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.

Thursday, May 31, 2012

Duffy's Bakery

Duffy's Bakery.

We walked the railroad tracks, then a short ways through the Connecticut woods, picking blueberries along the way. Trays of hot donuts, chocolate eclairs, and various breads fresh from the ovens. Treats offered up as we entered to see my Aunt Sally.

At night Aunt Sally  brought leftovers back to the apartment in the Three Rows Greek village - the row house village of mill workers - many of whom didn't speak English.  The summer nights were long and hot, and we kids exploited them to the fullest.  After dinner we grouped among the row houses to start up a game of kick-the-can. We ran until it was pitch black - older kids, younger kids - all joined in.  The adults sat on the steps, talked and watched.  Many not long from Poland and other Eastern European countries.

James ArnessSweaty, laughing, jostling we made our way to our respective small apartments at the end of the night.  Shortly after bathing and eating a Duffy's Bakery donut, Uncle Ernest came in from his job as a mill guard.  He plopped in front of the little black and white TV set in time for the start of "Have Gun Will Travel."  We spent the summer watching his beloved Westerns including his favorite - "Gunsmoke."

Fast forward a few decades and I'm getting up in the dark.  I'm driving to Shady Grove Metro to get to downtown D.C.  Managing money for pension funds, corporations, and endowments.  On the best of days, it was 1 hour 25 minutes one way door-to-door.  On many days, it was considerably longer.  At the end of the day,  I return home in the dark.  I am paid more than I am worth - but so is 99% of the industry.  I have a big house, a big SUV, and a TV that gets at least 50 channels - I have never actually counted them, although I have been tempted on stressed-out nights when I could find nothing to watch.

Weekends came and I vegged out, pretty much oblivious until the alarm went off on Monday morning.  Stuff piled up.  I know because I'm in the process of downsizing and have been involved in getting rid of the stuff.  I mentioned this to a friend, and he recommended I watch George Carlin's routine on "Stuff."

Three Rows Greek Village is still there.  Mostly boarded up, although there are a few apartments still occupied.  The mills are closed, so it is no longer a gateway for immigrants into American life.  The factories moved South and then overseas - it's all part of America's economic  history.

And I wonder when in my life have I been the richest.  I wonder how we measure being rich.  Is it just about piling up dollars?  Bloomberg thinks so.  They have a list of "...the world's richest people."

When were you the richest?

Monday, May 28, 2012

The First Thing You Need to Know About Retirement

One of the first steps in retirement planning is figuring out where your income will come from as you transition from receiving a career paycheck to receiving a paycheck from Social Security, your nest egg, a pension, and possibly other sources.

Today, you can find out how much you can expect to receive from Social Security by spending a few minutes online to create an account. If this was a recipe on the Food Network, it would be rated at the "Easy" level.

Go to  Create an account. Write down your password and the answers to the security questions in a safe place (especially if you are approaching the age where you plan to start taking Social Security!).

You'll come to a page that shows the amount you are expected to receive if you begin at "Full Retirement."  Next click "View Estimated Benefits" as shown:
Source: Social Security Administration

This will give you three numbers:  amount you would receive today (if you are over 62 years old), amount you can expect to receive at your full retirement age, and amount you can expect to receive at age 70.

This, of course, is an important first step in retirement planning.  At what age to take Social Security is the next step, and here a number of variables and assumptions come into play including spousal benefits, longevity assumptions, other sources of income, etc.

While you are on the site, be sure to check that your earnings record is correct.  If you are looking for a source that analyzes the question of when to take Social Security, check out A Social Security Owner's Manual by Jim Blankenship.

If you are looking to do a good deed on this beautiful Memorial Day, pass this information on to someone you think might find it useful.

Sunday, May 27, 2012

What Do Mutual Funds Cost?

Yesterday we looked at an approach to picking mutual funds for a 401 (k).  In particular we focused on the Maryland Supplemental Plan used by firefighters, teachers, police, and state and county workers. In other words a lot of people in Maryland participate in this plan to build a retirement nest egg.

We suggested, based on academic evidence and the recommendation of people like Warren Buffett and Burton Malkiel, that participants focus on low expense funds that track the market.

The question then becomes what is the difference in terms of dollars? Suppose we assume that the 3 funds that we considered yesterday each achieve an average annualized return of 7.5% over the next 20 years. After subtracting fees what will be the impact?

A neat little calculator to do this calculation is available at . . At the bottom of the page click Mutual Fund Fee Calculator .

Source: MarketRiders
For our example let's assume that $5,000 is i-nvested in each of the 2 higher cost fund offerings in the "Large Cap" sector looked at yesterday. The Neuberger Berman fund has an expense ratio of .69% and the Parnassus fund has an expense ratio of .75%.  For those in other plans, you may very well notice that the funds you are offered have expenses considerably higher even than these!

Click "Calculate My Fees" and you'll find that the annual fees are $74.00 and the value of the portfolio, under the assumption of a 7.5% return, after 20 years is $36,998.40.

