Go to the FINRA website, by clicking on the link.
Broker Check
Follow directions. If the person you are talking to is a registered representative, they will be listed here. So are many financial planners and other investment professionals.
A suggestion that there is a former complaint is not necessarily a strike out. FINRA has rigid rules regarding the reporting of complaints and they are nigh on to impossible to have removed, even if the complaint was dropped, or the matter settled. Frequently firms make a financial settlement to avoid the costs of arbitration. That does NOT imply the broker or the manager did anything wrong. It was a cost decision. An arbitration panel can rule in the broker's favor, but there are still costs associated with a formal arbitration, legal, fees, document searches, travel costs to go to the arbitration site. If an arbitration might cost a firm $30,000 or more, and the complaint can be settled for $15,000, then they may a financial decision to settle and everyone moves on.
If the broker has several complaints, got an adverse arbitration decision, or has any disciplinary actions, that's a different question. You will want to either investigate more thoroughly, or find a different prospective advisor. There are tons of advisors with no complaints at all, or some nebulous settlement that has no meaning. Find one of those.
Experience level. This is always a trade off. A broker with hundreds of clients almost guarantees you drop into anonymity fairly quickly. You are not going to be an active trader, you are not willing to pay more than 1% of the value of the transaction. If you don't mind paying an annual fee (usually charged quarterly) then pay no more than 1% total annually. This should include ALL costs.
Side note**Do NOT pay any fee for money market funds, especially now. Most money market funds aren't paying a 1% yield. If you have an additional fee of 1%, you are losing money just by being in the fund.
Again, if you agree to an annual fee, it is only on long term assets, not cash or cash equivalents.
A less experienced advisor has other issues. He or she is building their business, and trying to please the firm they represent. They are more subject to the demands of the firm to produce in certain favored product areas. A broker with a small client base may seem like a good choice, the logic being he or she has more time to focus on you. Problem is, they are focused on getting more and more clients. You choice is, big and possibly indifferent, or small and likely distracted.
Fortunately, you know by reading this blog, how to require an appropriate amount of attention without making yourself a pest. Trust me, 1% isn't enough to have a client that calls three times a week on every market gyration, or who wants an opinion of some stock Uncle Bob, who made a lot of money in the market, recommends.
(My reply was to ask the client to decide if he wanted me or Uncle Bob as his advisor. I was happy either way, but it was going to be one or the other of us, not both.)
For your fee, you should get a quarterly update of performance, compared to some related index or indexes. We'll go into what information this should include in future posts
Okay, now you have a bit more information on selecting an advisor. Good hunting.
Wednesday, July 20, 2011
Friday, July 15, 2011
Finding an Advisor
Before we get into a few wake-up questions for you, and for any advisor you may be thinking about hiring, let me remind you of your own behavior.
Most people lack the discipline to put together a sensible portfolio. Not the intelligence, the discipline. And they lack the discipline to stick with it. In a prior post, I went through where we go off course. Suffice it to say here, most of you will divert from the selected path, fail to rebalance your portfolio, and get mightily distracted with daily life.
All of the above are reasons you need a keeper, an advisor, a minder. A good one will prevent stupidity. A good one. The number of good ones is maybe ten percent of the available population, the next ten percent are okay, 80% are in it for fees and commissions, good luck to you.
Test questions:
Don't bother to ask for his/her track record. Different clients have different portfolios, yours may resemble someone else's but so what? Past performance is no guarantee of future results. Read the prior sentence frequently, and every time someone pulls out a track record, repeat it until they either put the track record back in the drawer, or you see they don't get it. That means you should leave and keep searching.
If they recommend any 'house' mutual fund or manager, leave.
Ask if they plan to buy individual stocks for you.
If they say 'yes,' leave.
Ask if they plan to buy mutual funds with any form of sales charge, front-end, back-end, never end, and they say 'yes'....leave. (Warning, they will likely say 'yes, but,' if so, you should definitely leave.)
Ask how they are compensated, and keep asking until you are clear.
Then ask what additional charges apply in your case. Everything. Let me repeat, everything. You are looking for transaction fees, mailing costs, yes, they charge you to send you trade confirmations. If they offer a mutual fund, what does the fund manager make, what are the administrative costs, and ask them to point to the page that outlines every possible charge. Bear in mind, the mutual fund has trading costs.
So ask about portfolio turnover in the fund. If it's twice a year, that means the advisor is talking a long term plan, but the manager of the mutual fund, which has you money, is swapping out the entire portfolio every six months. So the 'long term' talk is just that, talk.
There are various measures of turnover, I'll get into those shortly.
There's more, but this is enough to digest for now.
Most people lack the discipline to put together a sensible portfolio. Not the intelligence, the discipline. And they lack the discipline to stick with it. In a prior post, I went through where we go off course. Suffice it to say here, most of you will divert from the selected path, fail to rebalance your portfolio, and get mightily distracted with daily life.
All of the above are reasons you need a keeper, an advisor, a minder. A good one will prevent stupidity. A good one. The number of good ones is maybe ten percent of the available population, the next ten percent are okay, 80% are in it for fees and commissions, good luck to you.
Test questions:
Don't bother to ask for his/her track record. Different clients have different portfolios, yours may resemble someone else's but so what? Past performance is no guarantee of future results. Read the prior sentence frequently, and every time someone pulls out a track record, repeat it until they either put the track record back in the drawer, or you see they don't get it. That means you should leave and keep searching.
If they recommend any 'house' mutual fund or manager, leave.
Ask if they plan to buy individual stocks for you.
If they say 'yes,' leave.
Ask if they plan to buy mutual funds with any form of sales charge, front-end, back-end, never end, and they say 'yes'....leave. (Warning, they will likely say 'yes, but,' if so, you should definitely leave.)
Ask how they are compensated, and keep asking until you are clear.
Then ask what additional charges apply in your case. Everything. Let me repeat, everything. You are looking for transaction fees, mailing costs, yes, they charge you to send you trade confirmations. If they offer a mutual fund, what does the fund manager make, what are the administrative costs, and ask them to point to the page that outlines every possible charge. Bear in mind, the mutual fund has trading costs.
So ask about portfolio turnover in the fund. If it's twice a year, that means the advisor is talking a long term plan, but the manager of the mutual fund, which has you money, is swapping out the entire portfolio every six months. So the 'long term' talk is just that, talk.
There are various measures of turnover, I'll get into those shortly.
There's more, but this is enough to digest for now.
Wednesday, July 13, 2011
Do You Need a Financial Advisor?
Revisiting a prior post, let’s discuss whether you want or need a financial advisor (the spellings adviser and advisor are interchangeable, although it’s best to stick with one or the other to avoid confusion.)
First, need.
If you can read and write, you don’t ‘need’ an advisor. That is, of course, a gross oversimplification. Temperamentally, you may not have the diligence to learn a new vocabulary, then research the options, and come up with a plan for yourself.
Realistically, the tax laws, the snarled jungle of insurance, estate planning, retirement savings options and investment jargon may be too overwhelming, or too boring, for you to hack through.
So while you may not need one, you may certainly want one.
Depending on your level of wealth, you may also want tax advisors, which brokers and financial planners are mostly not. There are exceptions, but if you have that much money, then the oversight by a tax advisor coupled with a financial advisor is worth it. Good ones will not object to you having both. If you’re at the wealth level of estate planning, then someone with that expertise, an attorney specializing in estate planning, is another person you will add to the mix.
The reasons are simple, because it's complicated. Each of the three, financial, tax, legal, has a vested interest in making things increasingly complicated. They want complication because they become necessary, insuring their ability to charge fees because the average business owner, working stiff, doctor, whatever, doesn't have time to dig into a maze of rules and regulations.
Your state of residence further complicates your life by having different regulations regarding, taxes, estates and insurance.
If you don’t have an estate at the three million dollar level, then an estate plan is pointless, so you can skip the attorney. That said, you may want to have a will which, depending on your state, is something you need to get from an attorney, not a form from Office Depot.
