Sophisticated Confusion

There is a lot of talking head quasi-professional-technical advice being given on how the average investor should manage his or her savings. The difference between success and failure it seems is in the minutia. From talk radio to cable television here are some of the things being said on how to manage our money: Buy and hold is dead. Exchange Traded Funds are better than mutual funds. Watch bonds for signals to where the economy is headed. The Transport Index is a leading indicator of the future. Tech is always the bellwether indicator. Bio's surge when the market falters. The list goes on.

Most successful investors keep things simple, understand what they own and don't drive themselves nuts by checking their accounts every day. Warren Buffet once said that he doesn't look at his personal investments but a few times a year. He said you don't check the value of your home more than that then why do it with your stocks and mutual funds?

One of my pet peeves is running into someone who's asset allocated their $25,000 401(k) portfolio into about eight slices, and wants each piece to be a consistent winner, each and every day. When I explain they would do just as well with one good world fund that pays a dividend they look at me as if I just escaped a padded room.

The truth is most average investors can do just as well be settling on a portfolio of domestic, foreign and bonds funds. If you want to simplify it more create a design using a world fund that pays a dividend and add an intermediate bond fund. If you're 50-years of age a basic 50-50 allocation into those two funds will do just as well as anything complicated some money management firm cranks out and charges a huge annual fee.

No matter what anyone tells you, dear reader, there is no such thing as a perfect investment plan. Keep it simple, adjust it as time goes on and understand what you own.

Investing, in some ways is like romance. There are those that spend their entire lives looking for their soul mate and there are others who simply find someone they can be comfortable with. Those that spend their lives looking for their soul mate are consistently disappointed while those that settle never are.

Understanding Risk

Defining investment risk us as nebulous as defining time. We can get our minds around the basic concept but have trouble communicating what we mean.

For one person defining themselves as being a conservative investor may mean that they invest their money in cash and cash equivalents. Another investor it may mean burying money under the front porch in an old mayonnaise jar. Still another it could be to invest in equities that have significant less risk than the market. When attempting to communicate exactly what they mean by their definition of being a conservative investor to their stockbroker or financial planner the differences in risk and volatility can be significant even though they all use the same word it means something different to each of them.

To define the amount of risk an investor is comfortable assuming there are helpful methods that money management firms have designed. The most common are professionally designed risk questionnaires. The problem is that investors have to answer the questions, and that involves individual subjectivity.

And it's that subjectivity defining their investment risk is what gets investors and their planners in trouble. People with conservative tendencies have told me that their planner thinks that they should be investing in an S&P 500 mutual fund and that will achieve their goals in actual return and in relative emotional comfort. That's planner subjectivity, or ignorance, and is a time bomb waiting to explode.

To clarify what we mean the entire process of understanding risk to return can be dealt with by simply asking, 'How much return on investment am I happy making on a consistent basis and how much am I willing to lose if the markets suddenly go south?'

It should be that simple. And if more people did just that we would have a lot less problems, arbitrators and lawyers clogging up valuable investment management space and time.

Here's what you do - write your goals on a 3x5 card and tape it somewhere where you can see it everyday to remind yourself what you want to earn consistently on your investments and what price you're willing to pay when things go wrong. Stick with your written goals no matter what, during good times and especially bad. And, in case you still don't get it, things will go terribly wrong many times in your investment lifetime no matter how many rules and regulations the government creates and enforces.

What Roubini Said

Nouriel Roubini, a well-respected economist, who, some financial experts say, correctly predicted the magnitude of the financial meltdown, is not too optimistic about our economic growth for the next few years. Roubini, who spoke at the Reuters 2009 Investment Outlook Summit in New York, said the United States would experience a U-shaped recovery, where growth would remain relatively flat, or below the historical trend, for several years and then recover. He is, however, bullish on emerging markets.

Attending the Reuters conference were 51 economists from around the world. About two-thirds of those agreed with Roubini while the others felt we would be having a much more robust recovery, representing a V shape rather than a U. According to Reuters, the forecasters expected little inflationary trends but a 'stubbornly' high unemployment rate through 2010.

