Hedge fund irresponsibility

Yesterday I ran across an article THE ST LOUIS POST DISPATCH reprinted from THE WALL STREET JOURNAL by Gregory Zuckerman headlined:

"Who's sorry now?

Well, it's not hedge funds"

And it's about how many hedge funds have lost large chunks ("up to one-third") of their customers' money during the recent subprime stock market sell-off and decline.

And they refuse to take any responsibility for it.

According to Zuckerman, they "point fingers at other funds, once-in-a-lifetime events and their own computer programs."

Black Mesa Capital blamed "unprecedented market events."

Those words should put a chill in the hearts of anyone considering handing your money over to a hedge fund.

Yes, the past two months in the stock market are "unprecedented."

Gosh, gee willikers, darn it all to heck, Mr. Wilson!

I've got news for these hedge fund managers who're making millions of dollars -- history is being made every single day!

The future is going to be full of "unprecedented market events"!

Guess what? -- for the millions of dollars those investors are stupid enough to pay you, you're supposed to be prepared.

You're supposed to know how to deal with risk.

It's not like risk is anything new.

It's not like "unprecedented market events" are unprecedented.

The 1929 market crash was unprecedented. The oil embargo of 1973 along with the social dislocation caused by the Vietnam War and the Watergate investigations were all unprecedented to the stock market, which helped it decline dramatically 1973-74. The 520 point 22% crash of October 1987 was unprecedented. The high tech dot com boom of 1995-2000 was unprecedented and so was the Nasdaq tech wreck of March-April 2000.

I'm going out on a limb here, to make a tremendous prediction:

There're going to be a lot more "unprecedented market events" before we all die.

The world's not going to stop changing just because you don't hedge your hedge funds!

hedge fund irresponsibility
hedge fund irresponsibility

Terrorism and Investing

Here's an interesting article on How Does Terrorism Affect Your Trading.

The focus is on trading of stocks and currencies, which is certainly not my focus, but it's still an interesting read.

And although I don't see a mention of income investing itself, it does discuss long term investing strategies in relation to terrorism attacks. I'd say this - if you're investing for income, you're most likely banking on common human needs and desires. Coca-Cola, not software. Snack food, not biotechnology. Electric lights, not GPS satellites.

Terrorist attacks can certainly harm economies -- as September 11 did to the United States -- but as long as we're alive, we're going to keep on consuming basic commodities. Following September 11, business in the U.S. slowed dramatically -- car sales, restaurant sales and so on. Yet people kept using electric current to watch the news on TV and to eat Hershey's chocolate to deal with the stress.


terrorism and investing
terrorism and investing

Financial Rebel

I found an interesting blog called Financial Rebel.

I didn't find anything particular "rebellious" about it, but he gives his comments and commentary on the market and various company stocks and their prospects. Some people have found his article on how to own gold through using exchange traded funds useful.

Myself, I favor joining in with businesses that serve human needs, rather than expecting a chunk of metal to pay me money. That could include something such as the Mergent Broad Dividend Achievers Index.

One thing caught my eye in his comments on the current stock market -- it's quite volatile, and that's an open invitation to trading. I agree, but notice that he doesn't tell you how to trade volatility.

If you think that in the current market you want to be a day trader, all I can say is, good luck. You don't need to be reading this blog, you need to be reading the Help Wanted Ads.

But although I'm know expert, I know that the words "high volatility" are music to the ears of an options trader. That means it's tell to sell volality, because the price is high. You do that by selling puts and calls. There are relatively, safe and conservative ways to do that, and after I write and publish my book on investing for income, I'll tell people how to get rich quick by selling calls and puts.



Financial Rebel
Financial Rebel

Dividend Detective

I found a site that should be interesting for all income investors -- Dividend Detective.

This site is not about any kind of "fixed" or loanership or interest type of investing for income -- just dividends from equity investments. So for those of you who are resisting the double taxation of dividends, this can be a good resource.

But be aware that it's a membership site -- that is, access to much of the information is limited to subscribers. However, you can still obtain good information on, and lists of, dividend paying stocks, Real Estate Investment Trusts (REITs), Master Limited Partnerships (MLPs), CanRoys, closed-end funds, Canadian income trusts, and Business Development Corporations.

But if you want guidance on what to buy and when, you must fork over some cash.

My one gripe is that, from what I can see (and I didn't subscribe, so maybe this is addressed in the premium section for subscribers), the site encourages investing in individual securities. There is market commentary advising that certain ones or types be bought or sold. The whole idea of the site is to advise you on what to buy and sell, and when.

I strongly suggest you stick to exchange traded funds (EFTs) and index mutual funds, if at all possible (and it may not be with some of the most unusual securities, such as Business Development Corporations -- those are not your average every day investment.)


Dividend Detective
Dividend Detective

Bipolar Mr. Market

Obviously, I can't predict the amount dividends every high-paying stock is going to pay next quarter. But while the Dow and many stock markets around the world tumble on worries about the subprime mortgage industry in the US, and you feel poorer because the market price of your portfolio makes you feel like you just dropped off a cliff, think about this --

Is demand for electricity any less now than before this crisis started?

-- I can't speak for the overall economy, but here in St Louis the temporature has been reaching high 90s and triple digits (Fahrenheit) for over a week. Demand for electricity to run air conditioners is very high.

So has the true value of utility companies dropped?

Is demand for soft drinks any less now than before this crisis started?

-- I can't speak for the overall economy, but I'm pretty sure that lots of people are consuming record quantities of soft drinks, thanks to the terrific heat.

So has the true value of Coca-Cola (KO) and Pepsi dropped?

Is demand for gasoline any less now than before this crisis started?

-- Thanks to people driving and flying on summer vacation trips, I doubt there's been any serious drop in demand for oil and its byproducts.

So has the value of Canadian oil trusts dropped?

I hope you get my point -- don't count on market prices which are driven by market sentiment that blows hot and cold. In modern terms, Benjamin Graham's "Mr. Market" has a severe case of bipolar depressive disorder. He's going through a depressive stage right now.

And considering the amount of bad mortgage loans in the economy, I can't blame him . . . I feel bad when I think about the debts I owe!

But if you count on basic human needs for electricity, gas, snack foods and other such items . . . you can continue to receive income while everybody else is hoping Mr. Market will be happy again.

Bipolar Mr. Market
Bipolar Mr. Market

Canadian income trusts resources

I've been focused lately on researching Canadian income trusts. These are terrific investments, especially for income investors. Unfortunately, I have learned about them after the Canadian Finance Minister Jim Flaherty proposed to eliminate their tax-free status effective with 2011.

He proposed this on October 31, 2006, so it's become known as the Halloween Massacre.

Anyway, all income investors should be aware of the profits from Canadian royalty trusts which they can share in -- through receiving monthly dividend trusts. I've previously linked to the beginning of the information pages on my actual site, but I've also written:

Canadian Income Trusts -- Time to Buy or Dump? -- article in Ezine Articles

Review of Canadian Income Funds book in Go Articles

The Safest Way to Profit From Investing In Canadian Income Funds -- on my new Squidoo lens on Canadian income trusts.

If you're not already familiar with Squidoo, it's a fairly new site that allows you to put up pages on subjects you're interested in and knowledgeable about. It encourages the marketing of your own products and as an affiliate.

Despite the government's proposal to end income trust taxation, these are good investments now -- and it's possible that the proposal will never be passed into law. If you're a Canadian citizen, write to your members of Parliament.


Canadian income trust resources
Canadian income trust resources

Dividend Yield Hunter site

This site has its heart in the right place -- investing for income -- and so I wanted to like it more than I did:

Dividend Yield Hunter

One problem is that its domain name is misleading . . . it's focused on non-dividend income investments -- REITs, Canadian trusts, preferred stocks, and so on. It even lists some high-yielding money market accounts.

But it totally ignored common stocks that pay dividends, so it misses the biggest way to grow income faster than inflation in the long term.

It lists some basic information on each type of investment, and then lists some of them. It contains interesting information on shipping and transportation stocks. I'd thought they were high-yielding simply because the shipping business is so strong right now. That's the impression I got from reading various sales letters for financial newsletters sent to me. But apparently these companies get a tax break from the government. So that's interesting to know.

On a technical level, this site is poorly laid out. I had to scroll right and left, and move the screen around a lot. It badly needs a web design makeover to make it user-friendly.

It does contain some news and opinion, also. It has a model portfolio, but now real plan (although to its credit it does say that it doesn't support trading.)

