Thursday, December 11, 2008

Taking a Short Walk

In 2008 it turns out, many investors were taking a long walk off a short pier. The cement overshoes many of us were wearing didn’t help either. This was the end result of staying at the party, drinking the punch far too late into the night.

People smarter than me had left the party earlier in the evening having munched a few canapés, partaken only lightly of the punch, sold short and gone home before things got ugly.

Those of us who kept thinking the markets were due for a fall were proven right in our conviction, but dead wrong in having taken any action that would have proven prescient. So now that the shock – and hangover - has mostly worn off, what do we do? The markets have set so many records for volatility, only the most diligent day traders have been making any money.

Enter The Hedge

In a perfect world, somewhere in a perfect parallel universe, exists the perfect hedge. The perfect hedge goes up as much as the thing being hedged goes down, and vice versa, all without adding to the investor’s costs. But let’s get real. Hedging is inherently imperfect and of course it isn’t free.

In a market as volatile as we’ve experienced lately, many investors would probably be happy if the value of their risk capital accounts remained roughly the same from day to day. Too many of us have gone long (buying) when we should have gone short (selling) and gone short (selling) when we should have gone long (buying) – sometimes all in the same day. What, you too?

The traditional method of going short is to sell borrowed stock, buying it back after it declines (called “covering”), and pocketing the price difference (minus transaction costs). For those not willing to do the immense amount of research required to decide which stocks to short, Exchange –Traded Funds (ETFs) can also be sold short. ETFs are mostly constructed to follow market or sector indices – selling them short gives exposure to the same market or sector on the down side. An investor could construct a simple hedge of the S&P 500 Index by buying an ETF that emulates the index (sample ticker: IVV) and then selling the same ETF short to protect the long position by a pre-determined percentage. One of the advantages of short selling is that money flows into the account from the sale and some of that money (subject to margin requirements) can be used for re-investment. IRAs and qualified plan accounts (e.g., 401ks) are not allowed to sell short, but there are other ways to hedge long positions (keep reading).

Inverse Exchange-Traded Funds

Shorting a market or sector can also be accomplished by buying (going long) inverse ETFs. Inverse ETFs are based on derivative contracts that are designed to give an investor downside exposure to a market or sector. The share value of the ETF moves inversely to the value of the market or sector – by owning (long) the inverse ETF, an investor is short the market or sector. If the market goes up 1%, the matching inverse ETF goes down 1% and vice versa.

There is a growing sector of the ETF market that uses leverage to increase exposure to the desired market or sector e.g., 2 X the S&P 500 Index (sample ticker: SSO). If the S&P 500 goes up 1%, SSO will go up 2%. If the S&P 500 goes down 1%, then SSO goes down 2%. (Not accounting for tracking error which includes expenses charged by the ETF). There are now also many 2 X INVERSE ETFs in which one can invest (sample ticker: SDS). If the S&P 500 goes up 1%, then SDS goes down 2%. If the S&P 500 goes down 1%, then SDS goes up 2%.

A simple hedge of the S&P 500 Index could be constructed with $6,700 invested in IVV (long S&P 500) and $3,300 invested in SDS (2 X Inverse S&P 500). If the two funds are perfectly negatively correlated, the total invested value of $10,000 would change very little over time. Since we live in the imperfect world (home of the imperfect hedge) the total value would change, but it would remain fairly close to what we started with. Since the 2 X inverse ETF moves twice the % of the long ETF, one only has to commit about half the amount of funds committed to the long side to implement the hedge on the short side.

IRAs and other qualified plan accounts are not allowed to sell short, but they can buy inverse ETFs – effectively shorting by going long.

With the 2 X Inverse construction, investors can decide how much of a long position they wish to hedge. As described above, the 2/3rd - 1/3rd recipe approximately maintains a total dollar value – very handy during volatile daily swings. A long-bias hedge could also be constructed with a lesser % commitment to the inverse ETF.

There are Inverse ETFs available for many different market and sector indices. Investors can hedge their existing long positions by buying the inverse ETF that most closely matches the long position. It’s a good idea to review charts comparing the history of the long-short pairing to see how closely (negatively) correlated the pairing has been.

The chart below illustrates the negative correlation of the S&P 500 Index (ticker: IVV) and a 2 X Inverse ETF tracking the S&P 500 Index (ticker: SDS).

Hedging with inverse ETFs won’t keep you from walking off the pier, but they can turn those cement overshoes into a life raft.


Saturday, December 6, 2008

How Banking Really Works

A Primer On Fractional Reserve Banking
First published in the British humour magazine "Punch" on April 3,1957:

Q: What are banks for?
A: To make money.
Q: For the customers?
A: For the banks.
Q: Why doesn't bank advertising mention this?
A: It would not be in good taste. But it is mentioned by implication in references to reserves of $249,000,000,000 or thereabouts. That is the money they have made.
Q: Out of the customers?
A: I suppose so.
Q: They also mention Assets of $500,000,000,000 or thereabouts. Have they made that too?
A: Not exactly. That is the money they use to make money.
Q: I see. And they keep it in a safe somewhere?
A: Not at all. They lend it to customers.
Q: Then they haven't got it?
A: No.
Q: Then how is it Assets?
A: They maintain that it would be if they got it back.
Q: But they must have some money in a safe somewhere?
A: Yes, usually $500,000,000,000 or thereabouts. This is called Liabilities.
Q: But if they've got it, how can they be liable for it?
A: Because it isn't theirs.
Q: Then why do they have it?
A: It has been lent to them by customers.
Q: You mean customers lend banks money?
A: In effect. They put money into their accounts, so it is really lent to the banks.
Q: And what do the banks do with it?
A: Lend it to other customers.
Q: But you said that money they lent to other people was Assets?
A: Yes.
Q: Then Assets and Liabilities must be the same thing?
A: You can't really say that.
Q: But you've just said it! If I put $100 into my account the bank is liable to have to pay it back, so it's Liabilities. But they go and lend it to someone else, and he is liable to have to pay it back, so it's Assets. It's the same $100 isn't it?
A: Yes, but….
Q: Then it cancels out. It means, doesn't it, that banks haven't really any money at all?
A: Theoretically……
Q: Never mind theoretically! And if they haven't any money, where do they get their Reserves of $249,000,000,000 or thereabouts?
A: I told you. That is the money they have made.
Q: How?
A: Well, when they lend your $100 to someone they charge him interest.
Q: How much?
A: It depends on the Bank Rate. Say five and a-half percent. That's their profit.
Q: Why isn't it my profit? Isn't it my money?
A: It's the theory of banking practice that………
Q: When I lend them my $100 why don't I charge them interest?
A: You do.
Q: You don't say. How much?
A: It depends on the Bank Rate. Say a half percent.
Q: Grasping of me, rather?
A: But that's only if you're not going to draw the money out again.
Q: But of course I'm going to draw the money out again! If I hadn't wanted to draw it out again I could have buried it in the garden!
A: They wouldn't like you to draw it out again.
Q: Why not? If I keep it there you say it's a Liability. Wouldn't they be glad if I reduced their Liabilities by removing it?
A: No. Because if you remove it they can't lend it to anyone else.
Q: But if I wanted to remove it they'd have to let me?
A: Certainly.
Q: But suppose they've already lent it to another customer?
A: Then they'll let you have some other customers money.
Q: But suppose he wants his too….and they've already let me have it?
A: You're being purposely obtuse.
Q: I think I'm being acute. What if everyone wanted their money all at once?
A: It's the theory of banking practice that they never would.
Q: So what banks bank on, is not having to meet their commitments?
A: I wouldn't say that.
Naturally. Well, if there's nothing else you think you can tell me….?
A: Quite so. Now you can go off and open a banking account!
Q: Just one last question.
A: Of course.
Q: Wouldn't I do better to go off and open up a bank?


Monday, September 29, 2008

Confidence Game or Confidence Crisis?

The US House of Representatives just voted down the $700B “Wall Street” bailout bill. The US markets reacted in predictable fashion: the Dow Jones Industrials closed down -778, a drop of nearly -7%, while the S&P 500 index closed down -106, a drop of nearly -9%. Prices on US Treasuries soared as investors looked for a safe haven.

Even though the legislation had been hammered out between Dems and Repubs in marathon weekend sessions, enough of each party defected to the “nays” to defeat it. Predictably, there is predictable finger-pointing on both sides, each blaming the other for the failure.

My friends, though the bill was widely vilified as a bailout of Wall Street banks and bankers on the backs of US taxpayers, it could have gone a long way toward helping Main Street too. When Wall Street investors lose confidence in the game, they take their chips off the table. When Main Street investors lose confidence in the game, they line up at their local bank. The largest bank failure in US history occurred last week for that very reason – more than $16B of deposits had fled Washington Mutual in less than two weeks.

Now what?

Congress will try again, although at this point it is unclear if that will happen now, after the election, or be delayed until the next Congress. Someone has probably opened a book on this in Vegas already.

Until such time as this is addressed by our elected officials (as opposed to our selected officials – Paulson and Bernanke, et al), here is what I know:

· The FDIC still stands behind bank deposits up to $100,000 per depositer. Be sure you don’t have more than $100k in any one bank. You can view the rules at

· The Treasury put up $50B last week to insure money market fund assets for the next 12 months. The $1 net asset value is safe for the time being. If you are concerned about this, switch your money market fund to one that invests solely in US Treasury obligations.

