Only Dividends Matter

Your writer will take a reactionary stance here, contrary to most modern finance theory.

For the long term investor, only dividends matter for the value of a stock.

I chose that terminolgy for the reason that there is a "theorum" taught in business schools and by finance academics that dividends don't matter.  They are totally wrong.

A simple gedanken experiment proves my case.  Suppose you buy the IPO of a stock, such as GM, EK (Eastman Kodak), or AAPL and, as a long term investor, simply hold on to it ... to the bitter end.

What money do you ever receive?  The "bitter end" - the eschaton of stock investing - is either a cash buyout or bankruptcy.  All cash buyouts are pretty rare nowadays.  Can anyone name one in the past few years?  Bankruptcies are much more common:  GM, EK, etc.

Suppose the firm never pays a dividend.  If the end result is bankruptcy, the value of a long string of zeroes is ... a big zero. 

Suppose the firm pays dividends.  Then even if the end result is bankruptcy, the long term investor has received some value that he can reinvest in bonds or other stocks.

Over the long term, the bankrupcty of firms is rather common.  Management squanders cash and makes bad investments.  How we can marvel at the recurring "non-recurring" losses!

They buy back stock.  That only benefits the sellers by propping up their selling price.  Who is a seller?  For one, management is.  They use stock buybacks to prop up their pay.

Why is AAPL stock apparently undervalued?  No dividend.  They have a huge and growing hoard of cash.  The "market" obviously thinks management will squander it.  And continue to squander it.

GE bought back huge amounts of stock while the price was high.  And then proceeded to sell huge amounts when the price was low during and after the Panic of 2008.  Buy high, sell low - brilliant management.  Dopes?  No, self-serving hogs!

Long term investors should only pay for dividends.  Period.  Full stop.

Obey the Machine

Investment Rule #7

Don't try to be a hero. Don't be a swashbuckler. Don't be a nervous Nelly. Don't listen to the bloviators on the financial press. Don't listen to the pundits.

Don't worry ... be Happy ... Obey the Machine.

Just follow the investment rules and be happy.

Keep your emotions under control.

If you try to "add value" to the Machine's prescription, it's rather likely you will subtract value. You'll be buying what's in favor when you should be taking profits; you'll be bailing out in panic when you should be buying cheap assets; or you'll simply be randomly adding risk with "coin toss" moves with no net returns.

Don't do it. Just Obey the Machine.

And read this blog.

Actions

The jobs number was good, some economic numbers were good. Stocks rallied worldwide. Hmm that morning I received an email from a pundit saying the correction had begun. Huh?

The Machine aka Krypto has no new actions.

Word of the Day

"Suspire" - verb [$100] a T. S. Eliot word
Suspire means (intransitive) 1. to sigh; 2. to breathe; (transitive) 3. to sigh, to utter with long, sighing breathes.
Sentence: Seeing a well-paid pundit write that the correction has begun after the markets are down about 5%, Bunkerman can only suspire with disgust, "what utter bilge".

Taxes

Investment Lesson #6

Minimizing taxes will help increase your returns. Eventually and over time, you'll need to pay attention to taxes. The issues are very complex, however, and are different for many people. "What is to be done" about taxes depends on the tax rates, AMT or not, income expectations, prospects for tax rate change, etc.

Here are a few simple ideas.

For people able to save via an IRA, the Roth IRA is better for the long term. The traditional IRA is OK, however, if you are at least in the 25% rate bracket and can benefit from the income exclusion for IRA savings.

Having savings+investments in BOTH taxable accounts (normal brokerage, etc.) AND in tax-deferred accounts (IRA, 401K) is best. Then you can make adjustments to minimize taxes. Moves that result in gains are taken in the tax-deferred account; moves that result in taxable losses are taken in the regular account.

Try to keep the fixed income asset classes in the retirement accounts and the core parts of the long term equity classes in the regular taxable accounts. You'll not exchange those much, if ever, and any gain will be taxes at low, long term capital gains rates. The tax-deferred income can be reinvested tax free in the tax-deferred accounts, and when the income is drawn at retirement, it's simply taxed once.

Core gold & silver can be coins kept in the bank, but keep non-core amounts of the ETFs in a tax-deferred account. Those are taxes at higher rates so any exchanges (which are frequent) need to be done in a tax-deferred account.

I tend to dislike the tax-deferred annuity intensely; those are often sold to people who really should not invest in them and the fees are huge. One can buy VTI and not sell for 30 years, then pay a one time capital gains tax at a low rate. That's the ultimate tax-deferral and it costs nothing.

