Government Intervention and Stock Returns

An informative presentation by Dimensional Fund Advisors. They have a superlative research team.

"Should equity investors be alarmed by the prospect of greater government intervention in the US economy? Weston Wellington looks at examples of US intervention in the past and examines the record of stock returns around the world over the last thirty-nine years. The evidence suggests that government intervention is just one factor among many affecting stock returns, and that an above-average degree of intervention is not necessarily associated with below-average returns."

For the rest of the presentation: http://www.dfaus.com/library/videos/governme/

The Fight Over Who Will Guard Your Nest Egg

Another interesting article similar to the post just below, "Wary Investors Are Seeking Out Objective Voices ". Both argue that registered investment advisors have a fiduciary obligation to their client vs. the less stringent "suitable" standard provided by most other financial advisors.

From the Wall Street Journal, 3-28-09:

"A power struggle in Washington will shape how investors get the advice they need.

On one side are stockbrokers and other securities salespeople who work for Wall Street firms, banks and insurance companies. On the other are financial planners or investment advisers who often work for themselves or smaller firms.

Brokers are largely regulated by the Financial Industry Regulatory Authority, which is funded by the brokerage business itself and inspects firms every one or two years. Under Finra's rules, brokers must recommend only investments that are "suitable" for clients.

Advisers are regulated by the states or the Securities and Exchange Commission, which examines firms every six to 10 years on average. Advisers act out of "fiduciary duty," or the obligation to put their clients' interests first."

For the entire article: http://tinyurl.com/cd2bdb The link works only for a few days. If you can't access the article, let me know and I will try to gain access for another short period. rich.chambersABC@gmail.com Spam prevention: Remove the ABC from the email address.

Wary Investors Are Seeking Out Objective Voices

From the Wall Street Journal, 7-29-08:

"In the aftermath of the financial-market crisis, investors are leaving Wall Street to sign on with independent investment advisers.

Last year, registered investment advisers brought in more than $108 billion of net new assets into the three largest custodians, according to Charles Schwab Corp., which holds roughly $500 billion in assets for such advisers. By contrast, the four major Wall Street brokerage firms saw an outflow of $8 billion in 2008.

Investors seeking to repair their damaged nest eggs say the chief lure of independent advisers is more-objective guidance."

For the entire article:
http://tinyurl.com/m9x8b3
The link works only for a few days. If you can't access the article, let me know and I will try to gain access for another short period. rich.chambersABC@gmail.com Spam prevention: Remove the ABC from the email address.

Quote - Economics as a Profession

“Economics was the only profession where a person could be considered an expert without having once been right.”

- George Meany

All-bond allocation unwise despite equity jitters, says Ibbotson

A short article noting that while bond and stock returns were both about 8.5% over the past 40 years, expected future bond returns are 3 to 4% (annually) due to low current interest rates. A balanced portfolio of 60% stocks and 40% bonds returned 9.1% over the same 40 year period.

Read the entire article:
http://tinyurl.com/n5t8ny

Home Ownership Was Never a Road to Riches

There is a good article in the Wall Street Journal about this topic. The author (Neal Templin) starts out:

"My wife and I have sold all of our four previous homes for more than we paid for them—sometimes a lot more.

We’ve been pretty lucky. We’ve never overpaid much for a house, we’ve always bought in good school districts and decent neighborhoods, we’ve lived in neighborhoods where prices soared during the real-estate bubble, and we’ve been hurt but not decimated by the bursting of that bubble.

When I constructed a very basic cash-flow model for our home-buying history—selling price minus purchase price, renovations and repairs—it showed a roughly 3.5% annualized return on investment, from 1991 through the summer of last year. That’s when we sold our last home and bought our current one."

For the rest of the article:
http://tinyurl.com/m4xylp
The link works only for a few days. If you can't access the article, let me know and I will try to gain access for another short period. rich.chambersABC@gmail.com Spam prevention: Remove the ABC from the email address.

P.S. the number one reason home ownership does not lead to riches is that you have to live in it! Since you can't "spend" your home, it becomes wealth for your heirs but not for you. While it's true that some people can downsize and spend a portion of their home, it's quite rare when this is actually done in my experience. And yes, you can get a reverse mortgage, but this results in a significant wealth transfer to the reverse mortgage holder.

Should You Annuitize Some of Your Retirement Assets?

Everyone has found out how extreme stock market volatility can be! One way to avoid the highs and lows of stock investment and to obtain a lifetime benefit, is to use income annuities.

As an example, suppose you have $1,000,000 of investments in a balanced portfolio starting at the stock market peak Oct 7, 2007. At the bottom on March 9, 2009, your portfolio is worth a lot less, about $420,000 less*. Even if the stock market fully recovers (it always has), you might not want to experience such a emotionally wrenching drop again.

