Traditional stock picking focused on various fundamentals:

- the “value” of the stock taking into account the discounted cash flows of future profits
- what the assets of the company was worth after liabilities were removed
- how the technical characteristics of the market as a whole impacted the stock price

In addition “macro” items such as interest rates and inflation, too, impact the market as a whole.

While politics has always been part of the equation, today the market seems to be moving more than ever based on what the politicians are saying they’ll do. A recent WSJ article titled ‘CEO’s Message – Fix Europe, Or Else” had this great quote from an the CEO of Kingfisher, a UK company:

The outcome is very binary. It’s up to politicians

In order to invest in this sort of climate you need to be kind of like a “Kremlinologist”, or an analyst that used to attempt to decrypt what was going on inside the USSR’s communist party leadership, based on arcane clues and utterances.

Unfortunately guessing on what politicians will say or do is a new dimension of investing, and if it is moving markets, we all need to either get better at predicting their next reaction (since they rarely seem to plan ahead and mostly react when events are far gone) or stay out of the market.

All active investors are effectively “Kremlinologists” now.

This site has been a big fan of iBonds for several years now. Here is a link to a post I wrote in early 2010 that basically sums up the key elements of iBonds including:
- very low risk
- able to defer taxes indefinitely until redemption (up to 30 years). They are also exempt from state and local taxes
- very competitive interest rate of a “base” low amount plus inflation adjusted every six months
- able to buy $10,000 / year worth of bonds (that is the limit if you buy “jointly” between you and your spouse, but you can buy $10,000 in your name and $10,000 in your spouse’s name if you are not worried about will or trust issues)
- because they are very simple (deferring taxes) you don’t have to do much of anything as far as work to maintain these securities. You won’t get a 1099 form for interest if you select the “base” method which is deferring taxes until maturity or until you redeem them

The downsides are
- you can’t get at the money for 12 months (your latest purchase; if you have been buying iBonds annually for years it is only your most recent purchase that is held for 12 months)
- if you redeem within 5 years, you lose 3 months of accrued interest
- the interest rate, while WAY better than money markets or savings accounts, isn’t that great. The “base” interest rate offered by the US government now is 0.0%, so essentially you only receive the inflation component. Even with a “0.0%” base interest rate, inflation paid about 3.75% in 2011 which is a great rate considering the alternatives

Here is a link to the Treasury Direct site discussing iBonds. Starting 1/1/12 the US Government will no longer issue paper iBonds anymore. Thus you must buy them through the US government if you want them.

The Wall Street Journal recently had an article about iBonds. The article summarized their advantages and noted that beginning 1/1/12 they no longer were going to allow for “paper” issued iBonds which limits the number of bonds individuals can purchase. This article says that iBond limits were going to be $5000 per person; the treasury recently updated their rules and now you can buy up to $10,000 per person.

If you haven’t bought iBonds before now would be a good time to start. You can purchase bonds by year end 2011 (the next few days) and then buy some in early 2012. This starts the “clock” on the 12 months where you can access your money. After that the money is available for short-term cash needs (you do lose 3 months of interest in the next 5 years).

Stock market “co-variance” means in laymans’ terms that, when something happens, all the stocks in your portfolio move in the same direction. Regardless of an individual companies’ performance, financial position, or future prospects, every stock in the index moves up or down together. As you can see in the list above, the 20 or so stocks in this portfolio ALL went down today.

The types of events that used to move markets like this were due to wars, elections, or changes in policies such as interest rate meetings like the Fed. Now, however, it is often due to the inexorable series of financial crises that we have faced in the US and now in Europe with the Euro crisis. Today the German bond auction had difficulty, and this ricocheted across the ocean into our markets.

To be an investor today you need to keep one eye on the stocks that you select and another eye on the overall factors that are causing the market to rise or fall. Unfortunately, many of these items causing the market to rise or fall are caused by government policies and actions which are impossible to predict in the short run and impact the entire market.

It is frustrating…

A recent Wall Street Journal titled “The Young and the Riskless” details how “twentysomethings” are not investing in stocks, but instead are putting their savings into less risky investments.  The tag line on the article is:

Twentysomethings are seeking safety from market volatility at precisely the wrong moment in their investing lives.  Here’s how to get back on track.

From the outset I was struck by the author’s presumptuous and scolding tone. I also like their strategic use of the word “volatility” instead of the more appropriate term of “losses” when describing market events over the twentysomething’s financially sentient lifetime, which would be something like the last 10-15 years.

Per the charts in the article

The percentage of young investors who say they’re willing to take above-average or substantial risk has declined from 52% in 1998 to 31% in 2011. 52% of investors in their 20′s who say they will “never feel comfortable in the stock market”. 33% of 20-somethings’ non-401(k) portfolios held in cash, versus 27% for all investors.

It is important to understand how “faith” in the market is typically defined in the popular financial press. Faith usually means putting your money in an index fund (or ETF), with low fees, continuing to do so regardless of market conditions, and relying on the belief that “in the long run” it will all turn out alright and you will be able to retire rich. The “financial calculators” have an assumed rate of return that you receive on your money, similar to the same calculators that public pension funds use, and they are typically “set” between 6% and 10%. Due to the “miracle of compounding returns” you can amass large sums of money in the future.

