The Kindzia Blog

Swine Flu and Stock Markets Follow Up - April 30, 2009

I received some follow up emails after yesterdays post on Flu Pandemics and Stock Markets.  It appears that many of the readers felt the article gave the impression similar to "who knows?" what will happen if a real pandemic occurs.

I'd advise you to go ahead a review the stats one more time.  Perhaps a good summary might be, "Who knows in the very short short, but in the long run, I'm pretty darn sure..."

But if you don't want to re-read yesterdays post again, I'll give you something different and a little more clear to think about.  If you can't make out short term or medium term correlations between the two, I'd advise you to consider the following;

The value of the S&P 500 back on January 2, 1957 (the year that Asian Flu pandemic began) - 44.72

The value of the S&P 500 at the close of market yesterday, April 29, 2009 (keep in mind that the news about the pandemic is already out, markets factor in all known news and this is AFTER perhaps the biggest recession since the big daddy great depression) - The S&P 500 closed yesterday at 8,185.73.

Let's review one more time to see if you could pick out a long term trend based on the two numbers.

S&P 500 at the start of 1957 - 44.72

S&P 500 at the close yesterday - 8,185.73.

Safe to say that I think investors would have done ok even going through a few pandemics, a few wars, a few recessions, a few stock market crashes and even a severe recession tacked on to the end.

Just one last thought from a financial advisor and professional investor...most investors LAG the market.  That's right.  They don't do as well as the overall market.  In addition, most investors would do pretty well if they had long term returns that EQUALED the market, nothing more and nothing less.  But for many reasons (including poor investment behaviors), they continue to try to time the market.  But as I've written in previous postings, they have a terrible track record of timing markets (because they don't sell close to the tops, and they don't buy towards the bottoms.)  They tend to do the exact opposite which is what we are again seeing recently in the markets.  They rode equities down towards the bottom, to then sell low.  In turn, they reinvested in bonds (which are paying yields that are not only crappy in historical terms but far off the rate of return that they need to meet their long term objectives).

But, I'm willing to bet once the market comes back up and stabilizes and we enter a new phase of economic growth, many of these same investors will return to buying equities (just at much higher prices).  Funny how the game works.

Swine Flu, Pandemics and Stock Markets - April 29, 2009

Recent financial headlines have contained such items as, “World Stock Markets Plunge On Pandemic Fears” and “Swine Flu Hits Markets, Fears Of Pandemic Rise.”

 

Flu pandemics are the result of new strains of viruses that affect people that have no natural immunity.

 

According to the World Health Organization, a pandemic starts when three particular conditions have surfaced;

 

1.      A new disease is introduced to a population

2.      The disease and its agents infect humans which causes serious illness

3.      The agents/disease spreads easily and sustainably among human population

 

From an economic standpoint, pandemics are worrisome as they can impact as much as 15 to 35 percent of a given population and as a result, massive productivity loss as employees are simply too sick to work.

 

Analysts attempt to predict the impact of such pandemics on the economy and how different scenarios might impact specific businesses and industries.  Pandemics may impact the profitability of certain businesses and sectors more than others.  For example, if travel restrictions are put in place, this would impact an industry like airline travel which in turn may trickle down to the oil industry as a result of decrease demand for fuel.

 

An example of that was during the six month SARS crisis which occurred between November 2002 and July 2003 when international air traffic declined by about 30 percent.

 

Other companies such as drug maker GlaxoSmithKline, who produces Relenza, one of two medicines found to be effective against the deadly new strain of swine flu, saw its shares increase in value on Monday, April 27, 2009 by over 7.5%.

 

But do all pandemics mean doom for stock markets?  Here’s a brief summary of the three most recent flu pandemics and how they related to the equity markets;

 

Spanish Flu Pandemic of 1918 – This pandemic was possibly the deadliest outbreak ever on record.  Approximately 20 to 40 percent of the worldwide population became ill and some estimates state that it killed about 40 to 50 million people worldwide.  The S&P 500 fell by 24.7% in 1918, and rose by 8.9% in 1919.  The European/UK equity market rose by 25.4% in 1918 and by 27.0% in 1919.  The time period of 1918 and 1919 also coincided with the end of World War I.

 

Asian Flu Pandemic of 1957 – This pandemic was the second largest outbreak in recent history and came in two waves.  The first wave primarily impacted young children while the second wave mostly impacted the elderly.  It caused about 2 million deaths worldwide.  One difference between this time period and that of 1918-1919 was the advances made in science and healthcare.  The virus was quickly identified in 1957 and a vaccine was available in limited supply by August 1957.  The S&P 500 rose by 24.0% in 1957 and by 2.9% in 1958.  The European/UK equity market fell by 5.8% in 1957 and rose by 40% in 1958.

