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, June 28, 2012

A Floating Rate Note Exchange Traded Fund

One of the challenges facing investors today is the pathetic rate on cash equivalents.  Treasury bills and money market funds yield barely above zero.  Adding any duration in a quest for better yield involves taking on interest rate risk, and this needs careful monitoring.  Simply, if and when rates rise, bond prices will drop.  If they rise far enough and fast enough, bonds and funds with high duration could experience significant capital loss.

This challenge is very real for investors following an asset allocation strategy that calls for 10%, say, in cash.  With the rates noted above, the cash portion will fall behind inflation over time. 

One possibility investors can consider to mitigate this possibility, or at least to hedge against it to an extent, is with a floating rate note fund.  Granted the yield won't knock your socks off, but it will yield more than money markets and won't be impacted by falling bond prices.

An example is FLOT.  FLOT yields 1.24% - not the greatest yield around but a heck of a lot better than money markets! - and has an average investment grade credit rating of A.  In comparison, a 1-year CD will yield approximately 1% fixed,  plus you essentially lock up your funds for a year.

Morningstar has the necessary information to analyze FLOT.  You'll find there that effective duration is a mere .13 years, which means the prices of its underlying issues will be stable.

As always, I would limit exposure to 5% of total assets in a fund of this type.  FLOT is an exchange traded fund and, therefore, unlike a mutual fund.  This needs to be taken into account when buying and selling.

Disclosure:  This post is for informational purposes only.  Before making investment decisions, individuals should do their own research or consult with a professional.  I own this fund for my clients.

Wednesday, June 27, 2012

A Safe Withdrawal Rate Calculator

Things in the stock market many times are upside down.  This is part of what makes it interesting and a challenge.  This is why investors who rush in when all the news looks rosy and depart the ship like wharf rats (see graphic on left) when the news is horrible ( read "fiscal cliff approaching") underperform over the long run.  Unless you are a bloodless zombie ( read: "a really good financial advisor"), you are emotionally constructed to buy high and sell low.

Another upside-down event that affects investors is that they retire when markets are high and don't when they are low.  Some of you know exactly what I'm talking about - you looked at your nest egg in 2000 or in 2007 and figured you had reached your number and gleefully announced your retirement. And then had your head handed to you.

On the other hand, if your nest egg was sufficient to handle retirement in early 2009, it was a great time to retire.  The market was cheap on a valuation basis after stocks fell 37% in 2008.  It was, of course, a scary time and took some guts to actually carry through at the time.

These ideas have been researched by what I refer to as "the valuation school."  They argue that retiring without considering market levels and just taking 4% or 4.5% as a safe withdrawal rate in retirement is simplistic--that, in fact, the overall level of the stock market should  be considered.  A leading proponent of this view is Rob Bennett who has built on the work by John Walter Russell and constructed a neat calculator embodying these ideas.

The Retirement Risk Evaluator

To get to the calculator, click "risk evaluator" and you'll see:

CLICK TO ENLARGE  As you can see, you have a number of inputs you can put in for the calculator.  The P/E10 is the Shiller P/E discussed in yesterday's post.  The TIPS real return can be gotten at Bloomberg by clicking "Market Data" and then "Government Bonds" on the drop-down list.  There find the yield on the 10-year Treasury (1.63% today), scroll down and find the 10-year TIPS yield (-.50% today) and subtract (1.63 - (-.50)) to get 2.13%.

I also set the stock allocation at 60% and set my own P/E10s around the base case ("Scenario 3").  Click "calculate" and find:

CLICK TO ENLARGE As you can see, 4.43% is indicated as a safe withdrawal rate, given the assumptions, input into the calculator. A really useful outcome of the results is that individuals can calibrate withdrawal rates to their own risk tolerance levels.

If instead P/E10 was 17, the safe withdrawal rate, as shown in the table, would be 5%.

Scroll down the page below the calculator and you'll find an excellent write-up on the genesis of the calculator and its functionality.  I believe it is an excellent resource to be revisited from time to time as markets change and investors think about retirement.

Tuesday, June 26, 2012

What is the Shiller P/E Ratio?

Is now a good time to invest in stocks?  This is one of the most frequently asked questions I get from potential clients.  I like it because then I can whip out my crystal ball, put on a turban and John Lennon glasses, and lower my voice to mysteriously claim "... I see the S&P 500 3 years from now at ...."  Seriously, though, there is a tool that DIYers should know about that is widely used for valuation purposes; and that is the Shiller P/E.

Bob Shiller, author of Irrational Exuberance, is credited with foreseeing the bust as well as the housing crisis.  He has been named one of the country's top 100 most influential economists.  He is one of the leading voices in the argument that markets are not efficient and uses his particular P/E construction in that argument.