· Markets do come back. If the Dow can plunge -778 points in one day, it can rise +778 points in one day. For all of the gyrations the week of September 15th when Lehman Brothers filed for bankruptcy, the markets actually finished up for the week. If you needed the money in the near future, it wouldn’t be in the markets anyway, right? Right?

· In the near term, markets are likely to be choppy.

· Neither of the Presidential election campaigns can be counted on to add any sanity, but are more likely to use events to try and score with voters.

· I’m keeping the sensitivity dial on my BS detector set on HIGH – I suggest you do the same.

· Stay invested, stay diversified.


Friday, September 19, 2008

Helter Skelter

“When I get to the bottom
I go back to the top of the slide
Where I stop and turn
and I go for a ride
Till I get to the bottom and I see you again”
- Helter Skelter (Lennon-McCartney)

One of my daughters just loves roller coasters, but I think even she would’ve been nauseous this past week. Some of us held our breath while the rest of us held our noses.

That smoke you smell is from the friction of the over-heated U.S. Treasury printing presses cranking at maximum capacity to keep up with the obligations assumed by our very own federal government.

Losses in private business are – once again – being socialized on the backs of the U.S. taxpayer. Remember the Savings and Loan disaster in the 80s? That was a mere pittance at $150B. This dwarfs that by a magnitude of oh, say, at least 10X. The Crowned Heads of Government Finance (Bernanke, Paulson et al) were – once again – check-mated into backing private business with taxpayer dollars. The U.S. financial markets had become so intertwined that “too big to fail” was quickly replaced with “too complex to fail”. They drew a line in the sand with Lehman Brothers, but the markets quickly erased it with the loss of confidence in insurer AIG whose participation in the unregulated market for Credit Default Swaps (CDS) threatened market stability all over the world. Even providing financing to AIG wasn’t enough and now they are trying a fire break to cleanse the banking system of bad debts in the hope that will stop the firestorm.

So now the U.S. Government owns (one way or another) Bear Stearns ($29B), Fannie Mae, Freddie Mac (combined $6T), AIG ($85B), ALL THE BAD MORTGAGE LOANS IN THE ENTIRE COUNTRY (“We’re talking hundreds of billions.” – Paulson) but wait, it gets better: ALL LOSSES IN MONEY MARKET FUNDS for the next 12 months ($50B to start).

My brain hurts. As Everett Dirksen is often quoted as saying: “A billion here, a billion there, pretty soon it adds up to real money.”

My 2 cents: They better well make damn sure the financial “institutions” share in the cost and they better make sure it hurts because I can tell you, our share is gonna hurt. WE CAN’T KEEP DOING THIS.

You can kiss any campaign promise tax decreases good bye and the hidden tax of rising inflation caused by printing money will only add to the pain.

In spite of the wild ride, the U.S. stock markets actually eked out a small gain for the week.

I repeat my mantra for investors: stay invested, stay diversified.


Monday, September 15, 2008

The Day the Earth Stood Still

"Klaatu barada nikto."
- Michael Rennie to Patricia Neal in The Day the Earth Stood Still

The Day the Earth Stood Still was a film released in 1951. Like many sci-fi films, on the surface it appears to be about space aliens and ray guns, but there is a deeper story with an anti-war message.

The line delivered in the film is intended as instructions to the alien robot Gort to stop its assault on the military units surrounding the spaceship and to resuscitate (resurrect?) the character played by Rennie (shot and apparently killed in another scene) so he can deliver his speech in the closing scene.

In spite of the Crowned Heads of Wall Street working all weekend though, there is no resurrection for Lehman Brothers. Lehman began operations before the Civil War and had survived many other crises, but not this time. The government drew a line in the sand. Finally. There would be no taxpayer money backing any takeover of Lehman. Merrill Lynch saw the writing on the wall and quickly arranged a “merger” with Bank of America. That pretty much leaves only Goldman Sachs and Morgan Stanley as the last of the large, independent investment banks and rumors about their viability as independent entities abound.

So, is the earth standing still today? I don’t think so. Capitalism is doing what it does best: rewarding the winners and punishing the losers. The punishment taking place is obvious, but knowing who the winners will be is not so obvious.

What I do know though, is that the markets will recover. They always do. Now is not the time to bail. Stay invested, stay diversified.


Thursday, September 11, 2008

Uh, Wait a Minute

“Wait, oh yes wait a minute mister postman
Wait, wait mister postman”
- Please Mister Postman (as performed by The Beatles)

Now that some of the dust has settled after the U.S. Government takeover of Fannie Mae and Freddie Mac, more details are coming to light.

In the most recent post on this blog, I stated that the implied U.S. guarantee of Fannie and Freddie obligations had become an explicit guarantee. Dumb ‘ol me: this is not the case.

In an article on published today (Sept 11th):

“The federal takeover of the government-sponsored enterprises, or GSEs, on Sept. 7 failed to address whether the debt of Fannie and Freddie should be included in the budget, or whether it carries an explicit government guarantee. In an interview this week, Treasury Secretary Henry Paulson cited the ``incongruities'' in the law and said ``we should be clear, is there a government guarantee or isn't there?''

Any decision to add Fannie and Freddie to the budget wouldn't automatically translate into an explicit government backing for the companies' combined $1.7 trillion in unsecured debt and $3.5 trillion of mortgage guarantees. Granting the full faith and credit of the U.S. would require an act of Congress to change the companies' legal status.”

As Emily Litella would’ve said “Ohhh, that’s very different!”

The perception in the market seems to be that the U.S. is on the hook for the obligations, no matter what might be said. Ever heard of “credit default swaps”? Commonly referred to as CDSs, credit default swaps are insurance for investors. If you own a bond say, and are concerned about getting your money back, you can buy an insurance policy in the form of a CDS. Like all insurance, the price is (for the most part) directly proportional to the likelihood of the insured event occurring during the time period covered, i.e., the more likely it is perceived the event will occur, the higher the price of the insurance.

You can buy CDSs on U.S. government debt. What you say? Someone out there thinks we might not pay? Yeah – someone out there thinks we might not pay and in fact, the cost of CDSs for U.S. Government debt has increased quite a bit this year. Ouch. If the U.S. is perceived as a lower quality borrower, that means lenders will require higher interest rates. Think of the implications of such a shift in perception for you and me as U.S. taxpayers: higher interest rates means higher federal outlays for debt servicing which translates into higher U.S. taxes.


Tuesday, September 9, 2008

The State of the Investment Markets

“There was an old lady who swallowed a fly.
I dunno why she swallowed that fly,
Perhaps she'll die.

There was an old lady who swallowed a spider,
That wriggled and jiggled and wiggled inside her.
She swallowed the spider to catch the fly.
But I dunno why she swallowed that fly -
Perhaps she'll die.”
- Folksong

I thought it would be a good time to offer some perspective on what we’re seeing in the investment markets.

It’s been a brutal year: the Standard & Poor’s 500 index is down -12.3% for the year – this after Monday’s (Sept 8th) increase of 2% (25.48 points). Markets in other countries have fared no better and many in fact are doing worse. A global economic slowdown seems to be underway.

By now, the story of the housing bubble fueled by easy credit should be familiar. Too much easy money ignited demand for houses (new and existing) and created an unsustainable rise in home prices. We are still dealing with the consequences. Home values are falling and borrowers who thought they would be able to re-finance their way out of trouble are finding they can’t and are abandoning their homes to the lender. Mortgage foreclosures are approaching numbers not seen in the U.S. since the Great Depression of the 1930s (9% of all residential mortgages in the U.S. are in late payment status or foreclosure proceedings). Lenders have tightened their credit requirements – which means they are making fewer loans – while their assets – mortgages and mortgage bonds – are declining in value. Banks large and small are finding themselves in the unenviable position of having to raise capital in this environment – sell stock or issue bonds – to shore up their balance sheets so they can remain in business. Many of the largest U.S. banks have turned to Sovereign Wealth Funds (SWF) for capital, effectively selling part of themselves to non-U.S. investors. Of course, the U.S. Government has been doing this for years for essentially the same reason.

Enter the U.S. Treasury (or “Treasure Island” as I’ve seen it referred to). The U.S. Government explicitly guarantees only certain debt issues: U.S. Treasury obligations (T-Bills, Notes and Bonds) and mortgage-backed bonds issued by the Government National Mortgage Association (Ginnie Mae) being prime examples. There are two major Government Sponsored Entities (GSE) that have enjoyed an implicit U.S. Treasury guarantee: Fannie Mae (FNMA - Federal National Mortgage Association) and Freddie Mac (FHLMC - Federal Home Loan Mortgage Corporation). Fannie and Freddie as they are known, provide about half of the financing for home mortgages in the U.S. and have used the implied government guarantee to finance their operations.

Monday’s takeover of Fannie and Freddie – changing the implied guarantee to an explicit guarantee - could go a long way in reducing mortgage interest rates for new borrowers, stabilizing U.S. housing prices, and perhaps help to free up the tight credit markets around the world. In fact, today (Sept 9th) 30 year mortgage rates are being quoted at a national average of ~5.9%, down 50 basis points (one-half of 1%) from levels one month ago. This is a huge drop. Lower rates may help stabilize housing prices and home buyers may decide to quit waiting for prices to fall further and return to the market. There is still a large housing inventory overhang, but reducing it to historical levels (about 6 months’ worth is considered “balanced”) would really help the current economic environment.

