Monday, November 4, 2013

Last Words


I hit "publish" for my first post on this site on November 1, 2010.  Over the last three years, we have covered a lot of ground exploring the topic of investing.  This is the last Wall Street Smarts blog post, and it seems appropriate to end with final thoughts from several of the authors we have studied.

Al Frank, in Al Frank's New Prudent Speculator, had this final advice for his readers:

If you feel overwhelmed by information overload, step back and consider what is being asked of you, and what you must ask of yourself, in order to speculate successfully in the stock market.  Basically, all you need to do is buy some undervalued shares of several corporations' stock.  With a few hours of self-training, you can select undervalued stocks as well as the next person, if not better.  Spending a few more hours to understand the long-term positive nature of the market, the average upward trend of 10 percent or more for many years, within which are selloffs and rallies, you will be armed intellectually to cope with stock and market price fluctuations.

Ben Graham ended The Intelligent Investor with these parting words:

We are not going to end with J.J. Raskob's slogan that we made fun of at the beginning: "Everybody can be rich."  But interesting possibilities abound on the financial scene, and the intelligent and enterprising investor should be able to find both enjoyment and profit in this three-ring circus.  Excitement is guaranteed.

Burton Malkiel concluded with an analogy for investing in A Random Walk Down Wall Street:

Investing is a bit like lovemaking.  Ultimately, it is really an art requiring a certain talent and the presence of a mysterious force called luck.  Indeed, luck may be 99 percent responsible for the success of the very few people who have beaten the averages......The game of investing is like lovemaking in another important respect, too.  It's much too much fun to give up.

Peter Lynch listed his 20 Golden Rules for investing at the conclusion of Beating the Street, and the following is one of them: 

Owning stocks is like having children -- don't get involved with more than you can handle.  The part-time stockpicker probably has time to follow 8 -- 12 companies, and to buy and sell shares as conditions warrant.  There don't have to be more than 5 companies in the portfolio at any one time.

Jesse Livermore may have summed it up best in How To Trade In Stocks: 

There is nothing new on Wall Street or in stock speculation.  What has happened in the past will happen again, and again, and again.  This is because human nature does not change, and it is human emotion, solidly built into human nature, that always gets in the way of human intelligence.  Of this I am sure. 

Thank you for reading.

Monday, October 28, 2013

Enough is Enough


Throughout this blog, I have repeatedly pointed out that an individual must set a goal as the first step in any investment plan.  Why are you investing?  What is the purpose of the money you hope to make with the investment?  Saving for a rainy day or for a child's college tuition each require a different investment strategy.  The strategy for both of them will differ from the strategy for investing a retirement portfolio.  The Cat in Lewis Carroll's classic Alice's Adventures in Wonderland gave Alice the following directions: 

"Would you tell me, please, which way I ought to go from here?"
"That depends a good deal on where you want to go to," said the Cat. 

Ben Graham advised individuals that they should not invest to "beat the market."  Rather, the investor should focus on achieving his or her specific investment goal. You may recall the TV ads for an investment firm which promised to help you reach your "retirement number" (whatever that means).  They never explained what a person should do if and when they reach their number?

Al Frank, author of Al Frank's New Prudent Speculator quoted from the fourth century book on Chinese philosophy, Tao Te Ching, when he gave the following advice to successful investors:

In verse 9 we are told, "Going to extremes is never best...The way to success is this: having achieved your goal, be satisfied not to go further.  For this is the way Nature operates." *

In his book Where Are the Customers' Yachts? or A Good Hard Look at Wall Street, Fred Schwed, Jr. asked the following questions:

If a man makes thirty million dollars, and then loses the entire thirty million and some more to boot, would you say that such a man is quite bright in the head? I should like to carry this inquiry into intelligence a little further and ask a second question:  what do you think of the mentality of a man who goes down to Wall Street with very little and wins, by speculation, thirty millions, none of which he has as yet lost?  My own considered opinion is that he too is pretty loony.  In order to make his second unimportant million he had to risk his first precious million?  Obviously he did so, and did it time and again.  That he happens to have been successful each time does not really change the picture.  What could he have been thinking of each time he took all those risks?  The very contemplation of it makes my bourgeois soul shudder. **  (Author's emphasis in bold) 

If you have run through the ribbon at the end of a foot race, stop running.  If you keep going after crossing the finish line, all you can do is hurt yourself.  Some folks still believe the mantra from the 1990s that "More is better."  If you really think about it, more is just more and enough is enough.