We've looked at the P/E ratio as an important valuation metric before and have noted that there are various measures, including 12-month trailing earnings and expected earnings.  The Shiller P/E is based on the past 10 years earnings adjusted for inflation.  Here is a visual from gurufocus:

Notice in the graph where Shiller's P/E was prior to the crash in 2000 and the housing market crash of 2008.  In both instances, it was well above its historical mean - hence, its reputation as a valuation metric.

Today, as you can see, the Shiller P/E is 25% higher than the historical mean.  This would suggest that better opportunities for entering the market may be ahead.  Asset allocators may choose to use this tool to go to the lower bands in their targeted allocations.  Investors looking to enter the market may decide to average in, thereby expecting better entry points.

It is important to understand that this methodology assumes an inefficient market and that this inefficiency tends to dissipate over time - i.e., reversion to the mean takes place.

My assessment is that the tool is valuable at the extremes.  If it moves outside the 25% band from here,  asset allocators may in fact want to get a bit defensive and increase that defensiveness as the ratio moves further from its historical mean.  As a valuation measure, I believe it is one of the best around and would encourage anyone interested in assessing the market from a longer-term perspective to study and track this metric.  Furthermore, if you haven't read Irrational Exuberance, get a copy and read it - you'll be smarter because you did.

There is another use for Shiller's P/E that we'll take up in the future - as a guide for the safe withdrawal rate for retirees.  As always, this information is for educational purposes only.  Individuals should do their own research or consult a professional before making investment decisions.

Monday, June 25, 2012

Say It Ain't So Eddie

Source: Sports Illustrated
Eddie Murray is one of several professional athletes being investigated for trading on inside information that Abbott Labs was on the verge of buying Advanced Medical Optics in 1/2009.

Eddie Murray, a Hall of Famer, is one of the most beloved professional athletes in Baltimore history.  Furthermore, his is another case where you just have to scratch your head and wonder why he did it.  He is well off financially.

As an advisor, I have to end with a recommendation:  Please...look in the mirror...unless you see a member of Congress staring back. don't trade on non-publicly available information!  It's that simple.
If you are a member of Congress, you can disregard - you are above the law and can do what you want.

Sunday, June 24, 2012

How Did the Stock Pickers/Market Timers Do?

Standard & Poor's  tracks active fund manager performance relative to their index and calls this scorecard SPIVA (Standard & Poor's Indices Versus Active).  This is a comprehensive data set that strives to make apples-to-apples comparisons.  It studies consistency, takes account of survivorship bias, examines style drift, etc.

If you are interested in detailed information and trying to make up your mind on this important issue, you should spend some time reading the study.

Here are some broad results through the end of 2011:

% of Actively Managed Funds That Beat Index Over Past 5 Years
U.S. Large Cap Growth Stocks
U.S. Small Cap Value Stocks
Int’l Stocks
High Grade Bond Fund s (Interm.-Term)
Intermediate Gov’t. Bond Funds
Source: Standard & Poor's

Sooooooo...if we step back just 5 years and get together 100 large-cap growth stock active managers, 20 are going to outperform.  Seems like we are in a "Dirty Harry" situation-

"Did he fire six shots or only five?"  Well, to tell you the truth, in all this excitement, I kind of lost track myself.  But being as this is a .44 Magnum, the most powerful handgun in the world, and would blow your head clean off, you've got to ask yourself one question:  Do I feel lucky?  Well, do ya, punk? 

Friday, June 22, 2012

Are You Saving Enough?

There are numerous online calculators to show how much you will save over a period of time given various assumptions.  One that has a bit of a different slant is a calculator provided by Morningstar that tells you the rate at which you should be saving.  It also has a paper that is readable by the layman that explains some of the assumptions underlying the research.

The calculator only takes a few seconds and is worth visiting on an ongoing basis as events change in your life.

Begin by going to Morningstar's home page.  Scroll down to find:
Source: Morningstar

Click as indicated.  You come to:

Source: Morningstar
As you can see, you only have 3 inputs.  Notice also the link " a study."

The study is by Ibbotson Associates, well-known academic researchers in the field, and, as mentioned above the write-up at the link, explains some of their underlying assumptions.  The link also includes a useful table as a guide to how much you should have save at various ages and income levels.
The results should be viewed as a guide and adapted to individual circumstances fitting the overall financial plan.

I put in 45 for the age, $100,000 for income, and $200,000 for retirement savings.  The calculator found that with these inputs the saving rate should be approximately18% to replace 80% of  income in retirement.

Thursday, June 21, 2012

What is GDP?

Yesterday the Fed, amid considerable ballyhoo, held a two-day Federal Open Market Committee meeting at which they announced a six-month continuation of "operation twist" and produced economic forecasts by senior members of the Committee.

