Saturday, November 27, 2010

I Am My Own Worst Enemy

When it comes to selecting investments or any financial decision, we are often our own worst enemy. Over 15 years ago I became interested in certain aspects of the consciousness and the human mind. There were at least 3 roots to this inquiry, one personal, certain observations made during my practice of Tai Chi as a martial art, and the discovery in the Wall Street Journal (of all places) the U.S. military and intelligence community were using psychics to spy on the Russians. This search culminated in taking the Certified Hypnotherapist training offered by the National Guild of Hypnotists. Among other things, I have concluded human senses and consciousness are, at best, treacherous and often inadequate tools for the study of truth. The mental maps we use in our perception of reality, no matter how detailed and accurate, are not and never can be the territory they represent.

Having worked in a research laboratory for 25 years, I know that the participants in an experiment affect the outcome of that experiment. They design the experiment itself, select the instrumentation, the method of recording the data, they are participants in the experiment as they execute the experiment, and they choose how to present the outcome of the experiment. All these factors affect the accuracy and repeatability of the results. I can not say an iron bar weighs 100 pounds. I can say that the bar weighs 100 pounds plus or minus 0.1 pounds with a statistical confidence of 99.6%. There are more subtle problems found in experimental methods. For example, using the same data to both postulate a theory and validate that theory is a trap I have seen all too often.

We are over optimistic concerning our own abilities. Studies have indicated that about 80% of students predict they will perform in the top half of their class. Roughly one half of all high school football players believe they have a legitimate chance for a NFL career. In fact only 1 out of 3,000 college football players ever make it to the pros. I don’t expect to consistently beat the market, but I do believe that my decision making ability is better than the norm. If I didn’t, I would just buy index funds. Many serious men, such as Warren Buffett, recommend this plan for those of us who are part time investors.

If you have watched Sleepless in Seattle, you know we men like to quote the Godfather. In a conversation with his son, Michael, the aging ill Don Vito Corleone observes, “I spent my whole life trying not to be careless. Women and children can afford to be careless, but not men.” I too have spent my life trying not to be careless. I know that psychologists have demonstrated that the quality of a man’s judgments peak at about age 55. Then they decline. Have I started down that hill? Would I know if this were the truth?

Crowd psychology is a part of stock market performance. Benjamin Graham’s, Mr. Market is a most erratic irrational fellow. One day, sometime for no reason whatsoever, Mr. Market will sell a stock for 15% less than he paid for it yesterday or he is just as likely to pay 15% more for no particular good reason. Mr. Market becomes wildly optimistic just as a market is about to reach its peak (think of the Internet bubble). He is just as likely to sell everything in a fit of pessimism, just when the market has reached a bottom. That is the time he should be buying everything is sight. Sometimes this is called Buffett’s Rearview Mirror, a tendency to become irrationally optimistic at the end of a long bull market and irrationally pessimistic when a bear market ends in a crash.

Another all too human folly is termed Conservatism Bias and Confirmatory Bias. Because of my opinions I am likely to undervalue or ignore stocks that do not pay a dividend, missing out on opportunities like Apple or Google (Conservatism Bias). Because I believe in value investing and the importance of a sustainable dividend, I tend to seek out information that supports my prejudice.

Because outcome tends to reinforce our decision making process, we can learn the wrong lessons. We tend to congratulate ourselves on bad decisions that turn out well, such as purchasing a winning lottery ticket. I hear this from time to time from unhappy souls who have spent $1,000 to win $20 from a scratch off lottery ticket. Of course wise decisions can turn out badly. If a doctor misdiagnoses an illness, does that indicate I should never again visit a doctor?

We all know about Monday morning quarterbacks. Every Monday morning, along with my coworkers, we discuss the mistakes made over the weekend by our favorite teams. We know what plays the coaches should have called. Why aren’t they as smart as we are? Everyone knows that an Internet stock with no cash flow, no profits, and no price earning ratio that is capitalized at a value that exceeds the Gross National Product of Germany is going to become a great crashing disaster, but only after the fact. While the music is playing, everyone wants to dance.

