Why This Bull Market Stinks

Actually, it doesn't. If it's making you money (and some of that money remains after the inevitable correction), it doesn't stink. But, perception is reality, sort of, and the current eight year run up of the stock market hasn't been fully embraced with the folly and euphoria that we normally see. Generally, at this point in a bull market, the ideas that the good times will last forever and that we have reached a new era in investing/the economy start to take hold.

As an aside, take note of that. Because everyone has been waiting for the other shoe to drop, it's taking longer for the other shoe to drop. Don't be surprised if the bull market chugs along longer until we REALLY leave sanity behind or our economic situation  becomes so stark and dismal that even our guarded optimism proves too optimistic.

Josh Brown of The Reformed Broker lays out a good case as to why the this bull market is so disdained. Technology and algorithms are taking over and automation is a threat to the careers of many in the industry. So, the professionals fearing for their jobs is poisoning Main Street's feelings about the markets. Do I have strong feelings about where the market is headed? Well, it will come down sometime. When or how much is impossible to know. However, I do have strong feelings about trying to predict the markets. Don't. It's ok to have misgivings about the market, just don't let it be due to Wall Streets career worries and don't let concern paralyze you.

As another aside, Brown mentions the overarching trend towards quantitative, rules-based investing. While this is an improvement upon "gut-based" investing, let the buyer beware. Simply having an algorithm is no assurance of success. It must be robust, simple and able to survive markets that are constantly adapting. Some of these programs will likely deliver superior results, some will be serviceable and some will blow up. Control what you can control, kick the tires on your methodology, play it safe and follow your plan.

Fiduciaries and Fragility

In case you haven't noticed, the much talked about (in some circles) Dept. of Labor Fiduciary Rule has gone into effect. What does it do? Well, basically, it's going to elevate most people in the financial services industry to the level of fiduciaries. Being a fiduciary means acting in the best interests of the client. Many people (including this author) already operate under this standard, as opposed to the lower "suitability" standard used by many brokers and people in the insurance industry (who aren't also investment adviser reps-which would make them subject to the fiduciary standard).

There's little things people in the financial services industry like more than looking down on other people in the financial services industry, so I won't throw dirt on anyone's grave. There are some excellent and knowledgeable people in all corners of this business, and being a "fiduciary" is all well and good, but at the end of the day, it just gives a bad actor one more rule to break in pursuit of your money.

This probably isn't a bad thing, but I don't know how much help it will be. At the end of the day, it will result in more documentation and work for the adviser, but likely little advantage for the consumer. I'm not a Randian free market fetishist and  wouldn't pretend to think that no regulation is needed in the investment industry, but we are way past that point. From our overly-complex tax code to dizzying investment adviser laws to our arcane farm subsidies, our top-down economy is looking extremely fragile as it is poised to choke on itself.

This isn't me predicting "The Big One". After the 2007 crash, I was sure the next big market move was farther downward, and that simply wasn't the case. But, I would implore everyone to have their heads on a swivel, though, and realize the limits of laws and regulations while having an investment plan that doesn't lean on predictions and can survive both a good and bad economy. The odds are that laws such as the DOL will be ineffective at best, and at worst, will sap your adviser's time with more admin work. As usual, the client must remain informed, because your finances can't be completely outsourced any more than diet and exercise can.

Lastly, here's a good summary of what the DOL Fiduciary Rule.

The Calm Before the...?

Anyway you slice it, volatility is low these days. Per this article (with pretty charts) from Pension Partners, by a lot of different measures, the stock market is overwhelming stable and consistently higher than its historical averages. Do this mean that stocks have become less risky?

Well, actually, be grateful that stocks are risky. After all, risk drives the returns. If stocks start to look like bonds, be ready for bond-like returns. However, it's doubtful that stocks are less risky, but, as a whole, we will likely start to believe they are, settle in for nice, consistent positive returns and then we will get steamrolled by a market dive. The article quotes the one and only Nassim Taleb: "Don't confuse lack of volatility with stability, ever."

History's least favorite bull market is now over 8 years old. No one thought it would last this long, and while the party can't last forever, I'm not going to be the one foolishly attempting to predict when it will end, nor will I extrapolate these returns indefinitely into the future. Don't cash out and run for the mattress just yet, many have lost out on great returns by predicting doom and gloom. Just have a plan that can survive the bad times...and the good times, as well. No two market cycles are the same, but that doesn't mean the rules have altogether changed. The markets go up, then they go down. We just don't know when or by how much. So, expect the unexpected.

Managing the Excesses

Knowing that crazy things happen in the market and living through them with your portfolio intact are two very different things.

