Bert Whitehead, M.B.A., J.D. © 2009
You probably know someone who knows someone who invested in Maddoff’s Ponzi Scheme. These ‘investments’ pay handsome returns, but not because the money is actually invested, but because investors who cash in on their ‘profits’ are paid off with cash received from new suckers.
With the recent market collapse, we are hearing of more and more of these frauds. That’s because these scams run out of cash when people take money out faster than new ‘investors’ are putting new money in. As Ben Bernanke quipped, “When the tide goes out, we can see who’s naked.”
This blog will discuss the Maddoff scheme as well as other classic ways investors lose money in investments -- and how you can protect yourself. Some of the safeguards I will discuss have been outlined in a series of articles by my colleague, George Marrotta, a Research Fellow at Stanford’s Hoover Institution which I have linked if you are interested in perusing.
1) The simple rule that Maddoff’s investors ignored is: “Don’t Let Your Advisor Have Custody of your Investments.” Maddoff’s investors sent their money directly to him; the paper statements they received were made up by him and his staff. Using Schwab or other independent custodians allows you to review your statement directly on-line at any time. Always make out your checks to Schwab with your account number on it, and check your statements to make sure the deposit was received. Cf. www.emarotta.com/article.php?ID=320
2) Even with the safeguard of having an independent custodian custody your assets, it is still possible to get embezzled. There were recently two cases which individual advisors stole several million dollars from client accounts. In these cases, the advisors had very elderly clients and instructed them to sign transfers from their Schwab accounts to the advisor’s account, or the advisor had check writing authorization on their account.
This of course could happen to any of your accounts at a bank. The safeguard is simple: Make sure you review your bank and brokerage statements yourself every month and review withdrawals and transfers out to make sure you know what they were for and you received the money.
3) As we get older, it is much more difficult to keep track of everything in our lives. Your finances are one of the first areas impacted by old-age forgetfulness. If you find yourself becoming confused and forgetful with your finances, it is important to have someone in your life that you trust to review your finances with you. They can double-check to make sure mistakes aren’t being made. Where we notice that a client is becoming forgetful, we will bring it up and suggest a neurological exam, since this condition can greatly impact your financial situation if not dealt with appropriately.
4) The biggest scam I see our clients exposed to are private investment ‘opportunities.’ These usually have very nice glossy sales brochures and a salesman/organizer with a smooth line of snappy patter. These often involve unregistered securities which are virtually impossible to evaluate because there is not adequate financial information, disclosures, conflicts of interest, etc. to work with. We suggest you don’t even consider unregistered securities, even with (or especially with) friends and family. Time-shares are one of these scams.
5) If offered the opportunity to get in on the ground floor, ask them to email you a prospectus or ‘offering memorandum.’ I review a number of these deals every month for clients. Then I explain the risks involved, how the money is being used including payment of the organizers, the conflicts of interest involved, etc. This is the information which is technically ‘disclosed’ but that most people don’t read or understand. Once these factors are explained, clients generally take a more sobering approach to these deals.
6) It is also important to recognize and avoid financial hooks. In many investments the salesperson earns hefty commissions. This is disclosed in the fine print which no one reads. One clue is that you are charged a hefty surrender charge or penalty to get out in the first 5-10 years. For more information, go to www.emarotta.com/article.php?ID=324.
I do believe that a financial advisor should save a client more than the advisory fee charged. Often the savings in taxes, lower investment costs, avoiding commissioned products, insurance evaluation, getting better mortgage deals, etc. produce savings which are readily apparent.
But over my 37 years of doing financial planning, I think I have saved clients even more money by talking them out of inappropriate investments and keeping them from getting scammed.
If you have been dissuaded from an investment by your advisor, I’d like you to let me know about it. I’d like to do a blog someday on ‘Investment Horror Stories!’
Monday, June 22, 2009
Wednesday, June 3, 2009
How Long Does It Take to be a Long-Term Investor?
Bert Whitehead, M.B.A., J.D. © 2009
This year’s market bottom in March wiped out all the market gains in your portfolio since 1996 (13 years)! This has left many commentators sniveling about the stock market as an inferior investment vehicle. But I’m sure everyone reading this has consistently been told that you have to be a ‘long-term investor’ to profit in the stock market.
So if 13 years isn’t long enough, how long is long enough?
When I started as a Financial Advisor in 1972 we were in the recession that started in 1967. The Dow hit 1000 in 1967 and didn’t get beyond 1000 again until 1982 (15 years). There was a widespread belief in the 70’s that the market could never go over 1000.
The financial pundits at that time subscribed to the theory that whenever stocks went beyond 1000, companies would always issue more stock. The additional supply would force the stock prices down, So the supply/demand curves intersected at 1000.
This year the market bottomed at 6600 in March ‘wiping out all the gains’ since 1996! But if you look at the peak in 1982 when the Dow was at 1000 and compare it to the peak in 2007 when the Dow hit 14,000, the market rose 9.8% per year ‘peak-to-peak over that 24 years. Clearly the ‘permanent market cap’ at 1000 the academicians theorized has been discredited.
Even measuring the ‘trough-to-trough’ bottoms from 607 in 1974 to 6600 this year (25 years), the market increased an average of 10.0% per year. On top of this add in the 4-6% in historical dividend payouts and the total average annual returns are easily over 12%.
The stock market has consistently been the most accessible investment over the long term! These kinds of returns are available to every person by simply consistently dollar-cost-averaging into a large cap indexed mutual fund over the long term.
Deciding not to invest in the market now, especially for younger people, could be the worst financial decision you could make in your life. And remember: you are younger now than you will ever be for the rest of your life .
This analysis explains why Cambridge Bond Ladders are for 15 years, rather than the 5 years many other advisors suggest. Fifteen years cash flow will last you through any recession. To fully reap the profits of the stock market an investor should have a 25 year horizon. That’s how long is long enough!
