Me, Me, Me

This economic downturn has given me an excuse to rant a little on the next generation.  Of course there are exceptions to every generalization… but I think most mid to late working age folks would agree that the millenial generation (the “me” generation) has a few shortcomings which the rest of us were trying to get accustomed to. 

Millenials are often described as super-confident; carrying a sense of entitlement about them.  They demand rigorous structure, frequent positive feedback, and believe themselves to be truly unique and special (talk about high maintenance).  Expecting to land a leadership job with meaningful work and a career track when just out of college weren’t uncommon.  In recent years, I noticed that some of these characteristics were rubbing off on the rest of us, myself included.

There’s nothing like a healthy recession to curb that sense of entitlement and serve to remind that yes, indeed, you have to work hard in order to meet your goals.

Hyper-stagflation, future real estate crises, and other meltdowns notwithstanding, I trust that we will all (re)learn a little humility as we struggle through this downturn.

In a hurry to finish your taxes?

Don’t be.  Thanks to the Emergency Economic Stimulus Act of 2008, custodians/brokers have an extra two weeks to send you a composite 1099.  So realistically you won’t even get to start your tax return until late February.  The good news is that we’ll all probably not get as many revised 1099s as we did last year.  Good luck!

Know where your money is?

What follows is an excerpt of a press release from NAPFA that I think is very relevant for investors out there:

How to Monitor Your Financial Advisor

Madoff case adds to lack of investor confidence in financial services industry and increases the need for the Securities and Exchange Commission to proactively protect investors

ARLINGTON HEIGHTS, IL (December 16, 2008) – Bernard Madoff’s Ponzi Scheme, which allegedly helped defraud investors of $50 billion, is the latest example of how the financial services industry fails to protect those they serve. The market chaos coupled with this case and apparent inability of the Securities and Exchange Commission (SEC) to monitor large financial businesses highlights the intensifying need for tougher regulation.

Until this regulation is in place and agencies in place are cracking down on unethical, fraudulent practices, investors must take the necessary precautions to ensure they are not at risk. The National Association of Personal Financial Advisors (NAPFA) offers the following advice on how to protect yourself as you work with a financial advisor.

• Know where your money is. Whether your advisor is managing your money or you are the person who signs-off on each financial decision, an independent financial institution will hold your money. This company has “custody” of your money. Make sure you know which company it is; how to contact the company, and what your account numbers are.
• Read your monthly or quarterly financial statements. The firm that has custody, typically a broker/dealer, bank or trust company (known as the “custodian firm”) is required to provide you with at least quarterly financial statements and most will provide them monthly. Read them. Most importantly, make sure that these statements are coming to you directly from your custodian firm – not from your advisor.

See the rest of the press release…

Money Fund breaks the buck!

The real headline investors should pay attention to is slipped into a side column in today’s WSJ.  A large New York based money market fund manager “broke the buck” on a few funds including the Reserve Primary Fund (RFIXX).  This is the first time this has happened in 14 years!  Virtually anyone with a brokerage account has some kind of money market fund in their account where uninvested cash is held.

The mandate of money market funds is to maintain a $1 price (net asset value) every day and earn some interest buying short term corporate debt, CDs, treasuries, etc.  Funds run by the above mentioned manager are now worth less than $1 — thanks in part to Lehman’s collapse yesterday.

In recent times, many of these so called “conservative” funds have had to dip into less secure debt in order to pump up their yields and attract more investors.  In the past, a fund or two have had the parent company (like the big institutions that are failing at the moment) pump in some cash to avoid breaking the $1 threshold.  There was no bailout for the folks at the Reserve and their investors.

The lesson here is that not all money funds are alike — if you’re really worried about this happening to you, try a money market fund that only invests in US treasury securities.  You may get a lower yield, but at least you’re going to be in a default risk free asset.

Coming home to roost…

It’s the same story that will continue to play out in coming months.  Highly risky and irresponsible decisions made by companies are coming back to bite.

The recent failure of SemGroup as described by the WSJ comes to mind.  This little known, privately held company had apparently gotten carried away with it’s futures contracts by making speculative trades (instead of hedging like it should do).  It lost over $2.4 Billion on energy contracts (yes, that’s a “B” not an M).

The company just didn’t have the liquidity to cover the losses so it folded and is now run by it’s creditors.

When I read this, a few ideas came to mind that may be worth exploring further:  Maybe the talking heads on TV are right about oil prices — that the reason they are so high is because of all the traders/speculators, and not global supply and demand imbalances;  and we, as individuals, can’t do anything about macroeconomic issues or control Wall Street, but we can curb the impact of high gas prices or a job loss by stockpiling cash in a “rainy day” fund and maintaining a suitable budget.

Going, going, gone are the old 1980 Mortality tables

As many of you are probably aware, states are adopting the new 2001 CSO (mortality) table which has had life insurance companies busy redesigning their products. Basically the new table reflects the fact that people are living longer these days than they were compared to the old 1980 table. Now that people are living longer, life insurance should be cheaper!

I’ve seen that quotes for insurance have come down but not in a ‘wholesale’ type of fashion. Generally the change will only have a small impact on the average consumer, and I would be wary of anyone that told me I should replace my existing (life insurance) coverage because this new table is being adopted. There are other factors that should be considered irrespective of the table.

However, if you are in a situation where a cash value life insurance product (e.g. VUL) makes sense, you will want to be sure to evaluate your options before insurance companies stop selling 80CSO (old) insurance products December 31, 2008. This is because the definition of life insurance cost and modified endowment contract definitions are based on the prevailing table (soon to be 2001CSO).

Basically if you want to pump a lot of money into one of these policies (overfund), you should look into the old contracts while you still can. Again, I would be very wary of information you come across on this; remember, most life insurance is “sold” not bought by people.

