The Kindzia Blog

#3 - Unfunded Pension Obligations and State & Local Deficits - December 8, 2011

This is the continuation of a 10 part blog series entitled, "10 MACRO HEADWINDS IN THE FACE OF INVESTORS."

We often hear about the laws of unintended consequences.  We are witnessing some unintended consequences regarding pension funds and the long term effects on retiree's (or future retiree's). 

Pension plans run calculations each year estimating how much that they will need to contribute to the plan so that they could meet the required benefits in the future.  Future pension assets are nothing more that the past contributions into the funds combined with the growth rate of those underlying assets (investments).  Pensions then estimate how much they need to contribute and use an estimated return for those investments at about an 8% rate.

However, many pension plans (especially those for state and local governments and many unions) have under-contributed into those plans.  To make matters worse, the growth rate on those contributions are turning out to be far less than an 8% rate of return.

Pension plans need to be somewhat conservative in their investments.  This is for good reason as the need short term liquid assets to pay the benefits of those already in retirement.

If a pension plan runs an asset allocation model of 50% stocks and 50% bonds, they can generate an 8% return by getting either 10% from stocks and 6% from bonds or the reverse.

Unfortunately, not only have stocks not returned 8+% returns over the past number of years but it is highly unlikely that bonds will return anything close to 8% either.  How could they with the Fed manipulating interest rates to historical lows (around 2% on U.S. Treasury Bonds).

If pension plans invest half of their assets in bonds that pay 2%, the return on their equity holdings would have to be 14% so that the total return comes out at the 8% required rate of return in their actuarial models.  Is it reasonable that stocks/equities are going to return 14% in future years when GDP growth is stalled to crawl?

That leaves pension plans in quite a predicament.  A lower rate of return on investments would require much higher contributions to keep pace.  But that can't and isn't happening with major cutbacks in state and local governments because of budget cuts across the board due to the slow economy.

As a result, you can't avoid the inevitable.  There won't be the required funds to pay what was promised to many baby-boomers who are either approaching retirement or are currently in retirement.  The money just isn't there.

With so many baby-boomers coming into their retirement years, we have a collision on our hands of what is required for them to sustain their standard of living and what is available.  Social Security and Medicare benefits need to be reduced.  Pension funds won't be available based on what is promised.   Personal savings are inadequate and debt levels are high.

Since the majority of the economy is consumer based spending (70%) and the biggest component of spenders is the baby-boomer demographic, it's hard to imagine that this segment of the population is going to fuel a big, strong, and growing spending economy over the coming years.

#4 - U.S. Demographic Shifts - November 29, 2011

This is the continuation of a 10 part blog series entitled, “10 MACRO HEADWINDS IN THE FACE OF INVESTORS.” 

When you want to know who or what moves the economy the most, look no further than the American consumer.  Approximately 70% of GDP is composed of consumer spending that trickles its way through the economy. 

Over the past decade, the U.S. economy has been the recipient of a positive double whammy.  First, the baby boomers were in their prime spending years.  Second, these same baby boomers over-spent by taking on large amounts of consumer debt. 

Imagine a household that has $100,000 in earnings to spend.  Those earnings are eventually spent and trickle through the economy.  Now imagine the same family that not only under-saves but takes on additional debt by either tapping into home equity or accumulating credit card balances.  They not only spend their entire disposable income but they spend far more than they take in.  Extrapolate that extra amount of spending by most households and you get an over-heated economy that cannot be sustained forever. 

Fast forward to the present and now we have a negative double whammy for the economy.  The highest consumption for consumers takes place between the ages of 45 and 49 years old (with peak spending at 46 years old).  That’s when most people spend the most money in their lifetimes; raising kids, buying and furnishing bigger homes, upgrading automobiles, clothing, restaurants, travel and large amounts of discretionary spending.  Not only can consumers not keep spending borrowed money, but eventually they spend less as the result of having to pay back principal and interest on all the debt they accumulated during the last multi-year spending spree. 

There are 79 million baby boomers in the United States and that large group of people has just made their way through their peak earning years and now is on the other side of the mountain.  Naturally as people make their way into their 50’s and 60’s, priorities change.  People start to focus and worry more about retirement, savings, and a career that will be soon winding down. 

