Saturday, August 28, 2010

American Debtor

In a recent article from the New York Times the author stated, “It’s one of the toughest lessons an investor has to learn: while the value of assets can plummet posthaste, it takes forever to shrink the debt that was used to buy them.” Even as housing prices continue to fall and U6 unemployment holds at around 16%, American consumer debt remains stubbornly high. It isn’t that we are not trying, the Federal Reserve reports that while consumer debt has only dropped 6.5% from its peak in 2008, the number of credit card accounts has dropped by 23.2%.

As a people we are beginning to get the message, but for some it is too late. More statistics from the Federal Reserve Bank from the aforementioned article: During the months of April, May, and June half a million people had a foreclosure added to their credit report. Also the number of bankruptcies reported in the second quarter jumped 34% to 621,000.

Per Capita Debt Balances for an Average Consumer with a Credit Report

California $78,000
Nevada $73,000
Nationwide $49,000

Really! These are the numbers reported by the Federal Reserve. How can you tell if you are part of the problem or part of the solution? I have posted lists of the warning signs of financial trouble from time to time. This one comes courtesy of my Employee Assistance Program at work.

You are borrowing to meet regular expenses, such as food and utility bills.

You are barely able to make the minimum required payment on bills, but continue to charge.

You are using one form of credit, such as a credit card or a debt consolidation loan, to make payments on other debt.

You are using 20% or more of your take home income to pay credit card bills and personal loans (excluding mortgage payments).

Your revolving credit cards are charge to the limit.

You are behind on credit card payments and receiving calls from creditors or collection agencies.

You are bouncing checks.

You have no cash reserve.

If any of these indicators apply to you, get help now. Perhaps something as simple as a budget will help. Perhaps more serious debt counseling will be required, but don’t wait for a miracle. Do something today.

Friday, August 27, 2010

What is Truth?

“Crap being fed into our brains by people with an agenda.”
Dave Ramsey

Sometimes issues just kind of pop up all over the Internet. They can be discussed in totally different venues for totally different reasons, but the same subject is there, in each and every place. Lately, I have seen the question of the truth pop up on several of the blogs I follow. Barry Ritholtz, a somewhat liberal financial blogger, who normally avoids political rancor faced the issue head on. Stephen Freeman, a deeply committed Orthodox priest, tackled the question Pilate asked the Messiah in the Hall of Judgment, “What is truth?” Seth Godin, a marketing guru, challenged his readers to examine the truth of statements made to us by that little voice in our heads. Most recently, my pastor gave me some promotional material for Dave Ramsey’s Financial Peace University. Dave was talking about the truth, in this case financial truth.

Major media outlets in this country are biased, extremely biased. This is a world in which any two given media reports on something as simple and unimportant as a football game agree on very little but the score. Different networks have different biases, some liberal, some conservative. Expecting to see or hear the “truth” on American Television is a pretty hopeless task. Besides being politically biased, all the networks, including PBS, want your money. One of the things I love about the Internet is that I can read the same story from 3 or 4 different viewpoints. Sorting through that many different personalities and spins can give you a pretty good idea of the facts. Then, how you interpret the facts is your business.

In the movie, A Few Good Men, Colonel Jessep announces, “You can’t handle the truth.” He is correct. All of us have our own little mental maps of reality. We couldn’t operate without them. The world is too large and complex. Sometimes our mental map of reality and the world do not agree. When that happens, all too often, we conclude the world is in error and our precious beliefs and world view is correct. Psychologists call this phenomenon Cognitive Dissonance. It occurs when an individual is confronted with an uncomfortable truth that conflicts with their world view. The all too human response is to minimize the pain of realization with “justifying, blaming, and denying.” I have seen it happen over and over in churches, the columns of political commentators, and the publications of financial prognosticators.

