Investment Help

If you are seeking investment help, look at the video here on my services. If you are seeking a different approach to managing your assets, you have landed at the right spot. I am a fee-only advisor registered in the State of Maryland, charge less than half the going rate for investment management, and seek to teach individuals how to manage their own assets using low-cost indexed exchange traded funds. Please call or email me if interested in further details. My website is at If you are new to investing, take a look at the "DIY Investor Newbie" posts here by typing "newbie" in the search box above to the left. These take you through the basics of what you need to know in getting started on doing your own investing.

Tuesday, November 30, 2010

Unconventional Investing

Do you see yourself as the next George Soros, Jim Rogers, or some other well-known hedge fund manager? If so, then hopefully you know that you have to think differently from the crowd. If you are loading up on gold and patting yourself on the back about how smart you are, hold the high fives - you are probably headed for the proverbial crash.

An interesting post is presented along these lines by Kevin at Invest It Wisely where he looks at unconventional investment moves for 2011. Here he considers some areas that have not done well and at the moment are a bit unloved by the investment community. But these are exactly the types of situations that produce the outsized returns when they come into favor. To appreciate this, reconsider the mood of the country when BusinessWeek published its infamous "Death of Equities" cover in 1979. With a stock certificate folded into a crashed paper airplane and crumpled up stock certificates on the table, it captured the negative mood in the equity markets. Guess what? That was the time to sell the house, cars, kids - whatever - and put it all in the stock market!

Kevin's ideas are worth pondering.

Contrarian thinking - not easy but if you get it right, it goes a long way.

Monday, November 29, 2010

I Almost Became Famous

Many years ago, in a different universe, I had a streak of luck with a small fund. As I recall, it was a few million. It was a Treasury bond fund. I saw myself as a superb market timer; and when I took over the fund, I judged yields as being excessively high. I invested aggressively in 20-year and 30-year Treasuries. Treasury yields at the time were double digit.

As soon as the the investments were made, yields dropped like a rock. The push up in bond prices yielded a nice capital gain and, to capture my good luck, I realized the capital gain and put the proceeds in 1- and 2-year maturities. As soon as these buys settled, yields shot back up and I re-entered the market. This went on a few times during the quarter, and after a while I was feeling like King Midas.

When the quarter ended and the smoke cleared, I found my fund was the third best-performing fund in the country. Pensions & Investment Age produced the rankings and, in their quarterly performance issue, interviewed me along with other "top" managers/bond market rock stars.

I gave my burgeoning rock star status considerable thought, and it dawned on me that I could lock in this superior performance for a long time by "closet indexing." In the bond market, this would mean structuring the bond portfolio similar to the Aggregate Index - its benchmark. The portfolio would have the same average coupon, duration etc.

All of this is more complicated to explain than to carry out. By "closet indexing" I would retain the superior performance for some time while not taking a risky market timing posture. The superior performance would attract money, thereby increasing the size of the fund. Bringing money in, of course, is the purpose of institutional money management.

The reason I relate this story is twofold. First, you need to be careful in evaluating performance. A fund's performance may look good but really be the result of one period's luck. By coming into the fund and paying high fees to attain superior performance, you may be buying into a conservative approach - one which could be attained at much lower costs. Or worse, the manager comes to believe he or she is King Midas and it takes time to realize that the prior results were luck. Secondly, it is easier to produce exceptional results with a smaller fund. The history of Wall Street has many instances of funds which started out on fire and gradually turned mediocre as asset size grew.

As it turned out, I was recruited to go to another investment management company that offered me more opportunities. Still I wondered over the years how much money would have come in with the "closet indexing" approach for that fund.

Sunday, November 28, 2010

How to Become a DIY Investor

Yesterday I presented reasons for becoming a DIY Investor. The bottom line, IMHO, is that becoming a DIY Investor is the best chance for most people to reach their retirement goals. It saves a lot of money over time, and it gives them the best chance of getting and even exceeding market returns. does one become a DIY Investor? It's easy... get an MBA from Wharton! Ha! Ha! That's a joke.

Seriously, it is fairly easy and it doesn't take much time to carry out once implemented. You do need, however, the interest and the willingness to make a commitment. This is what I recommend :

1. Pay attention in the human resources meeting at work where the 401k provider talks investments. I know-some of the presentations can cause the eyes to glaze over. Try to stay awake and understand the fees of the funds and the choices offered. Don't rely on co-workers for getting ideas on how to allocate your balances and contributions. There is a lot to learn in these meetings and in meeting with the reps. Typically, 401k providers (think Schwab, Fidelity, Vanguard) have online technology available to participants that can provide in-depth info on asset allocation etc. Learn and use this to come up with an allocation you can be comfortable with in stormy seas because that's where you are headed.

2. Get an investment philosophy. Too many people approach investing as a seat-of-the pants operation. It is almost a given tha,t if you do, you will end up buying high and selling low. Don't take my word for it - google "Dalbar Study." My philosophy is based primarily on using low-cost, low-turnover, index funds within the framework of an acceptable asset allocation model based on my risk tolerance. I refer to this as "evidence based investing" simply because there are innumerable studies supporting this approach. This leads to point 3 - the best way to develop a philosophy is to read the masters.

3. Read "The Four Pillars of Investing" by William Bernstein, "The Elements of Investing" by Charles Ellis and Burton Malkiel. Watch the Google authors presentation by Dan Solin on YouTube.

