Rest of the World


  • Malaysia Plane Traced in Inmarsat Engineer London Huddle How they managed to figure out the area of the crash $$ $SPY Mar 30, 2014
  • UK Pension Revolution Putting Long-Term Bonds at Risk Need 2 match liabs drives demand 4 long bonds, lowers yields $$ Mar 30, 2014
  • Putin Has Exposed NATO’s Weakness US & NATO Europe willing to agree upon? What r they willing 2 risk? Be careful $$ Mar 30, 2014
  • China Said to Expand Property Survey Amid Oversupply Concern Will b difficult 2 end overinvestment by fiat $$ Mar 30, 2014
  • Chinese Pigs Eating Soybeans Cut US Supply to 1965 Low Chinese demand 4 pork drives demand 4 US Soybeans $$ Mar 30, 2014
  • Lira Fate Tied to Real Assets as Hot Money Flees In countries where inflation is a threat, invest in property $$ Mar 30, 2014
  • Business not ipso facto criminal: Tendency of presuming it guilty without proof is damaging India’s economy $$ Mar 30, 2014
  • Mr. Putin’s Revealing Speech Defender of Orthodox civilization as he sees it pushes back against encroahing NATO $$ Mar 30, 2014
  • Russian Forces on Border Stir Concern as Crimea Annexed Threats of more economic sanctions will not deter Putin $$ Mar 23, 2014
  • What the West Can Learn From Putin’s Other Neighbors Don’t make promises that u won’t keep; Putin is not scared $$ Mar 22, 2014


Financial Sector


  • So what is today’s nonbank business model? Legalized extortion done to “protect consumers,” objective is political $$ Mar 30, 2014
  • Wall Street Banks Cut Out of Prized Commercial Mortgages $MET $PRU originate commercial mortgages 2 fund own liabs $$ Mar 30, 2014
  • SEC Is Probing Dealings by Banks and Companies in Loan Securities Current CLO issuance drives loan issuance $$ $BKLN Mar 30, 2014
  • Pimco Chases BlackRock in ETFs as Money Returns to Bonds Amazing how people follow anything w/positive momentum $$ Mar 30, 2014
  • And if banks start lending aggressively, it will b time to radically shrink asset maturities in bond portfolios, velocity will b rising $$ Mar 30, 2014
  • Banks Lending Like It’s 2007 Belied by $10T Hoard But they aren’t lending heavy yet, if they do FOMC has 2tighten $$ Mar 30, 2014
  • Scandal-Hit British Banks Turn to ‘Weirdy Beardy’ “Why do you exist?” “Who r u?” Pondering existence bugs bankers $$ Mar 30, 2014
  • Josh Rosner: The Wrong Remedy for Fannie and Freddie Better to wind them up & get Govt out of the Mtge mkts $$ Mar 30, 2014
  • Iowa’s Friendlier Watchdogs Lead Insurer Pack to Des Moines Iowa DOI will regret embracing complexity, gtee funds2 $$ Mar 30, 2014


Market Impact


  • Which will win? $BRK.B or $IWM ? 3views: & & BRK will beat smallcaps $$ Mar 30, 2014
  • Americans Can’t Retire When Bill Gross Sees Repression Investments eventually reflect the underlying cash flows $$ Mar 30, 2014
  • Financial scars linger: 1/3 of investors wary of stocks Have 2 wait 4 these people 2 come & put in the top $$ $SPY Mar 30, 2014
  • 1999 Buffett: stocks can’t possibly meet public’s expectations. Internet? Notes how few got rich in auto &aviation $$ Mar 30, 2014
  • Declining Pension Benefits Leave Workers Uneasy Difficult 2 fund high benefits when interest rates r so low $$ $TLT Mar 30, 2014
  • Google Traders See Opportunity in Confusion on New Shares New nonvoting shares may allow 4 some arbitrage plays $$ Mar 30, 2014
  • Attention Suckers: Please Send Us Your Money @Ritholtz comments how the JOBS Act weakened investor protections $$ Mar 30, 2014


US Housing


  • High Prices Partly to Blame for Slow New Home Sales When markets near their peak, frequently volumes drop off $$ $LEN Mar 30, 2014
  • Time might be ripe for boomers to sell their homes and move on Sell them 2whom & @ what price? Lack move-up buyers $$ Mar 30, 2014
  • Finding a House That Won’t Destroy You Buy a house u can afford even under stressed conditions, reduce risk $$ Mar 30, 2014


US Politics, Policy & Economics


  • Florida’s Scott Travels on Corporate Tab as Lobbyists Tag Along Governors increasingly use corporate $$ 2fund trips Mar 30, 2014
  • IRS Takes a Position on Bitcoin: It’s Property Thus any trading of bitcoins involves capital gains &losses $$ $BTCUSD Mar 30, 2014
  • Google, EBay and the Roots of Collusion Some don’t want to annoy companies that r complementary 2their biz goals $$ Mar 30, 2014
  • The Individual Mandate Goes Poof Barack Obama undoes what House GOP would like 2undo, just not permanently totally $$ Mar 30, 2014
  • Global Warming Will Not Cost the Earth, Leaked IPCC Report Admits Will b interesting 2c how gets spun by bothsides $$ Mar 30, 2014
  • Economists: Rising interest rates are the biggest threat to recovery More evidence that rates will stay low $TLT $$ Mar 24, 2014
  • Kocherlakota: Don’t raise rates to head off possible crisis There may come a time when you will have no choice $$ Mar 22, 2014



  • Advice for a Happy Life by Charles Murray Marry young & someone similar 2u, don’t try2get rich, Groundhog Day $$ $SPY Mar 30, 2014
  • Why Runners Can’t Eat Whatever They Want Studies Show Heart Risks to Devil-May-Care Diets—No Matter How Much U Run $$ Mar 30, 2014
  • Speed Reading Returns Apps and Classes Help People Adapt 2Reading on Their Phones | More content 2 read everywhere $$ Mar 30, 2014
  • The book Scientology tried to ban Read about the *real* L. Ron Hubbard, from a book Church of Scientology hates $$ Mar 30, 2014