We now have a large percentage of those baby boomers that find themselves up to their eye balls in debt, approaching retirement and underfunded for their golden years.  Is it reasonable for us to assume that they will continue their high spending ways of the past?  

What we should expect is reduced spending by the largest demographic of our population.  These baby boomers should now have far less consumption as we move forward than they did during the past decade.  They not only have to ramp up savings for retirement, but they are finding themselves struggling to keep their jobs, all the while facing a mountain of debt to pay off.  Many aren’t on track to have their primary mortgages paid off prior to retirement and lack an inability to sell their McMansions to downsize their lifestyle. 

Naturally as we age, we become less productive in the workforce.  We lose technology skills, can’t (or won’t) work long hours or travel extensively.  Aging workers become obsolete or too costly compared to a younger, more skilled and harder working labor force.  It’s not uncommon for wages for aging workers to decrease as they approach retirement. 

And with reductions in retirement benefits, reduced pensions, lower social security and Medicare, the future isn’t too rosy for baby boomers to be spending large amounts of cash on discretionary items in comparison to their wild spending days of the past.  All this leads to a slower consumer economy that will face investors as we move forward. 

A similar demographic shift has been occurring in Japan over the past decade and it has not been pleasant for their economy.  The population has been aging while spending has been declining putting deflationary pressure on the economy and financial markets.

#5 - Extreme Volatility Within Equity Markets - November 17, 2011

This is the continuation of a 10 part blog series entitled, “10 MACRO HEADWINDS IN THE FACE OF INVESTORS.”

It’s an appropriate day to talk about volatility within the equity markets. Yesterday the NASDAQ hit a daily high of 2,688.86 about mid-afternoon. Today NASDAQ hit an intra-day low of 2,576.22 (and the day isn’t over yet). That’s a 4.37% swing within 24 hours of trading. And we wonder why investors don’t feel confident in equity markets?

Investors do not like volatility. It’s too hard on us emotionally to watch our hard earned savings swing up and down without rhyme or reason. It gets worse as we get older and accumulate more wealth. But this makes sense if we analyze why. Let’s go through an example.

Let’s say you are a 25 year old investor who is just out of graduate school and just starting out your long term savings and investing plan for retirement. And let’s say you are a great saver with a strong income because you are a Mr. Smarty Pants. You can save $1,000 a month (impressive for a 25 year old) and you have now been saving for 10 months.

After 10 months of hard saving you have accumulated $10,000 and right after hitting your 5 figure milestone, the stock market experiences a 20% pullback and you were invested in stocks. Now your $10,000 portfolio has dropped down to $8,000. That’s a set-back for sure but since you could save $1,000 a month, after three more months of savings, your portfolio is at all new highs of $11,000 even after experiencing a large 20% decline in performance. You could literally out-save poor investing performance.

Now let’s compare that to an older and wealthier investor. Let’s say that it is a married couple that is 60 years old, quickly approaching their desired retirement age of 65. They have accumulated $1.5 million dollars and are currently saving a very impressive $50,000/year. If their $1.5 million portfolio goes down the same 20% as the previous young buck investor experienced, that would equate to a $300,000 decline. I remind you that they are able to save $50,000/year (over 4 times the amount of savings as the 25 year old investor). Yet, where the young investor was able to save his way to all new highs after just a few months, the older couple would require over 6 years of savings at $50,000/year to close the gap on a 20% decline in their portfolio. That is a painful acknowledgement!

And so we can now understand that volatility impacts investors in different ways depending on age, wealth, emotional tolerance, and ability to save.

Our markets started going crazy again with volatility back at the end of July of 2011 as the European debt mess started making headlines again. I did a little original research since then. I took the high value of the S&P 500 each day and subtracted the low value of the S&P 500. I took that daily difference between the daily high and low and I divided the value by the previous day’s closing price. What I found was that over the past 4 months, the daily difference was 2.6% on average. That daily difference is higher than the average dividend yield of S&P 500 companies (which is about 2.3%). An investor who owns the average S&P 500 dividend stock could see the daily price swing higher than an entire years’ worth of dividends.

Why would we think an average investor would feel comfortable investing their hard earned savings in a market that is experiencing so much volatility? We can conclude that “in the long run” stocks will outperform bonds (especially since bond yields are near all-time lows), but the investor has to have the ability to weather the emotional storm along with the underlying systematic risk of the Europe debt mess.