In the September 7th Barrons Myles Zyblock of RBC Capital Markets said of the past markets move that, 'The market is digesting a lot of gains and it won't take much to trigger a correction.' Barclay;s Barry Knapp believes that a possible 8.5% downside before year-end is in the offing. Others thought a possible 15% correction by the middle of October was in the technical charts.

But, the good news and consensus is that the possible correction will be shallow and short. The S&P 500 low of 676 will be, according to the experts, a 'generational' threshold. Which is a nice way of saying it won't happen again any time soon and we can tell our grandkids where we were when the markets almost imploded.

Still, looking forward, the experts are factoring in higher multiples, saying that the market can indeed go higher.

And, what if you want to make a mutual fund investment in a non-qualified account for this quarter? I would wait until after any capital gains were paid out by the mutual fund before making that investment. It doesn't make sense to buy a fund have to pay taxes on the capital gain distribution and see you money take a possible hit before the end of the year. Also, if the experts are right you may be able to buy that fund later at a cheaper share price.

Schmart Too Late

It seems like only yesterday that investors and investment managers were fawning over the Harvard Management Company, the folks who manage the endowments for one of America's premier universities. Businessweek magazine, among others, bragged on how the geniuses at Harvard Management spread the money among a wide range of exotic assets including hedge funds, commodities, foreign bonds, TIPS and their favorite - timber.

Articles gushed how private investors could learn a thing or three about allocating their investments like the folks at Harvard Management.

Recently financial planning magazines exhorted the lowly registered representative (meaning me and a few other people) to adopt a similar allocation policy entitled 'Tactical Asset Allocation', the new-new thing that is surely the answer to what failed us recently and similar to the Harvard model. Only Harvard got hit just like everyone else. Losses were in excess of 30% in the past 12 months and the university was forced to borrow 1.5 billion dollars because of hard to sell assets - just the kind of assets they loved to pieces a few years back.

Now Harvard and their new management team is back at the drawing board, pulling in their far-flung investment managers and thinking liquid, less expensive and liquid.

It's times like this that Jack Bogle, found of the Vanguard Funds, seems like a genius, buying bonds and domestic stocks in two mutual funds and allocating his fixed income by the same percentage as his age. Cheap. Liquid. Effective.

There will always be new fangled ways to manage money. For a time some of these methods will be able to make gains but in the end it's the basics that count. Harvard Management, with some of the smartest people in the world on their staff, is just coming to that conclusion.

Simple often works better.

Who's at Fault?

How did the economic meltdown start and who started it? Lawrence McDonald, author of 'A Colossal Failure of Common Sense,' explained it was the fault of our government and especially Bill Clinton.

As we learned in high school the Glass-Steagall Act of 1933 was the great depression post legislation preventing commercial banks from merging with investment banks. It was the guardian that prevented the cowboys associated with the investment firms from raiding the savings and deposits of the average banking customers. Some very smart folks back in the day of Franklin Roosevelt wanted to prevent investment people from getting their hands on an seemingly unlimited supply of money belonging to the everyday saver.

As the years passed bankers and investment firms considered Glass-Steagall as old-fashioned and depression 'era' thinking and wanted the law to be repealed.

In 1988 several attempts were made to circumvent, even abolish, the act. One group thought that mergers between investment firms and banks would strengthen the financial industry. The other side composed of smaller banks was afraid that elimination of Glass-Steagall would lead to the larger firms crushing their smaller cousins.

The bombshell that started it all happened in the spring of 1998 when Citicorp bought Travelers Insurance that also owned the investment bank Smith Barney. Congress attempted to stop the purchase but the banking lobby prevailed and on November 12, 1999 President Bill Clinton signed into law the new 'Financial Services Modernization Act' that effectively removed any barrier between banks and investment houses.

McDonald concludes that within a decade the act would be directly responsible for bringing the entire world to the brink of financial ruin.

And now you know.

Stock Moats

Morningstar describes wide moat businesses as those that can't be hurt even if you allegorically shoot, strangle, poison and drop them off a tall building. Wide moat firms are those that enjoy an almost monopoly in their field.