A starting point is the financial advisor, or financial planner. They don’t have all the specifics, but have access to or have a decent general knowledge of possible pitfalls to help you decide what other professionals you may want to add.
We will follow up with what a financial advisor can help with, and what they cannot help with.
I’ll give you some litmus tests to guide you in figuring out whether the advice offered is something they can do, or something they imply they can do but can’t. You need not be mystified or dazzled by charts, graphs or statistics. They don’t tell you anything you need to know. They are props in the play. Designed to make you think the advisor knows more than he/she does.
First, need.
If you can read and write, you don’t ‘need’ an advisor. That is, of course, a gross oversimplification. Temperamentally, you may not have the diligence to learn a new vocabulary, then research the options, and come up with a plan for yourself.
Realistically, the tax laws, the snarled jungle of insurance, estate planning, retirement savings options and investment jargon may be too overwhelming, or too boring, for you to hack through.
So while you may not need one, you may certainly want one.
Depending on your level of wealth, you may also want tax advisors, which brokers and financial planners are mostly not. There are exceptions, but if you have that much money, then the oversight by a tax advisor coupled with a financial advisor is worth it. Good ones will not object to you having both. If you’re at the wealth level of estate planning, then someone with that expertise, an attorney specializing in estate planning, is another person you will add to the mix.
The reasons are simple, because it's complicated. Each of the three, financial, tax, legal, has a vested interest in making things increasingly complicated. They want complication because they become necessary, insuring their ability to charge fees because the average business owner, working stiff, doctor, whatever, doesn't have time to dig into a maze of rules and regulations.
Your state of residence further complicates your life by having different regulations regarding, taxes, estates and insurance.
If you don’t have an estate at the three million dollar level, then an estate plan is pointless, so you can skip the attorney. That said, you may want to have a will which, depending on your state, is something you need to get from an attorney, not a form from Office Depot.
A starting point is the financial advisor, or financial planner. They don’t have all the specifics, but have access to or have a decent general knowledge of possible pitfalls to help you decide what other professionals you may want to add.
We will follow up with what a financial advisor can help with, and what they cannot help with.
I’ll give you some litmus tests to guide you in figuring out whether the advice offered is something they can do, or something they imply they can do but can’t. You need not be mystified or dazzled by charts, graphs or statistics. They don’t tell you anything you need to know. They are props in the play. Designed to make you think the advisor knows more than he/she does.
Tuesday, July 12, 2011
Transcending Gravity: The Myth of Alpha
Since the blog is called know alpha, might be good to actually talk about Alpha.
Alpha, in the investment sense, means did you, or the mutual find, or the money manager, outperform the index. The index frequently used is the S&P 500, but it could be any index covering a broad swath of stocks, or in the case of bonds, a bond index.
The popular measuring formula is called Jensen's Alpha, not-coincidentally named after Mr. Jensen.
The difficulty with Alpha, is twofold.
First, let's say I'm measuring my portfolio of 20 stocks against the S&P 500. Right off, there's more risk with 20 stocks versus 500. Based on the law of risk and reward, I should do better than the S&P during good markets, or worse during bad ones. (This presumes they are diversified to a reasonable degree, not 20 gold stocks, or 20 real estate stocks. If the 20 stocks are all one industry, then there is even more risk, which is fine if that's what you're shooting for.)
Second, our friend Beta pops up in the formula for Alpha. You can read about the difficulty with Beta in a prior post.
In sum, there is no such thing as Alpha based on any repeatable evidence. A one shot measurement may demonstrate what is called Alpha, but change the length of time, the Beta changes, so the Alpha changes. If you doubt me, look it up. Google Jensen's Alpha and discover that even when money managers allegedly demonstrated Alpha, out performance, the Alpha disappeared when accounting for fees and expenses.
The postscript is this:
All performance measures tell you about the past. They use fixed numbers of past performance, or relative correlations of fixed numbers. That's fine if you are doing Newtonian physics. You can even get a man on the moon, repeatedly. (With the unfortunate surprise of occasionally blowing up the vehicle.)
The market future is variable, every minute, every day. The idea that a complex series of behavioral interactions among millions of investors will be repeated closely enough to use as a predictor is just that, an idea, a wish, a dream, and just as insubstantial.
Think of it this way. Anyone who can consistently beat the market just isn't going to clue you in about it. Why? Because that person is destined to own everything marketable. He/she has to, for a simple reason. His pile would keep getting bigger as other piles shrink. He can't do that if he runs around letting other people join in the fun by paying a fee.
Don't worry, it can't be done. Even by debonair, billionaire, hot air, investment bankers with BIG SWINGING...computers. Eventually, they crawl out too far on a limb, and their pile evaporates. You, me, or the man behind the tree cannot repeal the law of risk and reward. It's the gravity of investing.
Alpha, in the investment sense, means did you, or the mutual find, or the money manager, outperform the index. The index frequently used is the S&P 500, but it could be any index covering a broad swath of stocks, or in the case of bonds, a bond index.
The popular measuring formula is called Jensen's Alpha, not-coincidentally named after Mr. Jensen.
The difficulty with Alpha, is twofold.
First, let's say I'm measuring my portfolio of 20 stocks against the S&P 500. Right off, there's more risk with 20 stocks versus 500. Based on the law of risk and reward, I should do better than the S&P during good markets, or worse during bad ones. (This presumes they are diversified to a reasonable degree, not 20 gold stocks, or 20 real estate stocks. If the 20 stocks are all one industry, then there is even more risk, which is fine if that's what you're shooting for.)
Second, our friend Beta pops up in the formula for Alpha. You can read about the difficulty with Beta in a prior post.
In sum, there is no such thing as Alpha based on any repeatable evidence. A one shot measurement may demonstrate what is called Alpha, but change the length of time, the Beta changes, so the Alpha changes. If you doubt me, look it up. Google Jensen's Alpha and discover that even when money managers allegedly demonstrated Alpha, out performance, the Alpha disappeared when accounting for fees and expenses.
The postscript is this:
All performance measures tell you about the past. They use fixed numbers of past performance, or relative correlations of fixed numbers. That's fine if you are doing Newtonian physics. You can even get a man on the moon, repeatedly. (With the unfortunate surprise of occasionally blowing up the vehicle.)
The market future is variable, every minute, every day. The idea that a complex series of behavioral interactions among millions of investors will be repeated closely enough to use as a predictor is just that, an idea, a wish, a dream, and just as insubstantial.
Think of it this way. Anyone who can consistently beat the market just isn't going to clue you in about it. Why? Because that person is destined to own everything marketable. He/she has to, for a simple reason. His pile would keep getting bigger as other piles shrink. He can't do that if he runs around letting other people join in the fun by paying a fee.
Don't worry, it can't be done. Even by debonair, billionaire, hot air, investment bankers with BIG SWINGING...computers. Eventually, they crawl out too far on a limb, and their pile evaporates. You, me, or the man behind the tree cannot repeal the law of risk and reward. It's the gravity of investing.
Monday, July 11, 2011
Short Detour
If you are considering buying a home, you will want to click the title of this post and do some simple homework.
Wednesday, June 29, 2011
How'd We Miss That?
The excerpt below is from a book, cited underneath, that is a collection of research studies that were not then concerned with the current popularity of Behavioral Economics. The book is the seed research of that now well regarded topic, and Daniel Kahneman is the father of subject. It has also been further researched by Richard Thaler PhD, among others.
The excerpt addresses, not specifically, but by implication, how we missed the market crashes and how we overweight some scenarios versus other, equally probable ones.
In any plan, the cumulative probability of at least one fatal error could be overwhelmingly high even when the individual cause of failure is negligible.
Plans fail because of ‘surprises;’ occasions on which the unexpected ‘uphill’ change occurs.
The simulation heuristic, which is biased in favor of ‘downhill’ changes,
is therefore associated with a risk of large systematic errors.
In evaluating a scenario, alterations on ‘what could have been done differently’ are many times introduced.
