The Ignorant Investor

WASHINGTON (Reuters) - U.S. Treasury Secretary John Snow said on Thursday the Bush administration backed a strong dollar and said he saw no sign of a bubble in U.S. housing prices.

His attitude is confidence inspiring, no?

In Brokerages Cut Yields For Small Investors, Jane Kim of the Wall Street Journal writes:

Some brokerage firms are finding new ways to pay wealthier investors more on their cash holdings -- and pay smaller and even mid-tier investors less.

These firms are creating new "tiers" for the so-called sweep accounts that hold clients' cash, allowing investors with more money at a firm to earn higher interest rates while those with smaller balances earn less. Some firms are setting up as many as nine different tiers to segregate customers. Others are simply raising the bar on who gets the best rates. The sweep accounts typically contain proceeds from stock sales or dividends. But some investors keep their portfolio's entire cash allocation in such accounts.

The difference between tiers are significant. Charles Schwab's rates on the same type of account ranges from .5% for investors with less than $10,000 in assets held with the firm to 2.55% if you have $5 million in assets with them. That's a pretty wide range, and if I sound overly irritated off it's because I'm a Schwab customer. What kind of firm would set up a system that seems to be modeled on Dante's nine circles of hell?

Kudos to Citibank's Smith Barney unit and the few other brokerage houses that appear to have resisted this trend. There is no way your cash should not be earning something near the rate of inflation. Losing the equivalent of 2-3% of your cash in a year is not the route to a bright financial future, particularly at a time when stock prices are growing weakly, if at all.

Seen in my daily free e-mail from TheStreet.com:

On Tuesday's pullback, the S&P held above the Quarterly Swing Pivot of 1183.55.

I am an ignorant investor. I know that. But whenever the jargon starts flying in an article, I tend to put down the paper and look elsewhere for answers. Anything involving the market that can't be quickly explained in a sentence or two is something an investor like me shouldn't go near. Run a search on the term "quarterly swing pivot" on Google, and you'll see this:

Your search - "Quarterly Swing Pivot" - did not match any documents.

So did they just make this term up, or what?

I'm writing this down now as a reminder to myself. One of the dangers in following the financial news day to day is that it's easy to let short-term gyrations distract us from focusing on the likely trends that really drive returns from year to year. What you should do now is look out a year or two in the future:

What should the asset allocation be in 2006?
What types of assets or particular sectors are now trading below their long-term averages?
What are the risks of the market tanking versus the probability of it trading in a range or moving upwards?
Are there any investments that I've ignored out of my own ignorance?

Point is, for anyone but the short term trader, what you do now in investing is based around what will happen over the next few years, not just tomorrow. You've got to adapt your planning process accordingly.

I've never made any secret over my ignorance on many matters of economics or the more complex aspects of investing or trading, but I feel like this Wall Street Journal reporter may have missed something as he writes "Yield-Starved Investors Get a Break" in today's edition:

Many riskier investments got blown away by last month's hurricanes and the attendant fears of inflation, economic weakness and higher interest rates. The Dow Jones Industrial Average sank 3.3% and the Nasdaq Composite lost 3.2% this month. Real-estate investment trusts are down. Junk bonds are down. Even the safe 10-year Treasury note has been hammered.

Meanwhile, stodgy old income investments have been quietly gaining ground. The average yield on a money-market mutual fund has trundled up steadily to 3.18%, from 0.86% a year ago. A federally insured savings account from Internet bank EmigrantDirect.com now pays out 4%. And several banks have started offering one-year certificates of deposit yielding 4.6%; that's more than the yield on the 10-year Treasury.

"It really is fabulous news for savers," says Peter Crane, managing editor of iMoneyNet, a provider of money-fund information. "Back when rates were 0.5% to 1%, people had become desensitized to yields. Rates were so bad that people didn't even want to hear about it. Now they're starting to break out the calculator and see that they can make an extra few hundred dollars by moving their money to get a better rate."

Put aside the inappropriate comparison of performance with stocks, real estate and junk bonds and focus on the idea that better rates are bringing a smile to the faces of savers. A year ago when yields were at .86%, inflation was in the 1-2% range. Now yields on bank accounts are up to 3.18%, but inflation is way up, too. Notice the correlation? As inflation rises, yields usually do, too. This is because banks have to compensate lenders (which, essentially, is what you are when you make a 'deposit') for the falling purchasing power of their money by offering a higher yield.

