For the Model Shadow Stock Portfolio, you recommend entering limit buy orders at the ask price and limit sell orders at the bid price. [See the April 2010 AAII Journal or the Model Portfolios area of AAII.com for the portfolio rules.]
I would think it’s best to buy low and sell high. Therefore, wouldn’t it be better to enter buy orders at a small discount from the present bid price and a sell order at a small (0.5%) amount above the present ask price? This applies if the difference between bid and ask is less than 2%.
James Cloonan Responds:
Thank you for your e-mail. Of course it is better to buy lower and sell higher—if you can. Except in those cases where a retail seller and buyer both come in at a price between the bid and ask at about the same time, the individual always pays the spread. If a bid is 10.0 and the ask is 10.2, and you put in a buy at 10.1 and get a fill, it usually means the price moved to 9.9 bid, 10.1 asked. A limit order is a free option to a market maker. If you are a buyer, your order gets filled only if the price goes down. If the price trends up, your order never gets filled. If the price weakens, the market maker sells to you and buys the stock back cheaper.
It is true that stock prices move around all day and you may catch a low, but I believe if the bid/ask is close you should get your order filled immediately. You can save money by not trading as frequently.
Thank you for introducing some coverage of master limited partnershipsvia the March 2010 article by Cara Scatizzi [“Investment Offerings: Master Limited Partnerships”].
It appears to me that the article incorrectly states the tax treatment upon sale of the MLP units. In the example given in the article, at sale, proceeds exceed basis by $6, of which $3 comes from basis reducing distributions and an additional $3 comes from price appreciation in the units. The article states “...the unit holder pays capital gains tax on the $6 difference between the cost basis and the selling price.”
I believe that the reduction in basis distributions is “recaptured,” so to speak, at ordinary rates.
Charles Rotblut Responds:
You are correct, that was an error in the article. The reduction in the cost basis that is attributable to the allocation of depreciation and other deductions is taxed at the ordinary income rate, not the capital gains rate.
I’ll use the example in the article just to make sure we are on the same page. The unit was purchased at $17 and sold at $20. Each unit of the MLP paid $2 in income and earned $5 in distributable cash flow. The cost basis for each unit would be $14 ($17 – the distribution of $5 + $2 in income). This would result in a gain of $6 at the time the unit was sold ($20 – $14 = $6).
The investor would pay capital gains taxes on the $3 increase in the unit’s price (bought at $17 and sold at $20) and ordinary income taxes on the $3 that is attributable to the allocation of depreciation and other deductions.
Regarding your April 2010 article on technical analysis [“Why Technical Analysis Matters,” by Michael Kahn], the author might read the first chapter of Benjamin Graham’s “Intelligent Investor.” Graham distinguishes between two types of “investors,” one type is speculators and the other true investors. Technical analysis is for speculators. Fundamental analysis is for true investors.
P.S. Yes, I am still here, at 85. Finding my way to AAII was one of the best pieces of luck in my life. Another was finding my spouse!
Knowing thyself is essential—your age, what you are comfortable with, how badly you want to succeed. Holding your own stock picks is great. Index mutual funds have a place too. I even like closed-end funds that use leverage. Mix it up, because you never know what lies around the corner. Now technical analysis is on my learning plate.
Thomas From Maine
What the article omits is that we are all part of the herd (sentiment) and that the hardest thing is emotional detachment. Risk is least when your emotions say “wrong move” (i.e., at major peaks and valleys).
The most important thing for a long-term investor is correctly selected stop losses of 10% to 20% depending on the long-term (use weekly charts, not daily) history of the instrument.
Alfred From Texas