One of my favorite bloggers, Ben Carlson, points out that everything is obvious in retrospect. He really nails it here. There's a certain snide aspect to our writing about past market overreactions, positive or negative.  Ex post facto, we seem to take it on face value that "obviously, the market will come back" or "clearly the high valuations were unsustainable", but few of us actually put our money where our mouth is in real time.

Correspondingly, seeing a mathematical model of the returns over a time period isn't the same as experiencing the ups and downs in real time. As Michael Batnick points out, it's the difference between seeing a map and making the actual trip.

Every time the market experiences a wild swing, we weigh the possibility that this is just another example of the normal ebb and flow vs the possibility that something has fundamentally changed. The vast majority of the time, it's the former, but the latter theory is seductive, and that's why we fall for it.

What is Smart Beta?

Some of you casual investors might have come across "smart beta" (or "factor investing") lately and wondered what it is. Here's your chance to learn. I will take it easy on equations and math.

Basically, a couple of academics named Eugene Fama and Kenneth French built on some previous research (the first building block being the Capital Asset Pricing Model) and figured out that the biggest factors influencing returns are:

1) Beta-a measure of the volatility of a stock compared to that of the market as a whole.

2) Size-small companies tend to outperform large ones in the long run.

3) Value-stocks that are "out of favor" tend to offer the best chance for superior returns.

These aren't all of the factors. In recent years, people have discovered quality, momentum, etc., but the three above seem to be able to account for the majority of equity returns, so they are the most popular. The theory goes that superior stock performance isn't a mystery, it is a function of one  taking on excess risk by exposing a portfolio to various factors that offer the corresponding chance for greater return.

So, how is this done? More or less, you (or more likely, a mutual fund or ETF) "tilt" the portfolio by exposing it to one of more factors. So, maybe the fund only invests in companies that are below a certain size. Or maybe below a certain size AND out of favor. You get the idea.

Of the companies that have brought this idea to market, perhaps the best known and one with the longest track record  is Dimensional Fund Advisers. It  was started by some former students of Fama's (he and French both still serve as advisers to DFA), but they are far from the only player these days. 

The rubber is about to meet the road as there are now a variety of potential factors (the so-called "factor zoo") being exploited by a host of companies. How well will this perform in the future? It is impossible to say for sure, but this much we know: the more people who employ a strategy, the tougher outperformance becomes. But, if the people who are rushing into the strategy aren't going to stick around for the inevitable rough times, then maybe what we will see is a bubble bursting as people jump off the bandwagon, followed by performance in line with historical norms (which would be slightly above that of the indexes), as the reward to those who stayed the course. That's no prediction, only a scenario.

The reality is that there is a lot of good data behind factor investing, but markets are dynamic, so they are constantly adapting. That doesn't mean that there aren't some underlying constants due to human nature and economics, but it does make it impossible to optimize the future. There is a great deal of promise behind this type of investing, but they only thing we know for sure is that it, like all types of investing, will take discipline through the ups and downs as we try to determine whether we are in a cyclical decline or something about the strategy's prospects for future success has changed. That's the risk, and be grateful for it, because without it, there is no reward.

Book Review: The Incredible Shrinking Alpha by Larry Swedroe and Andrew Berkin

If you bore easily, this book is for you, because this book doesn't give you time to get bored. If it were any smaller, I might have to worry about this review being longer than the actual book.

The book is built around a pretty simple premise: alpha (the returns above and beyond an appropriate risk adjusted benchmark) is harder and harder to get. The reason? Well, there's a few of them. First, people are doing more passive investing these days, so their are fewer "suckers" to get taken but the often false promise of active management. Also, the competition is better, so more informed and more educated people (compared to generations past) are duking it out and negating each others advantages.

Swedroe and Berkin also lay out a few methods for individual investors to avoid investment minefield through passive investing and being hawkish on fees. They don't reinvent the wheel, per se,  but they do give you some of the past data on the wheel. It has several appendices with data on models, active management and simple investing. If you like this book, move up a few levels in complexity and try Your Complete Guide to Factor Investing: The Way Smart Money Invests Today by the same authors. Packed with stats and theory. Quick and inexpensive.

How Much Do I Need for Retirement?

Here's the liberating answer: no one knows. And as is generally the case in situations where no one knows, opinions seem to only get stronger.

As blogger Ben Carlson pointed out, retirement is kind of a new concept. People used to work until they died, which tended to be early because...people worked until they died. So, in the last 125 years or so, we've had the advent of the idea of retirement, the onset of social security, the overextension of social security, skyrocketing health care costs and the lengthening of life spans. Given all the constantly changing variables,  much like the guarantees on the box in Tommy Boy, these rules may only serve to help us sleep well at night.

