I ran across another nice tidbit from the book The Undercover Economist by Tim Harford the other day, which like the concept of price targeting, also manages to involve supermarkets. I guess everyone goes to supermarkets. 🙂

In a chapter exploring stock market pricing, he covers the the idea of rational investors, the “efficient market theory”, and the related “random walk hypothesis”.

You can see the same phenomenon at work at the supermarket checkout. Which line is the quickest? The simple answer is that it’s just not worth worrying about. If it was obvious which line was the quickest, people would already have joined it, and it wouldn’t be the quickest any more. Stand in any line and don’t worry about it. Yet if people really just stood in any line, then there would be predictable patterns that an expert shopper could exploit; for example, if people start at the entrance and work their way across the store, the shortest line should be back near the entrance. But if enough experts knew that, it wouldn’t be the shortest any more.

The truth is that busy, smart, agile, and experienced shoppers are a bit better at calling the fastest lines and can probably average a quicker time than the rest of us. But not by much.

To me, this is a nice and simple way to explain the argument of efficient markets to say, a fifth-grader. If the market price of a stock was a lot lower than the “true” value, people would start buying, and soon the market value would equal true value. Even someone that young can appreciate trying to pick the shortest line, weighing the possibility of getting through quicker with the possibility of ending up actually waiting longer than if I had just stayed put. In the end, how much do you really gain on average?

Relative Efficiency

I would expand this analogy a bit further, however. In the stock market, if you can reliably “beat” the average person by just a few percentage points a year, you would become rich. Really rich. In the supermarket, the prize is a few extra minutes. I think people would agree that a lot more people around the world are trying a lot harder to get rich, than people are trying to get through the supermarket line. In the stock market, you’re trading against professional arbitrageurs and some supercomputer programmed by a genius hired by Goldman Sachs.

Imagine a supermarket full of world-class athletes connected via radio to spotters placed above each checkout line! This constant competition increases the “efficiency” of the market, and therefore makes it much harder to be above average.

Switching Costs

Despite the slight chance of improvement, I still like to try and find the shortest line at the supermarket. But what if I had to pay 50 cents every time I switched lines? I’d probably stay put.

This is similar to what happens when you try and actively trade the stock market. An actively managed mutual fund will cost nearly a full 1% of your total assets a year, while a passive index fund will be around 1/5th that cost (0.20%). Over time, that really adds up. If you do it yourself, you’re also looking at stock commissions. If you spent $10 a trade and bought $500 of a single stock a month, that’s a 2% hit for a buy, and 4% round-trip. High costs are the primary reason why you always hear that actively managed funds don’t outperform index funds.

In the land of investing, you can keep trying to pick the fastest line, but be realistic about the competition and watchful of your costs. By “staying put” with low-cost mutual funds, you’re guaranteed to be above average.

If you’re a corporate “insider” such as an officer, director, or other certain employees, your purchases and sales of stock must be reported to the SEC in order to reduce illegal insider trading. Technically, an insider is not supposed to trade if they have “material nonpublic information” when making the purchase or sale. But still, who would know better?

Therefore, it’s interesting to see how insider trading activity as a whole by comparing the amount of shares being bought and sold during all this volatility, and then compare that with the market. See the graph below compiled in this CNN Money article:

Insiders loaded up overall during the panicky months of February and March, and then seemed to sell off a bit in happy August. I wouldn’t necessarily base future trades on this relationship, but it is definitely food for thought!

Here’s an update for my person-to-person (P2P) lending activity, which for me are unsecured loans between U.S. residents. It could be for credit card debt consolidation, car financing, business financing, or even buying a house. You can think of it as taking out the bank middleman, which pays tiny interest on checking account balances and then charges high interest to borrowers.

LendingClub Portfolio
I do my P2P Lending at LendingClub, where you can loan as little as $25. You can read more background in my previous update. Although they do have a service to pick for you, I tend to pick my own loans to try and find both a combination of good risk profile and also a person who I want to help out. It’s kind of a hobby of mine.

