Sushi Money

By now you’ve probably read the provocative article on Yahoo, Mutual Funds are for Losers. If not, take a look- it’s a good read and offers some excellent insight into investing strategies. But what about the premise? Based on the article, it’s not just a catchy title. The author interviews Phil Town and he really believes what he says, based on his experience. Do you agree? I don’t… and according to his metrics, that places me right in the loser category.

Normally I’m not bothered when so-called experts tout their strategies, their philosophies and their approach to business and investing. We can learn from the experience and knowledge of others. But why take an approach that blasts millions of people as losers because of their investing strategy? Hell it’s more than that… millions of people who put money in their 401(k) everyday as well. Are they losers too? Apparently so.

Do I disagree with his approach to investing? Absolutely not, and he makes a great case for value investing, research, due diligence and taking risk at the right time. By his own admission however he struck gold at an opportune time and his life has never been the same. Not everyone is going to do that. Many people have families at a younger age that they work very hard to support, and just finding some portion of their monthly income to set aside to invest each month is amazing. Are these people going to have enough money to buy a “good stock” and watch it make them rich over time? Maybe, but I doubt it.

The old axiom that says “It takes money to make money” is pretty accurate, and that’s why “the rich get richer.” Many people also don’t have the luxury of a risk profile that will let them put a ton of money into a few stocks they can hold for a lifetime. Mr. Town cites Warren Buffet’s quote that “Diversification is a protection against ignorance.” But how many people have the knowledge, experience and time to learn to tell the difference between a “wonderful business that is on sale and a bad business that isn’t?” Most people are simply not going to get there… we have millions of citizens who can barely make ends meet each month, keep debt levels down and who are trying to make a better life for themselves and their families. But I guess they’re all losers if they invest in mutual funds instead of stocks.

So Mr. Town, let’s say you have someone with millions of dollars who has an asset manager or financial planner to handle their assets and investing strategy. Let’s even say they don’t invest in mutual funds. So because they invest in individual stocks they are not a loser? Yet they’re paying the same percentages or fees to someone else to manage their assets, so they should fit right in to your loser definition. What about hedge funds? All those people dumping tons of money in hedge funds… they’re not losers? By the same definition, they should be, because they pay huge fees for the privilege, and opportunity, to make enormous sums of money in return.

I understand the point of Mr. Town’s approach… find superior companies at bargain prices, stay with them and watch your money grow. That is a wonderful approach, but I also think there are a few mutual fund managers who embrace that same approach. In my opinion, it’s not a bad thing to pay a mutual fund manager for their expertise and time, just like a wealthy person may pay an asset manager or planner a percentage of their portfolio over time. But I do believe in finding superior mutual funds with bargain priced management fees such as those offered at Vanguard. Expense ratios are very important, and paying too much for a mutual fund is indeed a losing proposition.

But just because people invest in an actively managed mutual funds doesn’t make them losers. In my book, just the fact that they are saving and investing makes most of them long-term winners because they’re ahead of many other people in the nation. Historically, almost half of all employees don’t even invest in their 401(k) over time! We’re trying to get more people to save and invest in the first place, and at least now with automatic enrollment for 401(k) plans, employees will have a better chance at establishing long-term retirement savings. And where are most employees going to put their money? Many buy company stock, but more now have the opportunity to invest in… you guessed it, mutual funds.

So why diversification? I’ll be the first to say that I’m ignorant to many aspects of investing and market dynamics. Nobody knows it all. Most people know very little about saving and investing. Some people don’t want to know anything about saving and investing. And there are always things we can learn, and many areas of investing and economic change that we cannot plan for.

Diversification protects me not only from my own ignorance, but the ignorance others.