That being said, here's some thoughts in the subject:

First, Mr. Money Mustache examines the old 4% rule and lays out his case why having about 25 times your annual spending is a good number. Also, note the first few comments at the end regarding risk. Don't plan for a 100% success rate, because it's an illusion. A couple my parents knew (acquaintances from high school or something)  always took separate planes when they traveled, so if one crashed, the other would be alive for the kids. Tragically, they both died in the 1980  MGM Grand fire in Las Vegas. Heartbreaking irony, and I honor their attempts to protect their kids from being orphans, but it's proof positive that you can only do so much before life steps in.

Second, the above mentioned Ben Carlson talks about uncertainty and the retirement issue and how this results in the need for continual monitoring.


The Step of Faith

I recently had a chance to hear Westin Wellington of Dimensional Fund Advisors speak (among many other people from the company). He handles a good deal of public facing communications for the firm, and it's easy to see why. Part of his presentation was a walk through the various market prognostications of the last 45 or so years, whether foolishly exuberant or apocalyptic. While few of us likely bought into all of these theories, I think most people could probably cop to being effected by one or two of them. So, listening to his talk was little bit like going through a photo album or one's worst haircuts.

One part of Wellington's talk really struck a chord with me. He spoke of the period around an infamous "The Death of Equities"  magazine cover in 1979. At this point, stocks suffered from years of underperformance. Little did anyone know that equities would soon go on a two decade tear. At this point in time, Wellington said (and I'm paraphrasing) that sticking with stocks would have required something more than data-driven discipline. It required a kind of "intuition" (his word) that capital markets worked. This could also be thought of as a step of faith. "Leap of faith" sounds a little extreme, given all of the data supporting the long term success of stock market investing.

This basically represents a type of investing first principle that would have served someone very well throughout the last 100 or so years. The idea of a first principle (whether in investing or more importantly, life in general) is kind of foreign in this day and age. Many of us go from issue to issue without a guiding ethos, or almost as bad, with an ethos that eventually collapses in on itself. Then, we argue with data that can be twisted or has so many layers that it is almost impossible to find the truth. I would argue that many of my most important beliefs were ahead of the science and data. But, I'll try to keep it to money here.

Author and "adviser-to-financial advisers" Nick Murray once wrote "optimism is the only realism". With respect to money and investing, I don't know if this is 100% true, but 1) it's probably closer to true than many of us realize and 2) it's probably a lot more useful to the opposite of this belief-that pessimism is the only realism.

I wish I could tell you that I didn't find pessimism interesting, especially as it relates to politics and the markets. There's something about contrarianism and pessimism that makes us feel smarter or better informed than others-and I like few things more than feeling smarter or better informed. The problem is that, in investing, pessimism involves a fair amount of being wrong in the form of missed opportunities. Don't get me wrong, pessimists will eventually be right. The question is, on balance, will this serve them well? Missing the 30% stock market correction isn't that great if you also missed the 200% run up that preceded it.

While I probably always knew this to some degree, I still was way too bearish after 2008. Perhaps it looks like a sign of weakness to admit this, so I will risk admitting that to the reader as he/she searches for an adviser who has never been wrong. But be careful, the adviser who has never been wrong is often actually just the adviser who has never admitted they were wrong. And the adviser who never admits he was wrong is the one who isn't learning, so I welcome this attitude, as long is it's the competition who is adopting it and not me.

I'm somewhat comforted in this by a few things, First, Prof. Eugene Fama, who has served as an adviser/board member/spirit animal to the above mentioned Dimensional Funds, has had to do a fair amount of modifying to his theories throughout the years. Now, an academic being wrong isn't unusual at all. What is unusual is admitting the deficiency of your theories and still being able to make money for yourself and others throughout the process of discovery. Most academics in the financial/economics field have to lose all of someone's money before they admit they aren't gods.

Does this mean we throw 100% of our net worth into a stock fund and ride out the storm? No. Most people's guts can stand that, so self-knowledge is key here. Know what you can stand, diversify your holdings accordingly. Just remember a few things. First, stocks involve risk. Limit your exposure to what you can stand to see cut in half (or possibly more). It happens. And it will happen again.

Second, know the true pluses and minuses are of those other assets you own as diversifiers, such as cash, bonds, gold, real estate, hog belly futures, your wine-vending machine business, Green Lantern comic books, etc. You've got to know enough that you won't shoot yourself in the foot or expect an asset with a 5% long term return to give you 10%.

Doing something always involves risk. So does doing nothing. Pick your poison, develop a plan and execute it.

Sticking to Your Guns

I always feel the need to qualify the fact that I'm not a Warren Buffet acolyte, for some reasons beyond the scope of this blog. But, I'd be a fool not to learn from him when appropriate. He clearly knows a thing or two.

