The Big Picture For The Week of April 1, 2012

The other day I was reading an article at Seeking Alpha about Annaly Capital (NLY). The author seemed to draw a negative conclusion and he got ripped pretty good in the comments. I would note that the author seemed to misread a couple of metrics and seemed to not fully understand a few others (for example traditional PE ratio isn't terribly useful in studying a REIT).   


As a mortgage REIT, NLY takes on a lot of leverage and the job of the company is to manage leverage correctly. This takes in all manner of variables that I think bulls would concede is complicated. Obviously anyone bullish on the name would believe that the management is capable of managing those variables. 


The big draw to the name is the dividend yield which is currently around 14%--that is the trailing yield and it is important to note that it is a trailing number. Looking back Google Finance for five years it looks like it has made all of its scheduled dividend payments but the amount of each dividend has a history of big swings in both directions. Foreign companies seem to put less weight on keeping a steady dividend, they pay out on business conditions and it would appear NLY does the same which is of course logical (and required) and not a knock on the stock. 


For me the stock ticks off all of the negative buzz words; financial, mortgages, real estate, leverage, interest rate spreads so we don't own it but in looking at the chart it has been remarkably resilient. For five years the stock is up 6.6%, plus all the dividends, while the S&P 500 is down 2% and the Financial Sector SPDR (XLF) is down 55%. 

I would also note that for the most part the ride has been much smoother than for the SPX of XLF but not 100% of the time. There was a two or three week stretch in early 2008 where it fell 28% and going back a little further it fell 40% in the second half of 2005. 

It is unlikely that I am going to buy the stock, I can't get comfortable with the entire picture that I think I see and I tend to believe that yields that high belie some sort of risk regardless of whether I know what that risk might be but I may have been too negative on it before (although technically there is no way to know)--certainly I am surprised how well it has held up.

Reading all the comments on the above post got me to thinking about how popular the stock is. it seems like I see at least one article about it on Seeking Alpha every day. If you click through to that page you will see that many of the articles have dozens of comments, some even in the hundreds. I don't know if there is a search function on Seeking Alpha to count comments but excluding Apple (AAPL) there can't be too many other stocks that are this popular (as measured by number articles and number of comments). 

As noted above other than a few spasms here and there the stock has been relatively even keel as opposed to going up several hundred percent so the interest is no doubt attributable to the dividend. Still the tone of the comments seems to imply a loyalty to the stock that is uncommon and combining that with a yield that is uncomfortably high leaves me continuing to avoid the stock. Candidly I don't understand the emotion that appears to be embedded into the loyalty but if there is an emotion tied in that is a negative for me.

The high yield might be a reason for people to be cautious but my lack of understanding of the sentiment is not a reason for anyone else to be cautious. For me this is just a head scratcher. 

As for the pictures, we got our new (to us) engine relettered to say Walker Fire and Engine 86. 
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Financial Crisis NIMBY

Zerohedge posted a brief research note from Brevan Howard noting visibility for what it calls a fiscal drag in 2013. It views this as a certainty to be caused by an increase in capital gains and dividend taxes, presumably as the Bush tax cuts finally expire, and the expiration in the reduction of the payroll tax that was in place in 2011 and was extended this year.  


This is interesting. I think the more important question is whether or not the above breaks are extended thus kicking the can a little further down the road or whether these breaks come to an end and the country begins to have some sort of reckoning for all of the incredibly easy and consumer friendly policies and the various too big to fail protection policies enacted. 


My own belief system (which is probably not relevant) calls for tearing off the band aid, I've said this all along and of course that is not what has happened. Many believe that housing and jobs are the two important parts of the US economy. Housing is still drifting lower (for the most part) and while employment numbers have not looked as bad as housing (we'll see if the increase in participation rates persists) we are still way behind most other past economic downturns in terms of job recovery. 


It would shock me if somehow the political will was exhibited such that the country turned the corner on being accountable for all that has gone on. The Fed's intention to keep rates at zero into 2014 supports the idea that no such corner will be turned, at least not yet.


I don't know when the country will ever be accountable but if it happens it could be very ugly. It seems as though many accept that not everyone will get what they want but far fewer believe that they will be the ones to give anything up. This is very visible in the comments on posts about social security. Some folks believe that to not get their full payment is to be stolen from by the government. 


Without getting into either side of that sentiment, if you are fully entitled to benefit from some pool of capital (like a pension) starting in five years and three years from now that pool of capital goes bust then entitled or not you face the reality of not getting paid. Pensions have PBGC but social security does not. While a five year timetable for social security is not correct the 2030s could be and so people of a certain age, who will absolutely be entitled to X amount may only end up with some percentage of X or not be able to start accessing X until much later than they expect. 


I have no doubt that such an outcome would cause a huge outrage. There's a NIMBY sense to what must occur if there is ever to be a financial reckoning but whatever the reality is that sacrifice of some sort will be in everyone's back yard, hopefully everyone plans and prepares accordingly.
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There is Nothing New About Conflicts of Interest

Earlier this week TheStreet.com announced layoffs. I've been an outside contributor there since 2005. My experience with them has been fantastic and I hope to write for them for a long time. I only found one news story about this from Business Insider and far more interesting than the article was the tone of some of the comments in terms of immense and intense hatred for all things Wall Street; any type of firm and the media covering it.

The comment thread was not contained to dislike for the Street.com, it was directed at everyone. Occasionally I see similar comments on posts at Seeking Alpha as well. Clearly the lousy long term returns of the last 12 years and the news about how various brokerage firms treat clients' interests is a very discouraging combination so I can't fault anyone for wanting to chuck the stock market altogether. 


I won't defend brokerage firms and the domestic equity returns for the decade were lousy and many of us will see another lousy decade in our lifetimes. I don't think the brokerage firm behavior is much different than it has ever been (my direct experience goes back to the 1980s) but it is more noticeable when returns stink and investment products malfunction one way or another. We all know that equity returns were lousy in the 1930s and 1970s as well as the 2000s so this has been happening about every three or four decades (the 1870s were also bad and there was a terrible bank crisis in 1907). 


The potential benefit to investing in stocks is getting a rate of growth for your assets that exceeds inflation. There is no guarantee it will work out that way for anyone but that is the potential. If you can take my word that dishonesty is not new and you realize that there have been other bad decades then these things become recurring obstacles to the thing we want which is having enough money when we need it. Other recurring obstacles include poor analysis (either our own or by the people we hire) and succumbing to our behavioral flaws. 

During the previous decade investors had to deal with all four (lousy results come along every so often but the other three can impede results no matter what the market is doing) yet Brazil managed to go up 300% and there was an ETF to access that market which also went up 300%--the iShares MSCI Brazil ETF (EWZ). As I've documented dozens of times there were plenty of markets that had normal returns in the previous decade and while there were not ETFs for all of them then, there are ETFs for many more countries now including some of the ones that will have great returns this decade. Of course there are always individual stocks too.

Some will read the above and reply that the stock game is rigged (brokerage firm dishonesty) but that didn't prevent Altria (MO) from going up a couple of hundred percent in the last decade (plus pay all those dividend) as the S&P 500 was declining. A rigged game also did not prevent client holding Nike (NKE) from going up a little less than 200% in that decade. I mention those two names because they are far from obscure microcaps. 

The point here is not to try to convince anyone that there are not dishonest dealings and conflicted interests but to instead point out that if these obstacles have always been there then part of the way to get to where we want to be is to work around these obstacles--obstacles we know will always be there. You don't have to buy IPOs, you don't have aggressively trade VIX ETNs; you can buy great companies for the long term and use plain vanilla ETFs for the long term and you can focus on increasing your savings rate. 