 

Hong Kong Flu of 1968 – This pandemic was mild compared to the previous two pandemics of the century and mostly impacted the elderly.  It caused approximately 1 million deaths worldwide.  The S&P 500 rose by 12.5% in 1968 and by 7.4% in 1969.  The European/UK equity market rose by 57.5% in 1968 and fell by 15.6% in 1969.

 

Stock market history shows that investors do react to pandemics in the short run.  However, as is the case with all breaking news, other issues also affect markets and the performance over the mid to long term is more dependent on the strength and weakness of prevailing economic conditions and long term profitability of businesses.  Therefore, although the equity markets react unpredictably to the unknown and can be volatile in the short term, such historical events should be taken in context of long term prevailing market conditions.

 

One thing is certain.  For those interested in prospering financially during or beyond any pandemic, the key is simply to survive it.

 

Stay healthy.

Why Investors Fail - April 22, 2009

Numerous studies indicate that most investor’s returns (often including the institutional investors) lag the market.  Some investors lose more than others and along those same lines, some often lose enough for multiple investors.

Is it because of a lack of higher education? Do they lack raw intelligence?  The answer is “no” to both of those questions.  Most investors possess not only a college degree (and often advanced degrees) but also plenty of raw intelligence to earn decent returns.

So what’s the problem?  Where do they break down and fail?  It’s not brain power that is causing them to fail, it’s a breakdown in investment behavior triggered by negative induced emotions.

Below are a few highlights of poor investment behaviors that sabotage the long term success of investors.

As easy as it is to hear the words, “Buy low and sell high,” that is not what happens.  As crazy as it sounds, the equity markets defy the basic laws of economics.  (Kindzia, are you crazy?  Did you just say the stock market defies the laws of economics?)  Yes, and here’s how.  The basics of economics revolve around the laws of supply and demand.  Looking at a basic demand curve, what we should witness is a negatively sloping curve.  What this implies is that as the price of goods and services rise, demand should fall.  Think about a pound of lobster for a minute.  If the price of lobster goes up to $100 a pound, demand should fall off a cliff.  But if the price of lobster were to drop to $3.99 a pound, demand should be much higher.  As price increases, demand decreases.  Got it?  Good.

Now, let’s look at the cycles of the equity markets (stocks).  What happens on the extremes of the demand curve?  As the prices of stocks increase (think strong bull market), demand increases (people want some of that fast easy cash.)  Investing is great, and simple and it’s easy money.  It is so easy your Grandmother can day trade and earn annual returns over 25%!  To repeat; as stock prices increase, demand increases (WHAT THE?!?!)

Now let’s move to the other extreme.  What happens in a big bear market?  Stock prices decrease.  And what happens to demand?  You got it, it shrinks. 

If you want proof, we could look at cash inflows and outflows in mutual funds.  Cash inflows into mutual funds are often at their highest at the top of bull markets.  For the month of October 2007, when the S&P 500 ended the month at its highest month end value of 1,549.38, cash inflows into mutual funds were +$24,558 billion for the month (with a “B” kids).  One year later as prices dropped and the S&P 500 was 37.5% cheaper, cash outflows for the month of October 2008 were -$127,988 billion (that’s minus $128 billion with a “B”).

Humans are an emotional bunch.  And unfortunately for too many of them, they make investment decisions based on these emotions and their “feelings” rather than crunching numbers or using logic.  Further, their feelings often sway them into making decisions based on what the market recently was rather than where the market is going.  They “zig” after the market already “zigged” and then once they’ve zigged, the market “zagged” and left them waiting for a bus that never came.

Markets move in cycles (albeit very difficult to predict cycles) but investors aren’t necessarily doing themselves any favors during these cycles.  Case in point, at the end of February 2009 when the S&P 500 closed at a end of month low of 735.09 in comparison to the month end high of 1,549.38 back in October of 2007, did investors line up to buy low?  Absolutely not!  They sold their equities and moved into bonds.