These can be classified as either:
Uphill: a change that introduces unlikely occurrences or surprises
Downhill: a change that removes an unlikely occurrence or surprise
Horizontal: one arbitrary value replaces another in the scenario,
neither arbitrary value is more likely, or less likely
-people are much more likely to undo a scenario with downhill changes than uphill changes…
horizontal changes are almost nonexistent.
Think of a cross country skier. It is easier to ski down than up, the psychological distance from peak to valley is shorter than from valley to peak.
Thus, mental simulations invariably have a preference for downhill variations.
Kahneman and Tversky, Judgment Under Uncertainty
I will explore the topic further in future posts.
The excerpt addresses, not specifically, but by implication, how we missed the market crashes and how we overweight some scenarios versus other, equally probable ones.
In any plan, the cumulative probability of at least one fatal error could be overwhelmingly high even when the individual cause of failure is negligible.
Plans fail because of ‘surprises;’ occasions on which the unexpected ‘uphill’ change occurs.
The simulation heuristic, which is biased in favor of ‘downhill’ changes,
is therefore associated with a risk of large systematic errors.
In evaluating a scenario, alterations on ‘what could have been done differently’ are many times introduced.
These can be classified as either:
Uphill: a change that introduces unlikely occurrences or surprises
Downhill: a change that removes an unlikely occurrence or surprise
Horizontal: one arbitrary value replaces another in the scenario,
neither arbitrary value is more likely, or less likely
-people are much more likely to undo a scenario with downhill changes than uphill changes…
horizontal changes are almost nonexistent.
Think of a cross country skier. It is easier to ski down than up, the psychological distance from peak to valley is shorter than from valley to peak.
Thus, mental simulations invariably have a preference for downhill variations.
Kahneman and Tversky, Judgment Under Uncertainty
I will explore the topic further in future posts.
Moron Beta
To revisit the current discussion, after my digression, Beta tells you what the relationship WAS between a security and the market. It tells you nothing about what the relationship will be.
As suggested earlier, Beta can be any number you want as it is dependent on the time frame chosen. A one year Beta is one number, and a one week Beta is another for the same security.
Phormula Phreaks argue that if you use the same time frame for both the security and the market, the problem is solved. It isn't. And to make matters worse, frequently the number for Beta is tossed out like it's a constant, and with no reference to the time frame used to calculate the Beta. Beta is a variable, that means it changes. Variability is the mortal enemy of predictability.
In sum, knowing what happened, which is all Beta tells you for a given time frame in the past, is NOT the same as knowing why it happened. Historians and statisticians frequently equate the two. They do this by attributing one off events with causality.
For instance, as pointed out in Everything is Obvious (once you know the answer.) by Duncan Watts, if you notice that each time the wind blows, the leaves of a tree move, that's once kind of cause effect. It happens a lot, it has validity.
What historians frequently do is take a one time event, and attribute causality to subsequent events. That is, if a cat meows, and the leaves shake, the meow caused the subsequent movement in the leaves. It ain't so. His example is a skirmish between English and French ships in the 14th century leading to the hundred years war, as if the skirmish 'caused' the war. Nobody can know that, and certainly can't know it at the time of the sea battle. As it has been put, there is no, "Dear Diary, the hundred years war began today."
As suggested earlier, Beta can be any number you want as it is dependent on the time frame chosen. A one year Beta is one number, and a one week Beta is another for the same security.
Phormula Phreaks argue that if you use the same time frame for both the security and the market, the problem is solved. It isn't. And to make matters worse, frequently the number for Beta is tossed out like it's a constant, and with no reference to the time frame used to calculate the Beta. Beta is a variable, that means it changes. Variability is the mortal enemy of predictability.
In sum, knowing what happened, which is all Beta tells you for a given time frame in the past, is NOT the same as knowing why it happened. Historians and statisticians frequently equate the two. They do this by attributing one off events with causality.
For instance, as pointed out in Everything is Obvious (once you know the answer.) by Duncan Watts, if you notice that each time the wind blows, the leaves of a tree move, that's once kind of cause effect. It happens a lot, it has validity.
What historians frequently do is take a one time event, and attribute causality to subsequent events. That is, if a cat meows, and the leaves shake, the meow caused the subsequent movement in the leaves. It ain't so. His example is a skirmish between English and French ships in the 14th century leading to the hundred years war, as if the skirmish 'caused' the war. Nobody can know that, and certainly can't know it at the time of the sea battle. As it has been put, there is no, "Dear Diary, the hundred years war began today."
Sunday, June 26, 2011
Quick Digression
Brit Marling, actor and producer, was featured in the Sunday New York Times Magazine today.
From the article:
The summer before her senior year, though, she took an internship at Goldman. If anything, it left her disillusioned. “I started to feel like it was all a bit of a fraud, all these charts and regressions and models.” She turned down the subsequent job offer...
Wow...she 'gets it' during a summer intern job at Goldman. What's taking everyone else so long? I can answer for myself. I worked in the business for twenty years before I realized predicting the future was crap, voodoo, of no value except to the predictors selling snake oil to the gullible (As I did. My only defense is that I didn't think it was snake oil at the time. I thought analysts, beta coefficients and standard deviations could help. I was wrong.)
From the article:
The summer before her senior year, though, she took an internship at Goldman. If anything, it left her disillusioned. “I started to feel like it was all a bit of a fraud, all these charts and regressions and models.” She turned down the subsequent job offer...
Wow...she 'gets it' during a summer intern job at Goldman. What's taking everyone else so long? I can answer for myself. I worked in the business for twenty years before I realized predicting the future was crap, voodoo, of no value except to the predictors selling snake oil to the gullible (As I did. My only defense is that I didn't think it was snake oil at the time. I thought analysts, beta coefficients and standard deviations could help. I was wrong.)
Thursday, June 23, 2011
Beta Not
Why don't I don't find the statistical models currently in use to be relevant, let's start with Beta.
If you look at both the Capital Asset Pricing Model, and Jensen and Treynor ratios, you will see formulas for calculating them. I'm not going to write up any more formulas that necessary, so if you want to see them, go to Google or Investopedia.
In each of these models, there sits Beta.
You can find a thorough discussion of Beta on Wikipedia as well, along with a criticism that conforms to my gripe about this allegedly magical statistic. The only magic is that it is not the same today as it was yesterday, but then, neither are you.
Every day the market is open, the Beta changes for the market, and for individual securities in realtion to the market.
So, while Beta is supposed to measure how much stock A would go up or down relative to the market as a whole, it only does so in the context of the past. It tells you what the stock did versus the market, not what the stock is going to do versus the market. But Beta is almost never presented that way. Advisors always say stuff like, "If the Beta is 1.3, that means that if the market goes up 10%, we can expect the stock to go up 13%."
NO, you can't. If you bought the stock last week, or last year, and measured it's performance against the market for that same time period, then the stock performed (PAST TENSE) 1.3 times better or worse than the market. You calculate a new Beta next week or month or year and you will get a different number.
You cannot know the Beta unitl the race is over, not at the beginning, and you can't place your bets at the end of the race.
The problem is, the guts of the formula for Beta change with every move in the market, so it is variable. And using it to calculate Jensen Alphas, or Capital Asset Models or Treynor ratios only plugs in a moving target, but pretends it's a static fact.
Nothing tells you what a stock is going to do, or what the market is going to do.
If you look at both the Capital Asset Pricing Model, and Jensen and Treynor ratios, you will see formulas for calculating them. I'm not going to write up any more formulas that necessary, so if you want to see them, go to Google or Investopedia.
In each of these models, there sits Beta.
You can find a thorough discussion of Beta on Wikipedia as well, along with a criticism that conforms to my gripe about this allegedly magical statistic. The only magic is that it is not the same today as it was yesterday, but then, neither are you.
Every day the market is open, the Beta changes for the market, and for individual securities in realtion to the market.
