BOND'S BLOG: Reflections of a Financial Planner.

Wisdom

2012-01-30T11:02:00.008-05:00

I read this article on a Wall Street Journal blog this morning: Can you Sum Up Your Investing Philosophy in 10 Words? It's well worth a look. Here are a couple of my favorite 10 word or less investment philosophies:

"Anything is possible, and the unexpected is inevitable. Proceed accordingly."

– Jason Zweig, author of article

"Invest for the long term and ignore interim aggravation."

– Charles D. Ellis, director, Greenwich Associates, and author,
“Winning the Loser’s Game”

"Do the math. Expect catastrophes. Whatever happens, stay the course."

– William J. Bernstein, Efficient Frontier Advisors, and author,
“The Four Pillars of Investing”

And here is my entry:

"If it sounds too good to be true, it is."

Unintended Humor

2012-01-26T08:18:00.006-05:00

Part of my job is to stay informed on the topic of financial planning, so I read several trade magazines every month, including, Investment Advisor, Financial Planning, Journal of Financial Planning to name a few. Last week I was reading Financial Advisor magazine and I saw this quote in the Editor's Note:

"If there is any takeaway from the last four years, it has been that the collective intellectual firepower of the so-called experts could practically fit on a thimble."

How great I thought, they finally get it. Good financial planning has nothing to do with looking for an "expert" who can predict what will happen in the future. Not only doesn't it help, it most likely causes bad decisions.
Then I made it to page 59 and saw this:

"Financial Advisor and Private Wealth magazines announce their inaugural all-star research team"

I couldn't help laughing out loud. First, the editor of the magazine admits that "the experts" collectively added no edge to our ability to manage our way through the financial crisis, and then his magazine continues the same old practice of guessing which "experts" will be best able to help us manage our way through the future. Good luck with that.

Addendum: I was asked to provide some further explanation of my comments. Is it inconsistent for me to criticize "experts" when in fact I am an expert in financial planning. For clarity, there are many people with an expertise in economics and finance who have a deep understanding of how these complex systems work. A lot of expertise goes into good financial planning, including an understanding of how broader economic issues affect personal finances. The best use of this expertise is to help our clients make reasonable and thoughtful financial decisions. What I am critical of is the media's reference to experts as people who can predict what will happen next.

Last Word on 2011

2012-01-16T09:14:00.000-05:00

Last week we sent out year-end performance reports to our clients and referenced the article below by Weston Wellington of Dimensional Fund Advisors. He does a great job of discussing what investors went though in 2011 (click the article to make it easier to read):

Asset Class Update: 2011

2012-01-11T08:55:00.001-05:00

It has been a while since we looked at the performance of the various equity asset classes we use within client portfolios. I believe the last time was over two years ago, so it's definitely overdue. Here goes:

You can see that 2011 was not a good year for stocks, with only Large Cap equities showing modest gains. This explains why the S&P 500 and Dow Jones Industrial Average were positive for the year. As we move down the list of asset classes, we see decreasing levels of performance, with Emerging Markets being the big loser for the year--down 18%. This should not come as a surprise given all of the turmoil over sovereign debt which occurred last year.
The three year returns are actually encouraging. Three years ago was the end of 2008, during the depths of the "financial crisis" when many experts were predicting a repeat of the Great Depression. Even with the uneven economic recovery and continuing issues concerning debt and unemployment, the average asset class in the table returned 14% per year, which any of us would have signed on for on December 31, 2008.

What is more interesting, is when you look at the last column for 10 year annualized return. Here we see almost the exact opposite of the 2011 results, with returns increasing as we move down the list. To me, that illustrates the power of diversification. No one knows before hand which of these asset classes will perform better than any other over any period going in the future. Basing an investment portfolio on such predictions is as likely to fail as it is to work, so our approach is to remained as diversified as possible all the time.

Finally, there is one important note. The table above is not intended to show the performance of any investments or portfolios managed by Bond & Co. It is a table of index returns, not actual investments which can be bought and owned by any of our clients. Also, keep in mind that past performance is not an indication or guarantee of future results.

Now What

2012-01-05T10:42:00.001-05:00

Now that we have entered the new year, there are a plethora of articles about what to do with your money and investments for 2012. Most of these articles are not worth reading. First of all, there is no reason to make investment decisions just because the calendar has changed from December to January. The world is just as volatile and unpredictable as always. Second of all, most predictions are wrong. Investing should be about appropriate asset allocation and long-term thinking, not predictions about "what looks good for 2012".

All of that said, today I read an article entitled "Where to Put Your Money in 2012" written by Burton Malkiel, a Princeton economist whom I have referenced before. The article is well worth reading, not because of any predictions, but because Professor Malkiel does a great job of providing wise perspective about long-term investing. Here is a quote:

"Whatever the specific mix of assets in your portfolio at the start of 2012, you would do well to follow one crucial piece of advice. Control the thing you can control—minimize investment costs. That is especially important in a low-return environment. Make low-cost index mutual funds or ETFs the core of your portfolio and ensure that any actively-managed investment funds you purchase are low-expense as well."

Seduced by Complexity

2011-12-09T08:40:00.001-05:00

It's rare when you read something that you completely agree with. The article below is one of those times. The authors web site is great, and I have posted some of his drawings before.

The article is easier to read if you click on it and open a new window.

Happy Thanksgiving!

2011-11-23T07:17:00.005-05:00

As the doom and gloom continue, I highly recommend that you read this article from the Wall Street Journal by Brett Arrends:

Panicking About the Markets? Read This -- Now. Here's a quick quote,

"Do yourself a favor. Stop worrying about Angela Merkel and Nicholas Sarkozy, John Kerry and John Kyl. Put aside your deepest concerns about the stability of the Spanish banking system and the latest austerity vote coming up in Athens or Rome. Take a deep breath. And give some thought to buying some good, high quality blue chip stocks. Yes, today.Thanks to the crisis, they're on sale. And they offer a compelling investment for all but the most risk-averse."

We hope everyone has a happy and safe Thanskgiving.

And the Answer Is...

2011-11-21T11:15:00.008-05:00

On Friday I posted this video, which is a tongue and cheek look at the Euro debt crisis. During the video, they do pose one very important question: Where will the rich Euro zone economies - Germany, France, etc.. get the money to bail out the poorer countries - Greece, Italy Spain,... when the rich countries have significant financial problems of their own and are already creditors to the poorer countries? They put it much better in the video:

"How can broke economies lend money to other broke economies who haven't got any money, because they can't pay back the money the broke economy lent to the other broke economy and shouldn't have lent in the first place, because the broke economy can't pay it back?"

First of all, this is not necessarily a new phenomena. Many times in the past, countries have borrowed money they couldn't repay. The old solution to this problem was war: go to the country that owes the money and conquer them, taking their land, crops, gold, etc... Fortunately, I don't think German troops are heading to Greece to claim the Parthenon any time soon.

So what will happen? Where does money come from? The answer is that the European Central Bank, along with other central banks, will "print the money". This is what the US Federal Reserve did in response to the financial crisis in 2008. In our current global economy, there is no intrinsic value to money. It is created by governments to facilitate trade in goods and services.

I am not saying that all of this money creation is a good thing, just that it is likely to happen. Right now, there is a struggle in Europe between the Germans and everyone else around this issue of money creation. One of the most likely effects of this would be inflation, which is something the Germans have an institutional fear of (Think World War I and the Weimar Republic).

So this all goes back to the discussion I've had over the past several months about government debt in general. One way out of a debt problem is to cause inflation, which may sound counter-intuitive to many. This makes the debt owed worth less, because debts incurred today will be paid back with currency that has lost purchasing power due to inflation. For example, if I owed you $10 but paid you back your $10 five years from now when it would only by $8 worth of goods and services, then I've "saved" $2. This is not a free lunch, and the price of inflation is paid by those who have savings and/or live on pensions or fixed incomes. This means that it is imperative for retired people to keep some of their assets in investments that will earn some positive return above inflation, such as equities have done historically. Socking away all of one's assets in bonds and cash can be disastrous when we are facing the potential for significant inflation in our not so far off future.

Of course, central banks could fail at their attempts to inflate. The economy is a very complex, unpredictable thing, and the digital revolution, along with China's re-awakening, have made things even more complex and difficult to predict.

Euro Crisis Teaser

2011-11-18T11:37:00.001-05:00

Over the next few weeks I will take on the "Euro Crisis", you know the one I mean. Here is a teaser video that asks a very important question. I will give an answer to that question on Monday (or Tuesday).

College Costs Going Down?

2011-11-15T10:52:00.001-05:00

As financial planners, one of our primary tasks is helping families plan for and fund college tuition expenses for their children. Given the current and future costs of a four-year college education, this can be a daunting task. However, I have posted in the past that the value of a college degree is very real.

Well, here is some good news, 5 Colleges Slashing Tuition. Maybe this is part of a trend.

Cautionary Tale

2011-11-07T16:18:00.000-05:00

Anyone who reads this blog knows that I don't believe that anyone can consistently outguess financial markets in a profitable way. Now we have another example of apparently very smart people making bets on which way markets will go and failing miserably.

Last week, MF Global declared bankruptcy and quite possibly broke the law. I have to admit that until the story hit the news a few weeks ago, I knew very little about MF Global. Here's a bit about the company from their web site:

MF Global’s well-regarded research and analysis franchise produces a wide range of actionable insights—from equity research and policy-focused analysis of U.S. legislative and regulatory topics, to commentary on macroeconomic trends and issues driving markets.

Sounds pretty impressive, particularly when considering that the firm's CEO was Jon Corzine, ex-CEO of Goldman Sachs, ex-US Senator, ex-Governor of New Jersey.

How can a company like that end of bankrupt? The simple answer is that they made a big bet on European sovereign debt that went wrong. Here's a more detailed explanation.

It doesn't matter how smart or experienced you are, placing bets on future market movements is a losers game.

Stick to the Plan

2011-10-11T11:17:00.002-04:00

One day it's up. Another day it's down. And it's beginning to feel a bit like Groundhog Day.

We know that the last six months have been extremely challenging for investors. We know that your September statements and quarterly performance reports are very discouraging. We can understand that there may have been times when you felt like throwing in the towel, given the current economic and financial environment. But we can't let our emotional reactions to current events drive our long-term financial decisions. This is what causes average investors to fail over time; selling low (when everything seems dismal) and buying high (after we feel comfortable that everything will be okay). And it is also why we still advocate that the best way to manage money is to develop an appropriate Asset Allocation plan based on your long-term goals, time horizon, and personal risk tolerance -- and then to stick to it through thick or thin. We know this takes patience and resolve -- and, yes, maybe even courage at times.

We are confident, however, that any long-term investment plan must still include a significant allocation to a diversified basket of equities. The challenge of being an equity investor in times like these is to remember that we aren't invested in the elusive "stock market", with its daily fluctuations and unpredictable swings, as much as we are part owners of profitable, cash-rich companies all over the world - Apple, Exxon Mobile, FedEx, Daimler, Samsung, ..... And the shares of many of these companies are at least fairly valued, if not undervalued, in historical terms. If you believe, as we do, that the global economies will eventually work their way out of their financial problems and this recessionary environment, then you need to be part of the recovery when it happens, even though we can't know how long that will take or how much more pain is still ahead of us.

For the vast majority of us, our Financial Plans require that our investments achieve long-term returns in excess of inflation so we can maintain our lifestyles during retirement. Investing (and remaining invested) in a broadly diversified portfolio of Domestic and International Equities, Real Assets, and Fixed Income has been a successful strategy in the past (including through the 2008-2009 financial crisis and its subsequent recovery), and we believe it will still be so in the future. That is, if you can stomach the sea sickness without jumping ship.

So what other options do we have as investors? Aside from Asset Allocation (which forms the basis of our investment strategy), we have a few other investment choices. For starters, we can try to “time the market”; that is, to buy stocks before they go up and to sell them before they go down. Or, we can “loan” our money to banks and governments through bank accounts and government bonds.