Meb Faber points out (in this article from a year go) that many investors could simply ride Buffet's coattails through  Berkshire Hathaway's B shares. That would result in a good overall return, but would also mean sticking through some periods on underperformance to get there.

DIY Personal Finance for Doctors

I just finished a very good book called The White Coat Investor by Dr. James Dahle, which shares a name with his website. The author tired of shoddy financial advice that doctors get and set out to learn as much as he could on the subject, and has made a pretty good go of it. 

The book covers a good deal of financial items specific to doctors, such as medical student loans and malpractice insurance, but it also covers a fair amount of material that is relevant for any small business owner. This would include corporate structure, taxation, retirement savings and asset allocation. And he also has a lot to say about living within your means, a subject that is important to us all.

Dr. Dahle achieved financial independence at a pretty young age and managed to turn his story and expertise into a side business. It's pretty impressive how much he has managed to learn about finance as a sideline gig, but that's the power of "want to". Personal finance is like exercise-you can pay someone to help you, but at the end of the day, you've got to be responsible for the results and some things simply can't be outsourced. 

Some people may not have a choice in the matter, but for many people, their financial situation can be as simple or as complex as they want to make it. But, the good news is that money is one of those subjects where one can learn a great deal through individual reading and experience. Now, some things are going to be too hard to master solo while thumbing through a book on the beach, but there's a lot to learn before you hit that wall.

Dahle has a good deal of less than glowing things to say about financial advisers, but at the end of the day, such opinions generally have an element of truth to them and I am in no position to argue with an individual's experience. Many of his complaints fall into one of these categories:

1) Lack of transparency

2) Cost

3) Misaligned incentives between practitioner and client

I would also say those elements are also present in the healthcare industry, but I won't quibble right now. When and if I  become enough of an expert on the subject to write my book about the medical field (don't hold your breath) I can expound on that. Bottom line is that  any professional that followed the advice outlined in this book would be well on their way to success, as they will be a few steps closer to figuring out what he can do alone. Also, since the realm of personal finance includes everything from investing to insurance to taxes to estate planning, there's going to be areas where people need help. No one (amateur or professional) can completely do it by without help. For times such as those, this book will leave the reader much better armed to find the right expert at a fair price.

The Importance of Persistence...Again

Ben Carlson's (not Carson's) website is one of the better in the financial world. Substantive content, easy to understand, delivered in a matter-of-fact manner with no inflammatory hot takes. I read his book (like his website, titled A Wealth of Common Sense) last summer and enjoyed it. It is full of good content, but one part in particular is worth re-visiting.

[Note: These numbers aren't audited. I used his data as a starting point and extrapolated some more myself with the help of Excel. I make no warranties, but since he is a Charted Financial Analyst and I majored in math, I am hoping we are at least in the ballpark.]

Carlson lays out the story of Bob, the world's worst market timer (the story is also found here on his website). Basically, it describes a guy who starts his career in 1970, saves progressively more cash each decade and happens to plow it into the market at the 4 worst times in the last 45 years. No dollar cost averaging. Only bad luck and bad decisions. 

[Note: Carson has the explanations of the funds/indexes used at the bottom of his page.]

Bob does have one redeeming aspect to his investing, though: he never sells. So, largely on the back of that single discipline, he parleys his $184,000 of investments in $1.1 million by the end of 2013. I did some back of the envelope calculations and that's about a 9% annualized rate of return. The annualized rate of return of the S & P 500 during this time was about 10.5%, but he didn't get that because he deployed his capital at the worst possible times.

But, all things considered, that is a pretty good return considering Bob demonstrated zero investing skill beyond a rigid "no sell" discipline. Now, he had to go through hell to get that return, but he did it. Carlson calculates that dollar cost-averaging would have gotten Bob about $2.3 million. 

Now, there is at least one big caveat: these numbers work out so well partly because Bob was 100% in stocks. Probably not a wise idea unless you have a really big appetite for risk. Most other people would have probably mixed in some bonds there, thus dampening returns. 

But, as Carson points out, the biggest takeaways are that 1) it generally pays to be biased towards optimism and  2) think long term. Also, you could probably put in a third item: as he would have been twice as well off had he bought into the market every month, consistency generally trumps guessing.

The Rise of Robo-Advisers

Betterment, a prominent robo-adviser, has decided to add humans....which kind of defeats the point of robo-advisers. But, that aside, if they are trying it, you can bet that another big robo-adviser (I'm looking at you, Wealthfront) will try it , too.