The problem with this mantra is that NO ONE has been winning with this strategy for a LONG time. What you see, instead, is that money put into the market is often battered immediately by volatility and is worth a fraction of what you put in only months prior. If you change jobs regularly (once every 2-3 years, as younger people often do) and are an avid 401(k) saver (which is recommended), many times when you pull out your money it will be valued far less than what you put in, or about even when the company match is taken into effect (depending on vesting). This can be demoralizing. I know that when I left companies in the late nineties and after the dot-com collapse I started putting more of my money into cash-like investment selections (despite warnings from my employers’ 401(k) educational materials) just because I hated moving balances worth a fraction of what I held back out of my pay when I left to start with a new company.

Also, in order to win “in the long run”, you have to stay with it in the short run. This means that when stocks plummet, you need to stay in the market and keep investing. If you decide to cut your losses and run, or stop putting new money in during market troughs, you don’t get the same benefits when the stocks rise later. This post I wrote basically said that no matter what you did in 2007, it turned out to be a loser, but if you bought during the trough in 2008 (or held throughout) you saw big gains later as the market turned back around (to where it was before). BUT if you didn’t stick with the markets, you didn’t benefit from these gains and ended up as a net loser. It is VERY HARD mentally to keep investing when markets are going down, but if you don’t buy low there is no way you can even conceptually win in the “long run”. If you bail, for sure you are going to fail, assuming you are following the mantra (which is what the WSJ article’s author was lamenting).

Kids see their parents’ struggles. Their parents have been believers in the markets, since the bear markets of the 70′s were replaced by the bull markets of the 80′s and 90′s. If you retired in the 90′s, after years of investing in the doldrums, you not only benefited from high interest rates which appeared to “goose” the compounding effect, but you also essentially did some great “market timing”, buying low and selling high. But the parents of today’s twentysomethings didn’t retire in the early 90′s, they kept working, and watched their investments suffer along. Now the parents’ are in a bind.

Not only did the markets get hit, but there isn’t really an underlying foundation of belief in WHY the market should do so great “in the long term”. In the past you could look at the track record of the US and show how we weathered recessions, panics and depressions, wars whether declared or un-declared, and always came out ahead. But today everything seems to be static or declining; our unemployment rate is high, we have high “real” inflation from commodity price increases (oil, food), and the cost of services like a college education or health care (if you can get insurance at all) is very difficult to bear. In order for the market to rise, the country needs to be productive, well run, and growing – does this seem to be today’s perception of American performance? This lack of an underlying narrative in why markets should rise of the long term (other than it has happened in the past), combined with the miserable ACTUAL performance during the last decade and a half, is killing confidence in the “long run” hypothesis that markets go up.

Another element of caution is that not only did stocks crater (or stay flat), but everything else fell apart too, in defiance of what the typical financial media said would occur. Housing became a miserable investment, rather than the guaranteed path to wealth that was painted in the press. Can’t you remember people saying that renting was “throwing your money away”? I remember having many, many people look at me in a dumbfounded fashion when I told them that I rented for over a decade when I could have easily bought. This thinking has obviously changed radically, despite record low interest rates (high rates would have made the housing problems unimaginably worse, at least in the short and medium term).

If kids travel, they can see how the “US Peso” doesn’t go far overseas. The dollars is worth a fraction of what it used to buy vs. the Euro, the Canadian dollar, the Australian dollar, or the Japanese Yen. The devaluation of the US dollar is another signal of our relative decline, along with our equity markets and housing markets.

The popular press’ scolding is going to fall on deaf ears until young adults see something out of their own experience that would convince them that stock investing is a winning strategy. The lack of anything except (comparatively) ancient charts of a world before the cell phone and the internet won’t sway them.

It really comes down to faith vs. experience. And among the young, experience is winning.

Generation X Addendum

This wasn’t mentioned in the article but a parallel trend I personally have noticed is that people of my generation (Gen X) are taking charge of their finances in their own way. Those with means tend to personally select stocks and get involved directly in their investing rather than “passively” investing through indexes (although ETF’s are part of their portfolio). While I am in the finance industry, many of my friends and acquaintances are not, but they have grown tired of bad and counter-intuitive advice and are taking matters into their own hands, in a variety of ways. Their particular strategies aren’t important – what is important is that they don’t believe the common wisdom and are taking responsibility for their own investment outcomes. In my opinion this is another manifestation of what the twentysomethings are doing, except by people with more assets to invest in the first place.

Cross posted at Chicago Boyz

The portfolios that we run on this site coincide with a market that effectively is a “do nothing” market.  We are basically flat over the last 13 years, meaning that there hasn’t been growth in the indexes since 1998.

The money that an index investor would have earned (i.e. if you put $100,000 in the SPY ETF or a mutual fund such as Vanguard’s VFINX) would have come through dividends, which averaged about 2% / year during the period.  Thus every year you received $2,000 in dividends (taxable each year) which means over the 13 year period you made roughly $30,000 (adding in compounding of interest) before taxes or maybe $24,000 after taxes depending on your bracket (and whether or not the 15% dividend received deduction applied during the period).