The first plan would be great if it worked. But the odds are against being successful at this strategy. We do not believe that anyone can do this consistently and over long periods of time. Sure, you could get lucky in any given year, but one wrong decision can, and has, ruined many. And being partially successful at this strategy is like spinning your wheels but getting nowhere.

The second plan is to “get out of the stock market” altogether. This might ensure that we never lose money during any particular time period, but our long-term, inflation-adjusted returns are almost guaranteed to be terrible, given the current state of interest rates and government finances.

Yes, there many other investment options, such as gold, annuities, and hedge funds. We’d be happy to discuss any of these with you in greater detail. But these investments also have their own risks and trade-offs that need to be taken into account.

So, the next time you feel like throwing in the towel, try to remember how you felt in March of 2009. Remember that nobody at that time felt that it was a great time to put new money into stocks (except maybe Warren Buffet). Instead, the majority of people were feeling shell-shocked and extremely worried that the stock market (and their retirement portfolios) would never come back in their lifetimes. In hindsight, that turned out to be a great time to invest in a diversified portfolio. During the market crash caused by the financial crisis (9/30/08 - 2/28/09) our model Diversified Equity Portfolio went down 40%. However, since then, through September 30, 2011, the same model Diversified Equity Portfolio earned almost 75%, and the total return for the last three years from 9/30/08 - 9/30/11 has been 4.5%.* Those of us who rode out the storm were able to recover quicker than expected, and we believe the same will be true this time.

Please feel free to contact us anytime. We don't want, or expect, you to feel as though you need to go it alone.

* May not reflect your actual portfolio performance depending on variables such as withdrawals and additions, dividend reinvestment, and timing. Model Diversified Equity Portfolio comprises 30% DFA Core Equity ll, 30% DFA Vector Equity, 15% DFA Int’l Core Equity, 15% DFA Int’l Vector Equity, and 10% DFA Emerging Markets Core Equity. For additional information and methodology, please contact our office.

Debt & Taxes

2011-10-02T11:28:00.002-04:00

In my last post about the national debt, I said I would move forward by looking at what the "debt crisis" might mean to our clients' financial plans. One obvious area of concern is taxes. The conventional wisdom seems to be that tax rates will go up as part of any solution to reducing the debt. This makes some believe that it is a good idea to pay taxes now, if possible, at today's rates, instead of the higher rates that may prevail in the future. This includes strategies like converting traditional IRA's to Roth IRA's, thereby paying tax on the traditional IRA's today and not in the future. There are also ways that people can move earned income forward and pay tax, or sell appreciated real estate or other investments in order to pay the tax now.

The problem with these ideas is that they are driven by assumptions about what the tax code will be like in the future. As my Dad taught me, this is letting the "tax tail wag the investment dog" and it is generally not a good idea. A great example of this problem is the tax shelters sold to individuals in the late 1970's and early 1980's. This was a time of high tax rates and poor investment returns. An entire industry came into being around selling limited partnerships that offered no investment return, but potentially large tax savings. To many people, this seemed like a no-brainer because in the world they saw, tax rates would always be high and stock markets would never again be profitable. Then a funny thing happened, the world changed. Ronald Reagan became President, tax rules were significantly changed in 1982 and 1986, and the stock market entered an 18 year bull market. All of those limited partnerships became basically worthless.

Similar things could happen now. Many smart people think that the most important thing the government can due in the face of the "debt crisis" and economic slump is to simplify the tax code. Here's one article of many that makes that point. Here's another tax plan from economist Larry Kotlikoff, which like many of the plans floating around lowers income tax rates for everyone, eliminates most tax deductions and includes some sort of national sales tax. I have no interest in endorsing one tax plan over another, but if serious tax reform does happen it will change everything. (Unfortunately there is an army of lobbyists in Washington whose jobs depend on an ever more complicated tax code, but that's another story)

So from the perspective of financial planning, I believe it is a bad idea to make significant financial decisions based around the idea that tax rates will be permanently higher in the future. This may happen or it may not. I still believe the best idea is to keep current taxes as low as possible and take it one year at a time.

This is Cool

2011-09-30T07:40:00.001-04:00

Our older son, Jack, is part of a First Lego League Robotics team, and his coach sent us this video. I have often written about the power of innovation and it's affects on economic growth. Amid all of the current doom and gloom, it's worth watching this to see what kinds of things are possible.

History of The National Debt

2011-09-20T13:13:00.007-04:00

As mentioned in my blog post from a few weeks ago, I recently finished reading Hamilton's Blessing: The Extraordinary Life and Times of Our National Debt. It's a pretty quick read which gives a good foundation for understanding how our current "debt crisis" came into being. I would recommend it to anyone interested in the issue.

Of course, we should all be interested in the national debt and deficit, since it affects all of us. In fact, this will likely be the most prominent issue of the upcoming presidential election. Having said that, one self-imposed, overriding rule for this blog is to stay clear of discussing politics, which, in truth, makes this topic a bit difficult. For it has been a string of political decisions that has gotten us into the current mess to begin, and surely, it will require political courage and compromise to get us out. Just to name a few of those aforementioned political decisions...

Moving the social security surplus "on budget"
Increasing the use of earmarks in spending bills
The seemingly endless complexity of the federal tax system
Deciding to go to war in Iraq--whether you support this decision or not

Here are a few notable quotes I've picked out from Hamilton's Blessing:

"Even a country as rich and productive as the United States can spend itself into bankruptcy as Spain did in the seventeenth century. Only fundamental changes in how the government raises money, how and where it spends it, and how it accounts for it can prevent a future fiscal disaster."

"Alexander Hamilton conceived of the national debt as a strategic instrument of national policy to be used to protect and advance the interests of the nation. In the last several decades, however, it has not been used for that purpose. Rather, it has become nothing more than an escape valve for political pressure."

"The now-forty-year-long string of significant annual budget deficits, incurred mostly in good times and largely for the purpose of ensuring the reelection of members of Congress (of all parties and political philosophies) constitutes overwhelming evidence that the system is irretrievably broken."

So let's all hope that, as a collective nation, we can have an honest and productive discussion about how to repair the fiscal mess that we have put ourselves into. In the meantime, we concern ourselves with the way in which the most likely solutions to the deficit will affect our clients' financial and investment plans--in particular, their impact on taxes, social security & medicare, and perhaps even our approach to investing. I hope to touch further on these topics next time.

Another Video

2011-09-12T12:34:00.001-04:00

Here are two more videos on why stocks remain an appropriate investment for long term investors. The first video is of Professor Richard Sylla of NYU. Here is a link to the accompanying article, and here are some good quotes:

"People ought to take a longer view and think in terms of years and even decades," Prof. Sylla says. "Most people are quite pessimistic right now. I am saying: The market may go down from here. It may go up. But if you look at the long sweep of history, this seems like a good time to buy because the average return is down near the bottom" and is likely to go up...

Prof. Sylla isn't trying to predict short-term behavior. He doesn't know whether stocks will be higher or lower at year end, and he isn't losing sleep over Greece, the sputtering U.S. economy or other problems now haunting stocks...

"We may not be able to get enlightened government policies until things get worse than they are now, which isn't a happy thought," he says. But in the longer run, "I think the country is going to recover and go on to prosperity again as it always has."

Stay Disciplined, Not Overconfident

2011-09-08T09:07:00.004-04:00

Below is a video from this morning's Wall Street Journal Online about lessons learned from the market crash of 2008, and here is a link to the accompanying article.

Please note that I have never heard of Michael Cuggino or the Permanent Fund, but I think his comments about investor disciple and avoiding overconfidence, both positive and negative, are very relevant in the current economic and market climates.

National Debt Redux

2011-08-30T13:28:00.005-04:00

About a year and a half ago, I made this blog post about the national debt, at the request of one of our clients. In the post I wrote:

This issue is so important and complicated, that I will not try to address it all in one blog post. Instead, I will look at pieces of the puzzle over several posts. Hopefully, I will get some feedback as I go along and will address the most pressing issues.

Much to my chagrin, I never followed up as promised. Since then, the national debt has become an even bigger issue, as witnessed by this summer's political drama on raising the debt ceiling. Fortunately, the very client who originally asked me to address this issue is also keeping me honest, having recently reminded me that I never made any subsequent posts. So, I will now take up the issue again, and this time, I promise to do it justice.

I think the best place to start is would be with this article in yesterday's Wall Street Journal, which provides an excellent primer on the national debt. I encourage those of you who are interested in this topic (and who isn't these days) to read it. The author of the article, John Steele Gordon, is a well known business and financial historian. He recently wrote a book on the history of the national debt called Hamilton's Blessing: The Extraordinary Life and Times of Our National Debt. I have just purchased the book with intent of using it to help guide us through the discussion over the next few months. So, please stay tuned...

Stay the Course

2011-08-23T09:21:00.009-04:00

It has been about a month since the stock market entered "bizarro world". On July 21, the Dow closed at 12,724 -- close to it's highest point since Lehman Brothers went bankrupt in September of 2008 and almost twice the level of the low point hit in March of 2009. Yesterday, the Dow closed at 10,854, representing almost a 15% drop since July 21. However, including this drop, we are still at a net increase of almost 7% for the past year.

Like it or not, it is not at all unprecedented for stock markets to lose or gain 15% over a single month, but it can certainly be unnerving, especially when daily volatility is so high. We would all be happy to get the 7% return of the past year without all of the volatility, anxiety, euphoria, etc... that has taken place month after month, but it doesn't work that way, and it never has.
Right now, with all of the dour economic news, many people are wondering why they should even have any of their money invested in stocks. Here are links to two good answers from well known and respected finance professors, as well as a quote from each article:

Don't Panic About the Stock Market

"My advice for investors is to stay the course. No one has ever become rich by being a long-term bear on the fortunes of the United States, and I doubt that anyone will do so in the future. This is still the most flexible and innovative economy in the world."

The Bond Bubble and The Case for Stocks

"Despite the sluggish economy, the corporate sector is churning out record profits and increasing dividend payments. We believe dividend-paying stocks are the answer to a Treasury bond market that looks more dangerous than ever."

Hold On Tight Part II

2011-08-17T09:13:00.000-04:00

We understand that many of you are nervous and apprehensive about the markets and economy. I will reiterate what I told a client over the weekend, since the same message is true for all. First off, don't panic. Bad decisions are made in times of duress. I don't know if we are in a secondary recession (double dip, etc..) and I'm not very sure it truly matters with respect to the markets in the short term, which are as volatile and unpredictable as ever. The most important idea for an equity investor to remember is that you are most concerned with the profitability of the companies you own, over the long term. None of your short term money is in equities, and you all have at least six years (or more) of spending in "safer" assets (ie cash and bonds). This enabled us to withstand the last crisis and to more than fully recover during the following market rebound.
An important long term risk right now is certainly inflation. Cash and bonds will at best keep pace with inflation or at worst significantly underperform inflation. Equities still offer a higher expected return than cash or bonds and have the best chance to outperform inflation, which is important for everyone.
So I still recommend that we stay the course and let our asset allocation plans work over time. The only alternative is to sell equities for some time and then see about getting back in. This is market timing and is a sure recipe for failure.
One final comment. This morning's anxiety is due to S&P's downgrade of the US credit rating. Would you prefer to believe S&P (who played a key role in bringing on the sub-prime crisis and its aftermath), or Warren Buffet (who, in an interview on Bloomberg Television Saturday, said that S&P was wrong and that the US merits a AAAA rating instead). We prefer the latter. Buffet's optimism and common sense have helped to make him one of the richest and most successful men in the world.
Please reach out to us if you'd like to discuss anything or if you just need a pep talk.

Bizarro World

2011-08-10T09:10:00.006-04:00

It feels like we are living in Bizarro World. In case you don't know, Bizarro World is the fictional planet where Superman's evil opposite lives. The motto of Bizarro World is "Us do opposite of all Earthly things!" Here is Wikipedia's entry for Bizarro World. (Most of us remember Bizarro World from the famous Seinfeld episode). Here's a quick rundown of recent Bizarro events:

- Last week, our government solved the debt crisis by...... agreeing to appoint a commission.
- Over the weekend, S&P, those same geniuses who rated subprime mortgages AAA, decided to downgrade Uncle Sam.
- On Monday, in reaction to this downgrade, investors decided to sell shares of companies that make profits and buy U.S. Treasuries - the exact things that were downgraded.
- On Tuesday, the Chairman of the Fed said that the economy is weaker than previously thought, and the stock market surged 4%.

