Sunday, September 30, 2012

Financial Illiteracy: Too Many Are Not Ready For Retirement

This week my thoughts have turned to retirement for others, including my children and grandchildren as well as many others that I know. The concept of a voluntary cessation of producing an economic income and relaxing comfortably at leisure is shaping up to be one of the great myths. They simply won’t have the money to be only mild spenders and not earners at hard work. If we think the current debt structures and deficits are troublesome, we only need to look at the future. Unless we dramatically change the savings, investing, and living practices, the size of the population that will need help to retire with any sort of comfort will be huge. In my view the only long-term answer to the crushing problem is practical education. Of the three parts to the solution: saving, investing and life style, my only expertise is in investing. Nevertheless, I recognize the other learned skills of budgeting (controlled spending) and leading a healthy life are equally important.

Investment is an art that begins with reading

While almost all could benefit from reading Wealth of Nations by Adam Smith, Securities Analysis by Benjamin Graham and David Dodd or even to a much smaller degree my book MoneyWise, these are not what I am talking about. The kind of reading that I am alluding to is reading the situations around the world by observing every single day. Particularly now in these stressed times we watch conspicuous consumption with some awe. We do not pay enough attention to those who are not currently spending because they can’t and those who choose to spend less. Both groups are important to observe. Those with little resources and living moment to moment didn’t follow (or found it too difficult to follow) their few successful classmates, teammates, fellow workers, neighbors, etc. There are always some that took advantage of the opportunities to move up and out. Luck was not the source of their ascendency, but rather they recognized opportunity and the willingness to do the difficult. The second group of curtailed spenders may well be future-oriented as distinct from living moment to moment. The second group has internalized the fact that limiting current spending is transferring resources (no matter how small) to a future period. This transfer can earn additional awards through investing. Other places to read the economy are the gas stations (gas prices and level of maintenance and repair work), supermarkets (changing prices, excess inventories, the shifting to store brands from nationally advertised brands, quality of produce, etc), and shopping malls with high turnover stores (promotional and everyday prices, inventory of your size, stock liquidations, imports vs. locally produced merchandise).

There are too many financial illiterates

At the last board meeting for the Museum of American Finance where I sit as a Trustee, there was mention of a study by Annamaria Lusardi (George Washington School of Business) and Olivia S. Mitchell (Wharton School, University of Pennsylvania) entitled “Financial Literacy and Retirement Planning in the United States.” In a survey of 1200 responding Americans, the study asked three very simple questions; (1) understanding that interest rates can add to the value of savings, (2) understanding that inflation can reduce spending power in the future, and (3) whether some form of diversification lowers the risk of loss. Only 35% of the respondents got all three answers correct. What is even more discouraging is when the respondents were divided between those that are planning for retirement and those who were not, 47% of the planners got all three correct and the non-planners 23.9% got all three correct.

Salary savings plans: 401(k), 457, 403b come to the rescue

These savings plans increasingly require all the new, and in many cases present, employees to participate in defined contribution plans which are replacing defined benefit plans where and when possible. These plans are usually funded by employer and employee contributions. These contributions are invested at the discretion of the employee into various options including default options if they fail to make a choice. Open end mutual funds are the single most popular choice for managing this money according to the funds' trade association, the Investment Company Institute (ICI). Last week I contributed a brief column to Reuters on how I select the various options to be offered within a plan. In addition to the nine alternatives, I suggested that a managed account offered through the 401(k) could adjust the investments to changing market conditions and outlooks.

There are two dangers lurking in these plans

Both of the dangers lurking in these plans stem from some of the participants (beneficiaries) of the plan and an occasional sponsor of the plan not grasping that these are fiduciary accounts whose sole purpose is to build retirement capital. Another survey by Transamerica Center for Retirement Studies found that 63% of those who had participated in a 401(k) plan drew cash out when they became unemployed, and 34% of the underemployed did as well. Not only is there a tax penalty for a premature withdrawal, they are in effect robbing their own retirement money and/or benefits that could go to their family or heirs. I suspect that many who withdrew would have been part of the 65% who did not correctly answer the three basic questions in the other survey. Also they did not read (or see) the poor and struggling retirees around them. In the long run they and the rest of society who will give them some support will have suffered from their financial illiteracy and their inability to observe others around them. The contribution to our future deficits will be caused by this failure to educate our people.

The second risk, which is much smaller, but still a risk in some relatively small plans of privately held employers, is an attempt to replicate the senior executive's personal investment account. Even in the smallest of plans with just one owner and one employee, the sponsor has a fiduciary responsibility to the sole non-owner employee that the money is being invested in a prudent fashion. Also the executive who presumably has a significant personal account would be better off investing in potential capital gain earners in their personal account where, under current US tax regulations, they will pay fewer taxes when they liquidate.