Among the forecasts, indeed as would be the case of  anyone talking about the macroeconomy, was GDP.  They ratcheted down the forecast for the 2012 range for GDP growth from 2.4% - 2.9% predicted in April to 1.9% - 2.4% today.  They moved down, as well, their forecast for 2013 from an April range of 2.7% -3.1%  to 2.2% - 2.8%.

The bottom line is they see a weakish macroeconomy thru the end of 2013.  Fed Chairman Bernanke stated in his follow-up press conference that he was poised to take additional measures (read "another quantitative easing") if the employment situation doesn't improve.  Well, if the economy performs in line with the forecasts, the employment situation isn't going to get any better.

What is GDP?

GDP stands for Gross Domestic Product.  Formally it is defined as the market value of all final goods and services produced within the economy over a specified period of time.  It is reported quarterly and the primary focus is the annual rate, corrected for inflation, i.e., so-called "real GDP."

GDP is comprised of four broad components:  C (consumption), I (investment, G (government), and NX (net exports).  Some points to keep in mind:  consumption comprises a bit more than 2/3s (hence, the ongoing national angst on household spending), investment is the most volatile as inventories and housing swing around, government has grown recently due to the aggressive fiscal policy stance of recent years, and NX has, for some time, been negative, reflecting the fact that we buy much more from the rest of the world than it buys from us.

To find the latest GDP report go to  There you will find that GDP is at $15.45 trillion. As a matter of perspective, 1 trillion is 1,000 billion and 1 billion seconds is 31 years. Thus, if you are less than 31 years old, then you haven't been alive 1 billion seconds.  The point is that $15 trillion is a big number!

Another way to think of GDP is that it is essentially what it would cost to buy all the goods and services produced in the U.S. over the past 12 months.  Yet another way is to think of it metaphorically as a pie.  Then the objective of monetary policy (and fiscal policy, for that matter - but that's another can of worms) and the Fed can be stated simply as grow the pie and put people to work without setting off inflationary pressures.

Markets are now questioning whether the Fed has sufficient tools to overcome a possibly weakening employment situation.  Stay tuned.

Wednesday, June 20, 2012

Will the Fed "Twist"?

Markets are getting bulled up on expectations of a perceived friendly Fed, including the possibility of a "Twist" operation.

What is a "Twist"? It is basically trying to lower long-term rates and raise short-term rates.  By manipulating the yield curve in this way, it supposedly helps the mortgage market.

But...the yield on the 10-year is at 1.65% and 30-year fixed rate mortgages are at 3.70%!  How will artificially pushing rates to even lower levels make a difference?

At this point, Bernanke is exploiting the Pavlov's dog characteristic of the markets.  Mention "Quantitative Easing" (or even just QE!) or "Operation Twist" and the stock market starts salivating. 

Maybe I was the only one taking notes in Econ 101, but I learned there that manipulating prices leads to misallocation of resources.  In the end, this ends badly - witness 2008.

Tuesday, June 19, 2012

What is SEC Yield?

Source: Capital Pixel
Last week I wrote a couple of posts on how you can increase yield by moving beyond money market funds and certificates of deposit (CDs).  This is important for all investors in today's market environment but especially those living on fixed income.

This post gets you started doing a little research and looks at SEC yield.

Begin by going to and check on CD rates.  This will give you your benchmarks.

Next you want to get a list of candidate exchange traded funds. Last week's posts gave a few.  To find more, just google "short-term bond ETFs."

Next, you need to do your research.  Understand that you're taking on more credit and volatility risk. Anytime you get a higher expected return or a higher expected yield, you are taking on more risk.  The alternative is to accept rates that are less than the rate of inflation.  Over a protracted period of time, this can seriously impact your investments.

For my money (great pun, huh?), the best research source is Morningstar.  Just put in the ticker symbol and you have most of the information you need.  Another good source is Yahoo! Finance, where you can get detailed price information, fund description, etc.

An important piece of information you may not be familiar with is SEC yield.  This is shown in the following table for various short-term funds along with other essential pieces of data:

Fund     Credit Quality     Effective Duration     12 mo. Yield     SEC Yield     Expense Ratio
MBB           A                          1.59 years              3.05                 3.31                .31
CSJ             A                          1.85 years              1.75                 1.26                .20
BKLN        BB                          ---                        4.86                 4.71                .76
HYS           ---                         2.47 years               ---                  4.88                .55

The SEC yield is an important data item in that it concentrates on most recent, 30-day distributions, net of expenses.  Thus, it is useful in comparing funds that have different expenses; and it doesn't mislead for the funds whose payout has been falling over the previous 12 months.  It is the yield you want to directly compare to CD yields you may be considering as an alternative.