This year’s market bottom in March wiped out all the market gains in your portfolio since 1996 (13 years)! This has left many commentators sniveling about the stock market as an inferior investment vehicle. But I’m sure everyone reading this has consistently been told that you have to be a ‘long-term investor’ to profit in the stock market.
So if 13 years isn’t long enough, how long is long enough?
When I started as a Financial Advisor in 1972 we were in the recession that started in 1967. The Dow hit 1000 in 1967 and didn’t get beyond 1000 again until 1982 (15 years). There was a widespread belief in the 70’s that the market could never go over 1000.
The financial pundits at that time subscribed to the theory that whenever stocks went beyond 1000, companies would always issue more stock. The additional supply would force the stock prices down, So the supply/demand curves intersected at 1000.
This year the market bottomed at 6600 in March ‘wiping out all the gains’ since 1996! But if you look at the peak in 1982 when the Dow was at 1000 and compare it to the peak in 2007 when the Dow hit 14,000, the market rose 9.8% per year ‘peak-to-peak over that 24 years. Clearly the ‘permanent market cap’ at 1000 the academicians theorized has been discredited.
Even measuring the ‘trough-to-trough’ bottoms from 607 in 1974 to 6600 this year (25 years), the market increased an average of 10.0% per year. On top of this add in the 4-6% in historical dividend payouts and the total average annual returns are easily over 12%.
The stock market has consistently been the most accessible investment over the long term! These kinds of returns are available to every person by simply consistently dollar-cost-averaging into a large cap indexed mutual fund over the long term.
Deciding not to invest in the market now, especially for younger people, could be the worst financial decision you could make in your life. And remember: you are younger now than you will ever be for the rest of your life .
This analysis explains why Cambridge Bond Ladders are for 15 years, rather than the 5 years many other advisors suggest. Fifteen years cash flow will last you through any recession. To fully reap the profits of the stock market an investor should have a 25 year horizon. That’s how long is long enough!
Tuesday, May 12, 2009
Inflation:The Next Scourge?
Bert Whitehead, M.B.A., J.D. © 2009
The stock market (S&P 500) closed on May 8 ahead of where it was at the beginning of the year. Since the low point on Mar. 9 it has risen 37%. Keep in mind that the stock market is a leading indicator. If recent trends are not a ‘false bottom’ the recession should end in 9 to 18 months, based on historical performance. Of course, we have been reminded that history is not a trustworthy predictor of future results…
There are other signs that the economy is starting to bounce back. Unemployment isn’t rising as fast as it has been, some companies are showing a profit. Consumer confidence is rising. Those are positive factors.
Nonetheless, we are still mired in deflation. Prices are actually dropping (social security recipients are startled that they are not receiving a cost of living adjustment this year). Every month there have been fewer people employed. More companies are going broke, real estate is still in crisis, banks and other financial institutions still haven’t been resuscitated. Now we are seeing state and local governments get in line for federal bailouts. The rest of the world also seems to be caught in this deflationary vortex.
Just as it seems like we might be turning the corner, the pundits are already spooking us about inflation. Inflation may be our next challenge, but further deflation is more likely for the near term and very possible for even the next 10 years. It looks like two of the auto companies are going to end up being owned by the unions and the government, and the financial industry has been in effect ‘federalized.’
Skeptics question whether business decisions will now be politicized, and determined by political considerations rather than by market forces. This could result in many new cars built to be small and energy efficient, which the government wants. But in the past buyers have spurned those in favor of larger vehicles. Will overseas auto companies move in to fill the demand? Unless gasoline prices go back to $4-5/gallon, most Americans want to buy their SUV’s. If Detroit won’t make them, someone else will.
If everything keeps falling in place, and recovery is in sight, we will have to deal with the trillions of dollars in government debt. The fed has been issuing a huge increase in Treasury bonds to fund the Stimulus programs. The concern is that, if and when we do pull out of this deflationary spiral, the world will be awash in US dollars.
This could result in higher interest rates which the government would have to pay to induce people to buy US bonds. Right now, the feds are buying bonds themselves to keep long-term interest rates (and hopefully mortgage rates) down. But at some point we will have to pay the piper. That means that this increase in the money supply will create higher inflation. Or will it?
As with most economic issues, there are too many variables to predict with certainty the outcome. If the dollar drops relative to other currencies, which we would expect with inflation, our goods become cheaper for people in other countries and our exports would increase. Because imports would be more expensive here, we would reduce our trade deficit.
During the 90’s Greenspan was baffled by the low inflation we experienced relative to the growth in the money supply. When he left office, he pinned it on the higher productivity the US enjoyed because we were able to outsource low productive jobs abroad. Generally high productivity which we typically see during recessions holds down inflation. During our current recession we have seen productivity increase, as companies shed less productive jobs.
Another factor is the savings rate of citizens. Japan had virtually no inflation in the 90’s when they increased their national debt exponentially to stimulate their economy. But because their savings rate increased, the extra money supply wasn’t spent and prices stayed level. We are now experiencing a significant increase in consumer savings, and we see a reduction in debt (partly because it’s too hard to get a loan now!). Unless the increased money supply is actually spent, there aren’t more dollars chasing too few goods.
The reality is that inflation will be our next threat if the government keeps spending at the rate they have been. There are factors which may absorb the impact of inflation, so it is not certain how much it will affect us.
In balancing portfolios to protect clients against inflation, we focus on the asset classes which provide the best buffers. Cash and inflation adjusted savings bonds are effective as their yield increases along with inflation. Mortgaged real estate is one of the best protections. While real estate is a long-term inflation hedge, it is too regional to reliably provide much protection unless it is mortgaged at a long-term fixed rate. Unhedged foreign equity mutual funds can be a buffer, except (as we have seen lately) world currencies have been moving up and down together. In some situations we recommend clients buy gold bullion coins.