  • Wrong: Not Voting Should Not Be a Choice Seems fundamental that no one should b forced to vote; it’s a protest $$ Mar 30, 2014
  • Wrong: Japan Is Doomed Unless It Learns to Love Inflation More “hair of the dog that bit you solutions” $$ $JPY $JOF Mar 30, 2014
  • Wrong: Digital v human: the new debate We’ve seen transformational technologies b4, takes a while 4 new jobs 2show $$ Mar 30, 2014
  • Wrong: Fed’s Bullard: Yellen’s ‘6 Months’ Comment Doesn’t Represent Change in Policy Stance Could have fooled me $$ Mar 22, 2014


Notes, Comments, Reples & Retweets

  • RT @ReformedBroker: In November 1999, Buffett wrote this op-ed for Fortune on why he doesn’t bet on innovation. @pmarca @hblodget http://t… Mar 27, 2014
  • RT @felixsalmon: “This means Bitcoins are not fungible, and that makes it unworkable as a currency.” cc @pmarca @bar… Mar 27, 2014
  • RT @journalistjosh: Crowdfunding emptor: Attention Suckers: Please Send Us Your Money via @BloombergView Mar 27, 2014
  • We enjoyed having @susanweiner speak to us at the #CFA Institute – Baltimore; we can all benefit from learning to write more engagingly $$ Mar 26, 2014
  • ‘ @PlanMaestro Yes, I remember that piece and the series that followed it $$ Capital efficient Mar 26, 2014


This was published in the “Ask Our Pros” column at RealMoney.  I don’t know when, and I don’t have the actual question, but looking at my answer, I think I know what was asked.

I’ve been cheated in the past by insurance companies.  How can I choose an insurance company that won’t cheat me?

This is a question after my own heart.  I worked in the life insurance business as an actuary for 17 years, serving in almost every area that life insurance companies have.

Life insurance agents and products have a bad reputation in the financial press.  Much of that bad reputation is deserved.  Products are often sold that pay agents well, but do not meet the needs of clients.  Agents influence the flow of information between the company and policyholder, and sometimes tell different stories to each side.

The life insurance industry has tried over the years to control the sales process better, so that only suitable products get sold.  Regulators have demanded it, industry groups want a better reputation, and individual companies have learned that writing bad business is unprofitable.  There are regulatory rules, industry conduct codes, etc.  It is difficult to root out bad apples among agents, which can flit from company to company; companies with bad records tend to get disciplined by the regulators and the courts.

Life insurance and annuities are products that are generally sold, not bought, excluding fancy tax reduction schemes used by high net worth individuals.  Typically, though, they get sold to people who will not plan for their own financial well-being, and would not save, invest, and protect their families on their own.  It is an expensive way to invest, but it is better than not investing at all.

There is a need for agent-sold financial products to help those that will not plan for themselves.  This provides a real service, though never as good as what an intelligent investor would do for himself, if he had the time to research everything out.

Disability and health insurance often get a bad rap over claims payment practices, often deservedly so.  Part of the reason for that is that people don’t want to pay the full price of these products; companies respond with lower priced products and get more hard-nosed about claims.  Part of the research that any person should do about an insurance company is their claims payment practices.  State insurance commissioners keep a record of which companies get complaints, and which do not.  Insurance fraud further pushes up costs, and makes companies scrutinize claims more.  Trial lawyers further push up costs by making medical malpractice expensive through exorbitant tort claims.

Auto and home insurance usually don’t draw the same level of complaints as the above areas.  There are some companies that try to be too sharp about claims practices; this is something to watch out for in any insurance company.  Auto insurance (or the equivalent) is mandatory; mortgage companies require home insurance.  The market is regulated, and usually highly competitive.

Another area of complaint is private mortgage insurance [PMI].  PMI benefits the lender, but is paid for by the homeowner.  The benefit to the homeowner is that he can buy a home, and not make a down payment of at least 20%.  The lenders require PMI when the ratio of the first mortgage to the appraised home value is greater than 80%.  New laws require PMI to go away when the ratio drops below 78%.  Homeowners can petition the lender when the ratio is at 80%.  (The lender will probably require a new appraisal.)

Now all this said, insurance companies have had a lower return on equity in the past 20 years than all other companies on average.  Insurance companies don’t make all that much money.  So where does the money go?  1) Agents.  2) Benefit payments.  3) Home office expenses.  Investment income usually subsidizes insurance companies; they lose money on underwriting on average, and when the pricing cycle is weak, they lose substantial amounts.  Since the inception of health insurance, the insurance industry may have lost money in aggregate.

In Summary:

  • Plan your investment and protection needs yourself, or find a trusted advisor to help you.  Investment knowledge pays its own dividends.
  • Study a company’s claims paying practices before buying.
  • Review expense and surrender charges and other contract terms.
  • Choose an insurance company off its reputation, and not price only.

The following was published at RealMoney on August 6th, 2007:

Editor’s Summary

The illiquid debt instruments at the heart of the current crisis are subject to regime shifts.

  •  We’re in a periodic repricing of illiquid debt instruments.
  • Look for the time when the bulk of the losses will be reconciled.
  • Stick with the companies that have strong balance sheets.

I appreciated Cramer’s piece Friday morning, which picks up on many themes that I have articulated for the last four years here on RealMoney.  Here are a few:

  • Hedge fund-of-funds demand smooth returns that are higher than that which a moderate quality short-term fixed-income fund can deliver.
  • This leads to the creation of hedge funds that seek yield through arbitrage strategies.
  • And the creation of hedge funds that seek yield through buying risky debts, unlevered.
  • And the creation of hedge funds that seek yield through buying less risky debts, levered.
  • And the creation of hedge funds that seek yield through buying risky debts, levered.