If I've got this right, the higher rates aren't "fabulous news" for investors. When inflation is taken into account, investors aren't making any more this year than they were last year. It's more like, "Hey- I'm pretty much where I've always been" news. Nothing to feel bad about, but it doesn't make me smile.

Seen on Yahoo in content supplied by Investors Business Daily:

Many mutual fund investors buy index funds on the belief that most fund managers cannot beat the overall market or a specific segment of the market.
That is not always true, but index funds have remained popular. If anything, index funds tend to have lower costs because there is less money management involved and less turnover than in most actively managed funds.

You'd think that a newspaper dedicated to investing would know a little more about the industry they're covering, right? The first paragraph misstates the claims index fund companies make: it's not that the indexes always beat most managers; rather, the claim is that over the long term most managers do not exceed their benchmark indexes. That's less of a claim, really, than an established fact. But, whatever. IBD is a trade publication, so it's going to mirror the attitudes of its readers, many of whom actually manage money for a living and have a real reasion to dislike index funds.

I also liked, "If anything, index funds tend to have lower costs." Well, duh. If an index fund doesn't doesn't have a fraction of the expense ratio of the average managed fund in the same class (an S&P 500 index fund should run no higher than .15-.20% vs. 1% for a managed large-blend fund), it's a sign that the company is trying to rip off it's investors. A major part of the advantage that index funds have in long term returns over their managed brethren is that savings of .75%-2% per year, every year. Surrender that advantage by investing in a high-cost index fund, you may as well put your money into a managed fund.

Quick note here on a real world example of the way assets classes tend to converge in their returns as long as you look at a long enough time frame. Comparing the Vanguard S&P 500 Index Fund and the company's Global Equity Fund, we see about the same average return over the past ten years. But if you look at the chart, you see that the S&P 500 Fund skyrocketed in the initial period of that ten year period, but since the bubble burst has mostly been flat. Compare that with the foreign equities fund, which muddled along unhappily for most of the past ten years until it had a skyrocketing period of its own beginning in 2002. Notice the way the two lines come together:


Source: Vanguard

An investor who invested $10,000 solely in either fund 10 years ago would have had long periods of frustrating returns, but would still have ended up with the same amount of money. Some sharpie someplace may have switched out of the S&P 500 into the Global Equity Fund around 1999, and if so, that person is now very happy. But from my own perspective, I think that when you go looking to play the index equivalent of Frogger you're timing has to be impeccable. Whether someone can do that consistently, I don't know.

I suppose there's a lesson here that when you think an index/asset class has gotten too expensive, look to the ones that have lagged for better returns.

A columnist at Smart Money writes:

TWO WEEKS AGO I suggested that investors sell shares of Exxon Mobil (XOM) and use the proceeds to buy Wal-Mart Stores (WMT) stock. If you'd made the trade that day, then you'd be ahead 11% overall — Wal-Mart is up 3.6%, and Exxon Mobil is down 7.4%.

I've noticed that folks at Smart Money frequently do this. They push a stock in a column or article, than if it goes up they trumpet that gain as evidence of their insight. Here's a question to ask them: "When you pick a loser, do you point out that you blew that call big time a couple of issues later?"

So far, I haven't noticed too much of that. Maybe I'm not reading enough of the articles. I try to read it all, but all the ads for mutual funds and brokerage houses tend to put me off.

Today's earnings report from Google paints a picture of a company making money hand over fist in the growing market of online advertising. I admit, I never saw this market coming. I don't know how big it's going to get. I'm constantly amazed at just how profitable it is. Seems like basic capitalistic principles should kick in and competitors Microsoft and Yahoo should be undercutting Google's massive profit margins in the hope of raising market share. So far, though, it just doesn't seem to be happening. Maybe these three are making so much money that they don't see a need to engage in some kind of price war like the damned economists say they're supposed to be doing. Damn those economists and their worthless economic theories.

So once again, Google's price is shooting up and I'm on the sidelines. The people-who-leap-in are once again justified in their anticipations; no matter what price you buy at, the stock just keeps going up. I have only one thing to say at this point: ARGHHHHHHH!!!

Yet I am sticking with my original forecast: the price of the stock has outstripped the long-term market for its product. Yes, the numbers continue to be against me. And no, I am not yet about to hang myself for not buying the stock. That's next quarter, when the company will announce that it has quadrupled revenues as all the cash spent by Madison Avenue on television, radio, and print advertising is now being driven up to a loading dock at Google Headquarters and dumped out in tall, shiny piles of gold doubloons.