If you must give up on stocks (or equity funds) then you need to understand the tradeoff of giving up potential returns that exceed inflation which is that you will probably need to save a lot more money. That doesn't have to be the end of the world if you realize this going in.    
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Debunking Myths

A contributor at Seeking Alpha who goes by the handle Regarded Solutions wrote a post about a month ago that sets out to debunk 10 retirement lies. Per the bio page Regarded Solutions is retired, there is no mention of gender and because of the liberal use of the word we in the bio I'm not sure if this is husband and wife but to keep things simple I will just use the word he when a pronoun is called for.

Before getting into the retirement lies he provides very transparent information on a dividend based portfolio.

Lie number 1 was "You will need multi-millions of dollars to retire 'comfortably'" which of course is good timing after I tried to explore a reader's comment about needing $2 million. His point here seems to be you can't spend more than what comes in. This is true of course so then what is comfortable? One person's idea of comfortable could easily require millions. He goes on to say "it's more about how much you spend" so if that is true (and I agree it is) then I am not sure any lie was debunked. This is good reminder about living within your means and again, I agree.

Lie number 2 was "Social Security will not be around for those over 50 when you retire." I don't see this one very often. I don't believe it will be around for people under 50 at least not the way we now know it. I have said many times that I, in my mid 40s, expect nothing which is the more conservative planning approach. If I am wrong then maybe I'll be able to get a sweet grille like Gator (Will Ferrell in the movie The Other Guys).

Lie number 3 was "Medicare will not be available for those approaching retirement" which again I've not read that people approaching retirement are in jeopardy.

Lie number 4 was "Keep a much smaller % of cash invested in equities." I'm not sure that the advisor community says this anymore, Bogle does however, but he is correct that people tend to become too conservative with their asset allocations. If you're 60 and either of your parents are alive then you need to plan on being around long enough for even "normal" inflation to eat away at your purchasing power.

Lie number 5 was "The 4% withdrawal rule is the best to follow." Obviously I believe in not exceeding 4%. His argument here is that he says he believes in the die broke philosophy. He talks about not wanting to eat saltines and then leave it all to the kids. How much someone does or does not leave to their heirs is a personal decision with no wrong answer so no quibble there. As a stark example the risk to the die broke scenario could thought of as planning at 70 to die broke at 95 and somehow being quite fit well past 100.

Also I may have missed it but this idea would seem to conflict with not spending more than what comes in. It looks like he believes in just spending the dividends so in theory he would never be broke. He is a very prolific writer and so I am sure this is addressed somewhere else in his posts.

Lie number 6 was "Annuities "guarantee" money for life." I don't care for annuities either. I was picked on about this a few weeks ago to the point of someone doubting my integrity but I simply don't believe in relying on an insurance company in this way.

Lie number 7 was "Stocks are too risky in retirement." This seems like a repeat of number 4 and I agree people often become too conservative.

Lie number 8 was "Make sure you have a professional advisor to 'help' you." Managing a portfolio requires time and a certain amount of understanding of markets and human behavior. Almost anyone can learn these things for themselves and manage their own portfolios. Not everyone wants to spend the time. Someone who does not want to spend the time should hire some help. An advisor can be a big help even if all they do is prevent clients from succumbing to their own behavioral flaws.

I tend to believe a portfolio needs time devoted to it but that does not have to mean hiring someone. Assuming Regarded Solutions is a do-it-yourselfer he is someone who wants to spend the time on his portfolio. This blog is written in part because I expect very few of the people reading it will ever hire me or anyone else to manage their money.

Lie number 9 was "Make sure you leave enough for the kids." This is a repeat from above and to be blunt I'm not sure the industry says this. I've worked at two buyside firms and at both the approach was along the lines of "what are your thoughts about leaving money to your kids or anyone else" and then the plan is built with that wish in mind.

I know people who view how much they leave to their children is a measure of their value as people and at the other extreme I know very wealthy people who believe the obligation ends once college is paid for and think it is crazy to leave anything to children. An advisor who questions that, as opposed to simply trying to execute the client's wishes, will have one less client. And of course an advisor may need to deliver bad news on this front but that is not the same thing as questioning the intention.

Lie number 10 was "Retirement is an outdated idea, work forever." I'm not sure this is a lie foisted upon an unsuspecting public by the financial services industry as I have been reading comments along these lines on my blog and in other places for many years. Recently I talked about one line of comments though that believes there is some sort of conspiracy to train us into believing we need to work longer and won't get the social security benefits we think we have coming.

Like a couple of things above, the manner in which we "retire" is very subjective. I could argue that I am retired now. I work from home doing things that I love doing and that I hope to do for a very long time. My personal belief is that working is a better way to stay mentally sharp for longer. Based on what I can tell Regarded Solutions stays very busy. I have no idea if the investment writing pays him anything but it is a vocation.

As for the potential financial benefit from working I've written about this many times in the context of trying to relieve some of the income burden that would otherwise be place on the portfolio. To his first point if your idea of comfortable can't quite be covered by the dividend income (I believe he is a dividend investor) then maybe another $500 or $1000 from some part time work could bridge the gap to "comfortable."

I agree with most of the ideas spelled out in the article, the common sense notion was very good but it is not clear to me that too many lies were actually debunked.
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"Volatility is Not an Asset Class"

The WSJ had a blog post further detailing the peculiar odyssey of the Velocity Shares Daily 2x VIX Short Term ETN (TVIX). A lengthy part of the post was devoted to the thoughts of one portfolio manager who among other things said that volatility is an indicator not an asset class.

The chart shows a spectacular implosion in the price of the shares. As mentioned last week the crazy action is mostly about a disruption in the normal creation/redemption process. There are several types of glitches/malfunctions that can create serious problems but this event seems to be especially remarkable for the number of buzzwords this fund takes in; ETN, leveraged, futures, VIX.

There is probably no way to know what portion of the volume or AUM in TVIX is for speculation and what portion is from hedging with the hedge idea being as stocks go down the VIX will go up and a 2x VIX will go up more.

The idea with speculating on VIX in one form or another is that the VIX moves around a lot in both directions which makes for good action for speculative trading.

The idea of volatility being an asset class would seem to be in the context of building a portfolio that includes alternative asset classes that have low correlations to equities. This could be thought of along the lines of market neutral funds, absolute return funds, merger arbitrage funds and any other number of so called hedge fund-like products.

TVIX is not the only VIX product with questionable benefit. The troubles with VXX have been widely written about so you can google this for more info but Google Finance shows VXX is down 96% in a little over three years. The problem with VXX as I understand it is that contango keeps eating away at the fund, it already had a 1 for 4 reverse split about a year and half ago.

VXX is meant to track VIX futures and I believe it does that, it has not worked out as a holding because of the dynamics of the futures curve for the underlying. TVIX has layered on top of that the disruption of creations which is internal to the provider.

I wrote about VXX three years ago and did not think it would be ideal as a hedge because there are so many variables in that market but I had no idea how bad it would be. One thing I have always said about these products is that if you are going to use them that you do so in moderation. TVIX is down a little over 50% in the last week. If you put 2% into this fund at the worse possible time then you have a 100 basis point drag on your portfolio which might aggravate you but will not be the reason that anyone would need to delay their retirement.

A little bigger picture, I've been writing about ETPs for a long time now with the same general optimistic tone which is bring these types of ideas, let the market decide if they have any utility and for any new products that you might actually want to buy that you should watch it for a while and then go in small. TVIX is a great example of why I say this. It strikes me as a disastrous product launch but the magnitude of the disaster falls squarely on the shoulders of anyone who used it.
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There is Always a Bear Case

Yesterday I was reading an article about one of the stocks we own. It was generally a favorable article. It drew several comments including a long-ish one laying out something of a bear case for the stock. The comment was articulate and possibly compelling.