Inflation is likely to drive interest rates higher, so some clients become concerned because the nominal value of their Treasury bonds drop. Not to worry: the bond will be worth its face value on maturity, and that is what we count on to provide the guaranteed cash flow for your retirement.
Many clients are taking advantage of the lower stock prices now to increase their dollar-cost-averaging into stocks. We are recommending to others that it is a good time to refinance their homes at lower rates to decrease their needed cash flow. When we meet with you next we will look forward to reviewing your portfolio relative to your current situation. We are proud that our clients’ portfolios have weathered this ‘storm of the century’ relatively unscathed and look forward to moving on with you on your journey to “FIPOM” (Financial Independence and Peace of Mind)!
The stock market (S&P 500) closed on May 8 ahead of where it was at the beginning of the year. Since the low point on Mar. 9 it has risen 37%. Keep in mind that the stock market is a leading indicator. If recent trends are not a ‘false bottom’ the recession should end in 9 to 18 months, based on historical performance. Of course, we have been reminded that history is not a trustworthy predictor of future results…
There are other signs that the economy is starting to bounce back. Unemployment isn’t rising as fast as it has been, some companies are showing a profit. Consumer confidence is rising. Those are positive factors.
Nonetheless, we are still mired in deflation. Prices are actually dropping (social security recipients are startled that they are not receiving a cost of living adjustment this year). Every month there have been fewer people employed. More companies are going broke, real estate is still in crisis, banks and other financial institutions still haven’t been resuscitated. Now we are seeing state and local governments get in line for federal bailouts. The rest of the world also seems to be caught in this deflationary vortex.
Just as it seems like we might be turning the corner, the pundits are already spooking us about inflation. Inflation may be our next challenge, but further deflation is more likely for the near term and very possible for even the next 10 years. It looks like two of the auto companies are going to end up being owned by the unions and the government, and the financial industry has been in effect ‘federalized.’
Skeptics question whether business decisions will now be politicized, and determined by political considerations rather than by market forces. This could result in many new cars built to be small and energy efficient, which the government wants. But in the past buyers have spurned those in favor of larger vehicles. Will overseas auto companies move in to fill the demand? Unless gasoline prices go back to $4-5/gallon, most Americans want to buy their SUV’s. If Detroit won’t make them, someone else will.
If everything keeps falling in place, and recovery is in sight, we will have to deal with the trillions of dollars in government debt. The fed has been issuing a huge increase in Treasury bonds to fund the Stimulus programs. The concern is that, if and when we do pull out of this deflationary spiral, the world will be awash in US dollars.
This could result in higher interest rates which the government would have to pay to induce people to buy US bonds. Right now, the feds are buying bonds themselves to keep long-term interest rates (and hopefully mortgage rates) down. But at some point we will have to pay the piper. That means that this increase in the money supply will create higher inflation. Or will it?
As with most economic issues, there are too many variables to predict with certainty the outcome. If the dollar drops relative to other currencies, which we would expect with inflation, our goods become cheaper for people in other countries and our exports would increase. Because imports would be more expensive here, we would reduce our trade deficit.
During the 90’s Greenspan was baffled by the low inflation we experienced relative to the growth in the money supply. When he left office, he pinned it on the higher productivity the US enjoyed because we were able to outsource low productive jobs abroad. Generally high productivity which we typically see during recessions holds down inflation. During our current recession we have seen productivity increase, as companies shed less productive jobs.
Another factor is the savings rate of citizens. Japan had virtually no inflation in the 90’s when they increased their national debt exponentially to stimulate their economy. But because their savings rate increased, the extra money supply wasn’t spent and prices stayed level. We are now experiencing a significant increase in consumer savings, and we see a reduction in debt (partly because it’s too hard to get a loan now!). Unless the increased money supply is actually spent, there aren’t more dollars chasing too few goods.
The reality is that inflation will be our next threat if the government keeps spending at the rate they have been. There are factors which may absorb the impact of inflation, so it is not certain how much it will affect us.
In balancing portfolios to protect clients against inflation, we focus on the asset classes which provide the best buffers. Cash and inflation adjusted savings bonds are effective as their yield increases along with inflation. Mortgaged real estate is one of the best protections. While real estate is a long-term inflation hedge, it is too regional to reliably provide much protection unless it is mortgaged at a long-term fixed rate. Unhedged foreign equity mutual funds can be a buffer, except (as we have seen lately) world currencies have been moving up and down together. In some situations we recommend clients buy gold bullion coins.
Inflation is likely to drive interest rates higher, so some clients become concerned because the nominal value of their Treasury bonds drop. Not to worry: the bond will be worth its face value on maturity, and that is what we count on to provide the guaranteed cash flow for your retirement.
Many clients are taking advantage of the lower stock prices now to increase their dollar-cost-averaging into stocks. We are recommending to others that it is a good time to refinance their homes at lower rates to decrease their needed cash flow. When we meet with you next we will look forward to reviewing your portfolio relative to your current situation. We are proud that our clients’ portfolios have weathered this ‘storm of the century’ relatively unscathed and look forward to moving on with you on your journey to “FIPOM” (Financial Independence and Peace of Mind)!
Monday, April 27, 2009
Are We Turning The Corner Yet?
Bert Whitehead, M.B.A., J.D.
Finally we have seen some positive news on the financial front, and many optimists think we have hit the bottom and the stock market bounced off its low-point. It’s nice to be able to take a breath from the brutal onslaught of bad news over the past year.
We have been preaching about the dangers of being out of the market, even when it is falling, While it has been psychologically stressful to maintain equity positions over the past year, recent market activity points to the reason to refuse to market-time.
Interestingly, the average gain for the S&P 500 in the 1 year following the low close for the 8 bear markets that occurred in the last 50 years is +36.5%. The current bear market is the 9th bear market of the last half century. The closing low point (so far) of this 9th bear market was 677 and it took place 7 weeks ago on 3/09/09. In the last 7 weeks, the S&P 500 has gained 28.5% (not counting the impact of reinvested dividends.