A reasonable approach is to purchase a lifetime income annuity so that your Social Security income and the annuity income cover you basic living expenses. Let's assume that takes $500,000 for the annuity. You can see about how much an annuity pays by going to:
http://www.incomesolutions.com/AnnuityCalculator.asp
For a female age 65, the annuity pays $38,280. The apparent return is 7.7%. Not bad for guaranteed income for life. The income stream will be very comforting in the next bear market.

If you kept the $500,000 invested in a balanced portfolio, a safe withdrawal rate is about 4% which is $20,000. The annuity pays a lot more!

It seems like a no-brainer to go with the lifetime income annuity. But what are the disadvantages?

1. You income is dependent on the ongoing success of the underlying insurance company.
2. Once you give the $500,000 to the insurance company, you cannot get it back. If you die the next day, your heirs get nothing. If you need more cash for an emergency, the insurance company will not give it to you. You or your heirs can get everything that is left in the investment portfolio.
3. The income stream is not inflation adjusted. The withdrawal rate from the investment portfolio is inflation adjusted. At 3% inflation, the withdrawal from the investment portfolio is projected to exceed the income from the annuity in year 23 (your age 88). So if you live a long time, inflation could become a problem. However, the insurance company guarantees to pay the income for your lifetime no matter how long. The investment porfolio provides no such guarantee.
4. There is no upside potential with the annuity while the investment portfolio could do better than expected permitting larger withdrawals than we projected. Of course the investment portfolio could do worse.

Should you annuitize? As always, "it depends" on your need for stability, your need to provide an inheritance, your life expectancy, and your concern about inflation.

*using DGSIX (DFA Global 60/40) as a proxy for a balanced portfolio. It was down -42% from 10-7-07 to 3-9-09:

Avoid Being Scammed!

You can hardly blame clients of investment managers for having a real sense of mistrust these days. How can they be sure their investment manager isn’t going to disappear with their hard-earned assets? In many life situations, it is difficult to know who to trust, especially in the choice of an investment manager.

This issue affects our clients, and it affects the people working here. The phone hasn’t been ringing so much these days with calls from prospective clients. Partly this is due to the gruesome bear market we have experienced, but much of it is that prospective clients don’t know who to trust. Getting a 2% CD rate begins to sound good compared to the possibility of being duped out of your money, as portrayed in the daily news cycle.

But most of our clients can’t afford to retire on CDs. Earlier generations could get by with CDs because their pension and Social Security incomes provided for most of their spending needs. These days there are few pensions to be had and many of these are under pressure. It’s now required that each individual save and invest intelligently in order to produce adequate retirement income. So who to trust?

The Securities and Exchange Commission’s website posts a list of questions to ask any financial professional. Could these be used to detect a scam artist?

• What experience do you have, especially with people in my circumstances?
• Where did you go to school? What is your recent employment history?
• What licenses do you hold? Are you registered with the SEC, a state, or FINRA?
• What products and services do you offer?
• Can you only recommend a limited number of products or services to me? If so, why?
• How are you paid for your services? What is your usual hourly rate, flat fee, or commission?
• Have you ever been disciplined by any government regulator for unethical or improper conduct or been sued by a client who was not happy with the work you did?
• For registered investment advisers, will you send me a copy of both parts of your Form ADV?

While these are good questions to ask, the Madoffs of this world can pass this test with flying colors. Thus these questions alone aren’t adequate to protect you from someone conniving to steal your money.

We submit that it is the investing environment that provides aid and comfort to the scam artist. So in addition to asking about the investment manager’s credentials, you must also understand where your money is and who can access it.

What do you need to protect yourself? We believe the following is extremely useful:

• Always use a third-party custodian.
• Use investments that are priced daily in a public market.
• Use investments that you understand.
• Avoid anything that sounds too good to be true.
• Avoid anything that is proprietary, secret, or touted as exclusive.
• Know how much the fee is and how it is paid.
• Lastly, trust with verification.

Always use a third-party custodian:
A third-party custodian gives you another layer of checks and balances. The custodian is legally required to protect your assets from everyone – including your investment manager. For example, Schwab prevents investment managers from withdrawing unreasonable management fees. Additionally, the custodian should send statements directly to you at least quarterly (the statements must not pass through the investment manager’s firm). Choose your custodian well. (Schwab is well-respected.)

Madoff did not use a third-party custodian for his clients. Therefore all the money went through his hands. He was able to fake statements and investments since no independent parties were watching.

Use investments that are priced daily in a public market:
If you can independently evaluate your portfolio any day you wish, then you have eliminated a major source of fraud. Some fraudsters create fake statements with any values needed to keep you convinced the portfolio is doing well. Publicly traded securities are easily valued so the fraudster prefers to avoid them.

Use investments that you understand:
It’s much harder to fake returns and statements for securities that are easily understood and verified independently. Stocks, bonds, and mutual funds are all easy to monitor. Hedge funds and private equity deals are not.