Finally, consider that insurance companies and brokers are always trying to squeeze out as much profit/commissions as they can from the (life insurance, and other) products they sell. As the transition to the new table concludes, companies may over/under price their new insurance products – so be sure to shop around!

Some comments on P/E ratios and valuation

A recent article in the WSJ asserts that if you use the Price/Earnings (P/E) ratio as a general guide, stocks have gotten expensive. Although the author points out that that looking solely at P/E ratios might have some pitfalls, he doesn’t seem to really back up that statement.

He points out that the 60 year average P/E ratio for the S&P 500 is 16x. When you look at the earnings for the last 12 months, the P/E ratio jumps to 21x. Thus, stocks must be “getting pricey”.

I think most savvy investors take this assertion lightly; however, others should be conscious of the fact that one line generalizations about the valuation of the Stock Market are dangerous.

A different way to look at the P/E ratios referenced in the article is one attributed to Nicholas Molodovsky called the Molodovsky effect. He posits that in mature, cyclical industries, the P/E ratios will actually go up in bad times… and P/E ratios will go down in good times. It seems counterintuitive because most people agree that low P/E stocks are “cheap” and high P/E stocks are “expensive”. Once you think P/E ratios trending up or down over time instead of a snapshot of value, the effect makes some sense, but here’s a hypothetical example:

MG Motor Company sells much fewer cars during a recession than when times are good (all things being equal), so it’s certainly in a cyclical industry since company earnings are tied closely with the economy. Let’s assume their stock is priced at $30 in 2006, and $23 in 2007. Earnings go from $1.50/share in 2006 to $.90/share in 2007. The 2006 P/E is 20x and jumps up to 26x in 2007.

In this example, the earnings decline boosts MG stock into “expensive” territory, even though the share price dropped $7. This is because the percentage decrease in the denominator (earnings) is greater than the decrease in the numerator (price) from 2006 to 2007.

The point here is that one line arguments of valuation should at least be narrowed to a particular industry and not applied market wide. Very often there are opposing interpretations of commonly accepted measures of value such as P/E ratios — depending on the assumptions made, you could make a case that stocks are expensive or cheap!

FICO Scores are changing soon

Fair Isaac & Co. is tweaking their methodology for computing an individuals FICO score in 2008. As you may already know, your score affects the rate you pay on loans (mortgages, auto, credit card); but you may not know that your FICO score is now frequently used by auto insurance companies, employers, hospitals, and others.

It’s more important than ever to ensure you have the highest FICO (credit) score possible. The typical recommendations for improving your score are:

• Avoid using too much of your available credit card debt
• Remove errors on your credit report (get reports free at www.annualcreditreport.com)
• Avoid making late payments
• Shop for auto/mortgage loans all during the same month
• Maintain old credit card accounts and if necessary, use them on occasion to keep them open

However, there are additional recommendations given what we know about the new scoring methodology:

• If you’re an authorized user on someone else’s credit card, you need to drop that and get your own card. FICO will no longer count authorized users toward good credit.
• Try to have a mix of loan types on record. You should have a better score if you have installment loans (student, auto, mortgage) and revolving accounts like credit cards.
• Pay your bills on time! More weight is being placed on billing issues (delinquencies) compared to the old FICO calculation method.

There are of course other credit rating systems out there, but these systems (including FICO) are all black box calculations that look at similar factors. Most of this work to repair or protect your credit is pretty straightforward, and if you maintain good habits around debt you’ll be in good shape. For those with problems, you will have to be patient since improvements take a while to “stick”; don’t be tempted by quick fixes or credit repair firms!

Beware the returns of March (and beyond)

As the first quarter of 2008 comes to a close, it is now a common time for people to check their investment performance and investigate new investment opportunities. If you look at the investment performance of various mutual funds (e.g. US large cap), many of them had terrible performance in 2001 and 2002 (even when compared to what we’ve experienced these past few months).

Beginning with 2008, advertised 5-year performance figures will not include these “spurious” old returns. Caveat emptor…

Confused about what the difference is between a broker and an investment adviser?

Me too! Just trying to figure out what’s happening with regulations and disclosures will only further confuse you, but here’s a list of keywords to google later: Merrill Lynch Rule, RAND Report, Cutting Through The Confusion.

There are various lobbying efforts, lawsuits, etc happening because they (huge brokers, investment advisers, consumer groups) all want a share of the “pie”. I think the main reason for the confusion has to do with politics and capture hypothesis in regulation, with the result being that this battle may never end until the structure of the financial services industry changes (and that may not happen in my lifetime).

So what is the take-away? It’s actually quite simple: A consumer must continually ask a financial services provider (broker, financial consultant, etc) if they are providing advice and service as a fiduciary.

In our industry, a fiduciary must advise and act in a client’s best interest, while a non-fiduciary must advise and act in a manner deemed suitable. Obviously, from a client perspective, suitability is a lower standard.

Now the problem is that some folks out there state that they sometimes provide services and advice according to the suitability standard, and sometimes according to the fiduciary standard. And if you follow the rule above, it makes for difficult conversation if every other question you ask is “are you acting as a fiduciary right now?”.

Let me be the first to propose an easy solution to all these lawsuits and convoluted regulations: When services and advice are given under the fiduciary standard, the person has to wear a bright green button on their collar; when given under the suitability standard, the person has to wear a red button on their collar.

And on the phone, two different tones can be added to the line in a similar fashion to the familiar “beep” you hear when somebody calls you on a recorded line. A website could have a small green or red flashing image in the top right corner of the web page.

So if you’re working with a guy that is constantly switching buttons, or you hear a melody of tones on the phone line — you’ll surely know you’ve got a flip-flopper on your hands.

That’s it, problem solved!