Archive for February, 2010
Fees, Exploitation and Confusion Hammer Investors
The financial industry is out to hammer you. If you haven’t figured that out, then it’s time to wake up to the cruel realities of the industry. Let’s see what it takes to become the hammer rather than receiving the brunt of the pounding, like the nail.
Fees, Fees, Fees
I interface with investors of all stripes and overwhelmingly the vast majority of them have no idea what they are paying in fees. When I ask investors what fees, commissions, and transactions costs are being siphoned from their wallets, I get the proverbial deer looking into the headlight response. And who can blame them? Buried in the deluge of pages and hiding in the fine print is a list of load fees, management fees, 12b-1 fees, administrative fees, surrender charges, transaction costs, commissions, and more. One practically is required to obtain a law degree in order to translate this foreign language.
Wolf in Sheep’s Clothing
These wolves don’t look like wolves. These amicable individuals have infiltrated your country clubs, groups, volunteer organizations, and churches. The following response is what I usually get: “Johnny, my financial consultant, is such a nice man – we have known him for so long.” Yeah, well maybe the reason why Johnny is so nice and happy is because of the hefty fees and commissions you are paying him. Rather than paying for an expensive friend, maybe what you need is someone who can accelerate your time to retirement or improve your quality of life. If you prefer eating mac and cheese over filet mignon, or are looking to secure a position at Wal-Mart as a greeter in your 80s, then don’t pay any attention to the fees you may be getting gouged on.
I don’t want to demonize all practitioners and aspects of the financial industry, but like Las Vegas, there is a reason the industry makes so much money. The odds and business practices are stacked in their favor, so focus on protecting yourself.
Confusion
Investors face a very challenging environment these days, needing to decipher everything from Dubai debt defaults and PIIGS sovereign risk (Portugal-Ireland-Italy-Greece-Spain) to proposed new banking regulation and massive swings in the U.S. dollar. If our brightest economists and government officials can’t decipher these issues and “time the market,” then how in the heck are aggressive financial salesmen and casual investors supposed to digest all this ever-changing data? Making matters worse, the media continuously pours gasoline on fear-inducing uncertainties and shovels piles of greed-motivating fodder, which only serves to make matters more confusing for investors. Do yourself a favor and turn off the television. There are better ways of staying informed, without succumbing to sensationalized media stories, like reading Investing Caffeine!
Pushy financial salespeople complicate the situation by attempting to “wow” clients with fancy acronyms and industry jargon in hopes of impressing a prospect or client. In some situations, this superficial strategy may confuse an investor into thinking the consultant is knowledgeable, but in more instances than not, if the salesperson doesn’t know how to explain the investment concept in terms you understand, then there’s a good chance they are just blowing a lot of hot air.
Here’s what famous growth investor William O’Neil has to say about advice:
“Since the market tends to go in the opposite direction of what the majority of people think, I would say 95% of all these people you hear on TV shows are giving you their personal opinion. And personal opinions are almost always worthless … facts and markets are far more reliable.”
Amen.
Mistake of Trying to Time Market
My best advice to you is not to try and time the market. Even for the speculators with correct timing on one trade rarely get the move right the next time. As previously mentioned, even the smartest people on our planet have failed miserably, so I don’t recommend you trying it ether.
Here are a few examples of timing gone awry:
- Nobel Prize winners Robert Merton and Myron Scholes incorrectly predicted the direction of various economic variables in 1998, while investing client money at Long Term Capital Management. As a result of their poor timing, they single-handedly almost brought the global financial markets to their knees.
- Former Federal Reserve Chairman, Alan Greenspan, is famously quoted for his “irrational exuberance” speech in 1996 when the NASDAQ index was trading around 1,300. Needless to say, the index went on to climb above 5,000 in the coming years. Not such great timing Al.
- More recently, Ben Bernanke assumed the Federal Reserve Chairman role (arguably the most powerful financial position in our Universe) in February 2006. Unfortunately even he could not identify the credit and housing bubble that soon burst right under his nose.