It's a complex area; be sure to consider any tax-driven decisions carefully.

Actions

None today.

Word of the Day


"Transvalue" - verb, transitive [$100]
Transvalue means to re-estimate the value of, esp. on a basis differing from accepted standards, reappraise, reevaluate.

Sentence: A major change in one's marginal tax rates must cause one to transvalue one's long term investments.

Fees will Flatten You

The financial industry is fat. Bloated. Littered with fee traps. Teeming with piranhas and wolves who want your money, mostly for doing nothing. Certainly nothing of value. Half the industry should not exist.

If you want to succeed at long term investing, you must minimize the fees and pay only for value received.

Here's a simple example:

Krypto invests in no fee index funds in accounts with no wrap fees and other fees. Suppose she gets 8% per annum. After 20 years, every $10,000 Krypto invested in the beginning has grown to $46,600.

You invest in funds charging fees in accounts with management fees and pay transaction fees, all together amounting to 2% per year in fees for nearly the same investments. That means your net return is 6% per year. After 20 years, every $10,000 has grown to only $32,070.

Golly, you, a gullible human, end up with about 2/3 of what my dog gets. She's retiring on filet mignon while your get fried mystery meat.

Last Friday I told you how to avoid most fees: Use Vanguard index funds and / or Vanguard ETFs in a Vanguard brokerage account. The fees are as close to zero as possible, or are zero. Just follow the investment lessons of this blog and your investments will perform exquisitely: you're guaranteed average with no fees, thus you will out perform almost every professional money manager over a 20 year time horizon.

Just do it.

Exceptions

It's OK to pay reasonable fees for planning and advice, particularly tax advice. Just be sure you ask what they are and understand the costs in $ and %'s. I willingly pay some fees to a broker whom helps Mrs. B learn about investing. A good husband should do that, otherwise, if he gets run over by a truck, his wife will be prey to every shark & gigolo.

Actions

Krypto is buying some Pacific stock index funds this morning. The money will come from cash.

Gold+silver is still just a weak sell - we wait. Real estate is creeping closer to a sell signal (the 5% signal).

Word of the Day

None today - have to take the trash out.

Time Out on a Tuesday

Today I take a break from the investment lessons to write about how Krypto Fund is and will react to event unfolding events in and arising out of the aftermath of the huge earthquake in Japan.

Market participants who read books will likely be reminded of the scenes in that great trading book, Reminiscences of a Stock Operator, when lead character, "Larry Livingston", gets a 'feeling' to short stocks just before the San Francisco earthquake of 1906. When the telegraph stories of the quake appeared, he piled on the shorts, seeing that the reaction of most people would be slow and the true extent of the devastation would take days to come out. Lary Livingston was based on Jesse Livermore, of course, and his prescient shorting before the 1906 quake was legendary.

Krypto did not short, and did not pile on shorts on Friday. She really doesn't trade and doesn't pay that close attention. After, Krypto is a dog, albeit a beautiful and smart dog. But NOW, her model is making noises. This morning it's giving a moderately strong buy signal for Pacific stocks and a moderate sell signal for gold+silver.

Stock futures across the board are plunging, down around 2-3%; Tokyo is down 10% overnight, meaning some prices in the model are rather stale. That moderate buy signal is probably a strong one now. Real estate and fixed income is strong.

I choose to wait until the dust settles. I don't trust the prices and big drops often last three days. Waiting will let me move with the correct, full signal amounts from Krypto Fund.

BUT this is a perfect example of why we sell on the way up .... when all looks rosy. Who knows what the future may bring? Krypto was selling bits of stocks, Pacific included, for months. She has lots of cash, and seems soon to get some good prices for redeployment of that cash.

In today's markets, declines often occur so fast, only a short term trader can act in time and sell; an investor will miss a chance to sell near the top. By the time an investor with a normal life & job reacts, the top is ... a lot closer to the bottom. Those rapid market moves resemble a one way, nonstop elevator ride down.

Word of the Day

"Tropism" - noun [$10]
Tropism means the responsive growth or movement of an organism toward or away from an external stimulus.
Sentence: Although it's a mere computer model, Krypto Fund exhibits dual tropisms, perhaps reflecting the brain behind the model: she leans towards the cheap asset classes and away from the expensive ones.

Robust Rebalancing Rules

Investment Lesson #4

To maximize your returns and minimize your risks, you MUST rebalance your investment portfolio as needed. Rebalancing prevents any asset class from getting too large or too small; it captures gains from the mindless fluctuations of the markets; and it lowers your risks with countermoves to market volatility.