#6 - Distorted Markets - November 16, 2011

This is the continuation of a 10 part blog series entitled, “10 MACRO HEADWINDS IN THE FACE OF INVESTORS.”

The markets are difficult to navigate due to an unprecedented level of distortions from Federal involvement. October inflation was 3.53%. At least we came down from September’s level of 3.87%. But if the government is manipulating the interest rate markets (which they are through monetary policy at the Federal Reserve) how can we get ahead when the interest rate on a 3 month treasury bill is .01% and the interest rate on a 10 year treasury bond is 2.01%?

Put this in perspective, you are an investor with $1 million dollars. You don’t want to take risk in the volatile equity/stock market so you buy a 3 month treasury bill at .01%. That means you would earn $100 bucks of interest on a million dollar bond. Wow, where do I sign up for that sh!t?

Likewise, the yield on a 10 year treasury is 2.01% today. A million dollars invested at 2.01% would yield only $20,100 in annual interest. We know that inflation is 3.53%. So with each passing day, your purchasing power is being flushed down the toilet. A wonderful treat for savers in this country! How do we expect retired folks to live in retirement off of their savings? After all, we told them over the years that pensions will go by the wayside and that they need to save and invest in their own programs like IRA’s and 401k’s. Now they are ready to retire and we tell them to go screw themselves, we need to bail out the bankrupt. NICE!!!

Dividend stocks are only attractive if we compare them against the manipulated interest rates. Interest rates should exceed the rate of inflation (usually about 150 to 200 basis points on the 10 year treasury). So if inflation is 3.5%, then long term rates should be 5.0 to 5.5%. If these interest rates were market driven (not influenced by Fed policy) then current dividend yields would not look that attractive at all.

Even so, if dividend rates on S&P 500 stocks are averaging 2.3% and inflation is 3.5%, then the only way you could earn a real return (inflation adjusted) is to get some capital appreciation in the underlying stock. But stocks appreciate if earnings are growing and earnings tend to grow when the economy is growing. How’s that growth going in Europe and here in the U.S.? Not so wonderful. Europe is slip-sliding-away into a recession.

So the government isn’t doing investors any favors. Why are they doing it then? They are doing it to save their own butt. We are accumulating federal debt at an unsustainable level (similar to Portugal, Ireland, Italy, Greece and Spain were over the years). Nations have to constantly refinance this debt as bonds come due and have to be rolled over into new bonds. What if we had to pay 4% or 5% or 6% on our new debt issues as a country rather than the manipulated level of 2%? We’d have much higher interest costs.

Eventually, the market realizes that the game is up – see Europe. Once the market feels that the game is up, investors no longer want to buy the riskier and riskier bonds at lower rates in fear that the bonds won’t be paid back (default risk). In order to offset increasing default risk, investors will want higher interest rates. If the debt levels continue to swell and interest rates spike higher and higher, the debt levels end up crushing the country (see Europe). It’s a really fun game.

#7 - The Nature of Secular Markets - November 15, 2011

This is the continuation of a 10 part blog series entitled, “10 MACRO HEADWINDS IN THE FACE OF INVESTORS.”

First hand personal experience has a way of influencing our perceptions, beliefs and biases. Sometimes we need to experience something ourselves for the lesson to register and change our behaviors. Our mothers might tell us, “Don’t touch that hot stove!” but the lesson only takes root once we actually touch the hot stove. Past history or statistics of other children burning their hands on hot stoves really doesn’t do much for a younger child. In similar sense, past history or statistics of equity markets don’t really register until the investor experiences something first hand themselves.

Equity markets have done quite well over the past 30 years or since the early 1980’s. The 18 year period from 1982 through the year 2000 was particularly quite profitable for equity investors. And during these last 30 years, we have been told, taught, nudged, programmed into assuming that stocks earn about a 10% return (on average). And since the trend was quite linear during that 18 year period, it reinforced our sense or perception of “average.”

Now it is true that over very long periods of time, say the last 100 years, that equities do “on average” earn 10% annual returns. But what many investors don’t realize is that it comes in spurts and phases depending on longer term trends or secular markets. So the old maxim may be true that, “stocks go up in the long run,” we must also balance that out with another reality in life which is, “in the long run, you are a dead!”