Here is Morningstar's formal definition:

This calculation is based on a 30-day period ending on the last day of the previous month. It is computed by dividing the net investment income per share earned during the period by the maximum offering price per share on the last day of the period. The figure listed lags by one month. When a dash appears, the yield available is more than 30 days old. This information is taken from fund surveys.

The table shows a wide range of ETF offerings including mortgage-backed, investment grade corporates, bank loans, and high-yield non-investment grade.

Included is just a sampling of some of the data items you would want to look at in beginning your research.  Be sure, as well, you understand how the issues in the funds behave in different markets.  For example, MBB - the mortgage-backed fund- will do very well in a stable environment as it gets the attractive yield shown.  If  yields rise sharply, however, the mortgages extend in maturity (i.e., homeowners stop refinancing, etc.).  If yields drop, then the bonds become even shorter as refinancings are faster than anticipated.  Similarly, if the economy goes into a serious recession, yield spreads on lower rated bonds will widen significantly and the funds will underperform.

My practice is to limit anything below investment grade to 2.5% of total assets.  Also, if you are doing the analysis for qualified funds, then you can just look at the yields straight up.  Otherwise, you'll want to be sure to look at them on an after-tax basis.

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

Sunday, June 17, 2012

Happy Father's Day!

Today's my day to be celebrated.  Not on the order of Mother's Day - I get that.  But I don't care to be celebrated.  I prefer to celebrate the kids.  After all, they are what being a father is about.

One way I value people is to the extent they get me to experience things in life I wouldn't have otherwise.  Each of my children has done that.

My youngest is Jill, aka "Bean," a professional pastry chef educated at the Culinary Institute of America (CIA) in New York.  Although I never got to see her play on the CIA men's basketball team (from what I heard, that's a good thing!), I did get to graduation.  Graduation at the CIA, as you might imagine, is not your typical graduation. Chefs serve an elaborate meal to show off their skills--complete with wine.  The guest speaker is typically from The Food Network - all on the beautiful campus on the banks of the Hudson River.  I've been to a lot of graduations--but none like that.

As part of her program, Jill  took an externship at Stella's restaurant in the French Quarter, New Orleans.  A bit pricey for the family, but we were able to at least go for the desserts (made by you know who!).

Jill took a room in the Lower 9th Ward.  This was the year after Katrina.  The family visited her for a week, and we got to see a side of New Orleans tourists don't often get to see.  It is easy for me to recall the family the last night sitting in the Great Room of the house where Jill rented a room (which she swears is haunted) after walking back from the banks of the Mississippi.

Jill called up last week and wanted me to guess who she had made brownies for.  After guessing Alex Ovechkin, Cal Ripken, Barack Obama,  Mitt Romney, and Miley Cyrus, I gave up.  She told me it was Warren Buffett!  I should have known - Warren Buffett is a man of simple tastes.  When the request came down to the kitchen, the head chef asked Jill if she could make brownies.  Asking a pastry chef if she can make brownies is like asking Bryce Harper if he can steal a base - "clown question, bro."

Lori, aka "Belle," ensconced in the middle, graduated from U of MD with a degree in Architecture.  As part of the program, she studied abroad in Italy where we visited at the end of her stay.  In visiting Venice, we did the usual gondola ride and, turning into one of the narrow alleys, saw the sun break through the clouds.  At that very instant, the group of school boys in the gondola ahead of us broke into an amazing rendition of Messiah.  It was one of those moments where, years later, you can close your eyes and bring it all back.

As other family members scoured the numerous shops in the alleys, I tried to envision the beginnings of modern day finance and the comings and goings of Casanova.

Most nights during our stay, we walked the streets of Vicenza trying out different flavors of gelato.

David is the oldest and lives in Alaska.  We have traveled from the East Coast to the Pacific Ocean on camping trips.  We have camped the Badlands in South Dakota.  We have driven the beautiful Natchez Trace to the Gulf of Mexico and, yes, broke down in Yosemite.  We have camped in Alaska.  On my second Alaska visit, we went to Talkeetna and took a plane to land on a glacier on Denali (Mt. McKinley).  The plane trip and the glacier walk around was an experience impossible to forget.

These are some of the experiences I would never have had if I wasn't a father.  They are what I enjoy recalling as I sit on the porch sipping red wine.  They make my Father's Day.


Saturday, June 16, 2012

Too Much Cash?

Yesterday I touched on the cash/emergency fund position held by many people and what they are sacrificing - basically the opportunity cost of holding cash equivalents in today's low-yield environment. This is an area that, in my experience, can fairly easily produce extra oomph to the portfolio.  And it is something to focus on with an advisor if you can't do it yourself.  Many times intelligent moves in this portion of the assets alone will more than pay for the advisor's overall services.