I’ll bet a few folks at Merril Lynch, Citigroup, Bear Stearns and a few other companies could have benefitted from a little more diversification over the last year. How much money have people, and businesses, lost over the last few years because of taking on too much risk, with too little diversification?! Maybe that’s what gets me a little steamed up about this article… I think the loser viewpoint is careless and doesn’t factor in degrees of risk, or how easy it is for a retirement portfolio to be destroyed in a very short amount of time. Nobody gets it right all the time, and even good companies can fall on hard times.

Diversification, and asset allocation, gives most investors the opportunity to balance risk with reward over time. We may not all become millionaires or billionaires. But with a little time and discipline, we can achieve a solid retirement portfolio that will make our future a lot more secure. What do you think, are mutual funds a losing proposition? Do you have a different strategy?

Does the market just keep going up?  The big 13k is close but does it really mean anything?  I don’t follow the technical indicators much, and for me it’s just a number.  Motley Fool expressed it pretty well in a recent article titled “Dow 5,000?” I don’t usually read the MF articles- too many hoops to jump through and it seems like most of their stuff is a sales pitch.  But many of the articles are informative, and I agree with Mr. Zimmerman about being prepared:

“…savvy investors should strive to fix their portfolios while the sun is shining, in part by ensuring that their basket of investments is spread intelligently across the market’s valuation spectrum.”

But what does it mean to spread your investments “intelligently across the market’s valuation spectrum?”  I think it means many different things to many different people.  One investor’s goals and tolerance for risk may be far different from another investors.  Before a pitch for some mutual funds, Mr. Zimmerman describes that value stocks should hold up better in a down market than growth stocks.  No real surprise there- growth stocks command a risk premium that value stocks may not since they have already fallen in value.  Growth stocks may have greater volatility with potentially greater variance of performance over time- higher returns in good times and lower returns in tough times.  One way to look at it is using a statistical measure called beta.  In essence beta is used to measure risk based on volatility, with the market having a statistical beta of 1.0.  Stocks with beta higher than that are potentially riskier, but also may yield a higher return.  Stocks with a beta lower than the market are less volatile and less risky but also have a lower expected return.  So value stocks should have a lower beta than growth stocks right? Not necessarily… if a high-flier stock has fallen greatly and some may consider it a value stock, it actually may have a higher beta and be classified as more risky after it decreased in price! Why? Because beta measures volatility. Beta can be a useful measure, but it’s only one way to look at risk.  Beta doesn’t work very well when price movements are considered.  There is a key issue here, and Investopedia has a great discussion of it in an article titled “Beta: Know the Risk“ from 2004 by Ben McClure.   For me, the big take-away is how I approach investing for the long term while considering the fundamentals.  From the article and a reference to Ben Graham:

“Try to spot well-run companies with a “margin of safety”–that is, an ability to withstand unpleasant surprises. Some elements of safety come from the balance sheet, like having a low ratio of debt to total capital. Some come from consistency of growth, in earnings or dividends. An important one comes from not overpaying. Stocks trading at low multiples of their earnings are safer than stocks at high multiples.”

I don’t know where we go from here… but I try not to care too much.  Saying I don’t care would be a specious statement… of course I care how the market and my investments do!  But at the same time- I agree with preparing for the down side because it will come… it’s just a matter of time.  When I’m better prepared, I’m less inclined to fret over market movements.  How we prepare for those times is the question, and my answer is to focus on fundamentals, invest for the long term, and keep on learning along the way. 

Some strange news out this week that illustrates, for me, how legislation is often very misguided.  Rep Charles Schumer (D- N.Y.) is apparently pushing legislation that will help “bail out” the “victims” of the subprime mortgage mess.  Laura Rowley on Yahoo wrote an excellent article, Footing the Bill for the Subprime Fiasco, describing this initiative.  Now I’m all for prosecuting illegal activity by predatory lenders and helping consumers find out how to rectify loans and deals that were brokered illegally.  But Ms. Rowley makes an excellent case regarding the fact that most of these mortgage loans were taken out by people who simply made poor decisions.  And she reiterates that the vast majority of borrowers, some 85%, are paying the mortgage on time.  I think Rep Schumer is making political hay out of this opportunity… having taxpayers foot the bill for a legislative remedy is just plain wrong.  Imagine if they tried to do this with the stock market!