There is still a long way to go. One of the big questions concerns further write downs of bad loans by banks worldwide, recently passing $500 Billion. Many commentators expect bank losses to eventually exceed $1 TRILLION. Stabilized housing prices could help homeowners re-finance their mortgages to affordable loans and remain in their houses. This in turn could help “stop the bleeding” in the banking industry. This in turn could help loosen the tight credit markets. This in turn could help businesses expand, creating more jobs. All of this would be positive for stock markets around the world.

Hopefully, the takeover of Fannie and Freddie will be the action that stops the “old lady” from attempting to solve a series of problems with an action that creates a bigger problem:

“There was an old lady who swallowed a horse -
She's dead, of course.”


Wednesday, September 3, 2008

Getting Organized in the 21st Century

With the ever-increasing proliferation of web-based services, a large hole in many financial plans is growing larger.

You may have prepared a comprehensive list of all of your financial relationships and related contact information: accountant/tax preparer, bank/s, legal document location/s, mortgage holder, credit cards, financial advisor/s, attorney, safe deposit box location (and key!), etc. (Here’s your chance to say “Why, yes I have!”…)

This list should be kept up to date and copies kept in more than one location. (Here’s your first chance to say “Why, yes I will!”…)

But, you may not have included the “keys” to your web-based relationships on this list: those important website addresses (banking, bill-paying, e-mail, shopping) with your login ids and passwords.

Virtually all web-based relationships are governed by a legal document you agreed to when you first established the relationship, the Terms Of Service Agreement (TOSA). Like me, when presented with a “check here if you agree to our terms” check box, you probably checked “yes” and didn’t think about it.

Time to think again.

TOSAs commonly contain “use” clauses and privacy clauses. The use clauses often state that your account access – like an e-mail account – will be terminated and all data wiped out if you don’t use the service for a stipulated time period, sometimes as short as 30 days. The privacy clause prevents the service provider from giving anyone else access to the service – they will not give anyone else your login and password. These are good things, but what happens when someone dies or becomes unable to communicate (a stroke) and their family can’t find their login and password? Short of a court order – at the family’s expense – they are out of luck.

Here’s another one: do you protect your home computer with a password? If no one else knows it, your family may not be able to access it if you die or become unable to communicate. What if your list of important items is on your password-protected computer?

Your vital documents should contain a list of all of your on-line account relationships with their related login ids and passwords. Of course, this list needs to be kept up to date.

It goes without saying, but don’t keep the sole copy of this list on-line!

Here's a link to what looks like a great organizer for just this purpose: (currently in development - enter your contact info and they'll let you know when it's available).


Friday, August 29, 2008

A Genesis Tale

"First God made heaven and earth.
The earth was without form and void,
and darkness was upon the face of the deep;
and the Spirit of God was moving over the face of the waters."
- Genesis, Chapter 1, verses 1 and 2

Day 1
God saw that money was without form, and darkness was upon it.
And God said, “Let there be financial engineering, that money may have form and be multiplied.”
And it was so, and God saw that it was good.

Day 2
God saw that there was no one to promote money in all its forms.
And God said, “Let there be Wall Street, that money in all its forms may be spread to the far reaches of the earth.”
And it was so, and God saw that it was good.

Day 3
God saw that Wall Street had no one to send out upon the earth to sell money.
And God said, “Let there be Salesmen, that the products of Wall Street may have promoters.”
And it was so, and God saw that it was good.

Day 4
God saw that the Salesmen had no one to call on.
And God said, “Let there be Prospects, that the Salesmen have someone to call upon.”
And it was so, and God saw that it was good.

Day 5
God heard the anguished cries of the Salesmen that they could not make enough money on salary alone.
And God said, “Let there be commissions, that the Salesmen shall earn bounteous incomes from the Prospects.”
And it was so, and God saw that it was good.

Day 6
And God saw that there was wickedness and avarice in Wall Street and the Salesmen, and the Prospects were crying out in anguish.
And God said, “Let there be independent advisors, that the Prospects may receive unbiased advice from fiduciaries.”
And it was so, and God saw that it was good.

Day 7
And God rested. Finally.

(I am an independent advisor and I accept the fiduciary role for my clients).


Thursday, August 28, 2008

401k Freedom of Choice

“Oh freedom (freedom), freedom (freedom), freedom, yeah freedom
Freedom (freedom), freedom (freedom), freedom, ooh freedom”
- Think - performed by Aretha Franklin

Many (if not most) 401k plans offer a limited menu of investment choices. One would expect that larger employers would offer more choices, but there doesn’t seem to be any correlation between the size of the employer and the investment options offered in a 401k plan. Unfortunately, many employers do not offer what financial planners would call a sufficient range of investment options. A typical 401k plan offers a limited number of mutual funds, often funds from the same mutual fund family e.g., T. Rowe Price, Fidelity and others (not to pick on either of these firms). A newer trend in 401k plans is offering mutual funds from several different fund families and, while better than “single family” options, the choices are still often narrowly limited.

Enter, the Brokerage Window.

Recognizing the desire for more investment diversity and control, more employers are adding the ability to establish a brokerage account within their 401k plans. With a brokerage option in a 401k plan, employees have an almost unlimited choice of investment options. One can finally build a 401k account tailored to their individual risk tolerance without compromising based on a limited menu of investment choices.

If your employer is offering a brokerage account option for your 401k plan, sign up.

Now, just because you can buy (almost) anything doesn’t mean that you should. This is your retirement money, not your Vegas money (you've seen those ads - "What happens in Vegas, stays in Vegas"? they don't mention that mostly what "stays in Vegas" is your money...). Build an asset allocation plan tailored to your personal risk tolerance and stick to it (e-mail me - see below - for a self-scoring Risk Tolerance Questionnaire). Professional financial planners (such as yours truly) design asset allocation plans all the time. Seek out competent advice – paying a professional fee for an hour or two of work will be money well spent.

The brokerage account option should allow you to invest in Exchange-Traded Funds (ETFs). ETFs are in many ways superior to mutual funds – cost being one of the most desirable. The cost of ownership in the average mutual fund is ~1.35% vs. ~.41% for the average ETF (per CNN). Why is this important? Because returns always vary, but expenses go on and on. Given the exact same investment performance between the average mutual fund and the average ETF, the ETF will have a return that is nearly 1% higher because of the lower cost.

1. Sign up for your plan’s brokerage account option.

2. Design an asset allocation plan – with professional help if needed.

3. Implement the allocation plan using ETFs.

4. Relax. Enjoy life.


Thursday, August 21, 2008

Think the Housing Crisis is Over?

" It ain't over 'til it's over "
- Yogi Berra

We’ve been hearing every week for some time that the credit crunch is over, that the banks have come clean on all their bad assets, the economy is averting a recession, housing prices have stabilized and everything is rosy again.

Time to buy a house! (There are a few banks that would love to sell you a house).

Trouble is, we’ve been hearing the same thing every week for a year and in spite of the increasing repetition, it is no more true now than it was then.

If you are thinking of buying a house, wait. They will be cheaper next year. There’s no feeling like watching the equity shrink in a house you just purchased. If you have to sell the house you own now first, be prepared to wait for a buyer and be prepared to slash your price.

Here is a chart I borrowed that is based on federal government statistics. It portends a total drop in home values of 34% to get back to the historical price trend line.


There are lots of other scary charts out there illuminating different facets of the same point: housing prices are not sustainable and have to come down (further). This is true in other countries too – easy credit made the leap across the oceans. Mortgage foreclosures are on the rise all over the world. Banks aren’t in the business of owning real estate – what will they do to get rid of the homes they’ve repossessed? Slash prices until they find buyers. What will this kind of price pressure do to the prices of other homes on the market? Yes – prices are going down.

It ain’t over yet. Just ask Yogi.


To Roth or Not to Roth

If you have a choice between a tax-deductible retirement plan and a non tax-deductible retirement plan, which one should you pick?

The answer has a lot to do with a current unknown – future income tax rates.

Let’s leave aside the issue of increased future tax rates since we don’t know what they will be and can’t do anything about them if we did.

If you contribute to an IRA or 401k and deduct the contribution against your current income you are probably better off if you assume your marginal tax rate (the rate you pay on the last dollar of income each year) will be the same as it is now. This is due to the difference between your marginal tax rate and your effective (average) tax rate.

Here is the 2007 Tax Rate Schedule for married couples filing a joint return:

The income ranges shown in the “Over/But not over” columns are called brackets. Each bracket has its associated tax rate of 10% to 35%. If your taxable income lands you in the 28% bracket, then you pay 28% on each dollar of taxable income in excess of $128,500. By making a tax-deductible contribution to a retirement account, you reduce your taxable income and thus your income tax due by the same percentage.

Overall though, your income – including taxable retirement plan distributions - is taxed at your effective or average tax rate. Calculate this by dividing your tax for the year (Form 1040 line 63) by your taxable income for the year (Form 1040 line 43). The resulting percentage will be less than your marginal rate.

As long as your effective tax rate at the time of retirement account distributions is lower than the marginal rate at which the contributions were deducted, you are probably better off using a deductible retirement account if eligible. Since we don’t know now if this will be true, hedging one’s bets is advised.

