Tuesday, March 27, 2012

Don’t Let Curtis Mismanage Your Money

Last time we looked at macroeconomic fundamentals, now it’s time to review some personal investment fundamentals. These are basic and you’ve heard them all before, but a friendly reminder never hurts.  The great thing about these principles is they apply to investment professionals managing multi-million dollar funds or someone who is just trying to handle his 401-K.

Number One: Diversify Your Investments
The important idea here is to spread your risk of making a bad decision.  Risk is your enemy, so your need to minimize it.  Even a brilliant investor makes mistakes, so we need for those mistakes to have minor impact.
My grandfather Tom had savings accounts at all six major banks in his city. He did this because he had lost money in the Great Depression due to bank failures.  This was his diversification strategy in case another depression occurred.

As a practical example, here is how I have increased diversification in the GeoDon Fund (the portfolio I inherited from my grandfather George):

      ·       Increased the number of stocks from 20 to 27.

·       Diversified within the energy sector of the fund by having stocks in petroleum, natural gas, propane, uranium and a utility.

·       Put an investment dollar limit on any new stock added to the fund, just in case I pick a dog.
When investing in mutual funds:
·       Make sure your mutual funds aren’t investing in the same type of securities.  For example, if you own three “large-cap” funds, you really aren’t diversified.

·       Your 401-K should be divided among at least three different mutual funds.  If your program doesn’t have three good funds, it is time to utilize a self-directed option.

And regarding minimizing mistakes:  My worst investment of 2008 was buying bonds from the Bank of Greece (You can start laughing now).  Why did I do this?  The bonds were paying a whopping 9% and of course a country like Greece was not going to go broke! (You can laugh even harder now).  The important thing is that I bought three other more stable bonds at the time, so my Greek bond investment was small and of course it was soon to get much smaller.  But diversification limited the loss in my big, Greek, investment screw up.
Number Two: Review Your Investments Periodically
Three years ago I worked with my financial advisor to restructure my wife’s IRA.  We selected seven strong mutual funds that were consistent with the strategy for the account.  I did not have time to review this account since then because of all the other financial decisions I had to make. I realized there was a problem in January when the account showed 0% growth for 2011.  Based on the investments, the account should have grown in the 3-6% range.
These were good funds three years ago, but not now.  Most of the funds had new managers who were not as skilled as the previous ones.   The account was diversified, but it was diversified among a group of lousy funds.   I moved the money to better mutual funds and it was like feeding a starving man.  The account immediately jumped to life and is now showing much improved results.
It is always a red flag when a strong performing mutual fund changes managers.  The investment firm will tell you that the fund strategy and philosophy will not change and they expect the fund to continue to produce excellent results blah, blah, blah. But if you are not careful, your fund could end up being managed by Curtis Painter.
Who is Curtis Painter?  He is the guy who replaced Peyton Manning as the quarterback of the Indianapolis Colts last season.  Curtis wore the same uniform, played in the same stadium, ran the same plays, but somehow did not achieve the same results as Peyton. The chances of the new fund manager being as good as the previous fund manager of a very successful mutual fund are very low. You should watch these funds closely and be ready to bail at the first sign of trouble.
Number Three: Manage Your Risk and Return
Everyone complains about the low interest rates paid on current certificates of deposits.  It is hardly worth tying up your money to receive a rate under 1%.  I believe the rules of risk and return still apply, but the problem is that the world has become a much more risky place. 

Therefore to gain a larger return, you will need to assume more risk.  To get the same 3-6% returns that you previously got with CD’s, you can invest is short-term bond funds.  Of course there is more risk because your principle is not insured.  Some good funds in this category are FGCIX, WBRRX, LALDX.  I do not own these funds, but I do own BAGSX and PSTCX which should provide slightly higher returns, with of course higher risk.  However to my knowledge, none of these funds has investments in the Bank of Greece.

Tuesday, March 13, 2012

Picking the Losers Instead of the Winners

In my last post I speculated that if the economy grew modestly, but adhered more to fundamental economic principles, that it might be beneficial to us in the long run. There are several economic “fundamentals” that we need to get back to after many years of wild, ravenous, living.  Let’s look at some:

1.    Investment Capital Should Flow As To Maximize the Best Long-Term Gains

One of the enduring, damaging, effects of the housing bust is the misallocation of capital.  So much money flowed into the housing industry that other emerging industries suffered.  These industries should have been getting more capital and growing faster. The industries would be larger and stronger now and be creating more jobs.

In addition, people went to work in the construction and mortgage industries because that’s where the money was.  It would have been much better if people would have been learning (by working in) or training for the jobs needed in our current and future economy.  Freddie the House Flipper was raking in big bucks, but house flipping is a very specialized skill that is only valuable under unique circumstances.  Now Freddie has lost his money and may not have the education and skills necessary to find a good job in this economy.

2.    The Government Should Concentrate On Just Being the Government

It is not the role of the government to save companies by buying them.  The government should have managed the bankruptcy of General Motors to provide stability, but the government is supposed to be the “referee” of the economy.  You can’t be the referee and play in the game at the same time.  The Obama administration blatantly picks the winners in the game.  Examples include green energy companies, the Chevy Volt (okay maybe it picks losers instead) and the waivers given to select companies regarding the new healthcare laws.  The government is supposed to try to “level the playing field” not change the rules to benefit voting constituencies. The market should determine the winners and losers not the government.

Also, the government is supposed to be the “watchdog” so crises like the housing bust never happen.  But the bankers and housing industry threw the watchdogs some juicy T-bone steaks and the Washington fat cats were too busy stuffing their faces to growl, let alone bark.  With the loosening of mortgage rules the government not only didn’t halt the crash, they helped create it. It also failed to stop Bernie Madoff’s Ponzi scheme even when it was alerted about it several years prior to the collapse.  The government did a horrible job regulating commerce in the aughts (00’s). 

3.    The Government Should Regulate – Not Punish

The government’s response to the housing bust is to punishment the banks, not truly regulate them.  The new financial reforms that some people are so proud of end up punishing the innocent banks that followed the rules and did not exploit sub-prime loans. 

The government needs to tighten and improve its regulation processes.  When you punish the banking industry, you punish the employees, you punish the stockholders and you punish the innocent banks.  It’s like when your grade school teacher got so upset that she punished the whole class for the bad behavior of one student.  Some of the bad banks are finally getting punished.  There should also be specific penalties for specific people at specific banks.  This will increase future accountability for executive decisions.

4.    Everyone Who Earns An Income Should Pay Income Tax

Low wage earners should pay very little tax, but everyone should pay something.  Everyone should know how it feels to have the government’s hand in your pocket. This is part of the principle of shared sacrifice.  This unites us, not divides us. We are not a healthy, free-market, democracy if a large percentage of people pay no income tax.

5.    The Government Is Not A Sugar Daddy

The more the government helps some people, the more these people learn to become dependent on the government.  In many cases it would be better if the government “helped” people by helping them find jobs through training, etc. instead of just handing out free stuff.  There is a limit to how much assistance the government should provide and we have crossed that line a long time ago.  Now we have a significant percentage of the population dependent on the government for their needs.

This entitlement mindset is getting way out of hand.   Last week it was reported that a recent $1 million winner of the Michigan Lottery was caught receiving food stamps.  This has happened in Michigan before, however what made this noteworthy was the woman’s response.  She was in no way remorseful. She argued that she was in fact entitled to the food stamps because “she was not working and has bills to pay”.   These bills included mortgage payments on her two houses. 

The Chevy Volt
2012 Chevrolet Volt