Can't talk. Work to do. Will be quick. Here's the opening from Tom Herman's column in today's Wall Street Journal:

More taxpayers will be ensnared by the rapidly expanding alternative minimum tax in 2006, and more than 11 million people will pay higher Social Security taxes. Additionally, many more people will face a much higher tax bill unless Congress extends a number of popular tax breaks that are due to expire at the end of the year.

No surprise. Government revenues, 2004=16% of GDP. Government spending, 2004=20% of GDP. Probability of cutting spending to equal revenue? 0%. Only option, raise revenues.

Expect lots of accounting tricks. Expect lots of talk about "squeezing the waste out of the bloated budget." But the talk won't come to anything. The need for more revenue always works out to collecting more in taxes. If the stock market shot upwards we would see a leap in revenues from capital gains tax receipts, but in how many years can the government rely on that to cover the cuts in the rest of the tax burden? It just doesn't work that way.

Make no mistake: the AMT is a middle-class tax increase. A tax increase on auto-pilot; a cynicism-inducing mechanism and a bizarre mockery of what government should be at a time when the Republican leadership and their wealthier Democratic cronies are talking about eliminating the estate tax, a move that would benefit a miniscule portion of the wealthiest individuals in America.

I try to keep politics off the blog, but, c'mon. At some point, it's just too much.

Reading a popular market blog today, I saw this quote from somebody identified as "Clay Allen of Market Dynamics":

The investor must make a commitment to eliminating poorly performing stocks just as soon as they can be identified. The best way to identify poorly performing stocks is with a long-term chart that shows relative strength. The investor must have a very clear idea about what constitutes unacceptable performance. There must be a predetermined decision point that cannot be reached without action being taken to sell the stock.”

Now this sounds like a very good idea. Keep an eye on your portfolio, sell the stocks that have turned into disasters. Okay. Always sell the disasters. Problem is, when you switch out of one disaster stock, you face the risks that its replacement is 1) another disaster stock, in waiting, or 2) will be outpaced by the stock you've just sold as time passes.

Hewlett Packard, for example, was a terrible stock to hold from January of 01 to about June or August of 03. Trust me: I held it myself during those dark days. Between January of 2002 and January of 2003, it went from over twenty and down into the low teens, back up to 15, back down to 12 or so, and then is shot up to finish up the year by breaking $20. Now had you bought at $20, as it reached around $12 bucks or so off I assume Mr Allen would have suggested dropping this stock like a hot potato. The thing is, what would you have bought instead that would have done any better?

Had you sold HP when it was at 12 and then mentally wiped the slate clean, then bought it again the very next day, HP would have been transformed from dog into a galloping thoroughbred on your books. The stock almost doubled within a few months, and it's now circling around 28. Outstanding performance, no? The only difference between disaster and hero in HP's case was the day someone bought the stock.

The point is, in reality every day you wipe the slate clean when you're thinking about trading the stocks in your portfolio. At any given moment, if you trade out of a stock you hold, chances are you're only going to trade into another. So you're constantly measuring performance of the stocks you own not against their past performance, but rather against the performance of all the other stocks you might buy. The time to sell is when you believe that the stock will not outperform its peers over the long term, and not a day before. If you think the new stock will go up faster than the one you hold, then sell the old one and buy the new one.

Now the hard part: take a look at GE or Merck or American Standard or Google or anyone of the thousands of other stocks on the market, and you tell me which ones are going to outperform HP tomorrow and the next day. Does anyone know? No, we don't. Some of the analysts and traders on Wall Street think they know, but they're only making educated guesses.

I'm all in favor of educated guesses, simply because we don't have any choice in the matter. Pretty much all life is a matter of guessing about what the future holds. But I would never confuse guesses with facts, as some on Wall Street are apt to do. Then again, I'm not in the business of selling investment advice or selling stocks.

In the news today:

Google gave the first details yesterday of how it would carry out its commitment to devote a share of its lucrative public stock offering to charity and social causes. It said it had donated $90 million to a new charitable foundation it started and would give another $175 million to nonprofit groups and what it considers socially useful businesses over the next two to three years.

Hey Google shareholders, guess what? Google is going to take a quarter of a billion dollars of your money and give it to charity instead of putting the money to work on improving their products or expanding the business. See, once you gave it to the guys who run Google you basically told them, "Hey- here's my money . . . feel free to give it to the poor."

I suppose the company will say it's justified from a business standpoint because it's good PR, but that $250+ million seems like a whole lot of cash to put towards what amount to the CEOs' favorite charities. My prediction: In a few years we're going to see a book about just how much money Google blew through in the years following their IPO.