You can hedge your future tax exposure by having a mix of “deduct now/pay later” (Traditional IRAs and 401ks) and “pay now/pay nothing later” (Roth IRAs and Roth 401ks) retirement accounts.

The income eligibility limitations for opening a Roth IRA are higher than they are for making tax-deductible contributions to a Traditional IRA. So it is possible that if you can’t deduct a Traditional IRA contribution you could be eligible to open a Roth IRA. If you don't qualify to make a tax -deductible IRA contribution, but are eligible to make a Roth IRA contribution do the Roth, as a Roth IRA is superior to a non-deductible IRA. (A non-deductible IRA contribution is not taxed upon withdrawal, but the earnings are taxed as ordinary income). There are no income limitations for participating in 401k plans although contributions may be limited for high income earners due to the non-discrimination rules if the plan doesn’t pass the required testing.

Remember that the rules can change: "Congress giveth, and Congress taketh away".


Wednesday, August 20, 2008

Carrots and Sticks

" If the people don't want to come out to the ballpark, nobody's going to stop them "
- Yogi Berra

You may be contemplating how best to allocate your retirement savings contributions among the many choices available. You have probably heard about the Roth IRA and its cousin, the Roth 401k. Let’s see if we can shed some light on the issues involved in making the choice of a Traditional IRA or a Roth IRA. Along the way we’ll do the same for the Traditional 401k and the Roth 401k.

Let’s assume that you want to save for retirement and that you can afford to do so.

So where do you put your money? We must distinguish here between the conduit by which you save and the actual investment of the funds. These are two different things. Today we are talking about the conduit by which you save and have little interest in the actual investment of the funds.

The conduit by which you save is the account into which you make your deposit – “contribution” in retirement account parlance. For example, an IRA (Individual Retirement Account) is not an investment in and of itself, but a conduit through which one can invest. I’ve had many conversations over the years in which people have told me they have an IRA but when I query them about what it’s invested in, they revert to insisting they have an IRA, believing the IRA itself is an investment. So, an IRA (or other retirement savings conduit) is not an investment but is a means by which one can invest. An analogy may be helpful: think of an IRA (or other account type) as a garage and the investment as your car that you park in the garage.

So which type of retirement conduit should you have? Like a lot of answers in the financial world, “it depends”, so let’s do a little compare and contrast.

#1 Caveat: All information here is based on U.S. tax laws as they exist in 2008.

#1 Carrot: ALL retirement accounts offer tax deferral on account earnings. No income taxes are due during what is called the "accumulation phase" - the period during which you are making contributions.

#1 Stick: You will pay income taxes on some or all of your retirement account balance at some point in time (either when the funds go in or when the funds come out).

Traditional IRA (tax deductible)
Carrot: Contributions made to a Traditional IRA may be tax deductible. This means for those who qualify, the amount contributed is deducted (line 32 of the IRS Form 1040) from “total income”. The annual contribution limit for those under age 50 is $5,000 ($6,000 if you are 50 or older). So if you contribute the full $5,000 and qualify to deduct the entire amount, then your income is reduced by the $5,000 ($6,000) contributed to the IRA. You have reduced your income tax by the amount of the IRA contribution times your marginal tax bracket. Assume your marginal tax bracket is 28%. This means that the last dollar of income you receive each year is taxed at 28% (not accounting for special treatment for capital gains, dividends, etc). This works in reverse when making a tax deductible IRA contribution. $5,000 times 28% = $1,400 off your tax bill for the year. Magic? No, just math. The bottom line is that putting away $5,000 only cost you $5,000. Without the deduction, you would have to earn $6,944, pay 28% in income taxes to bring home the $5,000 to put in the account.

Stick: All distributions from a Traditional IRA (with all contributions deducted) are taxed as ordinary income (no capital gains or other special treatment). An additional 10% penalty tax is added if the account owner is <59 – look for Publication 590.

Roth IRA (non-deductible)
Stick: Contributions made to a Roth IRA are not tax deductible. To put $5,000 in a Roth IRA account, you have to earn $6,944 then pay 28% income taxes to bring home the $5,000 to put in the account.

Carrot: All qualifying distributions from a Roth IRA are not taxed. This means no income taxes are due on the money earned by your contributions. A “qualifying distribution” is one that occurs after the account owner is 59 ½ AND the account has been open for five years. HINT: If you are eligible, open a Roth IRA now to get the five year clock started – especially if you are >50.

Income limitations apply - check the eligibility rules for opening a Roth IRA at – look for Publication 590.

Traditional 401k (tax deductible)
Carrot: Contributions made to a Traditional 401k are tax deductible. The annual contribution limit is $15,500 ($20,500 if 50 or older). Your employer may match a portion of your contribution. The employer contribution is not taxed to you at the time it is made. The same tax accounting applies as for a Traditional IRA: since the contribution is tax deductible, it only costs you $15,500 to make a $15,500 contribution.

Stick: All distributions from a Traditional 401k (including employer contributions and related earnings) are taxed as ordinary income.

Roth 401k (non deductible)
Stick: Contributions made to a Roth 401k are not tax deductible. Contribution limits are the same as for the deductible 401k and the rules are written such that total 401k deferrals are limited to $15,500 (or $20,500) so you can contribute to both types of 401ks at the same time, but the total contribution allowed doesn’t increase. To put $15,500 in a Roth 401k account, you have to earn $21,527 then pay 28% income taxes to bring home the $15,500 to put in the account.

Carrot: Qualifying distributions of your contributions plus earnings from a Roth 401k are not taxed. Employer contributions are not taxed to you when they are made.

ALERT: Employer contributions to a Roth 401k (plus related earnings) are accounted for separately and are taxed as ordinary income upon distribution. This is so for the simple reason that the employer’s contribution is a tax-deductible expense to the employer – since the employer contribution is deducted on the way in, it must be taxed on the way out.

So now that we’ve covered the basic differences between the retirement accounts available to most people, the question occurring to you is probably something like this: If I have a choice, what should I choose? We’ll cover that topic in our next post.


Monday, August 11, 2008

Word o' the Day: Insurance (ABC’s of Financial Planning)

Insurance is a risk transfer device.

For a fee, someone else will indemnify you, your possessions or property against loss for a certain time period.

The concept of insurance is based on the law of large numbers which states that the larger the number of observations of an activity, the more likely the observed outcomes of the activities will be equal to the expected outcomes. In essence, the more participants buying a particular type of insurance, the more likely the actual claims experience will match the expected claims experience. This allows insurance companies to price the risks they assume, knowing that a certain percentage of the insured population will submit a claim, but that a certain percentage will not. This is why insurance works – in some cases – or doesn’t work – in other cases.

I define “works” in this context as meaning the desired type of insurance is reasonably priced and readily available to those seeking the protection offered. Examples are auto insurance, life insurance and home insurance.

A good example of insurance that “doesn’t work” is health insurance in the U.S. It is – generally speaking – not reasonably priced and not readily available to those seeking protection. There are a number of reasons for this, but the basic reason is that health insurance in the U.S. is in violation of the law of large numbers. There are too many people who are not insured. If the U.S. were to somehow insure everyone living in the country, the cost of health insurance - on a per capita basis - would go down.


Thursday, August 7, 2008

Your House as ATM

“Cause I love to live so pleasantly,
Live this life of luxury,
Lazing on a sunny afternoon,
In the summertime.”
- Sunny Afternoon – The Kinks

There haven’t been too many sunny afternoons here this year, but that hasn’t stopped many homeowners from wanting to live pleasantly. Rising home prices over the last several years created large increases in home equity, prompting many - insert your town name here - homeowners to treat their home like a cash machine via home equity loans (HELOCs) or re-financed mortgages.

In the financial world, borrowed money is called leverage. In a leveraged transaction, the borrower invests borrowed money, and if successful, repays the loan, keeps the profit, minus the cost of borrowing. If unsuccessful, the borrower still has to repay the loan plus interest, but since the investment was a loser, she doesn’t have all of the borrowed funds to repay the loan and must cover the loss from other funds. This can be very painful financially.

The problem for - insert your town name here - homeowners leveraging the equity in their homes is that a good portion of the money borrowed is not invested in appreciating assets. Many - insert your town name here - homeowners spent the money in one of three ways: home improvements, experiences (vacations and trips) and depreciating assets (cars, boats, home furnishings, etc). Spending borrowed money on home improvements can work out successfully – if the home is increasing in value at a rate higher than the cost of borrowing. To be fair, there can be intangible rewards too, e.g., increased satisfaction with one’s living space. But, spending borrowed money on lifestyle choices (experiences or depreciating assets) is a poor use of leverage because neither experiences nor depreciating assets can be used to repay the loan. Long after the experience is over or the car is sold, the borrower is still making payments on the home loan. When the value of homes stops increasing or even declines, equity-leveraged homeowners can find themselves with little or no equity but – you guessed it - they still have loan payments. Home values in my local area have been fairly stable after the large run up in 2004 - 2006 unlike many other regions in the U.S., lulling local homeowners into perhaps a false sense of complacency. I can only imagine what people in parts of the country where housing values are diving are doing: working second and third jobs, cutting out all the extras and in the end, walking away (“jingle mail” - that's where you put your keys in an envelope and mail them to the bank).

Rainy Day Advice: if you haven’t tapped the equity in your home, don’t start now. If you have, review your decision and develop a strategy to repay the loan. If home values keep falling, today’s home equity party can easily become tomorrow’s home equity hangover.



