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.

Monday, July 30, 2012

Maryland's $37 bln. Pension System Earns .36%

 How did your investments perform over the 12 months ended 6/30/2012?

Maryland's $37 billion state retirement and pension system for employees and teachers earned .36% over this period.

Last week CALPERS, the country's largest public pension fund, at $233 billion, reported a return of 1% for the 12-month period ended June 30, 2012.

 Interestingly, a basic indexed portfolio invested 55% in SPY (S&P 500), 15% in VEU (global less U.S.), and 30% in AGG (U.S. investment grade bond market) would have returned 2.6% before fees.

The difference between .36% and 2.6% for the $37 billion Maryland pension fund amounts to $828 million.  That would go a long ways toward paying Maryland teacher pensions.

I have to agree with Jeff Hooke, Chairman of the Maryland Tax Education Foundation, who said the results "look like a minor disaster for fiscal 2011."

Source: Md. pension system earns close to nothing in past year by Len Lazarick

How Do Broker Stock Picks Do?

Source: Capital Pixel
In previous posts, I've described the process of picking a purported market beater as similar to trying to pick a blue marble out of a jar where 80 marbles are red and 20 marbles are blue.  After all costs are taken into account, this represents roughly the odds that picking an actively managed fund will outperform its index.  This holds across various asset classes, time periods, and even countries.  It is undoubtedly why investors are flocking to low-cost, well-diversified exchange traded funds and why the exchange traded fund market which has been based on index product has seen explosive growth.

From a different angle, I run into DIY investors who tout the research of their brokers or of someone they follow on CNBC. And, admittedly, judging by the length of research reports, the number of complicated colored charts, and metrics presented, the reports are impressive - both for fundamentalists (those who focus on balance sheets and income statements) as well as technicians (those who focus on visual patterns).
But the question doesn't change - do the picks add value?

The results of an ongoing study by Barron's - Zack's spreads light on this question and is described by Vito J. Racanelli in The West Coast Was the Right Coast.

The study examines the stock picks of 9 brokers over various time periods.  The longest period over which all 9 were included was 3 years.

The following table shows their results for the 3 year period:

3 Years
Wedbush Securities
McAdams Wright
BoA/Merrill Lynch
Edward Jones
Goldman Sachs
Morgan Keegan
Morgan Stanley Smith Barney
New Constructs
Charles Schwab
     Average Broker
     S&P 500 (With Divs)
     S&P 500 (Equal Weight)

The bottom line conforms with other lines of research.  If you feel lucky, go with the broker picks but recognize there could be a hefty cost if your rabbit's foot doesn't hold out.

There are other interesting results that can be gleaned from the study.  The winner over the 5-year period was McAdams Wright with a return of 14.12%.  Should you have gone with them?  For the most recent six months, they are at 3.95% versus 9.49% on the S&P 500.  Ooch!  As with previous research, consistency is an issue.  Playing the hot hand can be costly.

Friday, July 27, 2012

401(k) Fee Disclosures

The Department of Labor rules requiring 401(k) fee disclosures finally become available on the fall 401(k) statements.  Participants will see fees for the first time for administrative expenses as well as for investment management.

Smaller plans with less participants tend to take a bigger chunk out of the bottom line.  These plans, of course, tend to have the least sophisticated administrators.  In fairness, it should be noted that the larger plans do enjoy economies of scale; so their costs on a percentage basis should be somewhat less.  CNNMoney reports the following figures based on BrightScope data:

Total Assets                  average # of participants              Fees
> $1 billion                             53,650                                     0.36 %
$100 mln. - $1 bln.                       6,324                                     0.53 %  
$10 mln. - $100 mln.                       858                                      0.85 %
< $10 mln.                                    42                                       1.40%  
 Source: p.16, Money, August 2012

FYI:  A fee of 0.85 compounds to 13.5% over 15 years.  Thus, rolling over $10,000, say, to a 401(k) with these expenses could take out a good chunk of the nest egg over time.

401(k) participants will want to use this information to determine how to allocate their retirement contributions and make fund rollover decisions.  Generally, they will want to take advantage of any company match.  After that it may make sense to fund an IRA and use low-cost, diversified funds.  One outcome will likely be a general lowering of expenses as competition kicks in.

IMHO, it is a shame the government has to pass a law requiring this information.  Administrators should have insisted on it up front.  Once a few big providers got the message, it would become standard practice.          