4. Find an experienced fee-only registered investment advisor who charges by the hour. Go over with him or her the differences between taxable investments and qualified accounts such as 401ks. Talk about opening up an account at a discount broker and the mechanics of making trades, if necessary. If you are planning on rolling over 401k funds etc., go over how to do that. There are actually nuances (sometimes it pays to rollover company stock to a taxable account) that can avoid adverse tax events.

In carrying out point 3 above, you will find that the approach outlined here has, over long periods in the past, outperformed 8 to 9 investment professionals who claim they can "pick stocks" and/or "time the market." The reward for making the effort to becoming a DIY Investor could well put you on the road to retiring a couple of years early.

Picture: Burton Malkiel, author "A Random Walk Down Wall Street."

Saturday, November 27, 2010

Why Become a DIY Investor?

One way in which the world has become meaningfully different in recent decades is that people are now in charge of their own investments and retirement. It used to be that workers received a defined benefit at retirement and had a known monthly check coming in. Now we have IRAs and 401ks or other qualified accounts. Some of us are quick to throw our hands up and seek professional management. Here are some reasons to think about taking a different route - about learning how to manage your own money.

1. Save investment management fees. Pick up the local phone book and call 10 investment advisors out of the yellow pages. They will quote you a fee of between 1% and 2% of the market value of assets to be managed. For $1.0 million, that amounts to between $10,000 and $20,000/year. There are other costs as well. If they use mutual funds, the average expense ratio is 1.4%. If they trade actively, there are trading costs. Here's an idea: at the very least, take $5,000 of the $10,000 you save and take a great vacation. Take the other $5,000 and give it to Children's Hospital. Now you feel good, you've done good, you get a great tax break, and you understand what is happening with your money. Think of it like this: you can either drive your own car or you can have a chauffeur drive you around. For most people, the chauffeur is a big waste of money.

2. You have control of your money. If it is managed by others, you gradually lose an understanding of how it is invested. I know because I ask people questions that they find awkward. I ask them the most important question in investing: what percentage of your assets are in stocks and what percentage in bonds? Many people will hem and haw and sheepishly admit they really have no idea. I ask them how they performed last year. Some say they did OK and give me a dollar amount of how much their account went up. "My guy made me $22,000 last year." This of course, is meaningless. What was the percentage return? If the market went up 12% and "your guy" got you a return of 10%, he actually cost you 2%. I hate to rain on the parade, but this is quite common. People walk around thinking their advisor is doing a good job managing their money when, actually, the performance is horrible and very costly. I know many people will want to put this in the "ignorance is bliss" bin and move on. I'm obviously not in that camp. I've seen how the "ignorance is bliss" crowd handles markets like 2008.

3. It is not difficult to manage your own money. Think about this: you have probably managed or are managing a part of your own money already. If you have a 401k or a similar type of qualified account, you have probably read some investment related material, listened to a fund sponsor rep, and decided on how to invest your assets using the choices provided. Guess what? You are half way there. One thing that is generally missing is how to bring it all together by looking at all your assets holistically. But this is something most people can easily handle. Another thing you have to learn is how to pick appropriate funds and how to get the correct mix of stocks and bonds. Listen to the rep, but take what he or she says with a grain of salt. Many times they are insurance company sales people or brokers getting paid commissions for selling products.

4. It doesn't take a lot of time to manage your own money. Let me put it like this: that advisor I mentioned above who will get between $10,000 and $20,000/year to manage $1.0 million for you is getting one of the highest per-hour compensation rates on the face of the planet. I know. I've been there and done that. I know how many hours ( I probably should say minutes) typical advisors spend thinking about your account. I was in a meeting one time and the stock picker was asked by an advisor when the last time the stock had been reviewed. It turned out the stock was on the "buy list" and hadn't been reviewed in over a year and a half! The upshot is that, with today's technology, it is very easy to track and manage your investments using approaches recommended by highly-respected long time students of the markets.

Tomorrow we'll look at how to become a DIY investor.
Picture by LMW

Friday, November 26, 2010

Thoughts For The DIY Investor On Building a Bond Portfolio

Suppose we are a fly on the wall (actually in Maryland a stink bug is more appropriate - we've been inundated with them!) and looking in on a DIYer who has completed his asset allocation work and has come up with a percentage of assets to put into the fixed income. Just focusing on these fixed assets, how should they be specifically allocated?

Every situation is a bit different, but here is one approach.

First off, unless he has been living under a rock, the DIY Investor has heard a lot about the so-called "bond bubble." If he hasn't, he should use an advisor.

Should he buy individual bonds or buy funds? If he has the time, resources, and know-how, he can be my guest and buy individual bonds; but I generally recommend against it because individual bonds are illiquid, very difficult to price, and it is almost impossible to determine if you are getting good execution. To do it right, you almost have to use multiple brokers. All of these disadvantages can easily be overcome by using funds.

So, the DIYer makes the smart move, IMHO, and heads down the fund path. Let's assume he will use exchange traded funds. Warning: if he will make a lot of transactions, he should be aware of commissions! There are some commission-free ETFs, but most still have a commission.

Exchange traded bond funds provide a bewildering array of choices. From behavioral finance, we know this can be both good and bad. Some DIY Investors will exploit the available choices; others may freeze up and not be able to choose. Among the choices are corporate bond funds, Treasury bond funds, international bond funds, municipals, and agency bond funds.