Source: MarketRiders

Go through the same exercise and put in $10,000 for VIIIX , the low cost Vanguard fund that tracks the S&P 500.  You'll find that the portfolio value is $42,320.73 - 14% higher!

Granted, it's not going to be this clean in the real world. The funds will have differing returns. The surest outcome is that VIIIX will perform close to the S&P 500. The difference between the 2 alternatives could in fact be greater than 14%.

But think of this- if the portfolio is $1.0 million and the difference is 14% then it equals a number of years of payouts. Typically a safe withdrawal amount if taken to be 4%. This would be $40,000/year from a $1.0 million portfolio. The 14% difference (after just 20 years!) amounts to 3.5 years of draw downs.

 Disclosure: This post is for educational purposes only. Individuals should do their own research or consult fa professional before making investment decisions.

Saturday, May 26, 2012

Oriole Esskay Hotdog Race and Investing

Last night found me at Camden Yards (courtesy of an invite from my buddy Mike) watching the Orioles whup up on the lowly K.C. Royals.  Walk-up tickets sold were the largest in the franchise's history, and the atmosphere felt like an ALCS playoff game. Excitement is building as the Orioles continue to lead the division and major league baseball in wins.

As those who have been out to the Yard know, one of the popular, albeit goofy, side entertainments is the Esskay Hotdog Race where three cartoon hotdogs race on the jumbo screen.  The crowd jumps up and down and yells for their favorite.

Anyways, it struck me that picking a favorite hotdog in the race is probably similar to how many 401 (k) participants pick their investments.

This particular problem was on my mind because, in the morning, I had met with a young lady who works for the county and sought my help "getting started and learning about investing."  She told me she was the first one in her family to invest and is excited to learn the process.

An important part of the process that sometimes confuses people is choosing which funds to invest in.

As I watched the hotdog race, I reflected that probably 20% or more of the baseball crowd had likely faced this issue, via the exact same investment vehicle The Maryland Teachers and State Employees Supplemental Retirement Plans.

So how do you choose which funds to invest in?  Some plans have a ridiculous number of choices, and this is one area where research has shown that too many choices can be detrimental.  Thankfully, the Maryland Plan has a reasonable number of choices.

Some participants throw up their hands and go with target date funds.  These funds set an allocation based on your expected retirement and make rebalancing moves over time.  This is OK and is a lot better than not participating.  But choosing funds directly is a less costly method that can more accurately reflect risk tolerance.

Picking Funds

By the time you've come to pick funds, you've already picked an asset allocation model.  The young lady and I agreed to start with the "Moderate Model" which is basically 60% stocks and 40% bonds. Even though she is young and can stand some volatility, we thought it best to start a bit conservatively.  I explained, since she will be contributing on a regular basis, that the best thing for her would be for the market to drop 50%!  What is important to her is where the market is 30 years from now - not what happens over the next few years.

The "Moderate Model" specifies 30% allocated to "Large-Cap Stock Funds."  The choices offered are shown in the following table along with 1-year, 3-year and 5-year performance numbers:

FUND Ticker Exp Ratio 1 Yr.  3 Yr. 5 Yr.
Neuberger Berman Partners Fund Inst. NBPIX 0.69% -7.81% 23.60% -1.43%
Vanguard Instl. Index Fund Plus VIIIX 0.02% 8.54% 23.47% 2.07%
Parnassus Equity Income Fund Inst.  PRILX 0.75% 5.73% 20.67% 5.97%
S&P 500

8.54% 23.42% 2.01%

There are actually 3 additional choices, but they are not "Large Blend."  "Large Blend" means that the funds blend value stocks (i.e., those with low P/Es) and growth stocks (i.e., those with higher than average earnings growth).

So how do we choose?  Is this like picking in the cartoon hotdog race?  Should we throw darts? Actually there are well-defined principles supported by academic research and recommendations from leading market analysts.  Those who support this approach include Warren Buffett, Burton Malkiel (author:  A Random Walk Down Wall Street), Charles Ellis (author:  Winning the Loser's Game), Andrew Hallam (author:  Millionaire Teacher), and, of course, John Bogle, founder of the Vanguard Funds.

The process is straightforward:  pick funds that have low expense ratios and closely track the overall market.  This leads us to choose the Vanguard Fund with its .02% expense ratio and close tracking of the S&P 500 stock index.

As you go through this exercise, you notice that the low-cost index fund is not the best performer over some periods.  That's fine and to be expected.  It may not even be the best performer in the future.  What you get when you pick a low expense ratio fund that tracks the market is a fund that will beat 8 out of 10 competitors in a long-term race.

One point that gets a bit tricky is style.  Are the funds really "Large Cap Blend?"  To check this, go to Morningstar and put in the ticker symbol.  Do this for PRILX, the Parnassus fund listed above, and scroll down a bit.  You come to what is called the "Style Box":

Source: Morningstar

We find that, rather than a Blend, it appears the manager has tilted towards Growth.  A sausage has snuck into the race!