The name of the stock is not relevant but like many of the stocks we own, we have held it for years and coincidentally it has been an outstanding longterm performer; one of our best holds.

As I continue to monitor the stock and what is going on for the company from the top down in markets it sells into, from the bottom up and thematic factors the conclusion I draw is that the positives continue to far outweigh the negatives. I have felt this way about the name for a long time, it continues to be correct, at some point the story may change and hopefully I will catch such a change.

If you use narrower holdings in your portfolio, either country funds, sector funds, niche funds or individual stocks, there is some amount of monitoring you must do. No matter how much work you do here there will always be holders who know the story better than you and other holders who know far less than you.

Only reading things that support your side of the trade is clearly not a great idea but allowing yourself to be overly influenced by one article about something that you've spent a lot of time studying is not great either. If an article causes you to wonder if you've missed something and sends you back to re-learn a story or reorient to the thesis for owning the stock or fund then I think that is a positive.

The bigger point is one of emotion and insecurity. It may seem obvious but one article does not necessarily invalidate a thesis for owning a particular stock. There is a well reasoned bear case for everything in your portfolio. Well reasoned bear case is not necessarily the correct case. Even King Apple has threats to further prosperity. The threats may not play out anytime soon or ever matter but they exist. Of course threats to Apple could be correct and play out soon. If it is a name you own, then it is up to you to keep tabs and decide based on a reasonably sized sample of inputs not just one article.
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The Big Picture For The Week Of March 25. 2012

A few brief items this morning.

First up is the meltdown of the Velocity Shares Daily 2x VIX Short Term ETN which is more commonly referred to by its symbol which is TVIX. This is a levered ETN that tracks the futures market for the VIX index. Futures oriented products seem to have the greatest potential for "malfunctioning" one way or another.

The issue with TVIX is that issuer Credit Suisse had to stop creations due to internal size limits which caused a massive variance between the market price and IIV (the ETP equivalent of NAV)--it just blew up.

Any exchange traded product can have some sort of problem like trading at a discount or premium to its IIV but this is rarer with plain vanilla stock and bond ETFs and when it has happened with plain vanilla ETFs it has lasted only a short time. The next time there is a flash crash or other problem like with bond ETFs in late 2008 I will again assume short lived blip and not sell.

I would think issues like this with exchange traded notes would also be short lived but something like TVIX has a lot more going on under the hood than something like the iShares Global Nuclear Index Fund (NUCL).

For more in depth coverage of TVIX you can also read this from Barron's and also the Kid Dynamite blog as several blog posts about it.

The BATS IPO came off as probably the strangest debut of all time. BATS is a stock exchange and shares in its own IPO malfunctioned. As CNBC reported it there was a trade at $15.25 after pricing at $16.00 and then shares traded briefly at pennies before all trades were ultimately canceled. Finally the company canceled the IPO altogether. To my knowledge there is no connection to Billy Batts.

The last item seems like a good follow up to yesterday's post about $2 million. Cullen Roche excerpted a commentary from James Montier about happiness. To the extent people can figure out what makes them truly happy they might end up being able to waste less time and money on things that don't actually create happiness.
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$2 Million?

The other day a reader left the following comment;

I read a lot and figure someone needs $2M to really have a good shot at living well and retiring with few worries. Roger your thoughts?

The reader also shared that he is 58 with the implication that he is close to retirement age. Another reader left a comment on a Seeking Alpha post of mine agreeing that $2 million is the figure. Between the two comments I feel like I am being asked in part for my personal views and choices.

The best generic advice I can give is to live below your means, don't accumulate debt, save a lot and if you ever do need to fund your expenses/lifestyle out of your savings take no more than 1% per quarter. My use of the word generic is not meant as a slight, I believe the above combo is an essential foundation to a successful financial plan and we live by the first three now (we are a few decades from the withdrawal stage).

Assuming the 4% rule, a $2 million portfolio would allow for $80,000 in portfolio withdrawals. Are you then going to assume getting social security or not? How does the $80,000 (plus social security or not) compare with how much you live on now? Not how much you earn but how much you live on.

There are several types of expenses that we have to contend with and try to plan for one way or another. I've written about these before; things that probably can be easily planned, those that cannot and one-offs--things like vet bills, new tires and home repair.

Our recent three foot snow storm lead me to come up with another category which is things we probably will need. At some point I may not be able to shovel out a three foot snow storm. If we want to stay where we are then at some point we will need either a snow blower or an ATV that we put a plow blade on. These are not disastrous expenses but also not $100 to go to a baseball game either. We have a long uphill driveway which probably rules out a snow blower-- the cheapest option. A more expensive option would be the ATV and blade and an even more expensive option would be moving. Where we are it would not be wise to rely on being able to hire someone to do this for us.

This category is vague and obviously not completely knowable. There is visibility for needing to spend money on snow removal. This will take shape over time and become more visible. For some people there might be visibility for taking in a parent. Figuring out your variables here is obviously very important.

Once you figure your expenses (as best you can) you probably need to figure out what you need to be happy, what that costs and whether you can afford it as you envision or whether you need to make some sort of concession. Maybe you want to spend a month in France but you should really only spend a week. Maybe you want to spend $1000 on World Series tickets when you should really watch on TV from home. The compare and contrast possibilities are endless but you get the idea.

The other day I shared that we spent a lot (relative to us) on our New Zealand trip but that we incurred no debt in doing so which means the trip won't weigh on our finances in the future. The reason to mention this example is that spending on things that then stay with you for a couple of years will obviously add to the monthly financial burden which should be avoided at all cost--my own sense of priority would make an exception for medical events.

It is important for both partners to be on the same page with this issue and I know from professional experience that is not always the case. Getting the monthly nut down, saving a lot and doing some things that cost nothing creates a lot of options for doing other things and going places. We hike a lot and it costs us nothing. We spend a lot of hours on our volunteer endeavors which does not have to cost much if anything.

I also hit this topic with the idea of working much later than 65 or some other traditional retirement age. This will sound snobby but I have developed a low tolerance for staying with a job I don't like. This is a life's too short sort of thing. I realize I have been given a luxury that many people do not have but I think many people who read this site may have been given a similar luxury. I have three jobs that I love, two that pay and one that does not. I hope to do all three as long as I possibly can and with Mr. Backhoe as an example that could be a very long time.

This leads me to believe that plenty of people can find something they love that can pay them a little such that it removes some portion of the income burden they would otherwise place on their portfolios. Success here requires thought, time and planning.

I realize that was long winded but it addresses how I personally come at trying to figure this out. My nut is low enough that ex-a medical catastrophe we get by within the 4% rule. Let me be clear this is about living cheaply not having millions in the bank.

In today's dollars how much to do need to feel fulfilled in life and can you make the numbers work? If not then something will have to give.

Unrelated; the laptop saga is winding down. I got a new Lenovo in the mail yesterday. It was about half the cost of the one I bought in 2007 and probably four times the computer. I've transferred most of my documents and pictures but still have a lot of bookmarks to move over or otherwise set up, need to download a few things like Quicken and iTunes and I should be all set.
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The Goldman Sachs Equity Call

A big fuss was made over the Goldman Sachs call yesterday advising clients that equities will be the better hold than bonds for the next few years. Here are three links recapping the call here, here and here.

Before getting too excited I would remind that it is very difficult to predict what equities will do for one year let alone several years.

I would zoom out on a few points of how markets and cycles tend to work. The US stock market historically has had an up year just under 75% of the time, returns are not linear so often a large portion of the gains for an entire cycle will come in just one or maybe two years. Within a cycle it is likely there will be a big up year, a big down year and then several years of relatively muted results.