So, while Beta is supposed to measure how much stock A would go up or down relative to the market as a whole, it only does so in the context of the past. It tells you what the stock did versus the market, not what the stock is going to do versus the market. But Beta is almost never presented that way. Advisors always say stuff like, "If the Beta is 1.3, that means that if the market goes up 10%, we can expect the stock to go up 13%."
NO, you can't. If you bought the stock last week, or last year, and measured it's performance against the market for that same time period, then the stock performed (PAST TENSE) 1.3 times better or worse than the market. You calculate a new Beta next week or month or year and you will get a different number.
You cannot know the Beta unitl the race is over, not at the beginning, and you can't place your bets at the end of the race.
The problem is, the guts of the formula for Beta change with every move in the market, so it is variable. And using it to calculate Jensen Alphas, or Capital Asset Models or Treynor ratios only plugs in a moving target, but pretends it's a static fact.
Nothing tells you what a stock is going to do, or what the market is going to do.
Tuesday, June 21, 2011
Laugh or Cry
Gaaah!!! Having fun with CE credits. I'm revisiting the reasons why I don't work in the business any longer. I want to keep up with the CFP certification, been one since the mid-eighties. In all the years I've had it, when I worked in the business, I never got a single client because I was a CFP. So why keep up the certification? Good question. Particularly now that I don't do 'clients' nor am I affiliated with any broker dealer or planning group.
When I get a good answer, I'll let you know. For now, the answer is to keep up with all the ridiculous notions the industry foists on its representatives.
See, the industry believes that if you can calculate stuff like coefficient of variation, correlations, and know what Beta is, you can give better advice on constructing portfolios. This is, of course, useless for the most part.
The reason it's useless is that it tells you statistics about past performance. We know, if you've read some of this blog, that data about the past is virtually useless in predicting the future. Still, they persist.
It's Wall St. magical thinking. Repeated at 'hedge' funds, mutual funds, independent money managers. They think if they can just hone their numbers, they can get an edge on the rest of the market. I call it throwing more math at the problem.
It would be great, if it worked, but it doesn't.
That said, the CFP Board does provide much needed oversight in the advisory community. Keeps an eye on their members, and is diligent about rooting the bad guys out of the business. It also offers useful tools for getting a proper portfolio set up, and encourages fiduciary diligence in client relations. They even remind members that the math is far from perfect as the sole method of selecting investments. I admire their insistence on taking the client's temperature regularly, and acting with integrity.
I have demonstrated, using math strangely, that there is no way to 'outperform' the market in the long term. And the people who do it for one, two, or even five years in a row are merely on the right side of a coin flip. (See The Only Investment Formula You'll Ever Need 07/17/07.)
Why do I warn about the overuse of statistics? In upcoming posts, we'll talk about it, hopefully without choking on the math.
I'll leave this post with a question or two.
What does the Capital Asset Pricing Model and the Treynor Ratio have in common? And, why does it make them valueless in measuring investments?
When I get a good answer, I'll let you know. For now, the answer is to keep up with all the ridiculous notions the industry foists on its representatives.
See, the industry believes that if you can calculate stuff like coefficient of variation, correlations, and know what Beta is, you can give better advice on constructing portfolios. This is, of course, useless for the most part.
The reason it's useless is that it tells you statistics about past performance. We know, if you've read some of this blog, that data about the past is virtually useless in predicting the future. Still, they persist.
It's Wall St. magical thinking. Repeated at 'hedge' funds, mutual funds, independent money managers. They think if they can just hone their numbers, they can get an edge on the rest of the market. I call it throwing more math at the problem.
It would be great, if it worked, but it doesn't.
That said, the CFP Board does provide much needed oversight in the advisory community. Keeps an eye on their members, and is diligent about rooting the bad guys out of the business. It also offers useful tools for getting a proper portfolio set up, and encourages fiduciary diligence in client relations. They even remind members that the math is far from perfect as the sole method of selecting investments. I admire their insistence on taking the client's temperature regularly, and acting with integrity.
I have demonstrated, using math strangely, that there is no way to 'outperform' the market in the long term. And the people who do it for one, two, or even five years in a row are merely on the right side of a coin flip. (See The Only Investment Formula You'll Ever Need 07/17/07.)
Why do I warn about the overuse of statistics? In upcoming posts, we'll talk about it, hopefully without choking on the math.
I'll leave this post with a question or two.
What does the Capital Asset Pricing Model and the Treynor Ratio have in common? And, why does it make them valueless in measuring investments?
Sunday, June 19, 2011
401k Costs...New York Times Article
Click the title, read the article. If your employer is already providing a low cost 401k, congratulations. If not, here are options.
Saturday, June 18, 2011
Market Math...Flunked Again
I promised an update on math and market predictability. I've been taking CE courses for my CFP. Yes, they are annoyingly thorough. Lots of them involve using various formulae for analysing such unpredictabilities as the 'true' value of a stock, and measurement of performance.
I know it makes people feel better to think they have a clue as to the future value of a stock price, or even a hint as to the likelihood of the future value.
The common wisdom says current prices reflect investor expectations about a company's future earnings.
That seems quite ridiculous to me. The same managers do lots of math using past prices, and past earning growth, then, what? Make a pick based on future expectations?
Expectations of what? That the past will repeat? That happens only if you allow for a lot of leeway in your definition of repetition.
Microsoft, as an example was $23.40 five years ago. Today it's $24.15. In between it was $15.27 and $34.33.
Lots of people bought and sold it along the way. The net result of all that guesswork was zero. Nobody 'knew' it would rise to $34, nobody 'knew' it would shrink to $15. Please send along evidence you put actual money on the table to buy at $24, sell at $34, short, then buy back at $15. You don't have it. If I'm wrong, prove it, I'll recant.
Like 'low' PEs? During that period MSFT made scads of money, it has one of the lowest PEs around, not just in the tech sector. Right now it's under 10 times earnings.
How much do you own? Or how much are you going to buy? Money talks, bs walks. Demonstrate your belief in low PE stocks, if you have one.
This is NOT to be in any way construed as a recommendation to buy sell or hold MSFT or any other stock. We don't do that here. I use it to make a point. I could have used Berkshire. 90K 5 years ago, 116k today. Buy and hold netted you 5.25% a year, no dividend either. Did Buffett and Munger get dumb for five years?
Did you buy BRK at 90K, then sell at 148K, then short and cover at 78K, buy again? Then you made a killing percentage-wise. Except nobody did, because nobody makes those kinds of guesses repeatedly.
Even the beloved God of Stocks, Google, returned 5.2% over that time frame. Or did you presciently buy at 400, sell at 699, short, cover at 283 and buy again right away? Sure you did. Just, for the sake of accuracy, post those account statements, redact you name and account number of course, we don't want to know you that well.
You didn't? Don't feel bad, neither did anyone else.
During that same five year period, the S&P 500 (using the ETF proxy SPY) went from 125 to 130, under a 1% annual return, plus a 1 1/2% dividend give or take along the way.
This is the long way of saying, over time, you get what the market gives, no more, no less (except for the percent you give to a manager to pick stocks for you...oops.)
I know it makes people feel better to think they have a clue as to the future value of a stock price, or even a hint as to the likelihood of the future value.
The common wisdom says current prices reflect investor expectations about a company's future earnings.
That seems quite ridiculous to me. The same managers do lots of math using past prices, and past earning growth, then, what? Make a pick based on future expectations?
Expectations of what? That the past will repeat? That happens only if you allow for a lot of leeway in your definition of repetition.
Microsoft, as an example was $23.40 five years ago. Today it's $24.15. In between it was $15.27 and $34.33.
Lots of people bought and sold it along the way. The net result of all that guesswork was zero. Nobody 'knew' it would rise to $34, nobody 'knew' it would shrink to $15. Please send along evidence you put actual money on the table to buy at $24, sell at $34, short, then buy back at $15. You don't have it. If I'm wrong, prove it, I'll recant.
Like 'low' PEs? During that period MSFT made scads of money, it has one of the lowest PEs around, not just in the tech sector. Right now it's under 10 times earnings.