What the heck is a rational investor supposed to do when living on Bizarro World? I guess one answer is to jump right in, and start acting Bizarro - buy, no sell, no buy.....(I call this this the Jim Cramer answer). A better response is to sit back and enjoy the weather, knowing that an appropriate asset allocation plan is in place which will help us reach our long term goals (I call this the Frank Bond answer).

Please note that my intention is not to make a joke of or to minimize the real structural challenges facing the global economy, or the fact that our clients have real money invested in the stock market. It's just that, over the past two decades, I have learned that when it feels like we are living in Bizarro World, it really is best to sit tight until the dust settles.

Hold On Tight

2011-08-04T14:45:00.003-04:00

As I write this, the Dow is down 365 points, which certainly makes lots of people nervous. I wish I had new insights to offer or new words of wisdom, but I don't. Periods like now are part of the deal of being invested in stocks - the perils of short-term volatility in exchange for expected long-term returns that beat inflation.

Selling at times like this is a bad idea, because at some point markets will turn and we can't know when that will happen. Any money invested in stocks should be money that isn't needed any time soon, so that it can ride out scary times like this.

Hold on tight, fasten your seat belt, because it's a bumpy ride, as usual.

(If you feel the need for more reassurance, please call or e-mail)

What Goes Around Comes Around

2011-07-19T09:59:00.003-04:00

I just received this from Dimensional Funds. It speaks for itself....

Go to College

2011-07-07T11:53:00.005-04:00

It's summer, which means our kids are out of school and home driving us crazy! Actually I think summer vacation is important for kids, because childhood is so very short, and they need time to just be kids. However, I am pretty happy when the school bus comes back in September and the kids get back to learning.

As financial planners, helping our clients plan for the educations of their children or grandchildren is one our most important jobs. Recently, there has been a lot of chatter that going to college is not worth the expenses - students graduate with enormous debts, college is more about partying than learning, etc...

However, the facts are pretty clear, a college education means higher earnings and less job insecurity. Here is a chart from the Bureau of Labor Statistics:

You can see that the more educated one becomes, the more they earn and the lower the rate of unemployment. In fact, as we look at the current "slow" economic recovery, we see that the majority of the unemployed are people with less than a high school diploma.

This New York Times article expands in detail why a college education is such an important investment to make for your children. So enjoy the summer and let kids play, but remember that getting them ready for college is a year round job.

What Do You Think About This Market?

2011-06-15T09:42:00.002-04:00

This is a question that I often get at social events, especially when markets have been down - So, what do you think about this market? Anyone who knows me well enough knows that my general response will be - I don't know? Of course, this doesn't make for interesting conversation, so we usually end up talking about politics, which is about the same as talking about sports or the weather.

It's not that I don't care about what is happening in the stock market or the economy, it's just that I have learned that having an opinion about short-term market movements isn't useful. The stock market is volatile, has always been volatile, and will continue to be volatile. No important financial or investment decision should be made based on this short-term volatility.

The markets were up big yesterday but are set to open much lower this morning. What else is new? We invest in stocks, because they are the chief investments to own over long-term periods of time, when the primary concern is to protect purchasing power - fancy speak for beating out inflation. When this is your perspective, there is no reason to get worked up about what markets do in a day, a week, or even a month.

In honor of Fathers' Day, I'll finish with this cartoon:

Storm Clouds?

2011-05-24T09:58:00.003-04:00

I generally prefer an optimistic tone to our blog posts. There is plenty of pessimism out there to satisfy anyone looking for it and in the long run I am definitely an optimist. That said, there are reasons to be nervous about the ongoing economic recovery. Here is an editorial from this morning's Wall Street Journal, where Stanford economist Ronald McKinnon predicts that we are again entering a period of Stagflation, that dreaded economic malady that we haven't seen since the late 70's. Here is another WSJ piece, this time about how Nobel Economist Robert Mundell thinks we are headed for deflation and another recession. Finally, SmartMoney says we are in a stock market bubble.

I have no idea if any of these predictions is correct, although my experience tells me that most predictions are wrong and it is nearly impossible to identify the correct predictions in advance. Harvard Economist Greg Mankiw recently wrote an Op-Ed in the New York Times where he admits that economists really have no predictive skills:

"So those are the three questions that puzzle me most as I read the daily news. If you find an economist who says he knows the answers, listen carefully, but be skeptical of everything you hear."

Since we really can't predict what will happen next, I'll end with some good news. This CNN article says that going on vacation can make you smarter! Maybe we could get all of the economists to go on vacation for a while.

How Much Can I Spend?

2011-05-17T07:25:00.002-04:00

One of the most important questions we help answer for our clients as they near retirement is how much they are able to spend from their investment portfolio each year. A common approach to dealing with this issue to determine how much interest and dividends are being paid into the portfolio and then to spend that amount each year. We have always felt that this is a somewhat flawed approach. Rather than focusing on yield, we prefer to focus on the total investment return of a portfolio and then to calculate a reasonable, sustainable withdrawal rate.

Well, here is an academic's answer to the same question. The video below comes from the Fama/French Forum. Here is the introduction from that site:

"Should retirees limit their spending to the interest and dividends they receive? Ken French says investors should be indifferent to how they raise cash, whether through dividends and interest, or through the sale of shares--a method Merton Miller called "homemade dividends." Despite the economic logic, some investors focus on dividends and interest. While this approach may encourage disciplined spending, Ken explains that it also can distort one's investment approach--for example, when investors choose dividend-paying stocks over broad diversification, or chase higher yields by holding riskier bonds. In an effort to get more, they actually lose."

Economics Rap II

2011-05-02T17:42:00.008-04:00

Almost a year and a half ago, I posted this video, which is a rap video about two of the most influential economists of all time: John Maynard Keynes and F.A.Hayek. Well, the group that made the first video is at it again:

Just like the last one, I really think it is worth your time to watch the video. The rap lyrics are very clever in the way they describe the fundamental debate between Keynes and Hayek which has been raging for almost a century and which is particularly pertinent during the current "post-financial crisis recovery".

Which economist do you think I side with?

Virtual Currency Moves Forward

2011-04-26T15:27:00.000-04:00

A year and a half ago I made this post, which includes a video on how Ven Digital Currency was beginning to change the very nature of money. The idea is that money could become a truly virtual concept, facilitating trade on a global scale. This would ultimately eliminate the need for government backed currencies like the dollar and euro.

Well, here is another virtual currency that has been getting a lot of attention, Bitcoin Virtual Currency. My guess is that these virtual currencies are just the beginning and will be a common notion in the near future. Here is a Time Magazine article which discusses virtual currency in more detail.

The Danger of Safety

2011-04-11T07:38:00.002-04:00

It's not news that interest rates are still at historically low levels. Five year CD's are now paying less than 2.5%, and savings accounts effectively have no interest rate. This is good news for borrowers, and it all stems from the efforts of the Federal Reserve to rescue the economy from the financial crisis. It is not, however, good news for people hoping to use interest income to supplement their retirement income. A great explanation of this appeared in last week's Wall Street Journal, Fed's Low Interest Rates Crack Retirees' Nest Eggs. Here's a quote and a chart:

"The longer the central bank keeps interest rates low to stimulate the economy, the more money it pulls out of the pockets of millions of savers. Among the most vulnerable are retirees, who have few options to restore lost income on investments built up over entire lifetimes...average annual investment income for the 24.6 million American households headed by people 65 and older amounted to $2,564. That figure is down 34% from 2007, and is the lowest since 2003."

This all reinforces the idea that there really is no such thing as a totally "safe" place to put all of your money. Interest and inflation rates are not stable, and being on the wrong side of the investment track when they switch places can have serious repercussions on one's financial life. Life is risky, and that probably won't change anytime soon. We believe the best long term strategy is to have money in different types of assets - Cash, bonds, stocks, real estate, etc. This spreads your overall risk making it less likely that one event will significantly influence your general standard of living.

The reason that these retirees' nest eggs are cracking, is because all of their eggs were in one basket. Never a good idea, since sometimes the basket gets dropped and all the eggs crack.

Innovation Rules Again

2011-04-04T14:59:00.002-04:00

This blog post was on the Wall Street Journal web site over the weekend, PCs Make Americans $500 Billion Richer. The article is about two economists from the Federal Reserve Bank of Atlanta who have estimated how much utility Americans have gained from the incredible improvements in computing technology of the past several decades. Their estimate is $500 billion in 2009 alone. Here's a chart from the article:

I actually think their estimate is low, but that is only based on my opinion. The important fact to take away is that innovation and technology make us better off and that trend is not likely to stop anytime soon. The innovations taking place now and in the future will continue to improve all of our economic well being.

Printing Organs

2011-03-31T11:02:00.002-04:00

Over the past year I have read several articles and seen various shows that discuss new technology that allows the printing of human organs. This is one of the most amazing things I have heard about in my life.

I highly recommend watching this video to get some idea of what printing organs is all about and how it will dramatically change the future of medicine.

Scratch That Itch

2011-03-23T07:49:00.000-04:00

Last month, Berkshire Hathaway issued its annual shareholder letter. It is always enlightening to see what Warren Buffet has to say, and the most reveling quote in the letter is "Our elephant gun has been reloaded, and my trigger finger is itchy" This means that Mr. Buffett is eager to buy more companies, which shows just how optimistic he is about the future. He scratched that itch two weeks ago when Berkshire paid $9 billion for Lubrizol.

Now Mr. Buffett is in Korea, still itching for big deals. His optimism about the economic future is very interesting, because he hasn't always been so positive. He warned early that the dot.com market bubble and our recent housing bubble would not end well. The fact that he is now circling the globe looking for good investments should make us think that maybe good times are ahead.

Thoughts and Prayers

2011-03-14T15:43:00.002-04:00

Both Erica and I have Japanese friends, so we are very concerned, sad, shocked, etc.. over the events that have taken place over the past few days. Mother nature continues to show just how powerful she can be, and our hearts go out to everyone affected by the earthquake and tsunami. The internet is filled with information about what happened and what is happening, so I won't add much more.

However, from the perspective of this blog, it is interesting that just last week I wrote about alternative energy, and in particular new approaches to nuclear power. We are now witnessing the third "nuclear meltdown" of my lifetime (Three Mile Island and Chernobyl.) It's hard not to get nervous when the term "meltdown" is in the news. There are two excellent articles addressing this current nuclear "crisis" in this morning's Wall Street Journal:

Japan Does Not Face Another Chernobyl

Nuclear Overreactions

The biggest crisis facing Japan is dealing with the death and destruction wrought by this incredible natural disaster, not what is happening at the nuclear facilities. The likely outcome at the nuclear power plants is that they make it through this epic natural disaster without causing an environmental catastrophe. The power plants won't produce anymore electricity, which is an economic loss, but they also won't significantly contaminate the atmosphere.

Here is a quote from one of the articles referenced above:

"If a meltdown does occur in Japan, it will be a disaster for the Tokyo Electric Power Company but not for the general public. Whatever steam releases occur will have a negligible impact. Researchers have spent 30 years trying to find health effects from the steam releases at Three Mile Island and have come up with nothing. With all the death, devastation and disease now threatening tens of thousands in Japan, it is trivializing and almost obscene to spend so much time worrying about damage to a nuclear reactor."

Let's all keep the Japanese people in our thoughts and prayers.

Here We Go Again

2011-03-07T15:14:00.003-05:00

Not surprisingly, oil prices are on the move up. In fact, last week gas prices recorded their second biggest jump in the history of the gasoline market. I say this isn't surprising, because as the global economy recovers from the "Great Recession", we would expect commodity prices to rise as demand increases for food and energy.

The question on everyone's mind is, how high will gas prices go? The answer, of course, is that prices will continue to increase until supply and demand are in equilibrium. That's how markets work.