Our clients pay us to ‘watch their backs.’ So without being an outright pessimist I think that we are still in a perilous financial situation. The future of the auto industry is teetering and we may see 2 of the ‘Big 3’ bite the dust in the next few weeks. The economic reality goes even deeper than that. We are restructuring our national economy to be able to participate in a global economy.
Our prosperity over the past 15 years was based on a world-wide spending spree, fueled by cheap credit and over-leveraged real estate. The current government nostrums are designed to spur more spending, but no meaningful programs have addressed the banking and real estate collapses. We see the impact of these issues everyday in the ‘For Sale’ and ‘For Lease’ signs in almost every neighborhood and commercial area.
Each client’s situation is different, and so the approach best suited to you depends more on what is going on in your own life. If the breadwinner in your family is out of work, or you have kids in college, or are faced with disability, or are retired (or hope to be soon) – these are the key factors in your investment allocation. While the stock market may look great, it is a mistake to be kicking yourself for having missed out on the steep increase recently.
For clients in transitional or distressed situations, we want to maintain an extra cash cushion. If your life situation is stable and your bond ladder is on-track, dollar cost averaging into the stock market is very advantageous. Now that tax season is over, we have scheduled appointments with each client to review your portfolio and make adjustments as appropriate.
It is a mistake to conclude, based on the past 2 months market activity, that you should now jump in with both feet. It is likely that we may not hit bottom until next year, and then it may take a couple of years to fully recover. Market timing is a futile waste of energy.
Treasury bond rates are low, and the feds are buying bonds to keep long term rates down, so it will be advantageous for many clients to refinance at lower rate (unless you owe more on your house that it’s worth). Jumbo mortgages (i.e. more than $417,000) however still carry very high rates and it is seldom worthwhile to refinance those.
This experience of living through the worst economic period since the Great Depression of 80 years ago will have a lasting positive impact on most of our clients. The losses will ultimately be recouped, and we are able to outlast even a continuing downturn. More importantly it has made many of us aware that we were frittering away money on things we didn’t really value. This lesson I think has to be re-learned by each generation as we discover that our Schwab statements aren’t the scorecard for our real wealth.
Finally we have seen some positive news on the financial front, and many optimists think we have hit the bottom and the stock market bounced off its low-point. It’s nice to be able to take a breath from the brutal onslaught of bad news over the past year.
We have been preaching about the dangers of being out of the market, even when it is falling, While it has been psychologically stressful to maintain equity positions over the past year, recent market activity points to the reason to refuse to market-time.
Interestingly, the average gain for the S&P 500 in the 1 year following the low close for the 8 bear markets that occurred in the last 50 years is +36.5%. The current bear market is the 9th bear market of the last half century. The closing low point (so far) of this 9th bear market was 677 and it took place 7 weeks ago on 3/09/09. In the last 7 weeks, the S&P 500 has gained 28.5% (not counting the impact of reinvested dividends.
Our clients pay us to ‘watch their backs.’ So without being an outright pessimist I think that we are still in a perilous financial situation. The future of the auto industry is teetering and we may see 2 of the ‘Big 3’ bite the dust in the next few weeks. The economic reality goes even deeper than that. We are restructuring our national economy to be able to participate in a global economy.
Our prosperity over the past 15 years was based on a world-wide spending spree, fueled by cheap credit and over-leveraged real estate. The current government nostrums are designed to spur more spending, but no meaningful programs have addressed the banking and real estate collapses. We see the impact of these issues everyday in the ‘For Sale’ and ‘For Lease’ signs in almost every neighborhood and commercial area.
Each client’s situation is different, and so the approach best suited to you depends more on what is going on in your own life. If the breadwinner in your family is out of work, or you have kids in college, or are faced with disability, or are retired (or hope to be soon) – these are the key factors in your investment allocation. While the stock market may look great, it is a mistake to be kicking yourself for having missed out on the steep increase recently.
For clients in transitional or distressed situations, we want to maintain an extra cash cushion. If your life situation is stable and your bond ladder is on-track, dollar cost averaging into the stock market is very advantageous. Now that tax season is over, we have scheduled appointments with each client to review your portfolio and make adjustments as appropriate.
It is a mistake to conclude, based on the past 2 months market activity, that you should now jump in with both feet. It is likely that we may not hit bottom until next year, and then it may take a couple of years to fully recover. Market timing is a futile waste of energy.
Treasury bond rates are low, and the feds are buying bonds to keep long term rates down, so it will be advantageous for many clients to refinance at lower rate (unless you owe more on your house that it’s worth). Jumbo mortgages (i.e. more than $417,000) however still carry very high rates and it is seldom worthwhile to refinance those.
This experience of living through the worst economic period since the Great Depression of 80 years ago will have a lasting positive impact on most of our clients. The losses will ultimately be recouped, and we are able to outlast even a continuing downturn. More importantly it has made many of us aware that we were frittering away money on things we didn’t really value. This lesson I think has to be re-learned by each generation as we discover that our Schwab statements aren’t the scorecard for our real wealth.
Wednesday, April 8, 2009
Best Case vs. Worst Case April 2009
Bert Whitehead, M.B.A., J.D. ©2009
How will this recession play out? I like to ask people that question (although many of them think I should know). I have noticed a strong correlation between a person’s economic outlook and their political leanings. The extremists on both sides focus on certain factors in the global meltdown to support their point of view. I’d like to examine the extremes on both sides and explain why both an extreme positive or negative outlook is at best a very remote possibility.