Scrolling down on the same page will show you as well that the fund has a brand new manager!

Disclosure:  The information here is intended for education purposes.  Individuals should do their own research or consult with a professional before making investment decisions.

Thursday, May 24, 2012

Create Income in Retirement

There are two kinds of people in my world:  accumulators and decumulators.  I try to get the accumulators - those contributing to their nest egg on a regular basis - to look at the current market craziness as an opportunity.  They should care about the market 10, 20, 30 years from now.  Volatility presents an opportunity. Decumulators, on the other hand, have to be careful and ensure that they have a plan to handle volatile markets.

One product that can help in this, and which I've discussed on several occasions, is the single premium immediate pay annuity (SPIA).  This creates an income stream and essentially is a way to get back to a defined benefit situation.

One product I haven't mentioned is longevity insurance.  The concept is similar.  Pay a lump sum today for a guaranteed income when you reach 85 years old, say. This is an insurance product.  Die at 84, and you have received the comfort of knowing you would not run out of money but nothing more.  Live to 108 years old and you win, and you have an income to the end.  Best of all, it is relatively inexpensive.

An excellent overview of these products is given in Seeking Pension Replacement in Retirement by Mark Miller of Morningstar.  I would recommend that retirees and those entering retirement carefully read this article.  In fact, if you know any retirees (your parents, for example), have them read the article.

Also, if you are a member of AARP, send in the postcard from their monthly magazine to New York Life to get a quote.  Get a quote from Met Life.  A little research can save a couple of bucks.

Important caveats:  only consider a SPIA (other types of annuities can be hazardous to your financial health) and understand that, when you purchase an annuity, you lose control of the funds!

Disclosure:  I don't sell insurance and do not have a license to sell insurance.  This information is for educational purposes only.  Individuals should get professional advice based on their specific situation before making investment decisions.

Monday, May 21, 2012

Monte Carlo Analyses - Useful or Not?

Financial planning is challenging because of the number of unknowns.  We reach a point where we aren't generating a career-type paycheck, from which date we need to generate an income.  We don't know how long we need to generate an income, the rate of inflation, or what market performance will be.

We can start by making point assumptions on the unknowns.  We can assume we'll live to be 100, inflation will average 3%, and our investments will earn 7%.  Then, given the desired income and our income sources, we can see whether our plan will succeed.  As we think about this, we realize that it is way too simplistic.  One important observation is that sequence of market returns and inflation are important.

An "elegant" way around this problem is to carry out a Monte Carlo analysis where many paths are generated for inflation and market returns.  Then, of the paths generated, we can get a percent of success determination (I hesitate to use the term "probability" because we are using a sampling technique - it is not exactly like flipping a coin which is, in fact, a probability).

I put elegant in quotations because, like many things mathematical, a Monte Carlo analysis can project a greater degree of determination than is actually obtained.  As such, it has the potential to be abused by  practitioners to present an aura of expertise.
Suppose 80% of the paths succeed?  What does this tell us?  Is it good practice to report to a client that his plan will "fail" 20% of the time?  Does it require more elaboration?  To put it bluntly - does a Monte Carlo analysis with an 80% success ratio mean that 20% of the time the client will end up eating dog food?  Is the client hearing what we are trying to convey?

This issue has been examined by Michael Kitces in Do Our Brains Really Even Know How To Evaluate A Monte Carlo Analysis? on his blog Nerd's Eye View.  Michael is perhaps the brightest young financial planner in the country, and his blog is a must-read for those interested in the cutting edge of financial planning research.

My own take is that Monte Carlo analysis is valuable at higher rates of failure.  For example, if the failure rate is 60%, you probably need to work longer, save at a greater rate, or draw down a smaller income stream.  On the other hand, if the failure rate is 20%, then examining flexibility issues comes into play.  Can the client cut down on spending for a few years to get back on a successful path?

The good part of all this, I think, is that it gets the planner and the client to focus on the dynamic nature of the process.  Financial plans need to be revisited.

I think we may even have to take a step back and reconsider what we mean by "success."  "Success" is defined as "not eating dog food" in the Monte Carlo results.  Many clients, however, define
success as dying broke.  The client who ends up with $4 million in the analysis is a "success" but not so according to his or her goals.  The real success metric may be the percentage of paths leaving a client with $100,000 or less.

For those interested in an easy-to-use program based on  Monte Carlo simulations, I recommend the T. Rowe Price Retirement Calculator.  It is free and straightforward.  Use it at least annually.

Friday, May 18, 2012

Telephone Consult

Last night I did a phone consultation with a couple from Oregon--a beautiful part of the country I once drove through with my son on one of our cross-country camping trips.  We motored down the coast to see the Redwoods of California.  An awesome experience I recommend to one and all.