How much do you own? Or how much are you going to buy? Money talks, bs walks. Demonstrate your belief in low PE stocks, if you have one.
This is NOT to be in any way construed as a recommendation to buy sell or hold MSFT or any other stock. We don't do that here. I use it to make a point. I could have used Berkshire. 90K 5 years ago, 116k today. Buy and hold netted you 5.25% a year, no dividend either. Did Buffett and Munger get dumb for five years?
Did you buy BRK at 90K, then sell at 148K, then short and cover at 78K, buy again? Then you made a killing percentage-wise. Except nobody did, because nobody makes those kinds of guesses repeatedly.
Even the beloved God of Stocks, Google, returned 5.2% over that time frame. Or did you presciently buy at 400, sell at 699, short, cover at 283 and buy again right away? Sure you did. Just, for the sake of accuracy, post those account statements, redact you name and account number of course, we don't want to know you that well.
You didn't? Don't feel bad, neither did anyone else.
During that same five year period, the S&P 500 (using the ETF proxy SPY) went from 125 to 130, under a 1% annual return, plus a 1 1/2% dividend give or take along the way.
This is the long way of saying, over time, you get what the market gives, no more, no less (except for the percent you give to a manager to pick stocks for you...oops.)
Sunday, June 12, 2011
Sucker Punch
I've been reading lots of investment material, I'm a masochist at heart. I was reading about Modern Portfolio Theory, which you have to Capitalize (mixed metaphor.)
It's really a fascinating combo of science fiction and meaningless math.
First, it was foisted on an unsuspecting public 50 YEARS ago, and it's STILL called modern, despite there being nothing like today's derivatives and Warren Buffet was only 30 years old.
Investment Manglers, uh, Managers, are using it to decide how to construct portfolios, which they then foist off on YOU in the form of mutual funds, managed accounts and hedge funds. And YOU buy it, well, lots of you do.
Where are all the customer's yachts anyway?
Here are the general assumptions behind Modern Portfolio Theory, try not to throw up.
-Investors are risk averse.
Comment: It isn't true, as demonstrated by Kahneman and Tversky. The research is too long to go into here, but the truth is...investors are LOSS averse. They will actually seek risk under the right circumstances.
-Investors make decisions based purely on expected return and risk.
Comment: No, you didn't read wrong. He posited an investment theory based on people being rational...???
-Investors have a common one period investment horizon.
Comment: It then explains that the period can cover varied lengths of time. If you can make that sensible, let me know how.
-Investors have free access to all information relevant to investment decision making.
Comment: Having access and using it are not the same thing. And you'll have to explain Bernie Madoff if you believe this.
-I LOVE this one
-There are no transaction costs.
Comment: A portfolio construction model that denies costs. ALERT!!!....This is the founding investment theory your children are learning in the expensive Finance and MBA program you are paying for.
-Capital markets are perfectly competitive, so no one can manipulate the market.
Comment: Duh. It also begs the question of why your government should intervene by plowing borrowed money into financial crises, which is nothing but market manipulation.
Soon, we move to the Capital Asset Pricing Model for Dummies. Stay tuned.
It's really a fascinating combo of science fiction and meaningless math.
First, it was foisted on an unsuspecting public 50 YEARS ago, and it's STILL called modern, despite there being nothing like today's derivatives and Warren Buffet was only 30 years old.
Investment Manglers, uh, Managers, are using it to decide how to construct portfolios, which they then foist off on YOU in the form of mutual funds, managed accounts and hedge funds. And YOU buy it, well, lots of you do.
Where are all the customer's yachts anyway?
Here are the general assumptions behind Modern Portfolio Theory, try not to throw up.
-Investors are risk averse.
Comment: It isn't true, as demonstrated by Kahneman and Tversky. The research is too long to go into here, but the truth is...investors are LOSS averse. They will actually seek risk under the right circumstances.
-Investors make decisions based purely on expected return and risk.
Comment: No, you didn't read wrong. He posited an investment theory based on people being rational...???
-Investors have a common one period investment horizon.
Comment: It then explains that the period can cover varied lengths of time. If you can make that sensible, let me know how.
-Investors have free access to all information relevant to investment decision making.
Comment: Having access and using it are not the same thing. And you'll have to explain Bernie Madoff if you believe this.
-I LOVE this one
-There are no transaction costs.
Comment: A portfolio construction model that denies costs. ALERT!!!....This is the founding investment theory your children are learning in the expensive Finance and MBA program you are paying for.
-Capital markets are perfectly competitive, so no one can manipulate the market.
Comment: Duh. It also begs the question of why your government should intervene by plowing borrowed money into financial crises, which is nothing but market manipulation.
Soon, we move to the Capital Asset Pricing Model for Dummies. Stay tuned.
Important Past Post - Read and Understand All
Well, that’s a little exaggerated, you do need to figure out what percentage of your portfolio should be in stocks, how much in bonds, or in money market funds.
But for picking stocks, this formula will guarantee you avoid costly investment mistakes.
A = Total Stock Market
B = Active investors (traders, stock pickers, money managers, hedge funds)
C = Passive Investors (index buyers)
Y = Rate of return for the market
X = what we want to know
If Y, the market rate of return, is 12%, then the rate earned by C, passive investors, must also be 12%.
Let’s say for now that 70% of the investors are active, and 30% are passive index investors. So out of 100, or any number you like, could be a million or a skillion, but 100 will serve for now, there are
70 active investors
30 passive investors
Y is 12%
Plug in the numbers: 12%(A) = X%(B) + !2%(C)
So, given these facts, what did B, active investors, earn?
Let me simplify life for you, no matter what numbers you use for the market return, or the percentages of active versus passive investors, the answer is the same. In this case 12%.
Yes, the % earned by active investors averages the same percentage as both the market and passive investors, and obviously, not all active investors earn the same thing. some earn more, some less. The problem is that year over year, there is no way to predict which active investor will finish ahead, or which one will fall behind. It only looks that way when you look at the single most misleading, portfolio damaging indicator in the world, past performance.
I will discuss the absolute uselessness of past performance data in another section.
Before you challenge me on any of this math as flawed, let me point out it wasn’t me who thought it up. The general topic is discussed in Commentary, and a link to the article can be found in Referenced Articles. It is also referenced below
The formula used here is adapted from The Successful Investor Today, by Larry E. Swedroe,
St. Martin’s Press 2003.
For most equity investors, I believe in passive, index investing. I refer you to The Arithmetic of Active Management by William Sharpe, Nobel Laureate and Professor Emeritus at Stanford University as to the specifics of why. You can find that article in the section of this site called "Referenced Articles."
Essentially, Sharpe demonstrates mathematically why it is impossible for active investors as a group to perform any better than indexes, before costs. After costs, active investors must do worse. Are there active investors who will "outperform" from time to time? Of course, but always at the expense of other active investors who underperformed. Passive investors, by definition, get the market's rate of return, no more, no less. By the way, the active investors who do beat the market in any given year are almost never the same ones who beat it the next year. The simple arithmetic is that some fund manager will beat the market, but it's not likely to be the one you choose, and if it is, it's not likely that he can repeat the following year.
Saturday, June 11, 2011
Friday, June 10, 2011
Size Matters....but only a little
Beware of the man who offers you a reward, in this life or the next.
J. Krishnamurti
Today, we talk about what kinds of stocks make sense in the equity portion of our portfolio.
Back in the beginning of this blog, I talked about BIG STOCKS, Medium Stocks, and small stocks. There's a reason for that. That's the only difference in stocks, capitalization. To reiterate, capitalization is the size of the company. It's measured by the number of shares outstanding times the most recent price. Big doesn't mean the price per share. One stock could be a large cap (BIG STOCK) and sell for $20 a share, and one stock could be a small cap, and sell for $50 a share.
BIGGER is NOT better, but it IS bigger. So lots of investment companies, mutual fund and the like, go for big, because they are, in general, easier to trade in large quantities.
BIGGIE stocks would include the ones in the Dow Jones Industrials, and the S&P 500 indexes.