Some of the best advice I have come across comes from Peter Lynch, former Fidelity manager of the Magellan Fund. From 1977-1990 his fund’s investment return averaged +29% PER YEAR. Here’s what he has to say about investment timing in the market:
“Worrying about the stock market 14 minutes per year is 12 minutes too many.”
“Anyone can do well in a good market, assume the market is going nowhere and invest accordingly.”
Rather than attempting to time the market, I would encourage you to focus on discovering a disciplined, systematic investment approach that can work in various market environments (see also, One Size Does Not Fit All).
Financial Carnage
The long-term result for investors playing the game, with rules stacked against them, is financial carnage.
If you don’t believe me, then just ask John Bogle, chairman of one of the fastest growing and most successful large financial firms in the industry. His 1984-2002 study shows how badly the average investor gets slammed, thanks to aggressive fees peddled by forceful financial salesmen and the urging into destructive emotional decisions. Specifically, the study shows the battered average fund investor earning a meager 2.7% per year while the overall stock market earned +12.9% annually over the period.
Source: Bogle Financial Center
It’s Your Investment Future
Given the economic times we are experiencing now, there is more confusion than ever in the marketplace. Insistent financial salespeople are using aggressive smoke and mirror tactics, which in many cases leads to unfortunate and damaging investment outcomes. Do your best to prepare and educate yourself, so you can become the hammer and not the nail.
It’s your investment future – invest it wisely.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds (including Vanguard ETFs and funds), but at time of publishing had no direct positions in securities mentioned in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Extrapolation: Dangers of Mixing Cyclical & Secular
One of the toughest jobs in making investment decisions is determining whether changes in profit growth rates are due to cyclical trends or secular trends. The growth of technology and the advent of the internet have not only accelerated the pace of information exchange, but these advancements have also led to the explosion of information (read more).
Drowning in too much information can make the most basic decisions confusing. One of the dreaded by-products of “information overload” is extrapolation. When faced with making a difficult or time consuming decision, many investors choose the path of least resistance, which is to fall back on our good friend…extrapolation.
Rather than taking the time of gathering the appropriate data, exploring both sides of an argument, and having objective information guide educated decisions, many investors open their drawers and grab their trusty ruler. The magic ruler is a wonderful straight-edged tool that can coherently connect any two data points. The beauty of the wooden instrument is the never-ending ability to bolt on a simple convenient story on why a short-term trend will persist forever (upwards or downwards).
We saw it firsthand as the world got sucked down the drain of the global financial crisis. Throughout 2008 bearish pundits like Nouriel Roubini, Peter Schiff, Meredith Whitney, and Jimmy Rogers came out of the woodwork (read more about Pessimism Porn) comparing the environment to the Great Depression and calling for economic collapse. Needless to say, equity markets rebounded significantly in 2009. The vicious rally was not strong enough, nor has the economic data turned adequately rosy for the bears to pack up their bags and hibernate. To be fair, the panicked moods have subsided for “Happy Abby” (Abby Joseph Cohen – Goldman Sachs strategist) to make a few short cameos on CNBC (read more), but we are far from the euphoric heights of the late ‘90s.
I think recent comments by John Authers, columnist at The Financial Times, captures the essence of the current sour mood despite the economic and equity market rebounds:
“Last year’s rebound was, most likely, a bear market bounce. The central hypothesis remains intact. On balance of probabilities, the rally since March has been a (very big) rally within a bear market, and the downward move is a (not so big) correction to that rally. There is no new reason to fear we will revisit the lows of 2009, but every reason to believe that stocks are still fundamentally mired in a bear market.”
Just as overly pessimistic bearishness can cloud judgment, so too can rose colored glasses. Chief economist at the National Association of Realtors, David Lereah, is an example of how biased bullishness can cloud reasoning too. Among the many comments that made Lereah a lightning rod, in July 2006 he noted the real estate “market is stabilizing” and followed up six months later by claiming, “It appears we have established a bottom.”