The material from Al Frank's New Prudent Speculator by Al Frank, copyright 1995 by Al Frank, is used with permission of the copyright holders, the heirs of Al Frank.

**  Excerpts from Where Are the Customer's Yachts? or A Good Hard Look At Wall Street, Fred Schwed, Jr., copyright © 1940, republished by John Wiley & Sons, Inc, pages 152-154

Comments are always welcome.

Monday, October 21, 2013

Retirement - Your Second First Job (5)


In recent posts, I have touched on risk tolerance.  Your risk tolerance, whether you have measured it or not, is the basis of your investing style.  Your personal risk tolerance level will define your ability to withstand the basic investing emotions: fear and greed.  These inner pressures affect most investors as their portfolios move up or down with the market.  Justin Mamis,  a famous technical investor and author, felt that your view of risk is formed, in part, in your childhood.  In his 1991 book The Nature of Risk, Stock Market Survival and the Meaning of Life, he discussed this phenomenon as follows: 

The first word parents want a baby to understand and respond to is not Mama or Daddy--it's No.  How is anyone going to learn to venture, to take a risk, when "No" resounds?  Parents and baby may exchange smiles, but as soon as the baby wants to take a risk--that is, do something venturesome--the infant hears: "Don't touch that," Watch out," "Be careful."  From infancy's earliest days, taking a risk becomes a negative concept.  "Don't" becomes a family motto. An infant knows no risk; all is ahead.  Parents know all is risk, and try to protect.  The child learns what the parents teach, and a world that starts out full of possibilities becomes full of limits and danger.

Americans are often described as basically optimistic, when in reality it is that they are perpetually hopeful.  The market seems to represent hope itself.  And yet, among professionals, even those who function on the stock exchange floor, a frequently heard stock market expression is, "No one ever said it was going to be easy."   It never can be easy because the rule of the market is that you have to act before you know enough.  Because it is a process there is no one moment or single point, at which one can make an obvious "sure" decision. 

Thus it is not just information that becomes the key to taking a market risk; it is also necessary to understand such information in terms of our relationship to that knowledge.  "What do we know?"   "How do we know it?" and "What is our reaction to that information?" - as well as "What do we need/wish/want to know?" - are all questions that affect the decisions we make every day.  When a decision is required, the way we take information in, and how we use it, affects that decision.  Our self's style goes back deep into childhood.  The manner in which we let information in, our ability to understand it, to deal with it, and perhaps even distort it, all start with who we are, as developed from the moment of beginning, on our hands and knees, to explore the world.

Thus the risk we are about to take via our next decision is not a simple choice of "do it or not" or "yes or no."  Before deciding, we need to know why what we know is never enough, a question that, in turn, leads to what kind of information do we believe or trust? and is it us or the market?  But we must remember that there are times when the market, or life itself, is incoherent, unclear, and/or conflicting: times when it isn't us, it's it.  The risk can never be cured by knowing enough.

But when information is insufficient we need the trust and belief in ourselves, and the inner acceptance that we'll be okay anyhow.  We need the discipline to accept whatever is available.  We need the experience to understand all the ifs, ands, and buts, and yet still confront the risk and make the decision.  Setting ourselves free from the quest for information, oddly enough, is what reduces risk even as it appears from the freedom itself that risk is being scarily increased. 

Keep all of this in mind as you approach your job of retirement investing.  Enjoy your retirement.  Now get to work!

Excerpts from The Nature of Risk, Stock Market Survival and the Meaning of Life by Justin Mamis, copyright 1991 are used by permission of Mr. Mamis and Fraser Publishing Company.