BUT we do NOT rebalance continuously, every day or week. We wait for the asset classes to get significantly out of line. And we give the classes room in time and price to make significant moves. We also cap certain rebalancing actions. The basic rebalancing rules (#1 and #2) provided below are simple enough, but the exceptions (rules #3-5) are where you need to pay attention.

Rebalancing Rule #1

If an asset class gets more than 5% away from its canonical share of your portfolio, buy or sell (or exchange) enough to put it back in line. Example: US Stocks rise and now US stocks represent 31.5% of your total portfolio value. Sell some index funds or VTI to bring it back to 30%. Buy whatever is low, or if nothing is significantly low, put the money into cash to wait for something to get cheap.

Rebalancing Rule #2

For asset classes that are rising, do this every time the class gets out of line.

Rebalancing Rules #3

For asset classes that are falling, after one 5% rebalancing, wait. The next rebalancing should be done (A) if the asset class gets an additional 10% too small, or (B) after six months if it is just meets the 5% test.

Rebalancing Rule #4

For asset classes that continue to fall, wait. The third and LAST rebalancing should be done (A) is the asset class gets an additional 20% too small, or (B) after one year if it just meets the 5% test.

Rebalancing Rule #5

No more for now, regardless of whether the asset class continues to fall. Three strikes and you sit down and wait at least two years. That asset class might be in a multiyear collapse and bear market like Japan suffered in the later 1980s and early 1990s, or as gold & silver suffered in the early 1980s.

DO NOT KEEP putting money into an asset class that keeps falling - this is a rule required to robustness of the model - to prevent a catastrophic loss of funds. Theoretically, if a market keeps dropping and you do NOT cut off the rebalancing towards it, that falling class will consume all your money, like a black hole consumes everything the gets into its clutches. Stop after three swings and sit down awhile. Let the dust settle.

Summary

These rules provide you simple instructions to buy low, sell high, and sell high, buy low. Think of all those times you hear that prices are low and it's time to buy. If you don't sell something at high prices, you won't have any money to buy when prices are low.

Use cash as a buffer if nothing is cheap. Then when an asset class falls in prices, swoop in and scoop up some cheap shares.

The cut-off rules prevent your portfolio from unduly suffering if one or more asset classes fall too dramatically. Obey them. Don't be a hero ... or a pig.

Actions

I will monitor Krypto Fund closely, the large fall in Japanese stocks might provide a buy signal in my Pacific stocks.

Word of the Day

"Behoove" - verb, transitive [$10] British 'behove' with the 'o' as in no.
Behoove means 1. (preceded by 'it' as subject) (formal) be incumbent upon; 2. (usu. with neg.) befit [it behooves him to protest].
Sentence: For the well being of your investments, it behooves you to pay attention to the above rebalancing rules.

Use Time in Your Favor

Investment Lesson #3

Time.

Time is your friend.

First, as you leave your money invested for a long period of time, you benefit from compounding: the gains of of one year are reinvested to generate more gains. Here's a simple example - the Rule of 72.

The Rule of 72 is a simple, quick way to estimate how fast your money will double assuming a rate of return AND compounding: divide 72 by the return as a percentage. Suppose you make an investment that will provide 10% returns and you can leave your money invested as long as you wish. Applying the Rule of 72 (72 divided by 10) gives the wonderful result that your money will double in 7.2 years (approximately). Leaving your money invested, your money will have quadrupled in 14.4 years and been multiplied by eight in 28.8 years! Simple, non-compounded returns over those 28.8 years could result in only a return of 288% (28.8 years x 10% per year), but compounding gives you a 700% return (800% less original investment = 700% return). You've done almost 3x better by simply sitting, riding that investment along to more profits.

Second, you need to be patient about putting your money to work. Simply barging into stocks or bonds or gold with all your money at any price or time is a very, very risky move. All those investment asset classes have returns that vary with time: the returns go up or down. One month, the total stock market index VTI might be 66 per share, in a later month it might be 70 or 62. Or the moves can be larger. Ditto for bonds, even US Treasury bonds. Ditto for Gold.

Remember Rule #0: we want to do just average and we want to invest for the long term. If you barge in and put all your savings into stocks, and they go down 10% in a normal fluctuation, you'll feel rather rotten. That pain might make you do something stupid, like pull all your money out & barge into bonds. Of course, interest rates might rise and those bond prices might go down 10%. You feel double rotten. You are now fodder for the Street and the hedge fund piranhas. They are going to whip & drive you emotionally every way and eventually to investment oblivion. Don't play their games.