What has me worried is when I see sector-oriented indexed exchange traded funds (ETFs) in retirement plans. These are narrowly focused portfolios designed to replicate a fixed list of stocks in one sector or industry. My concern is that these are good trading vehicles particularly when combined with short sales of some stocks within the industry. But the flows in and out of these ETFs are much more volatile than the underlying stocks. According to the ICI, the gross redemptions for all sector/industry funds through August, 2012 was $146 billion and the total assets in these funds was $246 billion. To be fair, the gross redemptions were somewhat offset by some inflows. Nevertheless, the gross redemption total indicates to me the speculation that is going on within these kinds of vehicles. This is just one of the types of investments that may be wonderfully appropriate in a personal account, but should not be found in a fiduciary account for all employees in a plan. Luckily, instances of these hyper-aggressive strategies in retirement plans are rare.


I speak with bias, in that I manage a small, private financial services fund that has positions in a number of investment management stocks. Despite the problem with financial literacy, I believe that defined contribution plans will continue to grow at rates faster than employment and the economy in general. Investment management company stocks should benefit from this perceived trend.

Are you reviewing your retirement planning?

My next blog will come from London.
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Sunday, September 23, 2012

Investment Lessons of the Week

Previously I have written about the eventual trap of arrogance. Most politicians, and many investors will not admit to making critical mistakes. I try to be different. The only thing I promise each of our accounts is that I might make mistakes that hopefully I correct before there is too much pain. My main defense against arrogance is that I try to learn something new every single day. I have suggested this pattern to my children and grandchildren. The power of the new idea, new view, and new approach is that it forces one to relate the new with the old - and that becomes a challenge to many of our beliefs. Just this week, I have knowingly been exposed to at least five new elements to my thinking. All of these have a global context.

Logistics lead, but need to be interpreted

Last week I commented in my blog about what I learned from our visit to Mount Vernon. First, that steamship volume was increasing and that I saw many trucks from logistics companies going south on the Interstate Highway. This week a friend of mine noted that in September, the Baltic Dry Index moved from 662 to 778. What was even more encouraging is that the spot rate for the largest-sized vehicles carrying dry cargo (for example, iron ore) skyrocketed from around 2000 to 7600 this week. I believe the surge noted in iron ore shipments is due to the announced efforts to build many subway systems throughout Chinese cities. (As someone who for most of my life lived in and around New York City, the idea of relieving the roads of the clogging, expensive, and pollution generating car traffic seems to be a great idea.) To me the materially-increased infrastructure investment in China is a very practical stimulus that will use imported iron ore to make steel in local Chinese mills, a very intelligent way to address its economic slowdown.

A careful searcher for truth will almost always find some contradictory evidence. One of the oldest of all technical (market) indicators is the belief that the Dow Jones Industrial Average cannot make and hold new high levels if the Dow Jones Transportation  Average (which used to be composed of just railroads) does not confirm by making its own new high. The belief is that if the two indexes diverge they will have to find a bottom before there can be a successful sustained new high. This week the Norfolk Southern Corp. lowered its expectation for the current year’s earnings. The Dow Jones Transports declined on this news. The decline’s impact on the industrials needs to be put into perspective. The railroad is one of the largest shippers of coal in the country. Just as governments can attempt to make companies grow; e.g., solar and wind power, it can force lower sales of others. The Obama administration, along with much lower natural gas prices, is making coal an unattractive fuel for our electric utilities. Fuel for the electric utilities is not being delivered by train, but by pipelines, barges and other vehicles. Thus, as of this week I believe that we are seeing some resurgence in industrial activity, which the stock market is already discounting.

Cash to stock is becoming an easier switch

Last week I attended two investment focused meetings. In the first a large regional bank gathered some of its best potential and actual investment clients to a private lunch to hear my views on investing. They would not have taken time from their busy day if they were not already investing in equities or considering it. In our conversations they recognized that long-term they needed to be significantly exposed to the world of stocks, perhaps through funds. Everyone at the lunch could recite, in detail, their concerns about the stock market, but they still came and stayed for two hours.  One evening last week I was at a post-meeting dinner for a board on which I sit. At one point during the long dinner, a very successful second generation Wall Streeter leaned over to me to tell me he had not bought a common stock for his own account for over two years and now he was ready to buy. I suggested that he call a mutual friend of ours with whom he had successful business dealings, to help him reenter the market. He noted on his pocket pad to call our friend in the morning. These two instances suggest to me that the historic pattern of people coming into the stock market as it goes up is holding. While some of the easy money has already been made in the low volume markets, there will be opportunities at higher prices.