Some time ago, I reached the point in my life where I came to believe that Pilate’s question was not an attempt at clever cynicism, but an honest reply from the tired cynical heart of a ruthless, intelligent, complex man. After too many years of service in the Imperial bureaucracy, a world where there is no truth, only an ever shifting balance of power, policy, and personality, Pontius Pilate, the fifth Prefect of Judea, had become incapable of recognizing the truth. Beyond an inability to recognize the truth, Pilate, a successful survivor in a world where self preservation was job one, had become incapable of the courage necessary to risk his own life and career for the sake of another. As a result of all he had become and the life that he had lived, Pilate washed his hands before the city of Jerusalem, and knowingly sent an innocent man to suffer a horrible death.

John 18

[37] Pilate therefore said unto him, Art thou a king then? Jesus answered, Thou sayest that I am a king. To this end was I born, and for this cause came I into the world, that I should bear witness unto the truth. Every one that is of the truth heareth my voice.
[38] Pilate saith unto him, What is truth? And when he had said this, he went out again unto the Jews, and saith unto them, I find in him no fault at all.

Saturday, August 21, 2010

What Makes You Happy?

What makes you happy? What makes you really happy?

This is not a question I explore very often. Perhaps that is a mistake. This blog is focused on doing the “right thing,” primarily in an attempt to avoid pain. Can money buy happiness? I suppose we all know the answer is, “Yes, but.”

I remember a moment on Hawaii (the Big Island). I was sitting on the porch of a Kona Coffee store, overlooking the Pacific Ocean. I heard the sound of rain from a passing shower, as I watched the small dark clouds blow past. It was a transcendental moment. I was at peace with the world. Hawaiian vacations don’t come cheap, but the moment and even the coffee sample were free. Whoops, sounds too much like those Mastercard commercials from a few years back.

Two recent surveys, one by Gallup and one by Nobel laureate Daniel Kahneman and Angus Deaton of Princeton University both found there is a strong correlation between money and happiness up to an income of about $75,000 a year. Beyond that number there is no correlation between money and happiness. Although, something called
“life satisfaction” continues to increase with wealth. This apparently, “reflects whether people are obtaining their values and goals in a long-term and big-picture sense,” it also seems to include the satisfaction derived from comparing one’s own condition with that of others.

It has also been observed, that people are happiest when there is a close correlation between their expectations and reality. If my expectations were a job at the mill and a wife from the trailer park down the road, I might be happier than if I believed I was going to be a star in the NFL and instead ended up in the aforementioned mill and trailer park. I think this also effects incremental satisfaction with some of our purchases. I expect to own a reasonably interesting car in good working order. At one time in my life, my definition of such a car would include a used Volkswagen without a radio or air conditioning.

It turns out that what really makes us happy is social capital and mastery. If our connections with friends and family are in good order and we view ourselves as competent in our chosen field of endeavor, we tend to be happier than if our relationships are in chaos and we face failure in our career.

This example comes from “But Will it make you Happy?” A New York Times article by Stephanie Rosenbloom. “For the last four years, Roko Belic, a Los Angeles filmmaker, has been traveling the world making a documentary called “Happy.” Since beginning work on the film, he has moved to a beach in Malibu from his house in the San Francisco suburbs.

San Francisco was nice, but he couldn’t surf there.

“I moved to a trailer park,” says Mr. Belic, “which is the first real community that I’v lived in in my life.” Now he surfs three to four times a week. “It definitely has made me happier,” he says. “The things we are trained to think make us happy, like have a new car every couple of years and buying the latest fashions, don’t make us happy.”

Mr. Belic says his documentary shows that "the one single trait that's common among every single person who is happy is strong relationships."

Romans 14

[17] For the kingdom of God is not meat and drink; but righteousness, and peace, and joy in the Holy Ghost.
[18] For he that in these things serveth Christ is acceptable to God, and approved of men.
[19] Let us therefore follow after the things which make for peace, and things wherewith one may edify another.