Extrapolation is a fun, easy tool, but at some point the simple laws of economics must kick into gear. Supply and demand generally do not rise and fall in a linear fashion in perpetuity. As the saying goes, “The herd is often led to the slaughterhouse.” Rather, I argue mean- reversion is a much more powerful tool than extrapolation for investors (read more).
The country faces many critical problems that cannot be ignored and politicians need to show leadership in addressing them. I encourage and remind people that we have survived through multiple wars, assassinations, currency crises, banking crises, SARS, mad cow, swine flu, widening deficits, recessions, and even political gridlock. So next time someone tells you the world is coming to the end, or a stock is going to the moon, do yourself a favor by putting away the ruler and aggregating the relevant data on both sides of an argument before jumping to hasty conclusions.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at time of publishing had no direct positions in LM, or GS. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Short-Termism & Extremism: The Death Knell of our Future
In recent times, American society has been built on a foundation of instant gratification and immediate attacks, whether we are talking about politics or economics. Often, important issues are simply presented as black or white in a way that distorts the truth and rarely reflects reality, which in most cases is actually a shade of grey. President Obama is discovering the challenges of governing a global superpower in the wake of high unemployment, a fragile economy, and extremist rhetoric from both sides of the political aisle. Rather than instituting a promise of change, President Obama has left the natives restless, wondering whether a “change for worse” is actually what should be expected in the future.
Massachusetts voters made a bold and brash statement when they elected Republican Senator Scott Brown to replace the vacated Massachusetts Senate seat of late, iconic Democratic Senator Edward Kennedy – a position he held as a Democrat for almost 47 years. Obama’s response to this Democratic body blow and his fledging healthcare reform was to go on a populist rampage against the banks with a tax and break-up proposal. Undoubtedly, financial reform is needed, but the timing and tone of these misguided proposals unfortunately does not attack the heart of the financial crisis causes – excessive leverage, lack of oversight, and irresponsible real estate loans (see also, Investing Caffeine article on the subject).
With that said, I would not write President Obama’s obituary quite yet. President Reagan was left for dead in 1982 before his policies gained traction and he earned a landslide reelection victory two years later. In order for President Obama to reverse his plummeting approval ratings and garner back some of his election campaign mojo, he needs to lead more from the center. Don’t take my word for it, review Pew Research’s data that shows Independents passing up both Republicans and Democrats. The overall sour mood is largely driven by the economic malaise experienced by all in some fashion, and unfortunately has contributed to short-termism and extremism.
Technology has flattened the world and accelerated the exchange of information globally at the speed of light. Any action, recommendation, or gaffe that deviates from the approved script immediately becomes a permanent fixture on someone’s lifetime resume. Our comments and decisions become instant fodder for the worldly court of opinion, thanks to 24/7 news cycles and millions of passionate opinions blasted immediately through cyberspace and around the globe.
Short-termism and extremism can be just as poisonous in the economic world as in the political world. This dynamic became evident in the global financial crisis. Short-termism is just another phrase for short-term profit focus, so when more and more leverage led to more and more profits and higher asset prices, the financial industry became blinded to the long-term consequences of their short-term decisions.
Solutions:
- Small Bites First: Rather than trying to ram through half-baked, massive proposals laced with endless numbers of wasteful pork barrel projects, why not focus on targeted and surgical legislation first? If education, deficit-reduction, and job creation are areas of common interest for Republicans and Democrats, then start with small legislation in these areas first. More ambitious agendas can be sought out later.
- Embrace Globalization: Based on the “law of large numbers” and the scale of the United States economy, our slice of the global economic pie is inevitably going to shrink over time. How does the $14 trillion U.S economy manage to grow if its share is declining? Simple. By eschewing protectionist policies, and embracing globalization. Developing country populations are joining modern society on a daily basis as they integrate productivity-enhancing innovations used by developed worlds for decades. In a flat world, the narrowing of the productivity gap is only going to accelerate. The question then becomes, does the U.S. want to participate in this accelerating growth of developing markets or sit idly on the sideline watching our competitors eat our lunch?