Comments are always welcome.  

Monday, October 14, 2013

Retirement - Your Second First Job (4)


You have been saving, investing and growing your retirement portfolio during your working career.  As a retiree, you should now think like the British and focus on income.  The amount of income you need in retirement is dictated by your desired lifestyle.  How much will you need in order to do what you want for the remainder of your life?  You should start with a budget and see how your retirement income matches how you want to live.  If you have enough to "live the dream", great!  If your income falls short and you do not want to continue to work in some capacity, you have two choices: change your lifestyle or change your income level.  You need to decide how you will handle your retirement assets to support your retirement and not run out of money.  Answering that key question is your Second First Job. 

In the 1990s, William Bengen, a certified financial planner, studied this issue.  He made three assumptions, i.e., the portfolio was in an Individual Retirement Account (IRA) or other tax-deferred account; the retiree did not intend to leave any inheritance, and the savings had to last for thirty years.  Based on those premises, he determined that a retiree would not outlive his or her savings if withdrawals were limited to 4% of the account valued annually.

As with all other financial research and rules, not everyone agrees with Bengen's 4% rule.  Some look to the condition of the market at the time of retirement as a factor.  If the market is down or in danger of decline in the near future when you leave the work force, 4% may be too much to take out early in retirement.  If the market is rising and a retiree has a high risk tolerance (severe stock market fluctuations do not bother the individual), the rate might be set higher than 4%.  Like asset allocation rules, deciding on a rate of withdrawal is not a one time decision.  Both asset allocation and withdrawal rates should be revisited annually.  You might consider the 4% rule as a starting point for your first year of retirement.

Let's review your $800,000 combined hypothetical and cash portfolio from the last post.  As you may recall, we arrived at a notional value for your Social Security benefits of $400,000 (based on a 3% interest rate generating a $12,000 annual payment) and a cash IRA of $400,000.  The cash IRA was divided into debt securities worth $120,000 and the balance, $280,000, was invested in stocks or mutual funds.  Counting the Social Security payments as a debt security gives you a 65/35 percent allocation between your notional and actual debt assets and your equity assets (the age based allocation rule).  Using the 4% rule, this means that you can withdraw 4% of your $800,000 portfolio ($32,000) annually with the goal of your assets lasting 30 more years.  You are receiving $12,000, which is 3% of the $400,000 hypothetical value of your Social Security account.  In order to average 4%, this means that you might withdraw up to 5% of your $400,000 cash IRA.  Your retirement income of $32,000 would consist of the Social Security payments of $12,000 plus $20,000 (5% of $400,000) from your cash IRA.  Obviously, you would want to first withdraw the interest and dividends generated in your IRA to preserve principal.  If that is not enough, the balance would have to come from your principal.

The hope is that your equity holdings will appreciate at a rate greater than your withdrawal rate so your portfolio either remains the same or increases.  Another way to handle this might be to take out only the income generated by your portfolio.  In all probability, you would be taking out less than 4% from the total portfolio.  Conversely, you could increase your withdrawal rate to maintain your standard of living.  Keep in mind that with a higher withdrawal rate, your savings may not last as long as needed.  You might allocate more assets to equities for a potentially higher yearly return, but this would expose your portfolio to a greater degree of market risk.  To sustain a desired life style, you might make a greater equity allocation, a higher withdrawal rate or both.  You would have to decide if you can comfortably accept greater market risk.  What is your risk tolerance?

Decisions, decisions: yes, this is your Second First Job.

Comments are always welcome.

Monday, October 7, 2013

Retirement - Your Second First Job (3)


More on asset allocation.  When considering their portfolio's division between equity and debt, many retirees look at their retirement savings as the only assets which must be considered in arriving at their debt and equity percentages.  Many individuals do not look upon their monthly Social Security check as a retirement asset, but it most certainly is.  I believe your Social Security benefit should play a part in formulating your portfolio allocation.

