Learning from mistakes

I have been an investor all of my adult life and a portfolio manager and advisor for nearly 30 years.  And looking back on that lifetime of investing experience I can can affirm that I have learned more from mistakes – my own and others – than I have from my successes.

That thought was brought home after reading and article in The Motley Fool titled The Best Way to Learn As an Investor.

Capitalism is all about making, and learning from, mistakes. Jeff Stibel, CEO of Dun & Bradstreet Credibility Corp., made this point well in Megan McArdle’s new book, The Up Side of Down. “The brain is a failure machine,” he said. “When you’re born, you have about all the neurons you’ll ever have. When you’re four, you have pretty much all the connections between those neurons you’ll ever have. Then the brain starts pruning. The brain starts shrinking. You’re actually learning by failure.” …

At a conference years ago, a young teen asked Charlie Munger how to succeed in life. “Don’t do cocaine, don’t race trains to the track, and avoid all AIDS situations,” Munger said. Which is to say: Success is less about making great decisions and more about avoiding really bad ones.

The article goes on to point out that you should try to learn by the failures of others rather than making all their mistakes yourself.  Here are a few of the biggest mistakes people make which lead to financial disaster and ruin their lives.

1. The overwhelming majority of financial problems are caused by debt, impatience, and insecurity. Most people want to appear richer than they are so they dress, drive cars and buy homes that they really can’t afford and live on borrowed money.  Living beyond your means is a recipe for disaster.

2. Complexity kills.   The investment industry is full of creative people who are busy inventing complex products.  Many of them are accidents looking for a place to happen.    The University of California system is losing more than $100 million on a complicated interest rate swap trade.  If you can’t understand an investment, stay away.  That’s why we make things simple here by focusing on simple investments that are easy to understand.  Simple investments usually win.

3. So does panic. People who survive plane crashes and being stuck in blizzards are the ones who did not panic.  If you have the desire to do something because of the emotions of either greed or fear, sit down until the feeling goes away.  Napoleon’s definition of a military genius was “the man who can do the average thing when all those around him are going crazy.” It’s the same in investing.

 

 

Bitcoins

During a client meeting a few days ago we were asked about Bitcoins.  One of our clients had received a number of solicitations to buy Bitcoins over the last few months and he asked us for our opinion.

Bitcoins are an invented electronic “currency” that has attracted the attention of the financial press.  They are designed to appeal to people who are concerned about the value of more conventional currency.  Concerns about a national currency becoming worthless have been one of the main reasons that people have invested in gold, silver or other commodities.  These are said to have intrinsic value when paper currencies become worthless.  After all, gold and silver coins have been around a lot longer than pieces of paper with pictures of dead presidents.

Today’s transactions using conventional currency – like dollars – have largely been taken over by electronic transactions.  Every time you use a credit card, write a check, pay bills via your bank’s on-line bill pay program, you are moving ledger balances, not paper currency.  So why not use an alternative, global  electronic currency?

In my view, the problem with Bitcoins is not just that their value has gyrated even more widely than gold or silver, but that there is no national authority that stands behind their ultimate value.  The headline recently read: “Shutdown of Mt. Gox Rattles Bitcoin Market.” 

Once the pre-eminent marketplace for buyers and sellers of bitcoin, Mt. Gox stopped all transactions on Tuesday, and its website disappeared. The site later came back, carrying only a message that said the halt was “for the time being in order to protect the site and our users.”

We recognize that governments have often been guilty of debasing the value of their currencies.  However, we are not ready to jump on the Bitcoin bandwagon since they seem to be even more unstable and prone to failure and loss than all but the most irresponsible kleptocracies.

We advised our client to take a pass.

Fee-Only Advisors

What’s a Fee-Only Advisor? It’s an advisor who is compensated only by the client.  He receives no compensation based on the purchase or sale of a financial product.  He receives no commissions, rebates, awards, finder’s fees, bonuses or 12B-1 fees (“mutual fund trailers”) or other forms of compensation from others.

The typical “broker” is paid by commissions to buy or sell stocks, bonds, mutual funds, life insurance, annuities, partnerships or other investment products.  Some of these commissions and fees are disclosed, many are hidden in the fine print and not obvious to the client.  This creates an obvious conflict of interest on the part of the investment professional.  They are under pressure to get their clients to do something even when the best course of action is to do nothing.  There is also an incentive to sell high commission products like partnerships, annuities or other insurance products and mutual funds with front end loads.

The fee-only financial advisor has no incentive to do anything but grow his clients’ assets because he is usually compensated by a fee based on a percentage of the assets he manages, thus aligning his objectives with that of the client.   Our RIA firm is fee-only.