To review - most people usually hold more in cash equivalents like money market funds, Treasury bills, and certificates of deposit (CDs) than they should.  Some say it is for emergencies.  Some say it is to avoid risk.  Others also say it is because they haven't decided where to put it.  Actually, I gently remind the indecisive they have decided - it is in money markets, etc.  This is an area where avoiding making a decision is actually making a decision.

An important point in yesterday's post was that holding cash equivalents doesn't avoid risk; it substitutes purchasing power and re-investment risk for market and/or credit risk.


So how can the cash position be reduced and yield increased with an eye on market risk?  Keep in mind that we are focusing on short-term investments and not the broader fixed income portion of assets.

As a specific example, assume that you hold $20,000 in money markets, etc. and decide that $5,000 is sufficient for an emergency fund.  You seek to increase the yield on the additional $15,000/year by 2% and at the same time avoid market risk.  This would bring in an extra $300/year.  What is one way to do this?

The first point to be clear about is that moving from Treasury bills and CDs entails taking on credit risk. This is the fundamental risk-reward relationship.  The second point is that, to lessen market risk, we are seeking fixed income investments that have a short duration.  If you are willing to look past the market value of the investment and just look at cost (because you will hold it to maturity), you may be able to ignore price fluctuations.

With these caveats in mind, let's begin by looking at specific bonds.  If we go into Schwab's bond offerings (easy to do online and for most discount brokers) and putter around a bit, we find the following offerings:

Source: Charles Schwab
The yields-to-maturity are shown in the right hand column.  The Goldman Sachs issue yields 3.484% and matures in 3.5 years.  That's a 2.2% after tax yield for those in the 25% tax bracket.  Obviously these issues are a bit risky - the orange down arrow indicates they are in line for a possible downgrade. Still, they are most likely to retain investment grade status over the period even if they are downgraded . Not to be glossed over is the fact that the higher echelons of our Federal Government are generously populated by one-time Goldman Sachs partners/managing directors.

The J.P. Morgan piece is also interesting.  I would watch it to see if the yield doesn't become more attractive.  Maybe wait to see if it is downgraded and then pounce.  After all, how many businesses can lose $2 billion, treat it as a minor issue, and tell their shareholders they will be profitable in the upcoming quarter?

A different route to take with short-term funds would be to use exchange traded funds (ETFs).  One idea is short-duration corporate funds, such as PIMCO's new high yield fund HYS.  It has an expense ratio of 0.55%, expected yield in the neighborhood of 6%, and is an index fund managed by the biggest bond manager in the world.  Again, I would limit exposure to 5% of total assets.  Another idea, less risky and hence lower yielding, is Vanguard's short-term corporate ETF, VCSH.  The trailing 12-month yield is 2.28% and the expense ratio is .15%.

The bottom line is that there is a lot out there for DIYers who aren't lazy and are willing to take on a bit of risk in order to increase yield.

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

Friday, June 15, 2012

Are You Leaving $100 Bills on the Table?

Imagine getting out of your car at the supermarket and finding ten $100 bills lying on the ground.  What would you do?  My bet is you would do a "Chauncey." (See the video)

Well, there are a lot of people leaving $100 bills behind - a lot of $100 bills.  I know because I look at their statements.  This is especially on my mind now because I recently sat down with a lady in her mid-40s who had a bit more than $150,000 in various savings accounts and another $100,000 in certificates of deposit (CDs).  The savings account paid less than 0.5% and the CD rates were between 1% and 1.25%.

Me:  "You have a lot invested in cash equivalents."
Her:  "In case of emergency."
Whoa...she's braced for a heck of an emergency.

Like most advisors, an emergency fund is one of the first things I talk about and make sure a client has in place - they are tricky.  They depend on the stability of the client's income, type of car and age of house, etc.  Basically you want to be able to pay your Discover bill at the end of the month after having to buy a new water heater.  Assuming your job is stable, a couple of months' salary is sufficient.

As you have guessed,  having too big of an emergency fund leaves $100 bills on the table.  This jumps out at anyone who is aware of yields available in the market place.  If you have $50,000 more in emergency funds than you need and can increase the return on these funds by 2%/year, it amounts to $1,000/year.  Where's Chauncey?

Do the math for the lady in the example who has $250,000 in cash equivalents!  Because she is in her mid-40s, she has approximately 20 years until she is 65 years old and  will compound the money over the period.  She is leaving a lot of $100 bills on the table!

On occasion, the dialogue has gone like this:
Me:  "You have a lot invested in cash equivalents". 
Her/Him:  "Stocks and bonds are risky."
Let's talk about risk.

Stocks and bonds do go up and down, and that can be truly exhilarating or lead to grinding your teeth in your sleep depending on the extent to which you watch it and let it affect your emotions.  That's the risk most people focus on.  But there is also inflation risk that is more subtle.  For example, it seems like yesterday when people would tell me that they could invest in U.S. Treasury notes and generate $40,000/year.  Why did they need stocks or higher yielding, more risky, fixed income exposure?  Fast forward to today, and $40,000 is equivalent to $20,000 and their 10-year Treasury note re-investments yield 1.6%!