My first clients in Oregon (Yeah!), Fred and Wilma (made-up names to protect the innocent), had done their homework and were knowledgeable about investments.  They had a really good understanding of their income sources and living expenses.  Fred is a retired contractor and receiving Social Security.  Wilma will retire at year's end, is an accountant, and is 58 years old.  Fred is a Navy veteran and receives medical care there. Health insurance for Wilma will be a challenge since she is 58 and has a ways to go to get to Medicare. She assured me they are up to the challenge because she and Fred have been self-employed for years and obtain their health insurance through the business.

Once Wilma retires (1/2013), they will need to draw down approximately 3.7% of their investment assets.  After 4 years, Wilma's Social Security kicks in.  Then they will require a lot less from their investments, and they will easily be able to live the lifestyle they desire.  In fact, they may want to ramp up their spending, then, if they so desire.

Fred was familiar with the T. Rowe Retirement Calculator and agreed with me that he should revisit it at least yearly.  Spending only a few minutes putting in the inputs quickly reveals, by generating a Monte Carlo analysis, whether you are on the right path.  This is a tool everyone approaching retirement should be familiar with.

On the investment front, they had read Solin's excellent book, The Smartest Investment Book You'll Ever Read, and had selected a portfolio conforming to their risk tolerance.  The portfolio is comprised of well-diversified funds with 60% in fixed income and 40% in stocks.

Their broker is TD Ameritrade, and I suggested they consider commission-free ETFs offered by TD Ameritrade and utilize the low-cost, index funds.  In fact, I looked them up and recommended specific funds to match the asset classes of their portfolio.  For example, their portfolio required 8% U.S. Small Cap and I recommended VB, a Vanguard ETF with an expense ratio of 0.16%.

Fred and Wilma are members of AARP, so I suggested they send in the postcard in the monthly magazine that provides a quote on a single premium, immediate pay annuity with New York Life.  My guess is that the annuity would pay Fred about 5.8%.  Thus, if he put $100,000 into it, he would get $483/month as long as he lives.  If he dies before he is paid out $100,000, his beneficiary (most likely Wilma) will get the balance.  Think of it like Social Security (except it isn't adjusted for inflation!) or a pension.  The idea is to reduce market risk.

We talked about location of investments - put stocks in the taxable accounts and bonds in the IRAs to the extent possible.  We talked about drawing down the taxable accounts first to let the IRAs (qualified accounts) grow tax free as long as possible.

In addition to their stocks and bonds, Fred and Wilma have a couple of real estate properties where they have long time tenants who are interested in buying the properties.  This gives them diversification and a wild card in the event funds are needed.

On the planning side, a couple of issues came up that couples need to think about because they have the capacity to upset the apple cart.  One I suggested they look into is umbrella insurance.  The fact that we live in a litigious society means there is always a risk we could get sued for everything we own. Umbrella insurance is a protection against this and is relatively inexpensive.  I suggested they talk to the provider of their automobile insurance and get a quote.

A second risk is long-term care.  And it is expensive.  I suggested they look into the type of policy that covers 3 years jointly . In other words if Fred used 2 years ( for example, if he got Alzheimers), then Wilma  would still have a year.

There are a lot of Fred and Wilmas out there who have worked hard, lived within their means, accumulated a nest egg, and who have given considerable thought to their financial situation in retirement.  When you think about it, planning for 25 years or longer where you don't have a work-related paycheck coming in can be daunting.

Contrary to the impression you might get from the popular press, however, many couples have thought it through and, as a result, are looking forward to an enjoyable retirement. 

X-Ray Your Portfolio

Morningstar's X-Ray is one of the most useful, free tools available to investors on line.  Spend a few minutes with the tool, and you'll learn a great deal about your portfolio and how your assets are allocated.

Here's an example of how it works using 5 assets.
Source: Morningstar

CLICK TO ENLARGE  As you can see, you need the ticker symbol of each holding.  For the right hand column, you have the choice to put in the market value of the holding or the percentage value of the holding.  I typically use the market value, reading it and the ticker right off of the broker statement.

Note the link to add more holdings and the "Show Instant X-Ray" button.

After I put in my entries, it looks like this:

Source: Morningstar
CLICK TO ENLARGE  Even for a large portfolio, or several portfolios combined, this takes very little time. Look at the "Total dollar value of the portfolio" box at the bottom of the column as a check to ensure you picked up all values.

So, now all you have to do is hit the "Show Instant X-Ray" button at the bottom.  This gives us some good stuff:

Source: Morningstar

CLICK TO ENLARGE  Asset allocation is the primary determinant of performance over the long term.  This provides the basic picture that you need to consider.

But the performance doesn't always go to you.  The brokerage community has been clever in siphoning off a goodly portion of funds over time - whether the market goes up or down!  How much you say?  Well, just scroll down on the Morningstar page.

Source: Morningstar
CLICK TO ENLARGE  As you can see, the funds have an average expense ratio of 1.90%, higher by .45% than similar funds.  The corresponding metric for well-diversified ETFs typically ranges between .10% and .25%. Granted they aren't nearly as "exotic" as the funds shown here.