Financial Freedom

We talk a lot on this blog about financial goals.  The financial press is full of articles about how to beat the market, how to cut your costs or how to identify stocks for growth.  Those are not goals and can often be distractions.  Unless you’re in it for entertainment or the thrill of playing a game, your goal is not to beat some index or to find a stock that triples.  And playing that game often leads to failure.

The actual goal for most people who invest (or save) can be defined as “Financial Freedom.”  Another way of putting it is “Walk-Away Freedom.”  The ability at some point in your life to be able to walk away from work and devote your time to what you would really like to do.  Some people are fortunate.  They enjoy the job they are doing and see no reason to change.  Many others would like to change the way they spend their time.   Let’s call that change retirement.

Financial freedom is what most people want to have at retirement.  It doesn’t have to be at age 65.  Retirement is the point in your life where you no longer need the income from your job and can live on your investments or other income streams like social security, pensions, annuities, rents, royalties, etc.

When we speak with our clients or interview a prospective client our discussion is always on their goals. What makes them financially independent?  At what stage of their life will they have walk-away freedom?  The focus is never in beating an artificial benchmark like the S&P 500 or the DJIA because those are distractions.  These indexes don’t care about you.  We do.  That’s why so many people have asked us to help them manage their money.  We help them chart a path to their personal financial freedom.

What’s your goal for “Walk-Away Freedom?”

Five year returns can be misleading

Chris Latham at Financial Advisor talks about the words “long-term” and the fact that there is no consensus about its meaning.  If one year is not long-term, is 2, 5, 10 or more?  The longer the period being measured, the closer we get to actually talking about the long-term.  Of course we have to take into consideration that fact that our individual time horizons are not infinite.  A 20-year-old can afford to think in terms of a 70 year time span, someone 70 years old cannot.

Many people will look at a five-year span and make a judgement about the market, a stock or a mutual fund.  But there’s something revealing that tells us that we can be misled by these statistics.

In fact, one calendar year can make all the difference in the minds of stock investors. Compare the five-year period ending in 2012 with the same span ending in 2013. They look like two completely different time frames, even though they share three identical years. Counting dividends, the five years ended in 2012 returned 1.7% on the S&P 500, while the five years ended in 2013 returned 17.9%, the Times reports.

The long crawl up from the depths of the Great Recession accounts for the poor showing in the first snapshot, while last year’s 32.4% market rise accounts for the apparent miracle in the second.

Be cautious when viewing data that changes the beginning and end-points.  And keep in mind that market indexes are not important as a way of achieving financial freedom.

401(k) Balances Hit Record High

From CNN

The average 401(k) balance hit $89,300 at the end of the year, up 15.5% from $77,300 in 2012, according to an annual tally by Fidelity Investments. Most of the boost came from stock market gains as all three major stock indexes ended the year more than 20% higher.

People on the verge of retirement, ages 55 to 64 years old, saw their nest eggs grow to an average balance of $165,200 from $143,300 in 2012, Fidelity said. Savers with both a 401(k) plan and Individual Retirement Account managed by Fidelity had larger nest eggs, with an average balance of $261,400, up from $225,600 in 2012.

The 401(k) has replaced pensions as the way most workers save for retirement.  That’s a problem.  Most employees spend almost no time actually choosing the right funds in their 401(k).  It’s the reason that so many Enron employees lost their retirement when that company went broke.  It’s the reason why so many people lost so much in the crash of 2008 – 2009.

Even when their 401(k) holds most of their retirement savings, employees pay little attention.  The typical worker is given a list of mutual funds available to the plan and told to check off some boxes to say where his money is going to be invested.  The employer does not provide guidance, neither does the investment firm that sold the plan.  The typical “Big Box” broker is not paid to provide guidance, and typically doesn’t.

There is help for the worker who wants his money to grow while controlling risk.  There are a few RIA firms that can help.  If you are one of those whose 401(k) is serious money and you would like to get help, give us a call.

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Getting business owners to diversify

 Successful business owners usually have strong confidence in the growth of their business.  As a result, they tend to invest most of their assets in their business.  They know their business, but are not nearly as knowledgeable about more liquid investments.  They are nervous about putting money into investment they can’t control and reluctant to turn large sums of money over to others to invest for them.

As a result, they often put their financial future at risk because the bulk of their net worth is tied up in the success or failure of their business.

The financial shock of 2008 brought this home to many companies.  Between 2008 and 2010 more than 200,000 small businesses closed.  The failure rate for new businesses is between 50% and 70%.  Once a business is established, the failure rate drops.  But any number of things can come along; changes in demographics, changes in the economy or even changes in surrounding area can cause a previously thriving business to close.