Assuming you have no special knowledge (a very strongly supported assumption), you will be right 50% of the time. BUT the pain when you are wrong will be larger than the pleasure from being right. That's a fact of human behavior that underlies all economic theory. Almost all human beings are risk averse.

One can prove mathematically that by investing your money over time, in bits over the months and years, will reduce your risk a LOT. I saw this proof at MIT business school years ago; Fischer Black, the famous finance theorist, showed us the proof in class one day. I still remember it. He called it, time diversification. This is another free ride you can take, much like the asset class diversification.

Example: You receive $50,000 from a severance package. Don't put it all into your investments all at once. Put $5,000 a month into them, into whatever is cheap at the time (see rule #4), paying attention to your asset class percentages. You will reduce your risk and increase your chances of doing average.

The same applies to withdrawals, if you can wait. Suppose you know you'll need $50,000 in a year. Take out $5,000 a month from whatever is expensive - high prices, still paying attention to your asset classes.

Be patient. Use time as a tool for yourself. Get all the free benefits of compounding and time diversification. That's how you get the highest returns with the least risk.

Word of the Day

None today. I have to take the recycling out.

How to Do It

Investment Lesson #2

Yesterday in Lesson #0, I explained the Why - why I invest in the style of the Krypto Fund. And on Friday in Lesson #1 I listed the seven assets classes I use (really nine as one class has three parts).

Today we get specific. The How and the What. We stick to the K. I. S. S. method. [Taxes will complicate it a bit, but not excessively.]

All the investments are made in The Vanguard Group's index mutual funds and their exchange traded funds (ETFs). Those have the lowest fees. Our objective, remember, is to get average performance with almost no fees. That guarantees us excellent returns long term as we ride (for free!) the great bull elephant of world economic growth.

The minimum brokerage account at Vanguard is $3,000. In it, you can invest in Vanguard ETFs for free - no commissions. The annual fee is a mere $20. Those Vanguard ETFs have the lowest fees of all ETFs, and they are indexes - no human intervention to cause risk & losses. You can also invest in the Vanguard index mutual funds there for no fees; their management fees are the lowest and their service is excellent. You can electronically connect the accounts to your savings or checking account, enabling you to add or withdraw money quickly and easily. It's a fine deal for the common man and woman.

Cash: use Prime Portfolio
Treasury Inflation Protected securities - use the Inflation Protected Securities Fund.
Fixed Income - use the Total Bond Market Index Fund or the Long Term Treasury Fund.
US Stocks - use the Total Stock Market Index Fund - the ETF has the ticker, VTI.
Foreign Stocks - (a) 1/3 goes to the Pacific Stock Index Fund; (b) 1/3 goes to the European Stock Index Fund; (c) 1/3 goes to the Emerging Markets Stock Index Fund. The respective ETF tickers are VPL, VGK and VWO.
Real Estate - use the REIT Index Fund (REIT = Real Estate Investment Trust). The ETF ticker is VNQ.
Gold & Silver - Use the Vanguard Precious Metals Funds and/or the non-Vanguard ETFs, GLD and SLV that hold physical gold & silver at low cost. That Vanguard fund is not an index fund, but it invests in gold & silver mining stocks. I personally use a mixture of all three of these investment vehicles to invest in gold & silver.

That's it. Simple. Seven asset classes, nine if you count the three parts of the Foreign stock group.

What have we accomplished with these seven classes?

Notice that four classes are rather sensitive to inflation: Cash, TIPs, Real estate and gold/silver. In times of inflation, those classes have provided much protection at different times. For example in the 1970s prolonged high inflation environment, cash (i. e. money market funds) provided high yields, real estate boomed as did gold & silver. Now we have TIPs, too. Krypto Fund have much inflation protection.

For income we have the fixed income, the dividends on the US stocks and the REITs, and the income from the TIPs.

For growth, we have the US stocks, foreign stocks and the real estate. The

For Doomsday, we have the gold & silver and the cash.

These are the components of a well-diversified portfolio of investments - the Seven Pillars of investment.

How much do you put into each class? The depends on YOU - your risk characteristics: your How, What and When. How old are you? What is your future earnings outlook? When will you need the money?

Here are the canonical percentages to invest in each class. These are the baseline amounts, which you tweak (that's MIT-techie-speak for 'adjust') based on your own how, what and when:

0% cash
10% TIPs
15% Fixed Income
30% US Stocks
25% Foreign stocks (1/3 in each part)
15% REITs
5% Gold.

Make adjustments based on our age and future earnings and need to draw on the funds. But don't adjust them too much, except in extreme circumstances.