AARP, formerly American Association of Retired Persons, recently reported that the average 401 (k) balance for individuals in the 55+ age category had reached $255,000.  Let's assume, for the sake of discussion, that by the age of 65, the 401 (k) balance of a person who is retiring today has reached $400,000.  This sum constitutes his or her entire retirement savings.  The individual retires and transfers that money into an Individual Retirement Account (IRA).  Now, how to invest that money?  Following the traditional age based allocation rule, 65% of the portfolio ($260,000) would be invested in debt securities, such as US Treasuries, state or municipal obligations and corporate bonds.  The balance, $140,000, goes into publicly traded stocks or mutual funds, i.e., equity securities.  

However, if you consider your Social Security check as a monthly interest payment you receive on a government debt obligation that you own, those dollar allocations change.  The first step is to find the interest rate on a one year US Treasury obligation.  This information is available every day in the Wall Street Journal.  Assume you receive a monthly benefit of $1,000 from Social Security - $12,000 per year.  Assume further that the current interest rate on a one year Treasury is 3% per annum.  Your hypothetical treasury obligation generating a 3% return of $12,000 would have a notional principal of $400,000 ($400,000 x 3% = $12,000).  In effect, you may now consider that you have an $800,000 retirement portfolio consisting of $400,000 in a hypothetical one year 3% treasury obligation and your actual $400,000 cash IRA.  Under your age based allocation, your total portfolio of $800,000 (hypothetical plus cash) should then contain $520,000 of debt securities and $280,000 of equity securities.  Given the $400,000 notional value of your Social Security "investment", your cash IRA could then be divided into $120,000 of interest bearing securities and $280,000 of stocks or mutual funds.  Under this scenario, your IRA, on a cash basis, could contain twice the equity securities that it would if you did not include the Social Security payment in your allocation decision.  Equities have proven in the past to be a much better defense against inflation than debt securities.

Once a year, maybe each January, you should recheck the going interest rate for one year Treasuries, redetermine the present value of your Social Security "investment" based on your monthly checks (which are increased for inflation) and reallocate between debt and equity.  As stated in an earlier post, asset allocation is not a one time decision.  It should be revisited at least annually.  The allocation also changes as you age, resulting in more debt and less equity.  The age based reallocation need not be precise, year by year.  During your 60s, you might allocate 65% and when you are in your 70s, the debt percentage of the portfolio goes up accordingly. 

The age based allocation has been touted for many years by financial advisers; however, with the extended longevity expected for today's retirees, it may be necessary to consider an allocation which reflects a larger portion of equity in your portfolio than called for under the age formula.  This decision depends, however, on your capacity for risk tolerance.  Like Mr. Morgan's troubled friend, do your stocks or mutual funds keep you up at night?

Comments are always welcome.

Monday, September 30, 2013

Retirement - Your Second First Job (2)

The old rule of thumb regarding asset allocation calls for a portfolio to consist of a percentage of debt securities equal to your age and the balance invested in equities.  At the age of 65, you would have 35% of your retirement funds in equities under the rule.  As with all rules of thumb, they should not be followed blindly.  Setting your allocation percentages is not a "one and done" decision.  You should expect to change your allocation over time as circumstances dictate.There are a couple of other factors to keep in mind.  

A retiree must take the present state of the market into account in establishing his or her allocation between debt and equity securities.  Is the Market rising, declining or moving sideways?  Some consideration of the market is necessary when deciding how to allocate your portfolio.  As the Market changes, it is possible that your asset allocation must follow in some fashion.  How that occurs must be based in part on your investment mentality.

More important than the state of the market is your mental state.  You must honestly determine your risk tolerance.  Warren Buffett said that if you could not tolerate a decline of 50% in your portfolio's value without selling out your position, you should probably not invest in individual stocks.  Over your remaining years, the Market will rise and fall several times, carrying a portfolio of common stocks with it.  If a drop of 50% in value will likely lead you to panic selling, your equity allocation should be smaller than that of an investor who is psychologically able to ride out the decline.  It is said that someone once told J.P. Morgan that frequent changes in the value of the individual's  portfolio were causing him to lose sleep and asked what he should do about it.  Morgan's famous reply was "sell down until you can sleep."  Although anecdotal, the advice may be a good way to decide how much you keep in equities.  Retirement is supposed to be relaxing, not nerve wracking.