Comparing it to my site, I have to rank mine higher in terms of appearance and usability. I think I do a better job of giving in depth information about the investments, but I don't even try to keep up with news, so I don't give yields, which will change constantly. However, this site currently covers more types of investments than I do (yet - many more pages will come in the not too distant future). I also do not give an overall plan on my site -- but I am writing a book that will give a plan.

It's a good place to see a wide range of income investments and to get a list of some of them, so it's not a bad place to begin your research.

Dividend Yield Hunter
Dividend Yield Hunter

Global warming municipal bonds on the way?

Here's an idea for a new type of bond -- global warming bonds

Only I have to admit, the story is quite vague on details about how such bonds would work. Selling an issue of bonds would raise money -- but what would they spend the money on to reduce carbon emissions?

Also -- and very important to anybody who'd be crazy enough to invest in such bonds -- how would the bond debt be serviced? By the issuing government? Out of what revenue? General tax revenues?

One way or the other, I'm sure the taxpayers of this country are going to pay out the nose to solve this problem, if problem it is indeed.

However, unless they're a clear and rational use of the bond issuance money to generate income from whatever activity is done to reduce carbon emissions, then I'd strongly advise you to NOT add global warming bonds to your fixed income portfolio.

Global warming bonds
Global warming bonds

Canadian income trusts -- doomed or not?

I've just completed the beginning of a new section of my site on income investing -- on Canadian income trust funds.

So I just checked out the latest news, and it doesn't look good for those who've been hoping to stop the government of Canada from beginning to tax trusts in 2011:

You can read about that here:

Canadian trust fund taxation

The Conservative Party of Canada seems determined to shoot itself in the foot. It barely won the January 2006, where it promised no new taxes. So many Canadian voters feel betrayed by this broken campaign promise.

Plus, as the land of oil and natural gas in a politically stable country, Canada is well poised to benefit from the rising prices of energy, not to mention that most of these energy assets are in unstable and unfriendly places such as the Middle East, Russia and Venezuela. Of course the government knows this -- and wants to grab a big chunk of tax money.

I am sort of sympathetic to the "Why should trusts get away with not paying taxes when corporations have to" argument. My answer is that, simply, neither trusts nor corporations should have to pay taxes. It doesn't really make sense. Business structures are not people. Eliminate all double taxation. Just impose taxes on dividends received by individuals. This would make eliminate a lot of inefficiency.

Yet this is politically impossible. Liberals in Canada as well as the U.S. act like corporations themselves are evil rich people and it'd be a crime against the poor not to tax them.

Canadian income trusts
Canadian income trusts

Here's a site I found recently that could help you -- their focus is in the right places for income investors -- REITs, energy master limited partnerships, unit trusts, preferred bonds and convertible preferred bonds, fixed income bonds, royalty trusts . . . this site keeps up with yield, prices, news and so on.

ePreferreds Online


Only trouble, it's not free.

They also publish the Yield and Income Newsletter, which covers these same topics on a monthly basis.

I have two reservations.

1. Their newsletter recommendations are from major banks and brokerages. Yes, I know they're the professionals, but they must take a short term approach. They're also the institutions that encourage people to overtrade their stocks.

2. If you follow the news about which REITs are up, which master limited partnerships are down, which preferred bond issues look good, which royalty trusts don't etc -- you'll be tempted to start buying and selling your portfolio. If you get all this information and advice, you might make the mistake of actually trying to use it.

I much prefer a long term approach of diversifying your portfolio with high quality yet high yielding securities of all these types -- and holding them forever.

So I suggest you subscribe while you're still building a portfolio, to take advantage of current trends -- then forget about whether or not bond yields are too high or too low. Cash or reinvest your checks, but spend the rest of your time enjoying life or working a job or business that makes you even more money to invest.

Income Investing Site
Income Investing Site

Next -- Dow 15,000 or 10,000?

Stocks go up, stocks go down.

Do you feel poorer today than you did a week ago, thanks to the 700 pount loss in the Dow Jones Industrial Average?

If so, may I suggest that you need to rethink your investment strategy?
Another long time aphorism came to my mind in thinking about the latest decline in the Dow -- easy come, easy go.

The DJIA went from 13,000 to 14,000 in just 56 days.

Did that 7.7% rise in under 2 months reflect the American economy rising 7.7% in under 2 months? Of course not.

Yet a week ago, millions of investors were once again congratulating themselves on how smart they were to be buying stocks. I have o quarrel with that in general -- it's when you start thinking of market price rises as cash in your pocket, that I suggest you're out of touch with reality.

The truth is, we don't know the future. I don't know whether the market is going to rise or fall tomorrow, and neither do you. Nor do any of the paid commentators and talking heads.

What's more, we have no idea whether the DJIA has attained any unpenetrable "floor" . . . is there an absolute limit on how fair the DJIA can go down now that's at just over 13,000 and has been over 14,000?

We'd like to think that the DJIA will never see 10,000 or 7,000 or 1,000 again -- but we don't know. You have no guarantees. What if Al Quaida terrorists succeeded in setting off atomic or dirty bombs in multiple major American cities, including Manhattan where the New York Stock Exchange is based? How far down would the DJIA go? Who knows? Will that ever happen? I sure hope not. But we have no guarantees.

Nor do we have guarantees against biochemical terrorism, or a natural problem such as bird flu or natural catastrophes such as the flooding global warming allegedly will bring.

The trouble with called price rises in your stocks "capital gains" is that they all too often don't reflect real gains in REAL capital. The traditional economic definition of "capital" is not simply a profit made selling an investment -- that's the IRS's definition -- no, it's the productive assets of one kind or another.

Land, warehouses, forklift trucks, patents. Cash in the bank is simply the liquidity used to obtain capital assets or to pay the expenses associated with running them.

If the stock market were strictly rational, the price of a company's stock would go up only to the degree that the company achieved success in expanding its net capital assets. The price of the overall stock market would go up only to the extent that overall economic activity expanded the value of the country's net capital assets.

Obviously, the stock market is not strictly rational. Efficient, yes -- but not rational.

Of course, a strictly rational stock market would not go up or down in sharp, fast bursts. It wouldn't be so exciting, but you would still have the advantage of participating in the overall growth of the nation's economy. That's still a big advantage over money market accounts.

And if you buy only stock that pays dividends, then you get quarterly checks in your mailbox whether the market price is up or down. Use this drop in the Dow to buy dividend-paying stocks cheap.

They may never be this low again.

(Or maybe they'll get a lot lower -- but you don't know that, and you don't know when. So buy now to start collecting dividend checks now.)


Dow down 700
Dow down 700

What if . . . something unprecedented affects your investments?

Sometimes I wonder whether my way of thinking helps or hurts me when it comes to income investing and investing in general.

I think that if I were to try to get a "real" job in the financial world, I'd be at a disadvantage. That's because the general financial community accepts historical returns and situations, but I'm a long-time science fiction reader (and very minor writer) and therefore am used to asking, "But what if . . . ?"

For example, to the conventional, statistically savvy financial mind, the sun is not going to blow up tonight simply because it's been existence over 4 billion years and hasn't yet blown up. To most people, the sun going nova is simply an incomprehensible event.

But as a science fiction reader I'm used to thinking about suns going nova. If a particular star is about to go nova, it's going to go nova even though it's been in existence for billions of years, and therefore provided billions of mornings to any planets in its solar system.

My only comfort is my understanding -- hopefully not wrong or out of date -- that our particular G class, yellow sun is of a type that doesn't go nova. I put more faith in the findings of astronomers who've studied many stars that have gone nova or not than I do in the narrow, statistical viewpoint of, it hasn't happened in the past 4 billion years so it's not going to happen.

Sorry, but if there's something inside the sun that's about to make it go nova, all the statistics in the world won't stop it.

But, as I mentioned, I'm sure that pension fund managers charged with obtaining optimal performance at a given degree of risk are not interested in statistically highly improbable "long tail" events that may make their forecasts based on historical results irrelevant.

Yet the world is always changing, and sometimes the statistically improbable happens. In 1998 the Long Term Capital Asset "hedge" (I use quotes because they did not hedge their trades, but rather leveraged them 100 to 1 or more) fund placed a lot of money -- huge amounts of it borrowed -- on a derivative contract based on the historical relationship between United States and Danish government bonds.

In the summer of the 1998, a "what if" occurred that they didn't think of, despite their Nobel prizes in Economics and PhDs and Masters . . . The sun didn't go nova, but the Russian stock market did "melt down" -- losing about 90% of its value. This, following the Asian currency crisis of 1997, frightened people in developing countries around the world so much that the shipped all the cash they could to the United States and bought United States Treasury bonds, driving their price far past its historical relationship with Danish government bonds.