In 2009 the SPX was up 23%, in 2010 it was up 14% and last year it was flat. My thoughts for 2012 have been a big rally during the year that mostly retraces such that the year finishes up a little. If 2012 were to be up a little in the fashion I think will be the case or better than up a little then that would be four years without a large decline in a sequence similar to past cycles which paves the way for a down year in 2013. This conclusion is about how cycles often play out not about fundamentals and of course could be wrong. It is certainly not a given that 2012 will be an up year even though there are cyclical factors that support the year finishing at least a little higher.

Despite the worst financial crisis having exaggerated some of the volatility attributes of the market it does not appear to me to have altered the pattern of how the cycle is playing out. Of course time may invalidate this but for now this seems to be the case.

My thesis from many years back is that equity market growth would be less than it used to be in the US and Western Europe. I have felt that other markets like the Scandies, Anitpodean and certain emerging markets will be where growth comes from. The thing I take from the Goldman call is the possibility that the US and maybe Western Europe won't be such heavy anchors on global equity returns. During the crisis there were plenty of foreign markets that seemed to be dragged down more than was justified because of the fear created by the crisis. Market decline or lift for reasons that are unjustified all the time but the crisis is an easy one to point to.

Yesterday we went to a spring training game between the Brewers and the Diamondbacks with Joellyn's parents and Joellyn's aunt and uncle.
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Retirement Attitudes

Last night during the NIT game between UMass and the Drexel Dragons there was a John Hancock commercial that showed the same scenario playing out simultaneously in the bedroom of many boomer aged couples (clean it up, this is a G-rated post) where the husband is freaked out about retirement and the wife reassured him that the sky is not falling. It was actually a pretty powerful commercial.

On a related note I read a retirement article on Yahoo a few days ago that I meant to comment on. The interesting thing was not the article (I don't even remember what it was about) but the comments. Several took the tone that the government is trying to train (may not be the best word) us into believing that we need to work until we are much older before we should expect getting social security.

Essentially we are being manipulated into believing that things are worse than they actually are. There was also a comment or two that the financial services industry is in on it. I can say I am not in on it, if anything I've been manipulated into thinking that it will not go well for a lot of people who are relying on the government for a meaningful retirement safety net.

I cringe anytime I read an article that references one of those awful statistics about how many people over the age of 50 have less than $25,000 accumulated. Regardless of the right and wrong of it, I believe all of these people will become the government's problem and the people with more than $25,000 (obviously I am exaggerating) will have to sort it out for themselves.

In thinking about the first paragraph of the sky falling on retirements and the idea that "they" are trying to manipulate us has a lot of negativity. Letting this sort of negativity dominate the thought process and planning process is a killer figuratively and literally. Although this veers of the conversation that most investment articles have I believe it is crucial to long term portfolio success, and just about every other aspect of life, to have a positive outlook on things.

The way I usually phrase it in the retirement planning context is to view planning as a challenge to be solved and then set about solving it in a way that suits you.

On a related note Prescott is getting a semi-pro baseball team (not the same thing as minor league baseball but still pretty neat). Finding some sort of seasonal work for a sports team ties in with a lot of people's interests. The expectation should not be that this sort of thing will pay all the bills for ten years but that it will relieve some portion of the income burden placed on the portfolio. Prescott has several sports teams and someone could be lucky enough (from their viewpoint) to work for all of them.

In my opinion it is much easier to think creatively in these terms with a generally positive outlook. Preachy maybe, but I believe in this wholeheartedly.
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The Apple Party Continues

The share price is not the only thing about Apple (AAPL) that has gone parabolic, the media/blogosphere attention has also gone parabolic. The company announced a long awaited dividend for part of the cash hoard along with a share buyback.

George Moriarty collected a long list of Seeking Alpha articles here (George hired me on theStreet.com in 2005, we've been friends ever since and now he is working for Seeking Alpha).

I had a similar post recently and the mania around Apple has grown meaningfully since then (well, I think it has). The last time I mentioned Apple it was around 18% of the iShares DJ US Technology ETF (IYW) and now it is 20.9% of IYW. IYW is an ETF we use for some of our clients.

Trying to predict when or how a mania ends is pretty close to impossible other than getting lucky (everyone gets lucky every once in a while) but this will end one way or another as they all do and it would be reasonable to expect some sort of shareholder pain. Maybe this won't happen until $900 but right here the stock is up 48% YTD which is amazing for what was already one of the largest companies by market cap (now it is the largest).

In my opinion anyone who has made a lot on this stock would not go wrong selling some portion of it right here and continuing to (hopefully) ride up higher. If instead it starts heading lower then you sold at a pretty good time. I view this as a win no matter what scenario.

I have no argument to make against the stock, it has changed the lives of a staggering amount of people for the better and it is tough to envision what will come along to derail the company but figuring that out is not really something a portfolio manager needs to worry about (including do it yourselfers who are their own managers). This would be more for the analysts to figure out.

The reason I say portfolio managers don't need to figure this out is because they really just need to recognize that there is a mania that has sent the stock up at an unsustainable rate, know that this has happened many times before with other stocks (including AAPL) and deploy some sort of risk management strategy. I prefer the one mentioned above, other people may prefer stop orders, others may want to use options but some sort of protection would be warranted.

As for the picture; we have a lot of snow here.
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Massive Snow Storm

Not only is this the biggest March storm we've ever had it might end up being the largest snow storm for any month since we move here full time in 2002.

As I write this Sunday around 6pm we had 22 inches two hours ago and it is still snowing.

The first picture is from around 8am Sunday and the second one is from mid afternoon.

Hopefully regular blogging will resume tomorrow.









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Sunday Morning Coffee

This week's Striking Price column in Barron's (the column about options) had a recommendation from some brokerage firm of buying Bank of America (BAC) common and selling the January 10 call and selling the January 7.50 put for a total premium of $1.59 with common currently at $8.83.

That all sounds like very juicy options premium but anecdotally speaking it seems like with trade ideas like this the frequency with which the stock goes way above the $10 strike price plus the premium (so in this case $11.59) or way below the $7.50 and factoring in the premium is shockingly high.

This typically results in being stuck in the position if this starts to occur fairly early on when the volatility can go up (thus increasing the price) but before there is any meaningful decay in the option premium sold. And as a function of Murphy's law the stock won't come back in between the strikes until the options are rolled forward (meaning rolling forward frequently does not go well).

I wrote about this same thing a few years ago with a trade on Mastercard and selling calls that was recommended on CNBC. This is just anecdotal so do with it what you want.

Alan Abelson had his funniest line ever in this week's column: Silver, on the other hand, strikes us an awfully good hedge against capital gains.

Yesterday the fire department had its annual pack test. This is where each of the firefighters must go three miles on a track wearing 45lbs in 45 minutes or less. This is an annual requirement for fighting wildfires. I beat last year's time by 15 seconds finishing in 40:05 which I was pleased with. Another chief from a nearby department once told me that the chief of a small department needs to look like he can do it. My thought is that the chief of a small department needs to be able to actually do it.

Friday in the tourney was fantastic as two number 2 seeds fell. Rooting for schools like Norfolk State and Lehigh is what makes watching so fun.

Very busy weekend so a short post and we are due for a serious winter storm.
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The Big Picture for the Week of March 18, 2012

A reader left the following comment in reference to this post from January 13 of this year;

I know this post is off topic, but I just can't resist pointing this out. Take a look at what you wrote about two months ago.

Now take a look at what's been going on with US banks and SHLD. Will you admit that there's a risk in *underweighting* sectors and stocks about which you haven't done any true research? I'm not saying one should *overweight* sectors/stocks that have bad fundamentals, but there's a risk in underweighting them, which is what you recommend.

He then gave an opinion which you can read here. There are all sorts of things here.