For the month of February 2009, equity (stock) mutual fund outflows were -$25,029 billion while total bond mutual fund inflows were +17,152 billion.  And we see negative investor behavior in action at its worst.  The market “zigged” and moved to lower prices.  Investors reacted in the short run and then “zigged” themselves after the fact.  The key to successful investing is not going where the market just was but rather where the market will be.  If an investor was really apt at timing markets, the time to sell equities and move into bonds is not at the bottom of the cycle, it’s at the top.  The time to sell all of your equities and move into bonds wasn’t February of 2009, it was October of 2007!

So now where does that leave an investor?  Should they be loaded up on bonds and cash right now?  I’d be willing to say, “Probably not.”  If we go back and think about cycles, ask yourself this, “Assuming you can’t time the absolute bottom of markets, (just like we can’t time the top of markets), make the question a bit easier.  Right now are we at the top of an economic cycle and stock market cycle?”  I think you would be nuts if you said yes to that question. 

If we are not at the top, would it be fair to guess and say that we are closer to the bottom of a cycle than the top of a cycle?  And if we are at the bottom of a cycle and prices are low, should we be invested for our long term in bonds when the 10 year Treasury bill is yielding a pathetic 2.75%?  Will you hit your retirement goals if you yielded 2.75% over the next 10 years?

Further, bond prices rise while interest rates fall.  Likewise, bond prices fall when interest rates rise.  What is the risk return model of owning bonds in this interest rate environment?  How much lower can interest rates go when they are already down to practically nothing?  So best case scenario, you yield the low interest rate.  Worst case scenario is that you locked up at a low yield and rates move upwards and the bonds depreciate in price.  Not a lot of investors are taking this into consideration as they ran from the equity markets.

Finally, do we really want every investor buying stocks at the bottom of the cycle?  No, there always needs to be a buyer and a seller to make the sales transactions happen.  If we want to be the ones buying when prices are down, we need able and willing sellers at lower prices.  Think about it this way, if we really want to buy something at a great value, we need people to act irrationally and sell us valuable things at a discount.

Investors seem to always claim that they are long term investors.  I guess we should probably have them define what “long term” means in their minds.  I think of long term in terms of decades (or at least years).  But if we look at the trading practices of most investors, their idea of long term investing isn’t even six years but more like six months, six weeks or often only six days.

The time to buy stocks for the long term is now.

A Little Like Driving - April 15, 2009

Happy tax day!

I wanted to write a little analogy that compares driving and investing.  Imagine for a minute that the driving speed limit would equate to "average market returns." 

Now imagine that you wanted to go on a long driving trip, say across the United States.  Let's call that your long term goal for the trip, to go from New York City to Los Angeles.  And let's say you were interested in doing some planning for the trip such as, "how long will it take me to reach my goal?"

Well, the first thing that you would do is figure out the approximate distance which is 2,800 miles.  The next thing you would do is try to approximate the distance you could travel per hour, let's call that 55 miles per hour.  So then you could conclude that it would require about 51 hours of driving time to complete the 2,800 miles.  Factor in how often you plan on stopping for fueling (gas and food) and also sleeping/resting/sightseeing, and you could come up with a reasonable estimate to reach your goal.

Now does that mean that throughout the entire trip you would be driving 55 miles per hour at all times?  No, that would just be your average speed.  At times you might go faster (and even break the speed limit).  Other times you might have to slow down as you pass through a town, or go through a school zone.  You might even find that as a result of some unexpected bad weather or a severe accident, you might have to take a detour which requires you to add to your total distance.  Sometimes we even get lost.  Thus, you might have to actually go in reverse (albeit temporarily) to eventually reach your goal.

Now think of investing.  What is your long term goal?  What is your average "speed" at which you will be moving forward?

When you are driving, you do have the option of attempting to "go faster!"  Heck, we've all seen people fly past us driving 100 miles an hour at some point.  But what are the risks?  What are the times it's worth "going just a bit above the speed limit?"  Maybe we should even ask ourselves if it is even worth going too fast.  With increase speed comes increased risk.  And if we were going to try and make up a little time, would driving 100 miles an hour through a school zone be the prudent thing to do?  Is it worth a speeding ticket?  Is it worth the physical harm or permanent damage?

Likewise in investing we need to assess our comfort level in moving towards our financial goals.  Is it worth doing some speeding?  Is it worth the extra risk?  But at the same time, do we really want to do the entire trip refusing to use the interstate highways (like using stocks) but rather stay on secondary roads with speed limits that are only 35 and 45 miles per hour (like using bonds or cash)?

As an advisor, I often see investors that only want to drive on the slow country roads that pass through every town.  But I also see my fair share of those who are willing to put the pedal to the medal and attempt to speed their way through the entire trip it taking on enormous risk.