Why does cash get 0%? Because we will mostly use cash as a buffer - the place to put money when nothing is cheap and most other classes are expensive. And we use cash as a buffer to put some money that we will need to draw out over time as we need to use the money. Cash also connects your long term investments to your bank checking or savings account; it's the link bewteen your Krypto Fund and your daily operating life. You need that link.

That's it. Simple.

Taxes will complicate the matter, but those for another post.

Word of the Day

"Expatiate" - verb, intransitive [$10]
Expatiate means (usu followed by 'on', 'upon') speak or write at length or in detail.
Sentence: As Bunkerman expatiates on long term investing in this series of posts, you should try to absorb and read re-read each one each day to learn. If you have questions, grasshopper ;) you can post them in the comments (or call me if you know my phone number or email me if you know one of my emails.)

K. I. S. S.

Keep it simple, stupid.

I'm talking to myself here, not you. This is why I invest long term according to the Krypto Fund methods. I don't want to spend my life looking for stocks, commodities or anything. I've done that and it's a lot of work - very, very difficult work. I can make good money in that line of WORK, but unless one needs to, why do it? Life is too short.

Now about YOU. Most of you have a job and a family and plenty of responsibilities. Do you want to spend all your free time investigating investments? I think not. Besides, it's very, very hard to find winners. Here's why: There are about 7,000 stocks; even more bonds. There are about 7,000 mutual funds. And for the rich, there are about 7,000 hedge funds. If YOU want to pick your own investments, you have to find the few winners in that huge pool. Tough job. Your competition is lots of very smart, driven, informed, experience investment managers. You haven't got a chance. They will eat you alive.

Can you find a good advisor to help you? Maybe. Or maybe not. Again, you face a crap shot. And you'll pay plenty.

BUT the modern investment world has given you marvelous tools, a way to virtually guarantee a good - nay, excellent - long term investment perfomance. Those tools are index funds and diversification. ALL studies of investment performance show that almost all investment managers and mutual funds underperform the AVERAGE over a 20 year time horizon. How can that be? Fees. Consider a 1% annual fee. After 20 years, you've paid 20% of your money to the manager. That's a huge amount. Analogy: 1% is about the house take on even good bets on the crap table in Vegas and is about the house take on good play at blackjack. But the house always wins.

You can win in long term investing. You can avoid almost all the fees and ride long term growth in the world economy; it's virtually a free ride.

You can reduce risks even more. The world is a big place. Some places do well when others are stagnant. Sometimes there is inflation, sometimes not. The returns on investments vary over time and place. The tool of cheap diversification gives you an edge. Careful studies of investment markets over decades have PROVEN that diversification gives superior returns for any given risk level. There are two types of diversification: asset type and time. You can use these tools of the modern investment to give yourself SUPERIOR returns for long term investments for FREE.

Be a smart investor - it's easy. My dog, Krypto, can do it.

Here's what to do.

Don't worry about those thousands of stocks or mutual funds. Just pay attention to SEVEN asset classes (really NINE as one has three parts). NINE asset classes are easy to follow; you can do it once a week on Saturday morning. A baseball team has as many players. Don't pay attention to all the details and the blather of the pundits. Watch those NINE.

Invest in them in the lowest cost manner possible: index funds. The cheapest index funds are from The Vanguard Group. You don't even pay a management fee, since the management company is owned by the funds themselves. Those funds are huge, some of the largest in the world. Your economies of scale are fabulous. You can get the free ride.

And you have to construct your investments so you can maintain your diversification cheaply. You must be able to cheaply allocate your money among those important asset classes. You can do that at The Vanguard Group. I've used them for 30 years now. They provide excellent service and quality and cater to the common man and woman.

This post is #0 on my list given Friday, explaining why I do what what I do. Krypto Fund has beaten almost all big mouth investment advisors for years at low risk. Krypto Fund has ridden the 2000 tech bubble and the Panic of 2008. Even though the stock market is about 20% off its all-time highs of 2007, Krypto Fund is well over its all time high.

Krypto Fund follows the rules I listed in Friday's post. On Friday I listed the seven / nine important asset classes. Tomorrow I will tell you how to invest in them with specificity. All for free.

Ride the elephant, don't get trampled or stomped.

PS: Use this method for most of your long term investment money. If you want to make a small investment in some stock or company or whatever, go ahead (after good research). But keep it small at first. Maybe you'll get lucky. But if you keep it small at first, you won't be hurt if it craters.