The Best Case: The Stimulus plan works as designed world-wide and the economy bottoms out at the end of this year. The rebound is very rapid so that the stock market is back up to 13,000 by the end of 2010 and unemployment drops to 5% and we all sing “Happy Days Are Here Again!” The government devises regulations for banks and oil producers with congressional oversight to control their profits and pricing. Taxes are raised on businesses, investors, and high income earners to pay for energy, education, and health care services while lowering the deficit with the increased revenue. Increased government spending causes inflation which threatens to get out of control.
The Worst Case: The worldwide economy reels toward collapse with the US government selling bonds to provide money to support an ever-expanding list of government-provided entitlements, bailouts, and subsidies. More pressure is applied to other countries to follow our lead, resulting in rising stagflation worldwide and hyper-inflation in some countries threatens to spread globally.
Gross Domestic Production world-wide drops precipitously. Higher tax rates to target the most productive sectors of the economy result in less total government revenue as sales and incomes drop. Small businesses close, or start operating under-ground. Unemployment rises and pushes the world into a global depression. Protests and crime increase as populations become more impoverished. War looms.
The Truth: Neither of the two above scenarios are going to play out to the conclusion. This economic cycle will end and we will recover at some point. Stimulus programs may do more harm than good, but we are not going to become a socialist country. The dollar will not collapse and putting all your wealth in gold or another currency to avoid being wiped out is nonsensical..
There are simply too many economic factors at work to be able to determine the outcome. Most changes in a free market are self-correcting, e.g. as the dollar weakens, more foreigners want to buy US goods, services and real estate, which ultimately strengthen our economy and the dollar rises again. Supply and demand result in short-term price swings as markets seek balance by testing the extremes. Lower beef prices mean more people will start eating beef, and then ranchers will grow more steers. The outlook is further clouded by completely unexpected events such as a California earthquake, or a war in the Middle East that shuts down 50% of the world’s oil supply.
Most readers of this blog have already been impacted by this recession, and those who haven’t yet are likely to be in the next year. The worst reaction, however, is to bank on an extreme scenario. It is just as foolish to sell everything you own to buy gold because some writer ‘proves’ that hyperinflation is inevitable. It is folly to put all your assets into real estate because it’s so cheap now, and you believe that the big turnaround has already begun. Home prices are still dropping, and I remember the wisdom of my father: “Son, never try to catch a falling knife!”
The proponents of both extremes have personal agendas that focus their paradigms. Politicians and government economists want us to believe that the trillions we are spending is a brilliant idea. Those who predict doom-and-gloom profit handsomely as stoking fear sells their books and newsletters. Emotionally it is easy for us to assume the short-term upswing in the stock market means the recession is over, or seeing the market drop 25% in a couple of months means we are headed to Armageddon.
The final outcome of this historical financial crisis will likely to take 3-7 years to work out, and I doubt that we will bottom out before 2011 or 2012. Political agendas of both parties were a factor in creating this circumstance. Many regulations now scorned were once endorsed by both parties, e.g. encouraging mortgages to provide home ownership for all Americans. This seemed like a good idea at a time but most see that financial regulations need to be adapted to suit a society where many people are very naïve in financial matters.
People on both sides of the aisle should be concerned and active in this conversation. Our political process depends on our input. But don’t let it ruin your life. Don’t let the extremists in the political arena and their counterparts in the financial media lead you to take precipitous moves with your investments.
Functional Asset Allocation takes your personal situation as the primary driver in allocating your investments. While changes will need to be made this year, we want you to be able to survive any economic trend. Our job is to make sure you can sleep at night.
How will this recession play out? I like to ask people that question (although many of them think I should know). I have noticed a strong correlation between a person’s economic outlook and their political leanings. The extremists on both sides focus on certain factors in the global meltdown to support their point of view. I’d like to examine the extremes on both sides and explain why both an extreme positive or negative outlook is at best a very remote possibility.
The Best Case: The Stimulus plan works as designed world-wide and the economy bottoms out at the end of this year. The rebound is very rapid so that the stock market is back up to 13,000 by the end of 2010 and unemployment drops to 5% and we all sing “Happy Days Are Here Again!” The government devises regulations for banks and oil producers with congressional oversight to control their profits and pricing. Taxes are raised on businesses, investors, and high income earners to pay for energy, education, and health care services while lowering the deficit with the increased revenue. Increased government spending causes inflation which threatens to get out of control.
The Worst Case: The worldwide economy reels toward collapse with the US government selling bonds to provide money to support an ever-expanding list of government-provided entitlements, bailouts, and subsidies. More pressure is applied to other countries to follow our lead, resulting in rising stagflation worldwide and hyper-inflation in some countries threatens to spread globally.
Gross Domestic Production world-wide drops precipitously. Higher tax rates to target the most productive sectors of the economy result in less total government revenue as sales and incomes drop. Small businesses close, or start operating under-ground. Unemployment rises and pushes the world into a global depression. Protests and crime increase as populations become more impoverished. War looms.
The Truth: Neither of the two above scenarios are going to play out to the conclusion. This economic cycle will end and we will recover at some point. Stimulus programs may do more harm than good, but we are not going to become a socialist country. The dollar will not collapse and putting all your wealth in gold or another currency to avoid being wiped out is nonsensical..
There are simply too many economic factors at work to be able to determine the outcome. Most changes in a free market are self-correcting, e.g. as the dollar weakens, more foreigners want to buy US goods, services and real estate, which ultimately strengthen our economy and the dollar rises again. Supply and demand result in short-term price swings as markets seek balance by testing the extremes. Lower beef prices mean more people will start eating beef, and then ranchers will grow more steers. The outlook is further clouded by completely unexpected events such as a California earthquake, or a war in the Middle East that shuts down 50% of the world’s oil supply.
Most readers of this blog have already been impacted by this recession, and those who haven’t yet are likely to be in the next year. The worst reaction, however, is to bank on an extreme scenario. It is just as foolish to sell everything you own to buy gold because some writer ‘proves’ that hyperinflation is inevitable. It is folly to put all your assets into real estate because it’s so cheap now, and you believe that the big turnaround has already begun. Home prices are still dropping, and I remember the wisdom of my father: “Son, never try to catch a falling knife!”