Think of the stock market as taking a trip across the country at an average speed of 55 miles per hour.  Sometimes you move faster, sometimes slower.  Sometimes there was a wreck (and it might have even involved you through no fault of your own).  And the path between two points isn't perfectly straight.  It has some curves and bends and like I stated above, sometimes you have to add some miles to move around some unexpected events. 

Plan accordingly, but it's worth the trip.

Interrelated - March 15, 2009

If we seek to achieve goals in life that encompass my big three (wealth, health and happiness), we often discover how much these three relate to one another in our lives.  A large deficit in one area can quickly spill over and lead to a deficit in another area.

Wealth allows us an opportunity to not only purchase goods and services that make our lives more enjoyable and convenient (things that make us happy), they also can purchase goods and services like quality foods, medical care, and gym memberships that can lead to improved health.  But in times of recession or financial disarray, individuals also experience how a lack of wealth can lead to mental and emotional issues like stress, worry, fear, anxiety, anger, depression and despair.

In times of financial stress, individuals turn to items like drugs and alcohol, develop poor eating habits that revolve around binge eating and use food and drink as a source of immediate gratification in times of hopelessness.

If poor behaviors and habits continue over long periods of time, health diminishes.  It's tough to be happy when we are unhealthy.  Further, if we get to a point of severely diminished health, it's tough to stay wealthy (ultimately, we can't take the wealth with us once our health expires...)

Although wealth can solve a lot of problems and provide a lot of advantages, if you eventually had to choose between a clean and impressive looking personal balance sheet versus a clean bill of health (or angiogram) I bet many of the super-wealthy would eventually wish for the clean bill of health.

This should lead us right back to asking ourselves the appropriate way to balance our goals that encompass all three areas of wealth, health and happiness.

Living a life in full pursuit of immediate gratification for the sake of here and now happiness, is unsustainable over long periods of time without ignoring our health and financial security.  Likewise, being a health nut at the expense of our overall happiness or financial security has its flaws as well.  And if we look at the early deaths of business moguls who pursued financial success at the expense of all other things, we see the ultimate expense paid by a much shortened life.

It's Always Easier - March 5, 2009

It's always easier to put on an extra 20 pounds of weight than it is to take off 20 pounds of weight.  The requirements to do so would include more physical exertion, a cut back in caloric consumption, the feelings of unsustainable sacrifices, and possibly even moodiness as we adjust to new levels of normalcy.

Such is the case when making adjustments to our own financial spending habits.  It's a lot easier to live above our means than it is to live below our means.  We often find that many of our past financial decisions aren't quite as easy to cut back or eliminate because they had longer term agreements (i.e. debt payments) associated with our consumption decisions.

But ultimately, similar to losing the extra 20 pounds that we really didn't need, making the cut backs related to our spending habits results in a healthier and happier situation.  We simply eliminated the fat and excess that clogs our systems and slows us down.

As we move into the next phase of our lives, there are many important lessons to be learned from our previous behaviors of excess.  We must take note of what wisdom we acquired through past experiences and apply that knowledge in the future rather than allowing ourselves to slip back into our old bad habits caused by living in excess.

If we focus on our objectives in life (which in my case include wealth, health and happiness) we should be making day to day decisions that increase the possibility and probability of achieving those objectives in the future.  Too many times we seek and reach for the immediate gratification route at the expense of our long term success.

If we are considering our health, are we making daily decisions that ensure we are getting in an appropriate amount of exercise, an adequate amount of quality nutrients, necessary amounts of sleep, and time to decompress and reduce stress.

In similar fashion, if we are considering our wealth, are we making daily decision that ensure we are building and maintaining adequate emergency cash reserves, an appropriate level of net worth growth, and are we on a solid path to reduce and eventually eliminate any and all long term debt.

Three Current Themes of Poor Decision Making - March 3, 2009

I’m getting an abundance of calls, emails and messages and many of these are similar in nature dealing with the same issues and topics. 

As the questions (or pleading) continues, I am noticing that many investors are omitting certain factors and information from their decision making process.  As a result, this lack of information may result in more long term harm than they realize. 

Below are three recurring themes that are poorly influencing proper decision making.