My bigger concern is the longer-term future of energy. Our current dependence on fossil fuels is not good, to say the least. Besides the environmental problems caused by burning coal, oil, and gas, it leaves our economy susceptible to significant price shocks, which then hurt the most vulnerable parts of the economy.

Fortunately, help is on the way in the form of my favorite economic super hero: innovation. This article from the Wall Street Journal discusses three technologies that may help provide energy in the future. Even Bill Gates is in on the alternative energy wave. He is a significant investor in TerraPower, a new way of using nuclear power. You can see Gates explain his vision in this video.

There is no easy, single answer to our energy problems, but there are huge opportunities and scores of smart and entrepreneurial people working to take advantage of those opportunities. Unfortunately, we still have to face the likely pain of increasing gas and oil prices in the near future. However, the more expensive energy becomes, the sooner innovative ideas will be put into place that will have significant long term benefits.

Money in The Bank

2011-02-20T13:26:00.000-05:00

There has been much criticism of the US government's actions in response to the "financial crisis" of 2008. What seems to get less attention is that some of these actions worked as advertised and some even made money.

This post talks about how the emergency lending programs undertaken by the Federal Reserve between August 2007 and December 2009 have thus far produced a profit of $13 billion. By law, the Fed must remit all profits to the US Treasury, meaning these profits directly reduce the federal budget deficit:

"The programs generated widespread worries about the Fed losing money, which would become politically difficult to deal with and could potentially compromise the Fed’s independence. Officials were confident they wouldn’t lose any money, and so far, they’ve been borne out by events. What’s more, government budget projections expect the Fed to return a significant amount of money to the Treasury Department for years to come."

Maybe a few people in Washington actually know what they are doing.

All for One and One for All

2011-02-14T09:34:00.005-05:00

Here is a piece from this weekend's New York Times, which follows up my post last week discussing the strength of manufacturing in the US. The article is written by N. Gregory Mankiw, a Harvard economics Professor who I have featured several times in this blog. The topic is about how economics is not like sports, where there are winners and losers. Instead, the basic premise behind economic prosperity is that trade involves two parties who each benefit, making it a win-win situation, not a zero sum game.

We are not in a competition with China, Germany, etc., where one country prospers to the detriment of others. Instead, we all benefit from the increasing complexity of economic activity, making more of the world a prosperous place to live and work.

Here is a cool graphic from the US Department of Commerce showing America's major trading partners:

Made in the USA?

2011-02-07T07:57:00.001-05:00

There is a very common perception out there that nothing is manufactured in the US anymore. A recent Op-Ed in the Boston Globe explains how that idea is far from the truth. Here's a direct quote:

"Americans make more “stuff’’ than any other nation on earth, and by a wide margin. According to the United Nations’ comprehensive database of international economic data, America’s manufacturing output in 2009 (expressed in constant 2005 dollars) was $2.15 trillion. That surpassed China’s output of $1.48 trillion by nearly 46 percent. China’s industries may be booming, but the United States still accounted for 20 percent of the world’s manufacturing output in 2009 — only a hair below its 1990 share of 21 percent."

I would think that most people would find this information very surprising. Here's a chart of the data used to show how much manufacturing actually takes place in the US (click the chart to link to another article on this subject):

Here is one more link, discussing how US manufacturers have become more optimistic about their businesses over the past quarter.

There are absolutely less jobs in the manufacturing sector than in the past, but it is not because we manufacture less stuff, it is because technology has made us significantly more efficient and productive. I can't believe that is a bad thing.

Elegant Explanations

2011-01-31T16:43:00.000-05:00

I was just deciding what to post this week, when this link showed up in my in-box, sent by a client. It is a series of napkin drawings by Carl Richards which appear in the New York Times Bucks Blog. I think they are fabulous, as I always prefer simple, elegant explanations to financial topics.

Here is one I particularly like (click on picture to see the blog post):

No matter how much we plan, the future will always be filled with surprises. Good financial planning is about understanding this fact and making plans that can adapt to these inevitable changes.

What's Next?

2011-01-24T08:23:00.002-05:00

Here is an article from the Boston Globe which discusses how poorly "experts" do at forecasting the future. This is a great follow-up to last week's post about efficient markets.

A common belief is that, while maybe the average person can't predict what will happen next, surely there are experts out there who can. A look at the actual track record of these "gurus" quickly dispels this notion. In the above mentioned article, the author discusses Nouriel Roubini, the man who, in 2006, predicted the financial crisis of 2008 and, thus, earned the nickname "Dr. Doom". This correct prediction earned Dr. Roubini fame and fortune. Unfortunately, it was also followed by many incorrect predictions, such as excerpted below from the Globe article:

"But here’s another thing about him: For a prophet, he’s wrong an awful lot of the time. In October 2008, he predicted that hundreds of hedge funds were on the verge of failure and that the government would have to close the markets for a week or two in the coming days to cope with the shock. That didn’t happen. In January 2009, he predicted that oil prices would stay below $40 for all of 2009, arguing that car companies should rev up production of gas-guzzling SUVs. By the end of the year, oil was a hair under $80, Hummer was on its way out, and automakers were tripping over themselves to develop electric cars. In March 2009, he predicted the S&P 500 would fall below 600 that year. It closed at over 1,115, up 23.5 percent year over year, the biggest single year gain since 2003."

Now we have nothing personally against Mr. Roubini, but this is an example about why we do not use prediction as a tool in financial planning, because, in the end, the ability to be right about the future, even among well-informed, well-educated experts, looks a lot like luck. We think planning one's financial future should involve understanding cash flows, risk/return trade-offs, and other mundane financial concepts -- not betting on anyone's predictions.

Timeless Advice

2011-01-18T10:22:00.004-05:00

Here is a video interview with Burton Malkiel, Princeton economics professor and author of "A Random Walk Down Wall Street", one of the most important books ever written on the topic of investing.

In the interview, Professor Malkiel defends the efficient market hypothesis (EMH), which has come under much criticism in recent years. Critics have wrongly claimed that, if the EMH were true, markets would always price securities correctly, and, thus, stock market crashes like that of 2008 would not happen.

These critics have incorrectly interpreted EMH, because it doesn't assert that market prices are correct, just that no individual can regularly provide "better" prices than the market as a whole, and thus, it is very unlikely for any investor to consistently "beat the market."

It's worth listening to Professor Malkiel's explanation:

This and That

2011-01-10T08:58:00.003-05:00

I have been put aside a few web links over the past few weeks to eventually put on this blog, so I figure now is a good time to clean house and then start fresh:

Trade Deficit: I have discussed before that government statistics, like trade deficits, are inherently flawed, because their methodology doesn't reflect our current globalized economy. Clicking on the picture below will take you to a Wall Street Journal article which does a great job explaining this issue:

Video games: Here, Andy Kessler discusses how video games are positively affecting the economy. Further evidence of how innovation comes from places we often don't expect.

A Trillion Dollars: US government debts are now denominated in trillions of dollars. This site does a very cool job of showing just what $1,000,000,000,000 looks like.

Happy New Year!

2011-01-03T09:06:00.001-05:00

Hard to believe that it is already 2011. I figured I would start the year with a post focused on good news, so here is an article from this morning's Wall Street Journal, which talks about the fact that corporate America is flush with cash and firms have plans to actually use the cash this year for investment and hiring. This will, most certainly, help the economy continue to grow out of the recession.

My New Year's resolution for this year is to update this blog once a week, hopefully on Mondays. Let's see if I can keep it up.

Scary Scenario

2010-12-22T07:59:00.013-05:00

As much as I hate to write about scary things three days before Christmas, I was asked by a client to comment on this article, Hyperinflation Special Report, and so I thought that a blog post would be the best venue in which to do so.

In the article in question, the author claims that the US economy is headed for financial Armageddon; that the combination of excessive money creation by the Federal Reserve and unsustainable government deficits will result in the collapse of the US dollar and destruction of the US economy as we know it. The author goes on to claim that, in the wake of this economic collapse, we will be forced into a barter economy so that, ultimately, the world will reorganize around a new gold standard.

Do I agree with this doomsday scenario? No, I don't. The article is full of charts and graphs based on a variety of statistics. I won't counter those statistics, because we all know that there is plenty of data available which can be cited in such a way as to prove (or disprove) just about any argument. I am more interested in the underlying thesis of this article, which is fundamentally based on the belief that a fiat money system (one which is not based on a metal such as gold) is unsustainable and that the sooner we get back to the gold standard, the better we will all be. I believe, on the other hand, that the technological advancements of the last century ultimately make the gold standard a relic of the past.

Money is no longer a store of value. Instead, money is all about transactions. The economy of today is substantially more complex than ever. The gold standard broke down early in the last century, primarily because it couldn't handle the complexity of the 1920's global economy. For those of you who are interested in reading more about this topic, the book The Lords of Finance, which I've referred to in the past, explains how and why this occurred. I don't see how the gold standard could possibly function in an economy as complex as today's.

All that being said, I do agree with the author's suggestion that inflation is likely to return some time soon, and I have said so before. I just don't think that the likely scenario is a hyperinflation which will lay the economy to waste. Below are a few links to some alternate views about where the inflation monster may be headed:

Bernanke 1, inflation hawks 0

The Fed's Policy is Working

Economists Disagree On Future Path of Inflation

The Bond Rout and the Fed

There is certainly reason to be concerned about things like future inflation, government deficits, and high unemployment. However, I don't think the doomsday scenario is the likely outcome. I will refer you to one more book, Sonic Boom, which does an excellent job of discussing the complexity of today's world in which the rapid pace of change makes us all a bit uncomfortable. We live in a truly globalized world, and, like it or not, we are all in it together. I believe that unpredictable changes will shape our future and that, for the most part, these changes will be to our benefit in the long run.

I hope everyone has a very Merry Christmas and Happy New Year!

Three Years Later

2010-11-12T07:25:00.023-05:00

Last month marked an auspicious anniversary, because it was in October of 2007 that the US stock market reached it's all time peak. The Dow Jones Industrial Average closed at it's all time high of 14,093 on October 12, 2007. Of course, we all know what has happened since: the sub-prime mortgage meltdown, government bailouts, financial Armageddon, and so forth.

We actually first created this blog in response to "The Financial Crisis" during March of 2009, which turned out to be when global stock markets hit their bottom. One of our first posts was called "Where Do We Go from Here" , in which we compared the current financial crisis to the market crashes of 1929 and 1973. We have since revisited this comparison several times, including in May 2009, October 2009 and a few months ago in June 2010. Well, let's look at the graphs again (click on the graphs to see a larger image).

A few comments/observations:

Fortunately, I was correct in March of '09 when I suggested that the current crisis seemed more like that of the 1970's than of the Great Depression. If you look at the second graph, which has been extended to 36 months, you can see that the current value and the value from the 1970's are exactly the same. Good job Frank! Seriously though, I had no idea that these two lines would collide at the 36 month point, but my general idea was correct.
To me, one of the most interesting points is that after hitting bottom, all three lines reversed direction dramatically. It is probably no coincidence that, in all three cases, the reversal coincides with actions taken by the Federal Reserve to dramatically increase the money supply (which is really economics speak for "printing money"). Good job Ben!
The third graph shows that in both the Great Depression and the 1970's, after hitting bottom and reversing direction, both lines continued on an upward trend for several years. THIS DOES NOT MEAN THE SAME THING WILL HAPPEN THIS TIME! Neither I, nor anyone else for that matter, truly knows what will happen next. However, it is encouraging to know that the economy has twice recovered from serious "Crisis".

Alphabet Soup

2010-10-19T06:56:00.004-04:00

Credentials can be a tricky thing, particularly in the financial services industry. This article points out how many different credentials and designations exist for "financial planners" - CFA, CFP, CFRA, CSP.... This makes it very difficult for consumers to differentiate which professionals are truly advisors focused on the clients' best interest, and which are just sales people looking to sell products with high commissions.

