100 simulations on a monthly basis for 30 years. SPY has a mean monthly return of 0.85% and a standard deviation of 4.1% since inception. As you can see the curve is skewed right with a fat tail, a good opportunity for investors. The lowest simulated return of 350,000 dollars on a basis of 180,000 which is 500 dollars a month for 30 years still provides a return on investment of nearly 100%. The highest return was over 3 million dollars, with 57 of the 100 results over a million dollars.

I advise you to invest in SPY for retirement in an Individual Retirement Account. Using monthly historical prices of SPY since its inception we can calculate the probability of different returns for the index. Lets assume you invest $500 every month for the next 30 years in an IRA, based on historical data 100 simulations using 360 random individual monthly returns using standard deviation and mean that small monthly investment will on average grow to 1.16 million, an return on investment of 545%. The mean displays the scenario that is on average the result. It is calculated by taking all 100 results of the simulation and dividing by 100, the total input. We can further use the mean and standard deviation, a measure to quantify variation in a set of data, to calculate that 66% of investors who invest $500 a month in SPY in an IRA for 30 years will obtain a value between approximately 400,000 and 1.6 million dollars. Assuming stocks follow a normal distribution ninety-five percent of investors will see wealth between $1,817 and $2.1 million. Since stocks don't follow a normal distribution the returns on the low end left side are further negative then what would realistically occur because of the high upside of growth of the investment on the the right side. This allows investors to fund a wealthy retirement on only $500 a month because of SPY capturing the upside of the market while minimizing the risk.

Tesla- Intrinsic Value

        When someone says the word Tesla, what do you think of? Is it the sleek 288hp roadster, the semi with up to 500 miles of range, or more recently the unfortunate debacle with the Securities and Exchange Commissions probe into Tesla and Elon Musk's funding secured tweet? Tesla has caught the eye of many investors due to the immense upside and risk with 3.04 short ratio.Tesla's main business is the design, development, and manufacturing of fully electric vehicles, energy generation and storage, along with solar energy. Tesla currently has 3 vehicles; the first vehicle produced Model S, Model , a 7 passenger SUV, and the Model 3 which has been ramping up production. Tesla is working on producing the Roadster and Tesla Trailer, to expand its vehicle offering. Tesla is continuing to develop its self driving technology to improve vehicle safety. Tesla sells and services its vehicles through its own sales network. Tesla differentiates itself through its business model, owning its sales and service network, prestige, and acceleration to sustainable electric vehicles. Tesla controlling its sales network allows it to efficiently allocate capital and have better inventory control. Tesla in-house abilities to produce the drivetrain and other main devices such as interior and chassis allows for a competitive advantage once sustainable, an issue discussed later. Tesla boasts engineering expertise in lightweight materials used for electric cars such as aluminum.

Tesla has business prospects are encouraging. Electric vehicles look like they will be the main mode of transportation sooner rather than later. Tesla was one of the first to the market with a prestigious name to help support a higher price point, giving it a competitive advantage. Tesla has faced production problems in the past, but is on track to produce 70,000 vehicles this month, the most EV produced by one manufacturer in a single quarter. Tesla has set up a third production line under a tent in order to achieve production at this level, suggesting either its not sustainable or more resources will have to be acquired. There will be other options on the market for consumers going forward as Jaguar and Audi will both have EV available in the next few months that will have better range, and faster acceleration. Traditional car makers will compete with Tesla to with lower price points and lack the production problems. Shareholders have voiced concerns that although Musk is a great visionary, Tesla needs someone in charge that can execute production.Tesla has another hurdle it will have to overcome in addition to competition and production issues, tax credit phaseouts. In the United States, EV purchasers receive a $7500 tax credit on electric vehicles purchased from manufactures with less than 200,000 such models sold. Tesla has reached that milestone and phaseout will start to occur with the tax credit completely phased out by the end of 2019. On a vehicle that costs $49,000 that is a lot of extra money to spend or for Tesla to reduce the price when they already have a negative operating margin.


When determining the value for Tesla I used a weighted average cost of capital of 9% which leads to a estimated share price of $456 signaling a buy at the current price. Assumptions are made that Tesla's capital structure is 80% debt financing and 20% equity will remain the same. Another assumption is there won't be changes in risk in the business or market, which is hard to determine and seems unlikely based on new competitors, production issues, and the tax credit phaseout.

With rising interest rates due to the expansion of the economy Tesla has been operating under a beneficial interest environment. The Fed has signaled rising rates, since almost 70% of the value of the stock is calculated off of Tesla's terminal value shifts in interest can significantly lower the price. Lets say rates do rise and the cost of debt increases to 12%. Due to higher interest rates the market risk premium shrinks to 10% instead of 14% due to the high yield of bonds. Tesla's terminal value now accounts for almost 90% of the value and a target price of $397. With Tesla's current price of $300 a share I would not recommend buying Tesla due to the terminal value accounting for most of its value and the risk doesn't outweigh the reward.