Net result -- Long Term Capital Asset not only lost all its investors' money and went bankrupt, the New York Federal Reserve Bank had to intervene to prevent a massive breakdown of the United States (and, probably, world) financial systems.

So . . . what if millions of retiring baby boomers start selling their non-dividend paying, "growth" stocks?

What if . . . ?
What if . . . ?

Dow 14,000, and on up!

I meant to mention it earlier, but I did notice that the Dow Jones Average closed above 14,000 for the first time in history. Hip, hip hooray!

If you're accumulating stock, you should be sorry that the shares you are going to be buying now will be more expensive -- but only Warren Buffett and I seem to have figured that out. It seems to be immutable human nature in everyone else to place more importance on the total value of the stock shares they've already bought than on the price they're going to pay in the near future.

One reason is that we celebrate capital gains over dividends is the difference in tax treatment. This was alleviated by President Bush's tax cuts of 2003, but unfortunately that law is temporary. If Democrats are in charge in the future, they've made it known that they'll allow the lower tax rates on dividends to expire.

This would be bad, but I still advise investing for income. To get the preferential tax treatment on capital gains, you still have to realize those capital gains by selling them. And with many stocks after the baby boomers start to retire, you may not have any capital gains.

But the run up to Dow 18-20,000 foretold by Harry S. Dent seems to have begun.


DOW 14,000
DOW 14,000

Austrian School economic prophesy

Is the world and U.S. economy in a bubble which will inevitably break?

This article maintains that it is, based on the work of the Austrian School of economics:

Austrian economics

I don't know, of course. And just because the current leaders of the Austrian school think we're in a worldwide bubble, doesn't mean Hayek and van Mises would think so if they were still alive.

The dislocations which the author mentions all result from the drastic lowering of the value of the U.S. dollar. Perhaps India's stock market is valued more than the U.S. stock market in part because so many financial newsletters, including some from Agora, Inc -- the author's employer -- emphasize how much India and China's economies are growing in relation to the rest of the world.

If India were as economically developed as the U.S., its stock market obviously would be worth a lot more than the U.S., since India has 3-4 times as many people.

The advice to put 20% of your portfolio into gold, I think is crazy. Especially after reading Peter Bernstein's book The Power of Gold, which is a terrific argument against everything "gold bugs" such as this author say.

My own advice is to put all of your portfolio into income-generating investments such as stocks that pay dividends, if if you need to use DRIPs (Dividend ReInvestment Plans). Gold is just a metal -- it doesn't write you any checks, and it costs money to store safely.

I'm not saying the price of gold won't go up in the future -- perhaps tremendous just as the gold bugs are predicting.

But the problem with that is the same problem I have with buying stocks and other investments for capital gains. You can't realize your profit without selling the gold/stocks. And then you miss out on future gains, plus you must pay capital gains taxes.

There's at least one gold mining stock -- BHP Billiton -- that does pay dividends. If gold goes up, its dividends will likely go up. So you could buy shares of that company if you want to hedge your portfolio with gold.




Austrian doom and gloom
Austrian doom and gloom

Smart Capitalist blog

I found a website with a great domain name. I wish I'd thought of grabbing it -- Smart Capitalist.

It's a blog, and of course I was attracted to the article on High Income Investment Cash Cows.

I like the general thrust, but take issue with a few items. One, although energy and pharmaceutical companies are in the news a lot, that doesn't mean they're not cash cows, so they're not in the same category as high tech stocks. Some energy and pharmaceutical companies return a lot of cash. Obviously, oil and natural gas and energy itself are rising in price. And pharmaceutical companies have a good business in that once they find an effective drug and get it approved, it's a high margin business. The drug itself is almost "digital" in that it can be replicated very cheaply. The high price is not due to the ingredients, it's to pay for the research. So once a drug makes back its research costs, it's a big money maker.

He mentions insurance, too. I don't recall seeing insurance companies in the high dividend paying lists, but maybe they're just behind the biggies (REITS, consumer goods, utilities, banks). After all, Warren Buffett bought Geigo Insurance for Berkshire Hathaway, so he expected it a large cash flow from it. They buy a lot of clever and entertaining radio ads, so I assume they're still making good money.



smart capitalist
smart capitalist

The Gold Standard Not So Golden?

Reading The Power of Gold by Peter Bernstein makes me think again about gold as the money standard. I posted before my misgivings about how mining gold apparently creates wealth, instead of the formation of new, better and cheaper goods and services. Bernstein's story dramatize the effect of gold (usually negative) on economies through history, including what happened when Spain stole so much gold and silver from the New World.

And if the economy activity of a country increases, how does that automatically increase the supply of the gold metal? It obviously doesn't.

Yet the concept of hard money is still very popular. Conservative talk show hosts like to promote gold-buying services. I remember when Laura Ingraham interviewed Ron ?, a popular economic commentator and analyst (his own radio show used to be carried here in St Louis on Saturday night, but unfortunately they dropped him). She was surprised that Ron joked that everybody should own enough gold to "bribe the border guards."

The price of gold can go up, but this is not the same as the benefits of a passbook savings account. It's solid metal that doesn't itself pay any money or interest.

Bernstein is building a strong historical case for saying that gold is a liability rather than an asset, at least when you take it beyond its function as decorative jewelry and an electrical component. It's not money, is the message I've gotten from the book so far. And when you try to make it money, it's dangerous.

And the glory years when the world was on the gold standard? This was not the norm. The gold standard in the sense of pegging a country's currency to a fixed price for gold and saying that your paper currency is always redeemable into gold -- that's a product of the 19th century through the beginning of World War I. As somebody during that period said, and which Bernstein quotes enough times to make it clear he agrees, the gold standard was not the cause of the world's prosperity during that period -- it was a result of it.

I'm looking forward to reading what he has to say about modern times and finances.



gold standard
gold standard

MAKING 36% by Dr. Terry F Allen

Fuller Mountain Press sent me a small book for review: MAKING 36%: Duffer's Guide to Breaking Par in the Market Every Year In Good Years and Bad by Dr. Terry F Allen.

It's basically a lead generator book. That is, if you read it, get excited and want to begin its program -- but you're understandably intimidated by the work involved -- you can enroll in his email trade notification service.

Basically, he advocates making 36% by putting on calendar spreads. These are option trades that take advantage of the difference in volatility between LEAPS (Longterm Equity AnticiPation Securities) and short term options.

Unless you're already an accomplished options investor, I know that's as clear as mud. I've read about calendar spreads before, but I found his explanation somewhat difficult to read in detail. Yet, I know reason to doubt that it works. I'm simply doubtful that too many people can put on these trades and also make the necessary periodic adjustments simply from reading this book. I'd certainly hesitate to risk my money on that. But again -- that's all the more reason why you need his email service.

So far as I know, his method his standard. He does confine his calendar spreads to one particular equity -- one which I wouldn't have guessed, so it's not fair of me to reveal it here.

Plus, he provides a great service by giving us the name of a broker that allows us to do option trades within an IRA. That is terrific news for all of us saving for retirement.

For more information, go to Terry's Tips



calendar spreads book
calendar spreads book

Chinese investment advisor blogger arrested

This story about the arrest of a Chinese investment tips blogger is interesting, and scary in several ways.

Chinese investment tips blogger arrested

First, it reveals that the Chinese government gives warnings by first arresting people. This is apparently their warning to other such people giving investment tips. This guy did apparently go beyond giving his advice, as I myself do on this blog -- he made over $1 by selling investment advice. Here in the U.S. I'd be breaking the law if I gave individual investment advice since I'm not legally qualified to do that. (Though if you want to pay me $1 million, I might consider risking the penalties! :) )

Secondly, the investing psychology of the Chinese people is a boom mentality. A few weeks ago I read an article about how some woman believed that the Chinese government would not let the stock market crash before the Olympics of 2008.

So many Chinese investors apparently think they're now getting a free ride from the stock market -- it's going to keep going up and make them rich because the government won't let it, at least before the 2008 Olympics, to keep from losing facing internationally.

They may even be right, which means the whole question becomes, will they all pull out right before/during or after the Olympics? And, who's going to pay for it all?

Thirdly, the Chinese people also want the security and comfort of taking investing advice, including tips on specific companies, from other people who supposedly are experts. I could be wrong, but I suspect that right now there're not a lot of Chinese shareholders who have heard of the Efficient Market Theory, asset allocation, diversification or the benefits of index funds.


Chinese investment blogger arrested
Chinese investment blogger arrested

Euro headed down thanks to euro-boomers?