This video sums it up nicely:

For the record, my own personal alphabet soup looks like this:

MBA - Babson FW Olin Graduate School of Business

CFP - Certified Financial Planne r

RIA - Registered Investment Advisor

I Love Innovation

2010-09-30T12:24:00.006-04:00

The Wall Street Journal just published it's 2010 Technology Innovation Awards. As a proponent of the idea that innovation is what drives economic growth, I love articles like this. It's just really cool to see all of the remarkable innovations that ingenious people come up with. Here is a complete list of the winners. It is interesting to note that winners come from many countries, although the US has by far the most from any one country. Also, the winners come from large companies, small companies and individual inventors, showing that there are many ways to get great innovations.

Finally, here is a video that spotlights the top three innovations:

A Look at Bond Markets

2010-09-22T07:49:00.009-04:00

In this blog, I often focus on what is happening in the stock market, perhaps at the expense of discussing bonds. Well, some interesting things have been happening in the world of fixed-income. The first is that super-safe bonds, US Treasuries, are looking pretty risky right now as this WSJ article explains. With interest rates as low as they are, it is likely that they will go up again in the near future. This means that anyone holding these low interest rate bonds will see their value go down as interest rates rise. The price drop is more severe the longer the term of the bond, so it is much worse for 10 year bonds than it is for 2 year bonds. The graphic below from the above referenced article shows some past periods when holders of "safe" US Treasuries suffered significant losses.

This is also why we have always recommended owning bonds with close to a 5 year maturity, which reduces this "term risk" inherent in longer term bonds.

The other interesting development is the improvement in the corporate "junk" bond sector, discussed in this article. A Moody's executive quoted in the article says "The rebound is breathtaking." The graph below shows that default rates on junk bonds have returned to their pre-crisis level.

We generally recommend owning "junk", known as high-yield bonds, as part of a diversified investment portfolio, precisely because they behave differently than safer bonds, and this diversification can help the long-term performance of a bond portfolio.

Lessons Learned

2010-09-10T10:04:00.005-04:00

I recently saw Nick Murray speak. He is a well know advisor to financial professionals. He pointed out that we are approaching the 3-year anniversary of the all time high for the Dow Jones Industrial average (14,164 on October 9, 2007). We all know what has happened since then. Mr. Murray is quite good at keeping things simple and providing a clear perspective on financial markets.

Here are his five lessons learned from the past three years:

You can't call the economy in the short or intermediate term and neither can anyone else.
Neither can you or anyone else call the markets.
The more dramatic the next series of economic/market events will be, the less likely you can predict them.
a) There is no statistical evidence for the persistence of investment performance; "future relative performance with respect to past relative performance is random."
b) At critical turning points in an investor's life, relative performance will not matter.
The world did not end because it does not end.

Optimism

2010-09-03T07:36:00.006-04:00

This article was in last week's Wall Street Journal. The author, Ross DeVol, lays out a case for economic optimism. I'm not sure if he is right, but it's nice to hear an argument that the economy will improve going forward, as opposed to all of the doom and gloom that has dominated the media.

Here is a video with Mr. DeVol from CNBC:

And here's a link to the actual research report. Let's hope the optimists are right.

Double Dip?

2010-08-24T11:26:00.007-04:00

There is a lot of concern right now that we may be heading for a "double dip" recession, and the new home sales figures released today will only fuel that fear. I really don't know how the recovery will play out and whether we will, indeed, have a secondary recession. As I have said before, "no one knows".

What I do know is that the worst case scenarios thrown around during the depths of the credit crisis in late 2008 have not materialized. I also know that corporate America is sitting on an unprecedented pile of cash. It is ultimately corporate profits that drive stock prices, not the daily barrage of economic statistics.

The next few months will prove to be very telling on where we are headed, and the election season promises to be very ugly. I expect global stocks markets to continue their extreme volatility throughout the fall, so unfortunately, we need to hold on tight and keep our eyes to the long-term.

I'll finish this post with a song from country singer Merle Hazard, who often sings about economic topics. It's important that we all keep our sense of humor.

More Rational Optimist

2010-07-25T12:00:00.004-04:00

This is a 16 Minute video from the author of my new favorite book, the Rational Optimist. It's well worth the time to watch the whole thing.

The Rational Optimist

2010-07-18T13:00:00.005-04:00

I just finished reading this book, I highly recommend it to everyone.

We're off to the Cape for a few days. I'll comment more on the book when I return. In the meantime, check out this video:

Happy 4th of July (waiting for some good news)

2010-07-02T12:48:00.005-04:00

It has not been a very happy last few months. It seems all we have heard is bad news , from the oil spill in the gulf to the declining stock market and uninspiring economic data. I have nothing new to say about the markets other than what I have said previously.

I do believe the economy will improve, although it's anyone's guess at what trajectory. In the meantime, it may be a tough summer in the financial markets as a lot of cash continues to wait on the sidelines. However, that cash will eventually be put to work, rewarding the patience of long term investors

I hope everyone has a wonderful 4th of July weekend, a time to celebrate with friends and family the freedoms we enjoy in this country. I 'll finish with a short quote that sums up my feelings about Independence Day:

"You have to love a nation that celebrates its independence every July 4, not with a parade of guns, tanks, and soldiers who file by the White House in a show of strength and muscle, but with family picnics where kids throw Frisbees, the potato salad gets iffy, and the flies die from happiness. You may think you have overeaten, but it is patriotism." ~Erma Bombeck

Addendum

2010-06-14T10:57:00.003-04:00

From today's Wall Street Journal, Euro-Zone Industrial Output Surges. Pretty relevant to my last post.

Sell International Stocks?

2010-06-10T11:49:00.009-04:00

At a client meeting earlier this week, I was asked if we should stop investing in international stocks, particularly European stocks, in light of the recent financial turmoil in Europe. I think this is a legitimate question that many of our client might also be asking themselves. In response, here is a short video from the Wall Street Journal from earlier this week:

I think that the most important take away from this video is that the global economy is linked in a complex web of connections. When we invest internationally, what we are trying to do is to own shares of companies which not located in the US. The belief is that most of these companies will be profitable over the long run, despite the short-term budget problems facing some European governments.

Here's a short list of such companies, which are owned by many international equity mutual funds:

HSBC

Nestle

Novartis

Honda

TD Bank

National Bank of Australia

Siemens

Sony

Vivendi

Michelin

I make no claim about whether these are good or bad companies, but I do know that most of us have heard of them. I also believe that a truly diversified equity portfolio should include companies like these.

Now, I do have a few comments to make on the video itself. Firstly, there is a discussion about currency hedging in mutual funds. We generally prefer funds that do not engage in currency hedging. This is a pretty complex issue, which I would be happy to discuss in detail with anyone who is interested.

A second issue the video brings up is that, sometimes, what we may think of as domestic only equity mutual funds actually hold a lot of non-US stocks. This is something that also concerns us, so we monitor the holdings of the mutual funds we own so as to make sure that there isn't overlap between domestic equity funds and international funds.

Pep Talk

2010-06-07T10:44:00.020-04:00

I received this message from a client on Friday afternoon:

"Noticed that the stock market did not do so well today. I think I need a pep talk!! (something positive)...."

So here goes. When we first started this blog last March, we published a slide presentation entitled "Where Do We Go from Here ". One thing we did in that presentation was to compare the current market downturn with the downturns from the 1930's and the early 1970's. At the time, the current market looked more like the 1930's than the 1970's.

As you can see from the updated chart below (click on it to see it bigger), things have changed dramatically since the end of February 2009, when the red line hit it's bottom. Now we can say that the current market (red line) looks much more like the 1970's (blue line), than the 1930's (green line). Remember, it was not clear 14 months ago how things would play out. What we did say was that we thought the outcome would be more like the 1970's than the 1930's. So far, so good.

The recovery will not take place in a straight line. There will be periods of angst and nervousness as we move forward, but I honestly believe that forward is the way we will go. The chart below shows what happened in the 1930's and 1970's over a longer period of time. In both cases, the economy and the markets did recover and eventually moved strongly positive.

The economic recovery faces many challenges, including the debt problems in Europe, the slow jobs growth, and ramifications from the oil spill. However, the world has faced greater challenges in the past, and progress has continued on its forward march. I believe the road ahead will continue with this forward progress, but the road will be bumpy, and sometimes the ride will not be very comfortable. Just remember, we are all in it together, and we will hopefully benefit by staying calm and patient.

Pretty Cool

2010-05-25T09:56:00.015-04:00

This video and the web site it describes are pretty cool. I have been having trouble embedding the video, so I recommend right-clicking and watching on You Tube.

Hat Trick

2010-05-21T08:40:00.003-04:00

Wow, my third post this week. Clearly, this has something to do with the negative performance of global stock markets over the past few weeks. It's never fun to see markets go down, but that is how things work.

Apparently, the current correction has some relationship to the Greek government debt problems, or as we called it yesterday. "The Global Bailout" (Now, I will reiterate that the market performance of the past few weeks, down 10% or more, is perfectly normal and has many interconnected causes. It may very well be a good time to buy. Or not. No one knows)

Interestingly to me and readers of this blog is that I was in the middle of discussing the US government budget deficit, when the Greeks stole the headlines and panic began to spread, the theory being that Greece is just the tip of the iceberg. If the Greeks default on their debt, are Spain, Portugal and others next? Well, I've got some good news and bad news on that particular theory. The good news is that the iceberg is farther away than many think. The bad news is that the iceberg is also bigger than many think. Here's why:

The iceberg that I am talking about is the fact that in the Western Developed World (WDW) we are on a collision course with promises made to the baby boom generation concerning retirement. The primary reason these promises are such a problem is that life expectancy for baby boomers has increased by almost 10 years during their lives. That's a lot more social security checks than were originally planned for. This is a problem not only for Greece, but for governments at all levels in the WDW. Just look at California. The problem gets much bigger ten - twenty years from now as all of the baby boomers transition to retirement.

Which brings us to the good news; the real problems don't hit until ten years from now. A lot happens in ten years. Maybe Greece is the cannary in the coal mine and we will wake up and start acting like adults. There are solutions to the problem that could be enacted over the next decade. They may not eliminate the iceberg, but they may melt it a bit. I will look at some of those solutions next week.

Are We Worried?

2010-05-20T12:09:00.005-04:00

Just read this at the Wall Street Journal:

Stocks Fall as Strains Accumulate

Here's the opening sentence in the article:

"U.S. stocks tumbled, leaving key indexes on pace for their first correction since rallying from March 2009 lows."

I took the poll asking "Is the Market in for a Long Correction?' I voted no. The results through 1:18 PM were 60% saying yes, it will be a long correction. Let's hope the pessimists are wrong.

I also took the second poll which asks "Which is Having the Greatest Influence on the Dow? I answered "Global Bailout" which had by far the most votes.

So are we worried that government debt problems in various countries around the world will cause a secondary recession? In a word, yes. Not being concerned about these debt problems would be foolish. However, being worried or concerned does not mean we should panic. Instead, we need to understand the scope and magnitude of the debt problems, and then determine if we should then change our investment strategy.

Can't Get Blood From a Stone

2010-05-18T09:04:00.005-04:00

This article appeared in yesterday's Wall Street Journal. Here's a quote that sums up the author's thesis, along with a very interesting chart:

"Six decades of history have established one far-reaching fact that needs to be built into fiscal calculations: Increases in federal tax rates, particularly if targeted at the higher brackets, produce no additional revenue. For politicians this is truly an inconvenient truth."

The chart shows that regardless of how tax rates change, Federal tax revenues over the past sixty years have hovered around 20% of GDP. This relates to the blog post I made a few weeks ago discussing the income side of national deficits. In that post, I promised that I would make future posts discussing the expense side of deficits. I will follow through on that later this week - I promise.

Freefall?

2010-05-07T10:02:00.008-04:00

I received this e-mail from a client yesterday:

"Frank

What is your opinion on what has happened in the market this week? Do you see a very negative trend again or will this pass once Europe stabilizes? How concerned should we be?"

It has certainly been a scary few days in the markets. No one is happy to see such large declines over several days. This was only made worse by the apparent electronic trading glitch that caused the Dow to briefly drop by almost 1,000 points yesterday afternoon.