The challenge for the investment manager who offers to help the business owner diversify is to point out that a total focus on investing everything in his business leaves him and his family in a precarious situation.  One money manager likens it to riding a unicycle when they should be sitting on a piano bench.

The unicycle may be exciting and profitable, but you can easily fall.  The four legs of a piano bench are (1) the business, (2) a tax-qualified retirement plan, (3) a personal taxable portfolio and (4) real estate.  If the business is a huge success, the business owner wins big and, at retirement can sell out or leave it to his children.  If the business fails at some point, the other three legs of the piano bench are there to provide for his family and himself.

One investment advisor persuaded a reluctant entrepreneur to invest $5 million in a diversified portfolio instead of plowing it back into his company. At the meeting where the client finally agreed, his wife gave the advisor the thumbs-up behind her husband’s back, triumphantly mouthing the words, “My kids can go to college!”

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Remedying a Common Estate Planning Error: Improper Titling of Assets

The Hook Law Center has written an important essay on the issue of titling of assets.  It’s a common misconception that wills and trusts determine who gets a decadent’s assets.  This is not necessarily true.

Your will or trust generally does not govern disposition of the following:

1. Any real property or accounts that may be owned jointly by you and another with the right of survivorship;
2. Any real property with a transfer on death designation;
3. Any account that may have a payable on death or transfer on death designation;
4. Retirement accounts, 401(k) plans, 403(b) plans, and IRAs;
5. Survivor benefit plans; and
6. Life insurance policies.

The assets in these accounts, plans and policies will usually pass to the surviving co-owner or the designated beneficiary of these accounts, plans, and policies. Beneficiary designations usually override the disposition of your assets as provided in your will or trust, as any accounts, plans, and policies that designate a specific beneficiary will be payable to that beneficiary.

Read the whole thing.   And get a copy of my book BEFORE I GO to help you plan better.

 

9 Must Have Status Symbols that Say “I’m Rich”

To show that we’re not fixated simply on making money (and keeping it after it’s made) we though we would share this list of things that say “I’m Rich” from the Fiscal Times.

1. A swanky stroller.  Of course it helps to have an infant to put in the stroller, but that doesn’t require you to be rich. Fancy strollers with leather seats  and iPod speakers can be had for a mere $3500.
2. Designer fashion.  One happy designer tells the paper that her $7990 grey sequined ball gowns are selling like hotcakes.
3. Fine wines.  Forget two buck chuck, when you’re rich the price of a bottle of wine isn’t an issue and you would not be caught dead buying anything under $50 a bottle.
4. Specialty bikes.  The rich don’t go to Wal mart of Target for bikes.  They go to specialty shops where they spend about three hours being “fitted” for a bike that sets them back around $32,000.
5. Thumbing their noses at PETA, the rich wear fur.  And not just fur coats and capes but fur sandals for $895.
6. Expensive pets.  One Chinese mogul set what may be a record recently by spending $1.5 million for a Tibetan mastiff.
7. Fast cars.  Enough said.
8. Cruises.  The rich mingle on international cruises that are becoming increasingly popular.  The really, really rich cruise on their own private yachts.
9. The Bling.  Wearing a Rolex along with chains, diamonds and gold on neck, wrist and ankle show that you really don’t have to look at the price tag before you buy.  If you really want to separate yourself from the middling millionaire, get a watch that sells for about $300,000.

Once you have it, it helps to know what to do with it.  One thing that’s not listed, but should be at the top is charity.  Once you have enough, there are many out there who could use your help,and individuals do a much better job of helping their neighbors than government programs and impersonal charities.

Major Brokers Don’t Want Investors Under $250,000

As the major investment firms woo the millionaires and billionaires, they are working to drop the “smaller” investors.  There are several ways they do this.

It begins with account fees that make it prohibitively expensive to open small accounts.  Second, they won’t pay brokers on account that don’t meet their minimums.  For example, Merrill Lynch does not pay brokers on accounts under $250,000.  At these firms there is pressure from management to transfer accounts for the middle-market investor to call centers where they receive the kind of impersonal service you get when you call an 800 number.  This breaks the personal bonds that investors and advisors need to work well together.

The account minimums that the majors impose on their advisors may help the megabank-owned brokerages compete for high-net-worth clients.  But the requirements also means that modest investors cannot get the kind of personal guidance that they need to reach their goals.  It was a factor that caused us to form our own independent RIA firm because there’s more to client relationships than account size.