On another note of legislative foolishness, the State of Florida is finding out the hard way that capping property insurance rates is doing more harm than good.  The intention is well-founded, as many Florida homeowners are being priced out of the insurance markets.  But at some point, insurers simply cannot do business in a state where the risks outweigh the costs of doing business.  Motely Fool wrote an interesting piece titled Stupid Florida! in which they describe the problem.  They illustrate the issue with an example of a major insurer, USAA, basically pulling out of the property insurance market in Florida.  In a letter by the USAA CEO, he cites some interesting data:

1. Over the past 10 years, USAA has paid approximately $220 million more in Florida homeowner insurance losses and expenses than it has collected in Florida homeowner premiums.

2. Florida residents account for 49 percent of USAA’s exposure to natural disaster risk, yet make up only 9 percent of USAA policyholders and pay 12 percent of USAA’s property insurance premiums.

3. With more than $2 trillion in coastal property exposed to the risk of catastrophic hurricanes – and a history of frequent, strong storms across the state – Florida has the most challenging property insurance market in the country.

Therefore, the State of Florida has left us no choice but to take the following actions in order to limit potential future losses, and to protect the association and its members.

I feel the issue personally because I am a USAA member, and they carry most of my personal insurance business.  I read this very letter myself the other day. This is an excellent company and I’m proud to see the company take necessary steps to protect their viability as a company.  I feel bad for the Florida members and retirees who may need the coverage, but the Florida legislators have created the situation.  Legislation can do wonderful things… and it can also do great harm.  I think back to how the boat and yachting industry was nearly destroyed by the institution of the “luxury tax”…   What our legislators do locally and nationally really does matter.  I shudder to think of the changes that may take place with tax laws over the next few years with the Democrats leading the charge!

Are credit card fees and interest rates an increasing, but unknown financial risk for consumers?  You wouldn’t normally think of risk in this way, but if credit card industry practices are closely examined we carry a lot more risk around in our wallets than we realize.  At least with investing, the rules and regulations are pretty clear and you generally know where you stand when you take on the risk.  But with credit cards?  It’s a game of roulette that we play according to an indecipherable rule book, and credit card companies that can change the rules almost any time they please.  For more and more consumers, those rules are taking a heavy (and unfair) toll on personal finance and indebtedness.  Bob Sullivan of MSNBC’s The Red Tape Chronicles has written an excellent article titled Credit Card Companies’ Change of Heart in which he examines how recent Congressional investigation may have prompted several credit card companies to quickly change what many view as unbridled predatory lending policies.  I won’t reiterate some of the egregious examples by credit card companies as described by Mr. Sullivan’s article, but suffice it to say I learned a few things I was not aware of.  Some of the really interesting insight was provided by other people commenting on his article.  In those comments, people have provided real examples of how they were hit hard by the credit card companies for late payments, universal default and even surprising increases to card rates with little explanation.  There were also comments on personal responsibility- reminding others that “we choose to use the cards” and no one forces us to take on that debt.  True, however when one uses credit cards or borrows money in this manner, there is a reasonable expectation of being treated fairly without the lender being able to change rates, fees or credit card agreements on a whim.  I think these issues will become increasingly visible in the months and years ahead, maybe leading to a welcome overhaul of regulatory practices.  Bank and credit card company policies are fiercly driven to extract fees and charges from consumers at every turn. Personally, enough is enough and I’m going to work harder to pay down the debt I do carry, while resolving to use my cards less frequently.  I’ve always taken “financial pride” in using my credit cards wisely, maintaining good standing and paying down debt efficiently.  Although I have not been treated unfairly with the debt I do carry, the more I read the more I realize my credit card debt is a ticking time bomb awaiting change or modification by credit card fee-creation teams whenever they choose.  Even paying down debt involves risk of having your rates increased-  when a consumer is worried that paying down a debt too fast will incur an increased credit card rate, then something is wrong!  For me, the word risk has taken on new meaning when I consider the potential fees and charges I might be levied with by my credit card companies… these fees are far more excessive than management, administrative and brokerage fees for mutual funds and stocks.  Take a look at your own debt profile and the revloving or secured credit cards you carry… read the fine print and you too may see risk beyond mere debt. You know what?  I think I will write the word RISK in bright red letters across the top of my credit cards- the next time I pull out the card for a quick purchase I’ll think twice, and maybe use cash instead.