I would caution against using a few days of performance to determine what the trend may be going forward. Clearly, the situation in Europe, and Greece in particular, is troubling. Many people believe that Greece is only the tip of the iceberg, with Portugal, Spain and Italy soon to follow. This may or may not be true. In the summer of 2007, I went on record as saying that I didn't think sub-prime mortgage problems could bring down the entire US economy. Ooops! So I, nor anyone for that matter, really have no idea how serious the European government debt problems will become and how they will affect our clients' investment portfolios. If you spend some time trolling through the economics blogosphere, you will find such a wide variety of expert opinions, that it is clear no one knows how things will play out in the end.

In the short-term, we are always concerned about what may happen next. That is why we don't take much risk with money that may be needed within the next six years. However, in the long-term, investors are generally rewarded by not panicking during times of turmoil. Here is a quote from Warren Buffet's most recent shareholder letter:

"When it is raining gold, reach for a bucket, not a thimble... We've put a lot of money to work during the chaos of the last two years. It's been an ideal period for investors: A climate of fear is their best friend"

As I write this, the stock market is down significantly in volatile trading and could easily go down much further before reaching bottom. Or, we could see a huge rally next week. We could have a double dip recession, or the economy may continue its recovery despite Greece's problems. Only time will tell. My advice is not to panic, stay diversified, and remain conservative with money you may need in the near term.

Happy Tax Day !

2010-04-15T08:33:00.011-04:00

You could probably spend the entire day today surfing the blogosphere reading posts like this and this complaining about or criticizing taxes.

I am not going to join the tax debate (yet), but I think it's a good time to revisit my last blog post about national debt. I ended that post with this thought:

If we accept the premise that zero debt is not the appropriate goal, then it leads us to the subsequent discussion about how much debt is too much?

Since I don't want to presume the financial literacy of anyone, and because it never hurts to review the basics, let's remember this equation:

Income - Expenses = Surplus or Deficit

Our current national debt is the result of several years of budget deficits created when expenses have exceeded income.

Tax day is a great time to look at the income side of the equation, since government income is nothing but taxes. Yes, that is an over-simplification, but you can see that according to this chart, non-tax revenue is only 4%.

Unfortunately, the issue of tax revenues is a tricky subject. A tax rate of 100% is clearly a bad idea, but so is a tax rate of 0% (like it or not, the government needs money for the country to operate). So the logical next question is, "what tax rate will maximize government income without hampering the entrepreneurial spirit to make money?" Unfortunately, even respected "experts" disagree on the answer to this question. (For what it's worth, my personal opinion is that tax rates over 30% start to look too high, and those below 15% begin to look too low.)

In the next post on this topic, I will look more closely at the "expense" side of the deficit equation. This will allow us to get closer to the ultimate goal of determining the appropriate level of national debt.

Unfortunately, you'll have to wait a few weeks for the next post, because we are off to Disney World for a week of sun, fun, and relaxation with the kids.

National Debt

2010-03-29T16:47:00.011-04:00

I recently received this excellent question from a client, and he graciously allowed me to address it in this blog, because I'm sure it is a issue that puzzles many people:

"I've been puzzling over something lately, and my limited knowledge of economics has prevented me from reaching a conclusion."

"The US National Debt continues to grow. At this point, there is no way it can ever be ZERO, or even paid down significantly. Can it grow infinitely? At what point does something bad happen? If something bad is approaching, how is it possible to correct the course?"

This is one of the most important issues facing our economy as we try to recover from the "Great Recession." Unfortunately, government debt is one of those issues where there is little agreement among economists. Well, not exactly. There is agreement that too much debt is probably bad, and that large surpluses are also not good, but everything else is up for debate, including how much debt is too much.

An example of this disagreement has recently been going around the blogosphere. It is interesting to note that the blog posting this debate is entitled "inflation debate". That is because one common fear is that large deficits will ultimately get resolved with inflation, as the government "prints money" as a way to pay down the debt.

This issue is so important and complicated, that I will not try to address it all in one blog post. Instead, I will look at pieces of the puzzle over several posts. Hopefully, I will get some feedback as I go along and will address the most pressing issues.

It is important to understand the difference between debt and deficits. The US national debt is represented by Treasury Bonds -- money the government borrows from the public. These Treasury Bonds are then traded in the financial markets and represent low risk investments.

I believe that a country like the US should never have zero debt. Uncle Sam has the lowest cost of borrowing in the world, and debt plays an important role in the financial structure of the US government. Furthermore, Treasury Bonds are extremely important in helping global financial markets function properly. Remember that debt, which has bad connotations, is also called leverage, which has good connotations.

If we accept the premise that zero debt is not the appropriate goal, then it leads us to the subsequent discussion of how much debt is too much? And how much should we be concerned about current excess government spending? I will begin to tackle that in another post soon.

Good Luck Big Red!

2010-03-25T11:28:00.002-04:00

I try to stay away from non-related topics in this blog, but today I couldn't resist. My alma mater, Cornell University, is playing tonight in the Sweet 16 of the NCAA College Basketball Tournament. This is quite an achievement for an Ivy League school, where athletic scholarships are not allowed. It's the first time an Ivy League team has gone this far in the tournament since 1979.

So I for one will be cheering hard tonight, rooting for true student athletes!

One Year Later

2010-03-10T10:13:00.006-05:00

It was exactly one year ago yesterday, on March 9, 2009, that the global stock markets hit the bottom which followed the financial crisis in the fall of 2008. (They actually hit bottom first on 11/20/08 and then retested those lows on 3/9/09). The table below is an update to similar tables I have posted in the past, and it shows what has happened to stock markets in the one year since the bottom:

These levels of return are pretty remarkable, with Small Cap Value, Microcap, and Emerging Market stocks up over 100% in the past year. Of course, that level of return will certainly not continue, and we should expect to see some down periods as we move forward. However, it has been a powerful recovery from the brink of disaster--which no one that I know of predicted. I would challenge anyone to find one respected market commentator who said a year ago "Better buy stocks now, because they are about to go through the roof!"

Unfortunately, I have seen many articles and TV spots referencing this one year anniversary while posing the question of whether now is the time to get back into the market. My answer, of course, is that if you panicked and sold out of your stocks during the downfall, then there isn't a good time to get back in, especially not now after such a run up in prices. By sticking to our Investment Policies and remaining disciplined and forward thinking, our diversified portfolios have succeeded where many market timers have failed. Stocks are the appropriate place for long- term investment. As I have said ad nauseum, trying to time when to get in and out of the stock market is a recipe for losing money. The principals of Asset Allocation, Diversification, and Keeping Portfolio Expenses Low have again allowed us to successfully weather the worst of the storm, while achieving long-term portfolio growth.

Advice from Warren

2010-03-04T08:40:00.004-05:00

Here is an article that sums up Warren Buffett's most recent shareholder letter. I tend to like Mr. Buffett's advice, because it is simple and straightforward. It's hard to argue with the concepts of staying liquid and understanding what you own.

If you actually read through the shareholder letter, you will find the following bit of wisdom in reference to Mr. Buffett's business partner, Charlie Munger:

"Long ago, Charlie laid out his strongest ambition: 'All I want to know is where I’m going to die, so I’ll never go there'. ”

Can Anyone Beat the Market?

2010-02-25T15:03:00.009-05:00

So far this year, I have made two posts which point out that both actively managed mutual funds and individual investors have a difficult time beating the market. Well, continuing on that topic, here are two more articles which show that trying to beat the market is likely a waste of time. The first is titled, " How to Squander $170 Billion", and in it, we learn that plan sponsors, people in charge of pension funds, do a horrible job of picking investment managers. They hire and fire managers at the wrong times, thereby costing their funds billions of dollars. According to Professor Scott Stewart,

“Plan sponsors never make their money back. If they simply went on vacation, they could save their clients $170 billion – and that doesn’t count transaction costs.”

And then there is this report, Evaluation of Active Management of the Norwegian Government Pension Fund — Global, which is a pretty technical report, so I will summarize the findings. The Norwegian Government runs a sovereign wealth fund which is one of the largest in the world, with about $430 billion thanks to oil revenues. The fund spends considerable time and effort managing its assets, with an internal staff of 249 employees and hundreds of outside investment managers. Last year, the fund hired three academics to evaluate its performance, and they produced the report referenced above. Their conclusion is that "the overall behavior of the Fund is very similar to an index fund", which begs the question, why pay for all the staff and investment managers if your performance ends up just mimicking the market?

How Cool Is This!

2010-02-19T15:18:00.001-05:00

Check out this article in this week's Economist about a new machine that prints body parts!

Science fiction and reality keep getting closer together.

I Have Seen The Enemy, and It Is Me

2010-02-12T10:53:00.002-05:00

Here is a good interview concerning behavioral finance and how it affects individual investors. The finance Professor who is interviewed, Terrance Odean, makes the argument that due to behavioral biases like over-confidence, individual investors who actively trade in their accounts make a mess of their portfolios.

His advice to people is:

"Generally speaking, you should buy and hold, invest for a long horizon, pay attention to your trading costs and taxes, and diversify"

I couldn't agree more!

Another Optimist

2010-02-04T07:18:00.002-05:00

In this morning's Wall Street Journal, Andy Kessler writes that there may be a way for the Federal Reserve to exit the current monetary expansion without killing the economic recovery. Not only that, he thinks his plan could avoid rapid inflation and make bank panics a thing of the past. His idea is to have the Fed increase the amount of reserves that banks are required to hold, thereby reducing the amount of leverage in the banking system and giving the fed more control over money supply.

I hope Andy is on to something and that Bernanke is thinking along the same lines. A more stable banking system would certainly help all of us, and I am all in favor of solutions that require less regulation and bureaucracy.

An Optimist

2010-02-02T15:49:00.002-05:00

I read this article, "Why the Recovery Will be Robust" in yesterday's Wall Street Journal. What struck me is that this is the first time I've heard any economist claim that we will have a strong recovery. The general consensus has been that the recovery will be mild. I really have no clue how strong or weak the recovery will be, but I'm am often skeptical of consensus opinions. If everyone says the recovery will be weak, then I won't be surprised if it's stronger than expected.

I also like the article because it gives a pretty straightforward and simple explanation of how economies work. Here is a good example:

"The popular idea that the economy is driven by "stimulus" spending—as if politicians could capture and bring in resources from outside the economic system—is mistaken. Economies grow as the result of capital being put to work. Capital is plentiful. But it retreats in times of turbulence and uncertainty, coming back to work when uncertainty abates."

I agree that capital is currently plentiful, thanks to all of the actions by the Federal Reserve. Let's hope that businesses do a good job putting that capital back to work, resulting in a stronger than expected recovery.

Good News?

2010-01-29T10:45:00.003-05:00

The big news of the day is that US GDP rose 5.7% in the 4th quarter of 2009. However, with unemployment at 10%, the economy still has a way to go before we would call it "recovered", but we need to start somewhere.

Here are some economists reactions to the GDP news, some more positive than others. Also, here is an explanation of how the GDP increase was due in part to slower draw downs of inventories.

Active Management Fails Again

2010-01-28T09:01:00.004-05:00

Every six months, S&P publishes the S&P Persistence Scorecard, the purpose of which is to measure whether mutual funds managers are able to consistently outperform their peers. As you may guess, the results are not very good for active managers. According to the S&P study, "very few funds manage to consistently repeat top-half and top-quartile performance." In other words, fund managers who are better than average this year will likely be worse than average next year.

This is why we believe so strongly in passive management, which is all about lowering investment costs. Why pay high fees to active managers when they are not able to consistently achieve superior investment returns? We think the better approach is to keep costs down and to keep our actual returns as close as possible to the asset class in which we are investing. This means that we will be giving up the chance of having higher returns then our benchmark, but we are also eliminating the chance of having lower returns.

Lowering investment costs is why we are such big fans of Dimensional Fund Advisors (DFA), because they are so focused on lowering costs throughout the investment process. DFA has just redesigned their public website, and I urge you to give it a look if you haven't done so recently. There is lots of good information on how DFA adds value, like this explanation of "portfolio engineering".