In the short run, yield-seeking strategies work.  If a lot of players pursue them, they work extra-well for a time, as late entrants to the trade push up the returns for early entrants, with greater demand for scarce, illiquid securities with extra yield.  Pricing grids are a necessity for such securities, because the individual securities don’t have liquid secondary markets.  The pressure of demand raises the value not only of the securities being bought, but also of those securities that are like them.  (Smart managers begin to exit then.)

I’ve been through regime shifts in the markets for collateralized debt obligations (CDOs), asset-backed securities (ABS), residential-backed securities (RMBS) and commercial mortgage-backed securities (CMBS).  Something shifts at the back of the chain that forces everything to reprice.  For example:

1989-1994: After the real estate boom of the mid-1980s, many banks, savings & loans and insurance companies get loose in their lending standards and real estate investment, leading to a crisis when rent growth can’t keep up with financing terms; defaults ensue, killing off a great number of S&Ls, some major insurance companies and a passel of medium and small banks.

Late 1991-early 1993: The adjustable-rate mortgage market, fueled by demand from ARM funds, overbids for ARMs in an effort to provide a high floating rate yield.  As the FOMC loosens monetary policy, higher than expected prepayments force losses onto the ARM funds

Late 1993-late 1994: The FOMC threatens to, and does, start raising interest rates, which throws the residential mortgage-backed market into crisis.

Mid-1998-mid-1999: Long Term Capital Management blows up, forcing all manner of exotic ABS, CMBS and RMBS into the market for bids.  The bids back up, until the entire market reprices and then tightens in the space of one year.

1998-1999: Home equity ABS blow up, as defaults threaten to, and then do, emerge at levels far higher than anticipated.  Almost no originators survive.

1999-2001: Cruddy high-yield bonds reveal their true value as defaults threaten to, and then do, emerge.

2002-2003: The manufactured-housing ABS market blows up, as originators don’t take initial losses but roll borrowers over into new loans that reduce payments and extend payment terms, technically keeping the loans current.  The system collapses when the buildup of bad debts and repossessed homes becomes too great to roll over.

(Of the existing large securitization markets, only the CMBS market so far has not faced a real crisis, partly due to the influence of the B-piece buyers cartel: six or so firms that buy the junk-rated debt of deals and enforce credit quality standards on the individual loans by kicking out poorly underwritten loans.  But who knows?  Even that could be overwhelmed under the right circumstances.)

In each of these situations, there was a boom-bust cycle.  The markets did not adjust slowly and evenly to changing conditions; the transitions between “boom” pricing, and “bust” pricing were swift.  This is the nature of markets, particularly when enough debt is employed to amplify the process.

There is no conspiracy necessary to make the shift happen (though often the media will make it seem like there was one); the bubble pops when the financing proves insufficient to carry the assets.  After the bubble pops, it becomes a question of what the underlying assets can be liquidated for, allocating losses mercilessly according to the loan documents and bankruptcy priority.

Today the crises are nonprime lending, leveraged buyouts and other high-yield debt and over-leverage in the CDO market.  These will get worked out, as all other crises do, handing losses to those who speculated unwisely and allowing those who financed properly to prosper on the other side of the crisis.

As you invest, look for the time when more than half of the losses will be reconciled.  That will be near the bottom for homebuilders and housing finance.

That time may not come for another two years or so, but there will be money to be made once the crisis is mostly reconciled.  Just stick with the companies that have strong balance sheets.

A while ago, I wrote a piece on Tower Group after its stock price imploded, before it went down more, and attracted an acquisition offer from entities affiliated with the main owner of AmTrust Financial Services for $3/share.  Here’s another letter, from a different respective reader:

Hello, David:

I’ve been a longtime reader of your columns (back to RealMoney) and have a lot of respect for your opinion as an investor and analyst, particularly your insights into insurance companies.

Merger arb has been a (small) part of my toolkit for the last 15 years but haven’t yet seen an insurance merger quite as complicated as TWGP’s acquisition by ACP Re and AFSI.  With an 8% discount to the offer price and about 4 weeks until the shareholder meeting, this one looks intriguing.

There’s a (wordy) analysis of the deal terms here: .

A couple of specific questions about the deal, if you feel inclined to respond:

1.  Does Karfunkel’s potential conflict of interest in selling the part of TWGP he doesn’t want (commercial, personal) to the publicly traded company he chairs (AFSI) raise enough of a red flag that regulators may intervene?

2.  Are the NOLs owned by TWGP usable by ACP if there is a reverse takeover (TWGP the surviving entity) under Bermuda law?

3.  Does the price at which Karfunkel is selling the pieces to public entities using mostly public shareholders’ money raise any red flags to you?

As I said, I respect and enjoy your work and hopefully you enjoy it enough to continue.

First I will handle the questions.  Then I will hand out a few opinions.

On question 1, the answer is not likely.   The regulators will disallow any situation where an acquisition would significantly impair the ratio of capital to required capital to bear risk [RBC].  Now, shareholders could be another matter.  In this acquisition, two public companies that the Karfunkel families control are buying up the renewal rights to Tower Group Commercial Lines business (AmTrust Financial – AFSI), and Personal Lines business – (National General Holdings Corp – NGHC, which recently went public).

With renewal rights, the AFSI & NGHC acquire the assets and the right to renew existing business at terms mutually acceptable to clients & companies, but they do not acquire anything that pertains to claims from business existing prior to the deal.  In return, they pay money to ACP Re, Karkunkel’s private company owned by his grantor trust.

On question 2, the answer is not likely.  When Argonaut bought out PXRE in a reverse merger, the NOLs were disallowed.  Now, I’m not a tax expert, so maybe someone reeeeally clever can fox their way around this, but to me the answer is no.

On question 3, the answer is I don’t know.  The public companies that he controls have the advantage that they aren’t taking on much risk in a renewal rights transaction.  Whether they are paying the right price or not depends heavily on whether the reserving for claims at the Tower Group entities is overstated or understated.  Prior under-reserving may not have been fully corrected.  With smaller companies near bankruptcy, like Tower Group, there is the risk of death via many cuts.