Secondly, he will need to think about maturity. Other things equal, the longer the maturity of a bond, the more volatile the price. In his investigation, the DIYer finds that the typical grouping is in terms of short-term, intermediate-term, and longer-term bond funds.

From previous posts, the DIY Investor has learned about the yield curve and about a source of comprehensive information for Exchange Traded Funds. Thinking about the yield curve and the bond bubble, he develops a game plan for his fixed income assets positioning. He realizes that, first off, it is impossible to predict interest rates. If he could predict interest rates, he would be at Salomon Brothers making a zillion $s/year as a bond trader.

With these thoughts in his head, and respecting the bond bubble idea, he puts half of his fixed income allocation into the overall bond market by using AGG. AGG tracks the Barclay's Aggregate Bond Index - it captures the overall U.S. bond market. Under more normal circumstances, the DIY Investor would have considered investing up to 75% of his bond position in AGG.

Next, he would look at CSJ, a shorter-maturity ETF comprised of non-U.S. government names. CSJ presently has a yield of 2.79%. Holdings can be found on Yahoo Finance. He decides to put 25% of his fixed income assets into CSJ.

The remaining 25% he might spread around to high-yield bonds (HYG), emerging markets bonds (EMB), and mortgage-backed securities (VMBS).

There are, of course, many other choices for the DIY bond investor, but this at least has him started on a well-diversified, low-cost, low- turnover approach to the bond market that takes advantage of bond exchange traded funds.

This post is intended for informational purposes only. Specific investments should be undertaken only after completing research and consulting a professional advisor. I hold some of the ETFs mentioned.

Thursday, November 25, 2010

Wednesday, November 24, 2010

A Story For The Thanksgiving Table

A story, from Caroline Baum (one of my favorite writers), worth telling at the Thanksgiving table.

Enjoy the holiday!

Tuesday, November 23, 2010

Insider Trading Scandal

Many market observers accept the idea that markets are basically efficient. This means that knowing and analyzing publicly available information isn't really useful for achieving exceptional performance over the long term. For example, when your next door neighbor works himself into a frenzy over Walmart going into China, you shouldn't run out and immediately reallocate your IRAs to Walmart stock. Why? Because everybody and their brother already knows this. It is reflected in the price of the stock.

But inside information is different. Inside information gives an edge. Imagine you knew that the Food and Drug Administration was on the verge of rejecting a company's application for a cancer drug, and it wasn't publicly available information. This is valuable information. Acting on it could get you Bubba as a roommate (or the equivalent of the female version of Bubba, as the case may be).

Well guess what? The government is investigating all of Wall Street on insider trading charges. I'm hearing the sarcastic parrot from Disney's Aladdin saying over and over, "Why am I not surprised?"

Of course, if you see yourself as a stock picker, you could be buying the stock from the person with the insider information.

IMHO this is just another reason to avoid stock picking and market timing. If you can't avoid it, understand that you are buying and selling to the likes of Goldman Sachs and some of the biggest hedge funds in the country - those named in the probe.

Stick with funds that track the market. The innovative U.S. and global economy will overcome the stupidness of the monied players in the long run...again, IMHO.

Monday, November 22, 2010

What is Present Value?

The DIY investor needs to become comfortable with the relationship between bond prices and interest rates. Especially today, with rates at historically low levels.

I start one of my intro to macroeconomics classes each semester with the announcement that tonight my students will earn their MBAs. This, of course, is tongue-in-cheek; but it does give a hint to the importance of the concept to be discussed - present value. After all, present value is at the foundation of finance.

I begin by sketching out a problem on the board that involves figuring out how much to pay for an apartment building. There is a stream of rental payments, a need to factor in costs, and the estimating of inflation involved.

Later I stress the similarity to a bond and even to stocks. In fact, it comes to the point where students realize the need to value a future stream of payments is all around us. I jokingly point out that with their MBA they can go out and consult at $600/hour on valuing businesses - not far from the truth.

Before the night is over, though, we get into some mathematics. We talk about compound interest and derive the formula FV = PV(1+r)^t (where FV is future value and PV is present value) and then flip it around to solve for the all important present value PV = FV/(1+r)^t.

I'm a firm believer that students have to get their hands dirty to gain understanding. I have seen too many students over the years who thought they understood concepts until they had to apply them. In other words, it looks easy up at the board. Along these lines, I give them a homework assignment based on a group who won a $1 million lottery. The story is that a bunch of old guys pooled their money and when they showed up for the prize they were told it was $50,000/year for 20 years. The assignment is to calculate the present value of the 20-year income stream using a discount rate of 3% and again using 4%.

This illustrates forcefully the difference between cash in hand and a stream of future payments. It also illustrates why the old guys proceeded directly to court on the grounds of misleading advertising.

The real point of the exercise is to get at how bonds work - it shows, in a fun sort of way, the important idea that the value of a stream of payments moves in the opposite direction of interest rates. In particular, it is why bond prices fall when interest rates rise and bond prices rise when interest rates fall - a concept that is difficult for some investors and students to grasp.

The clever DIYer can extend the exercise to show why longer maturity bond prices are more volatile, the impact of discounting using yields on the yield curve etc.

Sunday, November 21, 2010

Need An Intermediate Bond ETF?

An exceptional resource for DIY investors seeking to do exchange traded fund analysis is at ETF Data Base (ETFdb). This is the list of intermediate bond portfolios from their site.