Friday, August 13, 2010

Beginner's Mind

In the beginner's mind there are many possibilities, in the expert's mind there are few.
Shunryu Suzuki

Beginner's Mind refers to having an attitude of openness, eagerness, and lack of preconceptions when studying a subject, even when studying at an advanced level, just as a beginner in that subject would. (Wikipedia) It is an openness to learning new things. I hope to maintain beginner’s mind as I continue to study and learn about financial issues, not just today but for the rest of my life.

In a New Yorker article entitled “Greater Fools,” the author, James Surowiecki, examines the dreadful condition of basic financial literacy in this country. The Financial Literacy Center has studied this problem for years. Their conclusions are not pretty. “Almost half of those surveyed couldn’t answer two questions about inflation and interest rates correctly, and slightly more sophisticated topics baffle a majority of people. Many people don’t know the terms of their mortgage or the interest rate they’re paying. And, at a time when we’re borrowing more than ever, most Americans can’t explain what compound interest is.”

The consequences of ignorance and foolishness surround us. High interest rate credit cards, repossessed cars, foreclosed homes, massive unemployment, personal and corporate bankruptcy, the recent subprime crisis, and the slow motion train wreck of the American pension system are all the real consequences of financial ignorance and folly.

Annamaria Lusardi, an economist at Dartmouth and the head of the Financial Literacy Center observes that at a time when financial decisions are more complex than ever, “It’s like we’ve opened a faucet, and told people they can draw as much water as they want, and it’s up to them to decide when they’ve had enough. But we haven’t given people the tools to decide how much is too much.”

Surowiecki observes, “Financial literacy studies have discovered an interesting unexpected result. The less people know, the more overconfident in their abilities they tend to be. In a German study, eighty per cent of those surveyed described themselves as confident in their answers on a questionnaire, yet only forty-two per cent got even half the questions right. This is known as the Dunning-Kruger effect: people who don’t know much tend not to recognize their ignorance, and so fail to seek better information…By contrast, well-informed people are more likely to ask others for help.”

James Chapter 1:5
If any of you lack wisdom, let him ask of God, that giveth to all men liberally, and upbraideth not; and it shall be given him.

This is the key to the Silver Eagle Experiment. Every day the participant asks God for wisdom, studies financial issues that are of concern to them, and every day the participant writes something new they have learned in a notebook. Very simple, very effective. As I continue to talk about financial issues with a wide range of people, I observe that the more sophisticated and successful tend to be more open to new ideas, more likely to study, and seek out expert advice. The people who find themselves in desperate straits seem to be more likely to look to lottery tickets or Government programs for salvation.

I continue to study the financial press every day. I read books, even books that are not in agreement with my personal financial prejudices. I try to maintain beginner’s mind, telling myself, “If you were all that smart you would be rich.”

Go and do likewise

Good article:

Sunday, August 8, 2010

Even a Blind Pig

Even a blind pig finds an acorn every now and then.

Without starting any arguments about free will, predestination, or the permissive will of God, let me observe that both skill and luck play a role in most arenas of life, including investment. There are activities, like chess, that are essentially pure skill. There are activities, like buying lottery tickets, which are pure luck. Most things in life fall somewhere between those extremes. In a excellent article entitled “Untangling Skill and Luck How to Think About Outcomes—Past, Present, and Future” by Michael Mauboussin the author uses statistical analysis to determine the importance of luck in a variety of sports, including the sport of investing.

The author observes, “One point is worth making right upfront: the outcomes of any activity that combine skill and luck will exhibit reversion to the mean. More technically, an extreme outcome (good or bad) will be followed by an outcome that has an expected value closer to the mean. Reversion to the mean is a tricky concept, and the relative contributions of skill and luck shed light on its significance for various activities.”

“There’s a simple and elegant test of whether there is skill in an activity: ask whether you can lose on purpose. If you can’t lose on purpose, or if it’s really hard, luck likely dominates that activity. If it’s easy to lose on purpose, skill is more important.”