“It is not the strongest of the species that survives, nor the most intelligent that survives.
It is the one that is the most adaptable to change.”
- Charles Darwin

Here in the United (Consumer) States, the shock of exponentially higher oil prices is rippling through the economy. The cost of simply getting around has nearly doubled in the past year. This not only affects your direct cost of putting gas in the tank, but virtually all of your indirect costs when you consider the cost of transporting the products you buy every day. Not to mention the almost innumerable products that are made from oil – e.g., plastic drink containers.

I was recently in Europe where consumers have been adapting to high energy prices for many years. Their houses are smaller (lower heating and cooling costs), their cars are smaller (lower operating costs), they ride bicycles (it’s a little shocking at first to see a guy in a business suit riding a bike), they have well-developed public transportation networks and they use them, they ride motor scooters, hot water is provided by on-demand gas heaters (no money wasted on heating a tank of water that may only be used 1 hour a day), dishwashers are uncommon and their clothes washers are low volume front loaders. If the laundry hanging from balconies and windows everywhere is any indication, clothes drying is commonly provided by Mother Nature.

Here’s a picture of gas prices in Milan, Italy (June 30, 2008):

That’s €1.55 (Euros) per Liter.

The exchange rate for U.S. dollars into Euros (at the time this picture was taken) was about US$1.58.

There are 3.8 Liters in one US gallon.

The price of one US gallon of gas in Milan: US$9.30.

How would you adapt to paying US$9.30 per gallon?

Walk more. Use public transportation. Drive less. Downsize your car. Ride a bike. Downsize your home. Replace your appliances. Europeans have been doing all of these for years. Here is a typical euro-sized car:

This is not to say that you have to adopt any of these changes, the US is still the land of the free and the home of the brave, and there aren’t any laws – except the economic laws of the marketplace – that compel energy consumption behavior changes (yet). It seems that $4 per gallon gasoline is the pain threshold that is causing at least temporary habit changes.

Reducing one’s energy consumption is an incremental process that should be reviewed in the context of one’s overall living cost. As an example, it may not pencil out to trade in a large SUV for a smaller car even though the smaller car travels two or three times as far on a gallon. Look at the total cost of such a trade – prices for used SUVs are falling faster than a Randy Johnson splitter - while the price of efficient smaller cars (particularly hybrids like the Toyota Prius) is rising as demand increases. Calculate your break-even on such a swap before proceeding. You will probably be surprised at how long the pay off takes. Another example is compact fluorescent light bulbs. Yes, they last longer and use less electricity than incandescent bulbs, but they also cost three times as much (not considering sales and sponsored giveaways which are currently popular). They also make every room look like a morgue. Incandescent bulbs will likely be legislated out of existence – remember what happened to full flush toilets. The last thing you want to do is throw out a working incandescent bulb. At least wait until it burns out before upgrading. LED lights - which are superior in every way - will replace fluorescent bulbs anyway, it’s just going to take a while before innovation brings the price down.

So if we don’t change our ways are we going to die? No. Newsflash: we’re going to die anyway…


Wednesday, June 4, 2008

Financial Cartography II

“When you come to a fork in the road…Take it.”
-Yogi Berra

Many people that engage my services have only a vague idea – financially speaking – of “where” they are going or how they will get “there”. I like to use the analogy of a jigsaw puzzle or a map to describe what financial planning is and what it does. Think of putting together a jigsaw puzzle without a picture of what the finished puzzle should look like – pretty tough, huh? The financial lives of many people I meet resemble that jigsaw puzzle – all the client knows is they have a box of puzzle pieces but they don’t have a picture of what the finished puzzle should look like. And, without that picture they feel helpless in putting the pieces together.

Financial Cartography describes the series of processes by which I help clients determine their dreams, goals and objectives with the end result producing a financial map for their lives. I find that as this map is drawn, re-drawn and refined with new details, that clients become more engaged in planning their futures and discover that they do have the power to decide where they are going and how they will get there. When the map is completed to their satisfaction, I integrate the aspects of financial planning into their map so they can reach their objectives along the way.

Financial Cartography is not “retirement planning”, but life planning. “Retirement” is just a tactic for living a period in one’s life. Living a happy and fulfilled life is the ultimate goal and retirement is merely one part of that life.


Monday, June 2, 2008

Mortgaging the Farm

" The future ain't what it used to be "
- Yogi Berra

Zero savings (negative savings rate), falling home values (disappearing home equity), vanishing home equity lines of credit (banks are “dis-approving” previously approved credit lines), upward-adjusting variable-rate mortgages, increasing cost of living, $4 per gallon gas, job insecurity, etc, etc, etc.

What is the strapped U.S. consumer to do? Caught between the proverbial rock-and-a-hard-place and not enough room to roll over.

Repeat after me: WE DID IT TO OURSELVES.

We took the easy money. Why save when I can borrow from my house at a near-zero interest rate (in real terms)?

And what is government’s response? Throwing more money at us: Lower Fed Funds rates, “economic stimulus checks”, homeowner bailout legislation, Wall Street bailouts (see: Bear Stearns – though to be fair, I don’t think the Fed had any choice on this one), “Elect Me Gas Tax Holidays”. Say what you will about Obama, but he’s right on at least that last one.

$600 tax rebates? Does anybody really think these checks will be spent on anything other than rent, food and debt reduction?

All of this is designed to keep us spending every dime that we earn and dimes we don’t earn. Now that we can’t tap our homes for easy money, we’re going back to our credit cards: consumer revolving credit outstanding is increasing, not decreasing as one might expect it to do in the face of a recession. When that doesn’t work, we’re taking out loans against our 401k accounts and considering exotic home loans like reverse mortgages (for those 62 and older) and “equity-sharing” home loan arrangements. All to prop up that which shouldn’t have been built in the first place – by this I mean the massive debt pile, not your home ;-).

Here’s a simple question: what happens when all of the possible avenues to keep the ship U.S.S. Consumer afloat have been exhausted? What then?

A simple personal prescription:

Don’t buy anything you don’t need.
Don’t buy anything you do need with credit.
Open a savings account today – make regular deposits. Here’s an easy one:
Start a debt reduction plan today. Here’s an easy to use spreadsheet:

You can’t mortgage the farm if it’s already mortgaged. Change your behaviors, change your life. Put yourself in a position to choose rather than react.


Tuesday, May 27, 2008

Water is the New Oil

“It is clear our nation is reliant upon big foreign oil. More and more of our imports come from overseas.”
- George W. Bush

"When the well is dry, we learn the worth of water."
- Benjamin Franklin

You can own oil, but you can’t own water. You can invest in oil and the industrial complex that finds, produces, refines and distributes it. You can invest in the industrial complex that finds, produces, treats and distributes water, but you can’t invest in water itself. Oil and its byproducts are toxic to life whereas water is essential to all life. Perhaps therein lies the origins of the difference to investors. Fresh water is, for the most part, not owned by anyone but is (in most cases) managed and distributed for the public good. The price you pay for public water is essentially the cost to transport, manage, treat, and distribute it to the tap in your home.

You can’t – at least not yet – buy water on any exchange in the world. As water supplies get tighter across the world, this could change. Water is the new oil – a precious commodity, increasingly harder to find, manage and distribute; and that supply is often subject to the whims of Mother Nature. Control of available water is subject to the whims of government. In some parts of the country, the availability of water is restricting the building of housing.

Some regions in the U.S. are learning the hard way – the Southeast is entering its third year of drought conditions. Lake Lanier, Atlanta’s main source of water is over 13 feet below normal, despite recent rainfall. See embedded drought map of the U.S. below. The world drought map doesn’t look any better.

Like oil, water must be transported from where it is found to where it will be used. Pipelines are commonly constructed to bring the water to a central collection and treatment plant. Once at the central plant, the water must be tested and brought up to potable standards. Only then is the water released into the municipal distribution system. You may have seen news stories about large consumer products companies and their quest for water to fill the millions of plastic bottles they sell each year – a lot of this water comes out of the municipal tap. You may also have seen stories about the treatment of sewage to return it to the potable water supply – this is happening now in Southern California

Investors can tap into the water pipeline at four main places: infrastructure, treatment of water entering the system, consumer products (bottled water) and treatment of water exiting the system (sewage treatment).

You can find stocks of companies involved in the various phases of water treatment and distribution but as readers of this blog know, I am a big believer in the diversification benefits afforded by Exchange Traded Funds (ETF). There are currently two ETFs concentrating on water – primarily transportation, delivery infrastructure and treatment.

1. PowerShares Water Resources Portfolio (ticker PHO)

2. Claymore S&P Global Water Index ETF (ticker CGW)

PHO is more U.S. focused in its holdings while CGW is more international.

Investors can play the consumer products angle with stock in Coca-Cola – distributor of Dasani (ticker KO), Pepsi-Cola – distributor of Aquafina (ticker PEP) or Nestle – distributor of Poland Spring (ticker NESN). U.S. Consumers are paying more for bottled water per gallon than they are for gasoline ($1 for a 16 ounce bottle equates to $8 per gallon).

Asset allocation: these investments are primarily in stocks of companies involved in the water industrial complex - these are not a commodity play on the price of water.


Thursday, May 22, 2008

A Journey With My Dad

(My father died May 10, 1999. Following is what I said at his memorial service. We still miss you Dad).