Finally, we come to language. In both undergraduate linguistics and in studying artificial intelligence in graduate school, I have run into philosophical discussions of the inherent limitations of language in creating a net of meaning. The very words I use in writing this article are inherently imperfect and limiting.

And please, let’s be careful out there today.

Saturday, November 20, 2010

Just Do It!

Eighty percent of success is just showing up.
Woody Allen

Sometimes writing this blog is easy. A subject just pops up in my mind and the post is written long before I sit down at the keyboard. Sometimes I stumble across some information that is so important I just have to pass it on. Sometimes I have nothing to say or I just don’t feel like writing. On those days, because I believe what I am doing is useful, I keep on looking until I find something I hope is of value. Sometimes I am surprised to discover what I thought was not all that special gets me an email from a friend expressing their appreciation. Sometimes a piece I considered especially valuable elicits no response whatsoever. I am learning the truth of Woody Allen’s famous axiom. Sometimes the hardest part of this job is just sitting down and doing it. I think that this is probably true of just about any aspect of money management from escaping the great American debt trap to managing a substantial investment portfolio. It is also true in areas where I consistently fail, like weight loss.

Every job has a hard part, a part that requires us to “show up” even when we don’t feel like it. Perhaps, if you are extroverted schmoozing with your customers is the easy part of your job. Perhaps, actually doing the work is hard. For an introvert, her art is everything. This person would find customers an inconvenience and an interruption. I have a friend who loves his ministry, but loathes fundraising. If he doesn’t make those phone calls, write those letters, and visit churches, he can’t do what he does so well for the Lord. I wish there was an easier way, but there isn’t. When fundraising needs to be done, he just does it.

So no matter where you find yourself along the road to financial freedom. Just get up this morning and do what needs to be done.

Let me end with a quote from “The Invitation,” a poem attributed to Oriah Mountain Dreamer that quite often appears on inspirational or motivational websites.

It doesn't interest me to know where you live or how much money you have. I want to know if you can get up, after the night of grief and despair, weary and bruised to the bone, and do what needs to be done to feed the children.

It doesn't interest me who you know or how you came to be here. I want to know if you will stand in the center of the fire with me and not shrink back.

It doesn't interest me where or what or with whom you have studied. I want to know what sustains you, from the inside, when all else falls away.

I want to know if you can be alone with yourself and if you truly like the company you keep in the empty moments.

Sunday, November 14, 2010

Rebates! Humbug! Bah, Humbug!

After two sobering entries on an important subject, here is a post on one of life’s petty annoyances, rebates. As we head into the Christmas shopping season, one of the many ways we will be manipulated by marketers will be through the use of rebates. If you remember this is nothing more than another ploy to separate a fool from his money you will be OK.

Rebates are an attempt to psychologically manipulate the buyer. The company offering the rebate knows that only 50% of all rebates will actually be paid out. They know that the larger the percentage the more likely it is that the rebate will be cashed. Hence a $1.00 rebate on a $2.00 item is more likely to be cashed than a $1.00 rebate on a $10.00 item. One might question the efficacy of submitting such a rebate, given the value of time that could be spent doing something more useful than filling out a form that could, in a small way, compromise your privacy. The cost of a postage stamp is 44 cents. The cost of an envelope is around a nickel. So what am I really getting?

Of course, I am going to take the big rebates when and if they are offered. I was offered a $50.00 rebate on my printer. After months, I actually received the rebate. When a friend built me a new computer for my home, I submitted something like five rebate forms for some of the pieces parts that went into my new machine. I ultimately received one less rebate than I submitted. I didn’t bother trying to figure out who lost my form or what happened. It simply was not worth the aggravation. Another rebate I received came in the form of a $75.00 prepaid credit card that came from the purchase of a new refrigerator. That was Sears way of offering “free” installation. By the way, I had to pay sales tax on that money. If the installation was really free I would not have paid 6% tax on that $75.00.