Word of the Day

"Apotropaic" - adjective [$10]
Apotropaic means supposedly having the power to avert an evil influence or bad luck.
Sentence: The Krypto Fund method of long term investing needs no apotropaic charms. The free tools of the modern investment world give it all the edge it needs: diversification and cheap index funds.

The Friday Fade

I'm tired. It's cold. Nothing is happening.

Ms. Market is dancing on the table again after a brief rest. Krypto has no new orders, but she seems to be getting ready to sell some European stocks (which are up a bit as the Euro rallies). She's also getting ready to sell some RE stocks. Taken together, the sell signals are strong enough, but that's not how the Krypto Fund works. She buys and / or sells on an individual asset class basis. We wait for higher prices and will monitor the numbers more often.

The unemployment claims numbers showed strong improvement. Let's see the jobs numbers today. Despite the inflation screechers who want to crucify the American worker on a cross of green (or gold), Battleship Ben's quantitative easing program has and is producing good results since it was announced last August. Job losses had fallen, job growth is better (but still lousy), and fear of a double dip recession vaporized under his heavy shelling. Keep it up, Ben. Fire away!!!

Investment Lessons

First, notice that headline is Investment lessons, not trading lessons. The time horizon is years, not months or days or minutes.

Second, this is what I DO, not just what I SAY. Krypto Fund contains the majority of my net worth and these writings explain how I manage it - my own money. The Krypto Fund produced good long term results over the decades, including riding out the tidal waves of the Panic of 2008 and the 2000 Tech bubble. I have learned over the years not to second guess Krypto - the personification of my fund computer model that embodies my investment rules. Or is that dogification? Krypto is one of my dogs; she will lief* work for dog biscuits. [*Word of the Day]

Third, the objective is to do a wee bit better than average for the long term. Average is really very, very good. Most people's investment returns are way below average. They are the fodder for the Wall Street and Hedge Fund hogs. Be a winner, not a loser.

Principles

1. Manage a portfolio of the seven major asset classes.
2. Diversify across the asset classes.
3. Add / remove funds using time diversification.
4. Buy low, sell high; sell high, buy low.
5. Minimize fees.
6. Minimize taxes.
7. Obey the machine.

Rule #1 - Implementation.

There are seven major asset classes for the individual to use; one asset class has three parts.

1. Cash (aka money market funds or savings accounts)
2. TIPs aka Treasury Inflation Protected securities
3. Fixed income - bonds of various types.
4. US Stocks
5. Foreign stocks (three parts: Europe, Pacific and Emerging Markets)
6. Real estate
7, Gold & silver and precious metal stock funds

That's enough for now. More next week.

Word of the Day

"Lief" - adverb [$10] archaic; appears often in Shakespeare, but also was common in the Irish dialect of the common people in the 1907 play of J. M. Synge, Playboy of the Western World .
Lief means gladly, willingly (usu. had lief, would lief)
Sentence: To paraphase Wimpy of the Popeye cartoons, Krypto would lief manage the fund next neek for a dog biscuit today.

Shakespeare, As You Like It, Act IV, scene I, Rosalind to Orlando:
Nay, an you be so tardy, come no more
in my sight: I had as lief be wooed
of a snail.

Monday Morning Ramblings

The Reform series will continue tomorrow. I need to pummel hedge funds today.

Are the Rich stupid? Or gullible? Or foolishly greedy? That's the logical conclusion one could make from the annual returns of their favorite club topic, viz. hedge funds. They love to put money into hedge funds; they've poured billions - trillions - into thousands of hedge funds. The economy of southeast Connecticut must depend on hedge funds, as must many exclusive districts in London or Switzerland. A hedge fund manager gets fat fees, often 2% of assets and 20% of profits. They risk nothing other than some pittance of their own money. They get to gamble with clients money and rake off those fees.

What do clients - investors - get? Oh, they can talk about their hedge fund investments with their pals over cocktails before those black tie galas or at the exclusive clubs, or vacationing at Palm Beach or exclusive resorts. What kind of person would invest for that mere psychological benefit? Any rational person would say no one. They would want superior returns at lower risk.

The numbers for 2010 are now out. The average hedge fund gained 10.4% in 2010 according to Hedge Fund Research, which returns agree with those of Hennessee Group LLC, an advisor to investors. [Source: WSJ over the weekend]. Krypto Fund had a 14.1% return with very low risk as almost 1/2 of its investments are in passive fixed income investments. The equity components of Krypto Fund are invested mostly in low fee index funds. Krypto Fund crushed the performance of all those hedge funds by 3.7%, a huge margin. What fees were paid ? Dog biscuits. Active trading ? Nope, almost no trading - mostly simple asset allocation trades when a sector became out of balance.