Most investors don’t really begin investing seriously until they are well into their 30’s and 40’s. As we discussed above, we are just coming off an impressive 30 year run in equities. Any investors that are now 50, 60, or 70 years old can easily be told that “equities average double digit returns annually” because they lived that period first hand. Their personal experience backs up their perceptions.

Back on October 14, I wrote a blog post entitled, “You Guess Which Weeks?” It was a little game I put together to show clients the real nature of long term markets. I listed the following 10 weeks and asked them to select which weeks the Dow traded at a range of 11,000;

· May 3, 1999

· November 15, 1999

· April 3, 2000

· May 21, 2001

· February 13, 2006

· July 3, 2006

· July 7, 2008

· April 12, 2010

· October 4, 2010

· October 3, 2011

The answer, much to the surprise of those I can get to play the game, is “all of them.” The Dow traded at a level of 11,000 in all of those weeks from May 1999 through October of this year. That is a 12 ½ year period. How old were you 12 ½ years ago? I was 29 ½ years old!!!

Many investors might believe that this is some sort of fluke or all time record. Or is it? Here are a few more examples;

On 12/31/1964 the Dow closed the year at 874.12.

On 12/31/1981 the Dow closed the year at 875.

That was a 17 year period where the Dow went…(everybody who can add shout it out…)…well, it didn’t go anywhere on the index alone.

On 10/1/1928 the Dow was at 240.44

On 1/2/1951 the Dow was at 240.96

That was a 23 year period where the Dow went…(everybody who can add shout it out…)

Now this is no reason to panic or get depressed or quit investing. I just want to point out that markets don’t move in a nice long term linear fashion where we get double digit returns year in and year out. It just doesn’t work that way. Further, that didn’t mean that nobody built wealth or increased their financial security during past secular markets. That’s just not true.

Hence the value of owning different types of investments that has an opportunity to generate a combination of interest, dividends and capital gains. Investments in REITs, master limited partnerships, stocks, bonds, metals, commodities, cash, and alternatives can allow an investor to obtain a total rate of return that is positive in nature over long periods of time even if we don’t get any growth on a particular index for an extended period of time.

Economies and markets tend to move in bigger phases. These phases are called secular markets and are often dictated by demographics, leverage, innovations or any host of factors that impact humanity.

By nature, most of us weren’t alive during the last secular bear markets and we don’t study history. So we don’t include it in a set of possibility outcomes. Rather, we tend to grasp towards things that we were told and that were reinforced based on our own personal experiences.

Markets are unpredictable. We don’t know what we don’t know about our future. We have never gone through a sovereign debt mess quite like this in the last 100 years of equity markets. Further, todays markets are much different than markets were 40, 60 or 80 years ago with global banks, derivatives, and massive sovereign debt in the most developed economies.

Only time will tell if we are in a secular bear market that may be longer or shorter than past secular bear markets. We know that we haven’t made any real progress since 1999. However, there are plenty of people that have built tremendous wealth and improved their financial security since 1999. Are you one of them?

Wealth building happens when we execute on the four pillars;

· Make a strong income

· Live below your means

· Save your money and invest prudently over long periods of time

· Reduce and eliminate your debt

Your personal behaviors have more to do with wealth building than what any particular index does over the next few years.

#8 - CDS Market Woes - November 11, 2011

This is the continuation of a 10 part blog series entitled, “10 MACRO HEADWINDS IN THE FACE OF INVESTORS.”

We all should know what a bond is. A bond is a security where one party is lending to another creating a financial obligation to repay the debt. Here’s a little harder term, “CDS.” A CDS is a collateralized debt security. A CDS is a financial derivative contract. That sounds complicated and fancy-schmancy and it is in many regards. But let’s boil a CDS down into plain English.

If an investor (whether that is a bank, a pension fund or an individual investor) buys a bond, they often can buy insurance on that bond. Why would they do that? They would do that to protect against the possibility of the borrower not paying the debt back. Then the lender is screwed out of the money by lending to a bum who skips town on the loan.

Let’s apply it in real terms. A country wants to borrow money, say Greece. And investors are interested in lending money to Greece to earn a rate of return (in the form of interest payments). And the investors want assurance that they will be able to collect the loan from Greece. They do this in two ways; first, doing analysis to gain assurance that Greece will have the money to pay it back and second, buying an insurance policy in case Greece can’t pay it back (the CDS contract).