So Richard Lehman is complacent about the coming baby boomer retirement "crisis" -- in the United States. Interestingly, he's not so complacent about what's going to happen soon in Europe. In his viewpoint, Europeans are too used to living on the welfare state. As I said in my last entry, he expect American boomers to just keep on working until they can afford to stop.

He expects European boomers to stop working and demand that their governments pay the promised retirement benefits -- no matter what.

Since few of them have this money (most Western European Social Security systems are in worse financial condition than that of the U.S.), they're going to have a problem meeting this demand. Also, birth rates in Europe in the past 30 to 40 have been lower on average than that in the U.S. Therefore, there're going to be even fewer workers per retireee than in the U.S.

Therefore, Western European governments are going to have to run their printing presses full-time, to send their baby boomer generation the pensions they've been promising them since they established their post-World War 2 welfare states.

End result -- the euro will be inflated and lose value in comparison to the dollar.

So the current situation where the euro is at a record high against the dollar won't last more than a few years or so.

euro baby boomer retirement crisis
euro baby boomer retirement crisis

NO USA baby boomer crisis, says author

I just read Income Investing Today: Safety & High Income Through Diversification by Richard Lehman, and he casually dismissed the upcoming
baby boomer retirement crisis.

No problemo, he says. Most baby boomers just aren't going to retire, at least not for many years.

He notes that in 1935 when the Social Security Act was passed in the United States, the average life expectancy was 64. Therefore, they knew in advance that over half of all workers weren't going to collect Social Security at all!

Now life expectancy is in the 80s. There's no reason to stop working at age 65, and so baby boomers won't. They'll be too scared of running out of money before they die.

This will bolster the Social Security trust funds, because these older workers will keep paying into the system. Plus, they won't be drawing checks until they reach the age (I think it's now 70) when they can receive full checks no matter how much money they earn.

This will also bolster the Medicare trust fund, because these boomers will still be covered by health insurance (though he doesn't seem to think about how much demands will be placed on health insurance companies by covering so many people in the 60s and 70s).

I think he's correct to a degree, but it won't be as smooth as he implies. For one thing, I'm sure that most baby boomers will not want to continue working at the same job they've hated for the past 30 years.

Start an online auction business, yes. Sell macrame designs, yes. Teach English to children in Nairobi, yes. Open up a bait shop in the Ozarks, yes.

Keep working the same, dull boring job -- no.


no baby boomer retirement crisis
no baby boomer retirement crisis

The Power of Gold

I've started reading Peter Bernstein's next book, The Power of Gold. Its theme can be discerned from the subtitle: The History of an Obsession. Its focal point seems to be the old story of a man who was transporting his fortune -- in the form of many pounds of gold -- when this ship he's on is hit by a bad storm. He strapped the gold to his body and of course it drags him to the bottom of the ocean. He didn't have the gold -- it had him.

Still, as always, Bernstein weaves a fascinating narrative of belief and history. I'm pretty sure that when we get to modern times, he's not going to come down on the side of those who believe that we should return our money to a gold standard.

But this book's copyright is in 2000, before the current run-up in gold's price. Are we in the early stages of a new bull market in gold? Should we care?

My own attitude is shaped by the realization that gold doesn't dividends, although it's possible for gold mining stocks to do so. It's not common, though BHP Billiton is a top international dividend paying stock.

gold
gold

Income Investing Book

Today I just made an important addition to my income investing site - I launched by sales letter for the book YES, YOU CAN BE A SUCCESSFUL INCOME INVESTOR! by Ben Stein and Phil DeMuth.

It's a good book, the one which opened my eyes to the absurdity of throwing money at common stocks in the hopes of capturing capital gains in the future, which you can't profit from without selling the stock and losing future.

In the near future I will finish my own book on income investing, but in the mean time you can read about Stein and DeMuth's here:

Income Investing for Baby Boomer Retirement


income investing book
income investing book

Preferred Stock Investing -- good book

I've finished reading PREFERRED STOCK INVESTING by Doug K Le Du and I'm quite impressed.

While I've been (justifiably) writing about the temporary, unpredictable nature of capital gains of common stocks, this guy has been looking at preferred stocks -- and figured out a system to capture the capital gains that many preferred stocks have, particularly during periods that interest rates are decreasing.

To reinforce his point that this system is very safe, he continually contrasts it with the benefits of certificates of deposit, but finds that he can usually get a total return more than 3 times that of a CD. He claims that the risk is the same. I'd say that's not true -- but it's true that the risk of high quality preferred stocks is low. He has criteria for screening out the risky ones.

If you work his system for enough years, you may eventually lose some money to a company that goes out of business, but it'll be rare. In the meantime, you can make a lot more money than with a certificate of deposit.

This book is a lead generator for his email notification service, which charges you for the information to work the system. However, he's fair - the book gives enough information to work the system yourself. But it'll take some time and trouble and paying fees to some websites, so it's probably cheaper to let him do the work for you if you're going to commit to making money this way. The price of this service may change, but it's quite reasonable - a lot less than I expected, in fact. I pay more a month for my Internet access.

And the worst that can happen is -- you collect quarterly dividend checks that are probably 3 times higher than the interest a CD would be paying you.


preferred stock investing
preferred stock investing

Preferred stock investing

I wouldn't have thought there was anything exciting about investing in preferred stock, but it turns out I've been wrong. I'm reading PREFERRED STOCK INVESTING by Doug K Le Du. I haven't finished, but it's clear he's outlining a clever way to take advantage of the ups and downs of preferred stock prices that result from interest-rate changes.

Figure out the interest rate trend, combine with his knowledge of how preferred stocks work, be very selective in your buying of these stocks (he gives 10 strict criteria, and only one to three such preferred stocks are newly issued every month), buy them cheap (using a smart method I'd never heard of), and then hold them until they reach their maximum value.

While I don't believe he can predict interest rate rises and falls, you can figure out the overall trend -- enough to use this system to make a profit.

I also like how one of his principles is reducing work. I think far too many financial/investing writers want readers to do tremendous amounts of research, read annual reports and so on.

My one possible objection is that his system does include selling for capital gains. However, finding new preferred stocks to "ride" on their way up, and using a smart system to get predictable capital gains is so different from common stocks that I am inclined to think this may be worth it. I'll reserve judgment until I've finished reading the book.

You can get it at: preferred stock investing.



preferred stock investing
preferred stock investing

Dividends versus Capital Gains Part 4

Bernstein also gives an unfair example -- unfair because, to make a rational argument, he uses an extreme and emotional example.

In 1974 Consolidated Edison voted to suspend paying dividends, because they were faced with a financial crisis. Many investors were upset, and Bernstein quotes a woman as saying that since her husband died Con Ed had to be her husband and support her.

Now, Bernstein is correct that in this extreme situation the board of Con Ed did the correct thing. A bankrupt company can't pay dividends. I'm not saying that a company should pay dividends that it needs to survive.

But that's not the normal situation. The textbook argument is not that a company pay dividends and go bankrupt or stay in business . . . it's that a company should not pay dividends to expand the business or invest in other, more productive businesses.

Shareholders are co-owners of the business. They should see some return (and I mean REAL, spendable return -- not the kind of "returns" that most financial writers refer to when they call capital gains a 'return' even though NOTHING has been returned to the shareholder by the rise in stock price) on their investment -- or else they'd be better off in bonds.

Let's say you bought a McDonald's franchise. When it's new you'd have to buy equipment, the building, and so on. Once it's established, it should reinvest some profits in maintaining or replacing needed equipment, interior decorating, advertising, and so on -- if the current number of fryers and grills and satisfying the customer demand, it doesn't need to buy new ones in the hope that if it does, more customers will walk into the restaurant.

Given that reality, who would blame the franchise owner for taking some of the profits out of the business? Nobody, except Bernstein.


Given these many issues, I think it's quite rational for investors to think that $1 in their pocket is worth $2 in the retained earnings of a company whose stock they own.

stock dividends
stock dividends

Dividends versus Capital Gains Part 3

And what about investors? Bernstein argues that if they need money, they'd be just as well off selling their shares of the company, which in theory are worth that much more, because the company didn't pay dividends.

He writes that it's irrational for an investor to spend $600 in dividends to buy a TV but not to be willing to sell $600 worth of stock (that didn't pay out dividends) to buy the same TV.

But as I've argued above, the share price in the long run is only a little influenced by retained earnings.

If stock prices always reflected a rational evaluation of the company's balance sheet, and balance sheet improvement (or decline) were always 100% reflected in the stock's price rise (or fall), then this would make sense.