This list was actually obtained by using the ETFdb screener tool. Using the various links and puttering around a bit, you will find it easy to compare fees, examine comparative performance, and see fund holdings. Furthermore, links take you back to the issuer's website.

As always, the DIY investor should take into account location of investments and tax consequences if it is a taxable account. Typically, an intermediate bond fund is most appropriate in a qualified account like a 401k, IRA, 403(b) etc. where Uncle Sam isn't grabbing a big chunk of the interest earnings - at least until it is drawn out in retirement.

Disclosure: this post is purely for informational purposes. I own some of the ETFs listed.

Saturday, November 20, 2010

Getting On the Yellow Brick Road

If your child (rising DIY investor) made more than $5,000 and less than $105,000 in 2010, he or she can contribute $5,000 to a Roth IRA. This can be done by opening a Roth IRA account at a discount broker before 4/15/2011.

One idea would be to buy 170 shares of VTI. This is Schwab's broad stock market exchange-traded fund. The commission is zero. This exchange-traded fund tracks performance of the Dow Jones U.S. Broad Stock Market Index, comprised of approximately 2,500 companies.

If your child is 18 and this fund achieves an 8%/year average annualized return, it will have increased to $181,160 by the time he or she is 65 years old. At that time 65 will be the new 45, with the advances in plastic surgery, medicine, exercise know-how and what all.

For what it's worth, a conservatively invested portfolio over the past 20 years earned slightly more than 8%/year - even with the weak performance of the past 10 years.

In addition to getting started on retirement savings, your child will gain knowledge about retirement savings vehicles, something that 90% (my own poll) of American teenagers are clueless about.

Full Disclosure: I am not affiliated with Schwab and I do not own VTI.

Friday, November 19, 2010

GM IPO a Success - Not

I guess a lot of bubbly was raised over the GM initial public offering. Who would have thunk?

Jeff Carter over at Points and Figures provides a take I agree with. He says that the Chinese took down 18% of the offering. Hey, we have to borrow from them to buy their goods, and they have to buy something of ours besides Treasuries - it may as well be our car companies.

It bothers me that this transaction is seen as a success. Besides how it evolved, there is the danger that, the next time an extremely inept industry (it wouldn't surprise me if it was the auto industry again) gets to the brink of bankruptcy, a bailout along the lines of GM will be more easily proposed. Hey, "It worked last time."

It's very possible that we are morphing from the bailout of the financial sector every decade to bailing out other sectors on a regular basis. How long before we try the same thing with the airlines?

When Wall Street makes a lot of money via a huge wealth transfer, anything is possible. If you're snickering, then you don't understand the housing crisis.

When Hayek penned "The Road to Serfdom," he didn't envision the road veering into the capital markets. After all, the capital markets were supposed to be the bastion of free market economics.

As it stands, the road is being repaved and widened.

Thursday, November 18, 2010

Bond Vigilantes-Bernanke Thwarted?

Bernanke wants long term rates to drop. That is the purpose of the much bally-hooed Quantitative Easing II program. The program buys longer-term securities to the tune of $600 billion, pushes their prices higher and yields lower. The lower long-term yields feed into the already historically low mortgage yields, pushing them even lower still, thereby resuscitating the moribund housing market. At least that's 'da plan.

But--in a cloud of dust on the horizon--the infamous bond vigilantes are riding in. They've got a lot of rope and they've got ugliness in mind. They're selling bonds, driving prices down and yields higher.

Part of the problem can be traced back to early 1994, a watershed event in Fed policy. At that time, Greenspan undertook what had been the usual course of monetary policy - he surprised markets. Beforehand, investment bankers were coolly raking in billions with the so-called carry trade. This is simply borrowing at very low rates and lending at higher rates at longer maturities. As long as the Fed plays along, this is a low-risk strategy to keep Wall Street in $3,000 suits and block-long limos. But the Fed didn't play along. It surprised markets by raising rates. Havoc ensued, rates skyrocketed, and a lot of money was lost. Greenspan never liked upsetting investment bankers. Pulling the punch bowl at the party wasn't his style.

Since then, the Fed, at the Federal Open Market Committee meetings, and in public speeches, has played along. Today it carefully announces its intended policy. Before any actions are taken, it makes sure the investment banking world knows exactly what it will do.

The upshot of all of this is that prices react ahead of the action (would somebody please explain this to the Fed Chairman?). What would you do if you were in the market for a big screen TV and Best Buy told you they were raising prices 15% next month?

Today this creates a dilemma. The policy has been announced, rates dropped, and employment has been minimally affected. Now the policy is occurring, but the bond vigilantes are selling; and the outcome is the opposite from that intended. Interest rates are on the rise. It is indeed getting ugly.

Wednesday, November 17, 2010

QE2 for Dummies

There are a million things wrong in this video, but it is a big hit. The American public is going from total ignorance to being misinformed. The video makes one good point - it does seem that we are in an episode of the twilight zone. I am saying this as one who is totally against quantitative easing and one who believes the Fed has made serious errors.

I would like to make an unusual suggestion-why not require a course in economics in high school?

Tuesday, November 16, 2010

A License to be Nosy

One advantage to being a financial advisor is that you get used to being pretty nosy about people's finances. It is, however, depressing because, like so many things in life, you find that there is what economists call a type of adverse selection going on. The people who read personal finance and investing blogs and attend investment workshops are not those who need it most. And the people who need it most are walking around clueless.

