Bond Exit Fees?

There is some buzz being created on the idea, apparently floated by the Federal Reserve, of establishing fees to exit bond funds with the purpose being to essentially deflate a potential bond market bubble.

I just watched an incomprehensible presentation on this topic by Rick Santelli on CNBC.

Look, this is a sad state of affairs.  Stupid ideas are the end game of price controls.  In tightly controlling the short term interest rates, the most important price in the economy, the Federal Open Market Committee has created a situation with serious pressures.

Take the most recent embarrassing presentation by Ms. Yellen.  After setting definitive objectives in terms of 2% inflation and 6% unemployment, now the FOMC says it's "noise" when the objectives, so clearly communicated to the financial markets, are exceeded.  What happens if the inflation measure they follow, the PCE deflator, goes above 2%?  It can be considered noise and, actually, the FOMC follows many indicators to assess inflation and unemployment.  Huh?

Ms. Yellen informed us that policy changes would be clearly communicated to financial markets, even in between FOMC meeting, via speeches, etc.  Is there anybody today questioning that Wall Street is running the show?

If she took a truth serum, she would tell us the problem is that the FOMC is worried that all hell will break loose when rate increases start because the market knows interest rates tend to go up and down over a protracted period.  That is, the market will see the first increase as the beginning of a longer term trend of rising rates.

The hope out there is that, if the Committee obfuscates long enough, the economy will jump ahead and stocks continue up so that it offsets the downturn in bond prices.  Good luck.

Volcker stopped the interest rate control approach and set the growth rate of the money supply. Thereby, through considerable pain, he broke the back of a vicious ramping-up of double digit inflation.  Now, thanks to the Greenspan, Bernake, and now Yellen FOMCs that believe they can forecast the economy and control the price of money, we are again backed into a corner and hence considering a stupid idea.  Again, the most likely outcome is that mainstreet will take it on the chin, especially the gray tsunami of baby boomer retirees.

As you follow this, keep in mind the confidently proclaimed 2005/2006 predictions by Greenspan/Bernanke, et al., that real estate markets are local and weren't a macro concern.  Keep in mind that Greenspan, referred to as the "maestro" by many of his FOMC colleagues, recommended that more first-time home buyers should take advantage of adjustable rate mortgages.  We know how that worked out.

Should You Take the Lump Sum or the Pension?

Source:  Capital Pixel

Lump sum or pension?  As usual, it depends.  If you are worried about the market and if providing for your spouse is a concern, then you should probably lean in the direction of taking it.  If, instead, your attitude is that you can do better in the market and/or your spouse can fend for him/herself (after all you'll be dead and won't have to listen to it on a daily basis), then the lump sum might look better.  ;)

There are a few things to know.  This is actually an area of potential conflict--even in the world of the pristine, fee-only, registered investment advisor acting in a fiduciary capacity.  This is because recommending you take the company pension, i.e. annuity, means less assets under management for him or her!

For most people, I recommend taking the pension (you should know that I'm a fan of Social Security) and, in fact, choosing the survivor option.  The survivor option will be a little less but will give you peace of mind that the surviving spouse will have that income stream.

I do recommend a bit of research to compare the offering rate with other single-premium, immediate-pay annuities out there.  After all, you can take the lump sum and buy your own monthly income stream. You can start here:

annuity information.

First look at the payout.  You will give the insurance company a certain amount (your lump sum), and they will give you a monthly payment until the last spouse dies.  How does this compare to the company payout?  This is a fairly easy comparison, although they always throw in some complications to confuse you.  For example, beneficiaries will receive promised payments under some annuities if you both pass away within 5 years.  A second consideration is the health of your company and the insurance companies you are looking at.  Make sure you understand your state insurance funds protection.  You'll, hopefully, be looking forward to a number of years of payments; and the state insurance could come into play.