But in the real world, stock prices rise and fall every day purely on the give and take of supply and demand, between the bulls and the bears, mostly due to factors beyond the individual companies.

Today's $600 capital gain could easily become tomorrow's $600 -- or more -- loss.

Stock price rises are not permanent.

A dividend check cannot be taken back. The shareholder may waste it, but at least it was theirs to spend, reinvest or lose.

A capital gain is here today, gone next year.

Maybe for a lot of years.

As Bernstein well knows, dividends were the only reason to own stock from the October 1929 crash to 1954, and from 1966 to 1981. Is he saying that if companies had only refused to pay dividends that their stock prices would have gone up despite the Great Depression and World War 2. Despite the social turmoil of the 1960s, the Vietnam War, Watergate, the 1973 oil embargo and the tremendous rise in commodity prices during the 1970s, and the tremendous spike in interest rates?

Does he really want to say that companies could have raised their stock prices during all those problem periods, if only they'd refused to pay out dividends but reinvested the dividends instead?

Given the uncertain and fluctuating nature of capital gains, it's hardly a surprise that investors want to hang on to the shares of stock they own and collect the dividends. When they keep the shares, they can continue to collect the dividends, or even collect capital gains in the future if they so choose.


stock dividends

stock dividends

Dividends versus Capital Gains Part 2

Granted, many companies just can't afford to pay dividends. New companies that still must make a lot of investments to secure their businesses. Capital intensive companies that have to spend a lot just to keep up with the competition, and so on. Still, I would advocate that most investors stay away from such companies.

The companies that do traditionally pay dividends tend to be older and more established. They can afford to pay them.

One good example is Coca-Cola. It's paid only probably billions and billions of dollars in dividends to shareholders over the course of its long history. If it'd kept all that money, would it be even more successful? Would it have smashed all competition from Pepsi to Vess? Would Coke be sold in every single country in the world, even North Korea? Would every person in the world be buying a 6 pack or more a day? Or that the executives who introduced New Coke would have figured out they were making a mistake?

I don't think so. I could be wrong, but I think Coke has obtained as much brand saturation up to this point as it could have. It will keep expanding in the future, of course, and branching out into different kinds of drinks, but I don't think that there'd be a Coca-Cola bottling plant on every corner of the world if only Coca-Cola had refused to pay its shareholders dividends. I think many people in the world had to wait for various political and technical barriers that had nothing to do with Coke itself to fall. Plus, there're cultural and financial reasons why many people don't buy a drink they're not used to and can't afford. And of course Coke can't buy entry into North Korea or Iran.

I doubt its stock price would be so much higher that its investors would be glad it didn't pay any dividends.

It's Bernstein himself in an earlier section of this book that stresses the action of "return to the mean," or that trees don't grow to the sky, and businesses don't take over entire stock exchanges. At some point, the useful of that cash to the business would have to diminish. Some businesses have a natural limit to their growth, bounded on consumer tastes and other demand for their goods and services.




stock dividends

stock dividends

Dividends versus Capital Gains Part 1

I was reading Against the Gods by Peter Bernstein again last night, and near the end there's a section about the misperceptions and departures from pure rationality that investors make. I was shocked when I started reading a section that began by saying that there's no rational reason for corporations to pay dividends, or for shareholders to want them to.

As much as I've enjoyed his books up until then, I now have to think that when he wrote that he purely had his head up his rear end. That's a rational academic argument, but it's got no relation to the real world.

The academic argument is that when a corporation pays out dividends, it is losing cash that could be better spent in other ways, such as paying down debt or being invested in some way to make a better return. By being used to improve the company's balance sheet or to make a better business investment, the company's financial position is improved.

This means that the company's stock in theory will be worth more, because the company will be in a better financial situation.

At the time this book was written, capital gains got preferential tax treatment, so an investor receiving dividends paid full tax on them but an investor raising the same money by selling stock paid less in taxes. That's been changed in recent years, but the Democrats plan to go back to socking it to the owners of dividend-paying stocks (anybody who owns dividend-paying stock is obviously rich and evil and needs to have their money taken away from them ((according to class-warfare Democrats)) . . . by I digress.)

(Bernstein didn't mention transaction charges, which favor the dividend receiver over the stock seller who must pay brokerage commissions, but I admit that's minor compared to the tax difference.)

That's a great theory, and a company's stock price does get adjusted for payout of dividends, but that's hardly a major factor in a company's stock price determination. As Bernstein has written about himself, per modern financial theories a company's stock price is mostly determined by the overall market.

How many investors say to themselves, I liked company X at $50 a share but since it just paid out a dividend of 50 cents per share I'm not going to pay over $49.50? Stock buyers that really like that company will buy at market.

Furthermore, it's not real world to say that all cash a company keeps in retained earnings is invested well. Companies can and do waste it. It may just go to give company officers more stock options, which is not a benefit to shareholders. It may go to acquire another company which is a waste of time and effort. Many things can happen to that cash, many of them of no value to shareholders.

The 50 stocks in this Mergent index are not doing poorly in the market place even though they pay dividends.

Not to mention, Enron, Global Crossing and obvious frauds. Most companies and executives are not frauds, but that doesn't mean they're building shareholder value the best way with retained earnings.


stock dividends
stock dividends

Don't sell stock and you don't have to worry about volatility

Later in Against the Gods, Peter Bernstein comes close to what I'll be writing about in my own book on income investing.

He points out that the volatility Harry Markowitz posits as equal to stock market risk does not matter to "For true long-term investors -- that small group of people like Warren Buffett who can shut their eyes to short-term fluctuations and who have no doubt that what goes down will come back up -- volatility represents opportunity rather than risk, at least to the extent that volatile securitites tend to provide higher returns than more placid securities."

In that sentence he cannot get away from a concern with market price. But he does mention his wife's late aunt who used to boast that she was his only in-law who never asked him what he thought the market was going to do.

"I didn't buy in order to sell," Bernstein quotes his aunt-in-law.

Most people don't understand this attitude -- but it's perfectly logical if you are buying to receive dividends for the rest of your life.

Then you don't need to care about the market price, as long as you continue to receive ever-incresing dividend checks every quarter.
Your only risk is the danger that the company will decrease, suspend or end its quarterly dividend payments.

dividends overcome volatility
dividends overcome volatility

Volatility is a good proxy for risk only if you are a short-term investor

Against the Gods by Peter Bernstein is subtitled "The Remarkable Story of Risk" though this is somewhat clipped. Obviously, risk as danger is not something that has a story. The book is about the attitudes and techniques people take in facing risk.

We have always faced danger. But we couldn't always buy insurance.

When it comes to stock market investing, Bernstein does finally discuss the nature of risk, when writing about Harry Markowitz's famous paper Portfolio Selection.

Because Markowitz uses volatility as a "proxy" for risk, Bernstein writes. The vast majority of financial writing do not even realize that volatility is not risk per se.

So he does discuss whether or not volatility is a good proxy for risk, or whether there's a better way to deal with it. If you don't look upon volatility as itself dangerous to your money, then stock market investing is less risky than putting your money into
a certificate of deposite that is risky because of its low yield.



volatility does not equal risk
volatility does not equal risk

Value investors exhibit Gambler's Fallacy

Peter Bernstein continues to raise interesting points in Against the Gods.

He writes about the concept of regression to the mean, and how this has worked as a system of investing for people such as Warren Buffett and other value investors. Although he doesn't mention it, it also explain the Dogs of the Dow technique (before it became well known.)

Not to mention the "magazine cover" effect. This is where people who make the covers of magazines in their fields for their accomplishments often go downhill afterward. SPORTS ILLUSTRATED has actually studied it, because there're numerous examples of players and teams who have never been so good as they were before making the cover of that magazine. One options guru I know of (you likely get mail order advertisements from him) uses magazine covers as a contrary indicator in his system. If a company or CEO makes the cover of a business magazine, it's time to dump the stock!

It also explain the Growth Trap as explained by Jeremy Siegel in his latest book The Future for Investors. When you pay a premium for a stock with great growth prospects, you don't do as well as you do when you put the same money into an investment that is not comparatively overpriced. He compares long term investments in IBM and Standard Oil, and in China and Brazil. (Yes, in the past Brazil has been the better long term investment despite all its political and economic problems and despite China's phenomenal growth -- keep that in mind the next time you get sales letters in the mail telling you that you're going to be poor if you don't invest in China and India.

However, keep in mind Bernstein's caution that it's not always easy to know where the mean is and when the regression will occur. People who invested in the stock market in 1930 because they thought the crash was over lost a lot of money.