This brief intro only touches on the information garnered from this exercise.  You'll want to examine the style boxes and the geographical location of your investments, etc.

All in all, I believe it is one of the best uses of your time in understanding your portfolio holdings.

Disclosure:  I definitely do not hold any of the funds mentioned above, although a new client does.  This post is for educational purposes.  Individuals should consult with an advisor or do their own research proior to making investment decisions.

Wednesday, May 16, 2012

Making the Nest Egg Last - Bengen

Seniors consistently say that running out of money is their greatest fear in retirement.  It's not surprising, then, that there has been considerable research on the appropriate nest egg paydown rate.  Bill Bengen set the ball rolling in this area when he published a series of papers in 1993 that looked at 30-year periods going back to 1926 (before the Great Depression) and analyzed payout rates.  He found that over the 38 thirty-year periods, a 4% paydown rate, adjusted for inflation, lasted for all but one 30-year period. 

This was the genesis of the 4% paydown rule that is widely used today.  Further study raised the rate to 4.5%.

To be clear on this rule, it works as follows.  If you retire today with a $1 million IRA (he assumed a tax deferred portfolio), you can take out $45,000 this year.  Next year, assuming inflation is 2%, you can withdraw $45,900 ($45,000 * 1.02) and so forth.

Clearly this is not an easy problem.  There are several important unknowns that raise their ugly heads-- including the rate of inflation, market returns, and how long a person will live.  Bengen assumed an asset allocation of 35% large cap stocks, 18% small-cap stocks, and 47% intermediate government bonds.

So what was the 30-year period that failed and why did it fail?  Surprisingly, it was the period when a person retired on 1/1/1969.  This is surprising because this period ended with the greatest bull market in the history of the stock market.  So, what was the culprit?  Inflation!

Updated Research

Bengen has revisited the payout problem in "How Much Is Enough?" in the May 2012 Financial Advisor magazine and examined additional periods.  In the exceptionally clear article, he furthered his research by comparing the first 12 years of 1969 to the period beginning on 1/1/2012.  This latter period, of course, has experienced 2 severe market downturns.  Bengen wanted to know if the 1/2000 was on a course for failure - a question facing many retirees today.  Furthermore, he suggested some steps for retirees in situations where the initial, crucial years of retirement are not very friendly in terms of the market and inflation.

In analyzing market performance, he found that 1969 produced a 7.6% average annualized portfolio return over the first 12 years compared to 5.4%  for the corresponding period beginning on 1/1/2000. Still, Bengen finds that the 2000 retiree is in much better shape because of inflation.  As the years  move along, the current withdrawal rate will be influenced by inflation.  Thus, in year 5, for example, the amount taken will depend on the prior 4 years' inflation.

Over the first 12 years beginning on 1/1969, inflation averaged 7.8% compared to 2.5% for the 1/2000 retiree!

Bengen captures the impact by tracking the "current withdrawal rate."  He finds that, at the end of the 12-year period, the failed 1969 withdrawal strategy had a current withdrawal rate of 12.5% (3x the initial 4.5%!) compared to 5.9% fot the 2000 retiree.

His findings emphasize the importance of staying focused on inflation.  We have come through a period of very modest inflation which naturally tends to cause people to lose sight of its potential significance.  Furthermore, many observers foresee the possibility of a sharp pick-up in inflation sometime in the next several years due to the monetary policies designed to pull global markets out of a severe slowdown.  This is something that retirees need to keep on the radar screen.

Bengen points out that, if the retiree senses the possibility of a failure, he or she can either reduce spending or increase income.  He states,
Take some pre-emptive action, no matter how mild, when the current withdrawal rate first exceeds the initial (or expected) withdrawal rate by 25%.
He has 3 recommendations for increasing income:  immediate pay annuity, reverse mortgage, change investment methods (avoid overvalued assets).

I strongly urge anyone interested in this vital area for retirees and near-retirees to click the link above and read Bengen's article.  What I've given you here is a Cliffs Notes version.  The article, unlike many in financial planning magazines, is highly readable.

Tuesday, May 15, 2012

Cyberbullying-Remarks by Grace McComas' mother Christine

Click link    :Remarks

Please Victoria Grant - Come to America

Twelve-year-old Victoria Grant explains the problem with the Canadian Banking System.  She needs to come to the U.S. to talk to Congress.  Bernanke's policy of controlling the price of money is causing huge distortions that will affect the U.S. long after he is gone.  Managing the nation's monetary policy to appease Wall Street is destroying the economy.  A 12-year-old gets it - why can't the Fed Chairman?

Monday, May 14, 2012

What is a Long/Short Fund?

I think it was President Reagan who popularized the phrase "Here we go again!"  After a brief respite, Main Street is once again trying to fathom the workings of Wall Street.  $2 billion lost hedging....but hedging is supposed to reduce risk, right?  More head scratching ensues as Dimon explains an "egregious mistake."