Thursday, July 26, 2012

Sandy Weill and Other Stuff

Yesterday Sandy Weill cleared his conscious and stunned the financial world by saying that he believes we should move back towards Glass-Steagall by separating commercial and investment banking.  This amounts to an admission that the banking supermarket he played a major role in creating was a huge mistake and that it created "too big to fail" behemoths that are harming the economy. Maria Bartiromo went apoplectic as she is wont to do, and politicians were trotted in front of the cameras to proclaim that it was a great idea worth considering.

Unsolicited advice to politicians:  keep your mouths shut.  Every time you open your mouths, you prove that you can't think for yourself.  You show that you are puppets spouting the party line, and you are pushing voters into the camp intending to vote across the board against incumbents.

Wouldn't it be something if Sandy Weill's McNamara moment will get Greenspan to admit that micro-manipulating the price of money via the federal funds rate was a mistake and caused the housing crisis leading to the Great Recession of 2008?  That would get me to go apoplectic.  Greenspan, in the '90s until the end of his tenure, and Bernanke today micro-manipulated this price.  Today it is at zero %, and markets are debating whether the Fed has any means at all to improve the economy.

What tends to be swept under the rug is that the Fed totally botched its mandate of ensuring a stable banking system, completely misunderstood the housing market debacle, and didn't understand the banking sector was in a solvency crisis rather than a liquidity crisis.  Other than that, they did a terrific job.  Banks loaded up on off-balance-sheet toxic debt as the FOMC focused on pontificating on their views of the likely course of the economy.

Speaking of forecasts - this from Ezra Klein in Why not Uncle Ben's Crazy Housing Sale?:

In January 2010, the Fed projected that the economy would grow 4.15% in so12.  By June 2011, it had revised that down to 3.5%.  By April 2012. it was down to 2.65 percent.  And in June, officials lowered expectations once again, saying they expect economic once again, saying they expect economic growth to be a mere 2.15% in 2012. Ouch.
Klein's article is worth reading because it illustrates so well how top analysts and observers fail to understand economic fundamentals.  Here is fundamental number 1, presented in the first week of Econ 101:  manipulating prices distorts resources.  This can be seen in the minimum wage market, rent control market, and even the Nixon price controls.  It is especially true for the price of money via the fed funds rate.

Lowering the fed funds rate to 1% in 2003 led to a moonshot in the housing market.  Resources gushed into housing.  People became mortgage bankers, real estate agents, carpenters, etc.  That's what prices do.  Then the Fed pushed fed funds above 5% - in effect, saying we didn't need all of the resources that had moved into real estate activities.  Think about this.  Today they wonder why it is so hard to get unemployment down.

As you read Klein's article and see that he supports buying mortgages and pushing down the rate on 30-year mortgages (again, affecting the price of money), you'll probably scratch your head.  This is exactly what got us into the present situation.

They say a definition of insanity is doing the same thing over and over and expecting a different result.

How about a different approach:  set a growth rate for M1 or M2 of 3%/year and let the market set interest rates, i.e., set the price of money.  Volcker did this, and it broke the back of spiraling inflationary expectations.

Wednesday, July 25, 2012

Joe Learns About Risk - In the School of Hard Knocks

Suppose you had enough money to put in Treasury notes so that you could live off the interest.  Would you be set for a risk-free, secure retirement?

You probably have guessed that the answer is no.  I found over the years, however, this wasn't an easy argument to make.  There were people who would show me their portfolio - 100% U.S. Treasuries - and explain that they could retire on the interest.  They would then say that they were taking no risk.

This is where the professional can add value.  He or she points out that there are different kinds of risk. Granted that U.S. Treasuries have zero credit risk, but they do have interest rate risk, reinvestment risk, and inflation risk. Let's examine this.

Joe - the First 10 Years

Let's go back 20 years.  Let's meet Joe, a composite of many who have approached me over the past 20 years to talk markets and investment strategy.  Joe explained that he didn't have to take risk because he had diligently saved and now, in 1992, had his assets all in the 10-year Treasury note throwing off $40,000/year.  Along with Social Security, he was looking forward to a great retirement.  Joe was 60 years old.

In 1992 the 10-year Treasury note yielded 6.73%.  Joe had $595,000 invested in 10-year Treasury notes to produce $40,000/year income.  In 2002, when the 10-year Treasury matured, the yield on the 10-year was 4.49%.  Now his $595,000 was producing $26,715.  Uh oh!

But this wasn't nearly the whole story.  Inflation had eroded the value of the dollar over this 10-year period to $0.78!  Thus, the $26,715 was equivalent to $20,837!  Thankfully, his Social Security had kept up with inflation; but, sadly, ten years into retirement and Joe had to change his lifestyle in a big way.