That brings me to my main insight.  Though there are no financing contingencies to this deal, ACP Re can walk away with no penalty if it merely wants to do so.  If they find a material adverse change, the deal can die, and TWGP will have to pay ACP Re a breakup fee.

Like Fairfax Financial’s offer to buy Blackberry, Prem Watsa had the equivalent of a “free look.”  Tower Group is desperate enough that they gave a “free look” to the Karfunkels and their allied companies.  The deal is not a lock, and a lot depends on what is written when the late 10-K is finally filed.

Why delay the 10-K?  My best guess is trying to get the claim reserves right.  After having to revise reserves twice before, the odds of further revisions are significant.  You have to understand that claim reserves for P&C companies are not a science, particularly for long-tailed lines, and Tower Group was overly aggressive in those lines.

But delay in filing the 10-K is not a positive sign.  If you have confidence in the actuarial analysis of reserves, why delay the filing?  Every other aspect of a P&C insurance company can be calculated within a few weeks of the year’s end.  No mysteries, except for the reserves.

So, if ACP Re concludes that the likely claim payments from the legacy business are likely to be larger than the net amount they are paying for the legacy business ($67 million), ACP Re can walk away, with no breakup fee.  In that scenario Tower Group could head to bankruptcy.

So, when I consider the arbitrage opportunities available by buying Tower Group common stock, I would pass.  As a rule, I don’t short, though I would be tempted to do so here.  Tower Group is a very complex company for its size, and as such, I have less confidence in its financials.  Complexity in financial companies creates inflexibility, which can lead to trouble when regulators deny moving cash from one company to another, which might lead to default on debts.

Avoid this situation, and all of the companies involved.  Buffett has his “Too Hard” pile.  This one is too hard, because no one can know the claims that will be paid from aggressively written legacy business.

Full disclosure: no positions in the companies mentioned


From respected reader:

Just did a quick calc based on NWLI earnings and thought I would pass onto you as I know you at least used to hold it as a double weight.  Let me know if you think there are major holes in this theory:

From the Annual Report:

“The yield on debt security purchases to fund insurance operations rebounded somewhat to 3.53% in 2013 from 3.37% in 2012 but was still below the 4.18% yield attained in 2011.”

So, investment yields improved, but are still down.  Their unrealized gains in securities dropped from $541 million to $146 because of this, so this part of the “hidden value” in the shares went down.

But if rates can get back up to that 4.18%, a quick calc says that would cause annual earnings on their $9 billion investment portfolio to increase $58 million.  If 2/3’s of this is credited to annuity holders, it leaves $19.5 million before tax for shareholders.  32% tax from 2013 gives after tax earnings increase of $13 million or $3.57 increase in earnings per share.

If we could get yields back up to 5.5% like they were a few years ago, using the same calc would give an increase in EPS of $9.38, or a 1/3 increase in earnings.

It is still a double-weight here.  It is not as cheap as it once was, but it is still cheap.  Financial stocks should always be valued on a combination of price-to-book and price-to-expected-earnings.

Why?  Because accrual items in the accounting can either be aggressive, fair or conservative.  If aggressive, earnings will be overstated, and book value understated.  If conservative, earnings will be understated, and book value overstated.  For the most part, the two measures balance the squishy accounting.

Now as for the disclosures in the NWLI 10K, we need to note that more than 2/3rds of the bonds that they hold are “held to maturity.”  That’s unusual, as is their policy where they don’t buy high yield bonds.  Held to maturity means the value of the bonds amortizes over time, but price moves don’t affect the accounting, unless default is likely.  Thus if interest rates rise, book value will not be affected much, but earnings will rise on a GAAP basis.

NWLI has a conservative investing culture, and in the present aggressive environment that is a *good thing.*  Adjusting for the held to maturity securities, the adjusted price-to-book is 55%, and my estimate of future earnings is one-ninth of the current price.  It is rare to find stocks trading at a significant discount to book and a single-digit P/E.

Full disclosure: long NWLI

While reading about portfolio companies today, I ended up reading this piece about Berkshire Hathaway.  Not that great of an article, and it got worse when I read this:

Then there is the big question, “Who will replace Warren Buffett (Trades, Portfolio)?” He is now 83 years old. There is no official word on who will take over, but in his letters to shareholders he takes time to praise many of the investment managers working for him. The current consensus seems to be that Berkshire will be run by committee. The company has plenty of assets and superior management, so it should continue to operate efficiently. [emphasis mine]

That’s not the way BRK works.  BRK is a group of businesses, run by men (male & female) who love their businesses, and would rather be running their businesses than taking a vacation.  When Buffett dies, and he *will* die one day, much as shareholders might like to hope otherwise, BRK will likely be managed much as it is today.  BRK relies on self-motivated managers that do their part to  make the company work.  Given the level of independence, it is the only way it can work, absent the possibility of considerable centralization after Buffett’s death.

The same applies to the management of the small central office.  Public stock portfolio management is separate from the purchase of private companies (with some informal overlap).  Operational management is limited, aside from efforts to fix lagging subsidiaries (think of Tracy Britt Cool).  The next CEO of BRK will have to have multiple skills, but he won’t have to “do it all” as Buffett does.  He will have to delegate yet further.

Think: how many people can understand all of the following:

  • The economics of a wide number of industrial businesses
  • The economics of one of the biggest insurers & reinsurers of the world
  • The quantitative aspects of Buffett’s derivative bets
  • Clever investing in public equities
  • Ability to acquire attractive public and private companies and on attractive terms
  • Minimizing tax impacts in the process
  • How to continually motivate the managers of a spread-out empire of companies

The successor to Buffett will likely be little different than Buffett — a capital allocator who motivates his many managers.  At the size of BRK, private equity skills may be more valuable than public equity skills.  BRK is a conglomerate, with considerable diversification.  Even a passing look at the corporate org chart screams “Big!”

You want a sharp delegator/decision-maker at the head of BRK.  He will hand off many responsibilities to others, but hold onto the core jobs of allocating capital, and evaluating/rewarding managers.