     Market madness this week.  Oh wait… did I say “madness”?  Isn’t that a term we usually hear when the bull is running, the market frothing with speculators and way overvalued?  Madness can be seen on both sides of the spectrum however. When the bears emerge from hibernation the emotions can also run at a fever pitch.  This was a tough week, but certainly not madness.  At least not yet.   We’ve seen it… and for me this isn’t it.  But lets be clear- I’m not a trader.  I am an investor who trades part-time when perceived opportunity arises, or when necessary.  Is it necessary now?  For me, no. For many others-absolutely.

     The beauty of the market is we must each wrestle with our emotions, our conscience, our judgement and yes, the beast itself.  I have overestimated myself before, and underestimated myself before, and the only thing I’m certain of is that I’ll probably do it again.  I learned a long time ago while flying airplanes that usually in an emergency the best thing to do is… nothing.  At first.  The absolute first thing you do is to not make things worse. 

     How might someone make things worse in today’s market climate?  I think reacting emotionally by liquidating all one’s assets could be an over-reaction.  If the individual felt it necessary to do so, then fine.  But if being in cash was the limit of their tolerance for risk, then perhaps they shouldn’t have been in the market in the first place.  And it’s certainly not a road to the achievment of wealth.  Do you try to time the market?  Sometimes?  Sure.  I’ve done it successfully at times, and miserably as well.  I personally believe market timing for the amateur investor is one of the worst destroyers of wealth.   “The market’s going down!  Quick- sell all the stocks! Liquidate the IRA!  Sell the mutual funds!”  An over-reaction?  Yes.  But I’ll bet it happens a lot more often than we admit. 

     I remember long ago while sitting in a classroom receiving some kind of flight-related instruction… the year was 1987.  In the middle of some boredom-inducing lecture someone was screaming and yelling while running down the hallway.  “What the heck is that all about?” I wondered.  He stuck his head in the doorway, wide-eyed with a look of fear and powerlessness… “The market’s crashing!”  and ran on to the next room down the hall.   “Hmmm…” I remember thinking, “I don’t have much anyway… so I’m not going to worry about it.”  I didn’t feel that the market and its risk pertained to me.  Honestly, I didn’t really care and didn’t know much about it.  Ignorance is bliss.  I remembered that scene however, and for a long time after I’ve wondered what that guy was investing in that drove such fear and emotion to the surface that day. 

     But I certainly care now. I’m part of the beast and the beast will set me free… eventually.  And because I care I want to make an informed decision before I react emotionally.  If I make a decision that loses money, so be it- I did the best I could.  I’ll learn from it and move on.  I recently read something I think has value:

“I understand the frustration of making the wrong choice & not researching enough only to find out later that you could have done it differently.  That said you have to acknowledge and move on and make your changes from where you are, and not what could have been.  I have been going in a new direction rather than to back-track and waste money undoing what I have already done.  There are always options and alternatives.  We all make choices every day and live with them, good or bad.  Acknowledge and Move on.  I do not waste any time on a bad choice and decision. Whats done is done & just move on from here.  Life is too short and just too much fun to waste on disappointments we all come up against. The alternative to these issues are simple and rather cheap and in the long run probably better.  Look for the strength in things rather than the weakness.   If you change your perspective you can be very pleased with your choices.”   Timber

Pretty darn good advice.  And it came from one guy helping another guy feel better about his buying decision… and the price he paid… he recently bought a new John Deere tractor.