So now years go by and investors keep lending money to Greece. They lend Greece billions and billions and along the way, people stop doing good analysis in determining if Greece is borrowing too much money (sort of like certain mortgage companies and credit card companies with individuals here in the United States). Pretty soon, Greece is spending money like mad on benefits, retirement programs, social programs and projects. The money is going out faster than it is coming in and future promises are building and building.

Eventually the debt becomes so large that investors come to the conclusion that Greece isn’t going to be able to pay the money back. “No worries,” some investors think because they bought a CDS contract insurance against this risk. But buried in the fine print the language states that if the bond is restructured “voluntarily” then the CDS contract is no longer enforceable. And the European Union, who realizes that Greece can’t pay the money back but also realizes that the banks will explode if they are forced to take the losses and pay out on the CDS contracts forces lenders to “voluntarily” restructure the loans and write off 50% of the face value. CDS holders are now screwed over. They are prevented from collected on the insurance. So they ended up paying for insurance that will never be collected even though Greece couldn’t pay the money back.

And so the European Union now has to deal with unintended consequences. Since there are plenty of other countries who are over-leveraged with massive amounts of debt, investors now believe that the CDS contracts can also be deemed worthless if bondholders are forced to “voluntarily” restructure and take a loss on the bonds. Keep in mind, this is like someone pulling a gun on you, demanding taking your money and then deeming the action “voluntary” by the victim. There really is nothing voluntary about taking a large restructuring loss on a bond of this nature.

So now we have bond holders who own billions of Euro’s worth of Italy, Portugal, Spain, Ireland, and Greece bonds that no longer will believe that their CDS contracts will pay off if the bonds won’t be repaid by dead-beat loser countries that acted irresponsibly with borrowed money. What would you do in their shoes? Well, you would either sell the bonds before they become worthless or drop in value or demand a much higher interest rate to offset the real risk of default.

And so we saw this “unintended consequence” happen with Italy this past week. Investors are coming to the conclusion that the financially reckless Italians may not be able to pay the money back. So they began selling the bonds or demanding a higher interest rate to offset the higher risk of default. And we saw the interest rates for 2, 5 and 10 year Italian bonds climb quite quickly.

It creates a death spiral. If the country has a deficit and needs to borrow money to meet their budget, they must pay higher and higher interest rates to meet their financial obligations. The higher the interest rate, the higher their interest expense goes up. Interest expense keeps climbing even though their revenues are staying constant or possibly shrinking. Eventually the debt implodes on them and they default because they can’t keep up with the increasing interest payments.

Individuals get themselves into this same predicament. They start out with good credit and can borrow a little money with a low interest rate since they are a low risk borrower. As they increase their debt, lenders deem the chances of default higher and charge higher rates. Soon the individual is obligated to pay so much in interest expense that they can no longer afford to pay down the principal on the loan. Bankruptcy soon
follows.

As we move forward into the end of 2011 and 2012, we are seeing countries that may end up getting caught in a debt death spiral triggered by the fact that the European Union leaders forced the Greek bonds to be restructured, “voluntarily.” By deeming the restructuring and write-off of bad Greek loans voluntary, they diminished or eliminated the value of the CDS market. What good is paying for insurance if it won’t
be paid? And by doing this, it will drive interest rates up on countries that can’t afford higher interest rates (like Portugal, Ireland, Italy, Greece and Spain).

Where they actually thought they were preventing further financial damage to irresponsible countries, the EU is tightening the screws on the very system they are trying to manipulate.

Investors need to be aware that governments (whether in the EU or domestically) aren’t very good at understanding the concept of “unintended consequences” when they start messing with things that they can’t comprehend. We often think that the
government knows what they are doing and will make things better.

The CDS market woes caused by government officials may end up expediting the demise of the irresponsible institutions that they are trying to protect. Go figure.

# 9 - The Trickle Down Of Slower Growth - November 10, 2011

This is the continuation of a 10 part blog series entitled, “10 MACRO HEADWINDS IN THE FACE OF INVESTORS”.

 

I want you to imagine a pizza pie on top of a pizza pan (fresh out of the oven!) Now imagine cutting that pizza pie into a bunch of smaller pieces. Now remove all of the pieces from the pan except for one. Let’s call that single remaining piece of pizza, “corporate profits” and let’s call the entire pizza pie “GDP” (gross domestic profit). Gross domestic profit (which represents economic activity) is comprised of a lot of pieces such as personal consumption, investment, savings, corporate profits, etc.