Middle size stocks would be in the Russell 2000, which also includes some smaller fry,and the S&P mid-cap index.
There are also small-cap indexes and even teeeny tiny cap indexes, called microcaps.
These are worn by elves another wee-people, who like to dance and sing, but are frequently trodden underfoot by the clunky BIGGIES.
In sum, since you, me, or the man behind the tree can't tell which stock is going to 'outperform' any other stock, I strongly suggest you mix your stock portfolio with some BIG, some Middle and some small. Micro is great for miniskirts, not for stock portfolios, skip them.
Next which one of the size selections has done the best in the past(which I'll remind me and you, has nothing to do with the future. However, we have to start someplace.)
J. Krishnamurti
Today, we talk about what kinds of stocks make sense in the equity portion of our portfolio.
Back in the beginning of this blog, I talked about BIG STOCKS, Medium Stocks, and small stocks. There's a reason for that. That's the only difference in stocks, capitalization. To reiterate, capitalization is the size of the company. It's measured by the number of shares outstanding times the most recent price. Big doesn't mean the price per share. One stock could be a large cap (BIG STOCK) and sell for $20 a share, and one stock could be a small cap, and sell for $50 a share.
BIGGER is NOT better, but it IS bigger. So lots of investment companies, mutual fund and the like, go for big, because they are, in general, easier to trade in large quantities.
BIGGIE stocks would include the ones in the Dow Jones Industrials, and the S&P 500 indexes.
Middle size stocks would be in the Russell 2000, which also includes some smaller fry,and the S&P mid-cap index.
There are also small-cap indexes and even teeeny tiny cap indexes, called microcaps.
These are worn by elves another wee-people, who like to dance and sing, but are frequently trodden underfoot by the clunky BIGGIES.
In sum, since you, me, or the man behind the tree can't tell which stock is going to 'outperform' any other stock, I strongly suggest you mix your stock portfolio with some BIG, some Middle and some small. Micro is great for miniskirts, not for stock portfolios, skip them.
Next which one of the size selections has done the best in the past(which I'll remind me and you, has nothing to do with the future. However, we have to start someplace.)
Sunday, June 5, 2011
Don't Turnover Your Portfolio to a Turnover Manager
Since it has been repeatedly proven (see older posts) that nobody has a secret formula for selecting superior stocks, then it begs the question, why hire someone to pick stocks for you?
The answer is, you don't. Financial advisors may serve a purpose for the undisciplined, or skittish, or reckless investor, but picking out specific stocks, bonds or mutual funds is not one of them.
The most common investment mistake, other than trading a lot, is owning pools of stocks via mutual funds or independent money managers and not knowing what the stocks are. I have almost never reviewed a 401k or investment portfolio that didn't have some kind of overlap.
For instance, you cannot tell what kinds of stocks are in sort of generically names funds, such at the Widget Growth and Income, The Whatsit Value Fund, The Whosis, Global Equity Fund. You have to look underneath the hood. One value manager's idea of a 'good' stock is also some growth and income manager's. So investors wind up owning mutual funds that have 30-50% of the same stocks in them. That defeats the purpose of diversification.
The other great mystery statistic never revealed in any easy to find spot is called 'turnover.'
Turnover is how much the fund managers swaps stocks. It averages somewhere around 58%per year (If it is an asset weighted rate, that is, bigger counts more.)
That means that around 60% of the stocks he owned at the beginning of the year will be changed by the end of the year. One wonders how it is that a stock that was so perfect as to be in the portfolio in January is an ugly stepsister by March or June.
Turnover means costs. No mater how cheaply the fund manager trades, there are costs to trading....ALL of them charged to YOU. Turnover requires increased administration costs, somebody has to keep track of all that buying and selling...ALL those costs are charged to YOU.
Next, how to diversify your equity assets in the only sensible manner.
The answer is, you don't. Financial advisors may serve a purpose for the undisciplined, or skittish, or reckless investor, but picking out specific stocks, bonds or mutual funds is not one of them.
The most common investment mistake, other than trading a lot, is owning pools of stocks via mutual funds or independent money managers and not knowing what the stocks are. I have almost never reviewed a 401k or investment portfolio that didn't have some kind of overlap.
For instance, you cannot tell what kinds of stocks are in sort of generically names funds, such at the Widget Growth and Income, The Whatsit Value Fund, The Whosis, Global Equity Fund. You have to look underneath the hood. One value manager's idea of a 'good' stock is also some growth and income manager's. So investors wind up owning mutual funds that have 30-50% of the same stocks in them. That defeats the purpose of diversification.
The other great mystery statistic never revealed in any easy to find spot is called 'turnover.'
Turnover is how much the fund managers swaps stocks. It averages somewhere around 58%per year (If it is an asset weighted rate, that is, bigger counts more.)
That means that around 60% of the stocks he owned at the beginning of the year will be changed by the end of the year. One wonders how it is that a stock that was so perfect as to be in the portfolio in January is an ugly stepsister by March or June.
Turnover means costs. No mater how cheaply the fund manager trades, there are costs to trading....ALL of them charged to YOU. Turnover requires increased administration costs, somebody has to keep track of all that buying and selling...ALL those costs are charged to YOU.
Next, how to diversify your equity assets in the only sensible manner.
Saturday, June 4, 2011
Important Digression
Click on title Important Digression
Go to the column, "Revealing Excessive 401k Fees"
Go to the column, "Revealing Excessive 401k Fees"
Friday, June 3, 2011
What? Stocks?
Continuing where we left off, if you are going to use the four asset classes I've been discussing, then what stocks, shat bonds and what real estate do you use?
First, if you own a house, and plan to continue to do so, then include the equity in the house as part of your portfolio in the asset class real estate. Then add up you investable funds beyond that.
Let's say it comes to $100,000 plus $100,000 of home equity. Then you may not want to include additional real estate in your investment portfolio of $100,000. You can't sell off part of your house, it falls in the illiquid asset category.
If you don't own a house, or choose NOT to include the equity as part of your investment portfolio, then you are going to divide up you $100,000 into some combo of thee big 4.
For argument's sake, let's keep it at 25% per assert class. That is 1/4th of the $100,000 goes into stocks, 1/4 to bonds, 1/4 to real estate, 1/4 to cash.
Now, what stocks?
Unless you have illegal inside information, there is no reliable way to value one individual stock over another. I know brokers talk about over-valued and undervalued, as if there were real prices that would express perfect equilibrium, but there aren't. If that was true, all stocks would sell at some multiple of their earnings, the same multiple. Say 10x last twelve months earnings. But the stock market doesn't work that way. Price/earnings multiples are all over the lot. The market collectively (all the bets of all the investors) decides to speculate on future prospects, not past success or failure. Any company's successful widget today can, via competition or product flaws, become tomorrow's whatsit, in the product trash-bin.
Your solution is to buy a basket of stocks, not an individual stock.
There is one trade off to buying one or two stocks only. You are more likely to hit the ball out of the park, and equally likely to go down in flames. So, like Dirty Harry asked, "Do you feel lucky?"
Buy an index. Do not pay a mutual fund manager to 'pick' stocks, he can't do it any better than you and a dartboard. (This includes private money managers, hedge funds or God. Even God can't pick stocks.)
Tomorrow. we'll talk about what indexes, although most of the discussion can also be revisited in earlier posts.)
First, if you own a house, and plan to continue to do so, then include the equity in the house as part of your portfolio in the asset class real estate. Then add up you investable funds beyond that.
Let's say it comes to $100,000 plus $100,000 of home equity. Then you may not want to include additional real estate in your investment portfolio of $100,000. You can't sell off part of your house, it falls in the illiquid asset category.
If you don't own a house, or choose NOT to include the equity as part of your investment portfolio, then you are going to divide up you $100,000 into some combo of thee big 4.
For argument's sake, let's keep it at 25% per assert class. That is 1/4th of the $100,000 goes into stocks, 1/4 to bonds, 1/4 to real estate, 1/4 to cash.
Now, what stocks?