‘Tis the season to be “Vixed”

Many commentators have spent much time noting that there appears to be a low level of fear expressed in the options on the S&P 500 as captured in a traded index with the symbol of VIX, (CBOE Market Volatility Index). If one reads Randy Forsyth’s article in Barron’s Friday September 21, we should be prepared for problematic markets. I have lived through the October “crashes” in 1978, 1979, 1987, and 1989 but not the big one of 1929. What I had not compiled were the other autumn events that were dangerous to one’s capital base. As today’s global stock markets are reacting to government manipulated fixed income markets, recognition of the following Autumn occurrences is important:

1.    September 24th 1869: the US government sold gold  to break the “corner” that was attempted by Jay Gould and Jim Fisk.

2.    September 20, 1873: the New York Stock Exchange closed due to a panic.

3.    September 21, 1931: Great Britain’s suspension of the pound’s link to gold.

4.    September 21, 1985: the so-called Plaza Accord broke the ascent of the US dollar. (Too bad to bring that wonderful grand hotel into another round of government manipulation.)

5.    September 16, 1992: The withdrawal of Sterling from the European Exchange Rate Mechanism and reportedly a huge winning bet by George Soros.

6.    September 23, 1998: the culmination of the Asian currency crisis which began in July 1997.

7.    September 11th, 2001: the attack on the World Trade Center in NYC.

8.    September 15th 2008: the collapse of Lehman Brothers followed the next day by the near collapse of AIG.(These were much more significant in the global fixed-income markets than in the stock markets.)

Long-term fears and where you hold your investments

Ray Dalio, the founder and co-CIO of Bridgewater Associates in an interview with CNBC  had some dark thoughts. His fear is that after a ten to fifteen year managed depression (austerity without growth), that the social tensions between various economic and ethnic classes in southern Europe may produce an appeal to some strongman/woman to take over and solve the problem; e.g. the appeal that brought Hitler to power. Much closer to home, a savvy investor shared her concerns with me. She is worried that in the US (and by some extent in other Western countries and Japan) that the medical and related costs of keeping the elderly will be too much for the younger tax paying generations to tolerate. A financial class war is what she is predicting.

I asked this smart, experienced lady how she was preparing for this with her portfolio today. In general she had foreign investments for 30-40% of her portfolio. But the bulk of the rest was in multinational companies. She uses Coca Cola as an example, which gets most of its earnings from outside the US. I am not sure that her strategy will deliver against her fears or those of Mr. Dalio.

For many years I have complained to various fund managers that displayed their portfolios on the basis of the statements they receive from their custodians. The custodians list securities on the basis as to where the entity is legally domiciled. From an analytical standpoint, I am interested where the company is making most of its operating profit. That is the country or region which will have, in general, the biggest impact on sales and operating earnings. For regulatory reasons I will probably won’t win this argument with published reports but with careful analysis I can probably guess the key sites of operating earnings power which should help in determining the strategic value of the investment. However, the concerns expressed by the lady and Mr. Dalio raise another issue.

If our current fears turn us into a refugee mentality, it is not where an entity makes its money that is important, but where are the assets and where can they be traded in a period of distress. If these fears become somewhat more widespread, we may see wealthy US investors move to vehicles that are beyond the problem areas.

Which comes first: weak currency or weak military will?

A study of history suggests that a weak military will eventually invite others to seize our assets and possibly our lives. Often the decline in military willingness to aggressively defend its homeland comes from a policy of weak currency management as it attempts to take market share away from trade counterparties by having lower prices than they do. For a generation we have seen that many Europeans will not support a strong military; e.g. in the Balkans, and we also see that the value of their currencies decline. While much has been written about Quantitative Easing Infinity,  in terms of US stimulation, on a longer-term basis the decline in the value of our currency is in effect a weak dollar policy. Combining our planned Asian withdrawals and defense expenditure cutbacks, a weak dollar policy is going to invite more trouble. As much as we don’t like to be negative, maybe we need to pay more attention to our worriers.

The bottom line: be careful and stage your money into equity vehicles with some concern as to where your assets are being housed.

What Do You Think?

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Sunday, September 16, 2012

Politics Follows The Market, Not the Other Way Around

This weekend my wife and I drove down to Mount Vernon, the ancestral home of George Washington. For many years Ruth has been a member of “The Life Guard Society.” This is a fund and friend-raising group to support the preservation and enhancement of our first president’s estate and image.  The name Life Guard comes from the group of 150 officers that successfully protected General Washington against personal violence. In other words they were the forerunners of today’s US Secret Service White House force. The purpose of the meeting was to celebrate the acquisition of Washington’s personal copy of a book called the Acts of Congress. This book contains the Constitution, the Bill of Rights and legislation that was passed in the first year of his Presidency. What makes this particular copy extremely illuminating is that it also contains the President’s own notes and concerns. A glance at his brief comments shows he was concerned about presidential powers. His concern was to understand the separate powers of the President, Congress, and the Supreme Court. (He was the only President to appoint all nine of the Justices.) 