As an aside, you see a lot written about retirees running out of money.  In real life, what happens is they change their lifestyle.  In other words ,if they make mistakes, then it means they don't eat out as often, take the trips they planned, repair the roof, etc.

Joe - the Next 10 Years 

The ensuing 10 years saw Joe's position deteriorate even more.  Today he has his Treasuries maturing and the reinvestment rate is 1.43%.  Furthermore, inflation has significantly eaten into the real spending power of his Treasury Note interest.  Joe is 80 years old and in a precarious position.


I tried to explain to Joe when he was 60 years old that there are different types of risk.  I suggested (pleaded, in some cases) for him to put at least 30% in a well-diversified equity portfolio.  I tried to explain that, by doing so, he actually reduced his risk.  Incidently, $100,000 in equities would have grown to approximately $400,000 today.  But, my advice to Joe was mostly to no avail.  He had his mind made up.

Today, of course, I see people all the time who have their money in money market funds.  Some are fully invested in CDs.  They tell me they don't want to take risk.  Some things never really change.

Tuesday, July 24, 2012

Kiplinger Quiz "Are You Saving Enough For Retirement ?"

Take this short quiz to see how you stack up against over 32,000 others who have taken the quiz.  This quiz is part of an article by Mary Beth Franklin, Don't Run Out of Money in Retirement.

A couple of points in the article worth mentioning.  First, recent research by Webb and Wei Sun of China's Remin University found that basing withdrawals on the required minimum distribution approach set forth by the IRS may be optimal.  RMDs are required at 70-1/2 and are based on an individual's life expectancy.

A second point, made at the very end, is that rules of thumb can be dangerous.  The withdrawal rate needs to be constantly reevaluated.  For instance, for much of the period over which studies are performed, bond prices rose as stocks declined.  In other words, bonds acted as a hedge.  Today markets face yields at historical lows, and the possibility exists that both fixed income and equity markets could decline at the same time over a protracted period.  This is just one significant way that the present environment differs compared to the past.  Others include medical costs and globalization.  The point is to reevaluate at least yearly.

Monday, July 23, 2012

Stocks Yield Higher Than Bonds and Other Stuff

According to Jeff Erdmann of Merrill Lynch, the average yield of Pepsi, Intel, Johnson & Johnson, Procter & Gamble, and McDonald's is 3.29%, 1.2% greater than the average yield on these companies' 10-year bonds at 2.09%.  After taking into account the favorable tax treatment of qualified dividends, the stocks yield 2.79% compared to 1.36% on the bonds which are taxed as ordinary income.  (Source:  Barron's, 7/23/2012, p. 28).

From the Pension Fund world:  According to Michael Aneiro, "Top Pension Fund Sends a Warning", Barron's, 7/23/2012. p. M9, CALPERS, the country's largest public pension fund at $233 billion, achieved a return of 1% for the 12-month period ended June 30, 2012.  Interestingly, 55% in SPY (S&P 500), 15% in VEU (global less U.S.), and 30% in AGG (U.S. investment grade bond market) would have returned 2.6% before fees.  That's an extra cool $3.7 billion--not to mention that big-time managers scraped off a hefty amount in fees and the huge staff maintained at the Fund.

Finally Europe:  Bloomberg Businessweek (7/23/2012, p.9) reports that the European Court of Justice ruled that workers in the European Union "are entitled" to another vacation if they get sick on vacation. Is this an incentive to, in fact, "drink the water"?

Saturday, July 21, 2012

Hedge Funds' Performance

Source: Wikipedia
From 7/23 issue of Bloomberg Businessweek (p. 39):

The main Bloomberg hedge fund index, which tracks 2,697 funds, fell 2.2 percent a year in the five years ended June 30.  The Vanguard Balanced Index Fund, which has a 60/40 split of equities and bonds, gained 3.5 percent annually, and the S & P 500 gained 0.2% a year.

Many hedge funds can invest anywhere.  They can invest in gold, Finnish mortgage-backed securities, or even raw timber.  I believe most were formed by those with institutional investment backgrounds and impressive academic degrees who had achieved a track record capable of attracting assets.  For example, the largest hedge fund ever was Long Term Capital Management which had come from the risk arbitrage group at Salomon Brothers.  In addition to two Nobel prize winning economists who had developed the theory of risk, it was peopled by genius level quants and even a former central banker of Italy.