Anything else is suicide for BRK.  That said, it’s not impossible that a future CEO would radically streamline BRK, and turn it into something more like GE.  That would be a big mistake, but it would look like low hanging fruit, because of the many similar businesses that could be combined.  Purchasing and central office services could be combined as well.  That might improve profits in the short-run, but it would destroy the unique corporate culture that Buffett has created.

Far better to have a “fixer” correcting the edges of the corporation like Tracy Britt Cool, or David Sokol, than to wholly change the healthy culture of a corporation, with uncertain rewards.

Full Disclosure: Long BRK/B for myself and clients


This was published in late 2007 at RealMoney.  I don’t know exactly when.


I came into the investment business through the back door as an actuary and a risk manager. For more than a decade, I worked inside several large life insurance companies creating investment products. My team’s dirty secret? We just wanted to clip a smallish profit on the assets, without taking much risk ourselves. If we could do that, and produce a reliable investment result for our clients, we were happy.

That was my job then; in a different sense, it is my job now.  My goal as a writer, commentator, and independent money manager is to take much of the risk out of personal investing while retaining most of the profit potential.

Nobody can avoid every up and down in the market. What you can do, however, is to ensure that you don’t get crushed when the market rolls over. My own portfolio is a case in point. Over the last seven years, starting in September of 2000, my investment process has yielded an annualized return of 20% a year.  I manage to a long horizon, so I don’t try to cut losses in the short run.  I am willing to take pain if I feel that the underlying fundamentals are intact.  I had only one losing year in that time, but it was a doozy. During four months in 2002, my portfolio lost 32% of its value.  I was shaken, but I scraped together my spare cash and invested. Over the next 16 months, my portfolio rallied 86%, which I found about as astounding as the 32% loss. 

The experience taught me that risk control works. Oddly enough, though, risk control doesn’t get a lot of attention. The most popular books and websites on investing spend nearly all their time focusing on the prospect of big returns; they rush over the matter of how to avoid big losses or how to deal with these losses when they happen. The result? Many people sour on investing because they take risks they don’t intend and lose a lot of money. They conclude that the investment game is rigged against them and they leave investing.


It doesn’t have to be that way. Let me suggest five simple ways you can control your worst tendencies, reduce your risk and become a happier investor.

Spread your bets around. The most basic rule of risk control is to diversify your investments. It is also the most neglected rule.

Perhaps the neglect is because most people don’t understand what diversification means. For starters, it means building a buffer against all the stuff you would prefer not to think about—unemployment, sickness, a horrible bear market, etc. Before you start investing, you need three to six months of living expenses set aside in bank deposits, money market funds and short-term bond funds. Having this cushion protects you from having to sell investments in an emergency, which in turn allows you to take risk with your remaining assets.

On top of your emergency funds, your portfolio should include a dollop of high quality bonds that mature in anywhere from two to 10 years. For older people, bonds cushion the downside of the total portfolio and ensure that you can’t be devastated by a stock market downturn. For younger people, bonds provide an additional benefit—you can sell them to buy stocks or other investments if the market plunges and you spot tempting bargains. So how much of your portfolio should you devote to bonds? As little as 20% of your portfolio if you’re in your twenties and a risk taker; 50% or more if you’re above 65 or naturally cautious.

Once you’ve got your emergency funds and your bonds stowed away, it’s time for stocks—and, once again, diversification should be your starting point. You don’t want to bet your entire future on a handful of stocks or on one industry or even on a single country. The easiest way to ensure that you’re widely diversified among many different stocks is to invest in a mutual fund or exchange-traded fund that holds scores of individual stocks, representing a multitude of different industries.

If, like me, you prefer to buy individual stocks, you have to balance your desire to be widely diversified against how much money you have to invest and—just as important—how much time you have to spend researching companies. My minimum for reasonable diversification is 15 stocks. When I started investing as a serious amateur back in 1992, I started with 15 stocks in my portfolio, and I bought $2,000 of each of them. Since then I’ve made maybe a dozen serious investing mistakes, but because I had my money diversified among many companies, none of my mistakes ever cost me more than 2% of my total capital.

These days I’m even more diversified: I run with 35 stocks, which is close to the maximum an individual can hope to track and research. Generally I devote an equal amount of money to each of my stocks—an equal weight, in investment jargon—because usually I can’t tell what my best ideas are. When a position gets more than 20% away from its target weight, I consider whether I should bring it back to equal weight or sell the whole thing.  Occasionally I deviate from equal weighting, but only when I have a very safe stock that is grossly undervalued. I never go above a double weight, which means that a single stock rarely accounts for even 6% of my overall portfolio.


The final way I diversify my portfolio is intellectually. I try to listen to as many viewpoints from as many different people as I can. I do this because the ideas of all but the most careful investors are internally correlated. They reflect some idea of what the economy is likely to do in the future, and they lean toward companies that fit that view. Some investors love companies with high P/E multiples and incredible growth stories. Other investors—and I’m one of them—love companies in distressed industries that are going for a song. You should listen to both camps. Doing so insures that you learn to think about investments from a wide number of perspectives. It makes investing more businesslike.

Here’s one trick you might find handy. As I gather my ideas from a wide number of sources, I print them out, and place them in a pile next to my computer.  I try to forget who gave me the idea, which forces me to look at the idea fresh, without the biases that come from trusting an authority figure.

Follow the cash. Most investors pay a lot of attention to how much a company earns; few investors realize how easily management can manipulate those earnings with fancy accounting. To reduce risk in the stocks you buy, keep an eye on a company’s cash flow as well as its earnings.

Your first step should be to look with a questioning eye at the non-cash, or accrual items, on the company’s financial statements. These include entries for such things as depreciation, inventory adjustments, or bad debt allowances. Cash is certain, but non-cash items such as these are anything but. Earnings can be thrown up or down by how quickly management decides to write down the value of a new factory or by how much it estimates its inventory of rotary-dial phones is really worth. The accounting industry tries to set guidelines for accruals, but management still has a lot of leeway.