A third consideration could be the low interest rates available today.  If you are patient and take the lump sum for a couple of years, your payout would be considerably greater if interest rates rise.  This is because higher rates mean higher payout; but also, the older you are the higher, the payout.

A caveat emptor:  be careful in dealing with insurance company people especially on the subject of annuities.  They'll flash their pearly whites, flatter you to the point of embarrassment, and sell you a high-priced product you don't need.  Keep repeating that you are only interested in a single-premium, immediate-pay annuity.

The genesis of this post is

the article by John Hechinger of Bloomberg: "Retirees Suffer as $300 Billion 401(k) Rollover Boom Enriches Brokers."

To me, this article is misleading and highly confusing.  It creates the impression that rolling over a 401(k) is something retirees and others shouldn't do when, in fact, it many times is the very best thing they can do to get away from excessive fees and poor investment choices.  In the article, it is not clear whether the author is talking about the lump sum from the pension or the 401(k).  Anyway, it is worth reading to pick out the errors and fuzzy thinking.  I definitely agree with the bottom line:  taking a lump sum and putting it into a broker recommended oil and gas venture is a bad idea for just about everybody!

Are You a Dave Ramsey Fan?

Dave Ramsey is the well-known guru for people trapped by excessive debt.  His strategy is to pay off the smallest debt and to create a snowball effect with the released funds to attack the bigger debt.  If necessary, he pushes a tough love approach whereby debt-laden people need to go on a beans and rice diet to pay off the debt. At least this is my take.  I haven't taken any of his courses or ever met with any of his counselors.  I listen to his radio show from time to time and have made it about halfway through his book The Total Money Makeover.

He apparently is a huge, life-changing help to many people whose life is overrun by debt.  And to me, this is a big deal.  I look at it as your money is either working for you, earning interest and dividends, or working against you by charging interest, late payments, overdraft charges, etc.  Much of the nation seems to be in the latter boat.

From time to time I run into people who spend more than they make and are digging themselves into the debt hole and recommend that they read Ramsey.

Having said all this, I cringe when he talks about investing in a "good mutual fund that earns 12%".  By the rule of 72, a 12% return doubles your money every 6 years.  Wow!  This sounds pretty easy (especially in a world of 2% inflation and anemic bond yields) and exciting to an investment novice. Unfortunately, it is not that easy; and evidence shows that funds with prior superior performance tend to subsequently underperform the market and have high fees that severely penalize investors.

Here are two other recent takes on Dave Ramsey:

"The Reality of Dave Ramsey's 12% 'Reality' (and why it really matters)" by Dough Roller

"Take Dave's Advice With a Grain of Salt" by Getting Your Financial Ducks In A Row

Advice From My Father

Needs Johnson's Baby Shampoo?

My Dad's been gone a few years and I still miss him.  I often marvel at how he would have enjoyed all the craziness that has gone on in the world since he has been gone.  He would never believe the Wizards actually made the playoffs and made a very respectable showing.  He would have loved all the RG III hoopla.
Anyway, he offered me 3 pieces of advice that you don't hear every day that made a difference for me that I think are worth passing on.

First, he saw me struggling in the job world as I liked to stay up late, run around with friends, and generally party.  He told me that, to get ahead in the job world, I needed to get into a routine that centered around a good night's sleep.  It worked wonders.

Secondly, he advised me to take a year off after high school and work before heading to community college.  I was the first in my family to go to college, and it was a dream of his to see me go.  After a year of working and saving, I headed off to community college with extra incentive that comes from working full time at the bottom of the food chain and no need for a student loan.  Years later, after going through the PhD program at the University of Maryland (all except dissertation), I marveled, even in those days, at the debt loads of my graduating friends.

Thirdly, he noticed my struggle with my rat's nest hair as I entered the professional job market (this was before rat's nest hair was in style).  He suggested shampooing every day with Johnson's baby shampoo. It made a difference in my look and in my confidence.

Happy Father's Day!!!!!!

What is Your Investment Horizon?