First, I believe I talk quite regularly about being wrong with sector decisions and that I mitigate that possibility, not eliminate but mitigate, by never zeroing out a sector. I've never been zero financials--I have been and still am zero weight in US banks. Our financial exposure consists of a Canadian bank, Chilean bank, an index provider and a foreign stock exchange company all of which adds up to less than the 14.8% currently in the SPX.

Further, I talk frequently about an active portfolio being a series of decisions of which some number will be wrong and some will be correct. If you are correct some reasonable percentage of the time then things are probably going decently in the portfolio. If you are wrong a lot then something probably needs to change.

The reader appears to say I have underweighted the financial sector with out having done any research. If that is what he is saying, then he 180 degrees wrong. If thinks that I am telling other people to make decisions without doing research he is wrong. It says at the top of this page that this site about sharing my process, not making recommendations. A lot of his comment is very selective.

A little more specifically to the comment. On January 13th I wrote that I think the fundamentals of domestic financials stink and I still believe that. My opinion that domestic financials stink is either correct and the last two months has been a good trade (I regularly say there will be good trades along the way) or I am wrong and the financials don't stink. It is one or the other.

Since that post the Financial Sector SPDR (XLF) is up 12.84%. Our financial exposure is assembled such that I hope it will be less volatile than XLF and with a higher yield because of what I think is going on with the sector. The one financial we own that does not pay a dividend is up a hair more than XLF and the other items are up less.

As for the Sears comment and that I don't own it, the stock has skyrocketed up 142%. The title of the January post was What Kind of Buyer Are You, as this blog is about my process; I am not a buyer who buys what I believe are lousy fundamentals. Again the fundies for Sears either are lousy or they are not; this an opinion that will be right or wrong but if I believe the fundamentals do stink then I realize the name could easily go up without me--I've lost no sleep over this.

One last point is that the way I manage portfolios, it will be very rare that any opinion I might have about something will be proven right or wrong in two months.
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The Proper Context of Low Beta ETFs

IndexUniverse had a post that explored some of the nuances of the PowerShares Low Volatility ETF (SPLV) and the PowerShares High Beta ETF (SPHB). The article was a little muddled in that it seemed to start out by making the argument for why now might be a good time to buy SPHB but then the author talked about why he does not like the composition of SPHB.

First, to the idea of some sort of tactical strategy of swapping back and forth between the two (this is what I think the first part of the article is about) it is certainly possible even if not easy to time. Some sort of objective trigger (but probably not a 200 DMA breach) could be used such that you lighten up on volatility after a big move up and you increase volatility after a big drop. It's a lot easier to articulate this than execute it; really not my type of trade.

I would argue that after the great run in the market and for SPHB since October, the time frame chosen in the IU article, we are probably closer to SPLV being the better hold. Since October, per the article, SPHB is up 36%, SPY is up 24% and SPLV is up 15%.

The author brings up the notion of being left behind with SPLV in an up move. That makes sense as typically it is the higher octane names that move up the most in a big lift for the broad market. For people who would rather not try to tactically time swapping low and high beta the context of how to think about the low beta funds is over the course of the entire market cycle or even longer.

If you've ever read any research on any of the buywrite indexes, these tend to be lower volatility than the broad market, you've seen that the outperformance benefit comes after years of holding it--assuming there will be outperformance. The angle behind these is that historically going up less and going down less has netted out to a better long term result.

Buying a low beta fund but not wanting to trade it tactically requires a willingness to think in terms of years on the believe that up less/down less will continue to net a better long term result. Whether it does or not is a different issue but going in this should be the mindset.
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Seeing What We Want To See

On the Seeking Alpha version of my post the other day about how risky stocks are or are not a reader left a comment whereby he thought my post validated his preferred investment style. This was very interesting.

For purposes of this short post it does not matter what his preferred style is, he read something and came away believing it was an argument for his approach. Clearly something behavioral is at work here. This is not a shot at the reader at all--I do this quite regularly and I expect I will in the future. Chances are many of us do the exact same thing.

Obviously we read articles or blog posts that don't validate our respective philosophies, I believe that reading things that take the other side of your argument can help expand your viewpoint some or maybe learn about the flaws in your style. All styles have flaws, except for mine....JOKE JOKE JOKE, so it is important to understand the drawbacks to what you do to help mitigate the consequences of these drawbacks.

Along the same lines understanding the pros and cons of your style could also help reduce the risk of seriously hurting your portfolio or your clients' portfolios (if you work in the business).

If somehow serious damage is done then you probably need to find a new style altogether. I don't necessarily define down 50% in a down 50% world as serious damage (although I believe in trying to avoid it) because this can be mitigated some, not completely, with proper asset allocation for people with time to participate in the recovery and also by mentally preparing for such an outcome. What I mean is if you hire a hold on no matter what indexer to manage your money then he should let you know well in advance of what will happen the next time the market tanks. He might tell you you will go down with the market and we will rebalance at such and such a point as an example.

Serious damage includes things like loading up on penny stocks (people still do this), putting 50% into a can miss biotech that misses or misusing options as three examples. Hopefully these sorts of things would be individuals learning the hard way but you never know.
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What Do The Stress Test Results Mean?

By now you know that the stress test results came out yesterday and that 15 of the 19 largest banks passed. The failed "banks" were Citigroup (C), Sun Trust (STI), Met Life (MET) and Ally Financial. I put banks in quotations because obviously Met Life is more of an insurance company. You can read this article for more details.

Taking the results on face value, banks in general could starting to recover. At some point the businesses will start to get healthy and maybe this has already started. Anyone believing this to be the case might have received a green light of sorts yesterday.

I have two reasons why I will still say Ni to domestic banks.

The first one has to do with the book value argument that some, like Barron's, have been making repeatedly since at least 2009. The counter argument to being cheap on a book value basis is that book value might be incorrect because there are very likely still more real estate write downs to come--I believe there will be more write downs. Anyone believing there will be no more write downs or that any future write downs will be negligible may use this argument as a reason to buy.

Another reason to avoid them in my opinion is the example set by tech stocks in the aftermath of their implosion. Actually I would say ongoing aftermath given how many of them are still way below where they were 12 years ago. In many instances the earnings have gone up plenty since 2000 (obviously part of the problem) yet there are plenty of stock prices that are just a fraction of what they once were.

Although the circumstances behind tech stocks and banks are very different I think the market action for the two will be very similar. Actually it could be worse for the banks because tech companies were allowed to fail based on their own lack of merit and this was not universally the case with bank stocks--some were allowed to fail but many were not and no one should be surprised if there are negative consequences for this.

I continue to believe that banks from many foreign countries are on firmer fundamental ground (ex Western Europe, ex Japan and ex China) and I also think that select small, domestic banks could be considered but they are more difficult to research.
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Just How Risky Are Stocks?

There was an article in the WSJ titled Stocks Are Riskier Than You Think. The article was very long and tried to make too many points but there was one particularly useful passage;

If you're expecting stocks to outperform, say, 70% of the time, you need to think about how much you stand to lose the other 30% of the time. It does not do you a lot of good to have 20 years of great performance, only to be trounced in a crash just before you retire.

A long standing idea is that stocks become less risky the longer you hold them. The basic idea there is with a long time horizon you have more time to recover from a downdraft.

In the last few years I've seen where some have turned this around. Stocks become riskier the longer you hold them because everyday that passes brings you one day closer to the next time stocks cut in half. Chances are anyone with a normally allocated investment portfolio in 2007 who was looking to retire in 2009 probably agrees that risk increases over time.

The article appears to question whether or not stocks really do offer the best chance at long term growth. I would say they do except for when they don't. Over most long periods of time stocks do offer growth, this has been the case and I believe will continue to be the case. In the last decade and change that has not been the case domestically and there have been other similar periods where domestic stocks did relatively poorly and this will happen again at some point in the future.

The experience of Japanese equities since 1989 certainly works against this argument but I'm not aware of any other market that has done so badly for so long.