Part of the disconnect is in the word "hedging."  To Wall Street, taking $2 billion to the race track and putting it on a long shot is hedging.  I don't think Main Street quite looks at it this way.

I was introduced to hedge funds at a luncheon in a hoity toity Washington D.C. restaurant by a Dean Witter institutional broker more years ago than I want to remember.  He explained he had a manager using a long/short approach.  The manager analyzed the stocks in the S&P 500 by screening on cash flow metrics, P/E ratios, earnings growth rates - all the usual stuff.  This identified the 50 stocks most undervalued and the 50 stocks most overvalued.  With these in hand, the manager shorted the worst 50 (sold them even though he didn't own them) and with the proceeds bought the best 50.

The broker explained this produced the holy grail - no matter which way the market moved the long/short fund would produce a positive return.  Wow...give me the dessert menu.

I was at a presentation this past Saturday where various investment strategies were enumerated.  A phrase that kept popping up was "it works until it doesn't."  This comes to mind with the long/short hedge funds.  When you think about i,t there is no long/short hedge except in the mind of the broker and the manager.  What happens when the 50 stocks shorted outperform the 50 best stocks?  Oops! This is sort of an embarrassing question because it implies the fund manager might not be that astute.

I was presented with many synthetic derivative proposals by Bear Stearns in the mid 1990s.  I frankly didn't come close to understanding most of them.  I did understand that they were the most illiquid impossible-to-price instruments I had ever come across.  As I read about JP Morgan London buying a credit default swap index to hedge high-yield global bonds (with the craziness going on in Europe), I  remembered the garbage I used to have presented to me that gave me a headache.

The best part of this for me is watching Maria Bartoromo go apocalyptic on CNBC whenever a guest suggests that maybe Wall Street needs to stop this so-called hedging. T he fact of the matter is that banks are no longer banks as most people understand them and instead are gambling casinos.  Sadly this is what did in Freddie Mac and Fannie Mae and has the potential to bring down the banking system.

Investment Discussion Group

A great resource for do-it-yourself investors is a discussion group where you can see questions investors are asking, see the resources others find worthwhile, and, perhaps most valuable of all, read about the mistakes others have made.  Such a resource is the discussion board at the website of the American Association of Individual Investors (AAII).

As you can see by clicking the link, the broad topic areas are "Portfolios,"  "Investing Topics," and even "Watercooler Talk."  Under "Investing Topics" you find:

Source: AAII

Click to Enlarge As you can see, the usual topics are included.  If you are weak in "Bonds," for example (as most DIYers are!), you'll want to pay attention to this module and follow the questions and responses.

Last week I saw an endorsement of WikiInvest in response to a question on performance for accounts at different brokers, and it led me to begin an evaluation.  Early assessment:  a valuable tool for many. So far, my main complaint is the lack of appropriate benchmarks.  It compares portfolio performance to the S&P 500 and the Dow Jones Industrials.  I am happy with Schwab but see WikiInvest as a tool that many investors may find valuable.

One of the interesting features of the Association is that its members have widely varying investment philosophies ranging from value stock pickers to technicians, with even some indexers (Yeah!) thrown in for good measure.

To participate in the discussions and ask questions, you need to be a member of AAII.  I have been for a couple of years and find the resources at the site valuable and, in fact, attend most monthly meetings at my local chapter.

Friday, May 11, 2012

Meet Your Future Self

Here is a fascinating TED Talk by Daniel Goldstein on software that ages people and the battle between present self and future self.  Seeing one's future self lessens the abstractness of saving for retirement.

Thursday, May 10, 2012

Thank you Abdul!

The other day I drove my niece to the Shady Grove/Gaithersburg subway so she could spend a couple of days in D.C. with my daughters.  On the way back, I stopped in at 7-Eleven to get a coke and a couple of candy bars.  If I'm not in a hurry, I like to take my time and watch what people buy.  I meander along the candy aisle watching out of the corner of my eye.  I note as the bottled water, potato chips, newspapers, detergent, etc.make their way to the cash register.

Finally, I made my way to the cash register and met Abdul.  Abdul smiled and asked if I needed anything else.  As is my practice, I asked him how business was going.  He said it was good.  I asked him how many hours he had put in that day - six, with one more to go. And so we chatted.  Finally, I thanked him for the great job he is doing and explained to him that I and my clients own just about all of the companies that produce the goods he is selling and I appreciate his smile and willingness to help customers.  In fact, I explained to him that I even make money when customers swipe their credit cards.

I don't have an iPod.  I don't drive a fancy car.  Sad to say, my cell phone isn't very smart.  In fact, I made a conscious decision sometime ago to forgo such luxury (in my view) items and put money into businesses.  So, as people buy iPods, luxury SUVs, and fancy cell phones, I just hear ka-ching, ka-ching.

I own these companies by investing in a broad stock exchange traded fund.  So, as I see you tapping away on your Apple computer or arranging a vacation on line, I see you using one of my businesses. When I  turn the pages of a magazine and see every other page is an advertisement (produced by geniuses who graduated from the nation's best universities, no less!) for some drug, I reflect that all kinds of businesses that I own participate to bring people what they need and want.