 

Corporate profits are simply a component of GDP (a single piece of pizza from the entire pizza pie). Over the long term, corporate profits are usually around 5% of GDP (1/20^th the entire pizza). We can now imagine cutting up the pizza pie into 20 pieces, eliminating 19 of them and that one remaining piece is “corporate profits.”

 

Over the past few years, corporate profits as a % of GDP have grown tremendously relative to the whole pizza. They have moved up from 5% of the total to the low teens (around 13%). We should be asking, “Why is this?” (I know you are losing sleep over this issue just like me. Staying up late, tossing and turning and wondering how this is going to impact your life.)

 

And if we step back for a moment and ask, “How did corporate profits/productivity increase so much in so few years?” Is everybody on Red Bull at work?

 

Corporations have learned to do more with less. More work output, less labor input. You, you and you get back to work, the rest of you, “You’re FIRED! Get your stuff and go home. Thanks for playing.” Companies also aren’t investing in new machinery, new factories, new upgrades, and new expansion. Rather, they are saving their cash and squeezing every ounce of profits out of the organization. Research and development is also carefully watched. This is not the time for companies to feel like taking risk on creating new things that may not pan out in an uncertain future. Lean and mean.

 

Let’s head back to the pizza pie and the slice for corporate profits. Now all of a sudden the piece of pizza which is normally 1/20^th of the pizza is now 1/8^th of the pizza. But if we think about the obvious, this growth cannot last or expand forever. A piece of the pizza can’t become bigger than the pizza itself. There are natural constraints to the growth. 70% of the economy is consumer driven. If less people are working, or wages are slashed, or people are cash strapped, how will they have money to buy the crap made by corporations? So things are ultimately inter-related.

 

The global economy should always be growing (the goal of all economies is growth). The growth is like growing from a small pizza to a medium pizza to a large pizza. As that pizza grows, the slice for corporate profits should grow in proportion. But now the pizza pie is no longer growing. A shrinking pizza is called a recession.

 

If GDP stops growing, then we should expect corporate profits to stop growing (as corporate profits are a component of the entire pizza pie). Stock prices reflect the expected future growth of corporate profits. The faster the growth in corporate profits, the faster we should expect stock prices to rise. In similar sense, should corporate profits halt (or go in reverse) so should stock prices as the value of the companies are now diminished due to shrinking profits. Who wants to own a business with shrinking profits? As profits diminish, investors should only be willing to pay less for that business, not more.

 

And thus we should now be able to follow the bouncing ball and connect the dots. If GDP slows down or halts, we should expect corporate profits to slow down or halt as well. Further, corporate profits as a percent of GDP are already inflated and far above historical averages. What will happen to corporate profits if they revert to the mean and move back towards their long term average of 5% of GDP? (Uhmm – BAD…) And if corporate profits halt or recede, then what should happen to stock prices? That’s right, stock prices should halt or recede as stock prices are a reflection of future profit expectations.

 

GDP impacts corporate profits. Corporate profits impact stock prices.

 

If GDP growth slows down to low single digits (or less in certain countries and economies), why should an investor expect stock prices to rise much above and beyond that GDP growth rate?

 

As an investor, our goal is to always understand our potential risk versus the potential return. Stock prices tend to front run actual economic data. And sometimes the economy is doing great but stock prices fall and sometimes the economy is doing poorly but stock prices rise. It’s a fun game, I know. But the wise investor is always attempting to understand what they have to gain versus what they have to lose. If prices get cheap enough, then an investor has less to lose. They have built in a margin of safety.

#10 - Poor Human Behavior - November 8, 2011

This is the start of a 10 part blog series entitled, "10 MACRO HEADWINDS IN THE FACE OF INVESTORS"  We have a lot going on in the world today.  So on that note, let's get to #10 which I call, "Poor Human Behavior"

"We have met the enemy and he is us..."

Humans are flawed.  Humans by nature are poor at risk management.  Need proof?  Pick up any newspaper.  A newspaper is loaded with daily stories of people that made very poor risk management decisions.  But let's go through some specifics that deal with poor human behavior and how it trickles down into our own personal success (or lack there0f).  I want you to challenge yourself as you read these and self-assess.  Are you helping or hurting your own chances of relative success?