I now have a total of 49 active loans with $1,548.42 in outstanding principal. Most are A grade, with a decent spattering of Bs. Keep in mind that a borrower has to have a 660 credit score as well as other additional requirements just to make their lowest G grade. (Only about 10% of loan applications are accepted.) Here is a screenshot from my account page:

Performance & Commentary
According to LC, my “Net Annualized Return on Investment” based on my interest payments received so far is 9.06%. The bad news is that I now have two late loans in my portfolio. One has negotiated a temporary reduced payment plan, while the other seems to be dodging phone calls. Also, one loan was paid off early. But I suppose this is par for the course, you get late payments and defaults. If your interest rate is high enough and you have enough diversification in loans, you’ll still end up ahead. We’ll see what happens, even with a default my rate of return so far is still higher than what I’d have gotten with an online savings account. But the risk is still certainly there for more downside.

What really baffles me is that both of my late loans are A-rated. According to the LC stats page, out of all the A loans issued so far, there are only 12 late loans out of 943 still active. That’s a tiny 1.3% late rate with zero defaults for LendingClub in general, and yet I managed to invest in 2 out of the 12 late ones. So either I’m very unlucky or I stink at picking loans, or… both. 😛

$25 New Lender Bonus
If you are interested trying P2P lending with no risk, you can still use this special $25 lender sign-up link to get a free $25 to try it out with no future obligation. There is no credit check and you don’t even have to deposit anything. After you are approved, the $25 will show up in your account balance, and you can lend it out immediately.

If you’re looking to borrow at LendingClub, it’s relatively straightforward. Send in your information, and see what interest rate they offer you. Compare it with your credit card or other financing options. If you like it, fill out your application carefully (verify income if possible) and go for it. If you don’t like the rate or the full amount is not funded, you can either accept partial funding or walk away with no obligation.

If you have an account with online broker Scottrade, or are thinking of getting one, this post is about moving funds in and out of your account. Like many brokers, the interest paid on idle cash sweep balances is very low at Scottrade, so it doesn’t pay to keep cash there. Here’s a current interest rate schedule from my account page:

Many other online brokers I’ve used like Zecco or TradeKing have online ACH deposits/withdrawal systems similar to online banks, but moving money around with Scottrade is a bit different, although in some ways it is also better.

Deposits
Scottrade has a service called MoneyDirect for electronic deposits. It is similar to most online bank transfer systems in that you just need the routing and account numbers for setup, but only allows one-way transfers from external bank to Scottrade.

However, a useful feature about the MoneyDirect system is that you can make instant, same-day deposits. So I can leave minimal cash in Scottrade, but if I wake up one day and want to make a trade, I can move up $100,000 into my account with just a few clicks during market hours. From the site:

New and existing clients will be given credit for the transfer the day it is requested, as long as the request is made prior to 8:45 p.m. (ET) Monday through Friday. Transfer instructions received on a non-business day or after the specified cutoff time will be processed the next business day around 6:00 a.m. (ET).

Restrictions: Funds deposited through Money Direct cannot be used to purchase stocks under $4, any unlisted stocks, any options, or any stocks that are deemed non-marginable by Scottrade until the third business day after the deposit.

Withdrawals
I’ve had an account with Scottrade for years, but despite vague promises, moving money out electronically through them is still unavailable. However, there is a workaround. If your account has a minimum account equity (cash + stock value) of $5,000, you can request checkwriting capability on your account. With checkwriting, you’ll have a checking account number and routing number that you can use to link to other financial institutions.

If you use certain banks using CashEdge, you can look for the “investment accounts” options as shown here. Scottrade is one of the participating brokers, although you still need your checking account number.

Scottrade will provide you a free Visa debit card and 50 free checks. My checks are through UMB Bank. I’ve gone below the $5,000 level and kept my check writing ability, so even if your account is usually smaller, it may be worth it to reach $5k temporarily to qualify for this feature. In addition, you can now access your money by writing yourself a check, using the debit card for a purchase, or making an ATM withdrawal.

Read my Scottrade review for more tips and my account opening experience.