This past week my TV went out as I was channel surfing, so I got the Comcast guys to come out. One was in his early 30s and the other was in his early 40s.

My nosy financial side (and business side as well!) surfaced, and I asked them if they were participating in their company 401k. From their expressions, I could tell they had never been asked this on a call; and I could just as well have asked if they thought there is life in outer space.

The expressions didn't alter one iota when I asked if Comcast has a company match. Maybe I'm extending my financial boundaries a bit here, but this is a question every employee should be able to answer for their particular company. If you've ever wondered why most financial advisors are bald, it is because they have lost their hair or pulled it out because people can't answer this question.

To state the obvious, taking advantage of the company match is free money; and one day, when we have stopped drawing a paycheck, all of us will be highly appreciative of this free money.

I could tell you the response later in the day from the lady who gave me the eye test at the Maryland Department of Motor Vehicles, but I'll spare you.

Hopefully I've made my point.

Monday, November 15, 2010

E* Trade Wisecracking Baby

If you're like me, you pay a little more attention when new Geico and E*Trade wisecracking baby ads come on. In fact, there have been times when, sadly, they have been the best part of a Sunday afternoon of football - especially if you live in the Washington D.C. area.

Anyways, you may have wondered what filters through the mind of a financial planner type as he or she views the baby dissing the family dog for not warning that the parent was coming to take his laptop or tablet in his "timeout."

Well, maybe you didn't wonder; but anyways.

The financial planner is figuring how old the baby is. I'm guessing the baby is 3 years old. And, obviously, the baby is earning a lot for the commercial. If the baby opens up a Roth IRA and deposits $5,000 (you need at least $5,000 in income to do this) and can make 8%/year, then in 62 years the baby will have approximately $590,000 from this one investment. Think of doing this for 3 or more years and you see the possibilities.

What to invest in? Maybe buy 107 shares of EEM - the emerging markets ETF to begin with.

For those who have been living in a cave and haven't seen the E*Trade baby, here is a link.

Sunday, November 14, 2010

A Picture is Worth a Thousand Words

I just finished discussing hyperinflation with my macro economics class. They'll see this picture tomorrow. It proves that a picture is worth a thousand words.

From Greg Mankiw's blog.

Two Investment Resources the DIY Investor Should Know

One of the very best ways to follow personal blogs is through weekend reading lists. Bloggers take the time to list interesting blogs of the week, usually with a short summary, making it easy to find posts that you might want to read. A good example is Dividend Monk's "Weekend Reading." This is resource #1.

In Dividend Monk's list this week is the "Dividend Calendar" from the "I Love Dividends" site. This second resource lists companies expected to pay dividends each month. For example, if you need income in August- you might want to pick from the following:
Gen. Mills

Notice that some companies are listed by ticker symbol and that they link to their Yahoo! Finance site, making it especially easy to check their dividend-paying record and yield. To me, this is similar to the popular bond ladders that investors like to create.

My readers know that I prefer low cost funds. I do, however, recognize that there is more than one way to skin a cat and that some investors have the time, know-how, and resources to pick individual stocks (especially those who are retired and need income).

Disclosure: This post is intended as a reference only. Investors should do their own research and consult professional advice pertaining to their specific situation.

Saturday, November 13, 2010

Cisco's Message?

Cisco earnings disappointed, big time, this past week and the stock got hammered in the process. So what's the message? CEO Chambers put the blame on governments cutting back spending - not just in the U.S. but in Europe and Asia as well. But we knew this. Apparently what we didn't know was the extent of the cutbacks and the timing.

Cisco is a bell-weather. Chambers said "We believe the public sector business will continue to be challenging for at least several quarters."

In the bond market, the Treasury struggled through another week of heavy issuance as yields pushed higher, especially at the longer end.

The S&P 500 is up a bit more than 9% year-to-date and bonds have also done well. To me, this adds up to a time to be a bit cautious and take some profits.

Disclosure: Commentary here is not intended as advice for any specific investor. Individuals should do their own research or consult an advisor as to their specific circumstances.

Thursday, November 11, 2010

Grab aTissue - Thanks Veterans!


"Beggar Thy Neighbor"

"Beggar Thy Neighbor." Ever heard the phrase? If you've studied the Great Depression, you have. "Beggar Thy Neighbor" is an action on the part of countries that is said to have exacerbated the Great Depression. It is when countries devalue their currency, thereby lowering prices to sell their goods more easily on world markets and, at the same time, not buying the goods of their neighbors. It is a modern version of mercantilist policy.

To understand currencies, picture the situation near to where I live. There is a circle and catercorner to each other are a High's and a Royal Farms (convenience stores for you Canadian readers), and each sell gasoline with their prices posted prominently on billboards. If one has regular gasoline at $.02/gallon less than the other, then it has a line of cars at the pumps and gets the bulk of the business for the day. In the same way, if the dollar drops versus the Euro, say, then all goods and services in the U.S. are thereby cheaper. This occurs naturally with the ebb and flow of demand and supply in the course of global trading. The problem is when currencies are aggressively manipulated by the world's largest economies. After all, isn't this what we are aggressively hammering China about?

All of this is, of course, well known by Federal Reserve Chairman Bernanke because, after all, he is a recognized expert on the Great Depression. This begs the question, therefore, of why he is pursuing a "Beggar Thy Neighbor" policy with his Quantitative Easing II program - especially given the fragile state of the world economy. He fully understands that lowering longer-term interest rates by buying bonds will cause the dollar to drop and U.S. goods to be more easily sold on global markets etc. He gets that pressuring the Chinese to increase the value of the Yuan will result in the U.S. buying less Chinese goods. He hopefully comprehends that all of this increases the odds of a trade war and is poor timing, given the state of the global economy. Even some of the Fed governors understand this.