Reading: Genesis 22, verses 1-12

Where are we going dad?
Down to Callahan Creek? Are we?
Can we put our toes in the water? Can we?
Are we driving to Kalispel? Are we?
Can we swim in Flathead Lake? Can we?
Are we there yet dad?
Are we there?

Where are we going dad?
Are you walking to school with me? Are ya?
Did you pack me a lunch? Did ya?
Will you visit my classroom today? Will ya?
Are we there yet dad?
Are we there?

Where are we going dad?
Can we stop at Wall Drug? Can we?
Can we visit Frontier Town? Can we?
What’s a tourist trap dad? Huh?
Are we there yet dad?
Are we there?

Where are we going dad?
Are we going out on the boat? Are we?
Can I row the dinghy in the harbor? Can I?
Will we go fishing for salmon? Will we?
Are we there yet dad?
Are we there?

Where are we going dad?
Will you show me how to tune up the car? Will ya?
Can I use the car tonight? Can I?
Why are you laughing at me? Why?
Are we there yet dad?
Are we there?

Where are we going dad?
Are you coming to my basketball game? Are ya?
Why are you so absent? Why?
Why do you withhold your love? Why?
Are we there yet dad?
Are we there?

Where are we going dad?
What am I carrying on my back? What?
I can’t see it, why is it so heavy? Huh?
Did you give this to me? Did ya?
Are we there yet dad?
Are we there?

Where are we going dad?
Is life about anger? Is it?
Is life about hate? Is it?
Is life about love and forgiveness? Is it?
Why am I confused dad? Why?

I love you and I forgive you.

Where are we going dad?
Are we there yet dad?
Are we there?

Wednesday, May 7, 2008

The Great American Distraction

“Thou shalt not covet.”
- God (The 10 Commandments #10)

I had occasion to visit a large “consumer electronics” store recently. It is probably the largest store of its kind in my metro area. If it beeps, flashes, projects, broadcasts, computes, rings, networks, communicates or otherwise distracts one’s attention, this place has it. And how. It is the largest toy store in town.

When I go to places like this one – which isn’t often – I find myself asking questions: “How are the people buying all this stuff paying for it?” and “Is this something they need or is it just entertainment (either what they are buying or the time spent in the buying)?” and “How much of the stuff in here was made in America by American workers?”

The U.S. has become the world’s largest consumer market. Not coincidentally, the U.S. is also the world’s largest debtor nation. Our IOUs have found their way to every corner of the world.

It is not my intention to book the reader a ticket on a guilt trip. The U.S. is still the “land of the free” – it is not illegal to spend money in whatever manner one wishes.


If you consume all you make – and more, by leveraging your income with credit cards and home equity loans – you will never become financially secure.

Too many Americans are scurrying in the Lemming Parade over the edge of the cliff following the bigger house, newer car and larger plasma TV into the abyss. Every one a distraction.

What is our own government telling us to do with that $600 tax rebate? “Go out and spend it.” I’ve already seen ads that promise to “double your tax rebate if you spend it in our store”. The vendor is willing to take a $600 hit to keep the goods flowing through his store. Do these messages sound a little desperate to you?

In the meantime, the Federal Reserve – supposedly independently in charge of monetary policy and primarily interested in price stability – has been slashing short-term interest rates attempting to mute the effects of a recession that has already begun. In theory, lower interest rates lead to growth in business and consumer spending. By the way, consumer spending is about 2/3rds of the U.S. economy. No wonder the government and the Fed are so desperate.

In the coming months you’ll be seeing a lot of articles and advice about the “New Frugality” – not spending and saving money will become hip here in the United Consumer States.


Friday, April 25, 2008

Living in Dollar Land

“When the music’s over
Turn out the lights
Turn out the lights
Turn out the lights”
- When the Music’s Over (The Doors)

Is anybody paying attention? The music is about to stop. Will we be able to keep the lights on?

The once mighty U.S. dollar – the world’s reserve currency - is going down the proverbial rat hole.

· The Euro could become the new reserve currency for the world, in spite of the unhappiness in the Euro Zone countries with the fiscal and monetary policies needed to support the common currency.

· Iran recently started up a bourse (exchange) for trading petroleum priced in Euros and other non-U.S. currencies.

· Meanwhile, the U.S. Federal Reserve is feeding the dollar’s decline by reducing short-term interest rates in what looks like an increasingly desperate attempt to head off a recession that has probably already begun.

If you live in the U.S. you are long the dollar. You are paid in dollars, earn interest in dollars, invest with dollars and pay all your bills in dollars.

How can you preserve the purchasing power of a declining currency? By going short.

You may ask: How can I short the dollar when I live in Dollar Land? In particular, how can I do this without a lot of headache?

Here are four relatively painless ways:

· Buy investments outside the U.S. – even if your investment is denominated in dollars you have more dollars after the currency exchange (assuming your investment choice is successful, of course).

· Buy commodities traded in dollars – the prime example is oil. The recent run-up in oil is in part due to the decline in the dollar (the higher price to the producer offsets the lower value of the payment).

· Buy foreign currencies – but be sure and avoid currencies pegged to the U.S. dollar.

· Buy investment funds that short the dollar.

There are mutual funds and exchange traded funds (ETFs) that follow these strategies. And, they are easily accessible to the average investor.

Some places to look:

Most, if not all of the products offered by these firms can be purchased through brokerage accounts at the major do-it-yourself investor marketplaces: Charles Schwab, Vanguard, Fidelity, TD Ameritrade, ETrade, etc.


Complete lyrics:

Generation Boomer

The Bejing Times World Edition, dateline: January 15, 3050
© Fox News

People’s Republic archeologists digging through the ruins of Old Los Angeles unearthed a previously unseen script for a United Consumer States television show that was apparently never produced. While the manuscript is undated, the naïve themes of free will, personal initiative and democratic rights for all sentient beings expressed would seem to place it in the latter half of the 20th century. Due to server-space limitations as a result of publication of the latest 9 Month Economic Restructuring Plan, we can offer our viewers only one page of the manuscript. We think you will find it quaint and amusing.

Generation Boomer

A tele-play in 4 acts.

Episode 1, Act 1, Scene 1

[T.V. science fiction show theme music begins]

Voice over: “Retirement, the final frontier. These are the voyages of Generation Boomer – whose continuing mission is to seek out new thrills, spills and chills. To boldly go where no generation has gone before! Warp speed!”

[sound of grinding gears, power down, etc]

Helmsman: [Russian accent] “The ship is not responding Captain!”

Captain: [arrogant accent] “Engineering – what’s the matter?”

Engineering: [Scottish accent] “We’ve run out of power!”

Captain: “First Officer – analysis!”

First Officer: [detached accent] “It appears that Generation Boomer is broke, Captain. In all the years of seeking new thrills, spills and chills, we forgot to save anything. In fact, we’re going to crash on that dim looking planet over there.”

Captain: “You mean Planet Poorhouse?”

First Officer: “Yes, I’m afraid so.”

Captain: “What can we do? There must be SOMEthing?”

First Officer: “Hmmm, well yes, there is one thing. Do you recall the films we saw in grade school when we were all afraid of The Bomb?”

Captain: “Well, yes, but what does that…?”

First Officer: “Do you remember what you were to do in the event of an attack? Crawl under your desk, bend over and kiss your …”

Captain: “N-O-O-O-O-O-O-O-O-O-O-O!!”

[cut to first commercial]

It’s never too late to do something about it!


Wednesday, April 23, 2008

Word 'o the Day: Fiduciary (ABC's of Financial Planning)

“Thou shalt have no other gods before me.”

- God (The 10 Commandments #1)

There’s a lot of flim-flam in the investment management / financial advice industry. One of the articles I share with prospective clients is titled “8 Things Your Financial Advisor Won’t Tell You” by Liz Pulliam Weston (link at the end of this entry). Look it up and read it – it may raise the hair on your neck – and if you are shopping for a financial advisor, it should.

Number 2 on her list is “I have no obligation to put your interests ahead of my own.” In many cases in this industry, she is absolutely correct. Registered Representatives (aka “Stock Brokers”) are legally obligated to place their employer’s interests first – as for their customers, they are only required to treat them “fairly” and provide advice that is “suitable”. Other than this squishy limitation, the customer and her money are fair game. And if there is a dispute, virtually all brokerage company agreements include a mandatory arbitration clause that the customer must agree to before they will open an account.

In contrast, Registered Investment Advisers and their affiliated Investment Advisory Representatives are held to a fiduciary standard. The U.S. Securities and Exchange Commission (SEC) enforces the Investment Adviser Act of 1940 (Act), the legislation that governs the conduct of Registered Investment Advisers and affiliated persons. The SEC interprets the Act as meaning that a Registered Investment Adviser (and affiliated persons) is a fiduciary to its clients and owes those clients a duty of undivided loyalty and utmost good faith (italics added for emphasis).

Powerful words. It reminds me of the cliche: “It’s the 10 Commandments, not the 10 Suggestions”.


Thursday, April 17, 2008

Never Fall in Love

“What do you get when you fall in love?
A guy with a pin to burst your bubble,
That's what you get for all your trouble,
I'll never fall in love again,
I'll never fall in love again.”

- Dionne Warwick (“Never Fall In Love Again” by Burt Bacharach)

How many times have you heard the expression “I fell in love with it / him / her / them”? Or how about “I couldn’t help myself – I fell in love”? Like my kids used to say, “Like infinity times, Dad”.