Its end game wasn't pretty.  Its value-at-risk model failed in the face of the liquidity freeze of 1998 as Russia defaulted.  The Federal Reserve had to engineer a bailout by bringing together the biggest investment bankers in the country and asking them to put up millions.  As an aside, Bear Stearns (may it RIP) was the only participant at the table who refused to put up money (classic "freeloader" case). Some say it is why the investment banking community turned its back when Bear reached the gallow steps in early 2008.

Friday, July 20, 2012

What is a Call Option?

Source: Capital Pixel
Suppose you want to "play" the stock market but (alas!) you have limited funds.  Or, suppose you are pretty fully invested but are getting the heebie jeebies reading the news coming out of Europe or prognostications on the "fiscal cliff."  Or assume you are seeking a way to increase income produced by your portfolio.  One area you might turn to is options.

Options are used in various ways to gamble/speculate, hedge, and produce extra income - not all at the same time.  In fact, the investor who is selling the options against securities in his or her portfolio is selling them to the gambler or hedger, as the case may be.

To buy and sell options you should know that, even though you may have a brokerage account, it is likely that you aren't approved for options trading.  You'll have to fill out an application that seeks to ascertain you have the means and sophistication to trade options. Furthermore, we'll just look at Yahoo! here, but brokerages have options platforms that you'll need to get familiar with if you trade options.  For example, Schwab has "Options Express" that provides all kinds of tools for the options trader.

Joe Gets Going

So how do call options work?  Let's take the case of Joe, who has $500, and sees himself as a budding stock market guru.  He's done his research and has determined that Intel is ready to pop 5 points.  Joe does the math and calculates that his $500 can buy 20 shares and a 5 point pop would get him $100.

Although a great return, Joe is disappointed.  $100 is hardly sufficient compensation for the brainpower that has gone into the trade.  He looks around and somehow is able to open an options account.  He looks into call options.

So, Joe goes to Yahoo! Finance and clicks "Investing" and then "options," as shown.

Source: Yahoo
 CLICK TO ENLARGE   This takes Joe to the quote box below (Joe notices there are 2 quote boxes and is careful to put the ticker symbol in the appropriate box!):

Source: Yahoo
Joe takes note of the various resources  available below the quote box to check out later.

He clicks "Get Options" and this brings him to:

Source: Yahoo
CLICK TO ENLARGE Now Joe is getting into the nitty-gritty. He notices a price column headed by "Strike."  This is the strike price.  If the price of the security is above this price, it is "in the money."  For the strike price of $17, Intel at $26.06 is way in the money, to the tune of $9.06.

Here's the point that Joe needs to get:  if he owned a call option on one share of Intel at a strike price of $17, he could buy a share for that price and sell it immediately for $26.06.

In fact, what is done is the option itself is sold.  As shown, selling the option would get a bit more at $9.95.  This is because of another critical concept - expiration date.  Options in the U.S. can be exercised (i.e., sold) anytime at the discretion of the holder up until the expiration date.  Here the expiration date (actually at the close of trading today) is shown in the ticker symbol "INTC120721...".

Looking back at the last graphic, Joe notices the other expiration months.  He decides to check out "Jan 14."

Source: Yahoo

Here's where it gets interesting for Joe, aka "Da' Gambler" (hey... I'm just poking fun at Joe here - he's got better odds trading options than going to Vegas!).

He is interested in the Jan 30 calls at $1.38. With his $500, he can buy 3 call options (they come in 100 share units) to have the right to buy 300 shares of Intel anytime between now and the expiration date 1/18/2014, at $30/share.  Recall from above that, if he bought shares outright, he could only buy 20 shares!

If Joe is right, and Intel pops 5 points, Joe could make a decent return, especially if it happens soon.  If he holds on to the end and Intel is 5 points higher, his call option will actually be worth slightly less. One of the concepts every options trader needs to understand is how the premium due to the time value of money works.

Fred Writes Calls

What about the other side of the trade?  After all, someone is writing these options.  Let's check in on Fred.  Fred happens to own 300 shares of Intel.  He is happily collecting 3.2% dividend on his Intel shares and augments this return by selling call options.  This greatly enhances his return in a sideways or even down market.  Fred will lose out, however, if Intel does, in fact, "take off."  Suppose Intel spurts 10 points.  Fred will miss that because he will have to sell his shares at $30 to Joe.

Fred and Joe, of course, don't know each other - all of this takes place on a centralized exchange.

Sally Hedges

The final player in all of this is the hedger.  This is Sally (FYI:  academic studies prove women are better investors than men).  Sally bought Intel at $15/share (Sally gets a smiley face) and wants to protect her profit.  One way for Sally to do this is to buy a put on Intel with a strike price of $22/share, say.  Puts are the opposite of calls.  The put would give Sally the right to sell at the strike price any time prior to expiration.  She can use the put to lock in her profit.  This hedging obviously has a cost.