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That depends upon what you’re looking for of course.  Lets assume an individual’s overall debt situation is well under control, and their credit card debt, if not paid off monthly, is mild.  If an individual is trying to stay away from all market risk, and wants to keep cash readily available for a near-term use, then “safety” is defined by your need for the money, for a purpose close at hand.  

Having an “emergency fund” is important for unforeseen situations… the time you really need money for something.  Most advocates say 3-6 months savings in the amount of your monthly income needs should fit that bill.  I think 6 months is more appropriate, and should be a first priority, especially in a family. So bank savings, money market accounts and CDs will fit the bill (CDs for savings, not an emergency fund due to possible penalties upon early withdrawal… e.g. you need the money).   Next is the credit card situation… pay down the credit cards!   

But what about longer term?  Is a safe bank/money market account or CD really helping over time?  Aside from peace of mind for knowing the money is there if needed, it may not be a safe place to keep funds.  Why?  Walter Updegrave from CNN Money writes a nice overview on why stockpiling cash may be a bad idea in a recent article “A lot of cash- too much risk.”  In essence he shows how the bite of inflation can slow the interest rate growth of bank savings (or CD or money market accounts) to a crawl.  That just doesn’t provide the necessary growth for someone trying to save for retirement or some other longer-term goal.  Mr. Updegrave shows the better alternative of really using a 401(k), if you have one, to grow retirement funds.  

I can think of few reasons why someone should not take advantage of 401(k) opportunities.  Most of those reasons involve hassles with paperwork, or how long one expects to be with a certain company, etc, etc.  But most 401(k) plans offer amazing benefits, and can be portable to take to a new employer.  Best of all, most 401(k) plans offer some kind of attractive matching or other benefit to how much you countribute… why pass up free money?    If you don’t have one, or just don’t want to use it… start an IRA.  We all need some kind of tax-deferred savings vechicle.  There is no better way to build retirement funds over time than a long-term tax-deferred approach to savings.  What if that just doesn’t meet your goals and need?  Maybe it can for a part of your savings program, and you can still use bank savings, money market and CDs for another portion.  You don’t like stocks or mutual funds?  Historically they provide the best long-term growth opportunities.  What about U.S. Savings Bonds?  They can provide a safe investment with a decent return, and can be used to fund education needs for children at a later time. 

The point is that there are many opportunities to grow your money over time… the earlier we start, the better off we are in later years.  I had a water-softener installed a couple weeks ago.  I didn’t plan on making a large appliance purchase this month, but the old water-softener finally gave in.  We live on well-water, and a good water-softener is essential.  Good reason for having an emergency fund… but more interesting was the conversation with the installer.  Here’s a guy in his middle forties that has a construction business on the side.  He was an energetic guy with lots of ideas and a strong work ethic.  He built his own house, had no debt, purchased only used cars, and was helping his children pay for school.  What about his retirement needs?  He had over $100,000 in savings.  Where was it?  In the bank, in a passbook savings account.

 This hard-working family man had never invested, never started an IRA, never looked at stocks or mutual funds, and was not comfortable with anything but cash at hand.  He was proud of his financial accomplishments, and should be… but he was also taking on a lot of “risk” in terms of the long-term safety of the growth of his money over time.  He also didn’t have any life or disability insurance beyond what social security might provide, and a family member to run the business in case of his disability.  Lots more there to be concerned about.  He knew he needed to start some savings and investment programs that would give him a leg up on inflation, but he was very risk averse.   We talked about some options and I referred him to a Certified Financial Planner to help get started.  He didn’t seem inclined to really want to do more however.  I wished him well… and hope he looks at other options.  It’s never too late to start!