The realistic downside risk to a well diversified global equity portfolio seems to be around 50%. Certainly any given incident could be larger but the realistic downside risk is not zero. If you own a bunch of index funds targeting different segments of the global equity market they are not going to all go to zero. I would say no single index would go to zero. Also a portfolio of 20, 30, 50, or any other number stocks will not all go to zero at the same time.

I'm not sure we know how much a bond portfolio can reasonably drop. The late 1970s was probably the worst bond market we've had, but that decline did not start at 0%. Yes with individual bonds you get your principal back but the decline in the meantime can be huge and you are getting yields way below the market when you hold on (the context here is longer maturities).

This makes an argument, in my opinion, for some form of active management. Others would stress asset allocation and I agree that is very important but I don't think is sufficient by itself. Had the investor mentioned above reduced his equity allocation some in 2007 because he was retiring in 2009 how much would he have realistically reduced by?

You've probably heard the term glide path in conjunction with target date funds. While I am no fan of the funds the concept is pretty standard; reduce equity exposure slowly over time. Someone who is retiring in two years at 63, 65 or 67 still has a couple of decades of inflation to worry about and so little to no equities for someone who is not extremely wealthy is not practical.

So I think if anything, the above investor might have gone from 65% to 60% or maybe 60% to 55% so the decline in 2008 would have still complicated the financial plan. Not surprisingly I take this as a validation (or confirmation) for having some sort of strategy for defensive action in a portfolio based on an objective trigger point.

I prefer the S&P 500 in relation to its 200 day moving average but the more important thing is that whatever objective trigger is chosen that it be simple to understand, offer some basis for believing it can work and then that it be stuck to.

Indexing has its benefits but I don't think there are too many offered in this context. A 50% hit to 50% of your portfolio at a point where you may not be able to hold on all the way through the inevitable recovery would seem like a bad strategy. Using the 200 DMA or any other similar strategy can't guarantee success but I think it is better than just letting the market happen to you.
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HELOCs to pay for gas?

A friend shared this picture on Facebook and I got a nice chuckle from it. Chances are everyone has made similar jokes about getting loans for certain day to day items but still it is pretty funny.

It also reminds us that no matter how much planning we do there will be certain costs that get away from us. Something like the price at the pump seems like an obvious candidate although this can be mitigated somewhat.

I'm not one who thinks it makes sense to buy a new car to save some number of dollars at the pump. I think reducing this expense might be more efficiently achieved by planning the week out a little better to try to reduce drive time. Then maybe when a vehicle needs to be replaced, go more economical at that time.

While a little ingenuity might be able to help minimize actually paying out an extra $200 per month for gas, this may not be the case with health costs. A large and annual increase in insurance premiums, as one example, may not be so easily mitigated.

Some expenses go down in retirement but those will likely be finite. If you have a $1500 mortgage then once you pay that off you stop making a $1500 payment. This year we are paying $331/month for a high deductible HSA. Since we've had this plan our premium has gone up 10-20% per year and in my opinion there can be no certainty the future increases won't be larger which makes future planning for this expense very difficult.

On one of my posts on Seeking Alpha a recently retired reader commented that retirement isn't quite as expensive as financial professionals tend to convey. I am not retired and he is which does carry some weight. My observations and general industry thought is that in early retirement the tendency is to spend more on things like travel and toys. At some point the travel slows down and there is then less spending and then the spending increases again for later stage health care.

It should be obvious that everyone's own circumstances are unique but some variation of the above is common. Embedded in the one comment about retirement being cheaper than planners tell you is the potential conflict that exists in that it is in most planners' interests for clients to save a lot and spend a little. I can't say this does not exist but I think most of the audience here is comprised of do-it-yourselfers.

The best thing is to run your own numbers, think about your own costs, vulnerabilities to your own financial situation--for example the threat of a large vet bill is one for us. A $1500 vet bill combined with getting caught off guard with needing new tires could make for a problematic month for many people. My own set of life experiences and biases leave me wanting to make a priority of not getting caught off guard financially. The simplest starting point I can think of is reducing the overhead IE minimizing the expenses.

On another note, I am thrilled about the impending start to the NCAA Basketball Tournament. In addition to rooting for San Diego State (my alma mater) I will be rooting the South Dakota State Jackrabbits, the other SDSU and Long Beach State along with most of the underdogs from game to game.

For whatever reason I still dislike any variation of the word dance when used in connection with the tournament. Amusingly I watched the McNeese State/Lamar game the other day Derek Wittenburg, yes that Derek Wittenberg, was the analyst for the game and must have used the word dance or dancing 91 times. Obviously he knows more than most of us about the NCAA Tournament but still...enjoy the games.
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Sunday Morning Coffee

A couple of items from Barron's to chew on.

First is an article titled The Worst of Times to Buy Stocks? which features analysis from a couple of people including John Hussman. People who read Hussman at least occasionally will find his comments familiar.

He notes the following current concerns with US equities;

• the Standard & Poor's 500 trading at more than 8% above its 52-week exponential moving average

• the S&P 500 up more than 50% from its four-year low

• the "Shiller P/E," based on the cyclically adjusted trailing 10-year earnings, developed by Yale economist Robert Shiller, greater than 18; it's currently 22

• the 10-year Treasury yield higher than six months earlier

• the Investors Intelligence's bullish advisory sentiment over 47%, and bearishness under 25%; in the latest data, the numbers were 47.9% bulls and 26.6% bears

Hussman says these indicators add today to a list of "A Who's Who of Awful Times to Invest" similar to past times where the market has gone on to do poorly. However he also concedes that these factors can persist for weeks or even months before the market starts to roll over.

I've been writing about Hussman for many years as I have taken a little bit of process from him to create my own process. One difference with this part of the process is preferring to take a "defensive posture" when index price levels indicate there is a problem. An observation like the one offered by Hussman is, in my opinion, a reason to become more skeptical but not yet make portfolio changes.

The indicators notwithstanding, the SPX was up last week. While a week means nothing in the grand scheme the news was generally not good until Friday but it went up a little bit anyway. I don't know if the YTD move is enough to be considered a buying panic, it appears as though the market does want to go higher for now. That may reverse at anytime of course, the easier path right here seems higher.

That is merely an opinion. If it continues to be right, we can go with it. If it turns around, if nothing else we can heed the 200 DMA to lighten up. When I say if nothing else I mean that in the past there have been trades to lighten up when things are going well and I would attempt to repeat that in the portfolio but if I don't, we still fall back on the 200 DMA.

The other thing to mention from Barron's is the interview with George Greig who manages the William Blair International Growth Fund (BIGIX). There is not a lot to say but I found the country allocation to be interesting.

As I look at the performance tab on Morningstar the fund has tracked closely to its benchmark index for the last five years (did not look at other time periods). The reason the country allocation is interesting is for how unremarkable it is. Other that 10% to Japan, versus 20%, it looks very similar to the iShares EAFE Fund (EFA). BIGIX has 23% in UK, 10% in Japan, almost 30% in developed Europe and only 3% in Australia. BTW the makeup of the fund on Morningstar is as of 1/31/12 so there may have been changes since.

I'd love to know the history of the country allocation although based on the five year chart I would guess that Europe has always featured prominently in the fund. Here I will bang the drum for the value in figuring out what to avoid and then actually avoiding it. In general terms it can be difficult for a portfolio manager to avoid large portions of their benchmark either because they are prohibited from doing so in which case they are stuck or because if they do avoid something, they end up being wrong causing a big lag thus hurting their career one way or another.

No idea whether any of this plays into the mutual fund mentioned above, I am just talking generally. If you are your own portfolio manager you certainly do not have these constraints. If you are able to spend the time on these things and your work concludes that the fundamentals for some region or sector are truly awful then you can underweight or otherwise avoid it.