No moat firms, on the other hand, are those that have an almost impossible time getting an edge over their competition. That doesn't mean that they're not profitable or bad companies it's just that they are in a highly competitive sector with lots of other firms fighting for the same consumer.

For example if ten years ago you were looking to invest in a software company the name Microsoft would spring to mind as a wide moat firm. It still enjoys a strong monopoly today.

On the flip side is DuPont, a giant in the chemical and just about everything else or what I call the kitchen-sink business. It makes a bunch of stuff from radiator coolant, seeds, plastics and bulletproof vests. It has a no moat rating because all the businesses it is involved in are loaded with fierce competition.

Bringing this to an investment perspective is that in 2009 investors are ignoring the wide moat businesses and are favoring the no moat firms. This is also being reflected in mutual funds that own wide moat companies and seeing less than stellar returns so far in 2009.

No moat firms are being well rewarded in 2009, as are their investors and the mutual funds that own them.

Which brings me to my point, or better yet to the point Morningstar made when they wrote about firms with wide and no moats.

Many investors who study this bit of arcane information will ignore firms that have a no moat rating. But, as you can see from my example of two quality companies with great products they operate in different markets. One enjoys a wide moat and the other no moat. Owning either one could possibly enhance your portfolio and over time both have returned value to investors. But, from an asset allocation viewpoint they perform differently during certain economic periods because of their different moat status.

We've been taught that to have a pure asset allocation we should buy investments hugely different from each other, such as foreign and domestic or bonds versus common stocks. Now here is something much more subtle and we can create an allocation simply by buying either a wide moat or a no moat stock, or both or finding mutual funds that do.

The next time you review your mutual fund or stock portfolio you may want to double check some of those holdings to see what moat-category they fall into if their lagging the market, What you may find is that you do not own a bad stock or mutual fund but one with a moat rating that is currently out of favor. You can use this to your advantage with both domestic and foreign stocks and be assured of identical results.

You learn something new every day.

What's Holding Back the Recovery?

Germany and France have emerged from the global depression faster and in better shape than Great Britain and the United States, according to the WSJ August 14Th. The biggest reason is consumers are spending in those countries something the Brits and Americans seem loath to do. Fear still grips us as home foreclosures keep rolling right along even as the Federal Reserve stated this week that the recession is near the end. July was another record month for people losing their homes with the Sun Belt leading the way and rust belt states Illinois and Michigan also in the mix. Unemployment continues its slowdown, and we're in double digit territory not counting folks who have given up looking for work. There are a lot of unemployed who've simply said, 'enough is enough' and retired or resigned themselves to odd jobs or off the books part time employment. Even illegal immigrants have tossed in the towel and stayed home.

If you're an investor who's bailed and put your retirement and investment money into Treasuries you're probably as nervous as a pickpocket at a police convention. You know what you want and have to do is to get back in to the market only you don't like your chances of getting caught if the stock market decides to suddenly reverse direction. You don't care what the Fed, your broker, the New York Times or your crazy aunt's tea leaves say, you don't want to chance losing your hard earned savings by moving into the stock market too soon. There is still a chance of a substantial sell-off such as what we experienced Friday as the markets dropped during the trading day triple digits and closed almost 80 points down on fear of deflation.

To be fair there are a lot of smart people on your side of the fence. The other's are on the other side waving you over and telling you things are fine and now is the time to be making some money.

Who do you listen to?

The best thing I can think of is to start dollar cost averaging into the market. Take your money and divide it into 1/12Th's and simple start buying what you once owned. Over the next 12 months you'll catch different prices both high and low but it'll be a comfortable way to get back in without the shock of diving in all at once and then maybe seeing the markets move back to their lows and laughing at you.

Finally, get more aggressive with your money. If you were invested in balanced or Target funds look for growth, growth-income or world funds to get more bang for your money. Those funds were hit hard and off some 40% and not because they were poorly managed, they just didn't expect the huge sell off that drove all prices down.

Getting back into the market is tougher than getting out. Any excuse is good enough for you to sell; you need some compelling reasons to venture back into the unknown.