All that superior performance with a public, easily copied strategy and no fees. Thus, what else can we conclude but that the rich are either stupid or greedily gullible or foolish or have psychologically weak minds, or any or all of the foregoing?

What else could one expect - there are thousands of hedge funds, just like there are thousands of mutual funds and now thousands of ETFs and thousands of managed account gimmicks at the big Street firms. All that vig created by the Street to rake off all the cream. The money managers and the Street get the beef and the customers get the gristle and fat. Those layers of fees guarantee poor performance on average.

Don't do it. Manage your own money with a simple, low fee, conservative strategy as Krypto Fund does. Sleep easy. Don't worry. Be happy. :)

Word of the Day

"Apocopation" - noun [$10] from "apocopate" - verb [$10]
Apocopate means the omission of a letter or letters at the end of a word as a morphological development [e. g. in the derivation of curio ].
Sentence: The title of the humorous Mozart opera, "Così fan tutte" contains the apocopation 'fan' from 'fanno' meaning 'they do'. In that title, 'tutte' is feminine plural for 'all" hence the literal translation is So do all (women).

Improving Returns

Many people have two pockets for their retirement money: tax deferred retirement accounts like IRAs and 401Ks and savings that has already been taxed, such as bank CDs and brokerage accounts. I'll skip ROTH IRAs for now as they are a hybrid (and not relevant to the main point of this article).

How do you manage this dual nature? What investments do you put in which pocket? This is not an easy question. Today I'll address one aspect of it.

Taxes do matter; for this analysis I'll use a 28% Federal tax rate. That's the AMT rate. I will leave State income taxes out; incorporating them is rather obvious, but since state tax rates vary widely, you have to do this part yourself.

A municipal bond portfolio that yields 5% will produce $5,000 for every $100,000 invested, after Federal taxation, which is zilch for most municipal bonds. For a taxable bond portfolio, one would need a yield of almost 7% to recover the same 5% aftertax yield. How to calculate this? Take the 5% and divide it by the decimal equivalent of 100% minus the tax rate, viz. 28%, which quantity is 72% which has a decimal equivalent of 0.72: 5% / 0.72 = 6.94%, almost 7%.

[NOTE: using the widely applicable 25% Federal marginal tax rate produces a 6.67% effective rate and the point still works; if your Federal marginal tax rate is 15%, stick to taxable fixed income investments.]

Investing at 6.94% in taxable bonds would give you a LOT of risk today (those are junk bond levels), but investing in municipal bonds at 5% is rather easy and can be done with solid A and AA rated bonds of good quality.

Therefore, much of the fixed income portion your retirement fund - my Krypto Fund - should be put in the taxable pocket and be invested in municipal bonds yielding over 5%.

This strategy must be tempered a bit due to the relative illiquidity of municipal bonds. You should do this only for the stable base portion of your Krypto Fund, which is in fact what Krypto does do. This portion is the part you do not expect to need to use to re-balance.

By using municipal bonds this way, you will increase the return of your Krypto Fund a lot. You're getting effectively 7% in fixed income, not the 5% available in corporate bonds. That extra 2% is a lot. Another way to think of it is this: I target a 5% taxable withdraw rate as readily achievable over a long term in the Krypto Fun with minimal risk of every running out. Getting 7% effective taxable return on a big part of the fixed income investments provides me a 2% per annum cushion that could be reinvested as reserves for unforeseen costs or big market pullbacks like 2008-9. That's good.

By the way, the rest of the taxable pocket for your Krypto Fund should be heavily geared to stocks for which low capital gains tax rates apply. This also gives you an edge for your returns for your Krypto Fund.

Word of the Day

"Syncretism" - noun [$10]
Syncretism means 1. the combination of two different forms of belief or practice (or art); 2. the fusion of two or more original different inflectionist forms.
Sentence: Long term retirement investing practice is necessarily a syncretism of the taxable and the tax free worlds of investments. One needs to combine the two worlds optimally to obtain the highest return for desired risk levels.

Long Term Investing

The Krypto Fund is the name that I use for all our long term investments: IRAs, 401Ks, and all long term, taxable accounts. On February 10, 2007 I first described how it is managed in this blog, and have written about its style a few other times. From recent comments, obviously I need to repeat and update this management style.

For 2010, the Krypto Fund is up about 12% year-to-date - pretty good compared to the averages & hedge fund averages. Krypto Fund contains almost all index funds in different asset classes. I use canonical allocation percentages and manage around those benchmarks. I do adjust them as I age.