1.       Failure to recognize that markets are forward looking

2.       The desire for immediate gratification

3.       Gut investing

Position #1 – The investor makes decisions based on what they see in the rear view mirror.  Investors are so wrapped up in what happened yesterday that they don’t consider what is projected to happen tomorrow.  For example, how many investors are taking into account that GDP growth is supposed to be 1.3% in 2009, 2.5 to 3.3% for 2010 and 3.8% to 5.0% in 2011 based on the Fed’s summary of economic projections which can be found HERE.

Fact; equity prices are influenced by two factors that often collide.  The first is investor sentiment.  The second is corporate earnings.  As Warren Buffett has stated in the past, “In the short run, the markets are a giant voting machine.  In the long run, the markets are a giant weighing machine.”  And what the markets weigh is the amount of future profits earned by those companies. 

Even when Goldman Sachs cut their 2010 S&P 500 per-share profit estimate to $63 from $69 (see HERE), an investor who thinks a reasonable P/E ratio of 15 should expect the S&P 500 to trade at 945 ahead of those earnings.  With the S&P 500 at 705 today, who amongst you would be disappointed with a one year gain of 34%?

QUESTION #1 – Are you investing with emotions based on hindsight information or are you investing with logic based on reasonable future anticipated information?

Position #2 – Investor wants immediate gratification.  What I mean by this is that they are making trades in an attempt to maximize their investment account balances today versus making investment decisions in an attempt to maximize their investment account balances tomorrow (or for the next 1, 3, 5, or 10 year period).  Many investors simply want IMMEDIATE RELIEF from seeing investment account balances decline.  Their investment strategy shifts from a longer term investment strategy to one that requires timing the market, short term trading, chasing hot sectors and preserving immediate asset balances.  In essence, many investors are saying, “I want my balance to be X right now no matter what” and are not making rational decisions on the probability that they can get X + Y and X + Z in 5 or 10 years by investing wisely.

QUESTION #2 – Are your decisions being influenced by immediate gratification or are your decisions being made for your long term financial interest?

Position #3 – Investor makes decisions with their gut.  It is the old, “gut instinct.”  On any given day, there are going to be investors that believe the market will go down and there are going to be investors that believe that the market will go up.  The current price of the markets is nothing more than the cumulative sentiments of the entire investment community.  If more people thought the market would go down tomorrow, then by nature, the price would have already moved downward today to reflect the anticipated reduced value tomorrow.  Again, as stated above, in the long run, market prices reflect the future profit potential of the aggregated companies in the markets.

So when an individual investor tells me, “I have this gut feeling” I don’t doubt that the feeling actually exists.  I’m sure they really do have a gut feeling.  But the markets are aggregating the gut feelings of pension fund managers, economists, institutional investors, mutual fund managers, brokerage analysts, hedge-fund managers, university professors, federal reserve staff members, professional investment advisors, and Warren Buffett.  The gut feeling of others may include facts and figures that you may not be considering.

The good news is that I went out on Amazon.com and discovered that amongst the enormous number of books written on investing, valuation, economics, and financial planning, there still isn’t a single book along the lines of, “How I made a fortune and beat the markets by investing with my gut!”

So if you can consistently call the markets based on “your gut,” I have very good news for you.  Not only will you be rich from investing, but you have a promising book tour ahead of you that should allow you to meet quite a few celebrities.  Please bring me back an autograph from Ellen because I think she is funny.

QUESTION #3 – The next time you get that “gut feeling” ask yourself, “Am I getting recurring tips from God or could this just be some gas after lunch?”

My question to you is, “Are you really willing to execute a long term investment strategy based on your “short term gut feelings?”

Financial vs. Investment Planning - February 20, 2009

Many people are feeling that this economy, housing market and financial market is for the birds.  So far there has been an increase in the subsidized bird food program in my backyard.  $10 bucks of high quality seed seems to bring me quite a bit of enjoyment each week in mini-viewing spurts. 

I received a good question from a reader that I never really gave specific thought to prior to the question;

"What is the difference between financial and investment planning?"

There's a good chance that each individual or advisor may have a slightly different interpretation of these two terms.  But I'll throw in my two cents, which after taxes and a weakening U.S. dollar is worth about two Mexican pesos.

Financial planning is the process of establishing a long term road map to achieve specific financial goals.  In my case, it is more like a personal creed, a way of life, a commitment to a process.

When I think of financial planning, I start out by asking myself, "What is it specifically that I want to achieve?"  I've thought hard over the years to get as specific as possible but not have that objective be loaded with convoluted details that hamper my ability to stay focused as economic factors that can change (often by the minute).