Other Stuff

I set up Joe as a stock picker.  Instead he may feel he can forecast the market.  Instead of call options on a stock like Intel, he would probably be more interested in a call or put option on  SPY, the exchange traded fund that tracks the S&P 500.

A couple of points about options for the beginner.  Fred is going to find that time goes by very fast when he speculates in options.  In other words, January will get here fast as he waits for Intel to take off.  Secondly, Fred should understand going in that there will be times when he is right (or at least guesses right) but his timing is wrong, i.e., Intel does go up big but only after the options expire (aargh!).  Also, options tend to confuse people because of the terminology.  Like other parts of the investment markets, they become clearer once you take a position.  If you do so, I suggest starting small and going slow.  It will appear that "out of the money" options are cheap.  They aren't.  It typically costs beginning options traders a few thousand in tuition to learn this.

I would also recommend reading at least one good book on options, especially if you are interested in going beyond the basics.  Options trading can get exotic fairly quickly with straddles, butterflys, strangles, etc.

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

Thursday, July 19, 2012

"Sheriff of Wall Street"

This is an interview by Jim Cramer of U.S. attorney Preet Bharara, the so-called "sheriff of Wall Street" at the recent "Delivering Alpha" conference.

Preet is smart and has a great sense of humor and is dead serious about nailing the bad guys.  Hopefully his audience took to heart his warnings on what suspected  insider trading could do to a firm.  In the interview, he points out that hedge funds et al. look at the law as a line and try to get as close to the line as possible without going over.  He points out that this is an unhealthy way to look at it.  Instead, create an ethical culture.

I do have to admit that hedge fund managers remind me a bit of many teenagers.  Lay down the law to them by telling them not to do something (don't take drugs, for example), and they hear it as a challenge on whether they can get away with whatever it is.

Anyways...every investor will enjoy and learn from this video:

Wednesday, July 18, 2012

What is the "Death Cross"?

Stock analysis falls into two distinct buckets:  fundamental analysis and technical analysis.  Fundamental analysis involves studying financial reports, industry trends, etc.  Technical analysis, on the other hand, studies charts and looks for patterns.  A big deal in technical analysis is when moving averages break key levels.

What is a Moving Average?

A moving average is constructed by dropping a term in the past and adding the most recent term and then taking the average.  As a simple example, consider a 5-day moving average of the temperature.  Today we would add the daily temperatures of the past 5 days and take the average.  Tomorrow we would drop the oldest day and add in the new temperature and again calculate the average temperature.  Continue for a period of time and you get a numerical sense of whether it is getting cooler or warmer.

If you want a challenge, see if you can find a bored teenager (easy part) who can calculate and graph a 5-day moving average of the temperature over the next 10 days without a calculator.  Good luck!

The Death Cross

Short-term trends relative to long-term trends are significant in technical analysis.  These are captured by various moving averages derived from laborious studies of past data.  One that stands out is the 50-day moving average relative to the 200-day moving average.  When the 50-day average moves above or below the longer term 200-day average, it gives the technician an important signal of a buy or sell, respectively.  It is an important tool in the kit of those who follow this approach.

Well, the "Ultimate Death Cross" to which Albert Edwards, of Societe Generale, has alerted the investment community is the impending fall of the 50-month moving average of the S&P 500 through the 200-month moving average.  In the past, including Japan in 1988, this has been followed by a long-term bear market.

Edwards adds in that declining analyst optimism data also implies a pending bear market.

Stay tuned!

Tuesday, July 17, 2012

The Weasel and the Fox

Suppose we sent the fox to investigate the weasel digging a hole under the fence to the chicken coop.  It's probably pretty clear to most people that the fox would be hard put to understand the problem and condemn the action.

Substitute the NY Fed (including former NY Fed president Geithner) for the fox, Barclays et al. for the weasel, and the Libor rate for the hen house, and you've got the gist of the Libor rate-fixing scandal and the failure of many to grasp the need to respond to the manipulation.

Here's the news:  the Federal Reserve manipulates the rate at which banks lend reserves in the U.S.  The target rate is determined by the Federal Open Market Committee, chaired by Bernanke, and detailed instructions are forwarded to the trading desk at the New York Fed. The New York Fed then buys and sells securities in the open market to manipulate the rate at the target level.  Push this rate to 1%, like they did in 2003, and you get a parabolic rise in house prices and all kinds of exotic mortgages offering low adjustable rate teaser rates, no doc loans, etc., coming out of the wood work.