By the way, rebates no longer come in the form of checks that can actually be cashed. They are likely to come in the form of stupid prepaid credit cards that can not be turned into cash at your local bank. The companies that issue these things know that it is unlikely that you will ever use all of the money on the card. They get to keep the $2.37 that you forget about. If you receive one of these annoying things, use it quickly and completely on purchases like gasoline or food. Zero it out in one or two purchases. These things are not covered by any of the recent credit card reforms. If it is lost or stolen you have 24 hours to report the theft. Typically, after one year they expire, even if unused. I have read about but not yet received a rebate card that can only be used at one store.

All things considered, rebates are extremely annoying. If possible try to find a comparable price at another store that is not offering a rebate. It is actually possible to find a better price without a rebate than the price with the rebate at a more expensive retailer. If the rebate is offered by the manufacture, a little shopping will give you the best price and the rebate. If you decide to buy an item with a rebate, take care of paperwork quickly, the option to apply for the rebate can expire in 90 days or less. Remember, the people who dream up these schemes are not your friends. Take what is offered when it is offered, only if it makes sense. Do not buy something you do not need just because it is on sale or it comes with a rebate.

Thanks to USA Today for inspiring this rant.

Saturday, November 13, 2010

The Very Latest Retirement Data

The information in this post comes from an article entitled, “Retirement Drawdown: Tips to Make the 4%-Percent Rule Work” by Steve Vernon, detailing the results of a new study by Chris O’Flinn and Felix Schirripa.

It was a little annoying to find this the same day I posted “The 4% Retirement Solution Revisited” but such is life. For the first time I have discovered the origin of the 4% rule. It was first proposed in a 1994 paper published by William Bengen. His research determined that, “Based on his early research of actual stock returns and retirement scenarios over the past 75 years, Bengen found that retirees who draw down no more than 4.2 percent of their portfolio in the initial year, and adjust that amount subsequent every year for inflation, stand a great chance their money will outlive them. In the same article, his analysis showed that "Retirees who draw down 5 percent a year run a 30 percent chance their nest egg will run out of steam before they do." (Wikipedia)

Using the same methodology developed by Bengen, O’Flinn and Schirripa expanded the original data set to include all retirement periods beginning each month since 1926. The end date for this study, June 2009 includes the most recent stock market collapse.

For all 20 and 25 year retirement periods:

No examples of failure with these portfolio periods if invested in 75% stocks and 25% bonds

No examples of failure with a portfolio invested in 50% stocks and 50% bonds in a 20 year retirement

2% failure with a portfolio invested in 50% stocks and 50% bonds in a 25 year retirement

For all 30 year retirement periods:

4% failure with a portfolio invested in 75% stocks and 25% bonds

8% failure with a portfolio invested in 50% stocks and 50% bonds

For all 35 year retirement periods:

8% failure with a portfolio invested in 75% stocks and 25% bonds

15% failure with a portfolio invested in 50% stocks and 50% bonds

The author wryly observes that since O’Flinn and Schirripa note that since the 4% rule failed when there was high inflation or a stock market crash early in a retirement period, “Don’t retire before the market crashes or before there’s high inflation!” Hmm, I’ll try to keep that in mind.

I think there are some important take aways from this new data. First, the old conventional wisdom that recommends holding your age in bonds. For example at age 60 I should be holding 60% in bonds and 40% in stocks may be too conservative. Perhaps the new conventional wisdom that recommends 115 – your age in stocks is more appropriate. At age 60 that would be 45% in bonds and 55% in stocks. Maybe an even more aggressive portfolio is worth the risk. Unfortunately, psychological data indicates that the quality of the decisions we make tends to peak in our mid 50s and then, even if we do not suffer from any cognitive disability such as Alzheimer’s, our decision making ability begins to decline. Will I be able to pick stocks at 85?