If I ask myself, "What is it specifically that I want to achieve," my current answer is this;

1. I want to be executing a plan where I am moving towards having NO DEBT (as in zero, nada, goose-egg).  That includes mortgages on primary homes, rental properties, auto's, etc.  Ask yourself this, "How little would it take to live if we didn't have any debt payments?"  Further, "How little stress would you have if you didn't owe a dime to any person or any bank/company?"
2. I want an adequate emergency fund that could sustain me through unusual, unexpected and unpredictable events.  When working with clients, I find that it's not the expected that causes problems financially, it's the unexpected and also the uncontrollable.  Cars break, tornados whip through houses, hurricanes devastate entire cities, jobs lost, health problems occur, etc.  How prepared are we for unexpected and unpredictable events (including cyclical setbacks in financial markets and economies?)

3. Generate a pool of capital that through dividends, interest and capital gains, could support me indefinitely; i.e. sufficient investments to live off of when I choose to no longer work even though I plan on working until I die (hopefully that is by choice and not by requirement).

So when I am thinking in terms of a financial plan, my big picture goals are always clear to see and remember; no debt, emergency fund, and sufficient investments.

As we proceed through each day, we are constantly prompted to make decisions that ultimately impact our health, wealth and happiness.  Having clear and defined objectives help make decisions that will impact us in the future.

Investment Planning is the process of choosing suitable investment holdings and strategies that hopefully allow us to reach our financial planning goals.  I break this down into two layers; what types of investments do we want to own, and then how do we manage those investments in a way that correlates to our overall strategy.

I often say, "There is a million ways to make a million dollars."  The hard part is picking one and then making it work.  But if you were to interview/examine one hundred financially secure individuals, you would find that each had a slightly (or significant) method of accumulating wealth.  Some choose commercial real estate, some choose residential real estate, some trade options, some start small businesses that eventually sell, some choose to work their way up the corporate ranks and make their money through executive compensation, some become famous artists, musicians and athletes.  Again, there is a million ways to make a million dollars.

The reality for many of us is that we either don't have the skill set to be a famous baseball player or we don't want to risk our time and money in a business endeavor that is uncertain to produce lasting material wealth.  No worries, many people have accumulated significant wealth by following very basic financial plans.

But back to investment planning.  If you are choosing to accumulate wealth through stocks (as in your 401k, IRA's and additional brokerage accounts), what is your strategy for those investments?  Are you a day trader?  Are you an economist?  Are you trying to time markets?  Are you a value investor, a growth investor, a micro-cap investor, an options investor, a currency trader?  What is your investment plan once you determined that you are going to be a stock investor (if that was your choice?)

And this is where I see many investors fall apart.  A lack of a clear, defined and specific investment strategy results in making bad decisions over long periods of time.  It's one thing to say, "I'm a long term investor who is capitalizing on the fact that corporate profits exceed the rate of inflation which results in wealth accumulation."  All that seems to go out the window when we read the newspaper, listen to the radio or watch TV during economic times that we are currently in.

Here are a few questions for you if you are trying to determine your investment planning strategy;

1. Do you think in ten or twenty years corporate profits will be much higher or much lower than current levels?
2. Will you most likely be alive in ten or twenty years from now?

If you could get clarity and confidence in those two questions, you're off to good start in making good investment planning decisions.

If your investment planning strategy requires being a nobel winning economist, the ability to forecast interest rates, a PhD in mathematics, a family member who is a U.S. Senator, or investment holdings that are loaded with mortgage backed securities, collateralized debt obligations, hedge funds, limited partnerships, and collar options, you may want to budget a little extra for mental therapy sessions with a certified professional.

You may eventually discover that trying to predict the unpredictable and control the uncontrollable is for the birds.

Schizophrenic Investing - February 18, 2009

Schizophrenia - a state characterized by the coexistence of contradictory or incompatible elements.

Based on some recent observations of investor behavior, it's clear that many investors are getting very distracted by information and data that ultimately has very little impact on their ability to reach financial security and independence.

Almost universally, current investors feel that they were in the wrong places in the market and as a result, they have seen their portfolios decline.  We all feel the emotional frustration of watching our 401k's turn into what could now be called 201k's.

Below are some returns from various indexes.  Dates used were October 9, 2007, which was the date the Dow Jones hit its high and Tuesday, February 17, 2009.  In all cases, the Barclays iShare Indexes were used and the related ticker symbols are included in parenthesis.