One final thought on active vs. passive management. Last year, Professors Eugene Fama and Ken French did an academic study looking at luck vs. skill in mutual fund management. I have seen Professor French lecture on this topic, and he says that when statistically analyzing mutual fund returns, the results of active managers "look a lot like luck." Which leads me to the conclusion, why pay for luck?

Economics Rap

2010-01-26T19:15:00.003-05:00

The video below has been all over the internet today, although I'm sure most of the viewers have been "economics geeks" like me. It's very creative and funny, worth the six minutes it takes to watch

The is the website of the group that produced the video, including a bunch of info on John Maynard Keynes and F.A. Hayek, the two "stars" of the video and two of the most important economic thinkers of all time.

Inflation Monster

2010-01-21T09:02:00.004-05:00

This article appeared in The New York Time over the weekend, and it was written by Harvard Economist. Greg Mankiw. The first sentence of the article asks "Is galloping inflation around the corner?" and that does a great job introducing what the article is about. The risk of future inflation is something I have posted about before, and it is something we discuss with all of our clients.

As the economy recovers, the Federal Reserve will be engaged in a very delicate balancing act of trying to avoid high inflation while keeping the recovery from losing steam, all in the face of large government budget deficits. I don't know how it will turn out, but I do know that high inflation wreaks havoc on personal retirement plans, as it is difficult for retirement incomes to keep pace with rapidly rising prices. That is why during retirement it is not advisable to put all of your assets in "safe" investments like cash and bonds, because those assets will not produce returns greater than inflation when the inflation monster does indeed arrive.

Here is the last paragraph of Professor Mankiw's article:

"Investors snapping up 30-year Treasury bonds paying less than 5 percent are betting that the Fed will keep these inflation risks in check. They are probably right. But because current monetary and fiscal policy is so far outside the bounds of historical norms, it’s hard for anyone to be sure. A decade from now, we may look back at today’s bond market as the irrational exuberance of this era."

Mad About Trade

2010-01-19T08:16:00.005-05:00

I just finished reading this book, "Mad About Trade"

The author does an excellent job of laying out the arguments for why trade benefits most Americans and of disproving many of the myths about how free trade is responsible for job losses, lower incomes, etc. I absolutely recommend the book for anyone who is concerned that America is losing its way in the global economy. The book's conclusion sums it up perfectly:

"Free trade confidently embraces the future. It affirms that Americans have much to offer the world and much to gain from collaborating with people in other countries as customers, suppliers, business partners, and friends. Free trade unites us with other people in an ever widening "community of work" that provides a powerful alternative to conflict and war. Free trade embodies a policy of hope rather than fear."

Back to Work

2010-01-05T12:38:00.007-05:00

Actually, we got back to work yesterday, but I was too busy to make a blog post. The problem with the holidays is that around December 15th, everything goes into what I call "it'll wait 'til next year" mode. This seems like a great idea at the time, but when you get back to the office on Jan 2, the things on your to-do list have multiplied like rabbits. I have already promised myself that this will not happen next year (Why do I hear my wife laughing?).

There is actually a lot to talk about as we enter a new year, and hopefully, I will address some of it soon, once I tame the to-do list.

In the meantime, here is a piece from the Economist about procrastination.

One World Economy

2009-12-21T08:35:00.005-05:00

I just read this article, The Global Imbalances Myth, in this morning's Wall Street Journal. The author addresses the current rhetoric that we are in trouble because the world economy is "structurally imbalanced", the idea that if America consumes everything and China makes everything, the result will be economic disaster. This is an idea that I do not believe in, as I think the best way to look at the world is as one interconnected global economy.

The issues of what will happen economically over the next several years, what role China will play, what will happen with the mounting US debt, etc.. are all important, and our views one these issues will shape how we manage our clients financial and investment plans. Here is a quote from the above referenced article that sums up my thinking on these issues:

"Today's consensus sounds very much like the orthodoxy of yesteryear - let each nation be its own system in equilibrium, interacting with other systems to create one mega-balanced system. Yet such balance has only existed in theory and only ever will."

It is highly unlikely that the increased economic and social interconnectedness we have undergone over the past decades will change course. Like it or not we are all part of one global economy. It is important that we understand this as we think about how the future may play out.

Fed Will Make Profit on Bailout

2009-12-07T16:37:00.002-05:00

How about that!

Same Share of a Bigger Pie

2009-12-03T08:57:00.003-05:00

The graph below comes from this blog post by Professor Mark Perry:

What the graph shows is that the US share of global GDP has remained remarkably constant over the past half century, during a time when global output increased by more than three times. This is evidence that debunks the myth that gains in places like China and India come at the expense of the US. The global economy is not a zero sum game. Professor Perry sums it up perfectly:

"Because of advances in technology, innovation, and significant improvements in U.S. productivity, America's share of total world output has remained remarkably constant at a little more than 25%, despite the significant increases in output around the world, especially in Asia."

Who Benefits from Innovation?

2009-11-30T08:50:00.009-05:00

I often talk about the power of innovation when arguing why the economy continues to move forward over time. This idea was best articulated by Joseph Schumpeter, an Austrian economist who coined the phrase "creative destruction." One of the most interesting considerations regarding innovation is the question of who benefits: the innovators, or the ultimate users of the innovation? The answer is that they both benefit.

This brings me to a great blog post by Steven Horowitz, an economics professor at St. Lawrence University. Professor Horowitz uses the most recent census data to show that, over the past twenty years, those living under the poverty line have seen a dramatic improvement in living standards. Many more poor people have things like dishwashers and air conditioners than did a few decades ago. It is important to note that he is not saying anything about the gap between the rich and the poor, which is another issue.

The entire topic of living standards, economic prosperity, and the rich-poor gap is complex and very politically charged. I only offer the reference to Professor Horowitz's blog, because I find it to be an interesting approach to the topic. What I like best is the quote at the end of the post, with which I couldn't agree with more:

"...as long as the Schumpeterian horse of innovation and the Smithian horse of the gains from trade outrun the Government horse of stupidity, the winners will continue to be you, me and our children and grandchildren, even if the stupid horse is running a bit faster than it used to."

Ultimately, economic prosperity is the result of businesses continuing to evolve, innovate, and trade around the world. As long as this remains true, we will work our way through the current economic difficulties.

Happy Thanksgiving!

2009-11-25T13:39:00.005-05:00

In honor of tomorrow's holiday, I though I would show something that we should all be thankful for. The table below shows returns for various equity asset classes through last Friday.

We have shown this table, or ones similar, several times this year, most recently in September. I chose November 20 as the date because it was on that date last year when the market reached its bottom. I remember very clearly how we felt at this time a year ago, and it wasn't very good. If I had said at that point that we would see market returns in the 60% range over the next year, I would have been called crazy.

So I for one am thankful that we can spend the next few days focusing on family, friends, food and football, as opposed to worrying about the economy and financial markets. I hope everyone has a wonderful Thanksgiving!

What is Your Present Outlook?

2009-11-19T16:22:00.005-05:00

Yesterday, I received a message from a client with the following questions:

What is your present outlook? Any suggested changes in investments or allocations?

Although these questions seem fairly simple, they really get to the heart of the issues underlying investment management. The first one is the harder of the two to answer. We have clearly been through a historic period in economic history; one that few saw coming, either in scale or scope.

Now that the economy is in recovery, the question on many people's minds is, "Will the recovery last?" There are many "experts" on both sides of this question that are more than happy to share their opinions. Just google "Will the recovery last?" to see what I mean. Unfortunately, many of these opinions are based on the the efficacy of particular government actions: Has the Fed gone too far or not far enough? Will the stimulus work? Will government deficits derail the recovery? etc... Furthermore, it is easy to find two well-respected economists who disagree about each point.

The problem I have with this approach is that it doesn't account for how businesses and individuals are reacting to the current environment. I am a strong believer that innovation and hard work are the foundation of economic growth, not government policies. Examples of innovation and hard work can be seen in this article about how tinkering is making a comeback in the current economic climate.

So to answer the first question, my current outlook is cautious optimism. I am not naive, and I understand that the current recovery is fragile and that there are lots of obstacles that we need to overcome. I also understand that government actions are important, and much of what has taken place over the past year is unprecedented. We really have no idea how the story will play out over the next few months and years, and that is the cautious part. We should all be ready for more bad news and possible short-term market losses. As I say over and over, no money that anyone plans on spending in the next six years should be invested in the stock market.

The optimistic part comes from the fact that good times come when they are least expected. A few weeks ago, I posted about Warren Buffet's purchase of Burlington Railroad. When times are bad, the truly bold, smart, and energetic come forward and lead the way. Why will that be different this time? It may take a while for things to get better, but they will.

The second question, about changes to investments or allocations, is much easier to answer. I am not recommending any changes. We are strongly opposed to market timing. We firmly believe that being globally diversified is the best way to invest. Markets will continue to be volatile, even when the recovery takes hold. Trying to time that volatility is a fool's game.

Everyone's investment assets should be allocated according to their individual risk tolerance, which is what we try to do. These allocations should not be changed based on views of what may happen in the near future, because more often than not we are wrong. Here is an article which explains some the reasons why we are prone to mistakes when we make investment decisions based on our "view of the future."

Thanks!!!!!

2009-11-11T09:15:00.004-05:00

Today is Veterans Day, a day when we should all give thanks to the brave men and women who have served our country and protected our freedom. It would be great to live in a world without violence, but unfortunately that is not reality. Maybe someday Veterans Day will seem like a quaint reminder of what the world used to be like, but for now it remains an important day to remember and honor the sacrifice and courage of so many. Thanks!!!

Here is a list of quotes honoring Veterans Day.

An All-In Wager on the Economic Future of the United States

2009-11-03T08:46:00.005-05:00

The title of this post comes from a statement by Warren Buffet, which he said this morning when commenting on his purchase of 100% of Burlington National Railroad (BNSF). Here's the whole quote:

"Berkshire's $34 billion investment in BNSF is a huge bet on that company... Most important of all, however, it's an all-in wager on the economic future of the United States... I love those bets."

Not only is Buffett buying the whole railroad, he is paying a 30% premium over yesterday's closing stock price. Mr. Buffett is many things, but one word rarely used to describe him is stupid. That said, he has certainly made mistakes in the past, and this purchase of BNSF might prove to be one of those mistakes. The bigger question is, is he wrong in betting on the economic future of the US? History suggests that betting against the US economy, or betting against Warren Buffett, is usually a suckers bet.

Here is a video of Mr. Buffet that I highly recommend.

Economic Rebound?

2009-10-29T13:19:00.003-04:00

The big news of the day is that economy grew at an annualized rate of 3.5%, beating expectations of 3% growth. Today, and over the next few days, we will be bombarded with analysis of this GDP report. A good initial summary of some of the reaction is here.

My take on this news is pretty simple; it beats the heck out of a shrinking economy. A year ago, when we were in the middle of the financial meltdown, anyone who predicted growth in the third quarter of 2009 would have been laughed at. Of course, the picture is not that rosy. Unemployment is too high, too much of the recovery is based on short-term government spending, etc.. However, we needed to start somewhere, and it appears that the recovery has indeed begun.

Only time will tell how solid and lasting the recovery will be, and there will continue to be significant disagreement about that as we move forward.

Out of the Woods

2009-10-08T10:37:00.007-04:00

Time to return to a picture that we have looked at a few times this year. The first was back in March, when we started this blog. The graph in question was part of a larger presentation we titled "Where Do We Go From Here", in which we discussed what the future may hold for the economy and our investments. This was done just after the markets reached their year lows of March 9th.

We revisited the graph again in May. At the end of that post I said this:

"So we are now two months out from the lows reached in early March, and the picture is getting a bit clearer. It looks like we may have avoided the Great Depression II, now we have to see how long recovery will take and how robust it will be."

And here it is, the newest update of the aforementioned graph (click on graph for larger image):

As a refresher, the graph shows what happened to US stocks during the three worst bear markets of the past century, The Great Depression (green line), the 1973-1974 Bear Market (blue line) and the present (red line). We have represented the US stock market as the Dimensional Adjusted Market 2 Index, which is a broader index than something like the S&P 500. The 32 month period represents how long it took for the market to reach bottom during the Depression.