The proponents of both extremes have personal agendas that focus their paradigms. Politicians and government economists want us to believe that the trillions we are spending is a brilliant idea. Those who predict doom-and-gloom profit handsomely as stoking fear sells their books and newsletters. Emotionally it is easy for us to assume the short-term upswing in the stock market means the recession is over, or seeing the market drop 25% in a couple of months means we are headed to Armageddon.
The final outcome of this historical financial crisis will likely to take 3-7 years to work out, and I doubt that we will bottom out before 2011 or 2012. Political agendas of both parties were a factor in creating this circumstance. Many regulations now scorned were once endorsed by both parties, e.g. encouraging mortgages to provide home ownership for all Americans. This seemed like a good idea at a time but most see that financial regulations need to be adapted to suit a society where many people are very naïve in financial matters.
People on both sides of the aisle should be concerned and active in this conversation. Our political process depends on our input. But don’t let it ruin your life. Don’t let the extremists in the political arena and their counterparts in the financial media lead you to take precipitous moves with your investments.
Functional Asset Allocation takes your personal situation as the primary driver in allocating your investments. While changes will need to be made this year, we want you to be able to survive any economic trend. Our job is to make sure you can sleep at night.
Friday, March 13, 2009
Have the Rules Changed?
Bert Whitehead, M.B.A., J.D. © 2009
We are experiencing the worst economic crisis since the Great Depression, and we are likely to see further erosion. It’s a perfect storm brought on simultaneously by a financial crash, a real estate crash, and an economic crash. Investors who have always ‘played by the rules’ by diversifying their portfolios are confronted by the reality that all asset classes are collapsing, except for long-term Treasuries and perhaps gold. Small businesses are closing, real estate across the nation has tanked, and even the safety of banks and insurance companies are questionable.
So have the rules changed? Many investment strategies which have long been considered sacred don’t work anymore. The basic principles which we use in Functional Asset Allocation, however, are sound. That means that investment portfolios should be based on ‘endogenous’ factors that reflect the client’s individual circumstances.
Most investment strategies have been based on Modern Portfolio Theory. This assumes that the correlations of investment performance should be the dominant consideration in constructing and managing a portfolio. Investment managers all promised they could ‘time the market’ to take advantage of the next asset class which would out-perform the market.
Those strategies are always based on ‘exogenous’ factors such as interest rates, historical performance of stocks, oil prices, etc. Long-term US Treasuries have never been considered as the core of a portfolio, because brokers don’t make any money on Treasury bonds unless they are constantly being traded.
For our clients, we are re-evaluating the appropriate investment risk exposure based on each individual situation. The ‘invisible hand of the market’ has radically rebalanced our portfolios so that most are now heavily weighted in bonds and cash vs. stocks. We do not slavishly sell out bond ladders to boost the client’s exposure to stocks.
The current economic cycle has magnified the risks clients are exposed to. Job security is questionable, real estate values have plummeted, and businesses across the board are faltering. In reviewing clients’ portfolios we take we consider three primary risk factors:
1) How much risk does a client need to take to achieve financial independence, i.e. how much is enough? If you already have enough to survive this financial cycle, we will recommend that you take less risk in your portfolio than previously.
2) How much risk are you already taking? If you have your own business, or are subject to being laid off, or are concerned about becoming disabled, it is appropriate certainly to take less risk in your portfolio since these risks are greater now than last year.
3) How much risk is appropriate for your situation? If you have dependents, kids to send to college, too much leveraged real estate, etc. your portfolio should be more conservative. If you are single with a good job and in good health, you may want to be more aggressive. Note that this has nothing to do with ‘risk tolerance’ which is an unreliable and irrelevant factor when balancing a portfolio.
We generally try not to reduce clients’ exposure to market risk by selling off stocks and equity mutual funds despite market drops. This cycle will pass eventually and maintaining a position in the market is critical to rebuilding your portfolio. Clearly younger clients have a once-in-a-lifetime opportunity to achieve financial independence by dollar cost averaging in the market now through their 401-K’s and other pension options.
When extra cash is available, we want to reinforce or add to clients’ bond ladders where appropriate. And in today’s markets, a heavy cash position is often appropriate. We are also cognizant that the government stimulus, which is being funded with a flood of Treasury debt, will likely cause serious inflation down the road.
The problem is that the current deflationary cycle may last 1-2 more years, or possibly 5-10 more years. Rather than selling Treasuries, we are positioning clients for inflation by increasing their cash cushion (which will earn higher interest in inflationary cycles) and urging clients to remortgage their homes with 30 year mortgages if they can do so for a rate that is 1.0% or more less than their current rate.
We are monitoring the investments which are held by our clients, and may make short-term suggestions during your tax appointment or by email. After tax season we will be reviewing your portfolio with you in depth to identify the appropriate amount of risk we suggest in your circumstances and the corresponding rebalancing required in your portfolio. The market is so volatile and unstable currently that we are avoiding unnecessary market moves.
Occasional market rebounds, as we recently have seen, don’t indicate that this economy has turned around. A single swallow doesn’t mean spring is here. While most polls indicate that the general public is optimistic about the federal government stimulus and other bold intervention, the overwhelming consensus of the business and financial communities is very negative. Market reaction has exacerbated fear and panic among investors.
The concern is that government reaction to the crisis is not focused on the central problems: financial institutions and housing. It is the uncertainty whether massive splintered federal spending, knee-jerk regulation, and laws targeted to special interests is doing more long-term harm with little to show in short term gain. This recession is world wide with most countries even worse than we are, and international markets are now increasingly concerned about the stability of Treasury debt.