I know Wall Street isn't real popular these days.  I know that investing isn't seen as a wealth-creating activity.  I do have to wonder, though, if people hear even a small whisper suggesting that maybe, just maybe, the historically unprecedented wealth creation of America is related to the fact that it has the world's most well developed capital markets system.

Today, everyone can own the wealth-creating businesses of America.  Abdul is in.

Wednesday, May 9, 2012

Financial Literacist

Let me coin a word - "financial literacist."  A financial literacist is one who seeks to increase financial literacy.  It is one of the hats I wear.

To do this, I write the blog you are reading, participate at financial literacy events, and give seminars.  I recommend books and articles for people to read and seek out unique ways to help people with their finances.

For example, here is a great article on "10 Money Mistakes Everybody Makes" by Brandon Ballenger at MoneyTalksNews.

Item #3 "Passing up retirement plans" is my bailiwick.  But I also note the "GymPact" idea mentioned in the video and pass the idea on.  With GymPact, you make an online commitment to go to the gym a set number of times per week along with other fitness people.  If you don't do it, you pay a given amount into a pool.  Those who satisfy the commitment split the pot.  The app is tied into the GPS and requires that you spend at least 30 minutes at the gym, etc.

This is all a bit too high tech for me.  I just put on my shorts, step out the front door, and go into my jog/slog thingy for 30 minutes or so.  But still, I'm interested in what the kids are doing these days to motivate themselves using satellite transmissions, social media, and whatnot.  GymPact is a clever way to hopefully lessen the widespread practice of wasting money on a gym membership.

One of the big frustrations I face as a financial literacist (see above for definition) is getting the message to the people who need it before it is too late.  A couple of weeks ago, I was on a panel at a local library branch; and it was obvious that the people in the audience were either those interested in and knowledgeable about  financial topics or who had messed up their financial lives.  I expressed the thought that 75% of the people in the library outside the room were the ones who really could benefit from the expertise freely given by the panel members.

Think about this.  If you habitually read blogs like this, you are probably already managing your finances well.  The push, I think, has to be to get friends and family to understand the basics of financial literacy before their financial situation becomes precarious.  To this end, I invite you to spread the word and become a financial literacist.

Monday, May 7, 2012

A Graduation Gift

It's that time of the year.  You're headed to a graduation party and need to show up with something. Your problem is solved.  And theirs.

The odds are that the graduate you are celebrating is on the verge of entering a world where the financial services industry is poised to eat him or her alive, and they have had no instruction or very little on how to defend themselves.  If it's a college graduation, some big bites have probably already been taken - just ask if they made it debt free.

I recommend two books, both of which can easily be read in a couple of weekends.  These books are literally life changing, in that they are loaded with information that will put the graduate on the right financial path and they are inspirational.  Each author has lived what they preach.  Check out their respective blogs to get a flavor of their writing style.

Book #1 Millionaire Teacher : The Nine Rules of Wealth You Should Have Learned In School by Andrew Hallam.  Excellent on explaining how to invest by minimizing costs with well-diversified exchange traded funds.  Great sense of humor.  Fun to read.  Blog

Book #2  I Will Teach You to Be Rich by Ramit Sethi.  Speaks the language of the younger generation.  Strong on automating finances to control expenditures.

Friday, May 4, 2012

Understand the Case for Dividends

It's no secret that the Federal Reserve has been on a mission to push investors into higher-yielding, riskier assets.  By pledging to hold the federal funds rate - the rate at which banks lend reserves to each other - in a range of 0 - 0.25% ( the so-called "zero bound"), they affect rates on short-term, less risky assets across the board.

Naturally, investors have found their way to both longer-term riskier bonds as well as dividend stocks.

To examine the attraction of a dividend paying stock compared to a bond, let's consider common stock for Sandy Spring Bank (full disclosure:  I own this stock), which recently announced a dividend increase (ticker SASR), and the benchmark 10-year Treasury.

Here's the announcement for SASR:

Sandy Spring Bancorp, Inc., (SASR - News), the parent company of Sandy Spring Bank, announced that the board of directors has declared a quarterly common stock dividend of $0.12 per share payable May 16, 2012 to shareholders of record on May 9, 2012. This dividend represents a $0.02 per share increase over the dividend paid in the first quarter of 2012.
Source: Global Newswire


Note the record date of 5/9/2012.  This is the date the stock has to be held.  Note the payable date of 5/16/2012.  These are the 2 dates shareholders need to know.  On 5/9, the stock will go ex dividend.

There are also simple rules that affect whether the dividend is qualified or not that income investors need to know to capture lower tax rates.  Essentially the dividend will qualify if it is a U.S. stock and is held for 2 months over the 4-month period beginning 2 months before the ex-dividend date.  If you are playing it close to the vest, just call a rep at your brokerage and ask.  The tax break is what pays you to take the risk!

