Missed opportunity

Today the portfolio increased significantly again, which I would have never guessed. On Friday I sold a small portion of my largest holding Betsson, that "cost" me a couple of thousand SEK as the stock rallied (again) today. Just to highlight that investing is hard.

I will now account for a "theoretical" case, one which I actually could have made in practice. In December 2006 I made a large (600 kSEK) investment (I thought so at least...) in two companies that are no more listed. I was quite bold (or I would rather say today to myself 'stupid' as I did not know what I was investing in, even though I had done a proper valuation of the companies) as I basically put all of my financial assets into those two companies. I was lucky and was able to exit both positions at roughly +/- 0 about two years later amidst severe market havoc.

Now, had I instead at the dates when the cash became available invested in a company called Betsson (it would have been possible, trading volumes on those dates well exceed the 600 kSEK I had at that time) and kept that investment intact until today, we would have had more than 35 MSEK (pretax), with about equal amounts in Betsson and Net Entertainment. That amount is without dividends reinvested... This year's dividends would have been over 750 000 SEK (pretax).

All my other savings and dividends during the years until now would also have made a substantial sum, with dividends most likely amounting today to between 200 - 300 kSEK.

Fortunately, I started to invest in Betsson about three to four years later, and have still got a very nice IRR on that investment with well over 30% annually at today's valuation.

Now, the case above is "theoretical" for two reasons (at least when it comes to myself);
A) I would not in 2006 nor today have dared to invest in a company with that short track record that Betsson had at that time
B) I would not during all the years have kept the full position as I during many times over the last years have deemed the company overvalued AND that the position would have had a too (by extreme measures) large weight in my total portfolio. (I am actually still scaling down this position from time to time as it is such a large share of my current portfolio)

I think the key lesson is that I would truly like to focus my investments for the future around "wonderful companies". But they are really hard to first understand and second to value properly and then thirdly to find at some kind of 'margin of safety' price or at least fair price. But in the long run, this is absolutely what you should try to learn.

How to measure portfolio return

At the blog AnotherValueInvestor there is currently a miniseries on how to calculate your own portfolio return. I would therefore like to give my view on how to calculate the annual compounded return for your portfolio. This is fairly easy to do with a spreadsheet program like Excel, Numbers or Google Docs Spreadsheet. For my own tracking I have used Excel since late 2000.

First start with identifying the exact dates and amounts for all your deposits and withdrawals from your stock accounts. Then do the following in your spreadsheet program:

Create two input fields (orange fields at the top first column in the figure below):
[A] today's date. If using Excel, use the TODAY() function
[B] the estimated portfolio return (denoted as 'CAGR to reach current value of portfolio'). Start e.g. with 10% as a reasonable starting value

Create at least four columns (six if you want to compare yourself with any index) with the following contents:
[1] Date (enter the date for the deposit or withdrawal to your account)
[2] Amount of deposit or withdrawal
[3] Calculate the number of years since the deposit or withdrawal (there are several simple functions in e.g. Excel to calculate this) using the input [A] above and column [1]
[4] Calculate the compounded value of your deposit or withdrawal [2] today given the estimated portfolio return [B] and time [3] since this deposit or withdrawal. The formula is    = [2] * ( ( 1 + [B] ) ^ [3] ).  "Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it." Albert Einstein

Create also at least one output field (grey fields at the top first column in the figure below):
[C] Current value of portfolio. In this field you summarize the whole [4] column. With everything now set, the output figure [C] should become equal to your current portfolio value (check in your stock account what it is on the [A] date) once you have the right [B] value input. Either test yourself (5-10 tries will normally make you come very close), or use a built in function like 'Goal Seek' in Excel.

Kids, I would like you to remember that my primary target regarding portfolio return is to measure that the compounded return over time is at least 10%* (read this previous post regarding having an absolute return target). However, it can still be relevant to compare to the most relevant practical alternative that I could entrust our capital to. That would most likely be an index fund that would try to closely follow the SIXRX index (such as Handelsbanken Sverigefond Index or SEB Sverige Indexfond).

Hence, for comparison, I have added in the SIXRX index. Find the index value for each relevant date and add them into a fifth column [5]. Then calculate in the sixth column [6] the current value of the deposit or withdrawal by dividing today's closing SIXRX index [D] (see the top right orange input field) with [5] and multiply with the deposit or withdrawal value [2]. Sum up all values in column [6] to calculate the value of the portfolio if you had invested in SIXRX [E]. Then use the [B] input again to match the [C] output with [E] and you will find the annual compounded interest that the SIXRX would have given you.

This model is simple to update every time you make a new deposit or withdrawal, just add a line and make sure the sums are correct in the 'grey output fields'. Using this model I can see that currently my portfolio have had an annual compounded return of 11,85% which is above my 10% absolute return target and 2,01%-points better than SIXRX.

Figure. Excerpt of simple model to calculate annual compounded return on your investment portfolio.

Using this model it is also very easy to see how much a withdrawal a long time ago have cost me. For instance, the withdrawal in May 2001 of 146 kSEK would have been worth 646 kSEK today in nominal terms before tax (while inflation has been about 17% during the same period). These things are always good to reflect upon...

Anyway kids, your portfolio is growing at a slightly higher pace (17,25%) mainly due to the fact that it is still more concentrated to fewer large (and so far successful) investments. So far it has also well outperformed SIXRX with about 5%-points.

* measured pre tax regarding capital gains tax in normal VP-account, after tax for ISK-account and after all transaction costs

Introduction

I will write this blog as one way (of several) to carry forward my learnings, knowledge and ideas from within especially the investment area to my kids. Hopefully I will learn additional new insights into investing by also sharing with the rest of the blog community.

It will probably still be a couple of years before you (i.e. my kids) will be interested enough to start to look into this area of life, but my wish is that it will be (much) earlier than for me. The reason for this is the enormous power of compound interest. I basically started something really called investing (in stocks) around 2002/2003 and then on a fairly small scale. Before that I was only speculating for a few years (even though I thought I was investing), and before that I did not think I could earn any money by investing. I most likely lost some 10-12 years of investing experience by simply not having been aware of the possibility. With some guidance early on in my life, I would most likely have been even (very) much better off today than I currently am.

Anyway, a key take-away:
Make sure you make compound interest work for you for as long time as is ever possible. So every day, month and year earlier that you start, the better. Simply put, reinvest the interest and next year you will earn more (given the same interest). Initially the effect is fairly small in nominal terms, but (depending on the interest rate) the nominal effect after several years can be very large.

One practical example from your own life: I have on your behalf invested an amount similar to your full 'barnbidrag' in stocks since you were born. Assuming
- a 9% compound interest (before taxes)
- that we continue to invest the full 'barnbidrag' until you are 18 years and
- that you do not touch the money until you are 50
then it will be worth more than 8 MSEK in nominal terms (and before taxes). Meanwhile, we have only set aside 226 800 SEK until you're 18. When I write this post, your combined CAGR (term I will use for compound interest) is about 17,7% (before taxes and during a timespan of give or take a decade). This I will NOT be able to continue to replicate due to several factors. However, I believe it could be possible to reach 12-15% with a lot of hard work spent on investing over a timespan of another about 40 years. That could mean in rough terms between 25 to 80 MSEK when you're 50 years old (and that's quite much money, even 40 years from now).

So think hard about the power of compound interest and start investing as early as possible.