For those of you not familiar with them, a robo-adviser is an online wealth management tool that provides inexpensive, algorithmic investment services  based on individual risk tolerances without a human financial planner. They basically provide cheap, customized passive investing. You enter some data and risk tolerance info, it spits out an appropriate portfolio that doesn't try to beat the market, merely to follow it.

Many see these as a threat to human advisers. I guess they are, if you think an adviser's job is to beat the market (wrong: it's to help you reach your goals). We probably won't know for sure how good these is until it endures a severe bear market. Some people also have problems with how they measure risk, but that's likely an issue for human advisers as well. And there is also the chance that the algorithms could snowball during a sell-off and create a self-perpetuating mess. I admit, this concerns me, but it seems like there is enough algorithmic activity going on in the markets that this possibility is always present in this day and age, with or without robo-advisers.

The point of all this is merely to say that human advisers are certainly using more technology (to make their jobs easier, serve the client better and reduce costs) and now we see that robo-advisers are using humans. Like most things in life, it's not generally an either/or. Sure some investors who have small nest eggs or are price sensitive may prefer the strict robo-adviser without human interference. And maybe some people prefer the old model where you pay 1.5% for the gray-haired guy in a suit in the oak-paneled room. But, many of us will find a balance in the middle. One of my favorite bloggers, Meb Faber, said (and I paraphrase), "The future belongs to advisers who integrate technology seamlessly and provide value through behavioral coaching". In short, a good adviser will keep the computers running and keep you from shooting yourself in the foot. 

To Flip-Flop Or Not To Flip-Flop?

I've been talking with some other advisers lately and getting into the weeds on best practices, hopefully, practices that serve both the business and the client. The two shouldn't be at odds, an adviser can't have a business without clients and they aren't doing their clients any favors by going out of business. And if an adviser is doing his clients a favor by going out of business, then he shouldn't be in business anyway.

During these talks, the subject of change has come up, and this can be a big problem for both advisers and investors. At the end of the day, people are people and a lot of the axioms of investing are pretty rock solid throughout the decades. But, also, the democracy of data and speed at which we have access to it has certainly made its mark. Some strategies that worked for prior generations don't work as well now. Or it could be that the strategy is undergoing a typical period of poor performance, which is pretty much inevitable. So, during the down periods, investors are constantly wondering if  they should just right the storm out, or if something about the markets has permanently changed. Or maybe, the markets haven't changed, but the investor is simply wondering if his initial assumptions had any merit at all.

The question is "when should we change our minds?" As this blog says, "the graveyard of investors is filled with people who refused to change their mind." True, we may know the guy who is still waiting for the whole internet fad to play itself out, but we also probably know someone who sold in 2008, who may well mostly still be in cash, missing out in very real gains. Flexibility is great, spinelessness is not.

Maybe one of the better ways to think about this is to look at one of the lions of modern finance, Eugene Fama. He made his hay off of the Efficient Markets Hypothesis, which basically said that stocks are all priced correctly, so don't bother trying to beat the market. He later modified his views into the Three Factor Model (developed with colleague Kenneth French), which said that a stocks return could be attributed to overall market return, the size of company,  and price-to-book ratio (or value, as in "is this stock cheap?"). It was later expanded to the Five Factor Model by adding profitability and what they call an "investment factor". Defining those isn't important right now. The fact that they modified their opinion is. Also, in the midst of this, Fama and French also came to the uncomfortable (for them) conclusion that momentum (a stock's recent movement) exists, as well. Although, how much merit they place in it is still up for debate.

It's also important to note that to Fama, this isn't merely an academic.question. He also serves as consultant, board member and thought leader for Dimensional Fund Advisers, so real money is on the line here. What he does and says has consequences. He's got every reason to remain entrenched in a position, but he still is curious and intellectually honest enough to modify his beliefs. Furthermore, the fact that he has made past adjustments isn't getting in the way of his acting on his current ideas, and making money for himself and others in the process.

Part of the difference between what people like Fama and French are doing and what the average investor is doing is familiarity with the data. For most, the only feedback they get with regard to investing is their current return. Not to sound like Johnny Cochran, but, if it's bad, they get mad. Then, they change things up at the worst possible time, a fool's errand when investing virtually assures that even the best strategies will give us a pretense to be dissatisfied at one point or another.

Performance alone, or lack of it, isn't a good enough reason to change course. Investors need to look for the reasons behind the performance-the explanatory factors-in order to determine whether  a change is warranted. Results are important, but they don't tell the whole story. At any given time, investing results could be bad. That's life. That isn't a reason for massive change any more than a passing mood is. In the same vein, the 2-3 days a month we generally spend in a depressed state isn't a reason sell the house, quit the job and follow Widespread Panic on the road.