As a result we really don’t know which way the market and the economy is headed. Many government economists are confident that the recovery will begin this year, though more stimulus spending may be needed. Wall Street is generally more pessimistic, expecting this downhill slide to last 5 years or more. That would mean even lower interest rates, further stock market drops, and real estate stagnation. It is not prudent to guess at this point which way the economy will go over the next 3-6 months and make major shift in portfolios.
No matter what happens, we want to take whatever steps are needed to protect you financially. The rules of Functional Asset Allocation haven’t changed, but it is likely that your world is changing and we will make sure your portfolio is adjusted accordingly.
We are experiencing the worst economic crisis since the Great Depression, and we are likely to see further erosion. It’s a perfect storm brought on simultaneously by a financial crash, a real estate crash, and an economic crash. Investors who have always ‘played by the rules’ by diversifying their portfolios are confronted by the reality that all asset classes are collapsing, except for long-term Treasuries and perhaps gold. Small businesses are closing, real estate across the nation has tanked, and even the safety of banks and insurance companies are questionable.
So have the rules changed? Many investment strategies which have long been considered sacred don’t work anymore. The basic principles which we use in Functional Asset Allocation, however, are sound. That means that investment portfolios should be based on ‘endogenous’ factors that reflect the client’s individual circumstances.
Most investment strategies have been based on Modern Portfolio Theory. This assumes that the correlations of investment performance should be the dominant consideration in constructing and managing a portfolio. Investment managers all promised they could ‘time the market’ to take advantage of the next asset class which would out-perform the market.
Those strategies are always based on ‘exogenous’ factors such as interest rates, historical performance of stocks, oil prices, etc. Long-term US Treasuries have never been considered as the core of a portfolio, because brokers don’t make any money on Treasury bonds unless they are constantly being traded.
For our clients, we are re-evaluating the appropriate investment risk exposure based on each individual situation. The ‘invisible hand of the market’ has radically rebalanced our portfolios so that most are now heavily weighted in bonds and cash vs. stocks. We do not slavishly sell out bond ladders to boost the client’s exposure to stocks.
The current economic cycle has magnified the risks clients are exposed to. Job security is questionable, real estate values have plummeted, and businesses across the board are faltering. In reviewing clients’ portfolios we take we consider three primary risk factors:
1) How much risk does a client need to take to achieve financial independence, i.e. how much is enough? If you already have enough to survive this financial cycle, we will recommend that you take less risk in your portfolio than previously.
2) How much risk are you already taking? If you have your own business, or are subject to being laid off, or are concerned about becoming disabled, it is appropriate certainly to take less risk in your portfolio since these risks are greater now than last year.
3) How much risk is appropriate for your situation? If you have dependents, kids to send to college, too much leveraged real estate, etc. your portfolio should be more conservative. If you are single with a good job and in good health, you may want to be more aggressive. Note that this has nothing to do with ‘risk tolerance’ which is an unreliable and irrelevant factor when balancing a portfolio.
We generally try not to reduce clients’ exposure to market risk by selling off stocks and equity mutual funds despite market drops. This cycle will pass eventually and maintaining a position in the market is critical to rebuilding your portfolio. Clearly younger clients have a once-in-a-lifetime opportunity to achieve financial independence by dollar cost averaging in the market now through their 401-K’s and other pension options.
When extra cash is available, we want to reinforce or add to clients’ bond ladders where appropriate. And in today’s markets, a heavy cash position is often appropriate. We are also cognizant that the government stimulus, which is being funded with a flood of Treasury debt, will likely cause serious inflation down the road.
The problem is that the current deflationary cycle may last 1-2 more years, or possibly 5-10 more years. Rather than selling Treasuries, we are positioning clients for inflation by increasing their cash cushion (which will earn higher interest in inflationary cycles) and urging clients to remortgage their homes with 30 year mortgages if they can do so for a rate that is 1.0% or more less than their current rate.
We are monitoring the investments which are held by our clients, and may make short-term suggestions during your tax appointment or by email. After tax season we will be reviewing your portfolio with you in depth to identify the appropriate amount of risk we suggest in your circumstances and the corresponding rebalancing required in your portfolio. The market is so volatile and unstable currently that we are avoiding unnecessary market moves.
Occasional market rebounds, as we recently have seen, don’t indicate that this economy has turned around. A single swallow doesn’t mean spring is here. While most polls indicate that the general public is optimistic about the federal government stimulus and other bold intervention, the overwhelming consensus of the business and financial communities is very negative. Market reaction has exacerbated fear and panic among investors.
The concern is that government reaction to the crisis is not focused on the central problems: financial institutions and housing. It is the uncertainty whether massive splintered federal spending, knee-jerk regulation, and laws targeted to special interests is doing more long-term harm with little to show in short term gain. This recession is world wide with most countries even worse than we are, and international markets are now increasingly concerned about the stability of Treasury debt.
As a result we really don’t know which way the market and the economy is headed. Many government economists are confident that the recovery will begin this year, though more stimulus spending may be needed. Wall Street is generally more pessimistic, expecting this downhill slide to last 5 years or more. That would mean even lower interest rates, further stock market drops, and real estate stagnation. It is not prudent to guess at this point which way the economy will go over the next 3-6 months and make major shift in portfolios.
No matter what happens, we want to take whatever steps are needed to protect you financially. The rules of Functional Asset Allocation haven’t changed, but it is likely that your world is changing and we will make sure your portfolio is adjusted accordingly.
Friday, February 27, 2009
Five Stupid Things Smart People Are Doing With Their Investments
Five Stupid Things Smart People Are Doing With Their Investments
Bert Whitehead, M.B.A., J.D. © 2009
The collapse of the financial markets has sparked terror for many investors. It’s hard to watch your regular 401-k contributions invested in solid mutual funds, and then vanish each month. If you are laid off, the fear of depleting your savings is gut-wrenching. If you are retired, unless you have a bond ladder, you may be thinking of going back to work. If you were planning to retire soon you may be postponing those plans. None of these options are very desirable.