- Hail Long-Termism and Centrism: Regulations and incentives need to be instituted in such a fashion that irresponsible behavior occurring in the name of instant short-term profits is replaced with rules that induce sustainable profits and competitive advantages over our economic neighbors. Much of the financial industry is scratching and screaming in the face of any regulatory reform suggestions. The bankers’ usual response to reform is to throw out scare tactics about the inevitable damage caused by reform to the global competitiveness of our banking industry. No doubt, the case of “anti-competiveness” is a valid argument and any reforms passed could have immediate negative impacts on short-term profits. Like the bitter taste of many medicines, I can accept regulatory remedies now, if the long-term improvements outweigh the immediate detrimental aspects.
The focus on short-termism and extremism has created an acidic culture in both Washington and on “Main Street,” making government changes virtually impossible. If President Obama wants to implement the change he campaigned on, then he needs to take a more centrist view that concentrates on enduring benefits – not immediate political gains.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
Article first submitted to Alrroya.com before being published on Investing Caffeine.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds but at the time of publishing had no direct positions in securities mentioned in the article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Fed Ponders New Surgical Tool
The Fed is closely monitoring the recovering patient (the U.S. economy) after providing a massive dose of monetary stimulus. The patient is feeling numb from the prescription, but if the Fed is not careful in weaning the subject off the medicine (dangerously low Federal Funds rate), dangerous side- effects such as a brand new bubble, rampant inflation, or a collapsing dollar could ensue.
In preparing for the inevitable pain of the Federal Reserve’s “exit strategy,” the institution is contemplating the use of a new tool – interest rates paid to banks on excess reserves held at the Fed. A likely by-product of any deposit-based rate increase will be higher rates charged on consumer loans.
Currently, the Federal Reserve primarily controls the targeted Federal funds rate (the rate at which banks make short-term loans to each other) through open market operations, such as the buying and selling of government securities. Specifically, repurchase agreements made between the Federal Reserve and banks are a common strategy used to control the supply and demand of money, thereby meeting the Fed’s interest rate objective.
Source: Data from Federal Reserve Bank via Wikipedia
Although a relatively new tool created from a 2006 law, paying interest on excess reserves can help in stabilizing the Federal Funds rate when the system is awash in cash – the Fed currently holds over $1 trillion in excess reserves. Failure to meet the inevitably higher Fed Funds target is a major reason policymakers are contemplating the new tool. The Fed started paying interest rates on reserves, presently 0.25%, in the midst of the financial crisis in late 2008. Rate policy implementation based on excess reserves would build a stable floor for Federal Funds rate since banks are unlikely to lend to each other below the set Fed rate. The excess reserve rate-setting tool, although a novel one for the United States, is used by many foreign central banks.
Watching the Fed
While the Fed discusses the potential of new tools, other crisis-originated tools designed to improve liquidity are unwinding. For example, starting February 1st, emergency programs supporting the commercial paper, money market, and central bank swap markets will come to a close. The closure of such program should have minimal impact, since the usage of these tools has either stopped or fizzled out.
Fed watchers will also be paying attention to comments relating to the $1 trillion+ mortgage security purchase program set to expire in March. A sudden repeal of that plan could lead to higher mortgage rates and hamper the fragile housing recovery.
When the Fed policy makers meet this week, another tool open for discussion is the rate charged on emergency loans to banks – the discount rate (currently at 0.50%). Unlike the interest rate charged on excess reserves, any change to the discount rate will not have an impact charged on consumer loans.
While the Fed’s exit strategy is a top concern, market participants can breathe a sigh of relief now that Federal Reserve Chairman Ben Bernanke has been decisively reappointed – lack of support would have resulted in significant turmoil.
The patient (economy) is coming back to life and now the extraordinary medicines prescribed to the subject need to be responsibly removed. As the Federal Reserve considers its range of options, old instruments are being removed and new ones are being considered. The health of the economy is dependent on these crucial decisions, and as a result all of us will be carefully watching the chosen prescription along with the patient’s vital signs.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds but at the time of publishing had no direct positions in securities mentioned in the article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
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