Falling in love should only apply to people. When someone falls in love with an investment, they are headed for nothing but “pain and sorrow”. Love affairs are only for the heart, not the wallet. Of course, human beings are imperfect and they frequently attach their emotions to physical objects and intangibles like investments.

See if any of the following sound familiar: “I love that stock!”, “I would never sell that stock.”, “I know that company.”, “I work/ed for that company – I know what’s going on.”, “I know the markets.”, “I know where this is going.” Conviction in the face of uncertainty is a sign of character, but conviction based on nothing but “love” is a sign of cluelessness.

Don’t get me wrong, I want my investments to go up in value as much as the next guy. But I’ve learned – sometimes the hard way – to divorce how I feel about an investment from the decision to buy or sell that investment. I have become indifferent to the specific investment of my money by focusing on two things: “Are the costs of buying, owning and selling reasonable?” and “Does this fit or not fit into my overall allocation plan?”. Of course, once in a while I will take a flyer on something just for the hell of it, but in those cases I am acting with intention i.e., I know I’m taking a flyer and deliberately choose to do so.

Loving an investment is unrequited. The investment will never love you back. It’s a one-way street and no matter how fervent your love, the investment is not going to drive down the street the wrong way to meet you.

Act with intention and leave the emotion out of it.


(complete lyrics here:

Sunday, March 9, 2008

When I Die

"And when I die,
And when I'm gone,
There'll be one child born
In this world to carry on, to carry on."
- And When I Die (Laura Nyro - as recorded by Blood, Sweat and Tears)

A death in the family has a way of focusing one's attention. Space isn't the Final Frontier, death is. Everyone should write a letter such as the following.

To my wife and children:

First off, I want to be cremated. Under no circumstances is this to occur at the _____ Funeral Home in the Fremont neighborhood of Seattle, WA. You know why I feel this way. What you do with me after that is up to you, but I do have a few suggestions: the Kootenai Falls on the Kootenai River between Troy and Libby, Montana; Flathead Lake south of Kalispell, Montana; Puget Sound in Washington; the outfield grass at Safeco Field (they don't actually allow this, it's just wishful thinking). If you pick Port Townsend, my preference is for Marshall's Folly - the underwater acreage south of the downtown ferry dock or anywhere in Chief Chetzemoka Park.

At some point you will open my legal documents that convey my love for you in a monetary sense. As I'm writing this, there isn't much, but that will change (could be even less!). If I still have life insurance, you are all named beneficiaries.

As for my stuff, I'll leave it to you to sort it out. I don't care who gets what, just that each of you wants what you get. If my clothes don't suit _____ , as to fit or style I'm not gonna feel bad that they are given away. I kept some of my dad's clothes after he died but eventually donated them after I was able to let go. You will know when that time comes. Hopefully I spent enough time sorting, consolidating and tossing that tidying up won't be a large burden. Mom knows I'm right, she just has a hard time letting go. You'll know how successful I was by the size of the job with which you are confronted. Bonne chance! You might want to hold an estate sale - you won't believe what people will buy. Whatever you don't want and can't sell should be donated to Goodwill Industries.

My legacy to all of you is my music in whatever form that takes. My goal was to record at least a rough version of everything I ever wrote - even "Goin' Down to the Banana House" (well maybe not that one...). I wanted to get it all down in a digital format for ease of transporting and sharing. Hopefully I got that done. There are also several notebooks of lyrics, song ideas, etc. stretching back to my teen years.

You can hold a memorial service if you wish, at the location of your choice. I have three requests: that it be held in a church (not a funeral home), that there is music, and that a rendition of "Harvest Time" (aka "The Reaper") is played. The writer's name is D.W. Spencer in case you need to look it up. There is at least one copy of the music and lyrics with my other musical literature. Whatever else you do is up to you - services are for the living. But please, no three hour marathons. If _____ is still around, I know she will make a musical contribution.

And lastly, I want you to know that I love each of you. You each have unique gifts to share with the world and it has always been my self-centered conceit that I did everything I could to encourage and support each of you in the development of your unique talents.

I love you,

Kim Miller - husband, friend, father

(complete lyrics here:

Monday, February 4, 2008

A Few Words About Inflation

"Well I'm not the world's most masculine man
but I know what I am and
I'm glad I'm a man and so is Lola,
- The Kinks ("Lola")

Is he glad he's a man and is Lola glad he's a man or is he glad he's a man and glad Lola is (really) a man? Which way is up? Gotta love the ambiguity. Speaking of ambiguities...

Inflation is a fact of life in any economic system. In the U.S., we think (well, the Federal Reserve thinks) that if inflation is ~3% or lower that it is “acceptable” and “under control”. But even at “just” 3%, prices will double in 24 years (Rule of 72). People in their 50’s will live long enough to see prices double. But inflation is not linear and every person’s inflation experience is different because we aren’t all buying the same goods and services.

Another problem with inflation is that the government cooks the numbers. Imagine that!

· You may have noticed over the past few years that when inflation figures are reported that you typically hear a figure for “core inflation, excluding volatile energy and food”. This is such a crock. Can you think of anyone you know who does not purchase energy and food? Energy and food are certainly part of my core basket of goods and services.

· The application of so-called “hedonic adjustments” was initiated during the Clinton years. Hedonic adjustments are concerned with the effect that the march of technological innovation has on prices. As an example, personal computers have gotten cheaper and cheaper over the years. The government decided that this improvement should be reflected in the calculations for inflation, thus the price of personal computers have essentially a negative impact on the official numbers.

And finally, probably the least-appreciated impact of inflation is the purchase of goods and services that do not yet exist! Think back 10 years – how many people had cell phones? How many people had MP3 players? How many people had a broadband internet connection at home? Did you ever imagine that you would want – let alone need - to purchase a personal paper shredding device? We could go on for several pages with examples. The point is that we don’t know what we don’t know. What will all these unknown items cost us? All of these unknown goods and services will be things that we will want to buy or for which a need will be created (e.g., identity theft = personal shredders).

If you are interested in how the books are cooked, visit Shadow Government Statistics at .

[full lyrics here:]


Word o’ the Day: Finance (ABC’s of Financial Planning)

“Money, get away
Get a good job with more pay and you’re O.K.
Money it's a gas
Grab that cash with both hands and make a stash
New car, caviar, four star daydream,
Think I'll buy me a football team”
- “Money” (Pink Floyd)

You could substitute the word “Subprime” for the word “Money” in the song. The subprime crisis – while enormous in its reach and deep in its impact – is but the latest in a long list of financial excesses perpetrated by the so-called Masters of the Universe (see Tom Wolfe’s Bonfire of the Vanities – read the book though, the film was excremental). If you delve into the personnel at any major financial firm you will find an enormous number of people with MBA after their name. These people spend their waking hours figuring out how to make something from nothing – they are the alchemists of the modern age.

Finance used to be pretty simple: structuring Initial Public Offerings (IPOs) of stock and structuring offerings of corporate and municipal bonds. There were always excesses of some kind of course – where there’s money there are always predators to be found. But still, it was a pretty straightforward endeavor – structure financing for a business or government endeavor and fund it by finding people (investors) to invest.

As time went on, finance became more exotic, creating ways for investors (mostly institutional investors) to play both sides of the market, creating hedges for shorting (making money when an investment declines in value), building the proverbial “better spreadsheet” and engineering more and more ways to arbitrage minute differences in markets around the world. Tools created included: Hedge Funds of all shapes, sizes and flavors, Hedge “Fund of Funds” as diversification, Private Equity Funds, Commodity Pools, Private Financing, and on and on. What was truly created? Fees for fund originators, fund salespeople and fund operators.

Players in the current Subprime charade (Bill Gross of PIMCO referred to it as “…the pyramid scheme, chain letter driven structure of modern finance…”) were driven by fee income generated at every step of the transaction. At the bottom of the pile is the lowly mortgagee, the person upon whose timely monthly mortgage payments the upside-down pyramid rests. So what happens to all the spreadsheet models when this person and many of his similary-situated brethren fail to deliver? No monthly payments equals no cash flow to the investors holding the bonds and derivative securities built on top of the timely monthly payment. The upside-down pyramid falls over, crushing the “new car, caviar, four star daydream”. And the “football team” too.


[View all lyrics here:]

Wednesday, January 30, 2008

Word o’ the Day: Exchange Traded Fund (ABC’s of Financial Planning)

“Tryin' to make it real — compared to what?”
- Les McCann (“Compared To What?”)

Exchange Traded Funds, commonly referred to as “ETFs” are usually defined as “compared to what”. This is because ETFs are unlike almost any other investment vehicle. I usually start my ETF discussion with “Compared to mutual funds…” but that presumes a depth of knowledge in the listener that they usually have yet to attain. And I like to keep discussions of investment esoterica down to earth in language that doesn’t require an immediate consultation of the dictionary. Let’s see if we can “make it real”.

Exchange Traded Funds are baskets of securities -
OK, what’s a “basket of securities”? Where does “basket” come from? Maybe “bucket” would be a better analogy. So, a “bucket of securities”. In one hand you carry the bucket and with the other hand, you select securities to put in the bucket. “Securities” (usually) means stocks or bonds. If you want to construct an ETF that follows the US stock market, you would put stocks of large US companies in the bucket. Examples would be GE, IBM, Microsoft, Boeing, Wal-Mart, ExxonMobil, etc. The individual stocks and the amount of each that you would put in the bucket would be based on an index – a 4-bit word meaning “list” - such as the Standard & Poor’s 500 Index.