Secondly, it would appear that the most important question is one of life expectancy. Data from the Boeing Company that was prominently posted on our bulletin board a work showed that each year worked beyond age 55 cut life expectancy by two years. Boeing, like my employer, is primarily a mix of skilled technicians, engineers, and administrative support personnel. Therefore, could we project that for each year you work past 55 there will be 3 fewer retirement years to fund? This, of course, is highly dependent on the nature of your work, genetic makeup, and lifestyle. There are only three careers that seem to provide a statistically high number of people who love their jobs. These are medical doctor, college professors, and religious professionals. Many of these people are highly energized by their work and never really completely retire. On the other hand, a 55 year old brick layer would almost certainly shorten his life if he continued to work. Also, the wear and tear on the body would undoubtedly produce serious disabilities requiring expensive medical treatments. I don’t have data to support this conclusion, but people who hate their jobs tend to live less healthy lifestyles. They tend to drown their sorrows in alcohol, tobacco, and unhealthy foods.

I used this one before and will probably use it again.

Proverbs 3
[5] Trust in the LORD with all thine heart; and lean not unto thine own understanding.
[6] In all thy ways acknowledge him, and he shall direct thy paths.

Friday, November 12, 2010

The 4% Retirement Solution Revisited

I don’t like to be too repetitive. However, this question came up twice in a little over a week, so I thought it must be time to revisit the 4% solution. A hypothetical portfolio invested in 50% bonds and 50% stocks in 1946, subjected to a 4% withdrawal rate would have lasted for 53 years. The same portfolio subjected to a 5% withdrawal rate would last 34 years. Projecting an 8% withdrawal, mentioned in “I could be wrong now, but I don’t think so,” the portfolio lasted less than 16 years. This information comes from Richard C. Young’s Economic Analysis Report. Most of the usual sources including my Schwab account retirement calculator recommend the 4% solution. This calculator helpfully adds the probability of various balances at your projected death date. This calculator and others assume a 4% draw will give you something like a 90% probability of not outliving your money. Greater certainty would require more money.

Here, once again, is the basic calculation.

Start with your current total household income. Let’s say for the sake of this example, $100,000. Psychologists have discovered that in spite of protestations to the contrary, people spend more in retirement than they think they will. 80% is the current number favored by conventional wisdom. Only a few years ago this number was 75%.

So the amount of money you are likely to spend in retirement is:

$100,000 X 0.80 = $80,000

Some of us who live in high cost areas like suburban Washington, D.C. are in a position to move to a lower cost area, dropping our cost of living dramatically without lowering our quality of life. I plan to move to a state with low housing costs and low taxes like South Carolina. Almost everyone will spend less in retirement. There are no more daily commutes. This drops automobile expenses. Clothing costs drop now that white collars and suit jackets are only required for weddings and funerals.

So where is that money going to come from? $80,000 is the goal. First assume that you will be receiving Social Security. This number is provided by the Social Security Administration on an annual basis. I believe that any politician that attempts a bait and switch on Social Security will be burned alive by the Baby Boomers. There are too many of us and we vote. Gen X and Gen Y? Your Social Security may or may not be there when you need it. Plan accordingly.

For the sake of this example, let us assume Social Security in the amount of $25,000 a year for both husband and wife. Let us also assume that this hypothetical husband and wife also have a guaranteed pension of $30,000 a year. Unfortunately the folks with defined benefit pensions are becoming an endangered species.


$80,000 - $25,000 - $30,000 = $25,000

This is the number you will have to generate every year (adjusted for inflation) for the rest of your life. To put things in perspective that is about the same as a job paying $12.50 an hour. To achieve this goal with a high probability of success, the economists and statisticians who study such things recommend the 4 percent solution.

Take the number not guaranteed by the Government or your employer and divide by 0.04.

Hence, in this example:

$25,000 ÷ 0.04 = $625,000

If you don’t like to divide, the same number can be calculated by multiplying your annual goal by 25.