What this all means is really very simple. Over time, if an individual’s performance heads towards an expected statistical mean, the activity is dominated by luck. Consider, if playing a particular slot machine is dominated by luck, it would be expected that any individual player would, over time, lose money at the payout rate of that particular casino, say 92%. In the games of poker or bridge even the best players can not overcome a run of truly bad cards, but over time a relative handful of the best players are routinely found sitting at the final table. In football, the outcome of a game can turn on something as unpredictable as the bounce taken by the ball after a punt was blown off course by a wind gust. However, over the course of an entire season, the best teams seem to have the best luck.

There is an interesting quirk in how humans tend to analysis outcome that has nothing to do with mathematics, “But academic studies have found that most people don't fully appreciate the role of chance in their investment results, “We have an asymmetric view of good and bad luck," said Shlomo Benartzi, a business professor at the University of California, Los Angeles. "It's well established that people attribute bad luck to randomness, but then attribute good luck to their own skill.” (The One Missing Investing Ingredient: Luck by Sam Mamudi)

So, if the outcome of individual investing over time tends towards some statistical mean, such as the performance of the Standard & Poor’s 500, what then should we then do?

It turns out the basic answer is pretty simple, consistent investment over time plus compound interest and diversification. If an individual consistently invests 10% to 15% of their income in a balanced and diversified mix of financial sectors and various investment vehicles including stocks, bonds, cash, and foreign currency over the course of 30 years, there is a pretty high chance that individual will be much wealthier than a similar individual who bought lottery tickets, or tried to out smart the market by timing the hot sector de jour. If interested, check out Asset Allocation (Part I and II) found in March and April of this year’s blog achieve. That means a LOW COST! balanced fund such as Vanguard Wellington, plus a bit of precious metals, and some inflation protected securities would likely be a good recommendation for the passive investor.

How about those of us who wish to actively manage our investments, at least to some degree? Again let me quote from the outstanding article by Michael Mauboussin, “In 1984, Warren Buffett gave a speech at Columbia Business School called “The Superinvestors of Graham-and-Doddsville.” 79 He referred to the coin toss metaphor and granted that some investors would succeed by luck. But he went on to point out that a number of successful investors came from the same “small intellectual village that could be called Graham-and-Doddsville.” Common to all of the investors was that they searched “for discrepancies between the value of the business and the price of small pieces of that business.”

Although luck certainly plays a role in investment, men like Buffett and Graham are often found sitting at the championship table as the tournament draws to an end. Let me give a simple example of how this works. The Bank of Nova Scotia (BNS) has turned out to be of my better investments. When I found the stock it was selling for a little over $25 a share then I bought a little more at over $27 a share. I reasoned that BNS:

1)Had been thoroughly pounded by the world banking crisis even though Canada was in better shape than most of the world since its economy is largely based on natural resources.

2)Although there was a housing bubble in places like Vancouver (just beginning to pop by the way) real estate was in better shape in Canada than the US.

3)Canadian banks seem to be better regulated than American Banks.

4)At the time I believed the Canadian Dollar was undervalued and I did not have enough invested in foreign currency.

Today BNS sells for $49 a share and pays a very righteous 3.81% dividend. However, since I bought it at a much lower price, that stock is effectively paying me something like a 7% dividend. Now, if I can just be that smart when it comes time to sell that stock?

In a disciplined approach to technical analysis, a subject for another day, an author recommended keeping a journal detailing the rationale for each investment decision, so that over time the individual could discover what worked and what did not work. I did this during a very brief experiment with technical analysis. I decided I was not cut out for that investment strategy. I think that the discipline of recording and analyzing our financial decision making process might also be good advice for the rest of us if we really want to learn something from Buffet and Graham.

Sunday, August 1, 2010

In a Bet There is a Fool and a Thief

Albert Einstein studied the problem of how to beat the game of Roulette. After spending a good bit of time examining the game, he concluded that it could not be done, and he was quoted as saying, "The only way to beat Roulette is to steal the money when the dealer's not looking."