In gambling circles, the belief that random results will soon revert to normal because they've been abnormal, is known as the Gambler's Fallacy.

A lot of people have lost a lot of money to casinos because they were sure the roulette's wheel long streak of red "had" to end on the next spin, or 7 had to come up, or the slot machine had to pay off . . .

regression to the mean
regression to the mean

Stock prices are a random walk toward greater wealth

In another section of Against the Gods by Peter Bernstein, he discusses whether or not the stock market truly moves in a "random walk" -- if it does, the graph of the market should resemble a normal distribution, or bell curve.

He graphed the moves of the markets for every month for 70 years, and found that they did indeed resemble a normal distribution bell curve -- with two differences.

First, there is an upward bias. That is, the long run the stock market does go up. We know that. And it proves that capitalism works. Our free market economic system is, on the whole, creating wealth, and this is reflected in the stock market.

Second, the "long tail" at the left is much bigger than a strict normal distribution would call for. This means, paradoxically, that extreme market moves to the downside happen more frequent than is statistically probable. His graph would have included the 1973-1974 downturn and the October 1987 crash.

Short term market results are not predictable. Stock prices change as a result of new events and information, but these events are unpredictable. Therefore, they add up to a random walk that as Burton Malkiel has described moves upward in the long run, thanks to the wind of economic growth.

If you want steady Eddy market prices you have to go with something like Treasury Inflation Protection Securities that increase in value on a regular basis and also have the benefit of going up at the inflation rate.



random walk
random walk

Nifty Fifty means you can overpay for growth stocks

Against the Gods by Peter Bernstein continues to contain a lot of concepts that are enlightening me in my research on investing for income.

He discusses Daniel Bernoulli and the Petersburg Paradox, where Peter tosses a coin until it turns up heads. For every toss of tails, Paul must pay Peter a number of ducats doubled from the previous toss. That is, 1,2,4, and so on into infinity. The expected value of being Peter is infinite, but nobody would pay that.

Then he transitions into the late 1960s and early 1970s when it seemed like the Nifty Fifty stocks were going to go up to infinity, and investors bought their shares as though they were worth any amount up to infinity. As though the real risk was in not owning shares in these stocks rather than in owning them, no matter how expensive.

If you know any stock market history, you know what happened. The market crashed in 1973 and hit terrible lows in 1974. The Nifty Fifty fell even farther than other stocks, since they had farther to fall. They did not surpass their December 1972 peaks again until July 1980.

Yet he also points out that they were good stocks and if you'd bought them at reasonable prices and just held on for the long run, you'd have made good money. They didn't grow into infinity, but they did have good growth prospects.

Bernstein doesn't mention this, but I suspect that their dividends made them worth holding on to. The real risks were in paying too high a price for the income stream and in selling those stocks when the prices were low.



Nifty Fifty
Nifty Fifty

Risk and the utility of wins and losses

I've been reading Against the Gods by Peter Bernstein, which is about risk and how people have learned about probability, how to measure risk, and to some extent control it or use insurance to relieve it.

According to him, it was a man named Bernoulli who first articulated the idea of utility -- that is, that individual people put different emotional values on outcomes. A previous ancient writer said that people should not be so afraid of being struck by lightning, since it happened so rarely. Bernoulli said that people just put a higher emotional importance on the risk of being struck by lightning than of other, more common, dangers.

And Bernstein points out that human life would be a lot less rich if there weren't people who put a lot more value on the reward of taking a risk than they did on the loss they'd suffer from failing. Those are entrepreneurs, explorers and other pioneers who set out to accomplishment something (often at great cost) that is unlikely but which could bring great wealth.

It also explains why I play the lottery. The purely numbers-oriented people say, "The odds are 75 million against you, it's a scam." But I put a greater value on the (admittedly, highly unlikely) wealth I could win than the $2 I lose by playing.

If I didn't play, that $2 would just be absorbed into my daily cash budget, so it has a low utility to me. But I wouldn't have the right to dream of what I'd do if I won.

And who knows? Maybe someday I win. I know the odds are against me, but somebody eventually wins all the money. As long as I have a ticket, it could be me.

If someone has to beg for change on a streetcorner, then they should spend that $2 on the food they need to survive.

If you're depending on the lottery to make you wealth, you need to get off your butt and learn how to make, save and invest more money. You need to perhaps buy some government TIPS bonds to help your savings keep up with inflation.

But don't blame the lottery because some people who play it actually should use that $2 for some other purpose, or because they're too lazy or unambitious to work for wealth in other, more certain ways.

utility and risk
utility and risk

Income Investing Today - new book

Income investing is becoming a more popular subject. I just found another hardcover book devoted to it in the bookstore today -- Income Investing Today by Richard Lehman. I've got it on order from Amazon and can't wait to read.

Obviously there are many people looking for an alternative place to put their money besides a passbook account in a bank or chasing "growth" stocks that often don't grow - or which soon pop like a balloon.

My only concern is that, from flipping through it, it's obvious that he comes from a fixed income background -- although he prefers to avoid that phrase -- and so focuses on various securities besides dividend-paying stocks. This puts your portfolio at risk from inflation.

Still, it takes dividend-paying stocks years to catch up and then surpass the higher fixed income securities, and money in the present and near-term is worth more than a money in later years.


Income Investing Today
Income Investing Today

Asset allocation period for rebalancing advice is poort

However, something about the how-to information on asset allocation in both books disturbed me even more than one writer wanting to see patterns in short-term random results.

The advice about rebalancing.

Both of them say that after a period of time you should rebalance your portfolio, selling the assets which have most risen in price and buying more of the assets which have risen the least (or fallen!).

There is no clear cut consensus on how often you should do this, nor even any guidelines. The books mention periods of one year, quarterly, monthly and even weekly -- but leave it up to the reader.

This seems to me an incredible weakness, for several reasons:

1. Using a short period means you have little opportunity to take advantage of long term trends. For example, if you'd started an asset allocation program in 1995 would it have made much sense to sell off all your stocks in 1996? That bull market ran through March 2000.

Also, bear markets can go on for a long time. Some asset allocation programs contain gold. If you'd started an asset allocation program in 1981, your portfolio would by now consist almost entirely of gold . . . how happy would you be about that?

2. If your accounts are not tax-sheltered, you're realizing taxable capital gains, so part of your portfolio's gains are going to the government.

Even tax-sheltered accounts will have increased transaction costs. Brokerages like to rebalance client accounts every quarter. I wonder why they do it so often?

Seems to me that a poor asset allocation program is little better than an HYIP con game.



asset allocation rebalancing flaws
asset allocation rebalancing flaws

Asset allocation assets exhibit random covariance

Recently I read several books on asset allocation. This is not a full review of them, but I did notice several disturbing points.

One of the books wrote a lot about the variance between difference types of assets, such as stock and bonds. This variance is a critical point for asset allocation, because the theory behind it, Modern Portfolio Theory, comes from Harry Markowitz's work showing that overall portfolio risk is reduced by holding assets that don't go up and down in tandem.

Anyway, the book went on at length about how tricky this is, because the variance of stocks and bonds changes over time, and came up with different variances over 3 year periods in the past.

I had one of those flashes -- and it goes like this.

The stock market moves in a random walk.

The bond market moves in a random walk.

Therefore, whether stocks and bond prices go in different directions through various 3 years periods is . . . ta! da! --

Random.

I mean, at any given moment either market go only be going up, down or sideways. Therefore, sometimes they'll go in the same direction, sometimes they won't.

Yet this book wants you to adjust your allocation periodically on the basis of these random moves.

Look, the whole idea is that you're reducing risk because these two markets both are random, but can go in different directions. But it's obvious that sometimes they'll go in the same direction.

If you want uniformity, put your money in a passbook savings account in a bank.


asset allocation illusion
asset allocation illusion

No level playing field for individual investors aiming for capital gains

Last night I began re-reading CAPITAL IDEAS by Peter Bernstein and suddenly he gave away an important clue about why individual investors such as you and I are at a disadvantage when it comes to trying to beat the stock market.

He mentioned how much the market's volume has gone from being transactions by individual investors to transactions by funds - pension funds, mutual funds, endowment funds and charitable funds. And he casually mentioned how these were tax-free -- that is, free of all capital gains taxes. He repeated this again a page or two later.

The proverbial light bulb went off over my head. No capital gains taxes! Say what?

I don't know about you, but I never knew that before. To tell the truth, I'd never thought about these funds paying capital gains taxes. I just assumed they did.

I can understand why the government allows them to sell securities without paying capital gains taxes, but it still puts you and I at a significant disadvantage relative to these institutions, when you and I try to compete as stock pickers.