Unless you have illegal inside information, there is no reliable way to value one individual stock over another. I know brokers talk about over-valued and undervalued, as if there were real prices that would express perfect equilibrium, but there aren't. If that was true, all stocks would sell at some multiple of their earnings, the same multiple. Say 10x last twelve months earnings. But the stock market doesn't work that way. Price/earnings multiples are all over the lot. The market collectively (all the bets of all the investors) decides to speculate on future prospects, not past success or failure. Any company's successful widget today can, via competition or product flaws, become tomorrow's whatsit, in the product trash-bin.
Your solution is to buy a basket of stocks, not an individual stock.
There is one trade off to buying one or two stocks only. You are more likely to hit the ball out of the park, and equally likely to go down in flames. So, like Dirty Harry asked, "Do you feel lucky?"
Buy an index. Do not pay a mutual fund manager to 'pick' stocks, he can't do it any better than you and a dartboard. (This includes private money managers, hedge funds or God. Even God can't pick stocks.)
Tomorrow. we'll talk about what indexes, although most of the discussion can also be revisited in earlier posts.)
Thursday, June 2, 2011
Doing a Little Homework
Experience is a hard teacher. It gives the test before the lesson. Do try and learn from others' bad decisions, saves you from having to learn from your own.
Before you dig in too much deeper, go way back to earlier posts on diversification and rebalancing.
Rebalancing is the only sane way to handle a portfolio. A quickie summary is, if you have your four asset classes divided equally, 25% of your investable funds would be in each. Then, each year, you see how you did. If stocks were UP 20%, bonds flat, cash would earn a bit in money market and real estate was down, then you would sell some of the stocks, and reinvest that capital in real estate, so that your get back to 25% in each asset class.
You are buying LOW, and selling HIGH, which is the idea. People talk about it, but they almost never DO it. The reason generally boils down to, "But I'm selling off some of the GOOD one and buying more of the BAD one."
Those people believe trees grow to the sky. And letting one asset class run way ahead of the others is a sure way to minimize your profit over time.
Diversification is up next. We know we have, for most people, four asset classes. Stocks, bonds, cash, real estate.
But what stocks, what bonds, what real estate? Cash is money market, there's not much to think about, a short CD, T-Bill or money market all accomplish the same thing, safe principal, a few bucks in interest or dividends.
Next up, your choices for the other three.
Before you dig in too much deeper, go way back to earlier posts on diversification and rebalancing.
Rebalancing is the only sane way to handle a portfolio. A quickie summary is, if you have your four asset classes divided equally, 25% of your investable funds would be in each. Then, each year, you see how you did. If stocks were UP 20%, bonds flat, cash would earn a bit in money market and real estate was down, then you would sell some of the stocks, and reinvest that capital in real estate, so that your get back to 25% in each asset class.
You are buying LOW, and selling HIGH, which is the idea. People talk about it, but they almost never DO it. The reason generally boils down to, "But I'm selling off some of the GOOD one and buying more of the BAD one."
Those people believe trees grow to the sky. And letting one asset class run way ahead of the others is a sure way to minimize your profit over time.
Diversification is up next. We know we have, for most people, four asset classes. Stocks, bonds, cash, real estate.
But what stocks, what bonds, what real estate? Cash is money market, there's not much to think about, a short CD, T-Bill or money market all accomplish the same thing, safe principal, a few bucks in interest or dividends.
Next up, your choices for the other three.
Tuesday, May 31, 2011
Asset Classes Simplified
Now that we've figured out liquid and illiquid, what are asset classes? I like simplicity. Complication frequently passes for wisdom, but it really is a method for obfuscating the issue.
If you can't understand it, then you must need an 'advisor' who does. Then you can pay him/her to make decisions for you. If it's simple, you don't need them, and that doesn't get their kids through college. That's why lawyers like more laws, doctors like more illnesses and accountants like more convoluted tax codes.
So, there are, to my mind, four asset classes. Things the average human being can realistically invest in.
Stocks
Cash
Bonds
Real Estate
People will throw up stuff like gold and silver, stamps, art. That's fine, but regular people don't buy that stuff. For collectibles, it's almost impossible to overcome the difference between what you pay and what you can resell for, unless it is your children's children who are doing the selling. The markups on art, stamps, antiques is simply too high. If you bought it for $1,000, and try and resell it the next day, you'll be offered $500. Unless you can find your own sucker at some point.
Gold and silver are less so, and I suppose there's a place for them. I watched the Hunts go broke 'playing' silver, and the price of gold do nothing for thirty years, then a recent boom. Personally, I think the current price is preposterous, approaching tulip bulb levels at their peak, but what do I know? I do know there's no shortage of gold, and no shortage of diamonds. It's merely a controlled market creating artificially high prices. Maybe I'll go into it in another blog.
In setting up your investment portfolio, you can do quite well with a mixture of the four asset classes above.
How much you devote to each, what percentage of your investable dollars, is a matter of personal risk tolerance. Can't answer that one for you. Here's some general guidelines.
You are a finite entity. Sorry to break the news, but you not only can't take it with you, but past a certain age, it doesn't do you much good. After age 75 or 80, what in heck can you spend the money doing? Hang gliding, mountain climbing, Parkour? Existing in doctor's offices and hospitals? Early bird dinner specials? The horror of baby boomers 'rockin' out' to Proud Mary?
Institutions, like Endowments, Trusts, Pension plans, are, at least theoretically, infinite entities, you are not.
That means they can take on more risk than an individual, because an individual retires and starts spending his savings and investments, or he dies and his inheritors start spending it.
Consequently, a Trust or Endowment can buy riskier investments because they have a very long time horizon for the investment to work out favorably.
On the other hand, I just made an argument for spending it while you're young enough to enjoy it. And there's one thing you can bank on, you can't spend money and save it at the same time. (Although realtors will happily explain why a huge mortgage and contributing to a 401k both make sense. They don't, that's where the complicated jive I mentioned above comes in.)
We'll chat more about houses (gag) later.
In sum, while the temptation to spend, spend, spend while you are young and lovely is there, you might want to think over being laid off at 55, at which point no corporation on earth will pay you a living wage, (overcompensated CEO's excepted) and you're 10 or more years out from social security, which isn't a living wage either.
You'll need something in the bank or investment account to draw down for those Proud Mary moments unless you want to burden your children, or don't mind shacking up in a cardboard box.
Next time, we'll talk about WHAT stocks, bonds, cash and real estate. Stay in touch.
If you can't understand it, then you must need an 'advisor' who does. Then you can pay him/her to make decisions for you. If it's simple, you don't need them, and that doesn't get their kids through college. That's why lawyers like more laws, doctors like more illnesses and accountants like more convoluted tax codes.
So, there are, to my mind, four asset classes. Things the average human being can realistically invest in.
Stocks
Cash
Bonds
Real Estate
People will throw up stuff like gold and silver, stamps, art. That's fine, but regular people don't buy that stuff. For collectibles, it's almost impossible to overcome the difference between what you pay and what you can resell for, unless it is your children's children who are doing the selling. The markups on art, stamps, antiques is simply too high. If you bought it for $1,000, and try and resell it the next day, you'll be offered $500. Unless you can find your own sucker at some point.
Gold and silver are less so, and I suppose there's a place for them. I watched the Hunts go broke 'playing' silver, and the price of gold do nothing for thirty years, then a recent boom. Personally, I think the current price is preposterous, approaching tulip bulb levels at their peak, but what do I know? I do know there's no shortage of gold, and no shortage of diamonds. It's merely a controlled market creating artificially high prices. Maybe I'll go into it in another blog.
In setting up your investment portfolio, you can do quite well with a mixture of the four asset classes above.
How much you devote to each, what percentage of your investable dollars, is a matter of personal risk tolerance. Can't answer that one for you. Here's some general guidelines.