Advisers need to be on guard for this as well. My general rule has been to make changes slowly, although I hope this doesn't prevent me from someday making a quick change if the facts are overwhelmingly obvious. That's where judgement comes in, and that comes with experience and knowledge. If you have these things yourself, you very well might not need an adviser. If you don't, that's where one can help. For all the knowledge that advisers like to think they have, with the proliferation of data and robo-advisers, their best service might merely be serving as a firewall between a client and a bad decision.

Rick Barry's Open Secret

Continuing yesterday's theme on index/passive investing, here is an article on Abnormal Returns about free throw shooting and investing.

The Cliff's Notes version is this:  an episode of Malcolm Gladwell's Revisionist History podcast talked about NBA legend Rick Barry's unorthodox style of shooting free throws: underhanded (or "granny style" or "potty shot"). He had some success teaching it to poor free throw shooters because, from a physics standpoint, it is an objectively superior way of shooting. But few stick with it, because it looks ridiculous.

Although index investing doesn't exactly look ridiculous, some people shun it for similar reasons as they do underhanded free throw: it's not as cool as active management. The bottom line? Whether it is textbook passive investing or something similarly mechanical and boring, forget being cool and seeking action. Go with what works. And with this style of investing, at least you don't have to do it in an arena full of spectators.

Passive Potpurri

This has been dealt with before, but it's worth repeating. A couple of things to keep in mind with "passive" investing (or "index" investing):

-"Passive" isn't exactly the best term. If you decide to invest passively, this still raises a host of questions. Which stock index do you use? What percent do you allocate to bonds? To foreign assets? Any precious metals? You haven't cut out decisions altogether, but you have reduced their frequency.

-To that point, once you decide to passively invest, buckle up for a potentially wide ride. If you put all of your money into a U.S. stock index fund, you could see it cut in half. If you dice it up more ways, you might be able to avoid such a dramatic turn, but you likely sacrifice upside returns.

-If you invest passively, it's unlikely that you will ever been the smartest one in the room, or the dumbest. But, the vast majority of investors fail to achieve index-level returns, so don't confuse "passive indexing" with "average". You would be much closer to the head of the class than the rear.

Passive/Index investing isn't the only way to invest, but it is among the simplest. But you must stick with it for the long haul. Passive investing is patient.

Dividends: Don't Lose the Forest Through the Trees

Meb Faber has a great piece on why dividends are overrated. Now, the "overrated/underrated" debates are kind of cliche, but caring too much (or caring at all) about dividends could be costing you money.

Here's a quick primer on dividends. Stock ABC is trading at $10. It declares a $1 dividend. The investor gets that dollar in their pocket, but the stock drops to $9. It isn't free money. That dollar represents one less dollar that the company can reinvest in itself. And if a company doesn't declare a dividend, anyone who needs income can simply sell enough stock to match the dividend they need/expect, so it's easy to replicate.

Combined with things like debt paydowns and stock buybacks, dividends can be useful (as seen in this book by Faber), but in isolation, they aren't that great of a metric.  It's important to remember, absent taxes, transaction costs and some psychological factors, dividends are a neutral transaction. Don't be fooled by the shiny object. There are things that matter in investing, but, in and of itself, a dividend likely isn't one of them.

When Dallas Is In Trouble, No One Is Safe

Big city promises big pensions to its public service sector, kicks the can down the road, thus creating a time bomb for future generations to deal with as they have to decide whether to stiff the retired cops and firefighters or the currently serving ones. Its a common tale, one that we normally associate with California or the Rust Belt, but Dallas? That's the grim scenario laid out in this New York Times article (not always the most trustworthy of sources, but I think this article is mostly on point, I vetted it with Zero Hedge).

Trading and investing off of the news is not a good idea. But, the news can remind us of larger truths. In this case, it's that you likely can't borrow forever. I hope to let you know for sure in about 10 years, once this latest experiment has run its course.

Many investors might have gotten over the election night  jitters that plagued the futures markets as Trump marched to an unlikely victory. The prospect of less regulation and taxation even has some one-time Trump opponents cautiously optimistic. However, that doesn't change the reality: our economy has some serious obstacles that would challenge any person not also capable of turning water into wine. Dallas is a healthy city in a healthy state, and it's still staring into the eyes of an intractable fiscal crisis. You can't invest by trying to time that latest meltdown, but your investment plan has to take into account the fact that meltdowns will happen. 

Have an emotionless method for investment (as opposed to a series of useless predictions) and be sure not to overestimate your risk appetite. Rough times are always ahead, the key is trying set yourself up to absorb them.