Procrastination - Let's face it, people by nature procrastinate.  The difference between the successful and the unsuccessful often comes down to taking action.  I know, I know, you always started studying and doing term papers way in advance.  You never waited until just before Christmas to shop for holiday gifts.  You started saving for retirement when you got your first paper route...

"A true procrastinator doesn't shovel snow.  A true procrastinator knows that the snow will melt...eventually!"

There is a difference between things that are urgent but unimportant and things that are important but not urgent.  We confuse these all of the time.  Successful people are constantly working on things that are important but non-urgent.  Think about examples in your own life for items that are important but not urgent.  I'll give you a few; exercise.  It's critically important for your health, but non urgent.  Saving for retirement is critically important for your financial future but not urgent.  Are you doing things daily that are important but non-urgent?  Those are the things that lead to long term and sustainable success.

Leadership - In general, we don't elect true leaders.  We elect politicians and we get fooled over and over again come election time.  And then when we elect politicians rather than leaders we allow them to govern without leadership.  We govern/manage our lives and the lives of others by crisis management.  Crisis management is not leadership.  Are you being a good leader in your own life?  Are you running your life by crisis management?

Waiting For The Crisis- If we combine procrastination and lack of leadership we eventually find ourselves waiting for the crisis by default.  Humans usually only take real action once things develop into a full blown crisis and then we try to solve the crisis in an emergency fashion.  By then, our options are severely limited and we lack the time to implement an optimal solution.  How many times have our leaders been forced to solve global financial crisis' here and abroad by holding "emergency weekend summits and meetings?"  Are you waiting until things come to a full blown crisis before addressing an underlying risk in your life?

A Lack of 5 and 10 Year Plans- Let me ask you this, "We are coming up on another presidential election.  Name a few things that specific and quantifiable items being discussed on a candidates 5 and 10 year plan for our nation?"  There aren't any.  There isn't a single candidate talking about a strategic 5 and 10 year plan for our nation (or a 20 year plan).  They are all talking about crisis management issues (or sex harrassment issues related to Herman Cain).

How many of you have a personal 5 and 10 year plan for learning, health, finances, job/career, family, etc.?  Do you know where you would like to be anywhere past next week?

No Margins of Safety - Humans don't seem to allow themselves any margins of safety to ever be built up into systems or prepare for rainy days.  Proper risk management can be aided by running counter-cyclical policies (prepare for rainy days when the sun is shining).  We tend to push things to the limit and fail to ask ourselves, "What if our forecasts, models, assumptions are wrong or over-aggressive.  When we had homework to do, we might believe that it will take 2 hours.  What if it takes double that to do a good job but we waited until the last minute?  We might run our retirement model at a double digit annual rate of return.  What if we only get 6% for a long stretch because of a poor economy and low interest rates?  What will that do to our model?  When is a good time to build in a margin of safety?

Lemmings - We are social beings and we are lemmings by nature.  Our Mom's would even ask us, "If Johnny jumped over Niagara Falls, would you too?"  We follow the herd and the herd rides a pendulum that swings between extreme emotions based on fear and greed.  We get a false sense of security by following the crowd.  We don't think independently but rather get comfort in saying, "But everybody else is doing it."  Are you a lemming?

Greed - We are greedy bastards and greed trumps logic and reason.  Think back of the tech bubble or the housing bubble or any bubble for that matter.  In hindsight, things always appear to be obvious and common sense.  But things aren't obvious when we are wearing greed shaded sunglasses.  Greed is extra powerful when we are also lemmings.  How driven by greed are you and is that greed realistic and opportunistic based on risk/return or are you wearing greed shaded sunglasses?

False Belief- We tend to assume that things will end up ok.  Things will be fine adn that somebody else is not only responsible for saving us, but that they actually will save us.  How many Japanese citizens and investors believed that their governement will "figure things out."  That was 20 years ago and since then, they are up to their eyeballs in debt and their equity markets have fallen 80%.  Societies fail, businesses fail, politicians fail, systems fail.  Are you too trusting in others to fix your problems?