This is reflected in our results; while valuations fluctuate about 1/2 the total return of portfolio one, our longest lasting portfolio at over 10 years, is due to dividends.  When we look to select stocks a strong (and sustainable) dividend yield is an important, although not the only factor we look for in the “list of six stocks” that we pick from each year.

In the October 24, 2011 issue of Barron’s there is an article titled “It’s Cheaper the Second Time Around” that discusses the fact that indexes have been flat for the last 13 years.

The fact that we are struggling daily to hold above a level first reached nearly 13 years ago is both sobering and, viewed in the proper light, profoundly encouraging for true long-term investors… we are finally returning to a time of ‘stocks for the long run’… anyone who believes in mean-reversion investing has to consider the current starting point for equities at least somewhat attractive…

Jim Paulsen of Wells Capital was kind enough to calculate the 10-year forward return from all points in historry when the market was flat or down over the priod 12 yars.  The result: a 7.2% annual gain, versus 4.7% for all other times, not including dividends.

It is good that this analysis disclaimed the impact of dividends and yet noted that they are important, although if the yield is relatively consistent over time (which isn’t true, since yields go down when stocks go up, and vice versa) the analysis should hold true.

This type of investing approach is also a version of “market timing” – you should buy when items are cheap, and sell when they are expensive.  The most obvious example of this is housing; if you bought in 2007-8 you probably are regretting it right now – that same house probably would cost you a lot less to buy in 2011 then it did back then, for the same exact house.  It isn’t obvious HOW to do market timing, but the effects are real for anyone struggling to pay on an underwater mortgage today.

Like every good investment analogy, there is a counterpoint – Japan.  Japan peaked long ago, in 1989, and still hasn’t recovered to the highs.  In order to be a long-run investor in Japan you apparently have to be very patient, indeed.  Of course at some point investors are entering the market and they don’t care about recovering 1989 highs anyways.

For our portfolios here at the site flat returns mean a few things:

1) we don’t feel so bad at our struggles to raise values since the market has been poised against us

2) we have been right to focus on dividends, since they have been the only reliable source of cash over the period (relative to stock values)

3) while the analysis is more complex many of the overseas indexes weren’t flat over the same time frame; we have been putting up almost 1/2 our picks from overseas companies (US based ADR’s to keep it simple) in that same time frame

4) there is some hope that our patience will be rewarded if values increase in the next decade

Terrell Owens is a football celebrity who has earned millions over his 15 year career as a receiver.  He has made more than $30M in salaries over that time and also had endorsement opportunities due to his high profile.

In a recent video Terrell Owens describes his financial predicament due to the NFL lockout.  Here is a link to the video, where he apparently sheds a tear.

In the video, Terrell is calling his “financial advisor” who apparently hasn’t been returning his calls.  Terrell can’t see his statements, and is confused by his low credit score.

You can’t tell what is “made for TV” and what is reality, but even the least web-savvy person knows how to get to their account balances online.  And your credit score is easily found; you can get a credit report for free from each of the major agencies to check any blemishes and anytime you buy a car or apply for a major purchase you usually also have the opportunity to see your score (if you ask). This type of behavior is sad and reflects a very low level of financial literacy.

Then Terrell talks about his “predicament”.  With the NFL lockout he has “no income” and yet he has “mortgages to pay” on his real estate as well as child support payments.

Note that this is an individual who has earned over $30M in his lifetime, along with other endorsement and income opportunities that are available to a high profile public figure.  He has had many opportunities to receive and re-invest this money, which should be making him MORE money today.

He has had the opportunity to build a large net worth position, meaning cash in the bank or hard assets (land, equity in a house, or financial assets like stocks or bonds), but he obviously hasn’t done this, because the minute his “income” stream is done, he is unable to remain current on his bills.

Terrell’s position isn’t hard for the financially literate to understand, but it is lost on him and most professional athletes, who often end up broke or bankrupt after they stop playing the game.  This site, called “Celebrity Net Worth”, also completely misses the point.  I don’t know how they attempt to calculate net worth, but they appear to show lifetime earnings and current earnings instead and they assume that Terrell has maintained this money, not spent it.  Obviously it is ALL spent because he is unable even to make child support payments of $5000 / month, which would be a drop in the bucket if he had retained even one years’ salary after taxes in the bank.

It is possible that one of these portfolios (at trust funds for kids) would provide someone a higher NET WORTH than Terrell Owens, at $20,000.  That is a profoundly sad statement, since Terrell does not seem to be stupid and he has gotten knocked around plenty in 15 years of NFL football, and has NOTHING to show for it.

It isn’t what you make, it is what you save, which is a function of 1) not spending it on consumables 2) not paying for the bills of your hangers-on 3) not paying for your kids out of wedlock or for ex-wives 4) not paying “managers” large fees while remaining personally ignorant 5) not investing in businesses with your friends, especially if they have a limited or non-existent professional track record.  Terrell Owens probably fails all of these items.

And someone should re-name “celebrity net worth” something like “celebrity lifetime earnings”.  They are NOT one and the same, as Terrell illustrates.