For non-accountants, the easiest way to sniff out possible trouble is to compare the earnings statement with the cash flow statement—specifically the top segment of the cash flow statement, which shows “cash flow from operations.” This is the amount of cold hard cash the company’s operations are generating, before making any payouts to lenders or shareholders, or investing in new equipment. In most cases, if a company’s earnings are growing, its cash flow from operations should also be going up, since higher earnings just about always mean more cash going through the business. So what if a company says its earnings are growing, but its cash flow isn’t?  You should be very, very wary. The financial statements aren’t necessarily bogus, but you have to puzzle out how a company’s earnings can be rising without throwing off more cash.

Sometimes there is no good answer to this puzzle. Remember Sunbeam, the small-appliance maker that hired “Chainsaw Al” Dunlap to goose its business? I owned the stock in 1996 when Dunlap came on the scene. But after two earnings reports I became suspicious. “All of these restructuring efforts are improving earnings, but they’re not producing cash from operations,” I thought. “What gives?” I concluded something fishy was going on, so I sold for a nice gain. Over the next six months, the stock rose by 60%—then plunged 90% as it became clear that most of Sunbeam’s increase in earnings was the result of accounting shenanigans, not real business gains.

Love the unloved. Most people avoid industries that are under stress.  Who can blame them?  The industry outlook is horrible; there can’t be anything good here. 

I take a different view. I believe that some of the safest plays you can make consist of buying financially strong names in weak sectors. These companies are usually cheap in comparison to their earnings and to their book values. You can find out more about how to spot undervalued companies by visiting the website of Tweedy Browne, the famous value-investing firm, and reading their excellent paper on What Has Worked In Investing (

In addition to the standard measures, I look for companies with good bond ratings.  The ratings agencies are out of favor now, because of the current furor over securitization, but they produce the best single measure of a company’s creditworthiness. The raters award the best ratings to companies that can generate cash well in excess of what is needed to pay all their creditors and that possess a low ratio of debt to assets.


Once I’ve bought a stock, I try to be patient, because the payoff is usually not instantaneous. In 2001, when steel stocks looked horrible, I bought Nucor, the soundest company in the industry. Steel companies dropped like flies in 2002 and the stock did nothing—until the end of the year, when enough steel-making capacity had been closed down that steel prices began to rise. Nucor flew, and I made a nice profit.

The key to making this contrarian strategy work is to not overdo it. Some industries—newspapers, say, or fixed-line telecom companies—truly do have questionable futures. You have to analyze each situation on its own merits.  At present, my favorite industries are insurance, energy, agriculture/food processing, cement, and chemicals.


My value-hunting approach means that most of the stuff I buy is not popular. I veer away from firms that are pioneering new technologies or markets. Such companies are easy to get enthusiastic about, but difficult to value because there are so many unknowns.

When I talk about the companies I own, the response is often, “You invest in obscure stuff.  What do you think about Google?” I don’t have an opinion on Google.  I can’t tell you whether it will produce enough profits over the years to justify its current price or not.  So much depends on future tastes and competition. I’d rather own cement companies; they are very difficult to make obsolete.

Take emotion out of it You should look over your portfolio two to four times a year. In my own case, I follow a very structured process. I take all of the investment ideas that I have gathered up since my last portfolio pruning, and rate them on valuation, momentum, and accounting quality to arrive at a composite measure of their overall desirability. I compare these ideas to the companies that are already in my portfolio.

This sounds complicated and so it is. But exactly how you do your ranking is less important than having a system for comparing the stocks in your existing portfolio to the alternatives that the market is offering you. Your goal should to take some of the emotion out of investing. You don’t want to fall in love with the companies that you already own. To avoid this, I try to pinpoint what companies in my ideas list are better than the median idea in my portfolio.  These become purchase candidates and I do further research on them.

I also look at the companies in my portfolio that are below the median in desirability, and I ask why I’m keeping them. In many cases, the companies are less desirable because they’ve gone up in price and are no longer as cheap as the once were. In other cases, they’re less desirable for the opposite reason— the company’s business has deteriorated and shows no signs of turning around. Every three to four months, I typically sell two or three companies from my 35-stock list and replace them with more promising companies from the ideas list. I typically hold a stock for three years.  Many of my ideas go against me at first, but often turn and make money for me later.


Smart money is slow money. If a stockbroker or financial planner tells you that you’ll miss a huge opportunity if you don’t buy right now, ignore them. A smart investor moves at his or her own pace.

To make sure that you don’t get pressured into buying something, it’s nearly always a good rule to avoid salespeople. Stockbrokers, financial planners, mutual fund salespeople and even the experts on the television all have financial incentives that can pull them in directions opposite to what’s in your best interest. Before buying any stock or any financial product, you should do a bit of background reading so that you understand what you’re buying and how much rival products cost. In many cases—insurance is a good example—you’ll find that the simplest product is your best buy. Complexity in insurance, and many other investments, is usually a cover for increased fees.

Especially when it comes to buying stocks, patience is your best friend. If an idea seems like a sure thing, sit on it for a month.  If the idea is still a good one, you will usually still have time to act on it.  If the idea is a bad one, the extra time will help you do further research and may make its problems evident.

One of the best ways to make money is to avoid losing it. When I approach new ideas, I try to ask how likely it is that I will lose money, and how much I could lose if I am wrong. I lose about 20% of the time. Six times in the last 15 years, I have lost half my money on an investment. Those are actually pretty good numbers. I can’t avoid all losses, but if I wait, take my time and do my research, I can limit my losses, and make money on the rest of my ideas.