People being people, our financial decisions are often based on how we feel rather than a rational process. Often these times lead people to take drastic action. They hope to reclaim all of the money they have lost in one brilliant financial move. The problem is that such approaches to investing are blatantly stupid, and I have seen the wreckage caused in the past when clients decided to ‘go for broke.’ This is the Gamblers Last Gambit: one last grasp to win all the losses back in one grand stroke. Here are five ways I’ve seen this happen with investors:
1. In 2002, a client who had lost a sizable portion of his money on the dot-com bust, sold every stock he had left and put it in cash. Vowing never to invest in the stock market again, he stayed on the sideline in 2003, when the market increased 30%, and missed the chance to have his portfolio recover.
2. Just recently a woman left her stockbroker who had her over-exposed to financial stocks which lost 80% of their value. Then she took the rest of her money and decided to buy puts and calls herself to make up her losses. In less than 6 months, she’s lost most of what she had left.
3. Another couple last year decided to sell their Treasury bonds last year, because they had appreciated so much. They planned to hold on to the cash and buy the bonds back when interest rates went back up. Meanwhile they have been earning less than 1%, and interest rates continue to drop and they can’t afford to buy their bonds back.
4. Then there’s the fellow who withdrew all his IRA savings and bought lottery tickets so he could retire early. (OK, he had brain cancer, so that’s an excuse).
5. Finally, there was a very smart financial advisor I knew in the 1990’s. He became a fan of the doom’s-day prophet of the time, and convinced his clients to sell all their assets and buy gold. He also did this with all his investments. (Not a good move in the ‘90’s!)
Now financial gurus are touting gold, or risky investment strategies, playing on investor’s fears to induce them to pay them for their secrets. Every stockbroker wants people to sell their Treasuries and let them invest the money = “Give me your money and I’ll make you rich!”.
Your situation is unique. We understand the broad context of your life situation and tailor your investments accordingly. It is futile to try to ‘hit a home run’ in this economic environment.
It takes patience. That’s why stocks are called long-term investments. For younger clients this is the best opportunity for you to guarantee your retirement. With stocks so low, continuing to dollar-cost-average now is a once in a life-time chance. For retirees with bond ladders, you have a 15-20 year investment horizon if you just wait for the economy to rebound. Taking sudden action now is folly.
The best thing to do is to stop listening to financial news on TV, reading the ‘ain’t it awful headlines’ and always looking for a guru to tell you the key to financial success. If anyone knew that, which there isn’t, they wouldn’t tell you because if everyone did it, their strategy wouldn’t work anymore. Face it: they make money selling newsletters to incite greed and fear. If you want to get rich quick, start your own newsletter!
“Fools rush in where Angels fear to tread.”
Bert Whitehead, M.B.A., J.D. © 2009
The collapse of the financial markets has sparked terror for many investors. It’s hard to watch your regular 401-k contributions invested in solid mutual funds, and then vanish each month. If you are laid off, the fear of depleting your savings is gut-wrenching. If you are retired, unless you have a bond ladder, you may be thinking of going back to work. If you were planning to retire soon you may be postponing those plans. None of these options are very desirable.
People being people, our financial decisions are often based on how we feel rather than a rational process. Often these times lead people to take drastic action. They hope to reclaim all of the money they have lost in one brilliant financial move. The problem is that such approaches to investing are blatantly stupid, and I have seen the wreckage caused in the past when clients decided to ‘go for broke.’ This is the Gamblers Last Gambit: one last grasp to win all the losses back in one grand stroke. Here are five ways I’ve seen this happen with investors:
1. In 2002, a client who had lost a sizable portion of his money on the dot-com bust, sold every stock he had left and put it in cash. Vowing never to invest in the stock market again, he stayed on the sideline in 2003, when the market increased 30%, and missed the chance to have his portfolio recover.
2. Just recently a woman left her stockbroker who had her over-exposed to financial stocks which lost 80% of their value. Then she took the rest of her money and decided to buy puts and calls herself to make up her losses. In less than 6 months, she’s lost most of what she had left.
3. Another couple last year decided to sell their Treasury bonds last year, because they had appreciated so much. They planned to hold on to the cash and buy the bonds back when interest rates went back up. Meanwhile they have been earning less than 1%, and interest rates continue to drop and they can’t afford to buy their bonds back.
4. Then there’s the fellow who withdrew all his IRA savings and bought lottery tickets so he could retire early. (OK, he had brain cancer, so that’s an excuse).
5. Finally, there was a very smart financial advisor I knew in the 1990’s. He became a fan of the doom’s-day prophet of the time, and convinced his clients to sell all their assets and buy gold. He also did this with all his investments. (Not a good move in the ‘90’s!)
Now financial gurus are touting gold, or risky investment strategies, playing on investor’s fears to induce them to pay them for their secrets. Every stockbroker wants people to sell their Treasuries and let them invest the money = “Give me your money and I’ll make you rich!”.
Your situation is unique. We understand the broad context of your life situation and tailor your investments accordingly. It is futile to try to ‘hit a home run’ in this economic environment.
It takes patience. That’s why stocks are called long-term investments. For younger clients this is the best opportunity for you to guarantee your retirement. With stocks so low, continuing to dollar-cost-average now is a once in a life-time chance. For retirees with bond ladders, you have a 15-20 year investment horizon if you just wait for the economy to rebound. Taking sudden action now is folly.
The best thing to do is to stop listening to financial news on TV, reading the ‘ain’t it awful headlines’ and always looking for a guru to tell you the key to financial success. If anyone knew that, which there isn’t, they wouldn’t tell you because if everyone did it, their strategy wouldn’t work anymore. Face it: they make money selling newsletters to incite greed and fear. If you want to get rich quick, start your own newsletter!
“Fools rush in where Angels fear to tread.”
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