Yesterday the 12-month Consumer Price Index was reported at 1.7%.  Investing cash equivalents at less than 0.5% or even in CDs at 1.5% is losing ground to inflation!  The bottom line is that risk comes from many directions, and hiding in cash equivalents leaves a  lot on the table.  It pays to investigate low risk ways of increasing yield on emergency funds and other short term investments..

Disclosure:  The purpose of this post is educational.  Individuals should consult with a professional or do their own research before making investment decisions.

Wednesday, June 13, 2012

Dimon Testifies on "The London Whale"

Today is likely to be a 3-ring circus as Jamie Dimon, JPMorgan CEO, testifies to Congress on the $2 billion losses incurred by the London trader known as "The Whale."

Dimon is another case of someone telling everyone else how to live and turning out to be a major sinner.  The bottom line is Dimon had weak risk controls in place and has made himself a poster child for a chops-licking Congress to skewer.

But there is another more important message, IMHO, for the individual investor to contemplate, emphasized by Dan Solin in "The Hidden Message in JP Morgan's $2-Billion Loss."  Consider that J.P. Morgan is one of the biggest trading entities in the world.  Bruno Michel Iksil, aka "The Whale," is obviously brilliant - you don't get to aggressively trade the size he traded at J.P. Morgan unless you are pretty smart.  He obviously had the very best resources including sophisticated value-at-risk models, the top graduates from the nation's business schools, etc., at his fingertips.  And still - he lost billions!

The message for individuals to contemplate is whether the fast-talking rep from the mutual fund provider/wealth manager promoting their stock picking/market timing skills can really do what they say they can do.  Dan Solin, author of The Smartest Money Book You'll Ever Read, says

The massive loss suffered by the bank is yet another indication of the inability of this huge institution (or anyone else) to predict the direction of the markets. Yet, the entire securities industry is premised on the false assumption that its members can add value by stock picking, market timing, and fund-manager picking.
He further points out:

The real skill of these "wealth managers" lies in their ability to convince you they have an expertise that doesn't exist. This latest debacle is one more example demonstrating the irrefutable fact that these investment gurus are emperors with no clothes, representing a significant, little-understood peril to your financial security.

Tuesday, June 12, 2012

Should You Wait on Social Security?

A perplexing problem for many retirees and near retirees is when to start receiving Social Security. There are a number of important dates:  begin at 62, full retirement age, have to start at least by 70. The longer you wait, the higher your payment - like most annuities - but if you die before you apply, you lose out.  The later consideration, of course, is why many just throw their hands up and take it at 62.

Others spend a lot of time trying to work out the brea-even point and then assess the odds that they will live past that point.

Here is another way to look at the problem, presented by Steven A. Sass of the Center for Retirement Research at Boston College - Should You Buy An Annuity From Social Security?

For comparative purposes, he presents the following table of inflation-protected annuity rates obtained from the Vanguard Annuity Calculator, January 2012.


The table shows that men have a higher payout than women (because women live longer) and that the payout drops for an inflation-adjusted annuity that lasts until the second person dies.  As an example, the table shows that, if a 66-year-old male purchases a  $100,000 annuity, he can expect to receive $5,300/year, inflation adjusted for as long as he lives.

The annuity is an interesting option in that the payout rate is considerably higher than the safe withdrawal rate from the so-called retiree's "nest egg."  This safe withdrawal rate is typically found to be between 3% and 4.5%, depending on the study.  A huge negative in purchasing an annuity is that control of the funds is lost - for emergency purposes as well as for leaving an inheritance.  This gets balanced against the fear of running out of money.

Sass argues that delaying taking Social Security is equivalent to purchasing an annuity from Social Security and  is another option to consider.  He presents an example where a retiree would receive $12,000 at age 65 and $12,860 at age 66 if he delays for 1 year.  If he delays and takes $12,860 from savings to pay his bills, then the annuity rate would be $860 (additional lifetime inflation adjusted payment)/$12,860 (amount taken from savings)  = 6.7%.

Sass presents two important tables in his article, that show the increase in payment on a percentage basis for delaying at various ages as well as the annuity rates from delaying Social Security, the retiree can compare to safe withdrawal rates and annuity rates offered by insurance companies.  He concludes "...buying an annuity from Social Security, especially in today's low interest rate environment, is the best deal in town."

Disclosure:  The information presented here is for informational purposes.  No recommendation is made.  Individuals should consult with a professional or do their own research before making financial decisions.