Federal Reserve


  • Why Central Banks Should Be Vague They would b better off saying nothing, as their ability 2analyze future is poor $$ Mar 21, 2014
  • Yellen and the Curse of Forward Guidance @BloombergView Better the Fed should shut up & let the market adjust $$ $TLT Mar 21, 2014
  • Yellen and the Fed Go Dark @M_C_Klein tells the truth, better the FOMC should say nothing, words don’t mean much $$ Mar 21, 2014
  • Yellen Punt Prompts Panic Interesting to be quoted in the article above. Author liked my comment on the weather $$ Mar 20, 2014
  • Essentially Yellen said monetary policy will b the same as before, only more so. But the forecasts show a faster removal of accommodation $$ Mar 19, 2014
  • Level of Central tendency of FOMC Fed Funds forecasts 2014-6, LR — 0.30%, 1.13%, 2.42%, 3.88% Change -0.04%, 0.07%, 0.25%, -0.01% $$ Mar 19, 2014
  • Level of Central tendency of forecasts for when the Fed first starts tightening Fed funds: October 2015, change from prior January 2016 $$ Mar 19, 2014
  • Level of Central tendency of FOMC PCE Inflation forecasts 2014-6, LR — 1.55%, 1.80%, 1.84%, 2.00% Change 0.04%, 0.03%, -0.03%, 0.00% $$ Mar 19, 2014
  • Level of Central tendency of FOMC Unemp forecasts 2014-6, LR — 6.21%, 5.73%, 5.41%, 5.45% Change -0.24%, -0.20%, -0.13%, -0.08% $$ Mar 19, 2014
  • Level of Central tendency of FOMC GDP forecasts 2014-6, LR — 2.81%, 3.04%, 2.76%, 2.21% Change -0.13%, -0.09%, -0.08%, -0.05% $$ Mar 19, 2014
  • Low-Wage Workers Are Finding Poverty Harder to Escape Low Marketable Skills plus divorce or no marriage w/kids $$ Mar 18, 2014
  • Fed set to roll out new low-rate pledge Fed spends 2much time on words, not enough on long-term efficacy of policy $$ Mar 18, 2014
  • Yellen should take away the punch bowl Fed will never do that; doesn’t like 2 take actions that point back @ them $$ Mar 18, 2014


Rest of the World


  • Bloomberg Hints at Curb on Articles About China Bloomberg makes its $$ by renting out terminals; wants more China biz Mar 21, 2014
  • CPI Credibility Lasts 34 Days as Doubts Return Well, that was quick – guess Argentina doesn’t want 2 pay more out $$ Mar 20, 2014
  • Putin’s Tools of Sabotage Beat Urgency of Ukraine Invasion Putin ready 2 play a rougher game, understands politics $$ Mar 20, 2014
  • Putin Is No Madman to Russians as Power Play Trumps Economy We shouldn’t fight over this, Crimea is Russian $$ $RSX Mar 19, 2014
  • “Nobody Knows Anything” Knowledge lost as Cold War Generation gone from foreign policy: C: $$ Mar 18, 2014
  • How China’s official bank card is used to smuggle money Between Macau Casinos & UnionPay, wealthy get $$ out of China Mar 18, 2014
  • China to Spend More Than $162B on Shantytowns Herding people into cities, but what will they do for work? $$ $FXI Mar 18, 2014
  • Alibaba Confirms It Will Begin IPO Process in US Could be valuable 4 $YHOO who owns ~24% $$ Mar 18, 2014
  • The Welsh dairy farmers who bought 320 buy-to-let properties in Sweden Worry when it seems easy 2 make $$ in housing Mar 18, 2014
  • Chinese Companies Caught in Yuan Riptide What was once viewed as “free money” proves to have a cost, panic ensues $$ Mar 18, 2014
  • Musk Jab at Rival Shows US Space Reliance on Russia Interesting how we rely on Russia 4 manned space flight $$ Mar 18, 2014
  • Nigeria Overtaking South Africa Masks Poverty Trap When economy is mostly resource extraction inequality common $$ Mar 18, 2014
  • Putin’s Motives Rooted in History Remain a Mystery Abroad Should b happy that most of Ukraine is allied w/West $$ Mar 18, 2014
  • Chinese Developer Bonds Sink in Secondary Trade Amid Collapse Test 4 Govt: how much bad credit will u bail out? $$ Mar 18, 2014
  • Japan Analysts Split on Fiscal Crisis Time as Tax Looms Testing the limits of how much a govt can borrow b4 crisis $$ Mar 18, 2014

New Businesses


  • Rock-Climbing Generation at Foot of US Startup Ascent Example of an unusual business catering to exercise wants $$ Mar 21, 2014
  • Zuckerberg, Musk Invest in Vicarious Part of brain that sees, controls the body, understands language & does math $$ Mar 21, 2014
  • Personally, I think Artificial Intelligence won’t succeed w/ that. No surprise that Vicarious is trying, though — would save lotsa time $$ Mar 21, 2014




  • Credit Card Data Security Standards Don’t Guarantee Security Antiquated technology relatively ez2hack, no surprise $$ Mar 21, 2014
  • Why Do High Frequency Traders Never Lose Money? Why do auctioneers & brokers rarely lose money facilitating trades $$ Mar 21, 2014
  • How to Decide on Your Investment in Bonds When rates are so low you should b extra careful, stay short & hi qual $$ Mar 21, 2014
  • Shadow Banking Deals Prompt SEC Plan to Cap Broker Leverage SEC does not go far enough, repo mkts should b ended $$ Mar 21, 2014
  • SEC to take another look at ETF regulation Should leveraged products & inverse products b allowed? Lousy returns $$ Mar 20, 2014
  • Junk Bonds at $2T as Gundlach Pulls Back Markets always seem large when they are overvalued, Gundlach is right $$ Mar 20, 2014
  • Seth Klarman warns of impending asset price bubble When he runs out of safe places 2 put $$ the red lights flash Mar 18, 2014
  • ARM Loans—a Vestige of the Housing Bubble—Are Making a Comeback True 4 wealthy & those with prime credit scores $$ Mar 18, 2014
  • Buffett gets the better of everyone, version 4,762 Parts w/his holdings of $GHC, retires shares of $BRK.A & $BRK.B $$ Mar 15, 2014