This is useful to keep in mind as you read articles like the interview mentioned above or you see segments on stock market television. Many of those folks were always going to have exposure to Europe and/or financials. Wherever the next crisis occurs (I mean the next one not a continuation of this one) you will see plenty of interviews with people who for whatever reason are going remain heavy in the ground zero segment because they really have to or think they have to.

The first picture is of the Vulcan Cafe in Auckland which I mentioned on our trip. And the second picture is of a mocha ready to be had on Muri Beach on Rarotonga.
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The Big Picture for the Week of March 11, 2012

A round up of a few things from the blog this week;

A reader left a useful comment on the Seeking Alpha version of my post Working With Your Retirement Number. It was a lengthy comment that included four of his rules including this; 3. Do not focus on a retirement age - set a goal of seeing your investment cash flow cover your living expenses, and then choose to retire if you wish after reaching that point.

Put another way, you can't retire until you're financially ready but I like the way he phrased it. For years I've been talking about something having to give if not enough money has been saved. The reader also opens the possibility of not retiring at all or retiring much later than the 60-65 that many people target.

Another reader left a comment expressing frustration with articles that generally address a "minimal retirement." He went on to share some details of the extent which he started saving early and often and how it has worked out for him so far without his having to live whatever he perceives as a "minimal retirement."

Obviously these types of terms are very subjective and although I am not sure, I think I frame this differently than what I think the reader is saying. I think that what most people hope for is to not have less of a lifestyle than when they were working. A $40,000 lifestyle before retirement will not reasonably become an $80,000 lifestyle after retirement but hopefully will not need to be a $20,000 lifestyle.

Various ideas about saving more and spending less are generally aimed at having a better shot at not having less of a lifestyle after retiring. In thinking about who is richer, the man who makes $100,000 but lives like he makes $200,000 or the man who makes $20,000 but lives like he makes $10,000 I believe the easiest path is to live below your means. Not everyone can do this but some can.

Whether this equates to a "minimal" lifestyle will be based on the the individual's personality, interests and perspective. Someone making $100,000 per year but "needing" new Mercedes every two years is going to probably end up feeling disappointment at some point.

On a related note yet another reader left the following on the original post on the blog;

...Also a GREAT deal of thriftyness. Example, No attending NFL,MLB, or NBA for me considering the expense vs free entertainment that is out there.

My reply;

That is an interesting train of thought. I tend to spend money on these sorts of things a few times a year. San Diego State (my school) is due to play on the smurf turf in November and I plan on going.

Assuming one does not go into debt for these extravagances then the decision to spend on them or not can boil down to how your doing financially.

What I mean is that if you are not adding to your debt burden then you can simply stop the activity if/when financial circumstances dictate.

Ditto with vacations. We spent a lot of money (for us) on our NZ trip, paying as we went. If our income changes we can simply not take a trip. Different story if we were going to be paying for the NZ trip for the next two years.

The thing to add is that paying bills and setting some reasonable amount aside takes priority over things like games, concerts and vacations. But if your bills are paid, you have set something aside and while we are at it have your debt under control (or better yet have eliminated your debt) then to the second reader's point; have some fun. If you are lucky to have something left over don't spend more than what is leftover.

Fun and living within your means are not mutually exclusive.

A quick laptop update; the old Lenovo is still working after appearing to die in Rarotonga. I said I was going to replace it but have not done so. As one reader noted, just threatening to get a new one might have done the trick.
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Trying To Work With Your Retirement Number

Doug Carey had post at Seeking Alpha titled How Much Do You Really Need To Retire? The article crunches some numbers for a 40 year old couple with $200,000 already saved, assumes $5000 of annual savings but with no mention of salary or expected salary growth. The author uses some software to determine they need $656,000 to generate enough income combined with $25,000 in social security to meet a $40,000 post retirement income need.

The product of the author's scenario and software has the couple running out of money at age 107.

Then the assumptions are revised to assume cuts to social security of 10%, 15%, 20% and 25% and has them running out of money at 91 with that 25% reduction in benefits. As I read, I wondered what about a cut of 100%?

I've never thought the program was going to disappear but the payout for some of us will be zero. Things need to change radically with social security and medicare and I think that means zero benefit coming down the wealth scale and clipping some folks that actually aren't all that wealthy. While I have no idea what this will actually look like, I personally do not expect to accumulate mid-seven figures but I also don't expect to get much in the way of a benefit either.

By now it is fairly obvious that people below a certain age, maybe around 50 or so, should not count on the number they see on their annual social security statement. If it pays out as it says and you saved assuming there would be nothing then you'll have a pretty good margin of safety.

There are all sorts of other tips that people can do like not spending your raises (assuming you get raises) but saving them instead; really the list is endless. And while these sorts of money saving tips can help I will continue to bang the drum about finding your own innovative solution to creating some sort of income from something you love doing and keep that income flowing in as long as you can.

If you can get your mortgage paid off early, reduce or eliminate other debt, and ratchet down the lifestyle some then I think it would be pretty reasonable to have $3000-$4000 monthly lifestyle. Using the 4% rule a $48,000 income need would require $1.2 million assuming zero social security benefit. Obviously not all of us are going to accumulate that much. Delaying retirement and then generating $2000 from hobbies/things you love doing, which is not unreasonable with sufficient planning, brings the portfolio need down to $600,000. While that is not an insignificant number it is achievable for people who make decent money and are good savers.

I want to stress that pulling this off will probably take years of planning. I would also stress the importance of being innovative. I've mentioned my neighbor with backhoe dozens of times. Another neighbor up here who is at least 75 is working on a highspeed internet service up here. I think it is WiMax but he is working for the entrepreneur who started the service. It will probably take them a year. It is a finite project, won't make him rich but would relieve some of the burden of his portfolio for the year (if he has a portfolio, I have no idea, this is just an example for an innovative income idea).
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A Diamond ETF On The Way?

Index Universe reported that IndexIQ has a physically backed diamond ETF in the works. Three years ago I had a light post asking why there was no diamond ETF. This idea intellectually appealing on some level. For men I think it might appeal the same way that we react when we see Jason Bourne's safety deposit box with cash in various currencies, all the passports, a weapon or two and a few other things. Maybe Bourne has a velvet envelope in there with a dozen diamonds in it.

I don't know if there is any connection for women or not other than I know my wife would not care.

A diamond ETF also appeals to fear of a total breakdown in society--maybe if the diamond ETF is successful there will be a cans of tuna fund too.

Seriously, the reason to explore something like this would be for what it can offer to a diversified portfolio. Something that offers a low correlation has a role all the more so if the low correlation is something that can be reasonably predicted (not to imply infallibility). I've written a lot posts over the years about the value I place on this for navigating market cycles.

The potential zigzag effect will be part of the argument for the diamond ETF if it actually lists. Then the ETF will either deliver a low correlation or it won't. My initial hunch is that such a fund won't get panic bids as reliably as gold appears to and that at times the correlation will indeed be low but maybe not when it would be most needed. It seems to me that like silver there is a cyclical aspect to diamonds, at least I think there is.

Diamonds are usually bought for jewelry. If that is correct then that means things like engagements, weddings and anniversaries. So there is one purchase for engagement and one for the wedding which could be more resilient in that those purchases "must" occur. The ones that don't have to occur are various anniversary purchases. There are potentially a lot of anniversary purchases that could occur and depending on the current state of the economy it would be easier to forgo earrings for a 5th anniversary and to the extent diamonds rely on that type of demand the correlation to stocks could go up as stocks and the economy turn down.

If you want to learn more about the particulars of how the fund will buy diamonds and store them read this post from Kid Dynamite. The entire procedure is lengthy with many steps but it is amusing to think that in the first few days of the fund the entire AUM could fit in Jason Bourne's safety deposit box.

