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.

Friday, October 14, 2011

Bulls, Bears, and Black Swans

"Those who do not learn from history are doomed to repeat it." - George Santayana
Mention black swans and you get investors' attention.  These are the rare events that destroy portfolios.  Unfortunately, they are not as rare as commonly thought.  Two have occurred in the last 10 years - the bust and the housing crisis.  The term, of course, was popularized by hedge fund trader Nassim Taleb in what was said to be the most widely read book on Wall Street a few years ago - The Black Swan.  The book is a must-read for DIY investors.  It is one of those books where you'll feel smarter after you've read it.

In another must-read, The Investor's Manifesto, William Bernstein says, "...the only black swans are the history that investors have not read."  This is his way of saying that extreme financial events won't be a surprise to those who know their financial history.  Bernstein cites the Great Depression during which stocks lost 90% of their value.  Interestingly, Taleb's investment approach is to stay highly liquid, hide in the bushes, and be ready to pounce when the black swan arrives.  It's an approach that has worked for him.

Bernstein uses this background to support his point that using historical returns can be costly.  In essence, it is looking in the rear view mirror - something investors do naturally.  An example he uses is highly relevant to today and worth thinking about for the DIY investor, especially those piling into bonds today.

From 1952 - 1981, long-term Treasury bonds had an average annualized return of 2.33% as inflation averaged 4.31%.  In other words, they had a negative real return over the period.  Over the same time frame, the S&P 500 returned 9.89%.  Bonds were referred to as "certificates of confiscation."

At the Treasury auction of 9/30/81, 20-year Treasury bonds were auctioned to yield 15.78%.  Over the 5 years up to that point, inflation averaged 10.11%!  As I recall, this was the weakest auction in terms of bidding interest in the history of the U.S. Treasury - this despite a "real" return in excess of 5%!  At the time Fed Chairman Volcker had already tightened money drammatically.  Over the ensuing 5 years, inflation dropped to 3.42%.

Over the 20 years following this auction, the real return (after inflation) on the long-term Treasury bond was 8.66%.

Today we find ourselves at the other end of the spectrum.  Recently the yield on the 10-year Treasury note dropped below 2%, producing exceptional returns in an environment where inflation has been anemic.  Inflation, however, is showing signs of perking up and is well above 2%.  The Federal Reserve, furthermore, has aggressively expanded their balance sheet by monetizing the debt aggressively with their various "quantitative easing" programs.  Banks are flush with excess reserves that could see a dramatic flooding of the economy with money over the next several years, thereby further fueling the inflation that Chairman Bernanke so desperately seeks.

But investors are looking in the rear view mirror and sopping up Treasury notes at every auction. Beware the black swan.


  1. I wish I would have bought long term treasuries in 1981 or zero coupon bonds. I did buy some several years later when I had some investable cash.

    What's you recommendation for the bond allocation? Keep maturities short? Buy TIPs? Stay in cash and wait for rates to go up? Or short long term gov't bonds? It's hard to know just how long the Fed will keep interest rates artificially low.

  2. Reading your article has been pleasure. Perhaps looking at what is happening with the stock market, interest rates with the banks and news from the past - people do learn.

    There is no incentive to save or a hope to preserve your money. Whereever you look - little or no hope. Believe you me, looking at our family budget the real inflation is on the rise.

    College fees, medical bills, gas, air line fees,....

    I start wondering where should we go for financial independence. As for 1-2% real return stock market is too risky.

  3. It is all about fear and greed (in a good way)!

    Back then during the dotcom boom, stocks were reaching dizzying heights and gold was largely ignored. Yet everyone kept pilling money in equities.

    After the boom, stocks started falling and gold started rising. Now I see a lot of chatter on how gold is the way to go!

    Looking back, wish I had bought gold (or even long term bank CDs) when the focus was on stocks. Looking forward, I'm buying more equities, now that fear has taken a strong grip pushing gold forward.

  4. re:Gouch I staying short in bonds (CSJ)and using corporates (LQD)and mortgage-backeds (MBB). Bill Gross made a big committment recently to mortgage backeds. I don't know if that's good or bad since he has been very wrong on the bond market this year!
    re: Financial Independence I actually think stocks can do well over the long term. People up their allocations after a period of good returns - like in 2000. The best time to invest is after a 10 year period where the market has not done well but earnings have increased. I am encouraging young people especially to load up on stocks by buying index funds.
    re: MC I agree with what you are doing. If you are going to time asset classes you have to be a bit of a contrarian - not easy to do!