The only difference here is that private banks have encroached on what central banks do on an ongoing basis.

This, of course, is likely to keep the Wall Street lawyer community pretty busy- as if they needed further work.  Hopefully it will also focus more attention on how central bank rate manipulation distorts resource allocation as well.

Bernanke starts his two-day Congressional testimony today.  Hopefully some senator will inquire as to when the Fed will start doing its job.

Monday, July 16, 2012

The Questions to Ask

The person with a wrench in his or her hand who has worked as a car mechanic for 20 years knows the questions to ask when they hear that whirring sound coming from the right back when the car gets up over 60 miles per hour.  Most car owners won't - they just know it is a sound they haven't heard and that something is wrong.

I'm in the same boat many times with new clients.  Just recently I was presented with a 401(k) managed by a leading 401(k) fund provider.  The administrator of the fund had that uneasy feeling that the fund wasn't doing that well.  He knew something was wrong but like the car owner didn't know the questions to ask.

I gave him a brief rundown of my recommended approach to managing assets using low-cost well-diversified index funds, concentrating on asset allocation and carefully monitoring performance relative to a well-defined benchmark.  This set the backdrop for questions.

We then looked at the 40(k). It was comprised of load funds that charged a front load of 5.75%.  Annual expenses were on the order of .66%.  He said he was sure he didn't pay the load but would ask his broker.

Here's a question to ask:
Has there ever been a load on any fund invested in this account?
As it turns out, sometimes loads are dropped once funds exceed $1 million.  Thus, this fund may not be paying a load on investments today - to which the broker would answer that it doesn't pay any load - but it has in the past!

Follow-up question:
Can you specify for me all payments received by you and costs charged to this account over the past 12 months?
The sad fact of the matter is that the industry is totally opaque when it comes to costs and expenses and how people are compensated.  Sadly, it is rife with conflicts of interest.

In discussing performance, the client said he can get performance anytime he wants by calling up his broker.  That's a bit different, of course, from being able to go online and retrieve performance through the close of the previous business day anytime you want  for any combination of account portfolios. But that's OK if the client wants to go through that hassle.  The real question to ask is:
Can I have up-to-date performance for year-to-date, 12 months, 3 years, and since inception compared to a relevant benchmark?
It is natural that, unless you are an investment professional or have taken the time to educate yourself, you wouldn't think to ask about a benchmark.  You wouldn't appreciate the importance of setting up a benchmark beforehand.  Think about this:  when you buy a car, it is likely that you study average miles-per-gallon, average annual maintenance costs, and even likely trade-in value.  All of these are benchmarks, i.e., reference points that aid in your decision.  Sadly, similar benchmarks are purposely avoided in the investment management arena.

Even the fact that these questions have to be asked tells you something!

Thursday, July 12, 2012

Bernanke Lectures

Interested in how central bankers think?  Here are the 4 lectures given by Federal Reserve Chairman Bernanke to GW students. Although they do take a bit of a time commitment, they are well worth watching IMHO.  The Chairman covers history, the crisis of 2008, the Fed's response, and the aftermath.

If you're like me, they don't provide a lot of confidence in the people flying the plane--if you get my drift.

Bernanke reminds me of a ghost buster who sees a ghost every time the bushes move.  He saw deflation in 2003 and, along with Greenspan, led the Federal Open Market Committee to push the fed funds rate to 1% in the face of a housing market that was already picking up. Why?  Because, as a student of the Great Depression, he arrived at the conclusion that the big mistake in the 1930s was the failure of the Fed to act aggressively in the face of an economic downturn.

He casually deals with criticisms of the Fed for lowering rates but cites weak data that 1% fed funds wasn't a serious cause of the housing bubble.  In this, he fails to mention evidence produced by John Taylor that suggested following the Taylor rule and keeping the rate at 3% and above would have dampened and possibly prevented the 2008 debacle.  The GW students, who on the whole asked some pretty good questions, failed to bring this up.

He also seems genuinely puzzled by the fact that the economy acted so differently to the housing bust compared to the 1987 stock market crash.  It is fact, supported by embarrassing quotes, that Fed officials, primarily Bernanke and Greenspan, were totally befuddled by the whole housing market downturn.  This extended to the Fed's confusing response of providing a liquidity response to what was (and still is!) a solvency problem.

Another puzzling piece to me is how Fed examiners didn't come up with a funny smell in doing their job of examining bank financials, because surely they came across their off-balance sheet holdings. Bernanke admits that the Fed was focused on controlling interest rates rather than ensuring a stable financial system (which is an important part of what Congress gave them a mandate to do!) during this period, but this simply isn't good enough IMHO.