It's Never Happened Before - Humans fortunately use history as a guide.  Unfortunately they tend to believe that since something didn't happen before, it can't happen in the future.  Example; Japan put up a bunch of nuclear reactors near residential areas on their coast.  Why?  Because when they did their planning and modeling for risk, they came to the bright conclusion that since a substantial earthquake and tsunami never happened in the past 100 years, it would happen in the future (until it did).  Finance folks blow themselves up with this flawed logic all of the time.  They run models based on what only happened in the past, totally discounting what could (and did) happen in reality.  And when those events happen, they go bankrupt.  (Home prices will always go up and can't go down...until they did...)  Just because something didn't happen in the past, doesn't mean that it can't or won't happen in the future.  Obviously we can't account for every single possibility in this universe.  But we under-estimate our risk based on flawed use of history.

Be aware that a major headwind for investors is the fact that humans are flawed and will screw things up.  We need to be aware that we are impacted when others do things that are quite stupid and illogical and only in hindsight will most people go, "Well that was obvious..."

How Investors In IPO's Are Mislead - November 4, 2011

You inquired about Groupon this morning (as many investors were curious/interested).  Groupon went public at $20/share and is currently trading in the $27.50 to $28.50 range the last hour (around 12.30pm EST on November 4, 2011).  So we immediately would think, “Wow, I could have had an immediate 40% gain had I invested in the IPO!!!  But it doesn’t work that way in reality for retail investors (people like you and me).  The stock immediately started trading on the open market at around $27.80 at 10:45am (not $20.00/share).  That’s when it officially started trading on the markets.  A normal person couldn’t buy the shares at $20.00 (the IPO price).

 

The shares jumped within minutes to a high of $31.14 and then within 30 minutes dropped hard to $25.90 (the massive volatility that I spoke about this morning.) 

 

So by the end of the day, the markets and the financial press will write headlines that state, “Groupon surges 40+% on IPO” but that is so misleading because anybody that actually bought the stock in the open market paid far more than that.  What is more accurate would be to say that “insiders” who owned the private stock were able to sell their shares to an underwriter for $20 who immediately was able to flip them to the general public for $27.80 (that’s how Goldman Sachs, or Morgan Stanley or the investment banks can get paid additional money.)

 

You can see this in reality by looking at the daily chart on Yahoo Finance or Google.  Here’s the chart on Google (may need to be updated to view November 4, 2011) - http://www.google.com/finance?q=grpn#

The ticker is GRPN.

 

And what maybe could end up written is an accurate story that states something like, “Groupon surges over 40% on IPO, retail investors lose 10% on first day of trading by buying shares on the open and watching them fall by the close of markets…”  There were investors who tried to buy within the first few minutes that ended up paying the $31.14 to get their shares.  So if the markets closed right now at $28.75, those investors who tried to rush in and buy would be down 7.5%+ on their hot IPO.

 

And I’m sure there were investors who rushed in as quickly as possible and paid over $30/share, watched the stock drop over the next 30 minutes to below $26, panicked because they didn’t know when the floor would kick in and sold to avoid further losses and within 30 minutes of their hot IPO lost 13% of their investment.

 

And that’s how people get mislead and scammed.  It’s actually a frustrating joke if you ask me because normal people get burned in these types of Wall Street games.

Sometimes Things Don't Always Make Sense - November 3, 2011

Today is a perfect example of how crazy it is. Greece is like, “Hey guys, our government may explode. We don’t want to leave the Euro unless you overhear us whispering in the background as to how bad our future looks if we don’t default. If we are going to blow up, wouldn’t it be more fun and enjoyable if we take down some others with us? After all, allowing us to become so over-levered was your fault, not ours…”

ECB big cheese says, “Intensified risk of economic downturns ahead” which is a politically correct way of say, “Holy sweet Mary and Joseph, take cover because we really screwed up and the ship is sinking. But I’ll cut rates by .25%!” And markets scream, “PARTY TIME!” Yep, makes perfect sense… WTF?!?!

Before, long term investing was holding things for years. Then long term investing was anything greater than 1 year and 1 day so you get LT cap gains treatment on your 1040 tax return. Then long term investing was a couple of months (which required incredible patience). Now long term investing is holding firm through the morning session unless the Financial Times runs a new headline.

And some of my clients are like, “Why aren’t we fully invested and sitting on so much cash. Don’t you know I need gains? I’m already underfunded for retirement, you told me so yourself!?!?!”