 If you're like most people, thinking about time is not easy.  In the US, things are old if they are 2 or 3 hundred years old.  Go to Europe and tourists marvel at sites thousands of years old.  The 30-year-old finds it hard to imagine his or her 65th birthday.  It is a challenge thinking about retirement. "That's far off, I have plenty of time to get started later."  This, of course, gets investment people to wring their hands and gnash their teeth.

We realize that time is the investor's big ally.  Even a small difference in return over a long period can make a huge difference.  An 8% return on $10,000 compounded over 40 years gives you $217,245.  Increase the return by 1% and the ending value is $314,094.  Our mantra is "get invested early and correctly."  Warren Buffett is the shining example of this.  Fifty years ago, he was investing in well-run companies and holding on to them.

The time frame is referred to as investment horizon.  Understanding and thinking about your  investment horizon is an important piece to determining an appropriate asset allocation.  Other things being equal, the longer your investment horizon the greater the tolerance for volatility and, therefore, the greater the capacity to take on stocks.  In layman's terms, the longer your investment horizon the more time you have to recover from a market downturn.

Most people have a longer investment horizon than they think when it comes to retirement planning. For example, many people think right-off-the-bat that the investment horizon is the expected retirement date.  And it is, if you think you might drop dead on that date!  Otherwise, you probably want to continue to have your assets earning a decent return.  In fact, you may need them to continue earning a decent return for 30 or more years.

Another consideration is that you may have as a goal to leave an inheritance.  Now the horizon shifts from how long you are going to live to the life expectancy of your heirs.

The bottom line is that your investment horizon is probably longer than you think!  As a caveat, keep in mind the rule of thumb of investing very cautiously for monies you will need within 5 years.  For example, if you are saving for a down payment on a house, your horizon is probably less than 5 years. Keep these funds in very short-term bond funds or money market equivalents.

Is the Market in a Sweet Spot, or What?

Readers of this blog know I'm not a market forecaster.  They know I don't have a crystal ball.  They know that I subscribe to the low-cost, well-diversified index fund investment philosophy touted by Warren Buffett, Burton Malkiel, Dan Solin, and Andrew Hallam.  What some may not know is that I follow the markets closely and have been following and investing for over 30 years.

And,  just because you're an indexer doesn't mean you can't have a bit in the market seeking to outperform the market.  I recommend this be kept to 10% or less of total assets.  This is the "fun" account.

Anyway, having said all of this, I have to say I've been amused by the constant long-time parade of talking heads on CNBC predicting a market correction.  I understand the guru status meter and how predicting a downturn in the market that actually occurs causes the needle to go crazy.  I've been around so long I remember Gazarelli's call in 1987 before the market crash that saw a 24% drop in one day.  I watched as her notoriety ramped up big time.  And as it ramped down.

Like a broken clock, some of these guru wanabees will eventually be right and garner followers who reward them for their correct market call.  Most of these gurus emphasize that their favorite valuation measures are high (above some critical level) on an historical basis.

Anyway, since everybody and their brother seems to want to offer a view, I thought I would offer mine.  First off, I believe the backdrop in today's market is important, maybe more so than at any time in history.  The notion that "this time is different" is nonsense is nonsense.  Every market is different! Today interest rates are at historically low levels in the U.S. but higher than important rates elsewhere in the world, namely Germany.  The yield on the 10-year U.S. Treasury stands at 2.59%, a full 1.24% (124 basis points) above the similar offering in Germany.  For Europeans, the U.S. Treasury note is extremely attractive given their year-over-year inflation rate of 0.5%!  Throw in U.S. dollar strength, and it is a terrific investment for European investors.

Another huge part of the investment scene that makes the present different is the gray tsunami of the baby boomers retiring and scrambling to live off their retirement funds.  Many are stretching, for an extra 1% to 2% is important for their standard of living.