In fairness, Bernanke, et al. deserve kudos for acting swiftly once they confronted the modern-day version of a panic when money market funds faced massive withdrawals.  I'm still not clear where they got the authority to guarantee everything they did, but they probably did prevent another Great Depression.

It is clear from watching the lectures that Bernanke is an excellent teacher.  I, for one, would like to see him go back to Princeton and resume his teaching career.

I'm sitting in the back of the plane until that happens--I hear that's the safest place.

Wednesday, July 11, 2012

How Are Your Investments Doing?

I have to admit that I am constantly surprised to learn that investors many times have no idea of their investment performance.  If they have an advisor, they are typically at the whim of the advisor in receiving investment performance.  More times than not, I find returns are reported absent any meaningful benchmark. This is like telling an alien that your automobile gets 30 miles to the gallon.  Is that good?  It would have no way of making an assessment.

I point out the fact that up-to-date investment performance, relative to an appropriate benchmark, is at the fingertips of Schwab clients.  Performance is available for individual accounts as well as for combined accounts.  For example, if you have a brokerage account, an IRA, and a Roth IRA, you can get performance for each account as well as all three accounts combined.

When I point this out to potential clients, they sometimes respond that they don't follow their performance by frequently checking on it.  I agree - it isn't a good idea to check on it constantly.  But isn't it good to know it is there when you need it?

Here is performance for Schwab's "Moderate" portfolio.  Note the well-specified benchmark.  The returns are for the last three months, year-to-date, one year, etc.  They are through the close of the previous day!  The return on the right-hand-side, 2.40% annualized,  is since inception of the account, 4/15/2011.

Source: Schwab

Source: Schwab
CLICK TO ENLARGE  Here is the model to which the returns are tracked.  This is where an investor begins to get information on whether it is an appropriate model.

The index approach that I and many others follow seeks to attain returns close to the returns of the model.

But the model is also useful for those who see themselves as a market-beating investor.  It provides a well-defined benchmark against which to compare stock picking, market timing prowess.  Sort of like telling an alien that similar cars only get 28 miles to the gallon.  Then it has a benchmark.

Monday, July 9, 2012

Do You Know What's in That Fund?

Here is a really excellent piece--Hey, What Do You Think Of My Investment?--I recently came across that describes where an advisor was asked what he thought about a particular fund.  I empathized because I run into this all the time.  Asking an advisor what he thinks about a particular fund puts him or her in a difficult spot without knowing the overall goals and structure of an individual's investment program.  It's like asking about a team's draft choice if you don't know the structure of the overall team.

Still, he analyzed the fund's performance and structure.  Performance was a bit erratic - having performed well several years ago but under by quite a bit over the past 3 years.  But this is seen a lot:  advisors and individuals pick the best-performing funds but then the funds don't live up to their past performance.

What I found interesting about the piece, and what should give pause to those who invest in funds via their 401(k)s, 403 (b)s, and even brokerage accounts, is that the fund only had 15% of the Fund's assets invested in small cap growth stocks.  But it is a small cap growth stock fund!  The fund isn't investing in what its title claims it invests in.  In fact, the writer points out:
Let’s say you decided you wanted to dedicate 5% of your portfolio to small growth, so you put 5% of your portfolio into this fund.  In reality, you’ve only put 0.75% of your portfolio into small growth, not 5%.
Please spend 5 minutes and read the article.  I believe it will be eye-opening for most readers and could save a good chunk of a lot of nest eggs over the longer term.

Saturday, July 7, 2012

Client Makes First Trade

Source: Capital Pixel
Experts continually point out that market timing and stock picking over long periods of time underperform the major market indices after taking into account fees, hidden and explicit, charged by active managers.

The impact on retirement assets can be substantive.  This has, understandably, attracted considerable attention to indexed investing.

The icing on the cake that investors are coming to understand is that the process is easy, doesn't require a lot of time, and can readily be monitored to see if you are on track to produce the required nest egg in retirement.

This week I introduced the trading part of the process to a novice investor.

We first reviewed 3 basic steps:  asset allocation, figuring out how to invest, and monitoring the process.  We chose an asset allocation model that is basically 40% stocks/60% fixed income/cash.  She is 42 years old and this is her entry into the world of investing, so she is starting a bit conservatively.  She set up her brokerage account with Schwab.

The model is: 
Source: Schwab

CLICK GRAPHIC TO ENLARGE  As you can see, the targeted percentage for each asset class is specified.  From here she just needs to know what funds to invest in, do a little arithmetic, and where to go on the Schwab site .