Exchange Traded Funds are passive investments constructed to follow the performance of an index -
What is a “passive investment”? A passive investment is one that is not actively managed i.e., a money manager is not reviewing what’s in the bucket and making changes based on what he thinks. The issuer of the ETF decides what index it will follow and the bucket is filled with stocks or bonds that are intended to replicate the performance of the chosen index. Stocks or bonds are removed from or added to the bucket only when there is a change in the index the ETF is following.

Exchange Traded Funds are inexpensive to own -
Because the money in an ETF is not actively managed, the management fees are low. A quarter of a point here, a quarter of a point there – pretty soon we’re talking about a lot of money – your money. Like stocks, you will usually pay a trading commission to buy and sell ETFs.

Exchange Traded Funds are tax-efficient -
Investors do not like paying taxes on their investments, especially when they don’t have control over when the taxes are to be paid. An investor who owns shares in Microsoft can decide when to sell those shares and thus decide when to pay the taxes on any capital gain realized as a result of the sale. An investor who owns a mutual fund can’t do this, because the manager of the mutual fund is in charge of when to buy and when to sell – and the manager doesn’t care about your taxes (he’s not going to pay them – you are). Owning an ETF is like owning an individual stock in that the investor decides when to sell and thus decides when to pay the taxes on any capital gain realized as a result of the sale. This is not to say that owning an ETF is entirely tax-free, but it’s pretty close. Because of the passive design, securities owned by the ETF are only bought and sold when the index being followed changes so there is very little buying and selling and thus, very little in the way of taxable gains over which you had no control. (ETFs will distribute dividends and interest received on stocks and bonds so some taxable income is inevitable). The tax angle gets better though. Most ETFs allow investors to sell their shares and take distribution “in-kind”. This means instead of selling for cash, the investor receives shares of the stocks owned by the ETF – for tax purposes, this is not a sale. (This is definitely esoteric and most people don’t do it this way, but they could).

Exchange Traded Funds are transparent –
You can find out at any time what stocks or bonds your ETF owns. Mutual funds report their holdings on a trailing schedule (often by 90 days or more) so by the time you get the list of what they own it is not current.

Exchange Traded Funds can be priced, bought, or sold at any time during the trading day -
Most people don’t know it, but when you look up a mutual fund price, it is a day old. This is because mutual funds don’t price their portfolios until the markets close – they are not priced in real time. When you buy a mutual fund you won’t know what you will pay for a share until the market closes – that’s why buy orders for mutual funds are only accepted in dollars, not # of shares – no one knows what the share price will be until the fund prices its portfolio at the end of the day. So if the market is moving up sharply and you want to go along, you can do so – today - by buying an ETF just as you could by buying an individual stock.

Exchange Traded Funds can be sold short –
How do you make money when the market goes down? Sell short. Short selling involves the sale of securities you don’t own. Without getting bogged down here, essentially you borrow stocks or bonds from another investor and you sell them. The proceeds from the sale are deposited into your account. If you are right and the price goes down, you then buy the stock or bond in the open market – for less than you sold it for - return the stock or bond to the lender and you keep the difference. You can do the same thing with ETFs. A good way to make money recently would have been to sell short one of the many ETFs that track the financial sector - banks and stock brokerages. Sell short at $60, buy it back at $40 and keep $20 minus the cost of borrowing the stock. You cannot sell mutual funds short. You can't sell short in a retirement account.

In portfolios, I use ETFs for broad asset classes and to make tactical sector bets. We’ll talk about that another time.

(complete lyrics here:


Monday, January 28, 2008

Saver, Investor or Speculator?

“A penny saved is a penny earned.”
- Ben Franklin

“A penny invested has a chance of beating inflation.”
- Kim Miller

Americans are great at speculating, mediocre at investing and terrible at saving. See which camp you fall into:

Savings are funds you put away for a future purchase or obligation or for an unforeseen event such as unemployment. You expect your savings to grow, albeit modestly without capital risk. You expect your savings to be available when you want with a minimum of trouble and without any dickering over its value (a dollar saved is always worth a dollar upon withdrawal). Savings are never investments. The prudent saver is patient and rarely disappointed, except on occasion when the yield offered across the street is ¼ point higher. The Saver has a plan and while he may be motivated to save out of fear, he is logical in his approach and is able to defer gratification. EVERYONE should be a saver.

Investments are funds you put into a venture in the hope of a future income or capital gains – i.e., that you will receive an income from the invested capital or be able to sell the investment for more than you paid in at the beginning (or both). You expect your investment to grow commensurate with the risk. Investments are never savings. The prudent investor is patient and is rarely disappointed – she knew what she was getting into at the beginning. The Investor has a plan and while she may be motivated to invest out of greed, she is logical in her approach and is able to defer gratification.

Speculations are funds you put into a venture with the certainty that it is going only in one direction: sharply up in value. Savings are frequently used for speculation (“I know this stock is going up – I’m going to put the household rainy day money in – it can’t miss!”). Speculators are never patient and are frequently – if not always – disappointed. They have unrealistic expectations going in. The Speculator doesn’t have a plan and is primarily motivated by greed – he is emotional in his approach and would have to look up “defer” and “gratification” in the dictionary. Think back to the late 1990’s when the US stock market did nothing but go up – do you recall reading a lot about “buyer’s regret” as the markets fell from their highs? Was that Investing or Speculating?

In my career I have met very few Investors but I’ve sure met a lot of Speculators. Most people think they are Investors, but they are really Speculators – “investing” on “hot tips” or buying “5 Star” mutual funds and then rending their garments when the reality doesn’t match their vision. Regret is such an ugly thing.

Investment entails the acceptance of risk – the dollar you put in today may not be worth a dollar upon withdrawal. If one expects an investment to appreciate by 10%, one has to accept the chance that it could decline by 10% (or more). The theoretical lowest value of a share of common stock is ZERO. The Speculator dismisses this absolute as “nay-saying” or “balloon piercing” or “boring”.

Let’s be clear: markets don’t care what we think! Stocks don’t care what we think! Mutual funds don’t care what we think! Bonds don’t care what we think! Invest all the emotion you like, it won’t make any difference. Think about your favorite sports team – if it mattered what you thought, wouldn’t they be champions every year?

The only way to win – with any consistency – is to have a plan. Use asset allocation to diversity your portfolio. Know the risks you are accepting and be comfortable. If you’re not comfortable, reduce the risk. Don’t accept more risk than you need to reach your goal. A good advisor will have you complete a Risk Tolerance Questionnaire before investing your money.

So which camp do you fall into?


Thursday, January 24, 2008

Word o’ the Day: Exchange (ABC’s of Financial Planning)

Investments are primarily traded – bought and sold – on an exchange. An exchange (commonly called “stock exchange” even though other investments are traded) is simply a marketplace that serves as a central venue to bring together buyers and sellers. In today’s world, the venue can be physical (a place) or virtual (electronic).

A well-known example of a physical exchange is the New York Stock Exchange (NYSE) in New York, NY. Traders gather on the trading floor of the NYSE and conduct business in person on behalf of their customers. As technology progresses though, the NYSE is performing more and more electronic trades. The NYSE has traditionally specialized in listing large U.S. companies.

A well-known example of a virtual exchange is the NASDAQ Stock Market also headquartered in New York but spread all over the world. NASDAQ operates an electronic system that enables its member firms to provide prices and availability for securities they are buying or selling for their customers. NASDAQ has traditionally specialized in listing smaller U.S. companies.


Tuesday, January 22, 2008

“Don’t Panic!”

Arthur remained very worried. “But can we trust him?” he said.
“Myself I’d trust him to the end of the Earth,” said Ford.
“Oh yes,” said Arthur, “and how far’s that?”
“About twelve minutes away,” said Ford, “come on, I need a drink.”
- “The Hitchhiker’s Guide to the Galaxy” (Douglas Adams)

Readers of the Hitchhiker’s Guide to the Galaxy will recognize the soothing words (“Don’t Panic!”) found on the cover of each copy. They are intended to subdue the feeling one would get upon realizing that the world is coming to an end before lunch. Today.

Investment markets around the globe fell out of bed over the last two days with a domino-like series of bumps. The U.S. followed suit today (January 22). You probably heard a little bit about it. Screaming headlines and talking (shouting?) heads magnify the valleys even more than they magnify the peaks.

Now is a good time to review one’s personal investment time horizon. Do you need the money you have invested (“invested” as opposed to “saved” – one doesn’t put funds one has “saved” in the markets) in the “near future”? Each person’s definition of “near future” is different. For our purposes, let’s say it’s the next 12 months. If the answer to that question is “yes”, then the money should be “saved”, not “invested” [see previous writing: Word o’ the Day: Cash (ABC’s of Financial Planning)]. If you have “invested” money you will need in the next 12 months you are speculating, not investing.

If the answer to this question is “no”, then the best advice I can give you is: go for a walk. Review your asset allocation [see previous writing: Word o’ the Day: Asset Allocation (ABCs of Financial Planning)]. Add different asset classes to your portfolio.

“Don’t Panic!”