Monday, June 11, 2012

Richard Feynman Commencement Address

Richard Feynman was a great teacher and arguably the second greatest U.S. physicist, behind none other than Albert Einstein, and also a great teacher.  He believed that, if you couldn't explain a concept in physics to a layman, then you didn't understand the concept.  Something to keep in mind the next time you meet with your financial advisor.

I have been a long-time Feynman fan and have read a number of books about him and his lectures.  I highly recommend Genius by Gleick and his own Six Easy Pieces - even if you aren't interested in physics.  You'll especially like the part where he explains that people believe they are answering a question when actually they aren't.  For example, saying "because it's slippery" doesn't explain why our feet fly out from under us when we step on ice.

Being a fan, you can understand that I was pleased to come across a commencement address by Feynman on Biz of Life's site entitled "Cargo Cult Science."

The message of this piece struck home because I've recently been reading a number of research pieces in financial planning that don't seem to me to be especially rigorous.

It is a fact of life that studying economics and finance has to rely a lot on history.  Sadly, we can't go into the lab and keep everything the same and see what happens, for example, after 2003 if the Fed doesn't lower interest rates to 1% and ignite a housing market boom.  Sadly, we rely very heavily on one historical episode - the 1930s - (which was very different from our world today) to make or support current policy.  In  financial planning, we look at failure rates in withdrawing funds from a portfolio when yields were a lot higher and the economy was at a younger stage and was a manufacturing behemoth.  And from this we get probabilities.

To be clear, the analysis is valuable but it doesn't give probabilities.  This is my point.

An example in sports is the way announcers or analysts sometimes talk about teams.  They'll say, for example, that (fill in the blank with a team) has only won a seventh game of a World Series two times in the last 50 years.  What does this tell us?   Can we derive a probability from this?  Over a 50-year period you obviously have very different teams.  It is hard for me to see this as anything other than a nonsensical observation.  It does, however, get fans riled up.

I'm convinced that the failure to appreciate this observation in finance is behind the ongoing failures of so-called "value-at-risk" models.  These models take historical data (from a world much different from the present) and derive probabilities.  Then they are shocked that the correlations don't hold up!

Understanding Feyman's message goes a long way in understanding how to interpret academic research, expert opinion, and, in particular, the ethical way to present and carry out that research.

Tuesday, June 5, 2012

Would You Take a Lump Sum for Social Security?

Often retirees are offered a choice between a lump sum payment and a pension when leaving a company.  My question is:  would you prefer a lump sum at age 62 or the specified CPI adjusted social security payment for as long as you live?  Assume that the Social Security payment is guaranteed.  Note that taking the lump sum gives you control of the assets, as well as a legacy when you die--assuming there is something left.  Note as well that you have the money to invest and could run up the value if you are an astute investor and the markets are friendly.

To put numbers on it, assume you are 62 today and you can get $2,000/month or a lump sum of $420,022.  Quote was from Berkshire Hathaway Group.

Lump sum or Social Security?

Monday, June 4, 2012

Ray Dalio

For those interested in successful investment managers, it would be hard to find someone more appropriate to study than Ray Dalio.  Ray Dalio is founder of Bridgewater Associates, one of the world's most successful hedge funds.  His funds look globally to find value.

Here is a recent interview Sandra Ward from Barron's did with him: "Dalio's World."  Dalio gives his view on the deleveraging process that is unfolding as well as his thoughts on gold and other investment areas.

One of the really interesting analogies Dalio makes in this interview is to compare present-day Europe and the problems it is having with America in 1789.  In 1789, America was 13 colonies held together by the Articles of Confederation.  The colonies had debts from the War of Independence, and they had tariffs with each other.  The setup was very similar to Europe's present Maastricht Treaty that created the European Union.  It was 13 years after independence that a central government in America was formed that could tax and take on debt and form a Treasury.

Dalio's view is that Europe must decide if it is willing to take that additional step and form a central government.  One has to wonder if this is at all possible given its long time history.
One thing that is important in thinking about these parallels is that America had superb leadership in forming its central government.  People like Alexander Hamilton (the only founding father not born in the U.S.) stepped up and performed crucial functions exactly when they were needed.  He, for example, had the Federal Government assume the debts of the colonies and proceeded to pay them off. This in spite of people around him advising that the debts should be reneged on.  After all, no one really expected to be paid back by the poor, fledgling nation.  Because of Alexander Hamilton, it didn't take long before America was one of the top credits in the world.

Another point worth noting is that America at the time was peopled by hungry, aggressive, hard-working peoples who had fled other countries for an opportunity to get ahead.

Dalio makes interesting points on the similar situations but the differences are so magnified, just in the areas of leadership and willingness of the people to find a way out of their debt quagmire, that it is hard to see a  workable solution.  Continually kick the can down the road and it goes off a cliff.