Just because these guys had one really good idea when they decided to sell advertising with searches, they now assume that all their ideas are brilliant. That's a dangerous kind of hubris.

I tend to zone in and out on the financial press. Watching CNBC, reading the journals, market related blogs- these things I do for fun. You can do all of it if you like, but I don't think it hurts performance to largely ignore it.

When I think back over the past 5 years of the market, in my category of "things I wish I would have caught" are two opportunities: the rise in small caps and the boom for defense contractors. However, I don't remember any articles telling me at the time that these areas were heading for a boom. And even if there were such articles, I don't think I would have noticed them among the thousands of articles, analyst reports, online discussions, and blog posts listing all the other possible trends in the market.

Among all that is written in the market in any given day, we know that some of it will be dead on. The problem is, we don't know which articles are the "right" ones. So what's the utility of reading them? I've been reading articles about the upcoming imminent recession for five years. They didn't turn out to be right, even though they were written by very smart people. I also remember lots of articles prior to 2000 about how the "new paradigm" meant the Dow could go far higher than 11,000-12,000. And in every year afterwards, the same predictions of "Dow 15,000" or "Dow 20,000" pop up, all supported by very rational reasoning. One of these days, the writer will be right. But who this mysterious writer is and when he will write this article, and, more importantly, whether I'll read it when it comes up and then, even more importantly, act on it, is the question I could really use an answer to.

So for now I'm cutting back on watching CNBC and reading market-oriented blogs and the Wall Street Journal. If anyone except me was reading this blog, I'd probably tell them to skip it and read "People" or "Woodworking Monthly" instead.

Well, we had the stock market boom. Then the real estate boom. Now get ready for the gold boom. The price of gold has risen sharply in the past couple of months, and whenever the price of something starts rising fast, there's often no shortage of investors ready to toss in money in the hope of riding the price to its peak and then bailing before it falls.

Is gold a good investment? It can be, but getting a good return on it depends on when you buy it. It's not like investing in a stock. An ounce of gold isn't going to expand its market share, increase profits, or come up with new, exciting products the way a company can. It's not going to create anything. And it's not like a loan, which pays interest. It pretty much just sits there, someplace in a vault, while you hope that it appreciates.

In the early 1980s when the price was last at its peak, it was going for something like $800 an ounce in 2005 dollars. In 2001 it was running at about $250 an ounce. If you bought in 1980, how do you think you felt to own gold over the next 20 years? If you bought in 2001, you're probably feeling pretty damn smart right now as it's playing around in the $470 range.

Short version: the upside is probably limited, and like many investments the time when the most news articles are written about it is probably the worst time to buy.

Is it better to be certain that you're right and end up being wrong than to be unsure that you've got the right answer and find out later that you were right all along? I don't know. I thought I did a while back, but now I'm not so sure even though I feel like I should take a firmer stance on the issue.

Is the economy heading for a recession or will it continue to chug along?

Will the insurgency die down in Iraq, or are the generals lying to us?

Could we get along without Texas? Maybe give it back to the Mexicans to rid ourselves of a state that seems built around cronyism and political tricks?

Of these three questions, I'm only certain about one of them. The other two, I'm still up in the air.

There will no doubt be a lot written about Bush's pick to fill Sandra Day O'Conner's slot. Mostly, it will be speculation. People like Harriet Miers don't tend to have a real long paper trail, and their friends and family and business associates know what the drill is when a reporter calls. We'll see a series of quotes on how bright she is, how hard she works, the respect that her colleagues have for her. Basically, the newspaper profiles will pick up as many warts about Miers as the average eulogy does about the deceased at a funeral.

What we do know about Harriet is that 1) she is a former big-firm corporate lawyer in Texas, 2) she is an elderly spinster, and 3) she is a close, long-term flunkie of Bush. In other words, if you wanted someone who represents the average American, this choice left you pretty damn disappointed. But c'mon- who really expected Bush to appoint anyone like that?

It's impossible to know how Harriet will rule when she's on the bench, and I doubt she's a huge radical (simply because those folks usually can't shut up long enough to fall under the radar the way Harriet has). But I'm willing to predict that: 1) she won't have a hard on for gay rights or social issues, and 2) she'll curtail Congress's rights to regulate business and she'll see a whole lot of involiate property rights sitting around every wealthy person's portfolio. Short version: She gets confirmed.

The question on everyone's lips: With an unmarried Harriet Miers sitting next to unmarried David Souter, can romance be far behind?