Book Review: "Chain of Title" by David Dayen

The good news is that this only potential effects people who own or want to own a house. The bad news is that that includes most people. David Dayen is a freelance writer whose first book is a very thorough and disturbing look at foreclosure fraud in America, particularly in Florida. It is the story of a cancer nurse, an employee at an auto-dealership and a lawyer (among others) who independently decided to fight their foreclosures and discovered massive fraud.

Most people are somewhat familiar with the idea of mortgage fraud, which is basically lying to get a loan or more favorable lending terms. Foreclosure fraud is the other side of the coin as holders of the loan foreclose when they don't actually have a standing to do so, generally by not having proper documentation and/or actual proper legal ownership. Mainly this is due to loans being repeatedly bought and sold so quickly that the paperwork is either behind or non-existent. In the rush to securitize these mortgages in the years leading up to 2007-2008, county offices such as the register of deeds or recorder were often bypassed by MERS, an online registry that was sloppily maintained. As a result, oftentimes, the company doing the foreclosing didn't even own the loan, and if money ever even properly changed hands, there was no proper proof that it happened.

Some might say, "So what? If the homeowner didn't pay their bills, who cares if all the i's were dotted?" This is a problem for a few reasons. First, there's a rule of law issue. With respect to justice, procedures are arguably as important as outcomes, this is what "due process" is all about. And if rule of law is important for right-wingers when they criticize the president over various issues,  then it is an equally valid basis for legitimate populist causes such as individual homeowners fighting Wall Street. From a pure capitalist standpoint, orderly property transfer is a important part of a free market economy.  Without it, things start breaking down as trust erodes.

The second problem is that in many cases, the homeowners were up to date with payments and the banks made errors. Dayen speaks of cases where the homeowner was behind by mere pennies due to an honest mistake and at least one case where they were ahead in their payments. Sometimes, a homeowner who was experiencing financial hardship requested a modification was informed by a rep from loan servicer that no one would pay any attention until they were actually behind in their payments.   Then, once they intentionally withheld money as a way to begin the negotiations, they were foreclosed on anyway (admittedly, there were also  cases where the banks didn't act for years). Simply writing all of these people off as deadbeats isn't appropriate or true. Were there owners how bought too much house and couldn't pay up? Yep, but there was also a fair amount of bank misbehavior.

Which brings us to the last issue: many of these loans shouldn't have been made in the first place. A lot of these homeowners simply bought too much house. Certainly, they were complicit in this error and need to answer for it and likely give up their house, but the banks also made such overreaches easier by failing to verify job or income status. If everyone had too much to drink at the party, the homeowners shouldn't be the only ones to deal with the cleaning up and fighting hangovers.

If there's any bright spot of this, it's the bipartisan aspect. It seems the Democrats handled this slightly better than the Republicans, but both parties didn't really do homeowners any favors, so finger pointing doesn't really get us anywhere. The Obama administration paid lip service to the problem, but action was largely slow or nonexistent. And there is certainly evidence that Florida AG Pam Bondi (of the GOP) tried to stand in the way of the investigation. Both parties left themselves wide open to the accusation that they are in the pocket of the banks as they ignored compelling evidence as long as they possibly could.

This book shined some much-needed light of an important issue and the many people who obsessed over justice not just for themselves, but for the general public. Thanks to the fast and loose approach many banks took with respect to the rules, it could take decades to unwind some of these title issues and reading this book as a great first step in getting the average consumer up to speed on the problems we face.

The Importance of Persistence in the Markets

A frequent theme on this site is that there is more than one way to skin a cat with regards to investing. Momentum, value and passive styles all have marks in their favor. Admittedly, though, value might be a little harder to implement than the other two, as it tends to take a stronger stomach and/or more data crunching.

I just got through with a pretty good book called Heads I Win, Tails You Lose by Spencer Jakab. It's more or less about simplicity and avoiding mistakes in investing. Even as someone who has read a fair deal on that subject, there were still a few nuggets that I either hadn't considered or just hadn't given much thought. But, like a classic such as Simple Wealth, Inevitable Wealth by Nick Murray, this much remains the same: whatever you do, you have to stick with it.

The three strategies outlined above (passive, momentum and value) may be different, but they all reward persistence. Despite the fact that each of these strategies can work and are valid, switching between them will serve you no better than a squirrel changing directions two thirds of the way across a street. The method is much less important than finding something that you are familiar with and believe in enough to stay with it through thick and thin.  

Of course, this is true for the money you have in the market when it starts to go bad. When things break against you, keep at it. If you are passive, stay passive. If your momentum strategy sends you signals, follow them to a T.  But,  the other half of the equation is that things work best when you also set money aside every month. Persistence isn't just about following your plan with the money you have already committed, it's also about continuing to set money aside on a regular basis in accordance with your initial investing method. This is why real estate can often appear to be such a good investment. For all of it's risks and potential faults, the structure of a mortgage is pretty good at encouraging discipline, as it  makes panic selling a bit harder than is the case with stocks and is a de facto automatic investment plan.