After the celebratory dinner there was discussion as to the importance of the written record of both the Declaration of Independence and the Constitution. Thomas Jefferson, one of the principal authors told Washington that there was nothing new in these documents as they expressed ideas that came from the Bible, ancient Greeks, and various philosophers. Once again this view gives me an opportunity to disagree with the third US President. What was new was not the words or thoughts, but that a diverse group of politicians and a few statesmen could and did agree with these principles and literally pledged their lives and assets in support of them.

The enacted political decisions of these 18th  Century men became possible only when they believed that there was support for these ideas and ideals on the part of the people. This is a clear example that politicians and many governments will only move when they deem to have some, if not total support. The old line is that the job of a politician is to find a parade and get in front of it.

What does this history mean for investors in 2012?

I have previously written about being in despair at various learned investment committee meetings with the consensus wanting to hold off making fundamental investment decisions until various elections throughout the world are in the record books. I humbly suggest that is a prescription for not only being late, but also wrong as to the long-term impacts of purely political moves.

Investors need to wake up and look as to what is happening in the real economy and market prices. For example, the US stock market large cap leaders are up mid to high teens on a year-to-date percentage basis. These returns are in many cases twice the too high actuarial rates for many pension plans. If these long-term plans were properly equity oriented and if they went to cash today, which they won’t, they would have met their obligations for two years. Probably much more significantly, this summer’s equity rally reduces the odds in some minds of a fear of a major market decline.

Another sign of the markets moving ahead of the politicians in response to the manipulation by the US Federal Reserve and the ECB, is the significant sale of US dollars not only to buy stocks, but gold and the euro. The latter is a bit breathtaking. Following the very bad practice of US bailouts and corruption of the bankruptcy acts as a vote buying exercise, the ECB will supply enough capital through the purchase of bank bonds to be prepared to restore the major banks’ capital requirements after a soon to be appointed European banking authority eventually forces a substantial write-off of the debts incurred on the periphery.

What is missing in almost all countries that are running deficits is that the politicians provide goods and services because the people won’t. Individuals do not recognize the responsibility for their own deficits. These deficits are not the mismatch of their expenditures versus their incomes. The deficits are much deeper as in healthy lifestyles, competitive useful knowledge, work ethics, and accumulating retirement income for themselves. I am told by those on the left that I am asking too much. I suggest that once again we can learn something from the ancient Greeks. Look at the last Olympics, people all over the world cheered the success of champions and other participants in many competitions even if they had little real understanding of the sport.  Further, in our society someone becomes something of a celebratory for completing a piece of art, musical composition or a book despite what some might say is the poor quality of the work. It is the completion of a recognizable task that is celebrated. What we should celebrate and therefore encourage is striving. When more Americans and Europeans show signs of striving we will begin in a meaningful way to dismantle the deficit producing engines.

How do we develop portfolio decisions?

The first thing to do is to look around you. "The trucks are rolling" was the message I got driving back from Washington on a Sunday. There were many trucks on the Turnpike. Many of them were from logistics companies that have become a critical part of “just in time delivery.”

At last night’s dinner someone in the steamship business noted that business was increasing. A mixed view is the continuing office building and luxury apartment construction one sees driving through Washington. At a recent investment meeting someone noted that people were coming up and offering twice the price for a condo than the owner had paid.

One of the negatives expressed about equities recently is that American businesses are running at very high operating margins in part due to a significant increase in productivity of a smaller labor force. For many companies, global sales growth has been disappointing. If I believe my eyes and what I see out of the logistics sectors of our economy, we are in the early stage of a re-equipment surge. At some point, even to get out today’s volume of goods and services, we will need to replace worn out machines and perhaps people.

One interesting question is how unproductive the heady amount of global Internet and media spending on entertainment is, compared to what has been lackluster spending on the part of business? While I do own a few shares of Apple from a historic accident, I do not consider myself a qualified analyst on the stock. I do not own shares in Microsoft directly, but a number of funds owned by my clients and I hold shares in both Microsoft and Apple. With that as a background, I wonder at what point are we going to see Microsoft’s business clients start to show some of the enthusiasm that has posted orders for Apple's iPhone 5? If that were to happen, the world will become more serious about working on its problems rather than its entertainment.

In the meantime selling US dollars is probably wise.

What do you think? 
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