Politics & Policy


  • Uneven Wage Gains Restrain Recovery Article has a lot of interesting data on what jobs r available to semi-skilled $$ Mar 21, 2014
  • Obama Keystone Choice Pits Donors Against At-Risk Senate Kind of a no-win situation 4 Obama; should ok the deal $$ Mar 20, 2014
  • Young Invincibles Are Killing Obamacare Obamacare destroys the healthcare system as healthy young people leave $$ Mar 20, 2014
  • Christie Counts on Revenue Surge Not Seen in Most States A Reaganesqe flaw: relying on the rosy scenario w/Dems $$ Mar 20, 2014


Companies & Industries


  • Phillips 66 Considering Splitter at Sweeny Refinery New trend: Partial refining. Those products can b exported $$ Mar 21, 2014
  • TV Subscriptions Fall for First Time as Viewers Cut the Cord It is cheaper to not have a cable subscription $$ $SPY Mar 21, 2014
  • A Sour Bean Sweetens Cocoa Supply Fascinating story of a high-yield bean that is more sour than low-yield beans $$ Mar 21, 2014
  • Buffett Cuts Tax Bill, Tells Others Not 2 Complain If Buffett weren’t so sanctimonious on taxes this would b small $$ Mar 20, 2014
  • IBM’s Watson to help in brain cancer research Fascinating 2c Watson sequencing DNA of cancer & suggest treatments $$ Mar 20, 2014
  • TED Winner Launches Campaign to Unmask Shell Companies Ambitious effort 2unmask those using shells 4 bad purposes $$ Mar 20, 2014
  • Windows XP: What to Do When Microsoft Ends Its Support Article agrees w/my answer; get a copy of Windows 7 $$ $MSFT Mar 20, 2014
  • Fannie Mae Wind-Down Deemed Threat to Home Recovery It will be painful, but we need to delever housing $$ Mar 19, 2014




  • IFRS could be stripped of accountancy watchdog role This would be very good. US GAAP is far superior to IFRS $$ $SPY Mar 19, 2014
  • Bugatti-Driving 26-Year-Old Tied to Penny-Stock Website Of John Babikian & the misnamed AwesomePennyStocks $$ $SPY Mar 18, 2014
  • Behind The Scenes With Dream Team, CytRx & Galena He gets inside firm paid/undisclosed promotions 4 $CYTR & $GALE $$ Mar 18, 2014
  • Individual investors Lose Money When Using Technical Analysis I can hear it now, “But they’re doing TA wrong!” $$ Mar 18, 2014
  • The Hidden Rot in the Jobs Numbers Here’s another way 2c it: $$ $TLT $MACRO Mar 18, 2014
  • Want Success? Choose the Right Parents Not sure I believe it, but interesting thesis $$ Mar 18, 2014
  • Pssst! Everything’s a Conspiracy Tough 2hold a significant conspiracy together, high incentives 2eventually reveal $$ Mar 18, 2014
  • To Make an Airplane Disappear, Start by Getting Through the Cockpit Door How difficult it would b2 take over a 777 $$ Mar 18, 2014




  • Late: City vs. Country: How Where We Live Deepens the Nation’s Political Divide This isn’t news; no surprises here $$ Mar 21, 2014
  • Wrong: ‘Ring of Death’ Throttles Georgia as Small Banks Close Lent 2 much on overvalued properties, their fault $$ Mar 20, 2014
  • Weak: Why gaining from value investing is hard Value investing typically does better on other side of mkt peaks $$ Mar 18, 2014
  • If We’re Going to Take Budget Forecasts Seriously, Then This is a Good Way To Present Them Kinda naive about stats $$ Mar 18, 2014
  • Wrong: Why equities sold off despite a dovish Fed Fed was not dovish. Yellen’s comments & Fed forecasts bearish $$ Mar 21, 2014
  • Weak: Robert Shiller On The Tech Economy Some innovations save labor; others create demand 4labor through new svcs $$ Mar 21, 2014


Replies, Retweets & Comments


  • The bigger change was the shift in the time tightening is likely to happen. That shifted up 3 months on… Mar 19, 2014
  • “Interesting to be quoted in the article above. If you want to see the other things I wrote about…” David_Merkel $$ Mar 20, 2014
  • RT @treehcapital: Credit investors like the elves in LOTR~when they leave Middle Earth, time to pay attention “Gundlach Pulls Back” http://… Mar 20, 2014
  • @treehcapital That’s a great analogy. I’ve lightened up as well, time to do more. Mar 20, 2014
  • We’ve been through periods like this before in human history. Inventions that save labor in an area… Mar 21, 2014

If you have a moment, read this Bloomberg article.  The brokers are utterly dishonest when they say:

Brokers contend that their borrowing is generally less risky than bank lending. Repo borrowing, for instance, is backed by collateral that can be readily sold to raise cash in case the other party defaults, said Steven Lofchie, co-chairman of the financial services group at Cadwalader, Wickersham & Taft LLP.

“If you think about a bank that is lending 90 percent against a house, versus a broker-dealer taking in 102 percent against a loan of a security, the broker-dealer’s credit risk is exponentially less,” Lofchie said.

This is true under ordinary circumstances, but not in a crisis, as we saw in 2008.  Seemingly safe securities were no longer safe, because too many overleveraged parties could not hold their positions when the prices of their seemingly safe securities started to fall.  This led to a panic, because of the structural error of financing long-dated securities with short-dated funding.  In a crisis, that is the fatal flaw of repo financing.

I think the proposals of the SEC are decent, and those that the broker-dealers propose are not.  I would go further and abolish repo markets.  They are crisis-bait.  The asset-liability mismatch invites trouble.

The proposal of the broker-dealers is flawed, because they don’t adopt a model where they match assets and liabilities.  Stable systems match assets and liabilities.  Until they do so, they should not be taken seriously.  The math of risk control wars against them.

This will be short, because in this case, as picture is worth a thousand words.  What sent the market lower today? This:

central tendency_1915_image001

The likely time for FOMC tightening shrank today, despite the many words saying that nothing was different.  This is the first time since the Fed started giving enhanced guidance that the time for tightening actually moved backwards (closer to the present).  Should we be surprised that long bonds fell, and equities less so?