At the same time, we have Treasury Secretary Geithner, like a parrot over in the corner, repeating the refrain that "the U.S. supports a strong dollar."

All of this has the G-20 in a tizzy and is leading to a possible confrontation at this weekend's meetings.

My prediction (going out on a limb here) is that global pressure will get the Fed to back off or at least lessen its policy and, thereby, cause the dollar to push higher, taking interest rates with it. I believe the rise in the dollar over the past couple of days reflects this expectation. Sadly, the actions of our policy makers continually make it difficult for business to operate. Who can be willing to hire workers in this environment?

Need Inspiration?

Andrew Hallam is a bone cancer survivor, an English teacher at the American School in Singapore, and a man who accepts a challenge head on. He also has a talent and a love for exploring the world of investing.

Here is one of his latest challenges:

Is there any doubt this will be added to his list of conquests?

Wednesday, November 10, 2010

Nasty Day in the Bond Market

Yesterday the yield on the 10-year Treasury note popped 12 basis points from 2.60% to 2.72%. As recently as last Thursday, this yield was at 2.53%.

Yesterday's upward push came as the U.S. Treasury auctioned off $24 billion in 10-year notes.

And, actually, the results of the auction were fairly good. Here's Bloomberg's assessment:

The 10-year note auction stopped out one basis point under the 1:00 ET bid, showing strength in line with the last four 10-year auctions. Coverage of 2.80 is strong yet is the lowest showing of the last nine auctions. Strong non-dealer participation is a big positive as dealers were awarded only 34 percent of the auction for the lowest share of the last six auctions. Money is moving into the Treasury market following the results.

The big question, of course, is whether this is the bursting of the much-discussed bond bubble.

We are past the news on Quantitative Easing II. We know the Federal Reserve's time frame and that they intend to buy up to $600 billion. We've seen some Fed governors expressing doubt about the efficacy of the move. We know that there is well-respected voluminous empirical evidence supporting economic theory that states that printing money is inflationary and non-beneficial to the real economy in the long run.

It reminds long-term observers of the macro economy during Nixon's price controls. Economic theory and evidence clearly shows that price controls lead to distortions that increase the longer they are in place. Yet Nixon's economic team somehow didn't understand this. Once the controls were lifted, inflation took off.

Today the Treasury auctions the 30-year bond. Its yield is up to 4.25% after dipping below 4% earlier in the month. It should be an interesting auction. If you can't wait for the results, tune into CNBC shortly after 1 pm.

As they used to say on Hill Street Blues, "Be careful out there."

Tuesday, November 9, 2010

Bonds at AAII/Baltimore

Mutual fund cash flows show investors piling into bond funds despite warnings of a developing bond bubble. Are you unsure of how bond funds work? Could you use a brush-up on bond strategies? Are you, like many investors, scrambling for extra yield?

This Saturday, at the monthly meeting of the American Association of Individual Investors (AAII) Baltimore Chapter meeting, Ed Gray of ScottTrade Inc. will give a presentation on "Bond Basics." He will talk about types of bonds, bond laddering, bond ETFs, and even preferred stock.

Learning to manage one's investments is, I believe, one of the highest self-education paybacks available. For example, the typical advisor will charge between $10,000 and $20,000/year to manage $1 million. That's for one year. Do the math, and you can figure the cost over 20 or more years.

A useful step in learning how to manage one's investments is to attend meetings like the monthly meetings of the AAII. After one year or so, with the speakers on various topics and discussions with other do-it-yourself investors, you could very well be on your way to intelligently managing your own money.

The fact is that, with the direct contribution/401k movement, we have been put in charge of managing our own retirement funds. The choice is to pay dearly for having others do it for you or seek to learn to do it yourself.

Monday, November 8, 2010

Is Inflation Over Emphasized?

From time-to-time I'll come across a comment that will just stop me in my tracks. I'll reread it and then it will stick in the back of my mind for days. That happened last week when I read a blog that said financial planners over-emphasize inflation. I read it, reread it, and said huh? I just couldn't understand how a personal finance blogger could think that. To me, it was like someone saying it's OK to sleep on a railroad track.

In the financial planning world, of course, I come across this fairly often. ,People will point out that if they put their money in a 10-year Treasury note, it is perfectly safe and the interest it generates is enough to live on.

Two issues: interest rates change, and the amount of goods the interest payments buy today are a lot more than they will buy in 10 years because of inflation. Let's look back 10 years.

Suppose you retired 10 years ago, put your savings into the 10-year Treasury note and it generated $38,055 in interest payments. Suppose also, along with Social Security and other income sources, you figured this as providing you with a comfortable retirement.

Now move ahead 10 years. What will this $38,055 buy today in terms of goods and services? In other words, what has been the impact of the general rise in prices, i.e. inflation, over the past 10 years?

To answer this, go to the Bureau of Labor Statistics inflation calculator, and put in $30,000 and change the year to 2000. You'll find that, today, the $38,055 will only buy $30,000 in real goods and services - a 21% reduction in buying power! And this in an environment that experienced exceptionally low inflation.