Those who had exposure to large cap domestic stocks such as the Barclays iShares Large Cap Blend Index (IWB) didn't like seeing a decline of 48.71% from October 9, 2007 to February 17, 2009.  Many feel that they should have had more exposure to something like Mid Cap Blend Index (IWR) until they realize that was down 51.49% over the same time period.

Maybe they should have been in small cap (IWM)?  Down 48.37%...

OK, forget U.S. stocks.  Maybe they should have went more international (EFA)?  Down 55.05%...

Emerging Markets (EEM) - Down 56.17%

Forget plain stocks, how about commercial real estate (ICF) - Down 69.55%

Natural Resources (IGE) - Down 45.88%

Perhaps they should have been in more commodities (GSG) - Down 51.5%

ENERGY!  That's the place.  Those big energy companies are greedy pigs that rip off the American public (IYE) - Down 40.63%

Financial Stocks (IYF) - Down 73.03%

Maybe they should have hid in South Africa (EZA) - Down 52.09% or Sweden (EWD) down 64.6%.

Maybe they should have skipped using indexes and just went into individual stocks. That is where the action is anyway.  How about these well known behemoth's;

• General Electric (GE) - Down 72.65%
• Disney (DIS) - Down 48.36%
• Microsoft (MSFT) - Down 38.17%

The issue is not whether you were invested in the right places or the wrong places in this market.  The issue was whether you were an investor or not an investor.

I've had quite a few people indicate to me that they no longer want to be investors.  Everyone is entitled to their own opinion and I don't put in any extra effort in wasting my time trying to explain to individuals why investing in your future is prudent or not.

The question we need to ask ourselves is, "Do we really think investing, especially over the long term, is a bad idea?"

Here is a list of what achieving long term financial security requires;

1. Generate an income stream, preferably as strong as possible.  Stay away from drug dealing even though it may appear to be profitable.
2. Live below your means.  Easier said than done regardless of the level of income that a person generates.
3. Take the difference between what you make and what you spend and invest it over long periods of time.
4. Use asset allocation (invest in assets that include stocks, bonds, real estate, natural resources, cash, businesses, etc.)  Jet ski's and football tickets don't count as asset classes.  Nor does a stockpile of beer.
5. Diversify (don't have all stocks in technology or banks or any economic sector).  Make sure you have growth and value stocks, large cap/mid cap/small cap, domestic and international.  In essence, don't put all of your eggs in one basket.  Note; CD's are what you should get at the bank, not the music store.
6. Have an appropriate emergency fund.  Usually that should be more than the change that is deposited in your car ash tray.
7. Don't take on too much risk.  If you feel like gambling, take a little cash and go to Vegas.  Everybody in Vegas appears to be good looking once you have a few drinks in you.   As an aside, stay away from stangers in Vegas that appear to be good looking if they don't include your spouse.  Bad investment...
8. Don't use too much leverage.  Borrowing money within reason to purchase a house or fund education can often be a great investment in our future.  Borrowing too much, especially in consumer debt can be a ticket to the bankruptcy court.  Note, golf clubs are not a "good investment."
9. Buy low.  I used to say, "Buy low and sell high" but if we own good quality investments and we are a long term investor, why would we sell before we need the money unless they are grossly overvalued (see tech bust of 2001 when technology stocks were trading at 200 times earnings).  How many people sell their stocks when the market is down and buy at the top of a bull market because "everybody is making easy money!" 
10. WE CANNOT TIME THE MARKETS.  Repeat after me, "WE CANNOT TIME THE MARKETS."  We think we can.  In hindsight things always look so easy.  But we can't. 

Please re-read number 10 above.  We cannot time the markets.  Fortunately that is not required to achieve success if you are a long term investor.  This is now the eleventh time that the S&P has experienced a signficant drop in the previous fifty years.  This included a 49.15% drop from 3/24/2000 to 10/9/2002 and a 48.2% drop from 1/11/1973 to 10/3/1974.  Plenty of people have achieved financial security over the past fifty years, all bad markets and recessions included.

If we look at the most successful investor of all time, Warren Buffett (the richest person in the world per Forbes Magazine), his success had nothing to do with predicting the economy, interest rates, job losses, the price of gold, politics, etc.  He bought good investments at great prices (bought low) and then he held on to those investments.  He is not very fond of selling.

For the record, the greatest investor of all time has found his Berkshire Hathaway shares (BRK-A) down 31.49% from October 9, 2007 to February 17, 2009.  That puts him down about approximately $20 billion dollars (probably a bit more than your losses...)

People that are financially secure today executed the ten items listed above. 