The most frequent question asked by the soon to be retired individual focuses on how large a portfolio he or she needs.  Remember the TV ads with the tag line, "What's your number?"  Fred Schwed, in his book Where Are the Customers' Yachts? or A Good Hard Look At Wall Street pointed out an interesting difference between American and British investors as follows:

The British, as a race, have been engaged with the problems of capital investment for a longer period than we have, and accordingly have reached a greater maturity regarding it.  Have you noticed that when you ask a Britisher about a man's wealth you get an answer quite different from that an American gives you?  The American says, "I wouldn't be surprised if he's worth close to a million dollars."  The Englishman says, "I fancy he has five thousand pounds a year."  The Englishman's habitual way of speaking and thinking about wealth is of course much closer to the nub of the matter.  A man's true wealth is his income, not his bank balance.

The retiree's goal is to manage his or her portfolio in such a fashion that there is enough income to sustain a desired life style.  It is up to the individual to do this; the Second First Job.  We will continue to look at this issue in the next post.

Excerpt from Where Are the Customer's Yachts? or A Good Hard Look At Wall Street, Fred Schwed, Jr., copyright 1940, republished by John Wiley & Sons, Inc, page 190.

Comments are always welcome.


Monday, September 23, 2013

Retirement - Your Second First Job (1)


Congratulations!!  You made it to retirement.  As the title of this post implies, you now have a new job.  During your working career, the majority of your retirement savings have, in all likelihood, been managed by a pension administrator or a 401K plan provider.  You may have picked the investment options or opted for the portfolio suggested by the plan provider.  In other words, while you were busy with your career, someone else was making most of the investment decisions for your retirement portfolio.  Like many others, you will probably choose to receive a lump sum transfer of those retirement proceeds into an Individual Retirement Account (IRA) after you have wrapped up your last days of work.  

You are now sitting at the kitchen table on that first morning of your "golden years" wondering where all the time went.  At some point you will begin to wonder about how much money you have and will you outlive your savings.  Your new job, what I call your Second First Job, is to make sure your money is there for you through the remaining time you have, hopefully a few decades.

When Social Security was created in 1935, the retirement age (when benefits could be received) was set at 65.  There were approximately 7.8 million people that age when it was established. Today, a 65 year old enjoying reasonably good health can expect to live at least an additional twenty plus years.  Most women have even more time left.  Remember, these are averages, and when trying to calculate your remaining life expectancy, you need to factor in family history and your life style. For our purposes, let's assume that, as a 65 year old man or woman, you have another twenty years of life ahead of you.  Your money has to last that long if you are single.  A couple must make the expectancy calculation based on the prospects for the survivor.  Here is a link to the Social Security website with a life expectancy calculator.  Another issue to consider is whether you want to leave a legacy for your children, but that is beyond the scope of this post.

The truly organized individual has probably lived within a budget for many years.  Many of us have not, thinking that there is always going to be another paycheck.  The game has now changed.  There will be no more paychecks, unless you intend to keep working in some capacity.  If you are not going to continue full time employment, the size of the paycheck will shrink.  It is now time for a budget to figure out what you can spend and where that money will come from for the duration of your life.  Once a budget is established, your Second First Job begins: how to fund that budget.

A typical retiree will have three sources of income:  Social Security, proceeds from an employer's retirement benefit program (pension or 401K plan) and personal retirement savings, usually an Individual Retirement Account (IRA).

As mentioned in an earlier post, there are three certainties in this life: death, taxes and inflation.  Of the three, inflation is a retiree's worst financial enemy. The annual inflation rate is low these days, but anyone 65 or older will remember the late 70s and early 80s when annual inflation rates were double digits.  There is no reason to believe that this could not happen again in the next twenty or so years.  Even low inflation rates, over time, will significantly erode the purchasing power of a retiree's income.

We will continue exploring this topic in the next post.

Comments are always welcome.