Reverse split arbitrage is the only way I know to make 10x returns on investments as small as a dollar in the stock market. In fact, the only way I know to make returns on that small of an investment in any capacity is flipping from the Craigslist free section and garage sales. In March 2021, for example, reverse split arbitrage profited $423 off a $57 investment. Only a small portion can be reinvested back into reverse splits. What should be done with the remaining profits?
Buy One Stock, But Own a Lot
I cannot give investment advice, but I can say what I do in my own account. First, I want broad exposure to a lot of U.S. stocks. My reasoning is simple: it’s very hard to pick individual winners. I generally believe that prices are accurate for large U.S. stocks. I also know that hedge funds with far more expertise and bigger research budgets than me blow up all the time, and so it must be very difficult to predict price movements.
I can avoid some of this uncertainty and limit my risk by purchasing a basket of stocks using a passive index fund. Instead of buying a bunch of stock in individual companies, I instead buy a single exchange-traded fund (ETF), say $VOO, which trades just like any other stock. Its price is tied to the performance of the companies it holds, just as if I actually held all of these stocks in the same proportions. I get broad diversification, the ease of buying a single ETF, and low fees as these are passively managed meaning that buying is largely automated and no one is researching these stocks ahead of time.
The S&P 500 and Why It’s So Great
There are a lot of ETFs that hold different things: tech stocks, consumer staples, energy, etc. It’s hard to know which one is best. In my account, I prefer stocks of large U.S. companies. One of the best indexes to track is the S&P 500, which is 500 of the largest, profitable U.S. companies representing about 80% of the entire U.S. market.
Why is the S&P 500 so great?
- It’s the benchmark by which all other investors are measured. Seriously, look at the prospectus of any fund and they’ll compare themselves to the S&P 500.
- It’s really hard to beat. In 2008, Warren Buffet famously bet hedge funds $1mm that that they couldn’t select a basket of other hedge funds that could be the S&P 500 over 10 years when including hedge fund fees. Hedge funds famously charge 2% of assets and 20% of profits, which seriously eat into returns. Even with the housing crises of 2008 and hedge funds ability to, you know, hedge, Buffet’s S&P 500 easily won out.
- ETFs that track the S&P 500 charge seriously low fees. Say a hedge fund charges 2% in a bad year. On a $10,000 investment, that’s $200/year. Most actively managed mutual funds are around 1%, so $100/year on the same investment. Two S&P 500 index funds, $VOO and $SPLG, charge a mere 0.03%, or $3 per $10,000 managed. Three dollars!*
- They represent the entire U.S. stock market. This index is such a vital measure of the U.S. economy that it simply cannot be ignored. If Tesla goes bankrupt, nothing really changes. If the tech industry has a bad decade but the energy industry is doing great, nothing really changes. But if the S&P 500 is down, the entire U.S. government steps into action: stimulus checks are issued, banks are bailed out, infrastructure spending increases, the Navy gets a new aircraft carrier, etc., etc., you get the idea. It takes a LOT for the S&P 500 to drop, say, 70%, so much that were it to happen, we’d have a whole new set of much worse problems.
Doing One Better: Adjusting for Risk
The only thing I like better that S&P 500 index funds is target year funds. Stocks provide great returns, but they can also go down by a lot, and stay down for a decade or so. That’s fine if I’m 25, as I have 40 years to make it back. But if I’m 60 and nearing retirement, I’d rather have lower returns in exchange for less downside risk. So what I really need is to hold more risky stocks when I’m young, and slowly transition over to less risky (but lower returning) bonds as I near retirement. I could go into my account and shuffle things around each year, but that’s a headache. Can’t someone do this for me for a nominal fee?
Enter target year funds. These are mutual funds named after a year, say 2050, in which you plan to start using the money. For most people, this is the year they will retire, but I’ve also seen people use target year funds to save for college, choosing a year near when their child will turn 18. These are great because they are essentially idiot-proof. In fact, the less you look at it the better, as the last thing you want to do is panic and sell when it’s down, missing the upside. And the management fees are quite reasonable at around 0.15% or $15 per year for a $10,000 investment. There are now target year ETFs that I’m aware of, but many brokers have them as mutual funds, and they are fairly standard in company 401k accounts. Here are Vanguard’s.
In summary, I invest my reverse split arbitrage earnings in $VOO if I can afford it or can buy fractional shares, or $SPLG if I need the lower share price. As of this writing, the bulk of my savings is in target year funds with Vanguard.
You Mentioned Reverse Split Arbitrage… What is That?
I know I said stocks are accurately priced, but ther is one small exception that only small investors can profit from.
Sometimes a company will consolidate their shares so that going forward every, say, 10 shares is combined into 1 share. Because the company’s value hasn’t changed, each share is now worth 10 times as much. It’s a simple accounting trick that raises share price, which a company sometimes needs to do for a variety of reasons.
Using real numbers, if you had bought 1 share before the split for $0.50, after the split you’d have 1/10 of a share, a fraction which historically could not be traded. To get around fractional shares, companies will sometimes pay the cash value of the fractional share, in this case $0.50. Other times, though, they will round you up to one full share. When they round up, the share you had bought for $0.50 is now worth around $5. You profit $4.50 at minimal at risk.
It’s nice, clean profit, but $4.50 is too small to get excited about. You can’t buy more shares in the same account, as that just means you’ll get rounded up less. You can, however, purchase a single share in multiple accounts at multiple brokers and let them all round up. There are at least 16 brokers that round up fractional shares from reverse splits.
If you’re interested in trading reverse splits that round up, subscribe to my newsletter and Twitter to get notified of upcoming splits the day they happen. Make sure your broker is one that rounds up fractional shares (some don’t round up as policy, while others charge fees). A running list of participating brokers can be found here along with sign up links to get you free stocks. If you’re interested in recent successful trades, they are posted here. More information about trading reverse splits can be found on the homepage here.
*These management are lower than the most widely-known S&P 500 ETF $SPY, which charges three times as much. $SPY can get away with this because it has a lot more trading volume and so someone trying to invest a million dollars won’t move the price too much. For the rest of us who use limit orders or trade less than a few hundred shares at a time, $VOO and $SPLG are better choices long term.