You and I will always hear about people that predicted or "called" the market directions.  But there are always people saying that the market will move up or down in the short run.  This has no correlation to their ability to accurately and consistently predict the movement of the markets, or interest rates, or the job numbers, or GDP reports.

A broken clock is still correct two times a day.

Protecting Your Ass(ets) - February 5, 2009

With the news continuing to roll out about the Madoff ponzi scheme/fraud, investors are left asking, "Who can you trust?"

Maybe the correct answer is "nobody."

I'm not sure I would go quite that far but one point that isn't being made enough is regarding "proper precaution" by an investor.  There seems to have been a lack of even an ounce of "skepticism" at the most basic levels of investing.

The most recent list, which is sure to grow, is now exceeding 13,500 names of individuals or institutions that have been swindled out of their money.  This list includes a variety of well known names in business, athletics and Hollywood.  For further details click here for a great article from media source cnbc.com.

This case shows how the most basic elements of protection were avoided or ignored, often by some very wealthy and sophisticated investors.  So what should an investor do if they want to take precautions and protect their assets from an episode like this.

1. Ensure that your investment funds are held by a custodian who is separate and independent from the advisor.  A custodian is a business or firm that has "custody" of the assets.  It is their business to track, report and keep a historical record of account activity and holdings.  If you are an individual investor, examples of financial custodian firms would include companies such as; Fidelity Investments, Charles Schwab, E*Trade, TDAmeritrade, etc.

2. Ensure that you are receiving statements directly from the custodian at the end of each month or calendar quarter.  Statements should not be coming from an independent advisors office directly.

3. Ensure that you could log on to your account online 24 hours a day, 7 days a week, 365 days a year to see the securities you own, the quantities owned and the cost and market values of those securities.

4. You independent financial advisor should be just that - "INDEPENDENT."  There should be a clear segregation of duties between someone who is giving the advice and someone who can have "their hand in the cookie jar."  In an ideal situation, your independent advisor should not have any access to your financial assets.  The independent advisors role is to perform a service, most often relating to the structure of the portfolio. Typical things an advisor would do as a service is research investments, structure the portfolio based on the goals and risk profile of the client, place trades to execute the purchase or sales of securities needed to assemble the portfolio and then communicate and educate the client on the status of the portfolio.  Even though the advisor can place trades on behalf of a client, does not mean they have access to the funds in the account.  They merely perform a service on behalf of the client.

If we look at the breakdown in the Madoff scandal, we see the most basic breakdowns in protecting investment assets.  Investors in Madoff's funds did not have an independent custodian and advisor.  The custodian of the funds was Madoff or an entity under the control of Madoff.  That gave him access to the client funds directly.

Month end and quarter end statements thus were coming directly from Madoff or entities under the control of Madoff. This gave them the opportunity to fabricate statements to facilitate the fraud.

It appears as though investors did not have online capabilities to log in and see what underlying securities were owned, quantities, market value, etc.  Quite frankly, investors didn't know what they owned.  (Actually, in hindsight, they owned nothing...which is the hard truth of the scheme/fraud). 

Investors took the leap of faith and invested in things that they had no idea about.  I doubt many of them couldn't explain what a hedge fund really was.  Nor did they know what the funds were invested in, what types of securities, the risks associated with those securities, etc.  There's a clear difference in owning a mutual fund or exchange traded fund in a Charles Schwab account that tracks the S&P500 versus a very complicated derivative swap.

As many found out the hard way, it's one thing to watch your mutual fund or exchange traded fund decline in a downward market.  It's another to watch your investment assets evaporate completely.  Knowing that you own a mutual fund or ETF that is comprised of companies such as Proctor & Gamble, Coca-Cola, Johnson & Johnson and AT&T should make an investor sleep better at night.

Finally, the advisor (Madoff) wasn't independent at all.  He was the opposite.  He was dependent on collecting funds from new investors to pay returns to existing investors.

The scheme clearly shows that rich, successful, popular and sophisticated investors alike can make tremendous errors in judgment that, when viewed in hindsight, appear to be rather elementary mistakes.  If large banks and institutional investors were swindled, should we be surprised that less sophisticated investors were swindled?

But here's my advice to any investor out there.  Make sure your investment assets are held with a custodian and that your advisor is independent from record keeping and handling of the financial assets.

I encourage you to pass this information on to anyone that you think would benefit from it; neighbors, family, friends, grandparents, etc.  Scandals have a way of repeating themselves because investors keep repeating the same mistakes.