The other picture is from Milford Sound.
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Good News; They're Profitable!

ETF Trends had a post covering the growth of new all ETF portfolio solutions being offered, based on the article, by large banks. The article excerpted a MarketWatch story that had a lot of quotes from someone at Wells Fargo about their product suite and the extent to which they wouldn't offer the products if they were not profitable.

These might be a tough sell after a VP of something or other brags about the profit being made off of $25,000 accounts.

I don't know anything about the specific portfolios that Wells Fargo offers but I have seen similar portfolios from other firms and from what I have seen they target broad asset classes only using broad index funds. They are easy for the client-contact person to implement as about all they do is select one of some number of possible portfolios and then the rest of the process is automated.

The portfolios aren't necessarily bad in and of themselves. Some folks are better using only the broadest funds and if history repeats and the market has an up year 72% of the time then these portfolios will do just fine at least 72% of the time. They may or may not beat the market but they will be close either way and that can be good enough most of the time for people who are good savers. I realize the last decade or so works against this argument but I believe select global markets will have normal decades going forward as they did over the last ten years.

Obviously if the portfolios are unmanaged then they will feel every bump in the road during years like 2008.

The issue tends to be the fee involved what is often an unmanaged portfolio. A systemic rebalance is not really active management. Paying 150 or 200 basis points for active management could turn out to be worth it, if a manager averages a net 400-500 basis points per year of alpha I'd say the fee would be worth it but that is up to the end user to decide. But if portfolios like this are not actually being managed and the fee is more than 150 basis points then it is easy to see how the portfolios can be profitable to the firm.

The first picture is at the Franz Josef Glacier and the second one is of a blue starfish we saw in Rarotonga. Blue?
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Consuming Content

A reader left the following;

A reader asked David Merkel the following: "I’m interested ... in a catalog of what, how, and why for “information sources you get pushed to” you and “information sources you pull/poll” on a daily or weekly basis."

I would love your response to the same question.

This is something that has come up before. I have to believe that a large portion of a portfolio manager's time is spent consuming information. This could include monitoring current events in the world, monitoring current events with portfolio holdings and trying to learn about companies that could be added to the portfolio.

The manner in which people access information is evolving, it has always evolved. Before the internet people could subscribe to things like Valueline, get S&P tearsheets, have annual reports mailed to them and have other types of information mailed. Anyone willing to shell out for a Bloomberg Terminal in the 1980s and early 1990s was getting pretty good information.

The beginning of the internet as a household utility is an obvious turning point for the democratization of accessing information that might have otherwise been available but extremely expensive before the internet. For the most part the information first available on the web was more data oriented with a few content sites like Motley Fool and theStreet.com starting out as web based (as opposed to MSM putting up websites).

Then at some point along the way blogs, aggregators and other more socially oriented content hit the scene in the early to mid 2000. I was not even close to being the first blog but late 2004 I think is fair to say was fairly early.

To the reader's question I get daily content from most of the usual websites like WSJ, the FT, Bloomberg, Reuters and so on. I also get content from Seeking Alpha, the morning must know column is the first thing I read when I turn on the laptop. I have always gotten a lot of content by just coming across it one way or another (linked in other articles, comments left on various things I read and a few other ways.

The biggest change in how I access info is from Twitter. I keep my feed up all day (most of the time) which allows me to let other people find good content to read. I do reciprocate with my Tweets but it is a good leverage of time; letting other people you believe know a thing or three fund stuff for you to read. In Dave Merkel's response is a mention of John Hempton. I doubt I would mention him in a list of a who I read type of post but have linked to him before and people Tweet about his posts without my having to think about it.

As far as stuff getting pushed to me, I get too much of that and I look at very little of it. Even when I unsubscribe I will start getting content from other sources, it really is a lot and again I don't find it very useful.

I'm sure something will come along that will be better than Twitter at leveraging time. Maybe the next Twitter will be Twitter (a joke from back when Alberto Vilar used to say Yahoo will be the next Yahoo).

One of the great aspects of this job is being able to spend time reading and learning but as it has since I started, it will continue to evolve and hopefully make the job a portfolio manager does even more productive.

The first picture was from the Muri Beach Lagoon which is so vast you need a wide angle lens to capture it and the second one is from the Vaima Restaurant which has tables out on the sand of the beach.
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It is ALIVE!!! And so are we

We made it back safely from our trip to New Zealand and Rarotonga right on schedule late Sunday night. I have a mountain of stuff to do this week both for my day job (managing money) and my volunteerism (fire department) so I set about trying to prepare a little late Sunday.

The other day I mentioned my five year old Lenovo laptop died so the first thing I did we turn on the netbook we have, which will be my back up until I get a new computer, to charge the battery and update Norton. I then tried to fire up the Lenovo and it turned on! I am writing this post on it. I do not know if this strengthens or weakens the case for it not being able to tolerate the electricity in NZ and Rarotonga but either way I am pretty stoked. I am still going to get a new Lenovo this week (either Best Buy, Costco or order one) but it will be much easier to transition to a new machine if the old one still works (hopefully it fires up again on Monday morning).

I will have a normal blog post up on Tuesday. Thank you for sticking with me through this long trip. Joellyn had a milestone birthday and I wanted to make a big deal of it. Apologies for not keeping up with the comments while we were away but that is difficult to do when time is more restricted than normal.

There are still a couple of hundred pictures from the Cook Islands that I need to add in to the folder for the trip, today's pictures are from the first couple of days in Raro.
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The Big Picture for the Week of 4, 2012

The Lenovo laptop I have been usung for five years fried yesterday for not being able to handle the voltage (or whatever the term). Fortunately it came at the end of the trip and given how old the computer was I knew it was just a matter of time before it would have to be replaced. Also fortunate is that I backed up everything onto an external hard drive before we left just in case this happened.

Interestingly I asked for reader input on which computer I should buy and Lenovo turned out to be a great choice. We are flying back home over night Saturday and I will be in Walker Sunday night.
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The Role of Ethics in Portfolio Construction

As a follow up to something he read about New Zealand a reader asks;

How do you factor in ethics when evaluating portfolio choices?

Things like ethics or anything that might fall even remotely under the header of socially responsible investing should be a personal decision based on priorities of the investor. In my opinion there is no single right answer; one person cannot say what is right for another.

My own view on this must be from where I sit as a portfolio manager. I perceive my job as trying to clients the best chance they can get of having enough when they need it and also to try to protect assets when that appears to be warranted.

Very anecdotally speaking it seems as though most socially responsible funds lag the market pretty consistently. I'm sure there are exceptions. While I can't be certain as to why this might be I do know that the tobacco stock and liquor stock we use in "large" client portfolios have done pretty well over the long term. The nature of the demand for the product makes them steady performers and future prospects look good in my opinion. I'm pretty sure tobacco and booze are no-nos in SRI funds.

If a portfolio manager makes the decision to omit a tobacco stock because of his beliefs about the tobacco industry then he is projecting his beliefs onto his clients and very subjectively speaking I don't think that is right. If a client tells us no tobacco, that is his belief not mine and we can accommodate that type of request with the proper paperwork.

I've read some literature on smoking and it turns out it is a very unhealthy habit (old joke of mine), I will never be a smoker and I wish everyone I know who does smoke would quit but my view on the demand for the product makes me think they are a must own. Likewise booze and weapons. We don't have gambling exposure, not because I am not a gambler (I don't even like March Madness pools) but because I view the volatility characteristics of the stocks as being relatively unfavorable for now--we did own IGT for a short time many years ago.

I'm not sure whether my view here is unique (although I doubt it) but this was a good question because the topic doesn't come up often except from people who run SRI funds.
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