But this isn't the only thing that upset the apple cart. On 1/1/2000 (yipee - Y2k didn't do us in!) the 10-year Treasury note yielded 6.67%. Today it yields 2.54%. Ooch!! Although greatly simplified, this partially illustrates the bind that many retirees find themselves in today.

Today's young people, on the other hand, have lived in a world of low inflation. Maybe most think it's non existent because it has crept up so slowly.

If they listen closely, they will hear their grandparents lament over the fact that the dollar doesn't buy what it once did. This is an expression of inflation.

Henny Youngman put it like this: "The country is getting stronger. It used to take two adults to carry $20 worth of groceries. Today a 5-year-old can do it." This is an expression of inflation.

All of this illustrates the impact of low inflation over a period of 10 years. But what's ahead? Prognostication is (besides not being easy to spell) always tricky, but the fact is that the Federal Reserve has taken the country into uncharted waters. The printing press is running overtime, and banks are filled to the brim with excess reserves. Inflation is caused by an excessive rate of growth in the money supply.

Is inflation over-emphasized? I think not.

Sunday, November 7, 2010

Parsing the Fed

Understanding the Federal Reserve is not easy given their convoluted, jargon-laden use of the English language. They have, however, improved since Alan Greenspan's tenure during which he took pride in confusing Congressional panels. It never seemed to bother him or Congress that he was mandated by law to explain the nation's monetary policy and, yet, publicly took pride in his ability to befuddle members of Congress. is a link to the NPR "Planet Money" site (one of the very best resources for those interested in entertaining ways to learn economics) that parses the most recent Fed statement explaining the $600 billion quantitative easing policy. It uses a tool created by Slate's Jeremy Singer-Vine called "Plain English."

Saturday, November 6, 2010

Quantitative Easing - Part II

There are two subtle dangers to quantitative easing (QE) that go beyond the massive build-up in bank excess reserves which could lead to an explosion in the nation's money supply and virulent inflation down the road. Before I get to them, let me say that a lot of people feel like we're watching Charlie Brown getting ready to kick the football as Lucy is placing the football in place. We've been down this road before in a different guise. Ten years ago we were assured by a prior administration that, by today, we would have balanced budgets. Well, where are they? What? We can't cut spending because of unemployment pushing 10%? The deficit is $1.3 trillion.

Today we are told that, when it comes time to reverse the QE to sell longer-term Treasuries to counter inflation, the Federal Reserve will be up to the task. Please, Charlie. Don't try to kick the ball!.

Danger I
Suppose QE is successful. Suppose the unemployment rate drops as inflation rises, but inflation is nipped in the bud as the Fed successfully reverses its policy. How could this possibly be a danger? Let's think back. Former Fed Chairman, called the "maestro" in the latter part of his tenure, was seen as the best Fed Chairman to ever hold the position. He was adept at manipulating the fed funds target rate every time the economy needed a boost or was viewed as too strong. Eventually traders came to expect a bailout by the so-called "Greenspan put." In other words, it led to excessive risk taking. We are still trying to dig out from the consequences.
Success this time will make it easier to use next time. This leads to ongoing manipulation of the economy until risk is no longer correctly priced. This is a dangerous situation.

Danger II
We are slowly digging deeper and deeper into a "do as I say, not as I do" situation. Consider Treasury Secretary Geithner's remarks:

“We will never use our currency as a tool to gain competitive advantage,” Geithner told
reporters today after a meeting of finance ministers from the Asia-Pacific Economic
Cooperation group in Kyoto, Japan.

Huh? Is there anyone who isn't pointing to the beneficial impact on the U.S. Trade Deficit from the falling dollar. On the previous quantitative easing post, Shawn Watson commented about arrogance. Are our officials not aware of how arrogant we look when we say one thing, do another, and then tell other countries how to manage their currencies?

Friday, November 5, 2010

Kiplinger's "Best Simple Portfolio"

Kiplinger's "The Best List" has a number of interesting entries this month, among which is their "Best Simple Portfolio"." In line with the theme of this site, it is comprised of low cost funds:

33% VTSMX Vanguard Total Stock Market
33% VGTSX Vanguard Total International Stock Index
33% VBMFX Vanguard Total Bond Market

This portfolio, as they point out, beats most investors. In fact, over some longer periods, similar types of portfolios, after fees, have been shown to beat 90% of active professional investors who tout their stock-picking and market-timing abilities.

Kiplinger's reports that, over the past 10 years, it has achieved an annualized return of 3%. Year-to-date through 11/4, it is up 11.14%.

I agree with Kiplinger but would prefer to use exchange traded funds and flesh out the portfolio a bit with a few extra funds. Also, the portfolio has to be adjusted for risk tolerance specific to particular investors. In any even,t investors can easily adapt the "simple portfolio" to use as a benchmark to assess how well they or their advisor is performing.

Thursday, November 4, 2010

What Is Quantitative Easing?

Yesterday the Federal Reserve, accompanied by considerable hoopla, announced a $600 billion "quantitative easing" (QE)program. This is actually QEII. After QEI, the stock market moved higher; so understandably some are happy. The job market? Not so much.

To understand QE, it is helpful to review normal Federal Reserve policy. Typically the Fed targets the federal funds rate. This is the rate at which banks lend each other reserves. Banks are required by the Fed to hold reserves versus deposits. The federal funds rate affects other short-term rates. Longer term rates are typically influenced by inflation expectations - not the Fed.