Avoid anything that sounds too good to be true:
Promises of future returns are the ultimate warning sign. No one knows the future, and if they did, they sure wouldn’t be telling us. Promises of positive returns under all conditions are just lies for anything other than risk-free securities: Savings accounts, CDs, and Treasury bills are about it.

Just by following the news you can get a good idea of how the investment markets are doing. Your investments should be performing in a similar range, otherwise, beware.

Part of Madoff’s mystique was that he had delivered positive monthly returns for decades with almost no exceptions. This must be a huge red flag to any sensible investor. Don’t let greed get in the way of common sense. Anytime someone offers you profits that sound exceptionally good, you should:

1. Wonder why me instead of his best friends and family?
2. Wonder why not keep the process a secret so it won’t get copied and possibly ruined?

Avoid anything that is proprietary or touted as exclusive:
This goes along with using investments that are priced daily in the open market and easily verified. Propriety and exclusive implies investments or a strategy that are hidden in a black box and unverifiable.

Know how much the fee is and how it is paid:
It should be very clear how much your investment manager is paid and how she/he is paid. If you don’t know for sure, ask.

Lastly, trust with verification:
After you have found an investment manager that passes all the above tests, you need to trust them so the relationship works for all. However, you must verify that the relationship stays honest.

• Review your monthly statements from the independent custodian for anything unusual like mysterious investments. Contact your custodian right away if you see any withdrawals you didn’t make or authorize.
• Monitor your performance and make sure it is about what you should expect from the types of investments you are using. If you are making money in a year when most others are losing, you should be suspicious not gleeful.
  

Buying High and Selling Low

"Last year, investors made a bad situation worse in the bear market by trying to time when to get into and out of stock mutual funds. As a group, they would have lost less money had they simply held onto whatever funds they owned when the bear market began."

- Mark Hulbert, New York Times 7-12-09

To read the entire article:
http://www.nytimes.com/2009/07/12/business/mutfund/12stra.html

We're becoming socialist. Should we get out?

"The degree of government intervention is just one of many factors affecting expected stock returns, and investors should be cautious in assuming it is a principal factor."

- Weston Wellington, Dimensional Fund Advisors

Quote - Confessions of a Former Mutual Funds Reporter

"Mutual funds reporters lead a secret investing life. By day we write 'Six Funds to buy NOW!' We seem to delight in dangerous sectors like technology. We appear fascinated with one-week returns. By night, however, we invest in sensible index funds."

- Anonymous Fortune writer, Fortune 4/26/99

Quote - The Big Tease

"What many of us foget is that all these diverse media vying for your eyes aren't trying to offer you advice, nor are they trying to influence you into making a rational decision. They are selling advertising."

- Jane bryant Quinn, Newsweek, "The Big Tease" 8/7/95

Quote - What's a bear market?

“A bear market is an extended period of time during which people who think this time is different sell all their investments to people who understand that this time is never different.”

- Unknown

Is Buy and Hold Dead? Part II

I found some thoughtful quotes on the topic:

From John Bogle (former CEO of Vanguard):“Our emotions tend to lead us in the wrong direction. We are usually optimistic when the market is high and pessimistic when the market is low. So the odds of being able to time the market are not good. The stock market isn’t a place for betting. The place for betting is Las Vegas.”

From Don Phillips, Managing Director of Morningstar:“No one’s used market timing successfully in a mutual fund over time.”

From Janet Bodnar, Editor Kiplinger’s Personal Finance
“With so many of us eager to make up market losses, we’re sitting ducks for new products and strategies – or new twists on old ones - that promise to recover lost ground quickly. Lately I’ve spent time on the road listening to what financial engineers and others in the profession are cooking up, and this is my advice: Proceed with caution. For instance, after the “lost decade” it was inevitable that buy-and-hold investing would be declared dead and that some pros would try to revive market timng. But at the Morningstar investment conference, nearly everyone seems happy to let market timing rest in peace. ‘It’s really dangerous,’ warns Chris Davis, the respected manager of Selected American Shares”.

From Jeremy Siegel, Professor at the University of Pennsylvania's Wharton School
"Stock-market investors are an unhappy bunch. Standard & Poor's 500-stock index is no higher than it was 12 years ago, and over the 10 years ended in May, stocks have returned a dismal minus 1.7% per year. So it's no surprise that investors wonder whether 'buy and hold' and 'stocks for the long run' are discredited concepts.

The short answer is that stocks are still the best long-term investments. As bad as the past decade has been, there have been other ten-year periods during which stocks have recorded even bigger losses. Yet over periods of 20 years or longer, stocks have never lost money, even after inflation. Including the latest bear market, stock returns have averaged 7.8% per year over the last 20 years and 11% annually over the past 30."