In the past most of this money was expected to be generated by the increasing value of the single family home. It was assumed that real estate prices go up forever. 2008 proved this was a bad assumption. My generation was shocked by the sudden and dramatic drop in property values. Now savings and investments will be required to cover that shortfall. The basic calculation is pretty simple but achieving the goal is difficult. If you don’t plan on getting married, buying a house, or having children, it will be pretty easy to generate enough in your 401K to guarantee a comfortable retirement. However, if you want to have a life, things get harder. Don’t despair. Pick an investment strategy that is comfortable for you. There are several that are well proven. Then stick to the task with relentless determination. A disciplined approach, plus time, and the power of compound interest will take you where you want to go.

Sunday, November 7, 2010

May Flights of Angels Sing Thee to thy Rest

On Thursday November 4, 2010 I lost a good friend. The world lost a good Christian and a good man. I want to take this moment to remember his life and his goodness.

MAN that is born of a woman hath but a short time to live, and is full of misery. He cometh up, and is cut down, like a flower; he fleeth as it were a shadow, and never continueth in one stay.

FORASMUCH as it hath pleased Almighty God of his great mercy to take unto himself the soul of our dear brother here departed, we therefore commit his body to the ground; earth to earth, ashes to ashes, dust to dust; in sure and certain hope of the resurrection to eternal life through our Lord Jesus Christ; who shall change the body of our low estate that it may be like unto his glorious body, according to the mighty working, whereby he is able to subdue all things to himself.

Domine Refugium Psalm 90

[1] LORD, thou hast been our dwelling place in all generations.
[2] Before the mountains were brought forth, or ever thou hadst formed the earth and the world, even from everlasting to everlasting, thou art God.
[3] Thou turnest man to destruction; and sayest, Return, ye children of men.
[4] For a thousand years in thy sight are but as yesterday when it is past, and as a watch in the night.
[5] Thou carriest them away as with a flood; they are as a sleep: in the morning they are like grass which groweth up.
[6] In the morning it flourisheth, and groweth up; in the evening it is cut down, and withereth.
[7] For we are consumed by thine anger, and by thy wrath are we troubled.
[8] Thou hast set our iniquities before thee, our secret sins in the light of thy countenance.
[9] For all our days are passed away in thy wrath: we spend our years as a tale that is told.
[10] The days of our years are threescore years and ten; and if by reason of strength they be fourscore years, yet is their strength labour and sorrow; for it is soon cut off, and we fly away.
[11] Who knoweth the power of thine anger? even according to thy fear, so is thy wrath.
[12] So teach us to number our days, that we may apply our hearts unto wisdom.
[13] Return, O LORD, how long? and let it repent thee concerning thy servants.
[14] O satisfy us early with thy mercy; that we may rejoice and be glad all our days.
[15] Make us glad according to the days wherein thou hast afflicted us, and the years wherein we have seen evil.
[16] Let thy work appear unto thy servants, and thy glory unto their children.
[17] And let the beauty of the LORD our God be upon us: and establish thou the work of our hands upon us; yea, the work of our hands establish thou it.


Saturday, November 6, 2010

Cable TV

“Because prices move inexorably toward the free, the best move in the network economy is to anticipate this cheapness.”
Kevin Kelly

Finally, some good news for those promoting financial responsibility, USA Today is reporting that Americans are dropping cable TV subscriptions at record rates. More encouraging news is they are not replacing those services with satellite TV or telephone services such as FIOS.

As readers of this blog know by now, I consider ditching cable TV as a good way to free up money to pay off debts. It is a luxury not a necessity. Americans are finally discovering an endless cycle of work and spend does not bring happiness. As a nation and as individuals we are finally waking up from a two decade binge of spending to a really nasty debt hangover. We are still a long way from frugality becoming the new cool, as some authors claim, but we are finally heading in the right direction. People are buying into the idea of voluntary simplicity.

There are other economic forces arrayed against cable TV. First the wretched quality of their overpriced services always leaves these companies in a tight race to the bottom of the customer service rankings with airlines and AOL. Why should I want to pay for a bunch of shopping channels and worse to get the History Channel and ESPN? My wife would ask the same question, substituting Animal Planet and the Hallmark Movie channel. The American consumer has been demanding ala carte cable service for years. Because the cable TV companies are close to being natural monopolies, they have consistently ignored their customers’ desires.