Returning to SASR, the .12 quarterly dividend implies a yield of 2.69% ( .48/17.87).  At the previous dividend, the implied dividend yield was 2.24% (.40/17.87).  In contrast, the yield on the 10-year U.S. Treasury note is 1.93%.  The coupon yield is 2%.

In comparing the two, a primary consideration is that there is a good likelihood that the stock dividend will be increased over time whereas the payout on the bond will remain constant over 10 years. 

The risk, of course, is that SASR stock may move a lot lower over the next 10 years.  On the positive side, if it moves higher, it is pretty much gravy for the income investor.  In contrast, the 10-year Treasury price is known for certainty 10 years hence.  At maturity it will be par, i.e. $100 per $100 principal. 

If you are interested in using stocks to generate income, you may want to follow dividend bloggers like Dividend Growth Stocks or consider dividend ETFs like SDY or DVY.

Disclosure:  I and my clients hold stocks and ETFs mentioned above.  The intent of this post is educational.  Individuals should do their own research or consult a professional before investing.

Thursday, May 3, 2012

Are You Saving Enough for Retirement?

A quick 10-question quiz on some  essential retirement basics from Mary Beth Franklin at Kiplinger.  People in their 50s should know these basics.  For example, you don't want to get to 65 and find out you had the opportunity to catch-up on retirement saving in your 401(k) that you didn't exploit.  Most people reading this blog will be familiar with the basics.  The challenge is to get the info to people who don't read personal finance blogs and don't pay attention to their retirement needs. Take the quiz and then send it to your friends.

Tuesday, May 1, 2012

Spending the Nest Egg (Con't.)

Yesterday we took a slightly different way of looking at spending the nest egg.  We examined a $1.0 million nest egg and assumed a $40,000/year payout (4% rule of thumb), adjusted for inflation of 3% over the first 10 years.  We met the required payout by using zero coupon Treasury bonds.  This process is referred to as "immunizing a liability stream."  It is sometimes used to meet pension fund obligations.

We found that, with today's interest rates, this cost us $430,440.

We next looked at the required return to grow the remaining balance of $569,560 ($1,000,000 - $430,440) back to $1,000,000 at the end of the 10-year period.  It was 5.7%.

At this point, we are 75 years old and we have our original $1,000,000 back.  We now need to start with a payout of $52,191, adjusted for inflation, to maintain our standard of living.

Before we move to the next 10 years--ages 76 to 85--let's revisit the assumptions.  We calculated a return of 5.7% to get us back to $1.0 million.  Let's assume this was attempted with an allocation of 50% stocks/50% fixed income which was gradually adjusted to 40% stocks/60% fixed income. Obviously there is no guarantee on the return.  What would our starting value for the next 10 years be if the return averaged 4%/year, say?  This is easy to figure out - $569,560 * (1.04)^10 = $843,088.  In this way, you can carry out all of the sensitivity analysis you want.

In thinking about the asset allocation return, you want to recognize that, although you are retired, these assets are earmarked for somewhat longer-term expenditure requirements.

On the payment side, we assumed inflation of 3%.  If you are doing this in a spread sheet, you can easily adjust inflation.  For example, you can examine the impact if inflation jumps to 4% 5 years from now.

The bottom line of all of this is that retirees, in carefully monitoring their nest egg paydowns, need to revisit the schedule at least annually and put in actual market performance as well as inflation experience.

76 - 85

The table shows us that our costs of immunizing the required payments for ages 76 - 85 total $407,875.  This is what it costs to buy zero coupon Treasury bonds that will generate the payments.  We started with $1.0 million and now have $592,125 at the start of the period from which to get payments for years 76 on.

If we can achieve an average annualized return of 5.38% over the 10-year period, we will start our 86th year with $1.0 million.

Additional Points

What we've looked at is akin to a  poor man's offshoot of what is known as optimal control theory, which uses linear programming techniques to optimize a multi-period problem.  It goes to the end of the period - for example, our 95th birthday - and asks how much we would need, on an inflation-adjusted basis.  This would be $40,000 adjusted for inflation if our goal is to die broke on our death bed, assuming it occurs on our 95th birthday.  Then it works backwards, taking into account specified constraints.

In terms of data, quotes on zero coupon Treasury issues can be found at Barron's "Market Data" Center under "Bonds" and then "Treasury Strips."   For those who aren't clear on how zero coupon issues work, look at the table above.  If you buy $1,000 worth of the 2029 issue, it will cost you $598 today. In 2029, you will be paid $ 1,000.

As a point of information, U.S. Treasury zero coupon bonds are the most expensive (i.e., lowest yielding) because of their safety.  In fact, there are highly-rated zero coupon Corporate bonds that would greatly lower the cost of immunizing described above.

Disclaimer:  Data was obtained from sources deemed to be reliable.  Post is for educational purposes only.  Individuals should do their own research or consult with a professional before making investment decisions.