Broker sites will have a prominent link on their main page to execute a  trade.  Click on the Schwab trade link and it takes you to:
Source: Schwab

CLICK TO ENLARGE This, of course, is where you enter the trade.

She opened her account with $10,000 and, by her model (above), she wants 25% in "Large Cap Equity."  Thus, she needs to invest approximately $2500 in a "Large Cap Equity" index ETF.

There are several ways to find the ticker symbol for various choices.  One way is to Google "large cap indexed ETFs."  Another way is to find someone who is knowledgeable about markets.  I suggested the commission-free Schwab ETF with ticker symbol SCHX.

At the bottom of each Schwab page is a quote box, which she used to find the price of SCHX.

Source: Schwab
She divided $2500 (amount she wanted to invested as determined above) by the price-per-share of $32.21, and she found that she needed to buy approximately 75 shares.

From here it is straightforward.  In the box above, she entered the symbol (SCHX), selected "buy" from the "Action" drop-down menu, entered 75 in the "Quantity" box, and chose "Market Order" from the "Order Type" drop-down list.  Then she clicked "Review Order."

CLICK TO ENLARGE  Note the estimated dollar amount of the trade.  On the same page, the amount available to trade is also given.  It is good practice to get in the habit of eyeballing this amount.

All she had to do next was to scroll down and hit the green "PLACE ORDER" button.

She had made her first trade!

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

Thursday, July 5, 2012

Where Are Investors Putting Their Money?

Tracking investment flows is a popular pastime on Wall Street.  It is a way to get a sense of market thinking.  Exchange traded fund (ETFs) flows for June, as reported by the ETF Industry Association, showed the biggest inflows, as follows:

SPY $3.6 bln. S&P 500 7.66
QQQ $1.4 bln. NASDAQ 7.65
LQD $1.3 bln.  INV. GRADE CORP. BONDS 1.3

 Biggest outflows:

VB $.965 bln. SMALL CAP STOCKS 10.42
SHY $.65 bln. 1-3 YR. TREAS.  NOTES -0.08
FXI $.568 bln. CHINA 4.27

*Returns are from Morningstar and are based on fund net asset asset value for the 30-day period ended 7/3/2012.

During the month, the Federal Open Market Committee announced a continuation of "operation twist" whereby they focus on investing in the longer maturity portion of the yield curve in lieu of shorter maturities.  It appears that this was impetus for investors to seek higher-yielding corporate bonds in this part of the curve.

For additional detail, see the Bond ETFs Remain Top Draw in June by Tom Lydon.

Monday, July 2, 2012

Year-To-Date Performance

Source: Capital Pixel
Although markets followed patterns of recent years and were a bit shaky during the 2nd calendar quarter of 2012, they held their gains for the year and rewarded investors who were well-diversified and who stayed with their asset allocations.  This performance builds on the 20-year performance ended 2011 of the diversified portfolio as reported by BlackRock.  The report covers several asset classes as well as a diversified portfolio comprised of 35% fixed income and 65% stocks.  Over the 20-year period ended 2011, the portfolio achieved an average annualized return of 7.7%. At that rate, money doubles in approximately 9 years.  Thus, over the period, a sum of money invested in line with the diversified portfolio would have quadrupled.

The performance of the asset classes comprising the diversified portfolio over the 1st 6 months of 2012 along with component weights and expense ratios are shown in the following table constructed with data from Morningstar :

CLICK TO ENLARGE  The overall portfolio has achieved a return of 6.1% year-to-date. 

A few observations are worth making here.  First off, there has been significant scary news throughout the course of the year that would scare even the bravest investors from the capital markets.  The talk of Europe imploding, the weak U.S. economy, and the fast approaching "fiscal cliff " has been incessant.  Secondly, the alternatives are pathetic.  Treasury bills and money market funds yield marginally above zero and, after taking into account inflation and taxes, are guaranteed to lose ground.  Finally, there is a group of so-called tactical asset allocators who argue that buy-and-hold is dead and that assets need to shifted around in response to valuation metrics. They argue, as well, that they don't really have an appropriate benchmark because they don't have a set allocation but can instead invest in any asset class.

I believe the numbers reported here bury the "buy-and-hold is dead" argument.  I would further argue that the performance here is an excellent benchmark for the tactical asset crowd.  It is a choice investors could easily choose over the tactical approach.  If the tactical approach isn't beating the well-diversified, low-cost diversified portfolio, then I would think at some point questions would arise.