As it has turned out in the current business cycle, the targeting of the fed funds rate is no longer an option for improving the economy because the Fed has pushed it to practically zero, with zero results. In other words, the Fed lowered the rate to practically zero; and we still have unemployment close to 10% with the possibility of further job market deterioration.

QE is a different policy from targeting the fed funds rate. Instead of targeting a short-term interest rate, QE commits a certain amount of money to buy longer maturity bonds. It will impact longer term interest rates. Yesterday the Fed announced a $600 billion QE program.

Here's the thing to get: the Fed creates money out of thin air. Think about this - if you want to buy my house, you have to get the money from somewhere. You have to get it from your savings or borrow it from somewhere. Not so the Fed. It just writes a check. What backs the check? Nothing. It is what is called "fiat money" - money by declaration. Money is literally created out of thin air.

Yesterday I posted a video where people were interviewed asking if Obama was a Keynesian. The responses were pathetic. Some thought the question was about if he was from Kenya. Along the same lines, if you asked people if gold backs the nation's money supply, most would say yes. The American people have no idea how Federal Reserve policy works. This would require an understanding of our basic economic system - something our leaders in education haven't deemed important.

Anyways, when the Fed buys bonds, the check is deposited and, thereby, the amount of money in the economy is increased. Banks can lend the excess reserves created by this transaction, and the amount of money in the economy would go up even more. This is what the Fed is hoping for but hasn't occurred yet.

This process is called "monetizing the debt"." And there is a lot of debt out there. It is the equivalent of running the printing presses to print money.

Why is the Fed buying bonds? After all, they could put money into the economy by buying anything - used cars, for example. They are buying bonds because it is a way to control longer-term interest rates - like the rates on mortgages, for example. They've come to the end of the line on controlling short-term interest rates; now they are after longer-term rates. In other words, they are now controlling the price of short-term money and long-term money.

QE is just another step on Hayek's "Road to Serfdom".

Wednesday, November 3, 2010

Is Obama a Keynesian?

I watched this video closely two times to ensure that none of my ex students were in it. If they had been, I was going to get some change of grade forms and submit "F"s. Thinking about yesterday's elections - don't complain people - we get exactly what we deserve! I'm not sure if I've ever seen a better piece on why the school system needs reform.

Tuesday, November 2, 2010

The Rule of 72

Last night's class was about inflation; and we talked a bit about what the CPI measures, how it is measured, and some of its shortcomings. During the class, I brought up the "rule of 72" mainly to show how long it takes for prices to double under given rates of inflation.

The rule of 72 is a good way to look smart, and one of the objectives in the work world is to convince people (especially your bosses) you're smart.

For example, if you tell me an investment will earn 4%/year, then I can tell you right away, off the top of my head, that it will double in 18 years. Pretty smart, huh?

To provide a practical application of the rule, I decided to spend a couple of minutes showing the results of saving at a young age.

The Rule
The rule is simple: 72 divided by a growth rate gives an answer on how long it will take for a magnitude to double. For example, if something is growing 8%/year, compounded, then the rule says 72 divided by 8 = 9 years. 9 years is the time it will take to double.

For homework, figure out how long it will take for a magnitude to double if it grows 4%/year.

The Lesson
Next, by a show of hands, I asked how many students were 20 years old; and most of the hands went up. That's what we worked with. I assumed an initial investment of $1,000 and an 8% average annualized compound return. By the rule of 72, that $1,000 will be $2,000 by the time the 20-year-old turns 29 years old.

We get the following:

29th birthday $2,000
38th birthday $4,000
47th birthday $8,000
56th birthday $16,000
65th birthday $32,000

If you think about this a little bit, you'll be able to understand why the dollar today is worth approximately one-fifth of what it was worth when I was in school (3 Musketeers bar cost $.25 versus $1.25 today). You'll understand Henny Youngman saying "the country's getting stronger - it used to take 2 adults to carry $20 worth of groceries, now a 5-year-old can do it." These, of course, are different ways of expressing inflation.

I let the class in on another piece of news. Subject to the workings of the Darwin awards, most of them would wake up one morning surrounded by friends and family with a birthday cake to celebrate their 65th birthday. This is not easy to grasp for a 20-year-old. It wasn't easy for me when I was 20.

The point is a basic one of personal finance: save when you're young and you don't have to save as much.

The corollary is: saving when you are young gives you choices when you are older. This is where a Walmart greeter as a guest speaker would be useful.

Additional Resource Interesting YouTube for those interested in critical thinking and learning more about the rule of 72.

Monday, November 1, 2010

Some Year-To-Date ETF Returns

Here are some year-to-date returns on indexed exchange traded funds from Morningstar :

Vanguard Total Stock Market VTI +9.14%
Vanguard Europe Pacific VEA +5.47%
Vanguard Emerging Markets VWO +13.96%
Vanguard Total Bond BND +8.28%
Vanguard REIT Index VNQ +25.34%
SPDR Gold Shares GLD +21.59%
GSCI Commodity Index GSG -2.28%

Returns are based on NAV. To find performance numbers, go to the Morningstar site ; enter ticker symbol :

CLICK TO ENLARGE Click "performance" and scroll down.


The funds' returns vary widely and may indicate a need to rebalance from, say, the REIT fund VNQ to the commodity index fund GSG, depending on the rebalancing band used.

Disclosure: the data here is for informational purposes only and is not intended as a recommendation. I hold some of the funds mentioned.