The canonical allocations NOW are this:
25% US stocks,
20% foreign stocks,
15% real estate funds,
25% fixed income bonds,
5% inflation-protected bonds,
5% gold & silver,
5% cash.

Since I think inflation protected bonds and fixed income bonds are greatly overvalued in bubble regions, the actual allocations NOW are 20% fixed income bonds, 0% inflation protected bonds and 15% cash with other asset classes at canonical percentages.

I use a spreadsheet to compute the asset class %'s, usually weekly based on Friday's prices.

US stock funds are Vanguard Total Market Fund, the corresponding exchange traded fund (ticker VTI), or the CREF Stock Account. [Mrs. Bunkerman was a scientist, so her retirement savings from work went to TIAA-CREF funds. Their "Stock Account" has some foreign stocks, so I reallocate these in the spreadsheet based on annual percentage components].

Foreign stocks are Vanguard Pacific Index, European Index and Emerging Markets Index Funds (& corresponding ETFs) - I allocate 1/3 of the total foreign stocks component to each, hence these are really 6.66% of total Krypto Fund each. Included here for total asset class calculations are the re-allocated CREF foreign stock amounts in correct proportions.

The real estate asset class is the Vanguard Real Estate Index Fund and the TIAA-CREF Real Estate Fund.

The fixed income bonds are the Vanguard Total Bond Market Index, various Long term municipal bonds, the TIAA traditional fixed income account, and the cash value of an old whole life insurance policy.

The inflation-protected bonds are Vanguard or TIAA-CREF inflation-protected bond funds, as appropriate.

Gold & silver are mostly American Eagle gold coins and silver bullion bars, plus ETFs for gold & silver (tickers are GLD and SLV, respectively), and the Vanguard Precious Metals Fund.

The Vanguard Real Estate Index Fund invests in REIT stocks, by the way, while the TIAA-CREF Real Estate Fund invests in actual buildings, etc., so they perform somewhat differently. Both are a bit leveraged, so I keep that asset class at 15%, rather than the 20% which would be appropriate for unleveraged real estate.

The spreadsheet computes the % size of each asset class each week. IF an asset class is more than 5% off its target percentage, I look to reallocate some funds to top it off if it's low or take some out if it's too large. For example, if the US stocks are over 26.25% of the total Krypto Fund, that's 5% off the target 25%. So I look to see what's low & move the excess 1.25% to other asset classes. One has to consider fund restrictions and taxes for frequent moves, but since we have multiple accounts, I have always been able to figure out a way to reallocate. See David Swenson's great book, "Unconventional Success" for a description of why this type of personal investing works well.

I have done long-term investing along this strategy for over 20 years. When I read his book, I was happy to see he agreed with me (joke haha) and I learned about the value of the inflation-protected bonds. So I added that asset class. I also recently became more aware of the leveraged in the real estate classes, so cut it back. I'm not perfect and continue to make changes as I see a need.

I also adjusted my rebalancing trigger to 5% from 10%, as I realized from his book I had been missing many good re-balancing opportunities with a 10% trigger. My percentages were pretty close to his, otherwise. Also, I have some gold & silver for many reasons.

On down moves, I make the re-allocations on the first 5%, BUT if another 5% adjustment is called for because of a down move, I wait awhile. Down moves can be fast & furious, and it's better to let the dust settle. This helped me alot in 2008 and 2009 to get more buying of stocks closer to the lows. In addition, for stocks, once the indices hit intermediate term highs, I make adjustments in them more frequently to keep the %'s close to canonical levels. This "buy-low, sell-high" and "sell high, buy low" intermediate term trading tactic lowers volatility and increases returns to help me stay fully invested at all times.

If some asset class is low, BUT is greatly overvalued, I put sale proceeds into cash as a buffer. Then when the low class readjusts to a more fair valuation, I buy it. This is the case with fixed income bonds and inflation-protected bonds now.

I love that name, The Krypto Fund. I like to think my dog, Krypto, pushes the computer key every week to do the reallocation. She accepts dog biscuits as payment. :-)

This investment methods works well: the Krypto Fund is at all time highs, even though the US stock market is almost 20% below its all time high. That buy-low, sell high and sell high, buy low asset allocation tactic worked well through the Panic of 2008 and the lows of 2009.

Word of the Day

"Quotidian" - adjective [$10]
Quotidian means something occurring daily.
Sentence: Krypto Fund rebalancing is NOT quotidian; I check it weekly, but often a month or more can pass before a change is made.