Here's a calculator that illustrates that point. I looked at the period from January 2005 to Dec 2015. This is far from ideal timing, as starting in 2005 is getting in at a relative high point. Starting with $100,000 and adding $500 a month gets you an ending balance of about 327k, which is an internal rate of return of about 8% (disclaimer: those numbers are not audited and based on me using Excel so take them with a grain of salt).  This compares favorably with the S&P 500's annualized return of 7.06% over the same period (per this calculator).

Also, it's important to remember that this rate of return will change as the ratio of initial investment (in this case $100k) changes in relationship to the recurring investment ($6000 a year, in this case). For instance, if you started out with zero dollars, your return will be better because you had fewer dollars in the market in 2007-2009 when it went south. This is a classic illustration of the disclaimer: individual results will vary according to how much you start with, the rate you add money and the time period viewed. This is another great reason why it is wise to focus on your return and goals as opposed to looking at your neighbor's performance.

Lastly, remember, for non-passive strategies, underperformance is almost a guarantee at some point. As a matter of fact, if you are consistently outperforming the market over all time periods, it might be a time to worry. Long Term Capital Management was beating everyone...until it crashed and almost brought down the world economy (side note: this outfit was led by geniuses, market superstars, PhDs  and Nobel Prize winners...so much for that). You have two basic choices. First, you passively can ride the ups and downs of the market, however high or low it goes. Second, you can undertake an alternate strategy knowing that, no matter who good it is, there are going to be times when you will feel like a fool when everyone else is making easy money. If you switch your plan then, that is a recipe for disaster.

Whatever you do, plan on doing it for at least a complete market cycle (about ten years). You can always change things up, but only after careful thought and reflection. And the reason better not merely be because the returns aren't good enough. If that were sufficient, everyone would be changing strategies every 5 years, and that leads nowhere.

Almost Nothing Good Happens After 1:00 AM

This is something that college football coaches know all too well. They get a phone call at 1:30 in the morning to find out that their starting center was involved in a pier sixer in the parking lot of a White Castle after getting pulled over while drunk driving on a stolen Segway.

As this article points out, the same could be said for after-hours trading. The early reaction in the futures markets to the Trump lead was not favorable. People who sold on such news missed a pretty quick rebound. It was such an obvious overreaction (and similar to the Brexit issues of a few months back), that it is hard to believe that anyone actually fell for it and sold.

This isn't to diminish the real political differences between the candidates. If Trump is your guy, you are happy. If you voted for Hillary, you aren't. These elections will have consequences in policy, whether they are good or bad depends somewhat upon the intersection of future events with your personal worldview. But, from an economic/geopolitical worldview, such a quick downturn was largely unwarranted. Now, Trump's economic policies may be dangerous and may start a trade war, but let's not look at them in a vacuum. 

First, the fact that Trump's economic plans have met resistance from economists isn't exactly a bad thing. Economists often stink at predictions as badly as, well, the pollsters who predicted a Trump loss. Could his policy be bad? Sure, but there's not even a guarantee he would enact them. It wouldn't be the first time he backed off a position. His campaign was a dance of staying somewhat true to his nature while being somewhat malleable. Like it or not, it worked and it is likely to lead to more of the same.

Second, the fact that Clinton was allegedly a "known commodity" was counting for a little too much as these markets took a dive. Does Trump have to own his potential negatives? Yes. But Clinton also has to own her security breaches, lapses in judgement on foreign affairs and cozy relations with people who might not have America's best interests at heart. That the markets found her to be the default "safe" option seems a little odd. They both have baggage.

Lastly, let's be honest, the current situation is the perfect recipe for a one-term president. We have a serious math problem with entitlements, demographics and health-care on the economic front, not to mention an ever-changing world outside our borders with a war with terror being waged, whether we want it or not. The business of governing will be hard for the foreseeable future and it won't be smooth sailing for any person, even if he/she were Reagan, Truman and Mother Teresa all rolled into one.

The GOP was saved in the 2014 midterms, doomed  from last summer until yesterday and now it is again resurrected. It now has an incredible amount of power...and an incredible chance to shoot itself in the back of the head. Whether you like that or not, it is a testament to how quickly things can change and how things are rarely as bad, or as good, as they appear. The only certainty is uncertainty. We must live with that...and, also, stay close to home (and away from eTrade) after 1:00 AM. Seriously, nothing good happens then, especially if you are married and over 40.