It is no secret that looking in the rear view mirror, although extremely costly at times, is the prevalent way of investing; and today that rear view mirror shows that dividend stocks have pulled up many income investors by the bootstraps.  Like the guests at the party passing around the secret message, gray-haired investors are noting the higher-than-Treasury-yield dividend payouts by the likes of Johnson and Johnson and are jumping on the bandwagon.

I look at all this in economic terms.  The safe dividend payers with rates above 3% are substitutes for fixed income.  Go back to your Econ 101 notes.  Remember how an increase in the price of apples resulted in an increase in demand for oranges?  Make the price of fixed income too high (i.e., keep Fed policy focused on low rates) and investors demand for  dividend stocks increases.  Especially attractive, when inflation is under consideration, is the potential for dividends to increase versus locked-in Treasury payments for the life of the bond!

Of course, other factors are in play as well.  The Fed is systematically reducing its Quantitative Easing by $10 billion per month at each session, and the Federal Deficit is narrowing.

I don't have a research assistant to run down a bunch of fund flow and Treasury foreign fund investment data for you, but I believe this behavior by marginal investors is an important part of the market that a lot of the gurus don't get.  That huge pockets of investors, both domestic and foreign, have driven spreads on junk bonds (and even junkier Euro zone members) to eye-popping tight levels and, consequently, now see the dividend payers as the way to go trumps the old "P/E ratios are above historical averages and therefore it is time to lighten up on stocks" message.

To the extent that this thinking is correct, a big threat to stocks is, in fact, rising rates that approach dividend yields.  In the absence of rising rates, stocks could continue chugging higher, despite higher valuations on an historical basis.  This is not to say other threats are not out there, including nut jobs heading up major countries.  It is to say that the odds favor continuing to exploit downturns in the market, as long as Treasury yields remain significantly below dividend yields on high quality stocks.

Just my 2 cents.

Inside Buffett's Brain

Here is an article that Warren Buffett fans will enjoy:

"Inside Buffett's Brain" by Pat Regnier in Money magazine,

It describes an attempt to create a formula that not just matches Warren Buffett's performance but exceeds it.

Trying to duplicate Buffett's success or at least discover his secrets has, of course, become something of a national pasttime.  Many people who become charmed by his folksy, common sense investment stories are convinced that they can do what he has done.

This reminds me of a presentation I went to many years ago at the National Press Club in Washington DC where the presenter was a money manager who had exceptional success in investing in so-called "fallen angels" - stocks that for some reason or other had fallen on difficult times and consequently had seen their stock price drop significantly.  I watched as the crowd nodded in response to the money manager's description of superior performance.  I watched as the crowd scribbled notes in response to his listing of things he looked for.

Finally, he got to the point where he named his fund's largest holding.  It was General Public Utilities which had gotten pounded as a result of the Three Mile Island nuclear accident.  At this point, there was a gasp and the scribbling stopped.  The crowd morphed in an instant from anticipating discovering the golden goose to understanding they weren't nearly on the same plane as a serious value investor.

According to the article, Buffett earned 19.7%/year, compared to 9.8% on the S&P 500, over the past 49 years!  Using the rule of 72, we can divide 72 by 19.7 and find that Buffett's portfolio was doubling every 3.65 years, on average!  And he did this with what most people would consider to be boring stocks--Geico, Coca Cola, American Express.

I think it is possible that, like the crowd that learned about General Public Utilities, many Buffett wanabees, formula or no formula, will be frustrated for two reasons.  First the world is different today. It is changing much, much faster because of technological advances, globalization, and general information flow making the identification of solid, basic companies that will be leading brands over a 30- to 40-year period considerably more difficult.  In today's world, products are produced with practically zero marginal cost and many times fixed costs are not that substantive.  Industries are disrupted by talented kids with computer power in the proverbial garage.  Secondly, few people in Warren Buffett's heyday had anywhere near his patience and staying power; and they are surely fewer and farther between today.

I think he knows this, and this is why he pushes index fund investing even to the point of recommending it to his heirs.