What we see is that after 23 months, the current market is well ahead of both previous bear markets, having risen 59% since the lows at the end of February. Not too shabby.

We have even begun to hear economists claim that the recession is technically over, and this includes skeptics like Paul Krugman. However, there also seems to be consensus that the recovery will take a while to get moving strongly, and unemployment may continue to worsen before it improves.

While I agree that there certainly are challenges ahead, I am glad that sticking to our principle of riding out the difficult times has paid off for our clients during this year.

Friday Humor

2009-10-02T09:06:00.002-04:00

This is a video of Austan Goolsbee, one of President Obama's economic advisers and a professor at the University of Chicago. Here he is performing at the Funniest Celebrity Contest in Washington, a charity event in which he took first place. Who says economists are boring?

Not All Government Spending is Bad

2009-09-29T11:51:00.007-04:00

I am generally not a fan of government spending. All too often, spending bills are packed to the gills with pet projects that only benefit one Congressperson's district. A great example of this type of "pork barrel" spending is the John Murtha Airport in rural Pennsylvania. This airport only serves about 30 people per day, yet it has received more than $150 million in taxpayer money over the past two decades thanks to Congressman Murtha. Unfortunately, there are literally hundreds of examples like this one.

There is one area where I have been in favor of government money and action, and that is in improving the power grid. I truly believe that we are in an energy revolution which will have profound influences on our economy and the environment in the near future. However, in order for this revolution to succeed, we must modernize our power grid. This seems like the perfect place for government involvement. This article discusses how federal stimulus money is being used to move toward a "smart grid". If these efforts are successful, then improved energy efficiency and lower energy costs will help the economy as it recovers from the current downturn.

All That Glitters

2009-09-22T09:28:00.005-04:00

What about investing in gold? The glittering metal has been receiving a lot of press lately, as the price per ounce has gone over $1,000. I have read some speculation that the price is headed to over $3,000 in the near future. The problem is that any price target for gold is just that, speculation. Gold doesn't have much real use, outside of jewelry. So the the return on investing in gold is solely based on the willingness of someone else to buy your gold from you at a higher price. That is not true for other types of investments over the longer-term.

Bonds pay interest, which you receive over the time you own the bond. The risk is that these interest payments won't keep pace with inflation, but as an investor, you know what those nominal interest payments will be before you invest.

Stocks represent ownership in companies, and as owners, we benefit as those companies grow and make profits. Stock prices certainly bounce around in the short-term and feel like speculative investments, but the longer-term return for stocks does a pretty good job of reflecting corporate profits.

Even commodities, like petroleum and agricultural products, have a different return story than gold. True commodities are "use assets", meaning that those that buy them do so because they need to use them. During periods of economic growth, global demand for commodities rises, thereby pushing up prices. We much prefer a diversified basket of commodities, not gold, as a hedge against inflation. Inflation refers to a general rise in prices across the economy, meaning that in inflationary periods, the prices of commodities should rise.

Here are two articles that do a good job of explaining why gold may not be a good long-term investment:

5 Reasons to Avoid the Gold Rush

What Price Suits Gold

Time to Sell?

2009-09-18T10:52:00.005-04:00

Now that we have seen significant recovery in global stock markets, the question which I am beginning to hear is,"Will it go down again?" My answer is "Yes, it will go down again, at some point". What I don't know is: when it will go down, how far it will go down, and for how long it will go down. History tells us that markets don't move in a straight line -- there are always ups and downs. Furthermore, I have yet to find anyone who has been able to consistently predict these ups and downs. That is why we only invest long-term money in stocks.

This post, from "The Economist", does an excellent job of summarizing my point. The blogger links to an article in which the author claims that now is the time to sell equities. His response to the argument fro selling now is as follows:

"Personally, I have no interest in arguing the point. Guessing what equities are likely to do is a fool's game, and I certainly hope none of my readers are trying to time the market with money they can't afford to lose."

We at Bond & Co. will always resist attempts to time the market, because we agree that it is a fools game. Instead, we set out to allocate investments in accordance with each individual's risk tolerance, and then we let events take their course.

The Year That Was

2009-09-14T14:16:00.006-04:00

You are all probably aware that the "financial crisis" has hit its one year anniversary. Believe it or not, it was a year ago when we woke up to the news that Lehman Brothers was going bankrupt, AIG was in BIG trouble, etc.. As we know, this catalyst evoked the global credit markets freeze and subsequent two month stock market plunge. On the morning of September 15th, I sent an e-mail to all of our clients, since we knew that the Lehman bankruptcy represented more than just a little bad news for investors. Here is a bit of what I wrote:

"...I have always said "don't panic, remain patient, and focus on the long- term". I am not changing my advice, and I still believe that we will benefit down the road by sticking with our long-term plans....Unfortunately, I don’t know exactly how bad markets will get or when they will turn around, but I truly believe the rebound will happen."

The table below shows what has happened in the global stock markets over the past year. Remarkably, the average of the asset classes that we follow is down only 7%, with international equities holding up much better than their domestic counterparts.

The table also shows annualized returns for the past 6 years. I chose 6 years, because we always recommend allocating client portfolios so that at least 6 years worth of living expenses are kept out of equity markets and kept in cash and bonds. That way there is no need to pull money out of stocks when they are tumbling like they did last fall. You can see that the average equity asset class return over the past 6 years has been 8.1% per year. Not bad when we consider that there were some who were predicting the end of capitalism not that long ago. 8.1% IRR is below the long-term average, but with inflation at around 3% over the past 6 years, that is still about 5% over inflation. This 5% also happens to be the assumed rate of return we use in many financial plans.

It is interesting to note how much better equity returns have been in the international markets. I remember back in the late 1990's when many respected investment "gurus" said that diversifying our portfolios into international stocks was unnecessary. Well, that certainly has not been the case. This is further evidence that listening to gurus is not a good way to construct an investment portfolio. We prefer to stick to the principals of asset allocation, global diversification and low costs as a way to capture the long-term potential of owning stocks.

The Future of Money?

2009-09-09T08:56:00.003-04:00

This video is very cool. It's about how changes in information technology are changing the concept and nature of money. It's worth watching.

Let's Kill All the Lawyers

2009-09-04T08:14:00.004-04:00

Since it's Friday, time for a little humor. This article appeared in this morning's Wall Street Journal. It is written by a Doctor saying that under the President's health care reform, lawyers will be deciding on how doctors should practice medicine. He goes on to propose that turnabout is fair play and maybe doctors should decide on how to best practice the law. He says,

"Since most of what lawyers do is repetitive boilerplate or pushing paper, physicians would have no problem dictating what is appropriate for attorneys. We physicians know much more about legal practice than lawyers do about medicine."

The article is clearly tounge and cheek and is pretty funny, but it does get at a very serious point. It sounds great to say that we need to reform the health care system, but as usual the devil is in the details.

Note: I really don't want to kill any lawyers. I knew "Let's kill all the lawyers" was a quote from somewhere, turns out it is from Shakespeare's Henry VI

Ben is Back

2009-08-25T18:59:00.005-04:00

Today President Obama announced that he is re-nominating Ben Bernanke as Chairman of the Federal Reserve. I take this as very good news. I have stated many times that you cannot underestimate the importance of the Federal Reserve during times of crisis, like the one we have been going through. Dr. Bernanke has certainly not been perfect, but overall, I think he has done an excellent job given the circumstances, and continuity is extremely important as we work our way out of the woods.

Greg Mankiw, whose blog I have often referenced, put It best:

"While there is certainly room for reasonable people to question some of the specific decisions Ben has made, in general he has led the Federal Reserve System with humility, intelligence, wisdom, and grace.

I extend my congratulations to the President for a fine decision and my condolences to Ben for having to spend the next four years overworked and underpaid."

Here is more reaction to Dr. Bernanke's re-nomination. Let's hope Congress does not make a sham of the nomination hearings and quickly votes in favor.

Back to The Blog

2009-08-20T11:57:00.014-04:00

Well, we're back from some time-off, ready to take on the world. We have actually been back for several days, which was mainly spent going through e-mails, voice mails, snail mail, ...

We had a lot of fun with our kids this summer, but I, for one, won't shed a tear when the school bus returns in two weeks. (I actually tell the kids that the first day of school is like Christmas for parents-- we dance and sing songs.)

I had a great suggestion from one of our clients concerning our last blog post. He said "It would be neat if the market stats and your resulting commentary were also correlated somehow to getting back on track with respect to retirement goals. That would make it all personally meaningful."

My primary goal with this blog is to make connections between the broader economy and the personal financial goals of our clients and other readers, so this suggestion is exactly what we are looking for.

Starting last November, when the stock market hit the first lows of the "financial crisis", we began to increase the rate of return assumption in our clients' financial plans. Now this may have seemed counter-intuititive to some at the time, especially in the midst of all the uncertainty and nervous feelings about the future of our economy, but it makes sense when you analyze how markets have traditionally recovered from downturns in the past. We have generally built financial plans with an assumed rate of return of 5% over inflation (or real return). Last November, after analyzing how markets have behaved in the years following previous downturns, we increased that assumption to a 6% real rate of return.

Looking at the table from our last blog post, we see that stock markets have recovered in the neighborhood of 55% since the lows hit in March (these lows were very close to the November lows). If you were to assume a 6% real rate of return over twenty years, every $100 invested would become $320 at the end of that time period. If, in the first year, the return is 55%, then you only need 3.8% return over the next 19 years to get to the same $320.

What this means is that we are now returning to a 5% real rate of return assumption in our financial plans. For our clients, this means that we have likely avoided the worst case scenarios that were put forth last fall, and their financial plans have likely survived without the need for drastic measures.

I am not saying that everything will be rosy going forward, but we are much more comfortable returning to a 5% real rate of return assumption for our financial plans. This is a relatively conservative assumption which is well below the average return over the past half century.

Asset Class Update

2009-07-30T10:12:00.007-04:00

Below is an update of a table we published in April and May. The data is from the Russell Investments index returns calculator found at www.russell.com:

The first column shows returns of the major domestic equity asset classes since the market bottom of March 9, 2009. They are pretty remarkable -- up an average of 55% over 4 1/2 months! We also see that Small and Microcap stocks have outperformed Large Cap stocks, which is what we would expect for this type of market recovery.

The second column shows returns over the past year. These returns are pretty sobering, as we see that the average is still down 20% over 12 months, despite the dramatic upturn over the past few months. This demonstrates just how bad things were, and that we still have a way to go before we recover everything that was lost in the financial meltdown of last fall. That said, a 20% decline over 12 months is not that unusual, and it does not look to me like we are in the midst of the Great Depression II.

This will be our last blog post for a few weeks. We are headed back to Cape Cod with our kids for one last hurrah of summer vacation. As usual we will be accessible by voice mail and e-mail. Hopefully, the world will remain relatively calm while we are away.

This is Scary

2009-07-15T09:40:00.004-04:00

After a nice vacation on Cape Cod with our kids, we have returned to work a little more tan and a lot more rested. Fortunately, it was a slow news period while we were away. The stock market bounced around a bit, so what else is new. The economic news was mixed, again nothing to get excited over. Most of the news dealt with the death of Michael Jackson, which meant I didn't pay much attention to the news.

Since there isn't really any surprising economic news to comment on, I thought I'd link to a story that isn't related to economics or finance. This was in today's Wall Street Journal. Apparently the Texas Board of Education has moved on from debating how much religion should be taught in Biology (evolution vs. creation), to how much religion should be taught in History. Call me crazy, but shouldn't religion be taught in Church? (Disclosure: My kids do attend church school on Sundays.)

Hooray for Summer!

2009-07-01T11:00:00.007-04:00

Yes, despite the weather, it is indeed summer! We have officially made it to July, and western civilization has not collapsed. This is great news, because about five months ago, lots of people were worried that we may not make it. So far, so good.

As of today, we here at Bond and Company are taking a quick vacation, as we head down to Cape Cod for some beach time. As always, we will be accessible via voice mail and e-mail, but we may not make another blog post for a few weeks.

We hope everyone has a great 4th of July!