You are a finite entity. Sorry to break the news, but you not only can't take it with you, but past a certain age, it doesn't do you much good. After age 75 or 80, what in heck can you spend the money doing? Hang gliding, mountain climbing, Parkour? Existing in doctor's offices and hospitals? Early bird dinner specials? The horror of baby boomers 'rockin' out' to Proud Mary?
Institutions, like Endowments, Trusts, Pension plans, are, at least theoretically, infinite entities, you are not.
That means they can take on more risk than an individual, because an individual retires and starts spending his savings and investments, or he dies and his inheritors start spending it.
Consequently, a Trust or Endowment can buy riskier investments because they have a very long time horizon for the investment to work out favorably.
On the other hand, I just made an argument for spending it while you're young enough to enjoy it. And there's one thing you can bank on, you can't spend money and save it at the same time. (Although realtors will happily explain why a huge mortgage and contributing to a 401k both make sense. They don't, that's where the complicated jive I mentioned above comes in.)
We'll chat more about houses (gag) later.
In sum, while the temptation to spend, spend, spend while you are young and lovely is there, you might want to think over being laid off at 55, at which point no corporation on earth will pay you a living wage, (overcompensated CEO's excepted) and you're 10 or more years out from social security, which isn't a living wage either.
You'll need something in the bank or investment account to draw down for those Proud Mary moments unless you want to burden your children, or don't mind shacking up in a cardboard box.
Next time, we'll talk about WHAT stocks, bonds, cash and real estate. Stay in touch.
Monday, May 30, 2011
Back to Basics..Asset Allocation
Perhaps a recap of salient points from earlier blogs:
What is asset allocation?
For most of the population, asset allocations is deciding if they can afford to take the kids to a movie, or only go to the park and hope there's no icecream vendor.
Kids, as anyone who has them know, are a money sponge. Life has many money sponges, golf, slot machines, boats, any mechanical device, and the mother of all sump holes, a house.
I'll visit the joys of home ownership in later posts.
But, we are discussing a different sort of asset allocation. We mean in an investment portfolio.
Assets come in simple to understand forms:
-Liquid assets
No, not vodka and wine, joyous as they are. Stay with me here, I mean that is either cash, or can be turned into cash easily. Money market accounts, short-term CDs, listed stocks and bonds, including mutual funds.
Liquid assets may or may not give you back the same amount of money you put up. Cash is cash. $100 bucks in the mattress is $100. (Inflation or mice may eat it, but that's not what I
mean.) Money in a savings account or money market fund will earn a little interest, you can get at it fairly easily and it will give you back no less than what you put in.
Liquid assets like stocks and bonds are also easily turned into cash (exceptions noted below) but may give you more, or less, than what you put in. That's called risk. Risk has advantages, we'll talk about risk more down the line.
-Illiquid assets are those that can't be unloaded easily. Like spouses and houses.
Whether your spouse is an asset or liability is fungible, and changes for day to day, even minute to minute.
I consider an illiquid asset anything that takes more than a week to turn into cash, or involves an attorney.
Some stocks and bonds start out liquid, then petrify and become illiquid. Owners of adjustable rate preferreds, some mortgage backed paper and auction rate securities found this out the hard way, by experience.
Here's a couple of rules:
-Everything is liquid until there are no buyers
-It's far less stressful to learn from someone else's mistake
As Lily Tomlin said, "Don't be afraid of missed opportunities. Behind every failure is an opportunity someone wishes they had missed."
Illiquid doesn't necessarily mean worthless. Auction rate securities, other adjustable rate paper may still pay the interest or dividend. You just can't sell it because the buyers are gone.
Given the number of stocks and bonds on the market, it doesn't happen very often. It happens most when some securities dealer has a 'New Idea.'
Here's another rule:
-'New Ideas" are frequently the types of securities caught in this quicksand.
The premise that a security would 'adjust' the dividend based on market conditions sounded great. Your principal stayed intact, you get a yield higher than CDs, for instance, and the rate would fluctuate with some interest benchmark. Except when new buyers decided they wanted no part of them. Old owners had no one to sell them to.
The lesson is, if the security you are interested in doesn't have a reasonable amount of daily trading, you may find that you can't sell it when you wish. That may or may not be a bad thing, but it isn't liquidity.
Nest, we'll do more detail on asset allocation. Stay in touch.
What is asset allocation?
For most of the population, asset allocations is deciding if they can afford to take the kids to a movie, or only go to the park and hope there's no icecream vendor.
Kids, as anyone who has them know, are a money sponge. Life has many money sponges, golf, slot machines, boats, any mechanical device, and the mother of all sump holes, a house.
I'll visit the joys of home ownership in later posts.
But, we are discussing a different sort of asset allocation. We mean in an investment portfolio.
Assets come in simple to understand forms:
-Liquid assets
No, not vodka and wine, joyous as they are. Stay with me here, I mean that is either cash, or can be turned into cash easily. Money market accounts, short-term CDs, listed stocks and bonds, including mutual funds.
Liquid assets may or may not give you back the same amount of money you put up. Cash is cash. $100 bucks in the mattress is $100. (Inflation or mice may eat it, but that's not what I
mean.) Money in a savings account or money market fund will earn a little interest, you can get at it fairly easily and it will give you back no less than what you put in.
Liquid assets like stocks and bonds are also easily turned into cash (exceptions noted below) but may give you more, or less, than what you put in. That's called risk. Risk has advantages, we'll talk about risk more down the line.
-Illiquid assets are those that can't be unloaded easily. Like spouses and houses.
Whether your spouse is an asset or liability is fungible, and changes for day to day, even minute to minute.
I consider an illiquid asset anything that takes more than a week to turn into cash, or involves an attorney.
Some stocks and bonds start out liquid, then petrify and become illiquid. Owners of adjustable rate preferreds, some mortgage backed paper and auction rate securities found this out the hard way, by experience.
Here's a couple of rules:
-Everything is liquid until there are no buyers
-It's far less stressful to learn from someone else's mistake
As Lily Tomlin said, "Don't be afraid of missed opportunities. Behind every failure is an opportunity someone wishes they had missed."
Illiquid doesn't necessarily mean worthless. Auction rate securities, other adjustable rate paper may still pay the interest or dividend. You just can't sell it because the buyers are gone.
Given the number of stocks and bonds on the market, it doesn't happen very often. It happens most when some securities dealer has a 'New Idea.'
Here's another rule:
-'New Ideas" are frequently the types of securities caught in this quicksand.
The premise that a security would 'adjust' the dividend based on market conditions sounded great. Your principal stayed intact, you get a yield higher than CDs, for instance, and the rate would fluctuate with some interest benchmark. Except when new buyers decided they wanted no part of them. Old owners had no one to sell them to.
The lesson is, if the security you are interested in doesn't have a reasonable amount of daily trading, you may find that you can't sell it when you wish. That may or may not be a bad thing, but it isn't liquidity.
Nest, we'll do more detail on asset allocation. Stay in touch.
Sunday, May 29, 2011
The Return of the Advisor
I've been gone for a while, the crash happened, no I didn't 'predict' it. My regular job got in the way of posts, so I rectified that by quitting. Now we're going to pick up the pace.
Again, the idea behind this blog is to help regular human beings make intelligent choices for their 401ks, their IRAs or Rollovers, or for their personal investment accounts. Although the basics apply to any market investor, corporate, trust or pension plan.
The principles outline in earlier posts still apply.
John Wayne said, "Talk low, talk slow, and don't talk too much."
Your Advisor says, "Costs low, go slow, and don't trade too much."
Remember our motto, courtesy of Warren Buffett, and backed by my personal observation and experience, "Most ideas are bad."
Again, the idea behind this blog is to help regular human beings make intelligent choices for their 401ks, their IRAs or Rollovers, or for their personal investment accounts. Although the basics apply to any market investor, corporate, trust or pension plan.
The principles outline in earlier posts still apply.
John Wayne said, "Talk low, talk slow, and don't talk too much."
Your Advisor says, "Costs low, go slow, and don't trade too much."
Remember our motto, courtesy of Warren Buffett, and backed by my personal observation and experience, "Most ideas are bad."
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