We have to pay capital gains taxes. That's a significant drag on the long term performance of any person buying and selling stock. It's why Warren Buffett's favorite holding period is "forever."

So by not having to pay it, these institutions are making decisions free of a major constraint that we face.

This is a major factor in the stock market -- and nobody's talking or writing about it.

So it's one more good reason why we should be investing for income, not capital gains. Because if we play the buy stocks now so they'll go up and we sell them at a profit game, we're competing against major institutions and fund managers who not only have tremendously more resources (including their time) than we have -- but they don't have to pay capital gains taxes, as we do.

Don't pay capital gains taxes, yet enjoy a cash return from your investments -- buy securities for income, and never sell them.


capital gains disadvantage
capital gains disadvantage

Stocking picking PQ randomly distributed?

Somewhere earlier in this blog or in an article, I speculated that the great investing success of Peter Lynch, Warren Buffett, John Templeton and a handful of others is not due to them being lucky stock pickers/coin flippers (as the Efficient Market Theory would have to claim), but neither does their success refute the Efficient Market Theory.

According to EMT, it's extremely difficult to beat the market on a long term basis -- but not necessarily.

I speculated that the ability to beat the market long term was made up of a number of personal qualities which were distributed randomly through the human population. So, quite by randomness, those individuals were born with and had the opportunity to develop the qualities that made them able to beat the market.

Therefore, the ability to beat the market still adheres among money managers, pension fund managers and mutual fund managers to a normal distribution, where only a small percentage do in fact beat the market long term.

Yet it's not due to luck in stock picking, but "luck" in the sense they were born with the ability (or, most likely, combination of abilities).

Anyway, in reading CAPITAL IDEAS by Peter Bernstein, he says something to the same effect, calling this beat the market long term ability "Performance Quotient" or PQ and speculates that only a tiny percentage of the population has the genius-level PQ.

He brings up an idea I didn't think of -- that most people with PQ do not manage money for others. They prefer to keep their talent (which still has to be coupled with hard work, just as people with high I.Q.s still have to work hard to come up with genius level ideas) and their investing results to themselves.

I'm not so sure of that -- successful money managers can make a lot of money by managing other people's money. Yet it's also true that the most successful managers are probably just as good or better at selling themselves than at their long term results. And many people with a high PQ may not be good at selling themselves -- it's a separate talent, after all.

Yet Warren Buffett started out forming a limited partnership with friends and relatives.

So who knows -- it's one thing to have a high PQ. It's another thing to have enough money to invest with it so that you can get rich.


Stock Picking
Stock Picking

Profit taking is dis-respecting capital gains - good!

According to the news, stock investors have spent the last few days "taking profits." Years ago I read a sour comment by a trader that they wished they were taking profits, but in reality was simply trying to get out at less of a loss.

Still, since the overall market did reach record highs early this week, I'm sure that many people did have profitable positions.

So if holding onto stocks for long-term capital gains the optimum procedure, why do the traders who know the market best always rush to convert their capital gains to cash? Could it be they value cash in their hands today more than the nebulous prospect of future capital gains -- capital gains which exist only on paper and which could go up in smoke tomorrow.

$7 trillion in capital gains vanished in March 2000. Today's Dow record could turn into the high water mark of a flood -- a record, but the water's receded. Capital gains come and go.


profit taking
profit taking

Harry Dent's latest bubble boom predictions

I just got through skimming the latest update from Harry Dent. Dent is the demographer/forecaster who uses demographic information to make stock market predictions, and has an enviable record of calling bulls and bears not based on company info, but on where in the lifestyle spending cycle the baby boom generation is.

In his most recent book, THE NEXT BUBBLE BOOM he predicts that the downturn from 2000-2002 would be followed by another bull market that would dwarf what we saw in the late 1990s -- with the Dow reaching 32,000 to 40,000 by 2010!

What's he saying now? I'll give you a hint - he's found another long-term cycle, the Geopolitical Cycle, which also affects results. And a look at today's headlines make it clear it's not boosting stock market results, although we're having a bull market despite the world's problems.

Dent still calls for a boom but has modifies its extent - and you better know when to get out. Because he's still calling for it to be followed by a long, extended bear market until 2022.

To check out the report, go to:

Harry Dent latest bubble boom report


Dent new forecasts
Dent new forecasts

New Dow Jones Industrial Average Record High

The Dow Jones hit a new record high yesterday, and as I write, it's higher for the day today.

Should you be cheering? If you're about to sell some stocks, yes. Otherwise, why bother?

If you're still buying stocks for your retirement, why would you cheer? The amount deducted from your paycheck will buy fewer shares of stock than before. More shares of stock are good.

True, the total market value of the shares of stock you have already bought is higher, and that makes you feel good . . . but so does cocaine, and it's not good for you in the long run.

Ideally, you should want stock prices to remain very low until right before you sell them -- then have them shoot up.

Of course, in real life they go up and down in unpredictable fashion and don't try to please you, me or anyone else.

The first quarter 2007 GNP is the lowest in 4 years. Will that bring the market down? Maybe.

Northwest Airlines emerged from bankruptcy. Will that bring the market up? Maybe.


stock market records
stock market records

Read CAPITAL IDEAS by Peter Bernstein

Last week I felt the need for a organized, comprehensive, textbook-ish explanation of Modern Portfolio Theory and other related modern financial concepts. I found several in Amazon that looked, but are expensive so I delayed ordering them.

But Sunday I checked out the book CAPITAL IDEAS by Peter Bernstein, thinking it was a history of Wall Street, and from reading the first 50 or so pages last night, it's obviously the comprehensive look at Modern Portfolio Theory I've been looking for, though written in a more interesting way than most textbooks, and organized in a way that makes sense to me, as a history or chronology of the events. Plus, he goes into what he knows of the personal lives of the people involved, helping to humanize the events.

I remember seeing glowing reviews of his book on risk, but didn't realize before the value in his earlier books. This is the first one of his I've read, and now I know I'll be reading the rest.

Burton Malkiel's A RANDOM WALK DOWN WALL STREET is good but doesn't explain these things in the step by step order of their historical development. So if you've read that book but you're still fuzzy on how the pieces fit together, CAPITAL IDEAS seems to be the solution.


Capital Ideas
Capital Ideas

Dividends and immediate gratification

In thinking about the usual need of people for immediate gratification, I'm surprised that so many people are hypnotized by the prospect of future capital gains versus immediate dividend or income income.

Increasing stock prices is one reason why companies buy back their own stock is to increase share value.

However, you can't spend any of this money until you sell the stock.

But apparently people feel an immediate gratification just from seeing a rise in the price of their stocks, even though they can't spend that money until they sell, and when they do they'll have to pay a hefty percentage to the government for capital gains tax. People get immediate gratification just from seeing the market value of their portfolio increase.

Plus, it's also true that, depending on when you buy the stock, it may be months before you receive that first dividend check. The market price can go up right after you buy it. But you actually have to wait a while for the dividend checks.

And, admittedly, the dividend yield on most stocks is so low that you have to buy a large amount of stock to get any kind of substantial check. And if you can afford to buy $20,000+ worth of stock at one time, the small percentage of current dividends still must not seem like much money to you.

The numbers for bonds and some other investments are larger than for most common stocks, but admittedly still don't seem a large return relative to the value of the money used to buy the security.

So, the magnitude of the numbers involve twist reality to make people think that they have big capital gains even though can't spend them, but dividends aren't worth waiting for, even though that's the current and ongoing reward for owning stock, which you can spend.

If you're going for capital gains and mistake market value for money in the bank, you think you still have all your original money plus the capital gains which could be much larger than any dividends.

financial immediate gratification
financial immediate gratification

Chinese stock market boom times

The AP today carried an interesting story about the stock market boom in China. The Shanghai Composite Index has gone past the 4000 mark. And it could go past 5000 in a month. This, on top of a 130% increase last year.

One broker was quoted as saying that 6 months ago they opened 4-5 new accounts a day - now it's 40-50 a day.

This trading is called, "chao gu" -- stir-frying stocks.

And people are mortgaging their homes and dipping into retirement funds to buy their shares of stock. Trading volume in Shanghai and a smaller exchange in Shenzhen recently exceeded all other stock markets in Asia -- including Tokyo.

A 60-year old cleaning lady doubles her initial investment of 20,000 yuan in two months -- and is celebrated in the media.

P/E ratios are around 30 to 40 -- still well below 1999 Internet and high tech stock pinnacles in the US.

Yet the article concludes with the observation by a Chinese woman that, "We hear that before 2008, the government won't let the prices fall. We're not afraid."