Sunday, June 3, 2012

What is the Treasury Yield Curve?

Yields have been pushed to historically low levels by the Federal Reserve, weak economic conditions, China pegging the Yuan, and a "flight-to-quality" as fears of Europe imploding increase.  One of the best ways to view this is with a graph of the Treasury yield curve:

Source: Barron's
The U.S. Treasury Yield Curve is a snapshot at a point in time of the yield-to-maturity of various maturity Treasury issues.  Issues that mature (i.e., pay back principal) in less than 1 year are called "bills," issues that mature between 1 year and 10 years are called "notes," and maturities out past 10 years are called "bonds."  Thus, the yield curve shows the yields on bills, notes, and bonds at a point in time.

As you can see in the graphic, the curve was upward sloping at each of the 3 dates shown.  Compared to a year ago and a month ago, Treasury yields were little changed for bills, (anchored by Federal Reserve policy) but fell sharply for notes and bonds.

Typically, an upward sloping yield curve presages an expanding economy because it is usually associated with an aggressive Fed policy.  Unfortunately, this hasn't been the case recently for the simple reason that, coming out of 2008, we didn't have so much a liquidity problem as a solvency problem.  Historically, liquidity problems have been solved by the Fed increasing the money supply and banks making loans with the resulting excess reserves.  Today, excess reserves are at record levels; but banks are still loaded with bad debts and are only cautiously beginning to lend.

The Treasury Yield Curve is a useful tool for quickly grasping the movement in rates over time.  If you are interested in looking at historical yield curves, go to Living Yield Curve.  Here you'll find periods where the curve was inverted, i.e., the yield on shorter maturities exceeded the rate on longer maturities. These were times when the Fed was following a tight monetary policy and usually resulted in a slower economy.

Saturday, June 2, 2012

Dealing With Class C Shares

My present project is converting a portfolio of high-fee C class share funds to low-cost exchange traded funds.  The class of mutual fund shares determines when and what and how fees are charged.  To completely understand the fees associated with various classes, you practically need a PhD in Physics.  This is by design.  It is one of the main reasons for the strong growth of exchange traded funds.

Let's look at an example to understand what these C share funds are.  The client holds BMECX--a "BlackRock US Opportunities" fund.  Put the ticker into Morningstar and find:

Source: Morningstar
CLICK TO ENLARGE  Note the arrows. You can easily see in the title that it is a class C share fund.  This typically means there is a sales charge (a load) of 1% if the fund is sold before holding for 1 year.  Don't ask me how they get away with this.  If you don't like the investment after 9 months and want to sell it, they charge you!  It is worth noting that one of the very first academic findings was that load funds do not outperform no-load funds.  Still they persist.

The expense fee on "C" shares are higher than average.  For load funds (i.e. sales commission funds), you either pay in the beginning, the end, or as you go along.  On this particular fund, the ongoing annual expense is 2.24%!

Note also the high rate of turnover at 120%.  Turnover is defined as sales divided by total value of the fund.  Thus, the entire fund was more than essentially replaced over the previous 12 months.  Trading detracts from performance, even in an environment of low commissions, when it is occurring at this level.

At the Morningstar site, click "performance" and you get:

Source: Morningstar
CLICK TO ENLARGE  Note that the fund is classified as MG (mid Cap Growth) and yet is compared to the S&P 500.  This is obviously not an apples-to-apples comparison.

The fund did well in 2007, 2008, 2009, and 2010 relative to the S&P 500 and relative to its group in the first 2 years.  It was definitely an easy sell (to a potential client) in 2009 and 2010.  But how did it do versus a low-cost, mid Cap growth ETF?  Consider the Vanguard Mid-Cap Growth ETF (VOT).  Put VOT into Morningstar and you find the fee is 0.10%.

Next, start with BMECX again, click performance and in the "compare" box put in VOT.  Also, in the box "add index" pick Morningstar's Mid-Cap index.  This still isn't apples to apples, but it is closer. The annualized return results you get are summarized in the following table.

         1 Year      3 Year      5 Year 
BMECX -15.04 9.35 -0.35
VOT -9.01 15.94 -0.37
Mid-Cap Index -7.25 15.97 -0.71
Rank in Category 92 94 50

The "Rank" is for BMECX.

A couple of points to note.  Over 5 years, the load fund matched the indexed ETF.  This indicates it had some pretty good years because it has not done well over the past 3 years.

This reveals an important message.  There are periods where load funds, despite the fees, will do well. The managers, after all, are usually really smart and have tremendous resources at their finger tips.  The problem, though, is that in the long run, as they are extracting a much higher fee than the index ETFs, they face strong headwinds.

At best, only 2 out of 10 will come out ahead over a 10-year period.  This is what the unbiased academic research finds in study after study.

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