Sadly, Americans, particularly unemployed Americans have much less in the way of discretionary income. Cable TV is a luxury not a necessity.

Much as I would like to believe this trend reflects a seismic shift in mentality of the American consumer, I expect the truth is that one of Kevin Kelly’s laws is taking effect. The cost of content delivered by a given technology will always tend to move asymptotically towards zero. In Rules for a New Economy, Kelly has traced the course of a number of technologies. When they are first introduced they tend to be affordable. I had cable when I lived in an apartment in Greenville, SC (1977-1978) that was located in a natural bowl surrounded by hills. We could only get one channel with the rabbit ears. From memory, basic cable gave us the three majors, PBS, a religious channel or two, and some trash for about $8.00 a month. Today the average cost of cable runs something like $70 a month, $120 a month for some of the premium services. At some point the customer is horrified by the rising cost or a new technology offers a better product at less cost. Then the price starts to drop, first fast and then really fast, heading towards but never reaching zero. In my lifetime I have seen the cost of long distance telephone service drop from something like $3.00 a minute to 3 cents a minute.

Affordable high speed Internet is becoming a “necessity” much as the telephone, which was first considered a luxury but in time came to be seen as a necessity. More and more shopping, bill paying, and financial services (such as banks and brokerage houses) are assuming their customers have access to high speed Internet. I have discovered that even in rural America, satellite Internet is the wave of the future. Free Internet services such as HULU are providing a huge range of television entertainment that is both free and available 24/7. Netflix provides downloadable movies at an extremely reasonable price. “Renting” the movies on line that you really want to see is far cheaper than paying for a bunch of junk you really do not want to watch. New technology is making it easy to integrate the Internet into a home entertainment center. People are cutting the cable.

From the article “More Customers Drop Cable TV; Is Internet or Cost to Blame?”
By Peter Sevenson

Thomas Clancy Jr., 35, in Lon g Beach, N.Y., canceled the family's Cablevision subscription this spring. He said he has been happy with Netflix and other Internet video services since then, even though there isn't a lot of live sports to be had online.

"The amount of sports that I watched certainly didn't justify a hundred-dollar-a-month expense for all this stuff. I mean, that's twelve hundred dollars a year," Clancy said. "Twelve hundred dollars is ... near a vacation."

Friday, November 5, 2010

The Intelligent Investor

Warren Buffet describes The Intelligent Investor by Benjamin Graham as, "by far the best book on investing ever written." It is the seminal description of the principles of value investing. The sage of Omaha is not alone in praising this book. On vacation I read the original 1948 edition of this classic. John C. Bogle, founder of the Vanguard Funds wrote the introduction. Other luminaries such as Irving Kahn, Walter Schloss, and Jason Zweig have praised this work.

The Intelligent Investor is the essence what I have been trying to learn over the last nine years. The value investor does not overly concern himself with the day to day fluctuations of the market. Instead, this investor attempts to identify companies with a promising income stream, sound management, and a sustainable dividend, buying them when their price dips, and then holding them, sometimes forever. Graham also recommends developing a defensive mix of fixed income securities and stocks to further protect the value of the investor’s portfolio against the slings and arrows of outrageous fortune.

In the sixty years that have passed since this book was written the particulars of all his examples have changed, but the principles taught are timeless. For example, I found it interesting he was aware of the inherent value found in unprofitable railroads. Thirty years later some of these unprofitable railroads went bankrupt. Those wise enough to understand what Graham was preaching made a killing buying these “worthless” securities. The real estate holdings of these railroads, proved to be worth many times the value of their cost.

This book is not an easy read. There is more to learn from his examples than can be absorbed in a single reading, no matter how slow and careful.

Graham is greatly amused by “Mr. Market,” an obliging fellow who comes to his door every day, offering to buy his stocks or sell him something else. Some days the price offered is ridiculously low and on other days the price is outrageously high, but over time the value of the intelligent investor’s holdings continues to grow and pay regular dividends.