Personally, I think somebody ought to be afraid. True, China's economy is growing at about 10%, an incredible rate. But so much of what the article describes sounds like 1999 all over again.

Apparently bank accounts pay just 3% dividends. I don't know if there's anything equivalent to American certificates of deposit or CDs, but the Chinese want higher growth.

I'd think the Chinese government would also be frightened of this boom. If everybody panics and wants to sell, how are they going to keep prices up, whether the 2008 Olympics have taken place or not?

China's huge push for growth comes out of a need to employ millions more people every year. Plus, there is a lot of unreported unrest in the countryside. If millions of Chinese people see their retirement savings vanish or lose their homes due to a stock market crash, that could cause a lot of damage to the economy, and pose a threat to the authority of the government.

It could soon be interesting times, investing in China.


Chinese stock market boom
Chinese stock market boom

Dividends and delay gratification

So much of investing, as so much of life, is a push-pull between the present and the future.

The better you resist the temptation to overeat bad foods now, the healthier you'll be in the future.

Same with exercise -- the more healthy exercise you do now, the better you'll be in the future.

The more money you save now, the more you'll have in the future. If you go into debt, you're really stealing from you're own future.

Yet it's so difficult to follow this through consistently. I've tried to tell young adults that they should start saving money, and they just start giving me excuses. Someday they'll be 50 or 60 and wish they'd taken my advice -- but they won't listen now. They'll have to learn the hard way. They just won't be convinced that if they'd work hard now, save a lot of money and let it grow, they could live like queens and kings in later life.

But "later life" is just not real to them yet. Drinking with their friends tonight is. The latest CD is real. The latest electronic toy. They just don't believe that if they give up those things now, they'll have much more pleasure later.

There's a similar dynamic with income investing. The best long-term income investments are the stocks of good dividend paying companies that consistently raise their annual dividends. Mergent has a list of about 300 companies that had raised their dividends every year for at least 10 years.

Yet, because the current dividend yield is so low, many income investors buy bonds, for the higher yield today. Even though the semi-annual coupon of bonds never goes up.

In 20 years, the dividend-paying stocks will be paying far more for the money they cost than bonds. But it will take 15 years or more to get to that point, and who wants to wait that long?

dividend investments
dividend investments

Inflation and TIPS bonds

One of the biggest risks of income investing is inflation. If you insist on picking stocks and selling them, you'll lose a lot of money that way. Income investors avoid that stupidity, but they still have to deal with the creeping loss of purchasing power. That's one of the discouraging things. Traditionally, income investors have bought bonds, but these are subject to inflation.

One good idea that happened during the Clinton administration was the introduct of Treasury Inflation Protection Securities which are basically zero coupon bonds with the government growing them faster as inflation rises.

How have the elderly traditionally dealt with inflation? Well, before World War 2, it wasn't an issue. If you had enough income from bonds then you continued to have enough income from bonds, although in the long run that could vary somewhat as interest rate levels rose and fell. Still, they didn't do that to extremes.

inflation TIPS bonds
inflation TIPS bonds

France to roll back socialism?

Hell froze over yesterday, which is another way of saying that the conservative candidate in France's presidential elections beat the rear end of the socialist candidate, and one of the first things he says is that France is going to be a friend of the United States from now on.

Plus he's going to make some much needed economic reforms to rollback socialism in France. All of which will be good for investing, since the more financial freedom people have anywhere in the world, the greater the wealth creation within the world. That's good for investors all over the world, whether they invest in stocks, bonds or even money market funds.

We saved Eastern Europe from communism, only to see Western Europe fall to socialism. Hopefully this is a sign that the continent is not totally and hopelessly lost.





French investments
French investments

Immigration and Social Security

I'm a little late, but most of you know that on May 1 various groups advocating changes in immigration law put on rallies in cities around the country.

Immigration is an interesting issue for many reasons, and very complicated. What does it have to do with investing?

First, unless you're savings up a lot of money and investing for income, you probably will depend on Social Security for income in your old age.

Yet all projections show that once us baby boomers start retiring in large numbers, there's going to be a huge gap between what the younger generations are paying into the Social Security trust funds and what the baby boomer retirees will technically be eligible for given their work records of paying into the system while they were employed.

I'm convinced that the reason leaders in both the Republican and Democrat parties don't crack down on illegal immigration and are proposing faster routes for illegal aliens to become citizens is that they're hoping that young immigrants working and paying Social Security taxes will "rescue" the SSA system for us baby boomers.

Yes, it's true that many illegal aliens work for cash. But many have Social Security numbers or use Social Security numbers of other people. This means that FICA taxes are taken out of their paychecks and sent to the Social Security trust funds.

Every year, the Social Security Administration sends every American over the age of 25 an Earnings and Benefit Statement showing their total gross wages for the past years. If the number for a year on your statement is larger than you expect, check your W-2 forms. Maybe an illegal alien is using your number.

Horrors? Hardly -- they're increasing your eventual retirement check. You can go to your local SSA office and have them take the earnings off your earnings record . . . but guess what? The trust fund is not going to return the money to anybody! If you don't keep the credit for those earnings, nobody will -- but the government will keep the money in the trust funds.

In THE FUTURE FOR INVESTORS Dr. Jeremy Siegel states that he believes that retirements for American, European and Japanese baby boomers will be funded by young investors in India, China and other developing countries buying up the stocks and bonds of our companies.

I don't know if that's true. Or whether it's desireable if true. But I believe the government's response to the immigration situation comes from the hope that illegal aliens will eventually fund the Social Security trusts.

immigration and Social Security
immigration and Social Security

Beware of mutual fund charges

If you have money in mutual funds, I hope you're doing it the smart way. Readers of my blog are too smart to invest their money in load mutual funds, right? You wouldn't put your money in a mutual fund that charges you a front end load, right? Please say you know better than that.

That front end load is 2-8% of your money that you lose right off the top, as your immediate "reward" for choosing that particular mutual fund out of the only 8000 or more that you could have chosen. That load goes into the pockets of the mutual fund company and is split with the broker or financial planner who conned you into sending your money there.

Studies have proven -- mutual funds that charge a load don't perform any better than no-load funds, no matter what that broker or financial planner who wants to get a commission from you claims.

Also beware of mutual funds that charge you a rear-end load -- that's a charge to withdraw your money. However, I admit I can sympathize with that one somewhat, since I believe that once you invest in something like volatile like stocks, you should be keeping your money in for the long haul.

What many people don't realize, however, is that even no-load mutual funds can charge 12b-1 fees to pay for all the advertisements they place in financial magazines. Also, they do charge management fees.

Management fees are legitimate, of course -- they aren't running the mutual fund for free. However, many funds take out an amount that's so large it dramatically affects your long-term performance.

That's why if I were going to invest in a mutual fund, I'd almost certainly pick Vanguard, which has notoriously low expenses. There're not the only ones, but they're a safe bet.

But personally I'd rather not invest in mutual funds. Their only advantage over owning individual stocks is diversification, and you can obtain that with exchange traded funds.

"Expert" management is often touted as an advantage of mutual funds, but since numerous studies have shown that actively managed mutual funds underperform the market in the long run, this to me is a disadvantage, not a benefit.



beware mutual funds
beware mutual funds

Baby boomer retirements hanging over our heads

It's inevitable that my thinking about investing and investments also be tied up with the concept of retirement. That's because I'm facing retirement in the not too distant future. Also, because so are about 78 million of my fellow baby boomers.

It's very unlikely that we'll treat old age the same as our parents.

Based on the expectation that baby boomers will begin selling stocks at age 65 to meet their retirement expenses, a lot of people expect stocks to go into a long bear market starting roughly 2009 or 2010. I'm not so sure the moment will be a dramatic, for several reasons.

It's unlikely every baby boomer who turns 65 will immediately sell all their stocks and go into bonds.

Not all baby boomers will turn 65 at the same time. When the first bunch hit 65, there'll still be many millions of us who are not yet 65, and still buying up stocks for our retirement funds.

From what I read, people who want their resources to last for the rest of their life, should not sell off more 4% of their assets in a year. Baby boomers following that advice will not immediately sell everything right away.

Many baby boomers will simply switch jobs and careers to something they enjoy doing, and so will delay having to live on investments.

A few of us plan to hang on to income-generating investments for the rest of our lives. Why sell stocks that are paying out good dividends? I don't want to live on the total yield generated by selling off shares of stock. Then I'd have to pay too much money to the government in capital gains taxes. I want to live dividends that keep growing every year



baby boomer retirement
baby boomer retirement